Problem 4: Free Response (20 points)

Evaluate the validity of each of the following prompts, and justify your response clearly, using terminology from Cost Basics and Terminology, Costing Methodologies and Their Limitations, Transfer Pricing, Relevant Costs and Operational Decisions, Cost Allocations and Context, Budgets and Variances, Performance Metrics, Incentives, and Control Systems. Maximum total answer length of 50 words per prompt.

Earnout agreements used as part of acquisition agreements are important, in part, to reduce moral hazard. (3 points)

EBITDA is an effective financial metric for performance measurement in part because it creates incentives for managers to limit capital expenditures. (3 points)

If sales volume exceeds that expected per the static budget, then sales activity variances will always be unfavorable both for variable costs and for fixed costs. (3 points)

Non-linear compensation plans are best, since linear compensation plans create incentives for gamesmanship by managers who will over-produce and over-sell in order to maximize their compensation. (3 points)

Managers should discontinue all unprofitable product lines. (3 points)

The net book value of a piece of equipment is relevant financial information when considering whether to sell it. (3 points)

I promise to never erroneously unitize fixed costs and will always Beware the Red Lines. (2 points)