Exercise 10-1 (10 minutes)

1. Net operating income

Margin =
Sales
$600,000
= = 8%
$7,500,000

2. Sales
Turnover =
Average operating assets
$7,500,000
= = 1.5
$5,000,000

3. ROI = Margin × Turnover

= 8% × 1.5 = 12%

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10 Introduction to Managerial Accounting, 9th Edition
Exercise 10-2 (10 minutes)

Average operating assets ...................... $2,800,000

Net operating income ........................... $ 600,000
Minimum required return:
18% × $2,800,000 ............................ 504,000
Residual income................................... $ 96,000

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Solutions Manual, Chapter 10 11
Exercise 10-3 (20 minutes)

1. Throughput time = Process time + Inspection time + Move time +

Queue time
= 2.7 days + 0.3 days + 1.0 days + 5.0 days
= 9.0 days

2. Only process time is value-added time; therefore, the manufacturing

cycle efficiency (MCE) is:
Value-added time 2.7 days
MCE = = = 0.30
Throughput time 9.0 days

3. If the MCE is 30%, then 30% of the throughput time was spent in
value-added activities. Consequently, the other 70% of the throughput
time was spent in non-value-added activities.

4. Delivery cycle time = Wait time + Throughput time

= 14.0 days + 9.0 days
= 23.0 days

5. If all queue time is eliminated, then the throughput time drops to only 4
days (2.7 + 0.3 + 1.0). The MCE becomes:
Value-added time 2.7 days
MCE = = = 0.675
Throughput time 4.0 days
Thus, the MCE increases to 67.5%. This exercise shows quite
dramatically how lean production can improve the efficiency of
operations and reduce throughput time.

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12 Introduction to Managerial Accounting, 9th Edition
Exercise 10-4 (45 minutes)
1. Students’ answers may differ in some details from this solution.

Financial
Weekly profit +

Weekly sales +

Customer

Customer Customer
satisfaction with + satisfaction with +
service menu choices

Internal
Business Average time
Dining area
Processes cleanliness + to prepare an –
order

Average time Number of

to take an – menu items +
order

Learning
and Percentage Percentage
Growth of dining of kitchen
room staff staff
+ +
completing completing
hospitality cooking
course course

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Solutions Manual, Chapter 10 13
Exercise 10-4 (continued)
2. The hypotheses underlying the balanced scorecard are indicated by the
arrows in the diagram. Reading from the bottom of the balanced
scorecard, the hypotheses are:
o If the percentage of dining room staff that complete the basic
hospitality course increases, then the average time to take an order
will decrease.
o If the percentage of dining room staff that complete the basic
hospitality course increases, then dining room cleanliness will
improve.
o If the percentage of kitchen staff that complete the basic cooking
course increases, then the average time to prepare an order will
decrease.
o If the percentage of kitchen staff that complete the basic cooking
course increases, then the number of menu items will increase.
o If the dining room cleanliness improves, then customer satisfaction
with service will increase.
o If the average time to take an order decreases, then customer
satisfaction with service will increase.
o If the average time to prepare an order decreases, then customer
satisfaction with service will increase.
o If the number of menu items increases, then customer satisfaction
with menu choices will increase.
o If customer satisfaction with service increases, weekly sales will
increase.
o If customer satisfaction with menu choices increases, weekly sales
will increase.
o If sales increase, weekly profits for the Lodge will increase.
Each of these hypotheses can be questioned. For example, the items
added to the menu may not appeal to customers. So even if the number
of menu items increases, customer satisfaction with the menu choices
may not increase. The fact that each of the hypotheses can be
questioned does not, however, invalidate the balanced scorecard. If the
scorecard is used correctly, management will be able to identify which,
if any, of the hypotheses are incorrect. [See below.]

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14 Introduction to Managerial Accounting, 9th Edition
Exercise 10-4 (continued)
3. Management will be able to tell if a hypothesis is false if an
improvement in a performance measure at the bottom of an arrow does
not, in fact, lead to improvement in the performance measure at the tip
of the arrow. For example, if the number of menu items is increased,
but customer satisfaction with the menu choices does not increase,
management will immediately know that something was wrong with that
particular hypothesis.

