Transcript Chapter 23
Performance Evaluation for Decentralized Operations Chapter 23 Prepared by: C. Douglas Cloud Professor Emeritus of Accounting Pepperdine University © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 1 Centralized and Decentralized Operations In a centralized company, all major planning and operating decisions are made by top management. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 1 Centralized and Decentralized Operations 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 1 Advantages of Decentralization For large companies, it is difficult for top management to do the following: Maintain daily contact with all operations Maintain operating expertise in all product lines and services © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 1 Advantages of Decentralization Decentralized operations provide excellent training for managers. Delegating responsibility allows managers to develop managerial experience early in their careers. (continued) © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 1 Advantages of Decentralization It helps a company retain managers. As a result of working closely with customers, managers become more creative in suggesting operating and product improvements. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 1 Disadvantages of Decentralization A primary disadvantage is that decisions made by one manager may negatively affect the profits of the company. Decentralization may result in duplicate assets and expenses. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 1 Responsibility Accounting In a decentralized business, accounting assists managers in evaluating and controlling their areas of responsibility, called responsibility centers. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 1 Responsibility Accounting 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 © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Learning Objective 2 Prepare a responsibility accounting report for a cost center. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 2 Responsibility Accounting for Cost Centers A cost center manager has responsibility for controlling costs. Cost centers may vary in size from a small department to an entire manufacturing plant. Cost centers may exist within other cost centers. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 2 Responsibility Accounting for Cost Centers © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 2 Responsibility Accounting for Cost Centers (continued) © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 2 Responsibility Accounting for Cost Centers from Manager, Plant A Budget Performance Report (continued) © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 2 Responsibility Accounting for Cost Centers to Vice President’s Budget Performance Report from Supervisor, Department 1—Plant A’s Budget Performance Report © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. (continued) LO 2 Responsibility Accounting for Cost Centers to Manager, Plant A’s Budget Performance Report (concluded) © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Learning Objective 3 Prepare responsibility accounting reports for a profit center. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 3 Responsibility Accounting for Profit Centers A profit center manager has the responsibility and authority for making decisions that affect both costs and revenues and, thus, profits. Profit centers may be divisions, departments, or products. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 3 Responsibility Accounting for Profit Centers Controllable revenues are revenues earned by the profit center. Controllable expenses are costs that can be influenced (controlled) by the decisions of profit center managers. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 3 Service Department Charges Examples of service departments include: Research and Development Legal Telecommunications Information and Computer Systems Facilities Management Purchasing Publications and Graphics Payroll Accounting Personnel © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 3 Service Department Charges Service department charges are indirect expenses to a profit center. Services provided by internal centralized service departments are often more efficient than services contracted with outside providers. Service department charges are allocated to profit centers based on the usage of the service by each profit center. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 3 Service Department Charges NEG Nova Entertainment Group (NEG) has two operating divisions: Theme Park Division and Movie Production Division. The revenues and direct operating expenses for the two divisions are shown below. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 3 Service Department Charges NEG NEG’s service departments and the expenses they incurred for the year ended December 31, 2012, are as follows: Purchasing Payroll Accounting Legal Total $400,000 255,000 250,000 $905,000 © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 3 Service Department Charges NEG An activity base for each service department is used to charge service department expenses to the Theme Park and Movie Production divisions. The activity base for each service department is as follows: (continued) © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 3 Service Department Charges NEG Service Usage—Purchasing Theme Park Division 25,000 purchase requisitions Movie Production Division 15,000 Total 40,000 purchase requisitions $400,000 40,000 purchase requisitions = $10 per purchase requisition (continued) © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 3 Service Department Charges Service Usage—Payroll Accounting Theme Park Division Movie Production Division Total $255,000 15,000 payroll checks 12,000 payroll checks 3,000 15,000 payroll checks = $17 per payroll check (continued) © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. NEG LO 3 Service Department Charges Service Usage—Legal Theme Park Division Movie Production Division Total $250,000 1,000 hours 100 billed hours 900 1,000 billed hours = $250 per hour (concluded) © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. NEG LO 3 Service Department Charges © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. NEG EE 23-2 © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 3 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Learning Objective 4 Compute and interpret the rate of return on investment, the residual income, and the balanced scorecard for an investment center. