Question

(1) "Describe the various Responsibility Centers within an organization".

(2) "Describe the Advantages and Disadvantages of using the Return On Investment (ROI) Formula forevaluating the performance of Investment Centers within an organization".

(3) " Describe the Advantages and Disadvantages of using the Residual Income Approach for evaluating the performance of Investment Centers within an organization".

(4) "Discuss the uses and benefits of Transfer Pricing among divisions within an organization".

Answer 1

1) Responsibility centers within an organisation - responsibility centers can be classified by the scope of responsibility assigned and decision- making authority given to individual managers. The following are the four common type of responsibility centers within an organisation.

1) Cost centers- a cost centers is that segment of organisations in which managers are held responsible for the cost incurred in that segment but not for revenues.cost centers managers have control only over the cost not over revenue.

2) Revenue centers- A revenue centers is a segment of the organisation which is primarily responsible for generating sales revenue. The Marketing Manager of a product line, or an individual sales representative are examples of revenue centers. Revenue centers manager does not have any control over cost.

3) profit centers- A profit centers is a segment of an organisation whose manager is responsible for both revenues and costs. The main purpose of a profit centers is to earn profit. Profit centers managers aim at both the production and marketing of a product.

4)Investment centers- An investment centers is responsible for both profits and investments. He also formulate the credit policy of an organisation. The manager of an investment centers has more author­ity and responsibility than the manager of either a cost centers or a profit centers.

2) advantage of using the return on investment forrmula.
1)Better measure of profitability - it ensures that assets are acquired only when they are sure to give returns in consonance with the organisation’s policy.
2) achieving goal congruence- ROI ensures goal congruence between the different divisions and the firm.
3)comparative Analysis -ROI is a good measure because it can be easily compared with the related cost of capital to decide the selection of investment opportunities.
4)performance of investment decisions - Performance of investment center manager can also be assessed advantageously with ROI.
   DISADVANTAGE OF USING ROI
1) Satisfactory definition of profit and investment are difficult to find. Its is difficult to determine what is profit and what is investment because there are many concept od profit and investments.
2)while comparing ROI of different companies it is necessary that comapnies use similar policy. And it is difficult to find companies that uses the same policy as your company follow.
3) ROI may influence a divisional manager to select only investments with high rates of return (i.e., rates which are in line or above his target ROI).

3) ADVANTAGE OF USING THE RESIDUAL INCOME APPROACH
1) Residual income will increase when investment earning above the cost of capital are undertaken and investments earning below the cost of capital are eliminated.
2) Residual income is more flexible since a different cost of capital can be applied to investments with different risk characteristics.
THE DISADVANTAGE OF RESIDUAL INCOME IS THAT:
The disadvantage of RI is that it does not facilitate comparisons between investment centers nor does it relate the size of a center’s income to the investment.

4) benefits of transfer pricing within an organisation
1) Transfer pricing helps in reducing duty costs by shipping goods into countries with high tariff rates at minimal transfer prices so that the duty base of such transactions is fairly low.
2)Reducing income and corporate taxes in high tax countries by overpricing goods that are transferred to countries with lower tax rates help companies obtain higher profit margins.

USES OF TRANSFER PRICING
1) Multinational corporation use transfer pricing as a method of allocating profits among its various subsidiary within an organisation.
2) If a subsidiary company sells goods to a parent company, the cost of those goods paid by the parent to the subsidiary is the transfer price.