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
