Performance Measurement & Decision Making

Question 1

What is the 80-20 rule in customer profitability analysis?

Answer 1

• 80% of profits usually come from 20% of a firm’s customers.
• 20% of a firm’s customers are usually completely unprofitable.

This rule highlights the importance of focusing on the most profitable customers to maintain competitive advantage.

Question 2

How can a manager use customer profitability analysis to improve profitability?

Answer 2

• Re-price activities that cause high costs-to-serve.
• Reduce available services for high cost-to-serve customers.
• Offer discounts to low cost-to-serve customers to increase sales volume.
• Shift unprofitable customers’ mix toward higher-margin products.

Customer profitability analysis helps in coordinating customers’ costs-to-serve and targeting marketing efforts.

Question 3

What is the purpose of product profitability analysis?

Answer 3

To identify unprofitable products and services so they can be re-priced or discontinued and replaced with more profitable options.

Accurate allocation of common costs and shared services is critical in evaluating product profitability.

Question 4

What are the primary means of segment financial measurement?

Answer 4

• Return on Investment (ROI)
• Residual Income (RI)

Candidates should know how each is calculated, interpreted, and how they compare and contrast with each other.

Question 5

What is the formula for Return on Investment?

(ROI)

Answer 5

ROI = Income of Business Unit / Assets of Business Unit

ROI measures the percentage of return earned on the amount of the investment.

Question 6

How is Residual Income calculated?

Answer 6

Operating Income - (Assets of Business Unit × Required Rate of Return)

RI measures the amount of monetary return provided to the company by a department or division, in excess of a targeted return.

Question 7

What assumptions are made in cost-volume-profit analysis?

(CVP)

Answer 7

• All costs are either variable or fixed.
• Total costs and revenues are predictable and linear.
• Changes in revenues and costs arise only from changes in units produced and sold.
• Fixed costs remain constant over the relevant range.
• Unit variable costs remain constant over the relevant range.
• Unit selling price remains constant over the relevant range.
• Constant sales mix is assumed for multiple products.
• Time value of money is ignored.

These assumptions simplify the analysis by excluding real-world complexities.

Question 8

What is the contribution margin?

Answer 8

The amount of revenues minus variable costs available to cover fixed costs.

Once fixed costs are covered, further increases in contribution margin flow straight to operating income.

Question 9

How is the unit contribution margin calculated?

Answer 9

Unit Contribution Margin = Selling Price per Unit - Variable Cost per Unit

This margin indicates how much each unit contributes to covering fixed costs.

Question 10

What is the formula for calculating breakeven volume in units?

Answer 10

Total Fixed Costs / Unit Contribution Margin

Question 11

Define ‘marginal analysis’.

Answer 11

Examines how benefits and costs respond to incremental changes in production.

Question 12

What are relevant revenues and costs?

Answer 12

Revenues and costs that occur in the future and differ between or among alternatives.

Question 13

What is a sunk cost?

Answer 13

A cost for which the money has already been spent and cannot be recovered.

Question 14

Differentiate between avoidable and unavoidable costs.

Answer 14

• Avoidable costs can be eliminated if a particular option is chosen.
• Unavoidable costs cannot be eliminated regardless of the decision.

Question 15

What is an opportunity cost?

Answer 15

The benefit that could have been gained from an alternative use of the same resource.

Question 16

True or False:

Opportunity costs are considered in accounting records.

Answer 16

False

Question 17

What is the importance of opportunity costs in decision making?

Answer 17

They are relevant because they occur in the future and differ between alternatives.

Question 18

What is the difference between differential and incremental costs?

Answer 18

• Differential costs differ between two alternatives.
• Incremental costs are incurred additionally because of an activity.

Question 19

Explain the concept of ‘marginal revenue’.

Answer 19

The addition to total revenue resulting from a one-unit increase in activity.

Question 20

What are explicit costs?

Answer 20

Costs that can be identified and accounted for, representing cash outflows.

Question 21

Fill in the blank:

______ costs are relevant to decision-making because they will continue if one course of action is taken but will not continue if a different course of action is taken.

Answer 21

Avoidable

Question 22

What is an opportunity cost in the context of financial decision-making?

Answer 22

The lost income or benefits from the next best alternative that must be forgone when a particular decision is made.

Opportunity costs are relevant in decision-making when resources are limited or constrained.

Question 23

When does opportunity cost exist?

Answer 23

Opportunity cost exists only when the availability of a resource is limited or constrained.

If resources are not constrained, all available opportunities can be selected, and no opportunities need to be forgone.

Question 24

How is opportunity cost calculated?

Answer 24

Opportunity cost is calculated from the revenues that would not be received and expenditures that would not be made for the other available alternatives.

Interest costs as part of opportunity cost are calculated only for the period when cash flows differ between options.

Question 25

# True or False: Opportunity costs should be included in incremental analysis for decision-making.

Answer 25

True ## Footnote Including opportunity costs in incremental analysis helps in evaluating the true cost of a decision by considering the benefits of the next best alternative.

Question 26

What happens if a company with **unused production capacity** accepts a new order?

Answer 26

The company can accept the new order **without stopping the production** of other orders. ## Footnote In this scenario, there is no opportunity cost because the company is not constrained by its production capacity.

Question 27

# True or False: If a company is already producing at full capacity, accepting a new order would require reducing or stopping production of some existing orders.

Answer 27

True ## Footnote This situation creates an opportunity cost, as the company must give up the contribution margin from the orders it cannot produce.