Problem I

The following selected data relate to the Idaho Division of Far West Enterprises (FWE):

Sales revenue P4,580,000

Uncontrollable fixed costs traceable to the division 1,360,000
Allocated corporate overhead 590,000
Controllable fixed costs traceable to the division 1,120,000
Variable costs 40%

Required:
A. Compute the following for the Idaho Division:
1. Segment contribution margin.
2. Controllable profit margin.
3. Segment profit margin.

B. Which of the three preceding measures should be used when evaluating the Idaho Division as an
investment of FWE's resources? Why?

C. Assume that management made the decision to prepare a segmented income statement that
reflected Idaho's five operating departments. Would all P1,120,000 of the controllable fixed costs
be easily traced to the departments? Briefly explain.

D. Which of the five-dollar amounts presented in the body of the problem would be used in computing
the income before taxes of Far West Enterprises?

Answer
A. 1. Segment contribution margin: P4,580,000 - (P4,580,000  40%) = P2,748,000
2. Controllable profit margin: P2,748,000 - P1,120,000 = P1,628,000
3. Segment profit margin: P1,628,000 - P1,360,000 = P268,000

B. Segment profit margin—This measure considers all costs of the division whether controllable
or not. The company will have to judge whether the segment profit margin, even though it is
not totally controllable by the division's management, is an adequate return on the assets (and
effort) employed.

C. The P1,120,000 amount is easily traceable to the Idaho Division but not necessarily to the
division's individual, smaller departments. Some of the costs might be traceable to these
smaller units; some not. Costs that are not traceable are not allocated in an effort to avoid
arbitrary results.

D. All five amounts.

Problem II
Fog City Retail operates a retail store in Phoenix, Las Vegas, and Portland. The following information
relates to the Phoenix facility:

The store sold 65,000 units at P18.00 each, after having purchased the units from various suppliers for
P12.50. Phoenix salespeople are paid a 5% commission based on gross sales dollars.

 Phoenix's sales manager oversees the placement of local advertising contracts, which totaled
P54,000 for the year. Local property taxes amounted to P14,500.
 The sales manager's P65,000 salary is set by Phoenix's store manager. In contrast, the store
manager's P134,000 salary is determined by Fog City's vice president.
 Phoenix incurred P6,800 of other noncontrollable costs.
 Nontraceable (common) corporate overhead totaled P68,000.

Fog City's corporate headquarters is located in Portland, and the company uses responsibility
accounting to evaluate performance.

Required:
Prepare a segmented income statement for the Phoenix store, being sure to disclose the segment
contribution margin, the segment controllable profit margin, and segment profit margin.

Answer

Sales (65,000 units x P18.00 P1,170,000

Less: Variable costs
Cost of goods sold (65,000 units x P12.50) P812,500
Sales commissions (1,170,000 x 5%) 58,500 871,000
Segment contribution margin P 299,000
Less: Traceable, controllable fixed costs
Local advertising P54,000
Sales Manager’s salary 65,000 119,000
Controllable profit margin P 180,000
Less: Traceable, uncontrollable fixed costs
Local property taxes P 14,500
Store manager’s salary 134,000
Others 6,800 155,300
Segment profit margin P 24,700

Feedback: The nontraceable costs are ignored.

Problem III
Countywide Cable Services, Inc. is organized with three segments: Metro, Suburban, and Outlying.
Data for these segments for the year just ended follow:

Metro Suburban Outlying

Service revenue P1,000,000 P800,000 P400,000
Variable expenses 200,000 150,000 100,000
Controllable fixed expenses 400,000 320,000 150,000
Fixed expenses controllable by others 230,000 200,000 90,000

In addition to the expenses listed above, the company has P95,000 of common fixed expenses. Income
tax expense for the year is P145,000.

Required: Prepare a segmented income statement for Countrywide Cable Services, Inc. Use the
contribution margin format

1. SEGMENTED INCOME STATEMENTS: COUNTYWIDE CABLE SERVICES, INC.

Countywide Segments of Company

Cable
Services Metro Suburban Outlying
Service revenue ...................................... P2,200,000 P1,000,000 P 800,000 P 400,000
Variable expenses ................................... 450,000 200,000 150,000 100,000
Segment contribution margin P1,750,000 P 800,000 P 650,000 P 300,000
Less: Fixed expenses
controllable by segment
manager ............................................... 870,000 400,000 320,000 150,000
Profit margin controllable by
segment manager................................ P 880,000 P 400,000 P330,000 P 150,000
Less: Fixed expenses,
traceable to segment, but
controllable by others ......................... 520,000 230,000 200,000 90,000
Profit margin traceable to
segment................................................ P 360,000 P 170,000 P130,000 P 60,000

Less: Common fixed expenses 95,000

Income before taxes ............................... P 265,000
Less: Income tax expense ..................... 145,000
Net income............................................... P 120,000
Problem IV
The following data pertain to the Oliver Division of Kemper Company:

Divisional contribution margin P700,000

Profit margin controllable by the divisional manager 320,000
Profit margin traceable to the division 294,400
Average asset investment 1,280,00

The company uses responsibility accounting concepts when evaluating performance; Oliver's division
manager is contemplating the following three investments. He can invest up to P400,000.

