Click to edit Master title style 1 Performance Evaluation for Decentralized Operations 23.

Click to edit Master title style

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Performance Performance Evaluation for Evaluation for Decentralized Decentralized

OperationsOperations

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Separating a business into divisions or operating units

and delegating responsibility to unit managers is called

decentralization.

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Decentralized Operations


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It allows managers to focus on acquiring expertise in their areas of responsibility.

Advantages of Decentralization 23-1

Decentralizing decision making provides excellent training for managers.

Decentralization helps managers create good customer relations by responding quickly to customers’ needs.

Managers often become more creative in suggesting operating and product improvement.


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Decisions made by one manager may negatively affect the profitability of the entire company.

Disadvantages of Decentralization 23-1

A potential disadvantage is duplication of assets and costs in operating divisions (e.g., each manager of a product line might have a separate sales force and administrative staff ).


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Responsibility Accounting

In a decentralized business, an important function of accounting is

to assist unit managers in evaluating and controlling their areas of responsibility, called

responsibility centers.

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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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The three centers differ in their scope of responsibility, as shown below:

Cost Center Profit Center Investment Center

Cost Revenue– Cost Profit

Revenue– Cost Profit Investment in

assets

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Responsibility Accounting for Cost Centers

In a cost center, the unit manager has

responsibility and authority for controlling

the costs incurred.

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Responsibility Accounting Reports for Cost Centers (continued)

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Responsibility Accounting Reports for Cost Centers

from Manager, Plant A Budget Performance Report

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(Continued)


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To Vice President’s Budget Performance Report

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

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(Continued)


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To Manager, Plant A’s Budget Performance Report

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(Concluded)


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Responsibility Accounting for Profit Centers

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).

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Controllable revenues are revenues earned by the profit

center. Controllable expenses are costs that can be influenced (controlled) by the decisions of

the profit center managers.

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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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NEG Example

NEG’s expenses for the year ended Decem-ber 31, 2008 for each service department are as follows:

Purchasing $400,000Payroll Accounting 255,000Legal 250,000 Total $905,000

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23(Continued)


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NEG Example

The activity base for each service depart-ment is a measure of the services performed. For NEG, the following applies:

Purchasing Number of purchaserequisitions

Payroll Accounting Number of payroll checks

Legal Number of billed hours

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(Continued)


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NEG Example

Purchasing

Theme Park Division 25,000 purchase requisitionsMovie Production Division 15,000Total 40,000 purchase requisitions

$400,000

40,000 purchase requisitions= $10 per purchase requisition

Service Usage

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(Continued)


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NEG Example

Service Usage

Payroll Accounting

Theme Park Division 12,000 payroll checksMovie Production Division 3,000 Total 15,000 payroll checks

$255,000

15,000 payroll checks= $17 per payroll check

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(Continued)


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NEG Example

Service Usage

Legal

Theme Park Division 100 billed hoursMovie Production Division 900 Total 1,000 billed hours

$250,000

1,000 hours= $250 per hour

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(Concluded)


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Service Department Charges to NEG Divisions

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Example Exercise 23-2

The centralized legal department of Johnson Company has expenses of $60,000. The department has provided a total of 2,000 hours of service for the period. The East Division has used 500 hours of legal service during the period, and the West Division has used 1,500 hours. How much should it be charged for legal services?


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For Practice: PE23-2A, PE23-2B

Follow My Example 23-2

Manufacturing Division Service Charge for Legal Department:

$15,000 = 500 billed hours x ($60,000/2,000 hours)

Sales Division Service Charge for Legal Department:

$45,000 = 1,500 billed hours x ($60,000/2,000 hours)


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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.

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Responsibility Accounting for Investment Centers

In an investment center, the unit 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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Divisional Income Statements—DataLink Inc.

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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.

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Rate of return on investment is one of the most widely used measures for investment centers and is computed as follows:

Rate of return on investment (ROI) =

Income from operationsInvested assets

The higher the rate of return on investment, the better the division utilizes its assets to generate income.

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Income from operation

Sales

Sales

Invested assetsxROI =

DuPont Formula

Profit Margin

Profit Margin

Investment Investment TurnoverTurnover

Investment Investment TurnoverTurnover

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ROI =$ 70,000

$560,000x

$560,000

$350,000

ROI = 12.5% x 1.6

DuPont’s Northern Division (ROI)


Sales

Sales


ROI = 20%

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ROI =$ 84,000

$672,000x

$672,000

$700,000

ROI = 12.5% x 0.96

DuPont’s Central Division (ROI)


Sales

Sales


ROI = 12%

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ROI =$ 75,000

$750,000x

$750,000

$500,000

ROI = 10% x 1.5

DuPont’s Southern Division (ROI)


Sales

Sales


ROI = 15%

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Campbell Company has income from operations of $35,000, invested in assets of $140,000, and sales of $437,500. Use the DuPont formula to compute the rate of return on investment and show (a) the profit margin, (b) the investment turnover, and (c) the rate of return on investment.


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a. Profit margin =$35,000

$437,500= 8%

b. Investment turnover =$437,500

$140,000= 3.125

c. Rate of return on investment =

8% x 3.125 = 25%


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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 assets:

$700,000 x 10% 70,000

$500,000 x 10% 50,000

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

$350,000 x 10% 35,000

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The Wholesale Division of PeanutCo has income from operations of $87,000 and assets of $240,000. The minimum acceptable rate of return on assets is 12%. What is the residual income for the division?


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Income from operations $87,000Minimum acceptable income

from operations as a percent of assets: $240,000 x 12% (28,800)

Residual income $58,200


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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 23-4


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The Balanced Scorecard

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When divisions transfer products or render services to each other, a transfer pricing

is used to charge for the products or services

Transfer Pricing 23-5


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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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Negotiated Price Approach

The negotiated price approach allows the managers of

decentralized units to agree (negotiate) among themselves

as to the transfer price.

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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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Click to edit Master title style 1 Performance Evaluation for Decentralized Operations 23.

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