Chapter 7

Performance Evaluation for Decentralized Operations

Managerial Accounting 8th Edition Warren Reeve Fess PowerPoint Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University © Copyright 2004 South-Western, a division of Thomson Learning. All rights reserved. Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc.

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Objectives

1.

List and explain the advantages and 2.

3.

report for a cost center.

Prepare responsibility accounting reports for a profit center.

4.

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

Objectives

5.

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

Centralized and Decentralized Operations

Advantages of Decentralization

   It allows managers to

focus on acquiring expertise in their areas of responsibility

.  Decentralizing decision making provides

excellent training

for managers.

Delegation improves Decentralization helps managers create

customer relations

customers’ needs.

employee morale

.

good

by responding quickly to  Managers become

more creative

in suggesting operating and product improvement.

Disadvantages of Decentralized Operations

 Decisions made by one manager may

negatively affect

the profitability of the entire organization.

 Assets and operating

duplicated costs are

(e.g., each division has its own administrative office staff).

Responsibility Centers

Cost Centers

Managers are held accountable for controlling

costs

.

Profit Centers

Managers are held accountable for

costs

and making decisions that impact

revenues

favorably.

Responsibility Centers

Investment Centers

Managers are held accountable for

costs

and

revenues

and are also held accountable for the efficient use of

assets

.

Responsibility Accounting for Cost Centers

COST CENTERS IN A UNIVERSITY UNIVERSITY COLLEGE

Dept. of Marketing College of Engineering College of Business College of Arts and Sciences Dept. of Accounting Dept. of Management

Responsibility Accounting for Cost Centers

COST CENTERS IN A UNIVERSITY DEPARTMENT Department of Accounting

Cost Centers Budget Performance Report Supervisor, Department 1—Plant A For the Month Ended October 31, 2006 Over Budget

Factory wages Materials Supervisory salaries Power and light Depreciation Maintenance Insurance, taxes

Budget

$ 58,100 32,500 6,400 5,750 4,000 2,000 975

Actual

$ 58,000 34,225 6,400 5,690 4,000 1,990 975 $111,280 $1,725

Under Budget

$100 60 10 These totals are shown on the Manager, Plant A’s budget performance report (Slide 13).

Cost Centers Budget Performance Report Manager, Plant A For the Month Ended October 31, 2006 Budget Actual Over Budget Under Budget

Administration Department 2 Department 3 $ 17,500 109,725 190,500 149,750 $467,475 $ 17,350 111,280 192,600 149,100 $470,330 $1,555 2,100 $3,655 From the Supervisor—Department 1, Plant A budget performance report (Slide 12).

$150 650 $800

Cost Centers

Administration Department 1 Department 2 Department 3

Budget Performance Report Manager, Plant A For the Month Ended October 31, 2006 Budget Actual Over Budget

$ 17,500 109,725 190,500 149,750 $ 17,350 111,280 192,600 149,100 $470,330 $1,555 2,100 $3,655

Under Budget

$150 650 $800 This is shown on the Vice-President’s budget production report (Slide 15).

Cost Centers

Administration

Budget Performance Report Vice-President, Production For the Month Ended October 31, 2006 Over Budget Actual Budget

$ 19,500 $ 19,700 $ 200

Under Budget

Plant B 395,225 $882,200 394,300 $884,330 $3,055 $925 $925 Note that “Over Budget” is a net figure.

Cost Centers

Administration Plant A Plant B

Budget Performance Report Vice-President, Production For the Month Ended October 31, 2006 Over Budget Actual Budget

$ 19,500 467,475 395,225 $882,200 $ 19,700 470,330 394,300 $884,330 $ 200 2,855 $3,055

Under Budget

$925 $925 Each of the line items above is supported by a cost center report.

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.

Profit centers

may be divisions, departments, or products.

Profit Centers

NEG, a diversified entertainment company, has two profit centers: the Theme Park Division and the Movie Production Division.

Revenues Operating expenses

Theme Park Division

$6,000,000 2,495,000

Movie Production Division

$2,500,000 405,000

Profit Centers

Charging Service Department Costs to Production Divisions

Purchasing Department: $400,000

(Activity base: number of purchase requisitions) Theme Park Division Movie Production Division: Total $400,000 25,000 purchase requisitions 15,000 purchase requisitions 40,000 40,000 purchase requisitions =

$10 per purchase requisition

Profit Centers

Charging Service Department Costs to Production Divisions

Payroll Accounting: $255,000

(Activity base: number of payroll checks) Theme Park Division Movie Production Division: Total $255,000 15,000 payroll checks 12,000 payroll checks 3,000 payroll checks 15,000 =

$17 per payroll check

Profit Centers

Charging Service Department Costs to Production Divisions

Legal Department: $250,000

(Activity base: number of payroll checks) Theme Park Division Movie Production Division: Total 100 billed hours 900 billed hours 1,000 $250,000 =

$250 per hour

1,000 hours

Profit Centers

Nova Entertainment Group Service Department Charges to NEG Divisions For the Year Ended December 31, 2006 Service Department

Purchasing

Theme Park Division

$250,000

Movie Production Division

$150,000

per purchase per purchase requisition requisition

Profit Centers

Nova Entertainment Group Service Department Charges to NEG Divisions For the Year Ended December 31, 2006 Service Department

