Segment Reporting and Performance Evaluation
Medium Practice Test
Introduction to Accounting
Medium Practice Test
Click the “Check Your Answer” box below each question to reveal the correct answer and explanation.
Responsibility Accounting – Segment Reporting:
1. In a centralized organization, decisions are made by
a. department managers
b. executive management only
c. employees
d. cost center managers
Answer
B. In a centralized organization all decisions are made by top level executive management. Lower level managers are given direction and are not part of the decision-making process.
2. Which of the following is a benefit to centralization?
a. improved employee satisfaction
b. lower management is more prepared to solve problems
c. divisions have consistent goals
d. managers have the flexibility to solve problems
Answer
C. When top management makes all the decisions, consistent goals are handed down to lower level managers in divisions and departments. Lower level management must always get direction from upper level management. This often leads to lower management satisfaction.
3. A report given to the manager of an investment center should
a. report product costs only
b. report controllable costs only
c. report variable costs only
d. report allocated and direct costs
Answer
B. Reports given to any segment manager should report controllable costs only. Controllable costs are all variable and direct costs. Allocated costs are not controllable by the manager of the segment.
4. Return on investment encourages management to focus on
a. how efficiently assets are used
b. only reducing costs
c. profits in relation to sales
d. both a. and c.
Answer
D. Return on investment considers profit margin and asset turnover. This is related to how much profit is obtained from sales dollars and how efficiently assets are used.
5. Segment profit is determined
a. the same way as income for the total company
b. by including results of inter-company sales
c. without considering depreciation expense on controllable assets
d. by including allocated expenses
Answer
B. Segment profit includes all sales of the division or segment, including sales to other segments. Segment profit includes all direct expenses and does not include allocated expenses. Total company profits includes allocated expenses.
6. A manager of a profit center is accountable for
a. operating assets
b. revenues only
c. only variable costs
d. all costs and revenues
Answer
D. A profit center includes both revenues and costs. A profit center is not responsible for decisions regarding operating assets.
7. Responsibility accounting defines an investment center as one with a manager who is responsible for
a. all costs only
b. all revenues only
c. all revenues, all costs and assets
d. all revenues, direct costs and assets
Answer
D. An investment center is responsible for all revenues, direct costs, and assets. The investment center is not responsible for allocated costs.
Performance Evaluation:
1. If all else remains constant, an increase in average operating assets will
a. not change the return on investment
b. increase the return on investment
c. decrease the return on investment
d. increase profit margin
Answer
C. An increase in operating assets will give a lower asset turnover. A lower asset turnover gives a lower return on investment. A change in operating assets will not change profit margin.
2. Which performance measurement ignores the short term and emphasizes the long term?
a. residual income
b. return on investment
c. segment margin profitability
d. none of the above
Answer
D. All of the above give management an incentive to make short term performance as high as possible at the expense of long term goals. A manager may not invest in operating assets timely. This will make each of the above higher. Segment margin profitability includes the direct cost of financing traceable assets.
3. When evaluating a segment, return on investment is
a. less than return on investment for the total company
b. less informative then residual income
c. not possible to determine
d. determined based on fair market value of assets
Answer
B. Residual income shows whether the segment is meeting goals set by management. Return on investment does not indicate if management achieved the goal. The total company return will be based on total company assets and may be more or less than the segment return on investment. ROI and residual income is based on operating assets at book value.
4. If the residual income for a segment is negative, then
a. the segment’s return on investment is lower than required return
b. the segment’s return on investment is higher than required return
c. the company profitability is negative
d. none of the above
Answer
A. A negative residual income means that the actual income is lower than the required income from the use of the assets. Return on investment uses actual income earned. A segment income is not an indication of the total company profitability which will include many segments and allocated costs.
5. When a division doubles its asset turnover and all other items remain constant
a. return on investment will increase
b. return on investment will decrease
c. residual income must decrease
d. the investment in assets must increase
Answer
A. Asset turnover is a multiplier when determining return on investment. When the multiplier is higher, return on investment will be higher also. Investments in asset must decrease to get higher asset turnover. Residual income will increase if assets decrease.
6. Operating income is
a. net income less interest and taxes
b. net income plus income taxes
c. gross profit less all expenses
d. net income plus interest expense
Answer
A. Operating income is income before interest and taxes. Interest and taxes are not included in operating income, so all expenses are not deducted.
7. Residual income is
a. the same thing as return on investment just calculated differently
b. a qualitative measure of performance
c. sales divided by operating income
d. operating income less operating assets times a required rate of return
Answer
D. The formula for determining residual income is actual operating income less the minimum required income. Minimum required income is calculated by multiplying operating assets by the required rate of return.
1. Determine the missing information related to the two companies below:
| Company 1 | Company 2 | |
| Operating Income | $50,000 | $25,000 |
| Average Operating Assets | ? | $100,000 |
| Asset Turnover | ? | ? |
| Profit Margin | ? | ? |
| Return on Investment | 12% | ? |
| Revenues | $400,000 | $500,000 |
Answer
Write what you know in the formula and solve for the unknown.
Company 1
Return on Investment =
Operating Income
Average Operating Assets
$50,000
$? = 12%
$ 50,000 $400,000
$400,000 X $?
