P2 - 6. Responsibility Centres & Divisons

Question 1

What is the driving theory behind responsibility accounting?

Answer 1

Budget holders should only be appraised against items of cost/revenue that they have control over

Question 2

When might an uncontrollable cost become controllable?

Answer 2

In the long term

Question 3

If a cost is not controllable by one person, who may it be controllable by? (2)

Answer 3

1. Another department

2. A more senior manager

Question 4

Why might uncontrollable items get allocated to a responsibility centre?

Answer 4

If the manager can influence the costs despite lack of control, e.g. careful use of equipment lowers maintenance costs

Question 5

How do you assess performance in a cost centre?

Answer 5

Cost variances (price/efficiency) and benchmarking against external providers

Question 6

What is an attributable cost?

Answer 6

One which can be specifically identified as belonging to a particular responsibility centre, usually controllable but not always (e.g. depreciation)

Question 7

How do you assess performance in a revenue centre?

Answer 7

Sales variances, revenue growth and market share

Question 8

How do you assess performance in a profit centre?

Answer 8

All variances for cost + revenue centres, plus profit margins and profit growth

Question 9

How do you assess performance in an investment centre?

Answer 9

All variances for profit centres, plus ROI, RI and EVA (linking capital investment to profit)

Question 10

What is the difference in classification of depreciation between a profit and investment centre?

Answer 10

It is now controllable

Question 11

What are the benefits of responsibility accounting?

Answer 11

1. Easy identification of individual managers responsible for satisfactory or unsatisfactory performance
2. Motivational benefits
3. Data availability
4. Planning and decision making

Question 12

What caution is needed in responsibility accounting?

Answer 12

Take care to ensure managers are motivated to make the best decision for the organisation overall and not just their part of the business

Question 13

What is the equation for ROI?

Answer 13

Divisional profit / divisional investment

Question 14

What is the figure used for divisional profit in ROI, if you are assessing the managers performance?

Answer 14

Profit before head office allocations, interest and tax

Question 15

What is the figure used for divisional profit in ROI, if you are assessing the division’s performance?

Answer 15

Profit before interest and tax, after deducting head office allocations

Question 16

What are the 2 major downsides of using ROI?

Answer 16

1. Can cause dysfunctional decision making (non goal congruent)
2. Easily manipulated - delay expenditure

Question 17

What is the equation for RI?

Answer 17

Divisional profit - notional interest

Where notional interest = divisional investment x cost of capital

Question 18

What does RI show?

Answer 18

The ‘net’ profit of a division after having deducted a notional charge for interest based on the amount of capital tied up in investment

Question 19

What does a positive RI show?

Answer 19

The division has performed well, and the profit is over and above what would be required by capital providers

Question 20

Why is ROI still commonly preferred over RI?

Answer 20

1. Gives an easy to understand % measure
2. Easier inter division comparisons as it is a relative measure, so accounts for size variation
3. Not felt that dysfunctional decision making happens often
4. RI requires an estimate of cost of capital

Question 21

What is the the purpose of the EVA calculation?

Answer 21

To show residual income based on the economic reality of the performance and decision making

Question 22

What is the equation for EVA?

Answer 22

Adjusted NOPAT - capital charge

Where the capital charge = WACC x adjusted opening net assets

Question 23

How do we treat interest in the EVA calculation?

Answer 23

Add it back (cost of interest included in finance charge via WACC)

Question 24

How do we treat training, R&D and advertising costs in the EVA calculation?

Answer 24

Add back to profit, capitalise and amortise over period of benefit

Question 25

How do we treat depreciation in the EVA calculation?

Answer 25

Add back to profits and deduct economic depreciation

Question 26

How do value assets in the EVA calcualtion?

Answer 26

Use their replacement cost, or economically depreciated value

Question 27

How do we treat provisions in the EVA calculation?

Answer 27

Remove movement in provisions from NOPAT and add back any opening provisions to opening capital employed

Question 28

How do we treat operating leases in the EVA calculation?

Answer 28

Capitalise them and add to capital employed, add back any lease charges in the year to NOPAT

Question 29

How do we treat tax in the EVA calculation?

Answer 29

Add back to arrive at NOPAT

Question 30

What are the 3 main benefits of the EVA figure?

Answer 30

1. Linked to cost of capital so consistent with improving shareholder wealth
2. NOPAT closer reflection of cash flow
3. Reflects economic reality of costs/revenue

Question 31

What are the 3 main limiations of the EVA figure?

Answer 31

1. Short termist view
2. Adjustments can be just as arbitrary
3. Difficult to compare different sizes of division

Question 32

What are the 3 main benefits of data analytics?

Answer 32

1. Can examine structured and unstructured data
2. Extracts useful information for more informed decision making
3. Provides a clearer picture of business conditions

Question 33

What are the 5 main benefits of data visualisation?

Answer 33

1. Enables users to absorb large amounts of data
2. Enablers easier comparison of performance measures
3. Reveals insight that might otherwise be missed
4. Simplifies reporting
5. Encourages collaborative working

Question 34

What are the 5 principles of effective data visualisation?

Answer 34

1. Identify the audience
2. Clarify the objectives
3. Use side by side comparisons
4. Draw user attention to most relevant data
5. Have good data analytics processes and reliable data sources

Question 35

What are the 3 specific issues with divisional performance metrics and human behaviour?

Answer 35

1. Controllability (de-motivational if not controllable)
2. Dysfunctional decision making (e.g. in ROI)
3. Short-termism (focus on 1 period)