printable flashcard on acca f5_ chapter 13 - divisional performance measurement and transfer...

7/31/2019 Printable Flashcard on ACCA F5_ Chapter 13 - Divisional Performance Measurement and Transfer Pricing_ Free Flash Cards

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ACCA F5: Chapter 13 - Divisional performance measurement and transfer pricing

1.1 Divisional performance measurement

What are the three types of division?

1 Divisional performance measurement

Cost centre, Profit centre,

Investment centre.

2.


What is a cost centre?

What are the typical measures used to assess

performance?


Division incurs costs but has no

revenue stream, e.g. the IT

support department of an

organisation

- Total cost and cost per unit

- Cost variances.

- NFPIs related to quality,

productivity & efficiency

3.


What is a profit centre?

What are the typical measures used to assess

performance?



- Cost variances

- NFPIs related to quality,


- Total sales and market share

- Profit

- Sales variances

- Working capital ratios

(depending on the division

concerned).

- NFPIs e.g. related to

productivity, quality and customer

satisfaction


What is an investment centre?


Division has both costs and

revenue. Manager does have the

authority to invest in new assets

or dispose of existing ones


- Cost variances- NFPIs related to quality,


- Total sales and market share


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. a are e yp ca measures use o assess

performance?

- ro

- Sales variances

- Working capital ratios

(depending on the division

concerned).

- NFPIs e.g. related to

productivity, quality and customer

satisfaction

- ROI

- RI

5.


1) What is ROI (Return on investment)?

2) What is controllable profit?

3) What is capital employed?


1) This is a similar measure to

ROCE but is used to appraise the

investment decisions of an

individual department.

ROI = (Controllable profit / capital

employed) * 100

2) Controllable profit is usually

taken after depreciation but before

tax. However, in the exam you

may not be given this profit figure

and so you should use the profit

figure that is closest to this.

Assume the profit is controllable,

unless told otherwise

3) Capital employed is total

assets less long term liabilities or

total equity plus long term debt.

Use net assets i f capital employed

is not given in the question.

Non-current assets might bevalued at cost, net replacement

cost or net book value (NBV). The

value of assets employed could be

either an average value for the

period as a whole or a value as at

the end of the period. An average

value for the period is preferable.

However, in the exam you should

use whatever figure is given to you


- It is widely used and accepted

since it is line with ROCE which is

frequently used to assess overall


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What are the advantages of ROI?

business performance

- As a relative measure it enables

comparisons to be made with

divisions or companies of different

sizes.

- It can be broken down into

secondary ratios for more detailed

analysis, i.e. profit margin and

asset turnover.

7. 1 Divisional performance measurementWhat are the disadvantages of ROI?


- It may lead to dysfunctional

decision making, e.g. a division

with a current ROI of 30% would

not wish to accept a project

offering a ROI of 25%, as this

would dilute its current figure.

However, the 25% ROI may meet

or exceed the company's target.

- ROI increases with the age of the

asset if NBVs are used, thusgiving managers an incentive to

hang on to possibly inefficient,

obsolescent machines.

- It may encourage the

manipulation of profit and capital

employed figures to improve

results, e.g. in order to obtain a

bonus payment.

- Different accounting policies can

confuse comparisons (e.g.

depreciation policy).


1) RI = Controllable profit

Notional interest on capital

2) Controllable profit is usually

taken after depreciation but before

tax. However, in the exam you

may not be given this profit figure

and so you should use the profit

figure that is closest to this.

Assume the profit is controllable,

unless told otherwise

3) Notional interest on capital =


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8.


1) What is risidual income?

2) What is controllable profit?

3) What is notional interest on capital?

the capital employed in the

division multiplied by a notional

cost of capital or interest rate.

- Capital employed is total assets

less long term liabilities or total

equity plus long term debt. Use

net assets if capital employed is

not given in the question

- The selected cost of capital

could be the companys average

cost of funds (cost of capital).

However, other interest rates

might be selected, such as the

current cost of borrowing, or a

target ROI. (You should use

whatever rate is given in the

exam).


Advantages of RI as a performance measure?


- It encourages investment centre

managers to make new

investments if they add to RI. A

new investment might add to RI

but reduce ROI. In such a

situation, measuring performance

by RI would not result in

dysfunctional behaviour, i.e. the

best decision will be made for the

business as a whole.- Making a specific charge for

interest helps to make investment

centre managers more aware of

the cost of the assets under their

control.

