P2 - 6. Responsibility Centres & Divisons Flashcards
What is the driving theory behind responsibility accounting?
Budget holders should only be appraised against items of cost/revenue that they have control over
When might an uncontrollable cost become controllable?
In the long term
If a cost is not controllable by one person, who may it be controllable by? (2)
- Another department
2. A more senior manager
Why might uncontrollable items get allocated to a responsibility centre?
If the manager can influence the costs despite lack of control, e.g. careful use of equipment lowers maintenance costs
How do you assess performance in a cost centre?
Cost variances (price/efficiency) and benchmarking against external providers
What is an attributable cost?
One which can be specifically identified as belonging to a particular responsibility centre, usually controllable but not always (e.g. depreciation)
How do you assess performance in a revenue centre?
Sales variances, revenue growth and market share
How do you assess performance in a profit centre?
All variances for cost + revenue centres, plus profit margins and profit growth
How do you assess performance in an investment centre?
All variances for profit centres, plus ROI, RI and EVA (linking capital investment to profit)
What is the difference in classification of depreciation between a profit and investment centre?
It is now controllable
What are the benefits of responsibility accounting?
- Easy identification of individual managers responsible for satisfactory or unsatisfactory performance
- Motivational benefits
- Data availability
- Planning and decision making
What caution is needed in responsibility accounting?
Take care to ensure managers are motivated to make the best decision for the organisation overall and not just their part of the business
What is the equation for ROI?
Divisional profit / divisional investment
What is the figure used for divisional profit in ROI, if you are assessing the managers performance?
Profit before head office allocations, interest and tax
What is the figure used for divisional profit in ROI, if you are assessing the division’s performance?
Profit before interest and tax, after deducting head office allocations
What are the 2 major downsides of using ROI?
- Can cause dysfunctional decision making (non goal congruent)
- Easily manipulated - delay expenditure
What is the equation for RI?
Divisional profit - notional interest
Where notional interest = divisional investment x cost of capital
What does RI show?
The ‘net’ profit of a division after having deducted a notional charge for interest based on the amount of capital tied up in investment
What does a positive RI show?
The division has performed well, and the profit is over and above what would be required by capital providers
Why is ROI still commonly preferred over RI?
- Gives an easy to understand % measure
- Easier inter division comparisons as it is a relative measure, so accounts for size variation
- Not felt that dysfunctional decision making happens often
- RI requires an estimate of cost of capital
What is the the purpose of the EVA calculation?
To show residual income based on the economic reality of the performance and decision making
What is the equation for EVA?
Adjusted NOPAT - capital charge
Where the capital charge = WACC x adjusted opening net assets
How do we treat interest in the EVA calculation?
Add it back (cost of interest included in finance charge via WACC)
How do we treat training, R&D and advertising costs in the EVA calculation?
Add back to profit, capitalise and amortise over period of benefit
How do we treat depreciation in the EVA calculation?
Add back to profits and deduct economic depreciation
How do value assets in the EVA calcualtion?
Use their replacement cost, or economically depreciated value
How do we treat provisions in the EVA calculation?
Remove movement in provisions from NOPAT and add back any opening provisions to opening capital employed
How do we treat operating leases in the EVA calculation?
Capitalise them and add to capital employed, add back any lease charges in the year to NOPAT
How do we treat tax in the EVA calculation?
Add back to arrive at NOPAT
What are the 3 main benefits of the EVA figure?
- Linked to cost of capital so consistent with improving shareholder wealth
- NOPAT closer reflection of cash flow
- Reflects economic reality of costs/revenue
What are the 3 main limiations of the EVA figure?
- Short termist view
- Adjustments can be just as arbitrary
- Difficult to compare different sizes of division
What are the 3 main benefits of data analytics?
- Can examine structured and unstructured data
- Extracts useful information for more informed decision making
- Provides a clearer picture of business conditions
What are the 5 main benefits of data visualisation?
- Enables users to absorb large amounts of data
- Enablers easier comparison of performance measures
- Reveals insight that might otherwise be missed
- Simplifies reporting
- Encourages collaborative working
What are the 5 principles of effective data visualisation?
- Identify the audience
- Clarify the objectives
- Use side by side comparisons
- Draw user attention to most relevant data
- Have good data analytics processes and reliable data sources
What are the 3 specific issues with divisional performance metrics and human behaviour?
- Controllability (de-motivational if not controllable)
- Dysfunctional decision making (e.g. in ROI)
- Short-termism (focus on 1 period)