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Solutions Manual, Chapter 10 15
Exercise 10-5 (15 minutes)

Division
Alpha Bravo Charlie
Sales (a) ............................ $4,000,000 $11,500,000 * $3,000,000
Net operating income (b) ..... $160,000 $920,000 * $210,000 *
Average operating assets
(c) .................................. $800,000 * $4,600,000 $1,500,000
Margin (b) ÷ (a) ................. 4%* 8% 7%*
Turnover (a) ÷ (c) .............. 5* 2.5 2
Return on investment (ROI) . 20% 20%* 14%*
Note that Divisions Alpha and Bravo apparently have different strategies to
obtain the same 20% return. Division Alpha has a low margin and a high
turnover, whereas Division Bravo has just the opposite.
*Given.

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16 Introduction to Managerial Accounting, 9th Edition
Exercise 10-6 (20 minutes)
1. ROI computations:
Net operating income Sales
ROI = ×
Sales Average operating assets
Osaka Division:
$210,000 $3,000,000
ROI = × = 7% × 3 = 21%
$3,000,000 $1,000,000
Yokohama Division:
$720,000 $9,000,000
ROI = × = 8% × 2.25 = 18%
$9,000,000 $4,000,000

2. Osaka Yokohama
Average operating assets (a) ..................... $1,000,000 $4,000,000
Net operating income ................................ $210,000 $720,000
Minimum required return on average
operating assets: 15% × (a) ................... 150,000 600,000
Residual income ....................................... $ 60,000 $120,000

3. No, the Yokohama Division is simply larger than the Osaka Division and
for this reason one would expect that it would have a greater amount of
residual income. Residual income can’t be used to compare the
performance of divisions of different sizes. Larger divisions will almost
always look better. In fact, in the case above, the Yokohama Division
does not appear to be as well managed as the Osaka Division. Note
from Part (1) that Yokohama has only an 18% ROI as compared to 21%
for Osaka.

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Solutions Manual, Chapter 10 17
Exercise 10-7 (45 minutes)
1. Students’ answers may differ in some details from this solution.

Financial
Profit margin +

Revenue per employee + Sales +

Customer
Number of new
+
customers acquired

Customer Customer Customer

satisfaction with + satisfaction with + satisfaction with +
effectiveness efficiency service quality

Internal Business
Average number of
Processes –
errors per tax return

Ratio of billable hours Average time needed to

+ –
to total hours prepare a return

Learning
And Growth

Percentage of job Employee morale

+ +
offers accepted

Amount of compensation paid Average number of

+ –
above industry average years to be promoted

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18 Introduction to Managerial Accounting, 9th Edition
Exercise 10-7 (continued)
2. The hypotheses underlying the balanced scorecard are indicated by the
arrows in the diagram. Reading from the bottom of the balanced
scorecard, the hypotheses are:
° If the amount of compensation paid above the industry average
increases, then the percentage of job offers accepted and the level of
employee morale will increase.
° If the average number of years to be promoted decreases, then the
percentage of job offers accepted and the level of employee morale
will increase.
° If the percentage of job offers accepted increases, then the ratio of
billable hours to total hours should increase while the average
number of errors per tax return and the average time needed to
prepare a return should decrease.
° If employee morale increases, then the ratio of billable hours to total
hours should increase while the average number of errors per tax
return and the average time needed to prepare a return should
decrease.
° If employee morale increases, then the customer satisfaction with
service quality should increase.
° If the ratio of billable hours to total hours increases, then the revenue
per employee should increase.
° If the average number of errors per tax return decreases, then the
customer satisfaction with effectiveness should increase.
° If the average time needed to prepare a return decreases, then the
customer satisfaction with efficiency should increase.
° If the customer satisfaction with effectiveness, efficiency, and service
quality increases, then the number of new customers acquired should
increase.
° If the number of new customers acquired increases, then sales
should increase.
° If revenue per employee and sales increase, then the profit margin
should increase.

