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Flashcards in Planning and Measurement Deck (41):
1

Jonathan Mfg. adopted a job-costing system. For the current year, budgeted cost driver activity levels for direct labor hours and direct labor costs were 20,000 and $100,000, respectively. In addition, budgeted variable and fixed factory overheads were $50,000 and $25,000, respectively.

The actual costs and hours for the year were as follows:

Direct labor hours 21,000
Direct labor costs $110,000
Machine hours 35,000

For a particular job, 1,500 direct labor hours were used. Using direct labor hours as the cost driver, what amount of overhead should be applied to this job?
A. $3,214.
B. $5,357.
C. $5,625.
D. $7,500.

C. $5,625.

Overhead is applied to jobs using a pre-determined overhead rate, which is calculated by dividing estimated overhead costs (both variable and fixed) by a budgeted or estimated quantity of a cost driver. In this case, the total overhead costs of $75,000 are divided by the 20,000 budgeted direct labor hours to arrive at an overhead application rate of $3.75 per direct labor hour.

The costs are applied to production based on the 1,500 actual direct labor hours used ($3.75 * 1,500 = $5,625).

2

In a process cost system, the application of factory overhead usually would be recorded as an increase in
A. Finished goods inventory control.
B. Factory overhead control.
C. Cost of goods sold.
D. Work-in-process inventory control.

D. Work-in-process inventory control.


Journal entries to record the manufacturing cost are similar for job-order and process costing. When overhead is applied, it is debited to work in process. The credit is to factory overhead applied. Work in process receives only applied overhead, unless some underapplied factory overhead is allocated to work in process at the end of the period.

3

Which of the following is assigned to goods that were either purchased or manufactured for resale?
A. Relevant cost.
B. Period cost.
C. Opportunity cost.
D. Product cost.

D. Product cost.


Product costs include direct materials costs and, in a manufacturing environment, direct labor and indirect manufacturing costs assigned to goods held for resale.

4

Fab Co. manufactures textiles. Among Fab's Year 1 manufacturing costs were the following salaries and wages:

Loom operators $120,000
Factory foremen 45,000
Machine mechanics 30,000
What was the amount of Fab's Year 1 direct labor?
A. $195,000.
B. $165,000.
C. $150,000.
D. $120,000.

D. $120,000.


Direct labor includes the wages of only those employees working directly in the manufacture of the product. Only the loom operators meet this definition. The factory foremen are supervisory, and the machine mechanics maintain the machines.

5

The accountant for Champion Brake, Inc. applies overhead based on machine hours. The budgeted overhead and machine hours for the year are $260,000 and 16,000, respectively. The actual overhead and machine hours incurred were $275,000 and 20,000. The cost of goods sold and inventory data compiled for the year is as follows:

Direct Materials $ 50,000
COGS 450,000
WIP (units) 100,000
Finished Goods (units) 150,000

What is the amount of over/underapplied overhead for the year?
A. $15,000
B. $50,000
C. $65,000
D. $67,000

B. $50,000


Traditional overhead allocation happens in 3 steps. (1) Establish the estimated overhead and divide by the estimated machine hours to get a predetermined rate (POR) of $16.25 = $260,000 / 16,000MH; (2) Multiply the POR ($16.25) by the "actual" number of machine hours (20,000) to get allocated overhead of $325,000; (3) Compare the $325,000 allocated to the actual of $275,000. This difference is $50,000 overapplied.

6

On January 1 Maples had two jobs in process: #506 with assigned costs of $10,500 and #507 with assigned costs of $14,250. During January three new jobs, #508 through #510, were started and three jobs, #506, #507, and #508, were completed. Materials and labor costs added during January were as follows:

Job number Materials Labor
506 $0 $2,000
507 0 1,500
508 4,000 3,600
509 3,800 2,000
510 2,600 3,100

Manufacturing overhead is assigned at the rate of 200 percent of labor. What is the January cost of goods manufactured and transferred from work-in-process?
A. $25,300
B. $35,850
C. $42,950
D. $50,050

D. $50,050


Jobs 506 – 508 were the only jobs completed so the costs of these jobs is the focus of this question. DM and DL for those jobs is $35,850, but OH had to be added at ($2,000 + $1,500 + $3,600) x 200% = ($7,100 x 2) + $35,850 = $50,050.

