ACCT5996: Management Accounting & Business Analysis
Management Accounting & Business Analysis
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ACCT5996: Management Accounting & Business Analysis
Recall: responsibility centres
ð A unit in an organisation where the manager is held accountable for the
unit’s activities and performance
Recall: responsibility accounting
ð Assigning responsibility to managers
Responsibility centres and accounting
2
ACCT5996: Management Accounting & Business Analysis
Centralised
ð Decisions are made at the very top level, and lower
level managers are charged with implementing
these decisions.
Decentralised
ð Allows managers at lower levels to make and
implement key decisions pertaining to their areas
of responsibility.
Each approach structures the relationship
between top management and
responsibility centres differently.
Approach to managing responsibility centres
3
ACCT5996: Management Accounting & Business Analysis
Centralisation v decentralisation
4
ACCT5996: Management Accounting & Business Analysis
“Keeping it real”: Decentralisation at Wesfarmers
5
ACCT5996: Management Accounting & Business Analysis
Costs of decentralisation
ð Narrow focus on own unit’s goals
ð Unnecessary duplication
Goal congruence: a behavioural
challenge
ð May be difficult to achieve in a
decentralised organisation
ð Performance measures and reward
systems may provide direction and
incentives
6
Decentralisation: Issues to consider
ACCT5996: Management Accounting & Business Analysis
What is it?
ð Price used when goods and services are
transferred between responsibility centres.
Why do it?
ð Important responsibility accounting tool,
particularly in decentralised organisation.
ð Allows selling unit to earn profit to reflect
their effort in producing the product
How can they be they set?
ð Autonomously by profit centre managers.
ð Intervention by corporate (inconsistent with
the decentralisation philosophy).
ð Corporate policies to govern transfer pricing.
7
Transfer pricing
ACCT5996: Management Accounting & Business Analysis
Market-based prices
ð Need competitive external markets
Negotiated prices
ð Market price may form the starting point
ð Cost may be the lower boundary
ð Consider spare capacity
Cost-plus prices
ð No external market price
ð Intermediate products
ð Standard variable cost plus mark-up
ð Standard absorption cost
ð Standard costs should always be used in favour of actual costs
8
Transfer pricing methods
ACCT5996: Management Accounting & Business Analysis
General transfer pricing rule
ð Provides guidance on the appropriate transfer price
ð Represents a minimum transfer price
ð May guide unit managers to make goal-congruent decisions
9
Transfer pricing
Transfer price = Additional
layout costs
per unit
+ Opportunity
cost to the
supplying
unit
ACCT5996: Management Accounting & Business Analysis
Scenario 1: An external market and spare capacity in the
supplying unit
ð Where there is spare capacity the transfer of product gives the supplying
unit additional profits that it would not otherwise have
ð The two units may negotiate a transfer price less than the market price
to provide an incentive for the buying unit to purchase from the
supplying unit
Scenario 2: An external market and no spare capacity in
the supplying unit
ð When there is no spare capacity the supplying unit will need to take
account of the opportunity cost of lost profits
10
Transfer pricing under different scenarios
ACCT5996: Management Accounting & Business Analysis
Scenario 3: External market and limited capacity in the
supplying unit
ð Where capacity is limited an opportunity cost needs to be accounted for
Scenario 4: No external market and spare capacity in the
supplying unit
ð There is no opportunity cost associated with the transfer so the transfer
price may be based on cost-plus
Scenario 5: No external market and no spare capacity in
the supplying unit
ð The transfer price will need to account for opportunity cost on lost sales
11
Transfer pricing under difference scenarios
ACCT5996: Management Accounting & Business Analysis
The effect of income tax
ð Effectively ‘transfer profits’ between business units in different countries
ð International transfer prices may be influenced by the different taxation
rates and different regulations
ð International tax considerations
ð Service firms and not-for-profit organisations
12
Transfer pricing issues
ACCT5996: Management Accounting & Business Analysis
Summary financial
performance measures used to
evaluate investment centre
performance.
ð Return on investment (ROI)
ð Residual income (RI)
ð Economic value added (EVA)
13
Financial measures in investment centres
ACCT5996: Management Accounting & Business Analysis
ð Invested capital: Assets investment centre has available to generate
profit
ð Return on sales: % of each sales dollar remaining as profit after
expenses covered
ð Investment turnover: Number of sales $ generated by every $ of
invested capital
ð
turnoverinvestment saleson return
capital invested
revenue sales
revenue sales
profit
capital invested
profit ROI
´=
´=
=
14
Return on investment
ACCT5996: Management Accounting & Business Analysis
ROI opportunities:
ð Increase return on sales
ð Increase the selling price or sales
revenue, or decrease expenses
ð Increase investment turnover
ð Increase sales revenue or reduce
invested capital
Actions taken only to make
these ratios more favourable in
the short term may have
adverse effects on performance
(now and/or in future).
