ACCA Paper P5 (INT) Advanced Performance management - Pocket notes - Kaplan

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Divisional performance appraisal and transfer pricing

Divisional performance appraisal and transfer pricing Chapter 8

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Interest paid net of tax*

(*so if tax is at 35%, take

interest payments x 0.65)

Deduct: Deduct:

Economic depreciation

(XX)

Non-interest bearing activities (e.g. trade

payables and tax payable)

(XX)

Any impairment in the

value of goodwill

(XX)

NOPAT in cash flow terms XXX Capital invested XXX

Recent exam questions

EVA & RI December 2007 - Question 2

EVA, ROI & RI June 2008 - Question 1

Candidates displayed an inability to calculate EVA and gave advantages when the question clearly

asked for disadvantages.

Exam focus

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Divisional performance appraisal and transfer pricing Chapter 8

Managerial and divisional

performance

Companies need to manage:

the economic performance of a •

manager’s division

the personal performance of the •

divisional manager.

Managerial performance

The key principle in assessing managerial

performance is controllability.

Divisional performance

The key issue to ascertain is whether the

division should be invested in or whether it

should be closed or sold.

Strategic portfolio analysis

tools

Ansoff’s product-market matrix

Ansoff’s matrix can be used to identify

particular strategies and the key areas which

will need monitoring and control.

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The matrix

Existing new

Products

Markets

new Existing

Protect/build

Consolidation•

Marketpenetration•

Costefficiencies•

Market development

newmarketsforexisting•

products

newsegmentsof•

existingmarkets

Diversication

Related•

unrelated•

Product development

newproductsinexisting•

markets

useexistingcapabilities•

ordevelopnewones

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Divisional performance appraisal and transfer pricing Chapter 8

Performance management issues

Protect/build – relatively low risk

How to identify products to divest or •

consolidate?

Investment required for market penetration •

may depress initial performance.

Cost efficiencies (cost cutting) can give •

immediate performance improvements,

but care is needed to ensure that long-

term prospects are not harmed.

Market development – medium risk

Key areas for concern:•

the attractiveness of the new market –

the risk of not fully understanding –

customer needs in the new market

the effectiveness of barriers to entry –

the likely reaction of existing firms –

a lack of an established reputation –

lack of supply-chain infrastructure. –

Time required.•

Product development – medium risk

Key areas for concern:•

the profitability and life of the new –

product

the risk of not fully understanding –

customer needs

estimating development costs –

the likely reaction of existing firms –

producing those products

a lack of an established reputation –

lack of supply-chain infrastructure –

time required. –

Diversification – high risk

Key areas for concern:•

the attractiveness of the new market –

acceptability to stakeholders –

the risk of not fully understanding the –

new business

the risk of applying inappropriate –

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management approaches to radically

different businesses

the potential lack of synergy –

time required. –

Boston Consulting Group matrix

The matrix and specific performance

management issues.

Monitor market growth•

Review cash flow•

Set targets•

Recent exam questions

December 2008 - Question 3a

Exam focus

Notes:

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Divisional performance appraisal and transfer pricing Chapter 8

high low

Relative market share

Market growth

low high

Star

isthehighreinvestment•

beingspenteffectively?

ismarketsharebeing•

gained,heldoreroded?

iscustomerperception•

improving?

arecustomerCsFs•

changingasthemarket

grows?

netcashflow.•

isthestarbecominga•

cashcow.

Cash cow

netcashflow.•

ismarketsharebeing•

eroded–couldthecash

cowbemovingtowards

becomingadog?

Problem child

Investment strategy

ismarketsharebeing•

gained?

Effectivenessofpromotional•

spend.

Divestment strategy

Monitorcontributionto•

seewhethertoexit

quicklyordivestslowly.

Dog

Monitorcontribution•

toseewhethertoexit

quicklyordivestslowly.

Monitormarketgrowth•

asanincreaseinthe

growthratecouldjustify

retainingtheproduct.

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Transfer pricing

Transfer price

The price at which goods and services •

are transferred from one division to

another in the same organisation.

Represents ‘revenue per unit’ to the •

profit centre ‘selling’ the goods or

services and ‘cost per unit’ to the profit

centre ‘buying’ the goods or services.

The objectives of transfer pricing.

To allow the performance of each division •

to be evaluated on the basis of profit.

Motivate managers by maintaining •

autonomy.

Ensure • goal congruence.

Minimise global tax liability by moving •

profits around the world.

Definition

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Setting transfer prices

Production constraints

Transferpriceis

opportunitycostoflost

contributionfromother

product,orextra

contributionwhichwould

beearnedifmoreofscarce

resourcewereavailable.

goodsandservicesshouldbe

transferredatopportunitycost

Surplus capacity

Transferprice:

shouldrecover•

marginalcostsof

supplyingdivision.

lessthanpricebuyer•

wouldpayoutside

companies.

Perfect competition in

market for intermediate

product

Transferatmarket•

price.

possiblesituations

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Practical methods of transfer pricing

Cost plus

producercalculatesunitcost.•

Mayaddmargintoguaranteeprofit.•

usestandardcosttoavoidpassingon•

inefficienciesandensurevariances

reportedindivisionresponsible.

Market price based

perfectcompetitionforproduct.•

Division’sproductmustbesameas•

offeredbymarket.

adjustmarketpriceforcostsnot•

incurredoninternaltransfer.

Issue

supplyingdivisionwantstousetotalabsorptioncosttoensurerecoverfixedoverheads.•

suppliers’fixedcostsbecomevariablecostsforbuyingdivision.Thiscanleadtowrong•

economicdecisions.

Two part pricing

1 Transferatmarginalcost.

2 Fixedsumperannumorperperiodpaidtosupplyingdivisiontowardsxedcostsandto

 helpgenerateaprot.

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General rule

Opportunity cost provides the mathematically

correct transfer price since it induces the

correct decision making behaviour in all

circumstances.

Transfer pricing in multi-national

companies

Important because almost 2/3 world trade

takes place within multi-national companies.

Issues are:

taxation•

remittance controls.•

Taxation

Altering the transfer price between •

divisions in different countries moves

profit between countries.

Anti-avoidance legislation tax authorities •

can treat the transaction as having taken

place at a fair ‘arms length’ price and

revise the profits accordingly.

Remittance controls

Government of host country in which •

investment has been made imposes

restriction on amount of profit returned to

the parent company. This limits parent’s

ability to pay dividends to shareholders.

May be done through exchange controls.•

May be avoided by:•

increasing transfer prices paid by –

foreign subsidiary

lending equivalent of dividend to –

parent company

making payments to parent in other –

forms, for example management

charges.

Foreign government may try to prevent •

the above measures.

Recent exam question

December 2008 - Question 4a.

Exam focus

ACCA Paper P5 (INT) Advanced Performance management - Pocket notes - Kaplan - 2010

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