7

Hoyt Co. manufactured the following units:

Saleable 5,000
Unsaleable (normal spoilage) 200
Unsaleable (abnormal spoilage) 300
The manufacturing cost totaled $99,000. What amount should Hoyt debit to finished goods?
A. $90,000.
B. $93,600.
C. $95,400.
D. $99,000.

B. $93,600.


Normal spoilage is a manufacturing cost because it is an expected and inherent part of production. Thus, it is included in the cost of finished goods. Abnormal spoilage is the amount of spoilage in excess of normal spoilage, and it is treated as a period cost.

The total units completed are 5,500 (5,000 + 200 + 300). Of this total, 5,200 are included in finished goods. Thus, 5,200/5,500 of the total cost incurred is included in finished goods. The remainder is a period cost.
Debit to finished goods = $93,600 = (5,200/5,500)$99,000

8

In the past, four direct labor hours were required to produce each unit of product Y. Material costs were $200 per unit, the direct labor rate was $20 per hour, and factory overhead was three times the direct labor cost.

In budgeting for next year, management is planning to outsource some manufacturing activities and to further automate others. Management estimates that these plans will reduce labor hours by 25%, increase the factory overhead rate to 3.6 times the direct labor costs, and increase material costs by $30 per unit. Management plans to manufacture 10,000 units.

What amount should management budget for the cost of goods manufactured?
A. $4,820,000.
B. $5,060,000.
C. $5,200,000.
D. $6,500,000.

B. $5,060,000.


The three factors of production - materials, labor, and overhead - must be adjusted to reflect the new budget constraints. This means that

Materials per unit = $200 + $30 = $230 per unit
Direct labor per unit = (4 hours labor X .75 X $20 per hour) = $60 per unit
Overhead per unit = (3.6 X (4 hours labor X .75 X $20 per hour)) = $216 per unit
Total cost per unit = $230 + $60 +$216 = $506 per unit
Total cost of manufacturing = $506 per unit X 10,000 units = $5,060,000

9

In June, Delta Co. experienced scrap, normal spoilage, and abnormal spoilage in its manufacturing process. The cost of units produced includes
A. Scrap, but not spoilage.
B. Normal spoilage, but neither scrap nor abnormal spoilage.
C. Scrap and normal spoilage, but not abnormal spoilage.
D. Scrap, normal spoilage, and abnormal spoilage.

C. Scrap and normal spoilage, but not abnormal spoilage.


Scrap is the material left over after making a product. It has minimal or no sales value. Scrap is automatically included in work in process for a product because it is part of the material cost of a product. In many manufacturing settings, it is impossible to use every bit of material input. For example, the circular punch-outs for conduit boxes are scrap.

Normal spoilage is output that cannot be sold through normal channels. It is an inherent result of production. In many cases, it is not cost effective to attempt to reduce the normal spoilage cost to zero. It is a normal part of the production process and, therefore, its cost is included in the cost of units produced.
Abnormal spoilage is considered avoidable. It occurs as a result of an unexpected event, such as a machine breakdown or accident. This cost is treated as a loss rather than a normal production cost.

10

Hoyt Co. manufactured the following units:

Saleable 5,000
Unsaleable (normal spoilage) 200
Unsaleable (abnormal spoilage) 300
The manufacturing cost totaled $99,000. What amount should Hoyt debit to finished goods?
A. $90,000.
B. $93,600.
C. $95,400.
D. $99,000.

B. $93,600.

This answer allocates no spoilage to finished goods. But normal spoilage is a manufacturing cost because it is an expected and inherent part of production. Thus, it is included in the cost of finished goods. Therefore, 5,200/5,500 of the total incurred cost is debited to finished goods.