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Solutions Manual, Chapter 10 19
Exercise 10-7 (continued)
Each of these hypotheses can be questioned. For example, Ariel’s
customers may define effectiveness as minimizing their tax liability
which is not necessarily the same as minimizing the number of errors in
a tax return. If some of Ariel’s customers became aware that Ariel
overlooked legal tax minimizing opportunities, it is likely that the
“customer satisfaction with effectiveness” measure would decline. This
decline would probably puzzle Ariel because, although the firm prepared
what it believed to be error-free returns, it overlooked opportunities to
minimize customers’ taxes. In this example, Ariel’s internal business
process measure of the average number of errors per tax return does
not fully capture the factors that drive the customer satisfaction. The
fact that each of the hypotheses mentioned above can be questioned
does not invalidate the balanced scorecard. If the scorecard is used
correctly, management will be able to identify which, if any, of the
hypotheses are invalid and then modify the balanced scorecard
accordingly.

3. The performance measure “total dollar amount of tax refunds

generated” would motivate Ariel’s employees to aggressively search for
tax minimization opportunities for its clients. However, employees may
be too aggressive and recommend questionable or illegal tax practices
to clients. This undesirable behavior could generate unfavorable
publicity and lead to major problems for the company as well as its
customers. Overall, it would probably be unwise to use this performance
measure in Ariel’s scorecard.
However, if Ariel wanted to create a scorecard measure to capture this
aspect of its client service responsibilities, it may make sense to focus
the performance measure on its training process. Properly trained
employees are more likely to recognize viable tax minimization
opportunities.

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20 Introduction to Managerial Accounting, 9th Edition
Exercise 10-7 (continued)
4. Each office’s individual performance should be based on the scorecard
measures only if the measures are controllable by those employed at
the branch offices. In other words, it would not make sense to attempt
to hold branch office managers responsible for measures such as the
percent of job offers accepted or the amount of compensation paid
above industry average. Recruiting and compensation decisions are not
typically made at the branch offices. On the other hand, it would make
sense to measure the branch offices with respect to internal business
process, customer, and financial performance. Gathering this type of
data would be useful for evaluating the performance of employees at
each office.

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Solutions Manual, Chapter 10 21
Exercise 10-8 (15 minutes)
1. ROI computations:
Net operating income Sales
ROI = ×
Sales Average operating assets
Queensland Division:
$360,000 $4,000,000
ROI = × = 9% × 2 = 18%
$4,000,000 $2,000,000
New South Wales Division:

$420,000 $7,000,000
ROI = × = 6% × 3.5 = 21%
$7,000,000 $2,000,000

2. The manager of the New South Wales Division seems to be doing the
better job. Although the New South Wales Division’s margin is three
percentage points lower than the margin of the Queensland Division, its
turnover is higher (a turnover of 3.5, as compared to a turnover of 2.0
for the Queensland Division). The greater turnover more than offsets
the lower margin, resulting in a 21% ROI, as compared to an 18% ROI
for the other division.
Notice that if you look at margin alone, then the Queensland Division
appears to be the stronger division. This fact underscores the
importance of looking at turnover as well as at margin in evaluating
performance in an investment center.

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22 Introduction to Managerial Accounting, 9th Edition
Exercise 10-9 (15 minutes)

Company A Company B Company C

Sales (a) .................................. $9,000,000 * $7,000,000 * $4,500,000 *
Net operating income (b)........... $540,000 $280,000 * $360,000
Average operating assets (c) ...... $3,000,000 * $2,000,000 $1,800,000 *
Return on investment (ROI) (b)
÷ (c) ..................................... 18%* 14%* 20%
Minimum required rate of return:
Percentage (d) ....................... 16%* 16% 15%*
Dollar amount (c) × (d) .......... $480,000 $320,000 * $270,000
Residual income (b) – [(c) × *
(d)]....................................... $60,000 $(40,000) $90,000
*Given.

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Solutions Manual, Chapter 10 23
Exercise 10-10 (20 minutes)

1. (b) (c)
Net Average
(a) Operating Operating ROI
Sales Income* Assets (b) ÷ (c)
$2,500,000 $475,000 $1,000,000 47.5%
$2,600,000 $500,000 $1,000,000 50.0%
$2,700,000 $525,000 $1,000,000 52.5%
$2,800,000 $550,000 $1,000,000 55.0%
$2,900,000 $575,000 $1,000,000 57.5%
$3,000,000 $600,000 $1,000,000 60.0%
*Sales × Contribution Margin Ratio of 25% – Fixed Expenses of
$150,000

