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23

Performance Evaluation for Decentralized

Operations

Student Version

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1

Describe the advantages and disadvantages of decentralized operations.

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In a decentralized company, managers of separate divisions or units are delegated operating responsibility. The division (unit) managers are responsible for planning and controlling the operations of their divisions.

Decentralized Operations

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Responsibility accounting is the process of measuring and reporting operating data by responsibility centers. Three common types of responsibility centers are—• Cost centers• Profit centers• Investment centers

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2

Prepare a responsibility accounting report for a cost center.

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To Vice President’s Budget Performance Report

from Supervisor, Department 1, Plant A’s Budget Performance Report

(continued)

Responsibility Accounting Reports for Cost Centers (continued)

Exhibit 3

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To Manager, Plant A’s Budget Performance Report

Responsibility Accounting Reports for Cost Centers (concluded)

Exhibit 3

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3

Prepare responsibility accounting reports for a profit center.

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In a profit center, the unit manager has the responsibility and the authority to make decisions that affect both costs and revenues (and thus profits).

Profit Center

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Service Department Charges

Services provided by internal centralized service departments are often more efficient than services contracted with outside providers. An internal service cost is called a service department charge.

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Profit Center Reporting

The income from operations is a measure of a manager’s performance. In evaluating the profit center manager, the income from operations should be compared over time to a budget. However, it should not be compared across profit centers.

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4

Compute and interpret the rate of return on investment, the residual income, and the balanced scorecard for an investment center.

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An investment center manager has the responsibility and the authority to make decisions that affect not only costs and revenues, but also the assets invested in the center.

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Investment Center

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Revenues

Revenues

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Investment Turnover

Profit Margin

Profit$$$

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Investment Turnover

Profit Margin

Profit margin is the ratio of income from operations to sales

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Investment turnover is the ratio of sales to invested assets

Investment Turnover

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Rate of Return on Investment

One measure that considers the amount of assets invested in an investment center is the rate of return on investment (ROI) or rate of return on assets.

ROI =

Income from Operations

Invested Assets

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Income from Operations

SalesSales

Invested Assets×ROI =

DuPont Formula

Profit Margin

Profit Margin

Investment Turnover

Investment Turnover

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ROI =$ 70,000

$560,000×

$560,000

$350,000

ROI = 12.5% × 1.6

DataLink’s Northern Division (ROI)

Income from Operations

SalesSales

Invested Assets×ROI =

ROI = 20%

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ROI =$ 84,000

$672,000×

$672,000

$700,000

ROI = 12.5% × 0.96

Income from Operations

SalesSales

Invested Assets×ROI =

ROI = 12%

DataLink’s Central Division (ROI)

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ROI =$ 75,000

$750,000×

$750,000

$500,000

ROI = 10% × 1.5

Income from Operations

SalesSales

Invested Assets×ROI =

ROI = 15%

DataLink’s Southern Division (ROI)

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DataLink’s Northern Division Proposal

Assume that the revenues of the Northern Division could be increased by $56,000 through increasing advertising to $385,000.

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Revenues ($560,000 + $56,000) $616,000Operating expenses 385,000Income from operations before

service department charges $231,000Service department charges 154,000Income from operations $ 77,000

Projected Impact of Change

Increase of $7,000

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ROI =$ 77,000

$616,000×

$616,000

$350,000

ROI = 12.5% × 1.76

DataLink’s Northern Division (ROI) Revised

Income from Operations

SalesSales

Invested Assets×ROI =

ROI = 22%

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Residual Income

Residual income is the excess of income from operations over a minimum acceptable income from operations.

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Northern Central SouthernDivision Division Division

Income from operations $70,000 $84,000$75,000Minimum acceptable income

from operations as a percent of invested assets:

$700,000 × 10% 70,000

$500,000 × 10% 50,000

Residual income $35,000 $14,000$25,000

$350,000 × 10% 35,000

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The balanced scorecard is a set of financial and nonfinancial measures that reflect multiple performance dimensions of a business.

The Balanced Scorecard

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5

Describe and illustrate how the market price, negotiated price, and cost price approaches to transfer pricing may be used by decentralized segments of a business.

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When divisions transfer products or render services to each other, a transfer price is used to charge for the products or services.

Transfer Pricing

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Market Price Approach

Using the market price approach, the transfer price is the price at which the product or service transferred could be sold to outside buyers.

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The negotiated price approach allows the managers of decentralized units to agree (negotiate) among themselves as to the transfer price.

Negotiated Price Approach

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Comparison of Exhibits 10 and 11

Income from Operations

No Units Transferred (Exhibit 10)

20,000 Units Transferred at $15 per Unit (Exhibit 11)

Increase (Decrease)

Eastern Division $200,000 $300,000 $100,000Western Division 100,000 200,000 100,000Wilson Company $300,000 $500,000 $200,000

Variable Costs per Unit < Transfer Price < Market Price

$10 < Transfer Price < $20

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Cost Price Approach

Under the cost price approach, cost is used to set transfer prices. Cost may refer to either total product cost per unit or variable cost per unit.

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