Bài giảng môn Kế toán, kiểm toán - Chapter 13: investment centers and transfer pricing

Residual Income

As a manager at Flower Co., would you invest the $100,000 if you were evaluated using residual income?

Would your decision be different if you were evaluated using ROI?

 

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Investment Centers and Transfer PricingChapter 13Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.Decision-Making is pushed down.Delegation of Decision Making (Decentralization)Decentralization often occurs as organizations continue to grow.13-2DecentralizationAdvantagesAllows organization to respond more quickly to events.Frees top management from day-to-day operating activities.Uses specialized knowledge and skills of managers.13-3DecentralizationChallengeGoal Congruence: Managers of the subunits make decisions that achieve top-management goals.13-4Return on Investment (ROI)ROI = IncomeInvested CapitalROI = IncomeSales Revenue×Sales RevenueInvested CapitalSalesMarginCapital Turnover13-5Return on Investment (ROI)Holly Company reports the following: Income $ 30,000 Sales Revenue $ 500,000 Invested Capital $ 200,000Let’s calculate ROI.13-6ROI = IncomeSales Revenue×Sales RevenueInvested CapitalReturn on Investment (ROI)ROI = $30,000$500,000×$500,000$200,000ROI = 6% × 2.5 = 15% 13-7Economic Value AddedEconomic value added tells us how much shareholder wealth is being created.13-8Economic Value Added Investment center’s after-tax operating income– Investment charge = Economic Value Added Weighted- average cost of capitalInvestment center’stotal assetsInvestment center’s current liabilities–()After-tax cost of debtMarket value of debtCost of equity capitalMarket value of equity(())Market value of debtMarket value of equity13-9Improving R0IThree ways to improve ROIIncreaseSales PricesDecrease Expenses Lower Invested Capital 13-10Residual IncomeAs a manager at Flower Co., would you invest the $100,000 if you were evaluated using residual income?Would your decision be different if you were evaluated using ROI? 13-11Residual IncomeResidual income encourages managers to make profitable investments that wouldbe rejected by managers using ROI.13-12Gross or Net Book Value($100,000 – $0) ÷ 10 = $10,000 per year$100,000 – $10,000 = $90,000 net book value13-13Gross or Net Book Value$15,000 ÷ $100,000 = 15%$15,000 ÷ $90,000 = 16.67%Since older assets, with lower net book values, result in higher ROI, managers are discouraged from investing in new assets. 13-14Measuring Investment Center Income Division managers should be evaluated on profit margin they control.Exclude these costs:Costs traceable to the division but not controlled by the division manager.Common costs incurred elsewhere and allocated to the division.The key issue is controllability.13-15Transfer Pricing The transfer price affects the profit measure for both the selling division and the buying division.A higher transfer price for batteries means . . . greaterprofits for thebattery division.Auto DivisionBattery Divisionlower profits for theauto division.13-16Goal CongruenceThe ideal transfer price allows each division manager to make decisions that maximize the company’s profit, while attempting to maximize his/her own division’s profit.13-17General-Transfer-Pricing RuleTransferpriceAdditional outlay cost per unit incurred because goods are transferredOpportunity cost per unit to theorganization because of the transfer=+13-18Centrally Established Transfer PricesAs a general rule, a market price-based transfer pricing policy contains the following guidelines . . . The transfer price is usually set at a discount from the cost to acquire the item on the open market. The selling division may elect to transfer or to continue to sell to the outside.13-19Negotiating the Transfer PriceA system where transfer prices are arrived at through negotiation between managers of buying and selling divisions.Much management time is used in the negotiation process.Negotiated price may not be in the best interest of overall company operations. 13-20Cost-Based Transfer PricesSome companies use the following measures of cost to establish transfer prices . . .Variable costFull absorption costBeware of treating unit fixed costs as variable. 13-21Behavioral Issues: Risk Aversion and IncentivesThe design of a managerial performance evaluation system using financial performance measures involves a trade-off between:Incentives for the manager to act in the organization’s interests.Risks imposed on the manager because financial performance measures are only partially controlled by the manager.And13-22Goal Congruence and Internal Control Systems A well-designed internal control system includes a set of procedures to prevent these major lapses in responsible behavior:Fraud.Corruption.Financial Misrepresentation.Unauthorized Action.13-23

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