No. 1 No. 2 No. 3

Cost P250,000 P300,000 P400,000
Expected income 50,000 54,000 96,000

Required:
A. Calculate the ROIs of the three investments.
B. What is the division manager's current ROI, computed by using responsibility accounting
concepts?
C. Which of the three investments would be selected if the manager’s focus is on Oliver’s
divisional performance, as judged by ROI? Why?
D. If Kemper has an imputed interest charge of 22%, compute the residual income of investment
no. 3. If Oliver's Division manager is evaluated by residual income, is this investment attractive
from Oliver's perspective? From Kemper's perspective? Why?

Answers:
A. No. 1: P50,000  P250,000 = 20%
No. 2: P54,000  P300,000 = 18%
No. 3: P96,000  P400,000 = 24%

B. Controllable profit margin (P320,000)  asset investment (P1,280,000) = 25%

C. None, as all will lower the current ROI.

D. Residual income: P96,000 - (P400,000  22%) = P8,000

This investment is attractive from both Oliver and Kemper's perspectives. The positive residual
income indicates that the investment income covers the imputed interest charge.
Problem V
Jasper Corporation is organized in three separate divisions. The three divisional managers are evaluated at year-
end, and bonuses are awarded based on ROI. Last year, the overall company produced a 12% return on its
investment. Managers of Jasper's Iowa Division recently studied an investment opportunity that would assist in
the division's future growth. Relevant data follow.

Iowa Division Investment Opportunity

Income P12,800,000 P 4,200,000
Invested capital 80,000,000 30,000,000

Required:
A. Compute the current ROI of the Iowa Division and the division's ROI if the investment opportunity is
pursued.
B. What is the likely reaction of divisional management toward the acquisition? Why?
C. What is the likely reaction of Jasper's corporate management toward the investment? Why?
D. Assume that Jasper uses residual income to evaluate performance and desires an 11% minimum return
on invested capital. Compute the current residual income of the Iowa Division and the division's
residual income if the investment is made. Will divisional management likely change its attitude toward
the acquisition? Why?

Answers
A. ROI = Income  invested capital
Current: P12,800,000  P80,000,000 = 16%
If investment is made: (P12,800,000 + P4,200,000)  (P80,000,000 + P30,000,000) = 15.45%

B. Divisional management will likely be against the acquisition because ROI will be lowered from 16% to
15.45%. Since bonuses are awarded on the basis of ROI, the acquisition will result in less compensation.
However, before a final decision is made, additional insights are needed concerning how the investment
will assist in future growth and in what magnitude.

C. An examination of the investment reveals a 14% ROI (P4,200,000  P30,000,000). Corporate

management would probably favor the acquisition. Jasper has been earning a 12% return, and the
investment will help the organization as a whole.

D.
Current residual income of Iowa Division
Divisional income P12,800,000
Less: Imputed interest charge (P80,000,000 x 11%) 8,800,000
Residual income P4,000,000

Residual income if investment is made:

Divisional income (P12,800,000/P4,200,000) P17,000,000
Less: Imputed interest charge
(P80,000,000 + P30,000,000) x 11%) 12,100,000
Residual income P4,900,00

Yes, divisional managers will likely change their attitude, particularly if they are team players. Residual
income will increase by P900,000 (P4,900,000 - P4,000,000) from the acquisition. The RI measure
focuses on the corporate perspective, not the divisional perspective, by integrating the firm's required
return on invested capital.
Problem VI
The following data pertain to Darrell Industries:

Interest rate on debt capital: 9%

Cost of equity capital: 12%
Before-tax operating income: P 35 million
Market value of debt capital: P 60 million
Market value of equity capital: P120 million
Total assets: P150 million
Income tax rate: 30%
Total current liabilities: P 15 million

Required:
A. Compute Darrell's weighted-average cost of capital.
B. Compute Darrell's economic value added.
C. Briefly explain the meaning of economic value added.

Answer:
A. WACC = [(9%  70%)  P60,000,000) + (12%  P120,000,000)]  (P60,000,000 +
P120,000,000)
WACC = (P3,780,000 + P14,400,000)  P180,000,000
WACC = 10.1%

B. EVA = (P35,000,000  70%) - [(P150,000,000 - P15,000,000)  10.1%]

EVA = P24,500,000 - P13,635,000
EVA = P10,865,000

C. Economic value added (EVA) measures the amount of shareholder wealth being created from a
company's activities and operations. To expand, debt and equity capital are used to fund
activities—activities that are hopefully conducted in a profitable manner. Profits cover the cost
of the related capital, with shareholders benefiting from the residual (i.e., EVA).