Accounting Q&A · Cost and Management Accounting · Topic 18
Work through the questions, then reveal the answers to check your reasoning.
25 short-answer questions. Try each question before revealing its answer.
Worked example
An internal component has a variable cost of 30. The selling division has spare capacity, and an outside supplier charges 42 for an equivalent component. A range of 30 to 42 may support an internal transfer.
Core concepts
1. What is responsibility accounting?
Reports results by areas of authority so managers can evaluate and improve performance.
2. What is a cost centre?
An area accountable for controllable costs.
3. What is a revenue centre?
An area primarily accountable for revenue generation.
4. What is a profit centre?
An area accountable for both revenues and costs within its authority.
5. What is an investment centre?
An area accountable for profit and use of invested assets.
6. What is the controllability principle?
Assess managers mainly on items they can influence within the relevant period.
7. Why separate allocated central costs?
Managers may have limited influence over central spending or the allocation basis.
8. What is a transfer price?
The internal price applied to a transfer between divisions.
9. Why use transfer prices?
They affect divisional profit, performance incentives and resource allocation.
10. What is the seller’s usual minimum transfer price?
Incremental cost plus contribution forgone on the best displaced alternative.
Worked applications
11. Variable cost is 20 with spare capacity. What is the seller’s minimum?
20 assuming no additional costs or alternative use.
12. If external sales are displaced and lost contribution is 8 per unit, what is the minimum?
28.
13. If an identical outside component costs 32, what is the buyer’s usual maximum?
32, adjusted for relevant differences in quality, freight or service.
14. If seller minimum is 28 and buyer maximum is 32, what is the negotiation range?
28 to 32 under these assumptions.
15. What is a market-based transfer price?
An internal price anchored to a comparable external market.
16. What is a cost-based transfer price?
A price based on stated costs, possibly with a markup.
17. What is dual pricing?
The divisions record different prices and headquarters reconciles the difference.
18. Why can divisional incentives conflict with company profit?
A transfer can improve group results while reducing one division’s reported profit.
19. What is linear programming used for?
Optimising a linear objective subject to linear constraints.
Review and exam practice
20. What is the objective function?
The quantity to maximise or minimise, such as total contribution.
21. What is a binding constraint?
A limit fully used at the chosen optimum.
22. What is slack in a capacity constraint?
Capacity left unused in the solution.
23. What is a shadow price?
The marginal value of relaxing a binding constraint within its applicable range.
24. What is expected value?
The probability-weighted average of possible outcomes.
25. What should a quantitative plan explain?
State assumptions, capacity, opportunity costs, decision criteria and sensitivity.