10.


Disadvantages of RI as a performance

measure?


- It does not facilitate comparisons

between divisions since the RI is

driven by the size of divisions and

of their investments.

- It is based on accounting

measures of profit and capital

em lo ed which ma be sub ect


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to manipulation, e.g. in order to

obtain a bonus payment.

11.


What other ways can divisonal performance be

measured?


- Variance analysis is a standard

means of monitoring and

controlling performance. Care

must be taken in identifying the

controllability of, and responsibility

for, each variance- Ratio analysis there are several

profitability and liquidity measures

that can be applied to divisional

performance reports

- Other management ratios this

could include measures such as

sales per employee or square foot

as well as industry specific ratios

such as transport costs per mile,

brewing costs per barrel,

overheads per chargeable hour.- Other information such as staff

turnover, market share, new

customers gained, innovative

products or services developed.

12.


Problems with comparing divisionalperformance


- Divisions may operate in different

environments. A division earning a

ROI of 10% when the industry

average is 7% may be considered

to be performing better than a

division earning a ROI of 12%

when the industry average is 15%.

- The transfer pricing policy may

distort divisional performance

- Divisions may have assets of

different ages. A division earning a

high ROI may do so because

assets are old and fully

depreciated. This may give a poor

indication of future potential

performance.

- There may be difficulties

comparing divisions with different

accounting policies (e.g.


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depreciation).

- Evaluating performance on the

basis of a few indicators may lead

to manipulation of data. A wider

range of indicators may be

preferable which include non-

financial measures. It may be

difficult to find non-financial

indicators which can easily be

compared if divisions operate in

different environments

13.2 Transfer pricing

What is a transfer price?

2 Transfer pricing

A transfer price is the price at

which goods or services are

transferred from one division to

another within the same

organisation.

14.

2 Transfer pricing

What are the objectives of a transfer pricing

system?

2 Transfer pricing- Goal congruence: The decisions

made by each profit centre

manager should be consistent

with the objectives of the

organisation as a whole, i.e. the

transfer price should assist in

maximising overall company

profits. A common feature of exam

questions is that a transfer price is

set that results in sub-optimal

behaviour.- Performance measurement: The

buying and selling divisions will be

treated as profit centres. The

transfer price should allow the

performance of each division to be

assessed fairly. Divisional

managers will be demotivated if

this is not achieved.

- Autonomy: The system used to

set transfer prices should seek to

maintain the autonomy of profitcentre managers. If autonomy is

maintained, managers tend to be

more highly motivated but sub-


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.

- Recording the movement of

goods and services: In practice,

an extremely important function of

the transfer pricing system is

simply to assist in recording the

movement of goods and services.

15.

2 Transfer pricing

What are the two main methods for setting a

transfer price?

2 Transfer pricing

Market based approach and the

cost based approach.

16.2 Transfer pricing

What is the market based approach?

2 Transfer pricing

If an external market exists for the

transferred goods then the transfer

price could be set at the external

market price.

17.

2 Transfer pricing

What are the advantages of the market basedapproach?

2 Transfer pricing

- The transfer price should be

deemed to be fair by the

managers of the buying and

selling divisions. The selling

division will receive the same

amount for any internal or external

sales. The buying division will pay

the same for goods if they buy

them internally or externally.

- The company's performance will

not be impacted negatively by the

transfer price because the transfer

price is the same as the external

market price.

2 Transfer pricing

- There may not be an external

market price

-The external market price may

not be stable. For example,

discounts may be offered to


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18.

What are the disadvantages of the market

based approach?

certain customers or for bulk

orders.

- Savings may be made from

transferring the goods internally.

For example, delivery costs will be

saved. These savings should

ideally be deducted from the

external market price before a

transfer price is set.

19.

2 Transfer pricing

What is the cost based approach?

What type of cost should be used and why?

What different type of standard cost can be

used?

2 Transfer pricing

The transferring division would

supply the goods at cost plus a %

profit.

A standard cost should be used

rather than the actual cost since

actual costs do not encourage the

selling division to control costs

and If a standard cost is used, the

buying division will know the cost

in advance and can therefore put

plans in place.Full, marginal and opportunity.

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