Chapter 14 - Divisional performance measurement and transfer pricing Flashcards Preview

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Flashcards in Chapter 14 - Divisional performance measurement and transfer pricing Deck (18)
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1
Q

What is the formula for Return on Investment (ROI)

A

ROI = (Controllable profit/Capital employed) × 100

2
Q

When is controllable profit taken?

A

After depreciation but before tax.

3
Q

What is capital employed?

A

Total assets - Current liabilities

or

Total equity + Long term debt`

4
Q

What are the advantages of ROI

A
  • Widely accepted
  • Can be used to compare with similar sized companies
  • It can be broken down into secondary ratios (Profit margin/ asset turnover)
5
Q

What are the disadvantages of ROI?

A
  • Dysfunctional decision making trying to maintain really high ROI.
  • ROI increases with age (Encourages holding on of old assets)
  • Encourages manipulation of figures to improve results
  • Different accounting policies can confuse comparisons. (E.g depn)
6
Q

What is the formula for Residual income? (RI)

A

RI = Controllable profit – Notional interest on capital

7
Q

How do you calculate the notional interest on capital?

A

capital employed x notional cost of capital

capital employed x interest rate

8
Q

What are the advantages of Residual income? (RI)

A
  • Helps prevent the dysfunctional behavior of ROI
  • Makes managers more aware of costs of assets
  • Can change interest to suit risk
9
Q

What are the disadvantages of Residual income? (RI)

A
  • Cannot compare between divisions as it is based on size of divisions
  • Based on measures which can be manipulated for higher bonus.
10
Q

What is the transfer price?

A

The price at which goods or services are transferred from one division to another within the same organisation.

11
Q

What are the objectives of transfer pricing?

A

Goal congruence - Maximise organisation profits
Performance measurement - Each division assessed fairly
Autonomy
Recording the movement of goods and services

12
Q

What are the two main methods of setting a transfer price?

A
  • Market based approach

- Cost based approach

13
Q

What is the market based approach of transfer pricing?

A

Set the transfer price at the external market price.

14
Q

What are the advantages of the Market based approach?

A
  • Should be deemed fair by managers

- This will not negatively impact the company performance.

15
Q

What are the disadvantages of the Market based approach?

A
  • There may not be an external market price
  • The price may not be suitable e.g discounts offered
  • Savings may be made from internal transfers (may need adjusted market price)
16
Q

What is the cost based approach of transfer pricing?

A

The transferring division would supply the goods at cost plus a % profit.

17
Q

Why should a standard cost be used rather than an actual cost?

A
  • Actual costs do not encourage selling to divisions to control costs
  • With standard costs the buying division will know the cost in advance.
18
Q

What are the three standard costs?

A
  • Full cost
  • Marginal (variable) cost
  • Opportunity cost.