Chapter 14 - Divisional performance measurement and transfer pricing Flashcards
What is a cost centre?
Division incurs cost but has no revenue stream e.g., IT support department
What is a revenue centre?
Division is only responsible for the generation of revenue
What is a profit centre?
Division has both costs and revenue
manager does not have authority to invest in new assets or dispose of existing ones
What is a investment centre?
both costs and revenue.
manager does have authority to invest in new assets or dispose of existing ones
What are typical measures used to assess performance in a cost centre?
- total cost and cost per unit
- cost variances
- NFPIs related to quality, productivity and efficiency
What are typical measures used to assess performance in a revenue centre?
- total revenue
- revenue per unit
- revenue (sales) variance
What are typical measures used to assess performance in a profit centre?
- all in cost and revenue
- total sales and market share
- profit
- sales variance
- working capital ratios
What are typical measures used to assess performance in a investment centre?
All for cost revenue and profit, plus, ROI and RI
How do you calculate the return on investment?
Controllable profit / controllable capital employed x100
What does it mean if the ROI > target cost of capital?
then accept the divisional project or appraise division as performing favourably
What does ROI enable?
comparisons to be made with divisions or companies of different sizes
What may ROI lead to?
Dysfunctional decision making
How do you calculate Residual income?
Controllable operating profit - Imputed interest (controllable cap employed x cost of capital)
when would be accept a project when calculating the RI?
if positive
What are some advs of RI?-
- reduces problems of ROI
- easy decision rule
- makes managers more aware of cost of finance
What are some dis advs of RI?
- absolute figures so does not facilitate comparisons
- difficult to determine appropriate cost of capital
- difficult accounting policies
What is the transfer price?
the price at which goods/service are transferred between divisions in the same organisation
What should a good transfer price include?
- result in goal congruence
- be fair for each division
- maintain divisional autonomy
- aid bookkeeping in the recording of internal transfers
How would a company set an optimal transfer price?
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
What is the minimum optimal transfer price?
Optimum transfer price = marginal cost of the selling division + opportunity cost of selling division
What would be the calculation if the scenario was a perfectly competitive market?
Optimum TP = market price - any small adjustment (any selling costs incurred in selling to the external market)
What would the opportunity cost be if the scenario was the selling division has surplus capacity?
Nil, because the selling division can meet external demand in full and still have excess capacity for making internal sales
What would be the calculation if the scenario was the selling division has surplus capacity?
Optimum TP = marginal cost of the selling division
What would be the calculation if the scenario was that the selling division does not have surplus capacity?
Optimum TP = marginal cost of the selling division + lost contribution
What is the maximum price buying division will pay?
Lower of:
External purchase price (external supplier)
Net marginal revenue (selling price - variable costs of buying division)