---

Normal spoilage is a manufacturing cost because it is an expected and inherent part of production. Thus, it is included in the cost of finished goods. Abnormal spoilage is the amount of spoilage in excess of normal spoilage, and it is treated as a period cost.

The total units completed are 5,500 (5,000 + 200 + 300). Of this total, 5,200 are included in finished goods. Thus, 5,200/5,500 of the total cost incurred is included in finished goods. The remainder is a period cost.
Debit to finished goods = $93,600 = (5,200/5,500)$99,000

11

Indirect labor is a
A. Prime cost.
B. Conversion cost.
C. Period cost.
D. Nonmanufacturing cost.

B. Conversion cost.

Conversion cost is the sum of direct labor and overhead. It is so named because this is the cost of the efforts that convert raw material into finished goods. Indirect labor is included in overhead and, thus, is part of conversion cost.

12

The accountant for Champion Brake, Inc. applies overhead based on machine hours. The budgeted overhead and machine hours for the year are $260,000 and 16,000, respectively. The actual overhead and machine hours incurred were $275,000 and 20,000. The cost of goods sold and inventory data compiled for the year is as follows:

Direct Materials $ 50,000
COGS 450,000
WIP (units) 100,000
Finished Goods (units) 150,000

What is the amount of over/underapplied overhead for the year?

A. $15,000
B. $50,000
C. $65,000
D. $67,000

B. $50,000

Traditional overhead allocation happens in 3 steps. (1) Establish the estimated overhead and divide by the estimated machine hours to get a predetermined rate (POR) of $16.25 = $260,000 / 16,000MH; (2) Multiply the POR ($16.25) by the "actual" number of machine hours (20,000) to get allocated overhead of $325,000; (3) Compare the $325,000 allocated to the actual of $275,000. This difference is $50,000 overapplied.

13

When production levels are expected to decline within a relevant range, and a flexible budget is used, what effect would be anticipated with respect to each of the following?
Variable costs per unit Fixed costs per unit
No change No change
Increase No change
No change Increase
Increase Increase

No change Increase

Variable cost per unit in the relevant range is defined to be a constant. This assumption enables cost-volume-profit analysis and many other functions within cost accounting.

Total fixed cost is assumed to be constant in the relevant range. With declining production, fixed costs per unit would increase because the number of units produced is decreasing.

14

In an activity-based costing system, cost reduction is accomplished by identifying and eliminating
All cost drivers Nonvalue-adding activities
No No
Yes Yes
No Yes
Yes No

All cost drivers Nonvalue-adding activities

No Yes


ABC systems increase (rather than eliminate) the number of cost drivers, to enable better modeling of cost along cause-effect lines. Cost drivers are explanatory variables that help to explain the behavior of cost. One or two independent variables typically are insufficient to explain the behavior of many indirect manufacturing costs.

ABC systems also seek to eliminate nonvalue-added activities, which are activities that do not add to the value of the product as perceived by the customer. In so doing, the total cost of producing the product is reduced without any effect on the value of the product.

15

Nile Co.'s cost allocation and product costing procedures follow activity-based costing principles. Activities have been identified and classified as being either value-adding or nonvalue-adding as to each product.

Which of the following activities, used in Nile's production process, is nonvalue-adding?
A. Design engineering activity.
B. Heat treatment activity.
C. Drill press activity.
D. Raw materials storage activity.

D. Raw materials storage activity.


A value-added activity is one that makes the product or service more valuable to the customer.

The only activity listed in the answer alternatives that adds no value to the product or service as perceived by the customer is raw materials storage.
ABC systems and JIT purchasing systems are frequently used together. One objective is to minimize inventory holdings. The level of inventory held has no bearing on product quality or the satisfaction of the customer. By reducing inventories, less material must be stored, reducing all the attendant activities and costs related to material storage. Thus, the total cost is reduced without affecting the customer and sales.

