divisionalisation, responsibility accounting and transfer pricing Flashcards
what is divisionalisation
separation of an organisation into divisions in order to better achieve the organisations goals
what are the bases for divisionalisation
- product or product lines
- markets
- geographical location
some reasons for divisionalisation
- allow for more focus of each divisionalised activity
- allow growth
- allow disposal of parts of the business
- clarify lines of responsibility
- free up senior management for more strategic focus
how is decentralisation different to divisionalisation
although they go hand in hand, decentralisation refers to the degree to which decisions making authority is delegated by corporate HQ to the divisional managers
what is responsibility accounting
the way in which divisional organisations measure the performance of its divisions
what are performance measures
they calculate measures to assess whether performance throughout the organisation is satisfactory
what do we consider to ensure the system performance management is effective as possible
- controllability by those being assessed
- goal congruence
- equity
- motivation
- long term is important
- is the measure itself correct
what does controllability and traceability mean
they are controllable and traceable by divisional manager and division
what are corporate overheads which have been reapportioned to the division, in terms of controllability and traceability
neither
what are investment centre managers responsible for
divisional investment in assets as ell as its profits
what is formula for return on investment (ROI)
divisional profits / divisional assets
what does ROI indicate
how good the division is doing at using its assets to generate profit
what are requirements for divisional profit in ROI
before interest and tax and ideally should be controllable by manger or traceable to the division
drawbacks of ROI
Dysfunctional behaviour – where a decision by a divisional manager is not in the best interests of the company as a whole. Because ROI is a relative measure rather than an absolute measure, it can be distorted to make performance appear better than it is.
residual income layout
Residual income (RI)
Divisional profit X
Less imputed interest* (X)
Residual income. X
*imputed interest = divisional assets x cost of capital
what does RI give an indication of
how well the division and/or its managers can add value. if the actual divisional profit is higher than the amount of profit we need to satisfy the investors then were adding value
why is RI less prone to dysfunctional behaviour than ROI
because it is an absolute measure rather than an relative one
what are some problems with ROI and RI
Identifying controllable and traceable costs/profits can be difficult in practice. The distinction between controllable, traceable and non- controllable costs can be very blurred and a sensitive issue.
* The use of net book values from financial statements means that both measures favour old assets.
* Performance measurement is not just about financial performance and non-financial factors and performance are important too. RI and ROI do not take them into account.
* Neither measure overcomes the problem of short-termism
what is short - termism
a form of dysfunctional behaviour in the form of a bias towards achieving short term goals at the expense of the long term benefit of the organisation
give some examples of short termism
Delaying renewal or purchase of new assets or recruitment of new workers which would improve efficiency (and probably effectiveness) of the organisation.
* Delaying or cancelling maintenance of equipment and training of workers.
* Reducing R&D projects, Quality improvement programmes or customer support activities in order to save costs.
what is transfer price
the price charged by the selling division for those goods and services to another division
what are the two categories transfer pricing fall into
- cost based transfer prices
- market based transfer prices
three key objectives of transfer pricing system
- maintain goal congruence
- maintain divisional autonomy
- fair performance measurement
optimum price - for the selling division what does the minimum price mean
variable cost of producing the goods to be transferred PLUS any opportunity cost arising because of lost external sales
optimum price - for the buying division what does maximum price mean
is the lower of
- Market price
- Divisional net revenue (DNR)
DNR = selling price of end product less variable costs in the buying division
what needs to be considered for international transfer pricing
currency - fluctuations in exchange rates
cost - cost of transportation and risk of loss and damage is greater
tax - profits are taxed at different rates depending on the country, provides an opportunity for companies to place profits in countries with lower tax rates. This can cause regulatory issues for the company as tax authorities usually challenge the practice of manipulating transfer prices just to save tax.
