BU247 Chapter Notes - Chapter 11: Accounts Receivable, Transfer Pricing, Profit Center

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6 Mar 2013
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BU247 Chapter 11 Financial Control Week 12
Evaluating Responsibility Centres
Using the Controllability Principle to Evaluate Responsibility Centres
-The controllability principle states that the manager of a responsibility centre should be assigned
responsibly only for the revenues, costs, or investments responsibility centre personnel control
-Revenues, costs, and investments that people outside the responsibility centre control should be
excluded from the assessment of the centre’s performance
-A significant problem in applying the controllability principle is that in most organizations many
revenues and costs are jointly earned or incurred
-The activities that create the final product in this company are sequential and highly interdependent
-Processing should be evaluated as a cost centre
-The choice of the performance measure should influence decision-making behaviour
Using Segment Margin Reports
-The profit measure is so comprehensive and pervasive that organizations prefer to treat many of their
organization units as profit centres
-The segment margin report divides the organization into responsibility centres
-One column is devoted to ach profit centre
-Organizations use different approaches to evaluate whether the segment margin numbers are good or
bad:
1. Past performance Is performance this period reasonable, given past experience?
2. Comparable organizations How does performance compare with similar organizations?
-Segment margin statements should be interpreted carefully because they reflect many assumptions
that disguise underlying issues
-The segment margin report contains arbitrary numbers because they rely on subjective revenue and
cost allocation assumptions over which there can be legitimate disagreement these arbitrary numbers
are called soft numbers
-The revenue figures reflect important assumptions and allocations that sometimes can be misleading
-Organizations need to design and present responsibility centre income statements so that they isolate
the discretionary components included in the calculation of each centre’s reported income
-Conventional segment margin statements cannot capture the interactive effects of such actions
-Responsibility centre income statements have to be interpreted with considerable caution and healthy
skepticism
Transfer Pricing
-Transfer pricing is the set of rules an organization uses to allocate jointly earned revenue among
responsibility centres
-Transfer pricing rules can be arbitrary when a high degree of interaction exists among the individual
responsibility centres
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Document Summary

Using the controllability principle to evaluate responsibility centres. The controllability principle states that the manager of a responsibility centre should be assigned responsibly only for the revenues, costs, or investments responsibility centre personnel control. Revenues, costs, and investments that people outside the responsibility centre control should be excluded from the assessment of the centre"s performance. A significant problem in applying the controllability principle is that in most organizations many revenues and costs are jointly earned or incurred. The activities that create the final product in this company are sequential and highly interdependent. Processing should be evaluated as a cost centre. The choice of the performance measure should influence decision-making behaviour. The profit measure is so comprehensive and pervasive that organizations prefer to treat many of their organization units as profit centres. The segment margin report divides the organization into responsibility centres. Organizations use different approaches to evaluate whether the segment margin numbers are good or bad:

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