QUESTION 3 (20 MARKS : 48 MINUTES)

Home Healthy Sdn Bhd (HHSB) is a division that produces medical equipment for stay-at- home patient. Currently, HHSB is evaluated based on return on investment. The desired rate of return is 20%. Any divisions that reported an increase in ROI will automatically eligible for yearly bonus. Those divisions reporting a decline in ROI must justify and provide reasonable and convincing explanations in order to be eligible for bonus. However, the bonus is limited to only 50% of the bonus paid to divisions reporting an increase in ROI.

Recently, Syarikat Sihat Sdn Bhd (SSSB), one of the largest companies in leasing medical equipment is looking for a potential buyer. HHSB's top management believed that SSSB's assets could be acquired for an investment of RM1,600,000 and thus has strongly urged the division manager to consider acquiring SSSB.

The division manager reviewed the company financial statements and believed that the acquisition may not be the best interest of his division. But, if he decides not to acquire SSSB, the top management is not going to be happy. Thus, he plans to propose to the top management of HHSB to consider changing the bonus policy that based on residual income (RI) as the basis with the 15 percent cost of capital.

The following data are gathered from the financial statements of HHSB and SSSB for previous year:

HHSB (RM '000)

SSSB (RM '000)

Sales

4,750

-

Leasing revenue

-

1,550

Variable expenses

3,000

650

Fixed expenses

750

600

Current assets

1,150

950

Non-current assets

2,850

550

Current liabilities

700

425

Long-term liabilities

1,900

600

Equity stock

1,400

475

REQUIRED:

(a)If HHSB continues to use ROI as a measure for divisional performance, explain why the division manager is reluctant to acquire SSSB. Show your detail calculation.

(3 Marks)

(b)If HHSB use residual income as the measure for divisional performance, explain why the division manager is more willing to acquire SSSB. Show your detail calculation

(5 Marks)

(c)Discuss TWO (2) actions of the division managers is likely to be affected by the use of the following performance measures:

(i)ROI

(ii)residual income

(4 Marks)

(d)If HHSB has acquired SSSB, the supply of material from SSSB to HHSB will be at market price, rather than at full manufacturing cost, because the management believe it is better for divisional performance measurement purposes.

(i)State your opinion with THREE (3) reasons whether you agree or not with the transfer at market price.

(4 Marks)

(ii)Describe TWO (2) other methods that HHSB can use to set transfer price other than full manufacturing cost and market price.

(4 Marks)