Responsibility Centres and Service Cost Allocation Flashcards
What are agency costs?
The costs of agents (managers) pursuing their own interests instead of the interest of the principle.
What is the controllability principle?
Holding managers responsible for only those decisions for which they are given responsibility.
Why would an organisation decide to decentralise?
- Environment - adapting in unstable environments ; product innovation, market/process changes.
- Information Specialisation - ‘local managers’ develop specific expertise which can be long to voice up the food chain.
- Timeliness of response - quicker when managers given authority to make changes quickly.
- Protection of central management time
- Training and motivation - incentivises managers to excel.
Give an example of an agency cost for each: COST, PROFIT and INVESTMENT centres.
COST - managers reducing quality in order to reduce costs->increase profitability. (important to monitor quality)
PROFIT - managers acting in order to maximise their performance.
INVESTMENT - managers may take short term view ignoring aspects such as longevity and maintenance.
What is the equation to calculate elasticity?
elasticity = dQ/dP * (P / Q)
How do you find the revenue maximising price of a product?
Revenue, =(P * Q), is maximised when elasticity = 1.
What is the control system?
To procedures that help ensure self- interested agents maximise value of the firm.
What reasons are there to allocate service costs?
What if service costs are not allocated?
- Signal to managers service is not free
- Compare costs of having internal service department with the costs incurred if the service is purchased externally.
- Provide information about the total demand for the service at the allocated cost
-service costs treated as free goods could lead to supply problems
- no incentive for managers to act efficiently
- senior managers cannot benefit from comparison with internal/external sourcing
Explain direct service cost allocation
-Allocate expenses of departments based on OVERHEAD allocation rates
- no allocation of costs incurred by service departments to other service departments ( written off )
- EASY but may be IMPRECISE
What are the steps involved in Reciprocal service cost allocation?
- Calculate the total costs to be allocated
- Calculate charge rate of departments
- allocate the total costs to service and operating departments based on charge rate and usage
- check total is equal
what factors could influence the make or buy or decision in reciprocal cost information?
- is the external price fixed or could it increase
- can demand be increased if needed
- what would happen to employers, redundancy gives bad rep
criticisms of reciprocal allocation
- complicated
- managers don’t understand it
- step down is easier and can give similar results
If the service costs allocated are variable, the reciprocal cost can also be described as what type of cost?
opportunity or marginal costs.
Information can be used to compare with the cost of external prices. External vs Internal Decision
Proft Centres
- decision rights
- performance measures
- when used
- incentive problems
Input mix (labour, materials, supplies)
- minimise total cost for given output
- maximise output for given budget
- Central manager measure output, knows cost functioning can set optimal quality and rewards
- CC manager knows optimal input mix
- incentive to reduce costs/ increase output by lowering quality
Cost Centres
- meaning
- performance measures
- when used
- incentive problems
Input Mix
Product Mix
Selling prices/quantites
-Actual profits
- Actual compared to budget profit
- PC manager knows optimal price/quantity
-incentive for the manager to maximise their own profit, to the detriment of firm/other divisions’ profits.