2. The ROI increases by 2.5% for each $100,000 increase in sales. This
happens because each $100,000 increase in sales brings in an additional
profit of $25,000. When this additional profit is divided by the average
operating assets of $1,000,000, the result is an increase in the
company’s ROI of 2.5%.
Increase in sales .................................................. $100,000 (a)
Contribution margin ratio ...................................... 25% (b)
Increase in contribution margin and net operating
income (a) × (b) ................................................ $25,000 (c)
Average operating assets ...................................... $1,000,000 (d)
Increase in return on investment (c) ÷ (d) .............. 2.5%

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24 Introduction to Managerial Accounting, 9th Edition
Exercise 10-11 (30 minutes)

1. Net operating income

Margin =
Sales
$70,000
= = 5%
$1,400,000
Sales
Turnover =
Average operating assets
$1,400,000
= =4
$350,000
ROI = Margin × Turnover
= 5% × 4 = 20%

2. Net operating income

Margin =
Sales
$70,000 + $18,200
=
$1,400,000 + $70,000
$88,200
= = 6%
$1,470,000
Sales
Turnover =
Average operating assets
$1,400,000 + $70,000
=
$350,000
$1,470,000
= = 4.2
$350,000
ROI = Margin × Turnover
= 6% × 4.2 = 25.2%

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Solutions Manual, Chapter 10 25
Exercise 10-11 (continued)

3. Net operating income

Margin =
Sales
$70,000 + $14,000
=
$1,400,000
$84,000
= = 6%
$1,400,000
Sales
Turnover =
Average operating assets
$1,400,000
= =4
$350,000
ROI = Margin × Turnover
= 6% × 4 = 24%

4. Net operating income

Margin =
Sales
$70,000
= = 5%
$1,400,000
Sales
Turnover =
Average operating assets
$1,400,000
=
$350,000 - $70,000
$1,400,000
= =5
$280,000
ROI = Margin × Turnover
= 5% × 5 = 25%

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26 Introduction to Managerial Accounting, 9th Edition
Exercise 10-12 (30 minutes)
1. ROI computations:
Net operating income Sales
ROI = ×
Sales Average operating assets
Division A:
$600,000 $12,000,000
ROI = × = 5% × 4 = 20%
$12,000,000 $3,000,000
Division B:
$560,000 $14,000,000
ROI = × = 4% × 2 = 8%
$14,000,000 $7,000,000
Division C:
$800,000 $25,000,000
ROI = × = 3.2% × 5 = 16%
$25,000,000 $5,000,000

2. Division A Division B Division C

Average operating assets ......... $3,000,000 $7,000,000 $5,000,000
Required rate of return ............ × 14% × 10% × 16%
Minimum required return ......... $ 420,000 $ 700,000 $ 800,000
Actual operating income .......... $ 600,000 $ 560,000 $ 800,000
Minimum required return
(above) ............................... 420,000 700,000 800,000
Residual income ...................... $ 180,000 $(140,000) $ 0

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Solutions Manual, Chapter 10 27
Exercise 10-12 (continued)
3. a. and b.
Division A Division B Division C
Return on investment (ROI) .......... 20% 8% 16%
Therefore, if the division is
presented with an investment
opportunity yielding 15%, it
probably would .......................... Reject Accept Reject
Minimum required return for
computing residual income ......... 14% 10% 16%
Therefore, if the division is
presented with an investment
opportunity yielding 15%, it
probably would .......................... Accept Accept Reject

If performance is being measured by ROI, both Division A and Division C

probably would reject the 15% investment opportunity. These divisions’
ROIs currently exceed 15%; accepting a new investment with a 15%
rate of return would reduce their overall ROIs. Division B probably would
accept the 15% investment opportunity because accepting it would
increase the division’s overall rate of return.
If performance is measured by residual income, both Division A and
Division B probably would accept the 15% investment opportunity. The
15% rate of return promised by the new investment is greater than their
required rates of return of 14% and 10%, respectively, and would
therefore add to the total amount of their residual income. Division C
would reject the opportunity because the 15% return on the new
investment is less than its 16% required rate of return.

