Performance Evaluation, Variable

Costing, and Decentralization

Management Accounting: The Cornerstone for

Business Decisions

Copyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved.

Learning Objectives

1. Explain how and why firms choose to decentralize.

2. Explain the difference between absorption and variable costing. Prepare segmented income statements.

3. Compute and explain return on investment (ROI).

4. Compute and explain residual income and economic value added (EVA).

Learning Objectives

5. Explain the role of transfer pricing in a decentralized firm.

6. (Appendix) Explain the uses of the Balanced Scorecard and compute cycle time, velocity, and manufacturing cycle efficiency (MCE).

Comment on Decentralization and

Responsibility Centers

What are some reasons to decentralize?

Illustrate Centralization Vs. Decentralization

Illustration of PepsiCo's Decentralized Divisions

Match Definitions

Cost Center

Revenue Center

A responsibility center in which the manager is only accountable for sales

A responsibility center in which the manager is accountable for both revenues and costs

Investment Center

Profit Center

A responsibility center in which the manager is accountable for revenues, costs and investments

A responsibility center in which the manager is only accountable for costs

Complete the Chart

What type of accounting information is use for measuring performance?

      Capital  

Center Cost Sales Investment Other

Cost      

Revenue    

Profit    

Investment

Differentiate Between Product and Period

Costs

Complete Chart

How are product and period cost classified under absorption and variable costing? Insert the word “Product” or “Period” were appropriate

  Costing Method

  Absorption Variable

Direct materials

Direct labor

Variable overhead

Fixed overhead

Selling expenses

Administrative expenses

How to compute inventory cost under absorption &

variable costing.During the most recent year, Fairchild

company had the following data associated with the product it makes.

Units in beginning inventory 0Units produced 12,000Units sold ($325 each) 10,000Variable costs per unit:

Direct materials $60Direct labor 90Variable overhead 60

Fixed costs:Fixed overhead per unit produced $25Fixed selling and administrative 100,000

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REQUIRED:

1. How many units are in ending inventory?

2. Using absorption costing, calculate the per-unit product cost. What is the value of ending inventory?

3. Using variable costing, calculate the per-unit product cost. What is the value of ending inventory?

Calculations:

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How to compute inventory cost under absorption &

variable costing.

How to compute inventory cost under absorption & variable

costing.11-1

2. Absorption costing 3. Variable costing

How to prepare income statements under

absorption & variable costing.

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During the most recent year, Fairchild company had the following data associated with the product it makes.

Units in beginning inventory 0Units produced 12,000Units sold ($325) 10,000Variable costs per unit:

Direct materials $60Direct labor 90Variable overhead 60

Fixed costs:Fixed overhead per unit produced $25Fixed selling and administrative 100,000

REQUIRED:1. Calculate the cost of goods sold under

absorption costing2. Calculate the cost of goods sold under

variable costing3. Prepare an income statement under

absorption costing4. Prepare an income statement under

variable costingCalculation:

How to prepare income statements under

absorption & variable costing.

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How to prepare income statements under

absorption & variable costing.

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3. Fairchild Company

Absorption-Costing Income Statement

How to prepare income statements under

absorption & variable costing.

11-24. Fairchild Company

Variable-Costing Income Statement

Review the Relationships Between Production,

Sales & Income

  IF   THEN

1. Production > Sales

2. Production < Sales

3. Production = Sales

How to prepare a segmented income

statement.Audiomatronics, Inc., produces MP3 players and

DVD players in a single factory. The following information was provided for the following year.

MP3 Players DVD PlayersSales $400,000 $290,000Variable cost of good sold 200,000 150,000Direct fixed cost 30,000 20,000A 5% sales commission is paid for each of the two

product lines. Direct fixed selling and administrative expense was estimated to be $10,000 for the MP3 line and $15,000 for the DVD line.

Common fixed overhead for the factory was estimated at $100,000; common selling and administrative expense was estimated to be $20,000.

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How to prepare a segmented income

statement.REQUIRED: Prepare a variable costing segmented income statement for Audiomatronics, Inc., for the coming year.

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Calculation: MP3 Players DVD Players Total

Sales

Variable cost of goods sold

Variable selling expense

Contribution margin

Less: direct fixed expenses:

Direct fixed overhead

Direct sell & admin

Segment margin

Less: common fixed expenses

Common fixed overhead

Common sell & admin

Net income

List Three Ways Investment Centers are

Evaluated

Match Definitions

ROI

Ave. Operating Assets

Sales / Average operating assets

Operating income / Sales

Turnover

Margin

Operating income / Average operating assets

(Beginning net book value + Ending net book value) / 2

How to calculate average operating assets, margin,

turnover & ROI.Celimar Company’s Eastern Division earned

operating income of $60,000 on Sales of $600,000. At the beginning of the year the net book value of the assets were $305,700, while at the end of the year they were $354,300.

REQUIRED: For the Eastern Division calculate:

1. Average operating assets2. Margin3. Turnover4. ROI

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Calculation:1. Average operating assets =

2. Margin =

3. Turnover =

4. ROI =

How to calculate average operating assets,

margin, turnover & ROI.11-4

What are three advantages of ROI?

How to calculate residual income.

Celimar Company’s Eastern Division earned operating income of $60,000 on Sales of $600,000. At the beginning of the year the net book value of the assets were $305,700, while at the end of the year they were $354,300. Celimar requires a minimum rate of return of 12%.

REQUIRED: For the Eastern Division calculate:

1.Average operating assets2.Residual incomeCalculation:

11-5

How to calculate EVA.11-6

Sales $600,000

Cost of goods sold 330,000

Gross Margin $270,000

Less: Sell & Admin Exp. 210,000

Operating income $ 60,000

Less: Income taxes @30% 18,000

Net income $ 42,000

Celimar Company’s Eastern Division earned net income last year as shown in the following income statement:

Total capital employed equaled $330,000. Celimar’s actual cost of capital is 10%.

REQUIRED: Calculate EVA for Eastern Division

Calculation:

How to calculate EVA.11-6

Discuss Transfer Pricing

Define the three ways to set transfer prices.

How to calculate transfer prices.

Omni, Inc., has a number of divisions, including Indigo Division, a producer of microcircuit boards and Lima Division a producer of controllers for heating and controlling manufacturers.

Indigo produces the bk-912 model that can be used by Lima Division in the production of its control systems for regulating heating and air conditioning systems. The market price of the bk-912 is $15 and the full cost is $8

REQUIRED:1. If Omni, Inc. has a transfer pricing policy that

requires transfer at full cost, what would the transfer price be? Do you suppose that Indigo and Lima would choose to transfer at that price?

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2. If Omni, Inc. has a transfer pricing policy that requires transfer at market price, what would the transfer price be? Do you suppose that Indigo and Lima would choose to transfer at that price?

3. Now suppose that Omni, Inc., allows negotiated transfer pricing and that Indigo Division can avoid a $3 selling expense by selling to Lima Division. Which division sets the minimum transfer price, and what is it? Which division sets the maximum transfer price and what is it? Do you suppose that Indigo and Lima Divisions would choose to transfer somewhere in the bargaining range?

How to calculate transfer prices.11-7

Calculations:

How to calculate transfer prices.11-7