16

A delivery company is implementing a system to compare the costs of purchasing and operating different vehicles in its fleet. Truck 415 is driven 125,000 miles per year at a variable cost of $0.13 per mile. Truck 415 has a capacity of 28,000 pounds and delivers 250 full loads per year. What amount is the truck's delivery cost per pound?
A. $0.00163 per pound.
B. $0.00232 per pound.
C. $0.58036 per pound.
D. $1.72000 per pound.

B. $0.00232 per pound.


Given that the truck costs $16,250 per year = 125,000 miles @ $0.13 per mile, and given that the truck has a capacity of 7,000,000 lbs. per year = 250 loads @ 28,000 lbs. each, the cost per lb. is $.00232 = $16,250 / 7,000,000 lbs.

17

A manufacturing company has several product lines. Traditionally, it has allocated manufacturing overhead costs between product lines based on total machine hours for each product line. Under a new activity-based costing system, which of the following overhead costs would be most likely to have a new cost driver assigned to it?
A. Electricity expense.
B. Repair and maintenance expense.
C. Employee benefits expense.
D. Depreciation expense.

C. Employee benefits expense.

18

In an income statement prepared as an internal report using the direct (variable) costing method, fixed selling and administrative expenses would
A. Not be used.
B. Be treated the same as variable selling and administrative expenses.
C. Be used in the computation of operating income, but not in the computation of the contribution margin.
D. Be used in the computation of the contribution margin.

C. Be used in the computation of operating income, but not in the computation of the contribution margin.


Sales

- Variable Manufacturing
- Variable Selling and Administrative
= Contribution Margin
- Fixed Manufacturing
- Fixed Selling and Administration
= Operating Income

The contribution margin equals sales minus variable costs. Fixed costs are deducted from the contribution margin to calculate income.

19

In an income statement prepared as an internal report using the direct (variable) costing method, fixed selling and administrative expenses would
A. Be used in the computation of the contribution margin.
B. Be used in the computation of operating income, but not in the computation of the contribution margin.
C. Be treated the same as variable selling and administrative expenses.
D. Not be used.

B. Be used in the computation of operating income, but not in the computation of the contribution margin.


Sales

- Variable Manufacturing
- Variable Selling and Administrative
= Contribution Margin
- Fixed Manufacturing
- Fixed Selling and Administration
= Operating Income

The contribution margin equals sales minus variable costs. Fixed costs are deducted from the contribution margin to calculate income.

20

At the end of Killo Co.'s first year of operations, 1,000 units of inventory remained on hand. Variable and fixed manufacturing costs per unit were $90 and $20, respectively. If Killo uses absorption costing rather than direct (variable) costing, the result would be a higher pretax income of
A. $0.
B. $20,000.
C. $70,000.
D. $90,000.

B. $20,000.

Absorption costing includes both variable and fixed manufacturing costs as product costs. Direct costing includes only variable manufacturing costs as product cost and expenses fixed manufacturing costs as a period expense.

In this case, absorption costing includes $20,000 of fixed manufacturing costs (1,000 x $20) in ending inventory while direct costing expenses the full amount of fixed manufacturing costs. Pretax income is consequently $20,000 higher for absorption costing.

21

Yarn Co.'s inventories in process were at the following stages of completion on April 30, Year 1:

No. of units Percent complete
100 90
50 80
200 10
Equivalent units of production amounted to
A. 150.
B. 180.
C. 330.
D. 350.

A. 150.

The equivalent units of production for the period is the amount of work, measured in terms of completed units, that was performed during the period. In total, 150 equivalent units of work were performed during the period, which is the same amount of work that would have been performed had 150 units been started and completed during the period.

150 = .90(100) + .80(50) + .10(200)

22

The following information pertains to Lap Co.'s Palo Division for the month of April:

Number of units Cost of materials
Beginning work in process 15,000 $5,500
Started in April 40,000 18,000
Units completed 42,500
Ending work in process 12,500

All materials are added at the beginning of the process. Using the weighted average method, the cost per equivalent unit for materials is
A. $0.59.
B. $0.55.
C. $0.45.
D. $0.43.