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 4 Responsibility Accounting for Investment Centers 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 4 Responsibility Accounting for Investment Centers DataLink Inc., a cellular phone company, has three regional divisions. These are shown in Exhibit 6. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 4 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. It is computed as follows: Income from Operations ROI = Invested Assets © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 4 Rate of Return on Investment The invested assets of DataLink’s three divisions are as follows: © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 4 Rate of Return on Investment Dupont Formula Sales Income from Operations x ROI = Invested Assets Sales Profit Margin © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Investment Turnover LO 4 Rate of Return on Investment The profit margin and the investment turnover reflect the following underlying operating relationships of each division: Profit margin indicates operating profitability by computing the rate of profit earned on each sales dollar. Investment turnover indicates operating efficiency by computing the number of sales dollars generated by each dollar of invested assets. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 4 Rate of Return on Investment DataLink’s Northern Division ROI Sales Income from Operations x ROI = Invested Assets Sales ROI = $ 70,000 x $560,000 $560,000 $350,000 ROI = 12.5% x 1.6 ROI = 20% © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. from Exhibit 6 LO 4 Rate of Return on Investment DataLink’s Central Division ROI Sales Income from Operations x ROI = Invested Assets Sales ROI = $ 84,000 $672,000 x $672,000 $700,000 ROI = 12.5% x 0.96 ROI = 12% © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. from Exhibit 6 LO 4 Rate of Return on Investment DataLink’s Southern Division ROI Sales Income from Operations x ROI = Invested Assets Sales ROI = $ 75,000 $750,000 x $750,000 $500,000 ROI = 10.0% x 1.5 ROI = 15% © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. from Exhibit 6 LO 4 Rate of Return on Investment Assume that the revenues of the Northern Division could be increased by $56,000 through increasing operating expenses, such as advertising, to $385,000. (continued) © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 4 Rate of Return on Investment Projected Impact of Change Revenues ($560,000 + $56,000) Operating expenses Income from operations before service department charges Service department charges Income from operations Increase of $7,000 (continued) © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. $616,000 385,000 $231,000 154,000 $ 77,000 LO 4 Rate of Return on Investment DataLink’s Northern Division ROI Revised Income from Operations ROI = Sales ROI = $ 77,000 $616,000 x x Sales Invested Assets $616,000 $350,000 ROI = 12.5% x 1.76 ROI = 22% (compared to the previous ROI of 20%) © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. EE 23-4 © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 4 Residual Income Residual income is the excess of income from operations over a minimum acceptable income from operations, as shown below: © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 4 Residual Income A visual portrayal of this useful tool. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 4 Residual Income Datalink Inc. establishes 10% as the minimum acceptable rate of return on divisional assets. The residual incomes for the three divisions are as follows: © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 4 Residual Income The major advantage of residual income as a performance measure is that it considers both the minimum acceptable rate of return, invested assets, and the income from operations for each division. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. EE 23-5 © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 4 The Balanced Scorecard The balanced scorecard is a set of multiple performance measures for a company. It normally includes performance measures for customer service, innovation and learning, and internal processes, as shown in Exhibit 7 (next slide). © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 4 The Balanced Scorecard © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 4 The Balanced Scorecard Some common performance measures used in the balanced scorecard approach are shown below. (continued) © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 4 The Balanced Scorecard Some common performance measures used in the balanced scorecard approach are shown below. (continued) © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 4 The Balanced Scorecard Some common performance measures used in the balanced scorecard approach are shown below. (continued) © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 4 The Balanced Scorecard Some common performance measures used in the balanced scorecard approach are shown below. (concluded) © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Learning Objective 5 Describe and illustrate how the market price, negotiated price, and cost price approaches to transfer pricing may be used to decentralize segments of a business. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 5 Transfer Pricing When divisions transfer products or render services to each other, a transfer price is used to charge for the products or services. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 5 Transfer Pricing Three common approaches to setting transfer prices are: 1. Market price approach 2. Negotiated price approach 3. Cost approach © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 5 Transfer Pricing © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 5 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. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 5 Negotiated Price Approach The negotiated price approach allows the managers of decentralized units to agree (negotiate) among themselves on a transfer price. The only constraint is that the transfer price be less than the market price, but greater than the supplying division’s variable costs per unit. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 5 Cost Price Approach Under the cost price approach, cost is used to set transfer prices. A variety of costs may be used in this approach, including: Total product cost per unit Variable product cost per unit © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 5 Cost Price Approach If total product cost per unit is used, direct materials, direct labor, and factory overhead are included in the transfer price. If variable product cost per unit is used, the fixed factory overhead cost is excluded from the transfer price. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.