Organizational Design, Responsibility Accounting and Evaluation of
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Transcript Organizational Design, Responsibility Accounting and Evaluation of
Organizational Design,
Responsibility Accounting and
Evaluation of Divisional
Performance
Chapter 18
To “de” or not to “de”
Centralized
Top-down approach
Upper management makes decisions, lower
management carries them out
Keeps organization focused on common
goals
Can be very bureaucratic and slow moving
To “de” or not to “de”
Decentralized
Responsibility for decisions pushed down to
lower levels
Takes advantage of local knowledge,
specialization
More timely response to issues
Better motivation
May lose sight of the “big picture”
May result in duplication of effort
Responsibility centers
Cost center
Responsible for costs incurred
Well-defined relationship between inputs and
outputs
Manufacturing, etc.
Discretionary cost center
Relationship between inputs and outputs not
well-defined
Marketing, etc.
Responsibility centers
Revenue center
Responsible for revenue generated by the
center
Profit center
Responsible for both revenue and costs
related to the center
Investment center
Responsible for capital investments and profit
Responsibility reporting
Performance reports
Show budgeted and actual amounts and
variances
“Roll-up” to the next higher level
Totals from lower levels become line items on
performance report of next higher level
Goals of responsibility reporting
Should provide information on
performance
Should distinguish between controllable
and uncontrollable costs and revenues
Should motivate desired behavior
Investment center performance
Return on investment
Ability to use assets to generate profits
Residual income
Excess of profit over required return on
invested capital
Economic value added
Excess of after-tax operating profit over the
weighted average cost of invested capital
(less current liabilities)
Return on investment
Economic profit after all costs including
opportunity cost of capital
Function of asset turnover and profit
margin
How efficiently does the center use its assets
to generate sales?
Asset turnover
What percentage of sales is profit?
Profit margin
Return on investment
ROI
=
ROI
Sales
Invested capital
=
X
Profit
Invested capital
Profit
Sales
Residual income
Amount of profit remaining after
subtracting the minimum required rate of
return on the invested capital
Residual
income
=
Investment
center
profit
Investment
center's
invested
capital
X
Imputed
interest
rate
Economic value added
Seeks to measure the amount of
economic value (as opposed to accounting
value) added
Adjusts accounting income for various
“distortions”
Capitalize R&D, advertising, training, etc. that
benefit future years
Use price level adjustments to restate to current
year values
Etc, as many as 160 adjustments
Economic value added
Basic formula
Investment
Economic
center's
value
= after-tax
added
operating
profit
-
Investment
center's total assets
Investment
center's
current
liabilities
Weighted
average
X
cost of
capital
Economic value added
Calculation of weighted average cost of
capital
Weighted
average cost =
of capital
After-tax cost
of debt
X
capital
Market
value of
debt
Market
value of
debt
+
+
Cost of
equity
capital
Market
value of
equity
X
Market
value of
equity
Some considerations
Invested capital
Use average of beginning and end-of year
balances
Which assets to include?
Total assets?
Total productive assets?
Total assets less current liabilities?
Gross or net book value?
Some considerations
Different measures may motivate different
behaviors
Example: A project that will return more than
the minimum cost of capital, but less than
current ROI
Will increase residual income
Will decrease ROI