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Chapter Chapter 2222Performance Evaluation for Performance Evaluation for
Decentralized OperationsDecentralized OperationsFinancial and Managerial Accounting
8th Edition
Warren Reeve Fess
PowerPoint Presentation by Douglas CloudProfessor Emeritus of AccountingPepperdine 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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1. List and explain the advantages and disadvantages of decentralized operations.
2. Prepare a responsibility accounting report for a cost center.
3. 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.
ObjectivesObjectivesObjectivesObjectives
After studying this After studying this chapter, you should chapter, you should
be able to:be able to:
After studying this After studying this chapter, you should chapter, you should
be able to:be able to:
5. Explain how the market price, negotiated price, and cost price approaches to transfer pricing may be used by decentralized segments of a business.
ObjectivesObjectivesObjectivesObjectives
Centralized and Decentralized
Operations
Advantages of Advantages of DecentralizationDecentralizationAdvantages of Advantages of
DecentralizationDecentralization It allows managers to focus on acquiring
expertise in their areas of responsibility. Decentralizing decision making provides
excellent training for managers. Delegation improves employee morale. Decentralization helps managers create good
customer relations by responding quickly to customers’ needs.
Managers become more creative in suggesting operating and product improvement.
Decisions made by one manager may negatively affect the profitability of the entire organization.
Assets and operating costs are duplicated (e.g., each division has its own administrative office staff).
Disadvantages of Disadvantages of Decentralized OperationsDecentralized Operations
Disadvantages of Disadvantages of Decentralized OperationsDecentralized Operations
Responsibility CentersResponsibility CentersResponsibility CentersResponsibility Centers
Managers are held accountable for controlling costs.
Cost CentersCost Centers
Profit CentersProfit CentersManagers are held accountable for costs and making decisions that impact revenues favorably.
Investment CentersInvestment CentersManagers are held accountable for costs and revenues and are also held accountable for the efficient use of assets.
Responsibility CentersResponsibility CentersResponsibility CentersResponsibility Centers
COLLEGE
Responsibility Accounting Responsibility Accounting for Cost Centersfor Cost Centers
Responsibility Accounting Responsibility Accounting for Cost Centersfor Cost Centers
College of College of EngineeringEngineering
College of Arts College of Arts and Sciencesand Sciences
College of College of BusinessBusiness
UNIVERSITY
Dept. of Management
Dept. of Marketing
Dept. of Accounting
COST CENTERS IN A UNIVERSITY
Responsibility Accounting Responsibility Accounting for Cost Centersfor Cost Centers
Responsibility Accounting Responsibility Accounting for Cost Centersfor Cost Centers
DEPARTMENT
COST CENTERS IN A UNIVERSITY
Department of
Accounting
Over Under Budget Actual Budget Budget
Budget Performance ReportSupervisor, Department 1—Plant A
For the Month Ended October 31, 2006
Factory wages $ 58,100 $ 58,000 $100Materials 32,500 34,225 $1,725Supervisory salaries 6,400 6,400 Power and light 5,750 5,690 60Depreciation 4,000 4,000 Maintenance 2,000 1,990 10Insurance, taxes 975 975
$109,725 $111,280 $1,725 $170
Cost CentersCost Centers
These totals are shown on the Manager, Plant A’s budget performance report (Slide 13).
These totals are shown on the Manager, Plant A’s budget performance report (Slide 13).
$109,725$109,725 $111,280$111,280 $1,725$1,725 $170$170
Over Under Budget Actual Budget Budget
Administration $ 17,500 $ 17,350 $150
Department 1 109,725 111,280 $1,555
Department 2 190,500 192,600 2,100
Department 3 149,750 149,100 650
$467,475 $470,330 $3,655 $800
From the Supervisor—Department 1, Plant A budget performance report (Slide 12).
From the Supervisor—Department 1, Plant A budget performance report (Slide 12).
Budget Performance ReportManager, Plant A
For the Month Ended October 31, 2006
Cost CentersCost Centers
Department 1 109,725 111,280 $1,555 Department 1 109,725 111,280 $1,555
Administration $ 17,500 $ 17,350 $150
Department 1 109,725 111,280 $1,555
Department 2 190,500 192,600 2,100
Department 3 149,750 149,100 650
$467,475 $470,330 $3,655 $800
Cost CentersCost Centers
This is shown on the Vice-President’s budget production report (Slide 15).
This is shown on the Vice-President’s budget production report (Slide 15).
$467,475 $470,330 $3,655 $800$467,475 $470,330 $3,655 $800
Budget Performance ReportManager, Plant A
For the Month Ended October 31, 2006
Over Under Budget Actual Budget Budget
Budget Performance ReportVice-President, Production
For the Month Ended October 31, 2006Over Under
Budget Actual Budget Budget
Administration $ 19,500 $ 19,700 $ 200
Plant A 467,475 470,330 2,855
Plant B 395,225 394,300 $925
$882,200 $884,330 $3,055 $925
Cost CentersCost Centers
Plant APlant A 467,475467,475 470,330470,330 2,8552,855
Note that “Over Budget” is a net figure.Note that “Over Budget” is a net figure.