D. $0.43.

Under the weighted average method, the cost per equivalent unit includes all the work done through the end of the current period, including the work performed on beginning inventory during the previous period. This is why the method is called the weighted average method. In this situation, material is added at the beginning of the process. Therefore, all units are considered complete with respect to materials. The costs associated with this effort form the numerator of the calculation.

The sum of units completed plus units in ending inventory equals 55,000 (42,500 + 12,500). The total cost incurred on material equals $23,500 ($5,500 + $18,000). Thus, the cost per equivalent unit for materials is $.43 ($23,500/55,000).

23

In a job cost system, manufacturing overhead is
An indirect cost of jobs A necessary element in production
A. No Yes
B. No No
C. Yes Yes
D. Yes No

An indirect cost of jobs A necessary element in production

C. Yes Yes


Another term for overhead is indirect cost. Indirect costs cannot be traced to specific jobs. In other words, overhead is not directly attributable to specific jobs.

All manufacturing cost is, by definition, a necessary ingredient of the total production cost. All jobs consume some overhead or receive the services of an overhead department or cost center.

24

Birk Co. uses a job order cost system. The following debits (credits) appeared in Birk's work in process account for the month of April Year 1:

April Description Amount
1 Balance $4,000
30 Direct materials 24,000
30 Direct labor 16,000
30 Factory overhead 12,800
30 To finished goods (48,000)
Birk applies overhead to production at a predetermined rate of 80% of the direct labor cost. Job No. 5, the only job still in process on April 30, Year 1, was charged with direct labor of $2,000. What was the amount of direct materials charged to Job No. 5?
A. $3,000.
B. $5,200.
C. $8,800.
D. $24,000.

B. $5,200.


Ending balance in work in process:

$4,000 + $24,000 + $16,000 + $12,800 - $48,000 (all attributable to Job No. 5, the only remaining job) = $8,800
Less direct labor charged to Job No. 5: (2,000)
Less overhead charged to Job No. 5: .80($2,000) (1,600)
Equals materials charged to Job No. 5: $5,200

25

In a job cost system, manufacturing overhead is
An indirect cost of jobs A necessary element in production
A. No Yes
B. No No
C. Yes Yes
D. Yes No

C. Yes Yes

Another term for overhead is indirect cost. Indirect costs cannot be traced to specific jobs. In other words, overhead is not directly attributable to specific jobs.

All manufacturing cost is, by definition, a necessary ingredient of the total production cost. All jobs consume some overhead or receive the services of an overhead department or cost center.

26

Absorption costing vs variable costing

Absorption costing includes all costs, including fixed costs, in figuring the cost of production,


while variable costing only includes the variable costs directly related to production. Companies that use variable costing keep overhead and other fixed-cost operating expenses separate from production costs.

27

The following information pertains to Quest Co.'s Gold Division for Year 1:

Sales $311,000
Variable cost 250,000
Traceable fixed costs 50,000
Average invested capital 40,000
Imputed interest rate 10%
Quest's return on investment was
A. 10.00%.
B. 13.33%.
C. 27.50%.
D. 30.00%.

C. 27.50%.

ROI = division income/average invested capital = ($311,000 - $250,000 - $50,000)/$40,000 = .275

Traceable fixed costs are deducted in determining division income. Corporate fixed costs would not be deducted. The imputed interest rate is not relevant to the question.

28

Wexford Co. has a subunit that reported the following data for year 1:

Asset (investment) turnover 1.5 times
Sales $750,000
Return on sales 8%

The imputed interest rate is 12%. What is the division residual income for year 1?
A. $60,000.
B. $30,000.
C. $20,000.
D. $0.

