Chapter 14 - Divisional performance measurement and transfer pricing

Question 1

What is a cost centre?

Answer 1

Division incurs cost but has no revenue stream e.g., IT support department

Question 2

What is a revenue centre?

Answer 2

Division is only responsible for the generation of revenue

Question 3

What is a profit centre?

Answer 3

Division has both costs and revenue
manager does not have authority to invest in new assets or dispose of existing ones

Question 4

What is a investment centre?

Answer 4

both costs and revenue.
manager does have authority to invest in new assets or dispose of existing ones

Question 5

What are typical measures used to assess performance in a cost centre?

Answer 5

• total cost and cost per unit
• cost variances
• NFPIs related to quality, productivity and efficiency

Question 6

What are typical measures used to assess performance in a revenue centre?

Answer 6

• total revenue
• revenue per unit
• revenue (sales) variance

Question 7

What are typical measures used to assess performance in a profit centre?

Answer 7

• all in cost and revenue
• total sales and market share
• profit
• sales variance
• working capital ratios

Question 8

What are typical measures used to assess performance in a investment centre?

Answer 8

All for cost revenue and profit, plus, ROI and RI

Question 9

How do you calculate the return on investment?

Answer 9

Controllable profit / controllable capital employed x100

Question 10

What does it mean if the ROI > target cost of capital?

Answer 10

then accept the divisional project or appraise division as performing favourably

Question 11

What does ROI enable?

Answer 11

comparisons to be made with divisions or companies of different sizes

Question 12

What may ROI lead to?

Answer 12

Dysfunctional decision making

Question 13

How do you calculate Residual income?

Answer 13

Controllable operating profit - Imputed interest (controllable cap employed x cost of capital)

Question 14

when would be accept a project when calculating the RI?

Answer 14

if positive

Question 15

What are some advs of RI?-

Answer 15

• reduces problems of ROI
• easy decision rule
• makes managers more aware of cost of finance

Question 16

What are some dis advs of RI?

Answer 16

• absolute figures so does not facilitate comparisons
• difficult to determine appropriate cost of capital
• difficult accounting policies

Question 17

What is the transfer price?

Answer 17

the price at which goods/service are transferred between divisions in the same organisation

Question 18

What should a good transfer price include?

Answer 18

• result in goal congruence
• be fair for each division
• maintain divisional autonomy
• aid bookkeeping in the recording of internal transfers

Question 19

How would a company set an optimal transfer price?

Answer 19

setting a transfer price between the acceptable range of the minimum price the selling division will accept and the maximum price the buying division will be willing to pay

Question 20

What is the minimum optimal transfer price?

Answer 20

Optimum transfer price = marginal cost of the selling division + opportunity cost of selling division

Question 21

What would be the calculation if the scenario was a perfectly competitive market?

Answer 21

Optimum TP = market price - any small adjustment (any selling costs incurred in selling to the external market)

Question 22

What would the opportunity cost be if the scenario was the selling division has surplus capacity?

Answer 22

Nil, because the selling division can meet external demand in full and still have excess capacity for making internal sales

Question 23

What would be the calculation if the scenario was the selling division has surplus capacity?

Answer 23

Optimum TP = marginal cost of the selling division

Question 24

What would be the calculation if the scenario was that the selling division does not have surplus capacity?

Answer 24

Optimum TP = marginal cost of the selling division + lost contribution

Question 25

What is the maximum price buying division will pay?

Answer 25

Lower of:
External purchase price (external supplier)
Net marginal revenue (selling price - variable costs of buying division)