Divisional Performance Measures

Question 1

What is responsibility accounting?

Answer 1

Responsibility accounting is used to measure the performance of decentralised units.

Question 2

What are the advantages of decentralisation?

Answer 2

1. Quicker decisions
2. More motivated management
3. Better decisions due to local knowledge
4. Reduced head office bureaucracy
5. Better training for all levels of management

Question 3

What are the disadvantages of decentralisation?

Answer 3

1. duplication in divisions i.e. greater cost
2. senior management loss of control
3. potential dysfunctional decision making i.e. not in interests of whole company.

Question 4

What are the conditions for a good performance measure?

Answer 4

1. Goal congruence
2. Accountability
3. Long term and short objectives recognised.

Question 5

What is the formula for return on investment (ROI)?

Answer 5

(Divisional Profit / Divisional Investment) x 100

Question 6

When calculating ROI do we use profit before or after tax?

Answer 6

PBIT (controllable profit)

Question 7

How do we calculate divisional investment when calculating the ROI?

Answer 7

Either:

1. Opening book value of TALCL
2. Average of BOP and EOP balances of TALCL

Question 8

What is the decision rule for ROI?

Answer 8

Only projects which increase the existing ROI should be undertaken.

Question 9

What are the problems with ROI?

Answer 9

1. Dysfunctional behaviour - only ROI increasing projects accepted - could be at expense of growth in corporate profits.
2. Ratio will be distorted by age of the assets
3. Profit can be manipulated.

Question 10

What is the alternative to ROI?

Answer 10

Residual income.

Question 11

What is the formula for Residual Income?

Answer 11

PBIT - Imputed Interest

Question 12

What is imputed interest?

Answer 12

Divisional Investment x Cost of Capital

Question 13

What is the purpose of RI?

Answer 13

To provide an absolute hurdle figure for profit based on the company’s minimum percentage return from a division.

Question 14

What are the advantages of RI?

Answer 14

1. Avoids dysfunctional behaviour - uses the group cost of capital in the decision - so bringing in company’s minimum return based on company view not division view.
2. Different costs of capital can be used to reflect risk.

Question 15

Which out of ROI and RI are used more frequently in practise and why?

Answer 15

ROI

1. dysfunctional behaviour is not material
2. ROI is consistent with ROCE (corporate assessment)
3. %’s more easily understood
4. RI requires cost of capital.

Question 16

If RI is positive what is the decision?

Answer 16

Return > return demand from investment so undertake project

Question 17

If RI is negative what is the decision?

Answer 17

Don’t undertake the project as we don’t get enough return.

Question 18

What is transfer pricing?

Answer 18

A transfer price is the price at which goods are transferred internally.

Question 19

Why is transfer pricing necessary?

Answer 19

Division receiving goods should be charged in order for performance to be measure equitably.

Question 20

What is the overriding question when selecting a transfer price?

Answer 20

Whether the transfer price is in the company’s best interest.

Question 21

What are the goals of transfer pricing?

Answer 21

1. goal congruence
2. equitable performance management
3. retain divisional autonomy (div manager decision to buy which..)
4. motivate divisional managers
5. optimum resource allocation