Budget Performance ReportVice-President, Production
For the Month Ended October 31, 2006Over Under
Budget Actual Budget Budget
Administration $ 19,500 $ 19,700 $ 200
Plant A 467,475 470,330 2,855
Plant B 395,225 394,300 $925
$882,200 $884,330 $3,055 $925
Each of the line items above is supported by a cost center report.Each of the line items above is
supported by a cost center report.
Cost CentersCost Centers
Responsibility Accounting for Profit Centers
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 may be divisions, departments,
or products.
Profit CentersProfit Centers
NEG, a diversified entertainment company, has two profit centers: the Theme Park
Division and the Movie Production Division.
NEG, a diversified entertainment company, has two profit centers: the Theme Park
Division and the Movie Production Division.
Theme Park Division
Movie Production Division
Revenues $6,000,000 $2,500,000Operating expenses 2,495,000 405,000
Charging Service Department Costs to Production Divisions
Charging Service Department Costs to Production Divisions
Purchasing Department: $400,000(Activity base: number of purchase requisitions)
Theme Park Division 25,000 purchase requisitions
Movie Production Division: 15,000 purchase requisitions
Total 40,000
$400,000
40,000 purchase requisitions$10 per purchase requisition
=
Profit CentersProfit Centers
Charging Service Department Costs to Production Divisions
Charging Service Department Costs to Production Divisions
Payroll Accounting: $255,000(Activity base: number of payroll checks)
$255,000
15,000 payroll checks= $17 per payroll check
Theme Park Division 12,000 payroll checks
Movie Production Division: 3,000 payroll checks
Total 15,000
Profit CentersProfit Centers
Charging Service Department Costs to Production Divisions
Charging Service Department Costs to Production Divisions
Legal Department: $250,000(Activity base: number of payroll checks)
$250,000
1,000 hours= $250 per hour
Theme Park Division 100 billed hours
Movie Production Division: 900 billed hours
Total 1,000
Profit CentersProfit Centers
Nova Entertainment GroupService Department Charges to NEG Divisions
For the Year Ended December 31, 2006
Theme Movie Park Production
Service Department Division Division
Profit CentersProfit Centers
Purchasing $250,000 $150,000
25,000 purchase 25,000 purchase requisitions x $10 requisitions x $10
per purchase per purchase requisitionrequisition
25,000 purchase 25,000 purchase requisitions x $10 requisitions x $10
per purchase per purchase requisitionrequisition
15,000 purchase 15,000 purchase requisitions x $10 requisitions x $10
per purchase per purchase requisitionrequisition
15,000 purchase 15,000 purchase requisitions x $10 requisitions x $10
per purchase per purchase requisitionrequisition
Purchasing $250,000 $150,000Payroll accounting 204,000 51,000
12,000 payroll 12,000 payroll checks x $17 per checks x $17 per
payroll checkpayroll check
12,000 payroll 12,000 payroll checks x $17 per checks x $17 per
payroll checkpayroll check
3,000 payroll 3,000 payroll checks x $17 per checks x $17 per
payroll checkpayroll check
3,000 payroll 3,000 payroll checks x $17 per checks x $17 per
payroll checkpayroll check
Nova Entertainment GroupService Department Charges to NEG Divisions
For the Year Ended December 31, 2006
Theme Movie Park Production
Service Department Division Division
Profit CentersProfit Centers
Purchasing $250,000 $150,000Payroll accounting 204,000 51,000Legal 25,000 225,000
Nova Entertainment GroupService Department Charges to NEG Divisions
For the Year Ended December 31, 2006
Theme Movie Park Production
Service Department Division Division
Profit CentersProfit Centers
100 hours x $250 100 hours x $250 per hourper hour
100 hours x $250 100 hours x $250 per hourper hour
900 hours x $250 900 hours x $250 per hourper hour
900 hours x $250 900 hours x $250 per hourper hour
Purchasing $250,000 $150,000Payroll accounting 204,000 51,000Legal 25,000 225,000Total service department charges $479,000 $426,000
Nova Entertainment GroupService Department Charges to NEG Divisions
For the Year Ended December 31, 2006
Theme Movie Park Production
Service Department Division Division
Profit CentersProfit Centers
Nova Entertainment GroupDivisional Income Statements
For the Year Ended December 31, 2006
Theme Park Division Movie Production Division
Income from operations before service department charges.
Income from operations before service department charges.
Revenues $6,000,000 $2,500,000Operating expenses 2,495,000 405,000Income from operations $3,505,000 $2,095,000
Nova Entertainment GroupDivisional Income Statements
For the Year Ended December 31, 2006
Theme Park Division Movie Production Division
Revenues $6,000,000 $2,500,000Operating expenses 2,495,000 405,000Income from operations $3,505,000 $2,095,000Less service dept. charges:
Purchasing $ 250,000$ 150,000Payroll accounting 204,00051,000Legal 25,000 225,000 Total service department charges $ 479,000 $ 426,000
Income from operations $3,026,000$1,669,000
Responsibility Accounting for
Investment Centers
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.