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28 Introduction to Managerial Accounting, 9th Edition
Exercise 10-13 (15 minutes)

1. Net operating income

Margin =
Sales
$150,000
= = 5%
$3,000,000
Sales
Turnover =
Average operating assets
$3,000,000
= =4
$750,000
ROI = Margin × Turnover
= 5% × 4 = 20%

2. Net operating income

Margin =
Sales
$150,000(1.00 + 2.00)
=
$3,000,000(1.00 + 0.50)
$450,000
= = 10%
$4,500,000
Sales
Turnover =
Average operating assets
$3,000,000(1.00 + 0.50)
=
$750,000
$4,500,000
= =6
$750,000
ROI = Margin × Turnover
= 10% × 6 = 60%

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Solutions Manual, Chapter 10 29
Exercise 10-13 (continued)

3. Net operating income

Margin =
Sales
$150,000 + $200,000
=
$3,000,000 + $1,000,000
$350,000
= = 8.75%
$4,000,000
Sales
Turnover =
Average operating assets
$3,000,000 + $1,000,000
=
$750,000 + $250,000
$4,000,000
= =4
$1,000,000
ROI = Margin × Turnover
= 8.75% × 4 = 35%

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30 Introduction to Managerial Accounting, 9th Edition
Problem 10-14 (30 minutes)
1. a., b., and c.
Month
1 2 3 4
Throughput time—days:
Process time (x) ................................ 2.1 2.0 1.9 1.8
Inspection time ................................. 0.6 0.7 0.7 0.6
Move time ........................................ 0.4 0.3 0.4 0.4
Queue time ...................................... 4.3 5.0 5.8 6.7
Total throughput time (y) ................... 7.4 8.0 8.8 9.5

Delivery cycle time—days:

Wait time from order to start of
production ..................................... 16.0 17.5 19.0 20.5
Throughput time ............................... 7.4 8.0 8.8 9.5
Total delivery cycle time ..................... 23.4 25.5 27.8 30.0

Manufacturing cycle efficiency (MCE):

Process time (a) ................................ 2.1 2.0 1.9 1.8
Throughout time (b) .......................... 7.4 8.0 8.8 9.5
MCE (a) ÷ (b) ................................... 28.4% 25.0% 21.6% 18.9%

2. All of the performance measures display unfavorable trends. Throughput

time per unit is increasing—largely because of an increase in queue
time. Manufacturing cycle efficiency is declining and delivery cycle time
is increasing. In addition, the percentage of on-time deliveries has
dropped.

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Solutions Manual, Chapter 10 31
Problem 10-14 (continued)
3. a. and b.
Month
5 6
Throughput time—days:
Process time (x) ............................................ 1.8 1.8
Inspection time ............................................. 0.6 0.0
Move time .................................................... 0.4 0.4
Queue time .................................................. 0.0 0.0
Total throughput time (y) ............................... 2.8 2.2
Manufacturing cycle efficiency (MCE):
Process time (x) ÷ Throughput time (y) .......... 64.3% 81.8%

As a company reduces non-value-added activities, the manufacturing

cycle efficiency increases rapidly. The goal, of course, is to have an
efficiency of 100%. This will be achieved when all non-value-added
activities have been eliminated and process time is equal to throughput
time.

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32 Introduction to Managerial Accounting, 9th Edition
Problem 10-15 (20 minutes)
1. Operating assets do not include investments in other companies or in
undeveloped land.
Beginning Ending
Balances Balances
Cash................................................... $ 140,000 $ 120,000
Accounts receivable ............................. 450,000 530,000
Inventory ............................................ 320,000 380,000
Plant and equipment (net) .................... 680,000 620,000
Total operating assets .......................... $1,590,000 $1,650,000

$1,650,000 + $1,590,000
Average operating assets = = $1,620,000
2

2. The margin, turnover, and return on investment (ROI) are calculated as

follows:
Net operating income
Margin =
Sales
$405,000
= = 10%
$4,050,000
Sales
Turnover=
Average operating assets
$4,050,000
= = 2.5
$1,620,000
ROI = Margin × Turnover
= 10% × 2.5 = 25%

3. The residual income is calculated as follows:

Net operating income......................................... $405,000

Minimum required return (15% × $1,620,000) ..... 243,000
Residual income ................................................ $162,000
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Solutions Manual, Chapter 10 33