Chapter 17 - Divisional Perfomance Measurements

Question 1

What does the divisionalisation mean

Answer 1

Divisionalisation is the situation where managers of business areas are given a degree of autonomy over decision-making. In affect the allowed to run the part of the business almost as though they were their own company

Question 2

Advantages and disadvantages of divisionalisation

Answer 2

Advantages

Faster decision-making
More local knowledge
More motivation as more trust and responsibility

Problems with divisionalisation
How to measure performance of the division/how to ensure goal congruence

Question 3

What are the financial performance measures for divisionalisation

Answer 3

Controllable profits
The most important financial performance measure is profitability however it would be unfair to penalise the manager that is running the division for decisions made at head office for example increasing everyone’s wage therefore it is important that any costs outside of their control should be excluded



Question 4

What are investment centres in regards to divisionalisation

Answer 4

Divisionalisation implies that the divisional manager has some degree of autonomy and in the case of investment Centre the manager is giving decision-making authority not only over the costs and revenue but additionally over capital investment decisions.

Question 5

Return on capital employed for divisionalisation

Answer 5

Return on capital employed is defined as controllable divisional profit expressed as a percentage of divisional investments and it is equivalent of return on capital employed as this is one of the reasons that it is very popular in practice as a division of performance measure

Question 6

What is goal congruence

Answer 6

This is when the goals of everyone of the same for example if the companies target return is 15% and one of the divisions is considering investments that would give a further 16% as a standalone percentage than the company would want to accept however if this additional investments meant that the overall profits for the division went down then the division would not accept despite the company wanting them to accept. This would mean that the division is not goal congruence

Question 7

What is residual income RI

Answer 7

Instead of using a percentage measure as with return on investments the residual income approach assesses the manager absolute profit however in order to take account of the capital investment notional or pretend interest is the doctor from the P&L profit figure. The balance remaining is known as visit your income

Question 8

How are return on investments and residual income different

Answer 8

Let’s say the investment is $500,000 and the company wants to make 15% returns and the profit is 82000 then for return on investments the answer is 16.4% however for residual income we look at how much in money rather than % the investment wants to make ( 500000 * 15%) $75000 and therefore is the 82000 more, yes 7000

Question 9

Reasons for using return on investments versus residual income

Answer 9

Return on investments
-far more common because it is more easily understandable as it’s like return on capital employed
-if comparing divisions of different sizes as use division this is poor performing may have a residual income at 10,000 and a tiny successful division a residual income 1000 so it’s unfair to compare residual income
– usually doesn’t lead to loss of goal congruence

Reasons to use residual income
– technically superiors leads to goal congruence decisions