15
Return on investment (cont.)
ACCT5996: Management Accounting & Business Analysis
ROI Strengths
ð Encourages managers to focus on both profits and assets required to
generate those profits
ð Can be used to evaluate the relative performance of investment centres,
even when those business units are of different sizes
ROI Weaknesses
ð May encourage managers to focus on improving short-term financial
performance
ð May encourage managers to defer asset replacement, to maintain a high
ROI
ð Discourages managers from investing in projects that are acceptable
from the organisation’s point of view
16
Return on investment (cont.)
ACCT5996: Management Accounting & Business Analysis
What is it?
ð= profit – (invested capital × imputed interest rate)
Imputed interest charge
ð Required rate of return the firm expects of its investments (cost of
capital)
17
Residual income
ACCT5996: Management Accounting & Business Analysis
Strengths
ð More likely to promote organisational goal congruence, compared to ROI
ð Takes account of organisation’s reqd rate of return in measuring
performance
ð Encourages investment in projects which yield a positive residual income
to the organisation
Weaknesses
ð Cannot be used to assess the relative performance of businesses that are
of different sizes, unlike ROI
ð Formula is biased in favour of larger businesses, unlike ROI
ð Can encourage short-term orientation/focus, as with ROI
18
Residual income (cont.)
ACCT5996: Management Accounting & Business Analysis
What is it?
ð Measures the value created over a single
accounting period
ð The spread between the return generated by the
business activities and the cost of capital
EVA = NOPAT – (Capital Employed x WACC)
19
Economic value added
ACCT5996: Management Accounting & Business Analysis
To improve EVA
ð Improve profitability without employing
additional capital
ð Borrow additional funds when the
profits earned are more than the cost of
borrowing
ð Pay off debt by selling assets
20
Economic value added (cont.)
ACCT5996: Management Accounting & Business Analysis
What are they?
ð Processes, practices and systems
that are used to motivate
employees through pay and other
benefits
Types of Motivation
ð Intrinsic: Derives from the interest
and enjoyment of the work
ð Extrinsic: Derives from sources
outside the individual
How to motivate?
ð Theories of motivation can design of
performance evaluation and
incentive schemes
21
Incentive systems
ACCT5996: Management Accounting & Business Analysis 22
Herzberg’s theory of work motivation
ðHygiene factors
ð Provide setting for encouraging employee
motivation, but do not themselves motivate
employees
ð E.g. Working conditions, wage levels,
rules/regulations, relationships with
colleagues, job security
ðMotivators
ð Factors that relate to job content and which
provide employee motivation
ð Achievement, recognition, the nature of the
work, responsibility, opportunities for
personal growth
Theories of motivation
ACCT5996: Management Accounting & Business Analysis
Expectancy theory
ð Employee motivation is a result of the strength of the relationships
between expectancy, instrumentality and valence
ð Expectancy: perception that effort will lead to a certain performance
ð Instrumentality: perception that performance will lead to desired outcome
ð Valence: the attractiveness of the reward
23
Theories of motivation (cont.)
ACCT5996: Management Accounting & Business Analysis
Individual incentive plans
ð Individuals are rewarded for achieving individual
performance targets
ð Subjective criteria may also be used
ð Commonly used at the higher levels of an
organisation
Profit-sharing plans
ð Cash bonuses are paid to each employee, based on
a specified percentage of the company’s profit
ð Does not tie individual effort to individual rewards
Employee share plans (share option plans)
24
Performance-related pay systems
ACCT5996: Management Accounting & Business Analysis
Gainsharing
ð Cash bonuses are distributed to employees based on some performance
target exceeded
Team-based incentive schemes
ð Individuals are rewarded based on their work team exceeding targets
ð Intended to encourage teamwork and cooperation between employees
ð Does not tie individual effort to individual rewards
25
Performance-related pay systems
ACCT5996: Management Accounting & Business Analysis
Consider the following issues
ð Identification with the group
ð Equity among employees
ð Competitiveness between employees
ð Relating individual effort to reward
ð Rewarding only good performers
The timing of incentive payments
can be crucial to achieving desired
outcomes