12.5 % X ? = 12%
Operating Income Sales
Sales X Average Operating Assets
“Profit Margin” “Asset Turnover”
Solve for operating assets: $50,000 / ? = 12% ? is $416,667
Asset Turnover is $400,000 / $416,667 = .96
Company 2:
Return on Investment =
Operating Income
Average Operating Assets
$25,000
$100,000 = 25%
$25,000 $500,000
$500,000 X $100,000 =
5% X 5.0 = 25%
Operating Income Sales
Sales X Average Operating Assets
“Profit Margin” “Asset Turnover”
2. The company has a minimum return on investment of 15%. Information related to the major division of the company follows:
| Division 1 | |
| Division investment | $750,000 |
| Division sales | $2,000,000 |
| Division profit | $250,000 |
| Division equity | $800,000 |
A. Compute return on investment for Division 1.
B. Compute residual income for Division 1
C. If sales increase 20%, and profit margin holds constant, what will be the return on investment for Division 1.
D. If asset turnover increases 50% because operating assets decrease, what is return on investment for Division 1?
Answer
A. Return on Investment
$250,000
$750,000 = 33.3%
The question did not ask you to show profit margin and asset turnover separately.
B. Residual Income:
| Actual Operating Income | $250,000 |
| – Required Operating Income (see below) | $112,500 |
| = Residual Income | $137,500 |
| Average Operating Assets | $750,000 |
| X Required Rate of Return | x 15% |
| = Required Operating Income | $112,500 |
C. Current situation:
Operating Income Sales
Sales X Average Operating Assets
“Profit Margin” “Asset Turnover”
$250,000 X $2,000,000
$2,000,000 $ 750,000
12.5% X 2.667 = 33.33%
If sales are up 20% and profit margin holds at 12.5%, income will also increase and the profit margin will not change.
Sales will be $2,000,000 x 1.2 = $2,400,000
Asset turnover will be $2,400,000 / $750,000 = 3.2 times
ROI is equal to 12.5% x 3.2 = 40%
D. If asset turnover increases 50%, asset turnover will be 2.667 x 1.5 = 4.0
Profit margin is not changed if only operating assets change.
Profit margin 12.5% x 4.0 = 50% ROI
3. The following relates to the company and one division:
| Division Sales | $1,000,000 |
| Variable Costs | $300,000 |
| Total Fixed Expenses | $500,000 |
| Tax Expense | $80,000 |
| Net Income | $120,000 |
| Division Operating Assets | $2,000,000 |
| Required Rate of Return | 15% |
| Corporate Expenses | $150,000 |
| Allocated Fixed Expenses | 40% of fixed expense |
A. Prepare a segment income statement for this division. Also show what is reported in the total company column.
B. Compute return on investment and residual income for the division
Answer
| A. | Division | Total Company |
| Sales | $1,000,000 | |
| Variable Costs | $300,000 | |
| Contribution Margin | $700,000 | |
| Fixed Expense | $300,000 | |
| Segment Income | $400,000 | |
| Corporate Expense | $150,000 | |
| Allocated Fixed Expense | $200,000 | |
| Operating Income | $200,000 | |
| Tax Expense | $80,000 | |
| Net Income | $120,000 |
Variable costs are always direct.
Division fixed expense:
$500,000 x 60% = 300,000, 40% is allocated = $200,000
You do not know the sales, variable costs, contribution margin or direct fixed expenses for the total company because you don’t have information on other divisions. Leave this blank.
Allocated and Corporate expenses are shown only in the total company column.
Tax expense and net income are shown only in the total column.
B. ROI = $400,000 = 20%
$2,000,000
Segment Income / Operating Assets
Residual Income:
| Actual Operating Income | $400,000 |
| – Required Operating Income (see below) | $300,000 |
| = Residual Income | $100,000 |
| Average Operating Assets | $2,000,000 |
| X Required Rate of Return | x 15% |
| = Required Operating Income | $00,000 |
4. A company sells two products, product A and product B. Total sales were $1,500,000 for the month. Contribution margin ratio was 35% for both products. Total fixed expenses were $565,000. Sales were $1,000,000 for product A. Traceable fixed costs were $100,000 for product A and $120,000 for product B. Common fixed expenses of $220,000 are allocated 40% to product A and 60% to product B. Corporate fixed expenses of $125,000 are shared equally.
Prepare a segment income statement for the company.
Answer
| Product A | Product B | Total | |
| Sales | $1,000,000 | $500,000 | $1,500,000 |
| Variable Costs | $650,000 | $325,000 | $975,000 |
| Contribution Margin | $350,000 | $175,000 | $525,000 |
| Fixed Expense | $100,000 | $120,000 | $220,000 |
| Segment Income | $250,000 | $55,000 | $305,000 |
| Corporate Expenses | $125,000 | ||
| Common Fixed Expense | $220,000 | ||
| Operating Income | ($40,000) |
Product B sales are $1,500,000 total less $1,000,000 Product A = $500,000
Contribution margin is 35% of sales, variable costs are 65% of sales
Traceable is reported in the segment columns
Corporate and common are only reported in the total company column.