What is responsibility accounting?
Responsibility accounting is used to measure the performance of decentralised units.
What are the advantages of decentralisation?
- Quicker decisions
- More motivated management
- Better decisions due to local knowledge
- Reduced head office bureaucracy
- Better training for all levels of management
What are the disadvantages of decentralisation?
- duplication in divisions i.e. greater cost
- senior management loss of control
- potential dysfunctional decision making i.e. not in interests of whole company.
What are the conditions for a good performance measure?
- Goal congruence
- Accountability
- Long term and short objectives recognised.
What is the formula for return on investment (ROI)?
(Divisional Profit / Divisional Investment) x 100
When calculating ROI do we use profit before or after tax?
PBIT (controllable profit)
How do we calculate divisional investment when calculating the ROI?
Either:
- Opening book value of TALCL
- Average of BOP and EOP balances of TALCL
What is the decision rule for ROI?
Only projects which increase the existing ROI should be undertaken.
What are the problems with ROI?
- Dysfunctional behaviour - only ROI increasing projects accepted - could be at expense of growth in corporate profits.
- Ratio will be distorted by age of the assets
- Profit can be manipulated.
What is the alternative to ROI?
Residual income.
What is the formula for Residual Income?
PBIT - Imputed Interest
What is imputed interest?
Divisional Investment x Cost of Capital
What is the purpose of RI?
To provide an absolute hurdle figure for profit based on the company’s minimum percentage return from a division.
What are the advantages of RI?
- Avoids dysfunctional behaviour - uses the group cost of capital in the decision - so bringing in company’s minimum return based on company view not division view.
- Different costs of capital can be used to reflect risk.
Which out of ROI and RI are used more frequently in practise and why?
ROI
- dysfunctional behaviour is not material
- ROI is consistent with ROCE (corporate assessment)
- %’s more easily understood
- RI requires cost of capital.
If RI is positive what is the decision?
Return > return demand from investment so undertake project
If RI is negative what is the decision?
Don’t undertake the project as we don’t get enough return.
What is transfer pricing?
A transfer price is the price at which goods are transferred internally.
Why is transfer pricing necessary?
Division receiving goods should be charged in order for performance to be measure equitably.
What is the overriding question when selecting a transfer price?
Whether the transfer price is in the company’s best interest.
What are the goals of transfer pricing?
- goal congruence
- equitable performance management
- retain divisional autonomy (div manager decision to buy which..)
- motivate divisional managers
- optimum resource allocation