Datalink Inc.Divisional Income Statements
For the Year Ended December 31, 2006
Northern Central SouthernDivision Division Division
Revenues $560,000 $672,000 $750,000Operating expenses 336,000 470,400 562,500Income from operations before service dept. charges $224,000 $201,600 $187,500Service department charges 154,000 117,600 112,500Income from operations $ 70,000 $ 84,000 $ 75,000
Invested assets $350,000 $700,000 $500,000Rate of return on investment 20% 12% 15%
Investment CentersInvestment Centers
20% 12% 15%20% 12% 15%
Revenues
Rate of Return on Investment (ROI)Rate of Return on Investment (ROI)Rate of Return on Investment (ROI)Rate of Return on Investment (ROI)
Investment Turnover
Profit Margin
Profit
Rate of Return on Investment (ROI)Rate of Return on Investment (ROI)Rate of Return on Investment (ROI)Rate of Return on Investment (ROI)
The profit margin indicates the rate of profit
on each sales dollar.The
investment turnover indicates the rate of sales on
each dollar of invested
assets.
Profit Margin
Investment Turnover
Rate of Return on Investment (ROI)Rate of Return on Investment (ROI)Rate of Return on Investment (ROI)Rate of Return on Investment (ROI)
Income from operation
Sales
Sales
Invested assetsxROI =
ROI =$ 70,000
$560,000x
$560,000
$350,000
ROI = 12.5% x 1.6 = 20%
Rate of Return on Investment (ROI)Rate of Return on Investment (ROI)Rate of Return on Investment (ROI)Rate of Return on Investment (ROI)
Income from operation
Sales
Sales
Invested assetsxROI =
Rate of Return on Investment (ROI)Rate of Return on Investment (ROI)Rate of Return on Investment (ROI)Rate of Return on Investment (ROI)
Profit Margin
Profit Margin
Inventory Turnover
Inventory Turnover
Northern Central SouthernDivision Division Division Profit MarginProfit Margin
Income from operations $ 70,000 $ 84,000 $ 75,000Revenues (Sales) $560,000 $672,000 $750,000
Profit margin 12.5% 12.5% 10.0%
Investment TurnoverInvestment Turnover
Revenues (Sales) $560,000 $672,000 $750,000Invested assets $350,000 $700,000 $500,000
Investment turnover 1.6 .96 1.5
Return on Investment (ROI)Return on Investment (ROI)
Income from operations $ 70,000 $ 84,000 $ 75,000Invested assets $350,000 $700,000 $500,000
Rate of return on investment 20% 12% 15%
Income from
Operations
Minimum Acceptable
Rate of Return on
Assets
– =Residual Residual IncomeIncome
Northern Central SouthernDivision Division Division
Baldwin CompanyDivisional Income Statements
For the Year Ended December 31, 2006
Income from operations $70,000 $84,000 $75,000Minimum acceptable incomefrom operations as a percent of invested assets:
$350,000 x 10% 35,000
$700,000 x 10% 70,000
$500,000 x 10% 50,000
Residual income $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.
The balance scorecard is a set of financial and nonfinancial measures
that reflect multiple performance dimensions of a business.
Innovation and Learning
• R&D investment• R&D pipeline• Skills and training• Time to market
Innovation and Learning
• R&D investment• R&D pipeline• Skills and training• Time to market
Customer• Satisfaction• Loyalty• Perception
Customer• Satisfaction• Loyalty• Perception
• Efficiency• Quality• Time
• Efficiency• Quality• Time
Financial• ROI• Residual income• Profit• Cost• Sales
Financial• ROI• Residual income• Profit• Cost• Sales
Internal Process
Transfer PricingTransfer Pricing
Transfer PricingTransfer PricingTransfer PricingTransfer Pricing
When divisions transfer products or render services to each other, a
transfer pricing is used to charge for the products or services
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 PricingBenefits of Transfer PricingBenefits of Transfer PricingBenefits of Transfer Pricing
1. Divisions can be evaluated as profit or investment centers.
2. Divisions are forced to control costs and operate competitively.
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.
1. Market price approach sets the price at which the product transferred could be sold to outside buyers.
2. Negotiated price approach allows decentralized managers to agree (negotiate) among themselves.
3. Cost price approach (variable or full) uses a variety of cost concepts for setting the transfer price.
Commonly Used Transfer PricesCommonly Used Transfer PricesCommonly Used Transfer PricesCommonly Used Transfer Prices
Variable Costper Unit $10
Market Priceper Unit $20
Full Costper Unit $13
Negotiated Price
Commonly Used Transfer PricesCommonly Used Transfer PricesCommonly Used Transfer PricesCommonly Used Transfer Prices
Transfer Pricing—Negotiated Price ApproachTransfer Pricing—Negotiated Price Approach
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.
AssumptionsAssumptions
If the division managers agree on a price of $15 per unit, how much will each
division’s income increase?
If the division managers agree on a price of $15 per unit, how much will each
division’s income increase?
The EndThe End
Chapter 22Chapter 22