divisionalisation, responsibility accounting and transfer pricing

Question 1

what is divisionalisation

Answer 1

separation of an organisation into divisions in order to better achieve the organisations goals

Question 2

what are the bases for divisionalisation

Answer 2

• product or product lines
• markets
• geographical location

Question 3

some reasons for divisionalisation

Answer 3

• 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

Question 4

how is decentralisation different to divisionalisation

Answer 4

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

Question 5

what is responsibility accounting

Answer 5

the way in which divisional organisations measure the performance of its divisions

Question 6

what are performance measures

Answer 6

they calculate measures to assess whether performance throughout the organisation is satisfactory

Question 7

what do we consider to ensure the system performance management is effective as possible

Answer 7

• controllability by those being assessed
• goal congruence
• equity
• motivation
• long term is important
• is the measure itself correct

Question 8

what does controllability and traceability mean

Answer 8

they are controllable and traceable by divisional manager and division

Question 9

what are corporate overheads which have been reapportioned to the division, in terms of controllability and traceability

Answer 9

neither

Question 10

what are investment centre managers responsible for

Answer 10

divisional investment in assets as ell as its profits

Question 11

what is formula for return on investment (ROI)

Answer 11

divisional profits / divisional assets

Question 12

what does ROI indicate

Answer 12

how good the division is doing at using its assets to generate profit

Question 13

what are requirements for divisional profit in ROI

Answer 13

before interest and tax and ideally should be controllable by manger or traceable to the division

Question 14

drawbacks of ROI

Answer 14

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.

Question 15

residual income layout

Answer 15

Residual income (RI)
Divisional profit X
Less imputed interest* (X)
Residual income. X

*imputed interest = divisional assets x cost of capital

Question 16

what does RI give an indication of

Answer 16

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

Question 17

why is RI less prone to dysfunctional behaviour than ROI

Answer 17

because it is an absolute measure rather than an relative one

Question 18

what are some problems with ROI and RI

Answer 18

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

Question 19

what is short - termism

Answer 19

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

Question 20

give some examples of short termism

Answer 20

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.

Question 21

what is transfer price

Answer 21

the price charged by the selling division for those goods and services to another division

Question 22

what are the two categories transfer pricing fall into

Answer 22

• cost based transfer prices
• market based transfer prices

Question 23

three key objectives of transfer pricing system

Answer 23

• maintain goal congruence
• maintain divisional autonomy
• fair performance measurement

Question 24

optimum price - for the selling division what does the minimum price mean

Answer 24

variable cost of producing the goods to be transferred PLUS any opportunity cost arising because of lost external sales

Question 25

optimum price - for the buying division what does maximum price mean

Answer 25

is the lower of
- Market price
- Divisional net revenue (DNR)

DNR = selling price of end product less variable costs in the buying division

Question 26

what needs to be considered for international transfer pricing

Answer 26

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.