Questions week 9-10-11 Flashcards
- Discuss why agency theory is relevant for businesses.
Agency theory deals with the relation of principals and agents where the principals assign responsibility to the agents and the agents work on behalf of the principals. Assuming that this relation is characterized by the existence of asymmetric information and that both parties
are utility maximizers, the agent may not always act in the best interest of the principal. In businesses usually exist lots of principal-agent relationships, such as between the management and employees. From an external perspective, the customer-seller relationship
can also be described as a principal-agent setup.
- Explain the concept of agency cost and identify its main cost components.
Agency Cost refers to the cost incurred by the principal caused by agents pursuing their own interests instead of the principal’s interests. There are three types of agency costs that principals face. Monitoring or control expenditures are incurred for controlling actions of the agent, such audits or monitoring devices. Bonding expenditures are costs stemming from
incentive pay received by agents. Both monitoring and bonding expenditures aim at influencing the behaviour of agents in a favourable way for the principle. The residual loss refers to the loss for the principle stemming from divergent behaviour of the agents.
Increasing monitoring and bonding costs generally reduces the cost of divergent behaviour of employees
- What are advantages of the bonus bank incentive system compared to traditional incentive systems?
In a bonus bank incentive system, bonus payments are not paid out immediately but over an extended period of time - often several years. It therefore fosters the long-term determination of decision makers in a company instead of rewarding short-term profits. Furthermore, it removes the problem of a “bonus cap” that often exists in traditional incentive systems.
- How does the concept of balanced scorecard relate to incentive pay schemes?
When designing incentive systems, all four dimensions of the balanced scorecard should be considered for evaluating the performance of employees: financial, process, customer and learning & growth. Most companies base their incentive pay on financial indicators, such as ROI or sales. Financial indicators have a past-orientation, though. Non-financial
performance measures better incorporate future prospects. They include indicators like
supplier integration (process), customer satisfaction (customer) and staff training efforts
(learning & growth).
- Identify and discuss the four kinds of quality costs.
Prevention costs are incurred to prevent defects in products; appraisal costs are costs incurred to determine whether products are conforming to specifications; internal failure costs are incurred when nonconforming products are detected prior to shipment; and external failure costs are incurred because nonconforming products are delivered to customers.
- Discuss the benefits of quality cost reports that simply list the quality costs for each category.
A quality cost report shows the amount of cost for each category as well as the rela-tive cost of each category. This report requires managers to identify the costs that should appear in the report, to identify the current quality performance level, and to begin thinking about the
level of quality performance that should be achieved.
- What are the four categories of environmental costs? Define each category.
The four categories of environmental costs are prevention, detection, internal failure, and external failure. Prevention costs are costs incurred to prevent degradation to the environment. Detection costs are incurred to determine if the firm is complying with environmental standards. Internal failure costs are costs incurred to prevent emission of contaminants to the environment after they have been produced. External failure costs are costs incurred after contaminants have been emitted to the environment.
- What is a relevant cost? Explain why depreciation on an existing asset is always
irrelevant.
Relevant costs and revenues are future costs and revenues that differ across alter-natives. Depreciation on an existing asset represents an allocation of a past cost. Past costs are never relevant.
- What role do past costs play in tactical cost analysis?
The only role of past costs is predictive. They can be used to help predict future costs.
- Why would a firm ever offer a price on a product that is below its full cost?
If a firm has unused production capacity and sufficient unused activity capacity, a one-time special order may bring in more revenues than the increase in resource spending needed to fill the order. In this case, short-term profits will increase.
- Why do gas stations in the middle of town typically charge a little less for gasoline than do gas stations located on interstate highway turnoffs?
There are a number of possible reasons; here are three. First, the price difference may be cost based. If interstate locations are more expensive than lots in town, then the higher cost of operating on the interstate could result in a higher price. Second, inter-state highway gas purchasers are often tour-ists. They do not have a long-term relation-ship with the gas station owner and, there-fore, the price charged may be higher. Third, the price elasticity of demand for gasoline purchased in town may be higher due to the larger number of competing
gas stations.
- Suppose that Alpha Company has four product lines, three of which are profitable and one (let’s call it “Loser”) of which generally incurs a loss. Give several reasons why
Alpha Company may choose not to drop the Loser product line.
Alpha Company may continue to produce and sell “Loser” because (a) customers of all lines prefer to deal with a “full-service” com-pany (i.e., if “Loser” is dropped customers will purchase profitable products elsewhere); (b) “Loser” is projected to begin making a profit in a year or so; (c) workers on the “Loser” line are learning new technology with spilloverbenefits for all products; and (d) “Loser” is really part of the marketing efforts for the entire
company.
- How does absorption costing differ from variable costing? When will absorption-costing operating income exceed variable-costing operating income?
Absorption costing differs from variable costing in that fixed factory overhead is included in unit cost under absorption costing. The result is that absorption-costing operating income is sensitive to fluctuations in inventory. Increases in inventory during a period will raise absorption- costing income above variable-costing income. The reverse is true if inventory decreases during a period.
