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Assignment. Course Title - Cost & Management Accounting (MGT-5105). Course Teacher - Mr. Md. Quamrul Islam (Associate Professor,JNU). Topic - Investment Center & Transfer Pricing. Section - B , Group H . Roll Range : 094963 094972.
Introduction :
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The creation of divisions allows for the operation of a system of responsibility accounting. Responsibility accounting is a system of accounting that segregates revenues and costs into areas of personal Responsibility in order to monitor and asses the performance of each part of an organization. A Responsibility center is a department or organizational function whose performance is the direct responsibility of a specific manager. In the weakest form of decentralization a system of cost centers might be used. As decentralization becomes stronger the responsibility accounting framework will be based around profit centers. In its strongest form investment centers are used.
model, and is pictured at under(Figure 1.1).This model consists of a margin subcomponent (Operating Income/Sales Revenue) and a turnover subcomponent (Sales Revenue/Invested Capital).These two subcomponents can be multiplied to arrive at the ROI.Thus, ROI=(Operating Income/Sales Revenue) (Sales Revenue/Invested Capital).A bit of algebra reveals that ROI reduces to Operatin a much simpler formula: Operating Income/Invested Capital.
g income Sales
Revenue
Sales
Margin
Tournove r
Figure:1.1 But, a prudent manager who is to be evaluated under the ROI model will quickly realize that the subcomponents are important. Notice that ROI can be increased by any of the following actions: increasing sales, reducing expenses, and/or decreasing the deployed assets. The DuPont approach encourages managers to focus on increasing sales, while controlling costs and being mindful of the amount invested in productive assets. A disadvantage of the ROI approach is that some "profitable" opportunities may be passed by managers because they fear potential dilution of existing successful endeavors.
ROI=(Operating Income/Sales Revenue) (Sales Revenue/Invested Capital) ROI=(800000 / 60000000) (60000000 / 4000000) ROI=0.133 15=20 %. OR, ROI=Operating Income /Invested Capital ROI =8000000/40000000 ROI=0.2 100=20%.
Limitations
1.Goal congruency issue: incentive for 2.Comparable to interest rates and the high ROI units to invest in projects with ROI higher than the minimum rates of return on alternative rate of return but lower than the units investments. current ROI. 3.Widely used and reported in the 2.Comparability across SBUs can be business press. problematic.
Though ROI and RI have the same roots and results, RI proves better in certain circumstances as explained below: If ROI is made a criteria, managers would be reluctant to make additional investment in fixed assets as it may bring down the ROI. In previous example, a manager was happy with an ROI of 20%. If an additional sum of Tk.10 million is made which would bring incremental return of Tk.1.2 million, this would bring down overall ROI to 18.4% {(8 m+ 1.2 m) / (40 m + 10 m)}.
But RI would give results in monetary term which would show an increase. Supposing, Cost of Fund (minimum required returns) was 10%, RI in the foregoing example, before additional investment, would be Tk.4 million {(8m - (40 m x 10%)}. With additional Investment and the returns, it would increase to Tk.4.2 million (8m+1.2m) - {(40 m + 10m) x 10%}. Thus RI would increase by Tk.200,000 which is a good sign.
companies. Economic Value Added (EVA) sharpens the view of corporate governance by redefining its goal. It has long been accepted that companies should seek to maximize profits. The firm of Stern and Stewart attempts to change the target somewhat by saying that shareholders will benefit if the firm maximizes EVA instead of accrual profits. Economic value added (EVA) uses accounting information to improve decisions and motivate employees. According to Erik Stern, president international of Stern Stewart, Although EVA is based on accounting, when implemented the system must be simple and operational or it is irrelevant.EVA is not a metric but a way of thinking, a mindset. While the language is technical, the lifestyle is operational.Central to the concept is the idea of opportunity cost.Capital is used in each division of the organization. That division is required to earn a rate of return based on the amount of capital it uses and the cost of that capital.The firms cash flow is subtracted from the required profits, based on the rate of return, to give economic profits. Using this method, the divisions earning the highest returns are favored. More capital is invested in them. Those which earn less but are still above the target return also receive capital allocations. Divisions below the target return are reevaluated. These are sold off if it appears they will be unable to meet the threshold. The term used for terminating a division is harvesting. The thinking is that the division may have grown ripe (mature),thereby making it eligible for harvest (sale or discontinuation).
Calculation of EVA:
The basic formula for calculating EVA is : Net Sales
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Operating Expenses Operating Profit(EBIT) Taxes Net Operating Profit After Tax (NOPAT)
Capital budgeting.
Corporate valuation.
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Transfer Price
To motivate managers. To provide an incentive for managers to make decisions consistent with the firms goals To provide a basis for fairly rewarding managers. Minimization of customs charges. Minimize total (i.e., worldwide) income taxes. Currency restrictions. Risk of expropriation (government seizure).
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Here, the general transfer rule and the external market price are equal.
The long-run average external market price should be used, because distressed market prices can severely affect transfer pricing profitability.
The biggest drawback with using variable cost is that when excess capacity exists, the selling unit cant show contribution margin on the transferred goods. 4.Full Cost Based Transfer Pricing
The biggest drawback affects the buying units view of costs as fixed for the company as a whole as the variable costs for the buying unit.
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