Chapter 8 Flashcards
4 types of responsibility centre
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
formula for ROI for an investment centre
controllable divisional profit / divisional investment
what should you compare ROI to
PY or a target
what is dysfunctional behaviour
when a manager only makes decisions that will increase divisional ROI which may not be at the benefit of the company as a whole
is RI less likely to cause dysfunctional behaviour over ROI, true or false
true
what is more commonly used, RI or ROI
ROI
Advantages of RI
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
weaknesses of RI
does not facilitate comparisons between companies
can be difficult to decide on an appropriate measure of capital employed
why is ROI more commonly used
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
formula for EVA
net operating profit after tax less a capital charge
capital charge = WACC X net assets at start of period
difference in profit used for EVA (NOPAT)
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
what does NOPAT stand for
net operating profit after tax
approach to calc PAT (profit after tax)
add back : goodwill amortised R&D and advertising non cash items depreciation interest (net of tax)
advs of EVA
maximises shareholder wealth
replaces multiple goals with one financial measure
consistent with NPV
removes distortion from accounting policies
disadv’s of EVA
complex
based on historic data
makes interdivisional comparisons difficult
inconsistent with published FS
what is a transfer price
the price at which goods or services are transferred from one division to the other
why are transfer prices necessary
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
issue with transfer pricing being based on actual costs
buying division cant plan for how much
buying division would pay for all inefficiencys
when should the selling division use marginal costing
when it has spare capacity, there is no external market
what would happen if the selling division sold at full cost ( variable cost + fixed overheads)
may lead to a high transfer pricing
what is dual pricing
when an external market exists, credit the selling division with the market price but debit buying division with the VC
what is two part tarrif pricing
transfer prices are set at a VC and once a year there is a fixed fee to the supplying division to represent FC
What is the market based approach to transfer pricing
is the supplying division is at full capacity, the revenue lost is the true cost
formula for minimum transfer price
marginal cost to selling division + opportunity cost of resources used
what is the opportunity cost if an external market exists
contribution lost from external sale
what is the opportunity cost if an external market does not exist
nil or opportunity lost on not using resource to make alternative products
