Residual Income Residual income approach has one major disadvantage It cant be

Residual income residual income approach has one

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Residual Income Residual income approach has one major disadvantage. It can't be used to compare the performance of divisions of different sizes. When comparing investment centers, it is probably better to focus on the percentage change in residual income from year to year rather than on the absolute amount of the residual income.
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Transfer Pricing (1 of 2) Transfer pricing : price charged for the internal sale of products between two different divisions of the same company Becomes sales revenue to selling division Becomes a cost to the buying division Affects operating income, ROI, sales margin, and residual income Optimize overall profitability by encouraging a transfer price only if the company would benefit from the exchange
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Transfer Pricing (2 of 2) Optimize overall profitability by encouraging a transfer price only if the company would benefit from the exchange Vertical integration: purchasing other companies within one’s supply chain to maximize profits
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Strategies for Determining Transfer Price
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Global Considerations Do the divisions operate under different taxing authorities such that income tax rates are higher for one division than the other? Would the amount paid for customs and duties be impacted by the transfer price?
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Flexible Budget Flexible budget: A budget prepared for a different level of volume than the one originally anticipated “Apples-to-apples” comparison For performance evaluation purposes at the end of the period Actual sales volume x Budgeted assumptions Master budget variance: difference between the actual revenues and expenses and the master planning budget “Apples-to-oranges” comparison Master budget—planning purposes at the beginning of the period
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Volume Variance Volume variance: the difference between the master budget and the flexible budget Arises only because the actual volume differs from the volume originally anticipated in the master budget
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Flexible Budget Variance Flexible budget variance: difference between the flexible budget and actual results Highlights variance due to causes other than volume
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Investigating Causes for the Variances Management by exception Need performance reports to understand how operational decisions affected the company’s finances Manufacturing cost variances receive a great deal of attention
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