l9 : performance measurement & management

Question 1

what is the key performance indicator in a decentralised and multi-divisional firm?

Answer 1

profitability

Question 2

give 5 advantages of decentralisation.

Answer 2

1. top management freed from everyday problems to focus on strategic issues
2. lower level management gains experience
3. motivation
4. better information
5. evaluation of performance

Question 3

give 4 disadvantages of decentralisation.

Answer 3

1. loss of bigger picture
2. lack of coordination
3. conflict of interest & agendas
4. communication

Question 4

what is a managers main objective for a a decentralised, multi-divisional firm?

Answer 4

preserving divisional autonomy whilst ensuring firm-wide optimisation

Question 5

what is the equation for ROI?

Answer 5

net profit / investment in net assets
OR
(sales / investment in net assets) x (net profit / sales) ≡ asset turnover x profit margin

Question 6

give 3 advantages of using ROI as a measure of divisional performance.

Answer 6

1. relative measure which takes account of profit as well as all assets invested in the firm / division
2. compatible with conventional financial reports
3. enables comparison between firms / divisions

Question 7

give 4 potential problems of using ROI as a measure of divisional performance.

Answer 7

1. calculation of operating profit may be different as divisional revenue & expenses calculated diff
2. determination of asset base (cost or NBV used?). if NBV is used, investment base will shrink overtime due to depreciation, making ROI increase even though it might actually need investment
3. transfer pricing problem
4. dysfunctional behaviour

Question 8

what is RI?

Answer 8

residual income. income or profit that is generated by a division which exceeds the minimum acceptable level of income (amount necessary to cover cost of capital)

Question 9

why are ROI and RI used?

Answer 9

divisional profit is inadequate measure of divisional performance - have to take account of investment in assets required to generate that profit.

Question 10

give the equation for RI.

Answer 10

divisional profit - charge for capital invested = RI

Question 11

what does a positive RI mean?

Answer 11

means the division is generating returns in excess of the minimum requirements of the business. higher the excess returns, better the performance of the division

Question 12

what is EVA?

Answer 12

economic value added. measures amount of wealth that has been created for the shareholders

Question 13

give the equation for EVA.

Answer 13

EVA = NOPAT - (R x C)

NOPAT - net operating profit after tax
R - required returns of investor (cost of financing)
C - capital invested (net assets)

Question 14

what is transfer pricing?

Answer 14

setting prices for inter-divisional trading

Question 15

what are the 5 objectives of transfer pricing?

Answer 15

1. optimising of the profit of the business
2. assessment of performance
3. independence of divisions
4. tax minimisation
5. allocating divisional resources

Question 16

what makes a good transfer price?

Answer 16

• maximises economic benefit of company as a whole
• facilitates localised decision making
• appeals to divisional managers - should be happy with the prices
• tax saving

Question 17

what is the key point of transfer pricing?

Answer 17

transfer prices should motivate managers of individual divisions to act in the best interests of the firm as a whole

Question 18

what are the three transfer pricing methods?

Answer 18

1. market-based transfer prices
2. cost-based prices (variable cost based & full cost based)
3. negotiated prices

Question 19

explain market-based transfer pricing.

Answer 19

applicable when external competitive market exists. price is an objective, verifiable amount which has real economic credibility. price may not always be appropriate for the division as may be spare capacity leading to lost sales.

Question 20

explain cost-based transfer pricing.

Answer 20

variable cost based & full cost based.
using these pricing methods may lead to slack, wrong decisions being made. can also lead to negotiation which involves power play & interpersonal skills.

Question 21

explain negotiated prices transfer pricing.

Answer 21

more practical, widely used. but pricing is artificial (not market behaviour based) and has all same disadvantages of cost-based pricing.