Chapter 8

Question 1

4 types of responsibility centre

Answer 1

cost centres - management are responsible for costs only
revenue centres - - management are responsible for sales only
profit centres - management are responsible for profit
investment centres - management are responsible for working capital and profit

Question 2

formula for ROI for an investment centre

Answer 2

controllable divisional profit / divisional investment

Question 3

what should you compare ROI to

Answer 3

PY or a target

Question 4

what is dysfunctional behaviour

Answer 4

when a manager only makes decisions that will increase divisional ROI which may not be at the benefit of the company as a whole

Question 5

is RI less likely to cause dysfunctional behaviour over ROI, true or false

Answer 5

true

Question 6

what is more commonly used, RI or ROI

Answer 6

ROI

Question 7

Advantages of RI

Answer 7

RI increases when investments above cost of capital are undertaken
RI increases when investments earning below the cost of capital are eliminated
RI is more flexible

Question 8

weaknesses of RI

Answer 8

does not facilitate comparisons between companies

can be difficult to decide on an appropriate measure of capital employed

Question 9

why is ROI more commonly used

Answer 9

ratio’s are easier to understand and can be used to compare

RI is complex and time consuming

a company may feel the dysfunctional behaviour associated with ROI will not happen

Question 10

formula for EVA

Answer 10

net operating profit after tax less a capital charge

capital charge = WACC X net assets at start of period

Question 11

difference in profit used for EVA (NOPAT)

Answer 11

add back any expenses that are to do with investments in the future

cash basis not accruals basis

depreciation added back and economic depreciation deducted ( if not included question just use normal depreciation)

tax paid is deducted from profit

Question 12

what does NOPAT stand for

Answer 12

net operating profit after tax

Question 13

approach to calc PAT (profit after tax)

Answer 13

add back :
goodwill amortised
R&D and advertising
non cash items
depreciation
interest (net of tax)

Question 14

advs of EVA

Answer 14

maximises shareholder wealth
replaces multiple goals with one financial measure
consistent with NPV
removes distortion from accounting policies

Question 15

disadv’s of EVA

Answer 15

complex
based on historic data
makes interdivisional comparisons difficult
inconsistent with published FS

Question 16

what is a transfer price

Answer 16

the price at which goods or services are transferred from one division to the other

Question 17

why are transfer prices necessary

Answer 17

for control purposes so it can go through accounting software

performance measurement - not fair for the department providing the goods or service if not

motivation of managers

Question 18

issue with transfer pricing being based on actual costs

Answer 18

buying division cant plan for how much

buying division would pay for all inefficiencys

Question 19

when should the selling division use marginal costing

Answer 19

when it has spare capacity, there is no external market

Question 20

what would happen if the selling division sold at full cost ( variable cost + fixed overheads)

Answer 20

may lead to a high transfer pricing

Question 21

what is dual pricing

Answer 21

when an external market exists, credit the selling division with the market price but debit buying division with the VC

Question 22

what is two part tarrif pricing

Answer 22

transfer prices are set at a VC and once a year there is a fixed fee to the supplying division to represent FC

Question 23

What is the market based approach to transfer pricing

Answer 23

is the supplying division is at full capacity, the revenue lost is the true cost

Question 24

formula for minimum transfer price

Answer 24

marginal cost to selling division + opportunity cost of resources used

Question 25

what is the opportunity cost if an external market exists

Answer 25

contribution lost from external sale

Question 26

what is the opportunity cost if an external market does not exist

Answer 26

nil or opportunity lost on not using resource to make alternative products