Purchasing Payroll accounting

Theme Park Division

$250,000 204,000

Movie Production Division

$150,000 51,000

payroll check payroll check

Profit Centers

Nova Entertainment Group Service Department Charges to NEG Divisions For the Year Ended December 31, 2006 Service Department

Purchasing Payroll accounting Legal

Theme Park Division

$250,000 204,000 25,000

Movie Production Division

$150,000 51,000 225,000

per hour per hour

Profit Centers

Nova Entertainment Group Service Department Charges to NEG Divisions For the Year Ended December 31, 2006 Service Department

Purchasing Payroll accounting Legal Total service department charges

Theme Park Division

$250,000 204,000 25,000 $479,000

Movie Production Division

$150,000 51,000 225,000 $426,000

Nova Entertainment Group Divisional Income Statements For the Year Ended December 31, 2006 Theme Park Division Movie Production Division

Revenues Operating expenses Income from operations $6,000,000 2,495,000 $3,505,000 $2,500,000 405,000 $2,095,000 Income from operations

before service department charges.

Nova Entertainment Group Divisional Income Statements For the Year Ended December 31, 2006 Theme Park Division Movie Production Division

Revenues Operating expenses Income from operations Less service dept. charges: Purchasing Payroll accounting Legal Total service department charges $ 479,000 Income from operations $6,000,000 2,495,000 $3,505,000 $ 250,000 204,000 25,000 $3,026,000 $2,500,000 405,000 $2,095,000 $ 150,000 51,000 225,000 $ 426,000 $1,669,000

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.

Investment Centers

Revenues

Datalink Inc.

Divisional Income Statements For the Year Ended December 31, 2006

Operating expenses Income from operations before service dept. charges Service department charges Income from operations Invested assets Rate of return on investment

Northern Division

$560,000 336,000 $224,000 154,000 $ 70,000 $350,000

Central Division

$672,000 470,400 $201,600 117,600 $ 84,000

Southern Division

$750,000 562,500 $187,500 112,500 $ 75,000 $700,000 12% $500,000 15%

Rate of Return on Investment (ROI)

Revenues

Rate of Return on Investment (ROI)

Profit Investment Turnover Profit Margin

Rate of Return on Investment (ROI)

The

profit margin

indicates the rate of profit on each sales dollar.

The

investment turnover

indicates the rate of sales on each dollar of invested assets.

Investment Turnover Profit Margin

Rate of Return on Investment (ROI)

ROI = Income from operation Sales ROI = $ 70,000 $560,000 x $560,000 $350,000 x Sales Invested assets ROI = 12.5% x 1.6 =

20%

Rate of Return on Investment (ROI)

ROI = Income from operation Sales x Sales Invested assets Profit Margin Inventory Turnover

Profit Margin

Income from operations Revenues (Sales)

Profit margin Investment Turnover

Revenues (Sales) Invested assets

Investment turnover Return on Investment (ROI)

Income from operations Invested assets

Rate of return on investment Northern Division

$ 70,000 $560,000 12.5%

Central Division

$ 84,000 $672,000 12.5%

Southern Division

$ 75,000 $750,000 10.0% $560,000 $350,000 1.6 $ 70,000 $350,000 20% $672,000 $700,000 .96 $ 84,000 $700,000 12% $750,000 $500,000 1.5 $ 75,000 $500,000 15%

Income from Operations – Minimum Acceptable Rate of Return on Assets = Residual Income

Baldwin Company Divisional Income Statements For the Year Ended December 31, 2006 Northern Division Central Division Southern Division

$70,000 $84,000 $75,000 Income from operations Minimum acceptable income from operations as a percent of invested assets: $350,000 x 10% $700,000 x 10% $500,000 x 10% Residual income 35,000 70,000 50,000 $35,000 $14,000 $25,000

The

balance scorecard

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

• • •

Customer Satisfaction

Loyalty Perception • • • •

Innovation and Learning

R&D investment R&D pipeline Skills and training Time to market • • • • •

Financial

ROI Residual income Profit Cost Sales • • •

Internal Process

Efficiency Quality Time

Transfer Pricing

Transfer Pricing

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

transfer pricing

is used to charge for the products or services

Benefits of Transfer Pricing

1. Divisions can be evaluated as

investment

centers.

profit

or 2. Divisions are

forced to control costs

operate competitively.

and 3. If divisions are permitted to buy component parts wherever they can find the best price (either internally or externally), transfer pricing will allow a company to

maximize its profits

.

Commonly Used Transfer Prices

1.

2.

3.

Market price approach

sets the price at which the product transferred could be sold to outside buyers.

Negotiated price approach

allows decentralized managers to agree (negotiate) among themselves.

Cost price approach (variable or full)

uses a variety of cost concepts for setting the transfer price.

Commonly Used Transfer Prices

Variable Cost per Unit $10 Full Cost per Unit $13 Negotiated Price Market Price per Unit $20

Transfer Pricing—Negotiated Price Approach Assumptions

1.Division M produces a product with a variable cost of $10 per unit. Division M has unused capacity.

2.Division N purchases 20,000 units of the same product at $20 per unit from an outside source.

If the division managers agree on a price of $15 per unit, how much will each division’s income increase?

Chapter 7

The End