Apply Responsibility Accounting
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CPA Business Analysis and Reporting (BAR) › Apply Responsibility Accounting
Thornwood Division is a cost center. Budgeted controllable costs total $450,000 (direct materials $180,000, direct labor $120,000, variable overhead $60,000, fixed overhead $90,000). Actual controllable costs were: direct materials $188,000, direct labor $116,000, variable overhead $65,000, fixed overhead $88,000. Allocated corporate overhead of $45,000 is identical in budget and actual. What is the controllable cost variance for performance evaluation?
$2,000 favorable
$7,000 unfavorable
$7,000 favorable
$52,000 unfavorable
Explanation
Controllable cost variance excludes allocated corporate overhead, which is outside the manager's control. Actual controllable = $188,000 + $116,000 + $65,000 + $88,000 = $457,000. Budgeted controllable = $450,000. Variance = $457,000 - $450,000 = $7,000 unfavorable. Option A applies the correct amount but labels the direction incorrectly. Option C includes the allocated overhead in the variance calculation. Option D results from an arithmetic error.
Thornwood Division reports actual controllable costs of $457,000 versus a budget of $450,000, plus allocated corporate overhead of $45,000 (equal in both actual and budget). What is the total cost budget variance including all line items?
$52,000 unfavorable
$0
$7,000 unfavorable
$12,000 unfavorable
Explanation
Total actual = $457,000 + $45,000 = $502,000. Total budget = $450,000 + $45,000 = $495,000. Total variance = $502,000 - $495,000 = $7,000 unfavorable. Because allocated overhead is identical in actual and budget, it does not change the variance amount - only the controllable costs drive the difference. Option A incorrectly includes allocated overhead in the variance. Option B treats allocated overhead as eliminating all variance. Option D applies an incorrect budget amount.
Westbrook Division is an investment center reporting net operating income of $480,000 and average operating assets of $3,200,000. What is the division's return on investment (ROI)?
6.67%
12.5%
15.0%
20.0%
Explanation
ROI = Net operating income / Average operating assets = $480,000 / $3,200,000 = 15.0%. Option A inverts the formula. Option B divides by $2,400,000 instead of $3,200,000. Option C divides by $3,840,000.
Westbrook Division reports net operating income of $480,000, average operating assets of $3,200,000, and a required rate of return of 10%. What is the division's residual income?
$800,000
$320,000
$160,000
$640,000
Explanation
Residual income = NOI - (Required rate x Operating assets) = $480,000 - (10% x $3,200,000) = $480,000 - $320,000 = $160,000. Option B adds NOI and the capital charge instead of subtracting. Option C reports only the capital charge ($320,000). Option D doubles the residual income through an arithmetic error.
Division B purchases a component and processes it further. Division B's selling price for the finished product is $80 per unit and its additional variable processing costs after receiving the component are $15 per unit. What is the maximum transfer price Division B would be willing to pay for the component?
$65 per unit
$50 per unit
$80 per unit
$55 per unit
Explanation
Maximum transfer price = Final selling price - Division B's additional variable processing costs = $80 - $15 = $65. Division B will not pay more than $65 because at any higher price it would be unprofitable for Division B to accept the transfer. Option B is Division B's selling price, which ignores its own processing costs. Option C subtracts both the additional variable costs and an assumed fixed amount, overstating deductions. Option D represents the external market price for the component, not Division B's maximum willingness to pay.
Clearview Corp. has two investment centers: Division X (NOI $240,000, operating assets $1,500,000) and Division Y (NOI $180,000, operating assets $900,000). What is the ROI for Division Y?
15.0%
16.0%
20.0%
25.0%
Explanation
Division Y ROI = $180,000 / $900,000 = 20.0%. Option A is Division X's ROI ($240,000 / $1,500,000 = 16.0%). Option C applies an incorrect divisor of $720,000. Option D applies an incorrect divisor of $1,200,000.
Clearview Division Y reports NOI of $180,000, operating assets of $900,000, and a required rate of return of 12%. What is Division Y's residual income?
$108,000
$36,000
$180,000
$72,000
Explanation
Residual income = NOI - (Required rate x Operating assets) = $180,000 - (12% x $900,000) = $180,000 - $108,000 = $72,000. Option A is the capital charge only ($108,000), not residual income. Option B is NOI before deducting the capital charge. Option D applies an incorrect required rate or operating asset base.
Clearview Division X reports NOI of $240,000, operating assets of $1,500,000, and a required rate of return of 12%. What is Division X's residual income?
$180,000
$72,000
$60,000
$240,000
Explanation
Residual income = NOI - (Required rate x Operating assets) = $240,000 - (12% x $1,500,000) = $240,000 - $180,000 = $60,000. Notably, Division X generates more absolute NOI than Division Y ($240,000 vs. $180,000) yet has lower ROI (16% vs. 20%) and lower residual income ($60,000 vs. $72,000) because its larger asset base raises the capital charge and dilutes the return rate. Option A is NOI before the capital charge. Option B is the capital charge only. Option C is Division Y's residual income, not Division X's.
Ridgecrest Division has a current ROI of 18%. A new investment opportunity costs $500,000 and is expected to generate annual NOI of $75,000 (ROI of 15%). The company's required rate of return is 12%. Based on ROI analysis and residual income analysis respectively, what is the correct recommendation?
ROI says accept; residual income says reject
ROI says reject; residual income says reject
ROI says accept; residual income says accept
ROI says reject; residual income says accept
Explanation
ROI analysis: the project's ROI (15%) is below the division's current ROI (18%), so accepting it would lower the division's average ROI - creating incentive to reject. Residual income analysis: RI = $75,000 - (12% x $500,000) = $75,000 - $60,000 = $15,000 positive. The project earns above the cost of capital and increases total residual income - RI says accept. This conflict illustrates a key limitation of ROI: it can motivate managers to reject value-creating investments that would dilute an already-high ROI. Options A and D misstate at least one measure. Option C reverses the conclusions.
A profit center manager is evaluated on profit before allocated corporate overhead. The manager's reported profit has improved each year for three years, while the company's total profitability has declined over the same period. Which concern does this raise?
The profit center manager is underperforming because total company profit declined
The company should replace profit center evaluation with cost center evaluation to better align incentives
The profit center may be optimizing its local performance in ways that impose costs on shared services or other divisions, creating improvement in the unit's reported results without improving total company value
The evaluation metric is flawed because excluding overhead allocation distorts all performance measures
Explanation
When a profit center improves locally while total company performance declines, a common explanation is suboptimization - the division is making decisions that benefit its own reported profit at the expense of other units or shared resources. For example, the division may delay payments to shared service groups, negotiate aggressively on internal prices, or underprice sales to related divisions in ways that shift costs or reduce revenues elsewhere. Option A incorrectly attributes the company-level decline to this manager. Option B overstates the flaw; pre-allocation evaluation is a valid and common approach for assessing controllable performance. Option D recommends a structural change that is not supported by the analysis.