D. $0.

To solve for residual income (RI), you must first solve for assets (investment) and income. Since an asset turnover of 1.5 is sales/investment and sales is $750,000, we use $750,000 / x = 1.5, where x = investment. Thus, investment is $500,000. Since a return on sales of 8% is profit/sales and sales is $750,000, we use x / $750,000 = 8%, where x = income. Thus, income is $60,000. Now, RI = income less the rate given at 12% multiplied by the investment. Thus, RI is 0 = $60,000 - .12 ($500,000).

29

A company's target gross margin is 40% of the selling price of a product that costs $89 per unit. The product's selling price should be
A. $124.60.
B. $142.40.
C. $148.33.
D. $222.50.

C. $148.33.

If P = price and C = cost, and cost is $89, target gross margin is .4P, and P - C = .4P. Thus, we solve for P in the equation P - $89 = .4P to find P = $148.33.

30

The target capital structure of Traggle Co. is 50% debt, 10% preferred equity, and 40% common equity. The interest rate on debt is 6%, the yield on the preferred is 7%, the cost of common equity is 11.5%, and the tax rate is 40%. Traggle does not anticipate issuing any new stock. What is Traggle's weighted average cost of capital?
A. 6.50%.
B. 6.77%.
C. 7.10%.
D. 8.30%.

C. 7.10%.

The calculation of the weighted average cost of capital (WACC) involves proportional weighting for debt and equity with the debt figure reduced for deductible taxes. Thus, the cost of debt is 1.8% = 50% (6%) (1 - .4); the cost of owners' equity is split for the preferred 0.7% = 10% (7%); and the common 4.6% = 40% (11.5%). Thus, the WACC is 7.1% = 1.8% + 0.7% + 4.6%.

31

Related to the CFROI metric, "the required annual cash investment needed to replace fixed assets" is the definition of what?
A. Free cash flow.
B. Economic depreciation.
C. Economic value added (EVA).
D. Cash flow return on investment (CFROI).

B. Economic depreciation.

The required annual cash investment needed to replace fixed assets is the definition of economic depreciation.

32

A company has a tax rate of 40%. Information for the company is as follows:

Amount Before-tax Cost
Mortgage bonds $1,200,000 7.2%
Common stock $3,800,000 10%

What is the weighted average cost of capital (WACC)?
A. 9.33%.
B. 8.64%.
C. 0.08%.
D. 8.60%.

B. 8.64%.


The calculation is ($1.2M / $5M) (.072) (1 - .4) + ($3.8M / $5M) (.1).

33

Which of the following accurately reflects prevailing thought processes regarding the new value based metrics?
A. Accrual-based metrics are discredited.
B. Cost of capital is increasingly ignored.
C. Shareholder value is not typically viewed as being as important as achieving strategic objectives.
D. All of the above reflect prevailing thought processes regarding the new value based metrics.

A. Accrual-based metrics are discredited.

Accrual-based metrics are discredited, since they are not designed to reflect true economic substance, but to meet other external reporting goals.

34

A company has two divisions. Division A has an operating income of $500 and total assets of $1,000. Division B has an operating income of $400 and total assets of $1,600. The company's required rate of return is 10%. Division B's residual income would be which of the following amounts?
A. $40.
B. $240.
C. $400.
D. $640.

B. $240.

Residual income is calculated as operating income less the investment (total assets here) multiplied by the required rate of return. Thus, Division B's residual income is $400 - .1($1,600) = $240.

35

Brewster Co. has the following financial information:

Fixed costs $20,000
Variable costs 60%
Sales price $50

What amount of sales is required for Brewster to achieve a 15% return on sales?
A. $33,333
B. $50,000
C. $80,000
D. $133,333

C. $80,000

This answer follows a contribution margin income statement format involving a 15% markup on sales, solves for quantity, (i.e., $50Q - 0.6(50Q) - $20,000 = 0.15(50Q)), and then multiplies quantity by price ($50 x 1,600 = $80,000). Note: variable costs are 60% of sales, not 60% of total costs.

