Lecture 3 Flashcards
What are responsibility centres?
A responsibility centre is an organizational unit that is headed by a manager who is responsible for its activities.
* If each responsibility centre meets its objectives, the mission, goals, and strategies of the organization will be achieved.
What is efficiency?
Ratio of output to inputs, or the amount of output per unit of input
What is effectiveness?
Determined by the relationship between a responsibility center’s output and its objectives
The relationship of efficiency and effectiveness?
For an optimum every responsibility centre needs to be both efficient and effective.
What are the criteria for assigning responsibilities?
- The core operations of the unit and the measurement possibilities of input and output
- The organizational structure → functional, business unit, matrix organization
- The controllability principle
- Specific strategic concerns
What are revenue centres?
- Output (i.e., revenue) is measured in monetary terms, but no formal attempt is made to relate input (i.e., expense) to output.
o Actual sales or orders booked are measured against budgets or quotas.
o Simple and effective way to motivate salespeople to attract and retain customers.
o Little incentive to manage expenses and working capital.
o Sales personnel must recognize they are working not only for their own unit but for the overall good of the company.
o Financial metrics are often complemented by non-financial performance measures.
Engineered expense centres
Usually found in manufacturing operations
* Their input can be measured in monetary terms.
* Their output can be measured in physical terms.
* The optimum monetary amount of input required to produce one unit of output can be determined.
o Compare standard versus actual costs. We know this as the variance analysis.
o Set specific quality standards
Discretionary expense centres
Include administrative and support units, R&D operations and marketing activities.
* The output of these centres cannot be measured in monetary terms.
o E.g. The completed ‘product’ of an R&D group may involve several years of effort.
o Levels of discretionary expenses may change
o Financial control is exercised at the planning stage before the expenses are incurred.
o Inputs stated as annual budget, may be hard to relate to outputs
o Outputs cannot be measured in monetary terms
Profit centres
- Financial performance measured in terms of profit (revenues – expenses)
- Profit measures both effectiveness and efficiency → no need to determine relative importance of effectiveness versus efficiency → managers want as many profit or investment centers are they can.
Investment centres
- Profit is compared with the assets employed in earning it.
o Can compare performance of one unit with that of other units, or with similar outside companies.
o It is only valuable to compare absolute profits if the assets employed are the same → often not the case - Motivates unit managers to accomplish the following objectives:
1. Generate adequate profits from assets
2. Invest in additional resources only when the investment produces an adequate return.
Conditions for delegating profit and assets employed responsibilities:
- The manager should have access to the relevant information needed for making such decisions.
- There should be some way to measure the effectiveness of the trade-offs the manager has made.
What are advantages of profit or investment centres?
- Improved quality of decisions due to local manager knowledge
- Speedier decisions as do not have to wait on top management
- Top management have more time to focus on strategy
- Excellent training ground for general management (because profit/investment centers are similar to independent companies)
- Profit consciousness is enhanced because managers will always find ways to increase profits
What are disadvantages of profit or investment centres?
- Delegation leads to some loss of control
- Increased control costs
- Quality of decisions made at unit level may be reduced
- Friction over setting transfer price
- Business unit competition may lead to dysfunctional decision making
- Competent general managers may not exist because not enough opportunities
- Too much emphasis on short-run profitability
What are constraints on profit and investment centre authority?
- To realize benefits of the profit and investment centre concepts, manager needs to be autonomous president of an independent company.
- Organizations divided into completely independent units, lose the advantages of size and synergy.
- Top managers would be withdrawing their own responsibility.
- Responsibility centre structures represent trade-offs between unit autonomy and corporate constraints.
What is transfer pricing?
A method of accounting for the transfer of goods and services from one responsibility centre to another.
The transfer price should:
- It affects the revenues of the producing profit centre (PC), the costs of the buying PC, and, hence, the profits of both entities
- Provide each business unit with the relevant information it needs to determine the optimum trade-off between company costs and revenues.
- It should induce goal-congruent decisions.
- It should help measure the financial performance of the individual responsibility centres.
- The system should be simple to understand and easy to administer.
- It should be acceptable to the tax authorities.
