Chapter 14: Divisional Performance Flashcards
ROI
Divisional Performance (divisional profit) / Divisional investment (Capital employed)
Drawback of ROI
May encourage divisional managers to make decisions that are in their best interests but not the best interests of the company overall.
Referred to as non goal congruent behaviour or dysfunctional behaviour
RI (Residual Income)
Divisional net profit - Notional (imputed) interest
Notional (imputed) interest = Divisional investment x cost of capital
Residual income is therefore the income over and above the minimum expected profit.
If RI is positive then the division has performed well and value is being added to investors.
Problems with ROI and RI
Shorterism - managers making decisions that are best for their short term reward, rather than what would be better for the business in the long term
Which profit to use (controllable or divisional)
Which investment figure to use (average or opening NBV)
SOFP figures based on historic costs and NBV will make it hard to compare divisions. Due to longer time holding the assets, more depreciation, lower NBV, ROI and RI higher
Transfer prices between divisions for cost centres
Cost Centre - Transfer at cost as division do not have any targets relating to profit
Transfer prices between divisions for profit/investment centers
Market price
Transfering at market price
Should ensure goal congruent behaviour, both divisions should be happy.
Transfer at an adjusted market price. External price less adjustment to reflect the fact an internal factor may make savings in admin, packagaing costs etc
Needs an external market
Cost based systems - Should we use actual cost or standard cost?
Standard costing should be used because if the internal transfer happens at actual cost, there is no incentive to control their costs. They would pass them on.
Using standard costing the division receiving the transfer will know in advance how much it is going to cost so therefore they can plan and budget
Cost based systems - Should we use full cost or marginal cost?
All the costs from the division transferring the goods are covered - they are happy
This may end up charging more than someone else for the transfer. The company overall may be worse off if the division buys in and the cost is higher than the marginal cost of making the product themselves.
Non-goal congruence
Cost based systems - Do we add a mark-up onto cost?
If the division transferring the product is a profit / investment centre, we should allow them to make a fair profit on internal transfers. This would suggest adding a mark up is appropriate
However they may end up charging more for the product than a third party, when the group could make the product themselves for less.
Non-goal congruence
Dual Pricing - External market exists
Internal transfers, credit factory with market price as income and charge (debit) the shop with the variable (or marginal) cost.
However this is awkward for head office admin and accounts function because internal sales and internal cost will not net off to £Nill
Two-Part Tariff and Lump Sum
Factor transfer to shop at variable shop
Each period a lump sum fixed fee is given to the factory by Head Office as contribution towards its fixed and potentially profit.
However, essentially treating the factory as a cost centre which can be demotivating