36

To measure inventory management performance, a company monitors its inventory turnover ratio. Listed below are selected data from the company's accounting records:

Current year Prior year
Annual sales $2,525,000 $2,125,000
Gross profit percent 40% 35%

Beginning finished goods inventory for the current year was 15% of the prior year's annual sales, and ending finished goods inventory was 22% of the current year's annual sales. What was the company's inventory turnover at the end of the current period?
A. 1.82.
B. 2.31.
C. 2.73.
D. 3.47.

D. 3.47.

Inventory turnover is calculated by dividing the cost of goods sold by the average inventory. Cost of goods sold = $2,525,000(1 - .4) = $1,515,000; average inventory is [.15(2,125,000) + .22(2,525,000)] / 2 = $437,125. Thus, inventory turnover = $1,515,000 / $437,125.

37

The DuPont method of ROI uses sales to analyze what two elements of return separately?
A. Income and assets.
B. Income and common stockholders' equity.
C. Gross sales and net sales.
D. Income and cost of capital.

A. Income and assets.

Income and assets are related to sales to determine return on sales and the efficiency with which assets were used to generate those sales.

The basic formula for ROI is: ROI = Net Profit / Total Investment * 100.

38

How is contribution margin (CM) different from gross margin (GM)?
A. CM equals sales less cost of goods sold; GM equals sales less total expenses.
B. CM equals sales less variable costs; GM equals sales less cost of goods sold.
C. CM classifies cost by manufacturing v. non-manufacturing; GM classifies cost by variable and fixed cost behavior.
D. CM is used for external reporting; GM is used internally for cost-volume-profit analysis.

B. CM equals sales less variable costs; GM equals sales less cost of goods sold.

CM classifies costs by behavior and is used internally.


Contribution Margin = Sales - Variable Costs

The calculation of the Gross Profit is: Sales minus Cost of Goods Sold. The Cost of Goods Sold consists of the fixed and variable product costs, but it excludes all of the selling and administrative expenses. Contribution Margin is Net Sales minus the variable product costs and the variable period expenses.

39

Which metric is often used as an alternative to ROI and is generally defined as "operating Income less (the required rate of return multiplied by invested capital)?"
A. Times interest earned.
B. Economic value added.
C. Cash value added.
D. Residual income.

D. Residual income.

Residual income = operating income - required rate of return (invested capital).

40

Galax, Inc. had an operating income of $5,000,000 before interest and taxes. Galax's net book value of plant assets on January 1 and December 31 were $22,000,000 and $18,000,000, respectively. Galax achieved a 25% return on investment for the year, with an investment turnover of 2.5. What were Galax's sales for the year?
A. $55,000,000.
B. $50,000,000.
C. $45,000,000.
D. $20,000,000.

B. $50,000,000.

ROI = (income / sales) * asset turnover; and ROI = 25% = $5M / sales * 2.5. Thus, solving for sales, the result is $50M.

41

North Bank is analyzing Belle Corp.'s financial statements for a possible extension of credit. Belle's quick ratio is significantly better than the industry average. Which one of the following factors should North consider as a possible limitation of using this ratio when evaluating Belle's creditworthiness?
Accounts Receivable Marketable Securities Inventories
Yes Yes Yes
Yes Yes No
Yes No Yes
Yes No No

Yes Yes No

B is correct.
The quick ratio (also called the acid-test ratio) measures the relationship between current assets that are cash or can be converted to cash quickly and the total of current liabilities.
Current assets that can be converted to cash quickly include (in addition to cash) accounts receivable and marketable securities (expected to be sold in the near term). Inventories are not included in the quick ratio because, normally, they cannot be converted to cash quickly.

By excluding inventories (and other current assets that cannot be converted to cash quickly, e.g., prepaid assets), the measure of assets available to pay current liabilities in the quick ratio is more conservative than the measure of assets used in the working capital (or current) ratio; thus, the quick ratio is also called the acid-test ratio.