Click to edit Master title style 1 Performance Evaluation for Decentralized Operations 23

Click to edit Master title style 2 Separating a business into divisions or operating units and delegating responsibility to unit managers is called decentralization Decentralized Operations

Click to edit Master title style 3  It allows managers to focus on acquiring expertise in their areas of responsibility. Advantages of Decentralization 23-1  Decentralizing decision making provides excellent training for managers.  Decentralization helps managers create good customer relations by responding quickly to customers’ needs.  Managers often become more creative in suggesting operating and product improvement.

Click to edit Master title style 4  Decisions made by one manager may negatively affect the profitability of the entire company. Disadvantages of Decentralization 23-1  A potential disadvantage is duplication of assets and costs in operating divisions (e.g., each manager of a product line might have a separate sales force and administrative staff ).

Click to edit Master title style 5 Responsibility Accounting In a decentralized business, an important function of accounting is to assist unit managers in evaluating and controlling their areas of responsibility, called responsibility centers. 23-1

Click to edit Master title style 6 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 23-1

Click to edit Master title style 7 10 The three centers differ in their scope of responsibility, as shown below: Cost Center Profit Center Investment Center Cost Revenue – Cost Profit Revenue – Cost Profit Investment in assets 23-1

Click to edit Master title style 8 Responsibility Accounting for Cost Centers In a cost center, the unit manager has responsibility and authority for controlling the costs incurred. 23-2

Click to edit Master title style 9 13 Responsibility Accounting Reports for Cost Centers (continued) 23-2

Click to edit Master title style Responsibility Accounting Reports for Cost Centers from Manager, Plant A Budget Performance Report 23-2 (Continued)

Click to edit Master title style Responsibility Accounting Reports for Cost Centers To Vice President’s Budget Performance Report from Supervisor, Department 1, Plant A’s Budget Performance Report 23-2 (Continued)

Click to edit Master title style Responsibility Accounting Reports for Cost Centers To Manager, Plant A’s Budget Performance Report 23-2 (Concluded)

Click to edit Master title style 13 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 (and thus profits). 23-3

Click to edit Master title style 14 Controllable revenues are revenues earned by the profit center. Controllable expenses are costs that can be influenced (controlled) by the decisions of the profit center managers. 23-3

Click to edit Master title style 15 Service Department Charges Services provided by internal centralized service departments are often more efficient than services contracted with outside providers. An internal service cost is called a service department charge. 23-3

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Click to edit Master title style 17 NEG Example NEG’s expenses for the year ended Decem- ber 31, 2008 for each service department are as follows: Purchasing$400,000 Payroll Accounting255,000 Legal 250,000 Total$905, (Continued)

Click to edit Master title style 18 NEG Example The activity base for each service depart- ment is a measure of the services performed. For NEG, the following applies: PurchasingNumber of purchase requisitions Payroll AccountingNumber of payroll checks LegalNumber of billed hours 23-3 (Continued)

Click to edit Master title style NEG Example Purchasing Theme Park Division25,000 purchase requisitions Movie Production Division15,000 Total40,000 purchase requisitions $400,000 40,000 purchase requisitions = $10 per purchase requisition Service Usage 23-3 (Continued)

Click to edit Master title style NEG Example Service Usage Payroll Accounting Theme Park Division12,000 payroll checks Movie Production Division 3,000 Total15,000 payroll checks $255,000 15,000 payroll checks = $17 per payroll check 23-3 (Continued)

Click to edit Master title style NEG Example Service Usage Legal Theme Park Division 100 billed hours Movie Production Division 900 Total1,000 billed hours $250,000 1,000 hours = $250 per hour 23-3 (Concluded)

Click to edit Master title style Service Department Charges to NEG Divisions 23-3

Click to edit Master title style Example Exercise 23-2 The centralized legal department of Johnson Company has expenses of $60,000. The department has provided a total of 2,000 hours of service for the period. The East Division has used 500 hours of legal service during the period, and the West Division has used 1,500 hours. How much should it be charged for legal services?

Click to edit Master title style For Practice: PE23-2A, PE23-2B Follow My Example 23-2 Manufacturing Division Service Charge for Legal Department: $15,000 = 500 billed hours x ($60,000/2,000 hours) Sales Division Service Charge for Legal Department: $45,000 = 1,500 billed hours x ($60,000/2,000 hours)

Click to edit Master title style 25 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. 23-3

Click to edit Master title style 26 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. 23-4

Click to edit Master title style Divisional Income Statements—DataLink Inc. 23-4

Click to edit Master title style 28 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. 23-4

Click to edit Master title style Rate of return on investment is one of the most widely used measures for investment centers and is computed as follows: Rate of return on investment (ROI) = Income from operations Invested assets The higher the rate of return on investment, the better the division utilizes its assets to generate income. 23-4

Click to edit Master title style Income from operation Sales Invested assets x ROI = DuPont Formula Profit Margin Investment Turnover 23-4

Click to edit Master title style ROI = $ 70,000 $560,000 x $350,000 ROI = 12.5% x 1.6 DuPont’s Northern Division (ROI) Income from operation Sales Invested assets x ROI = 20% 23-4

Click to edit Master title style ROI = $ 84,000 $672,000 x $700,000 ROI = 12.5% x 0.96 DuPont’s Central Division (ROI) Income from operation Sales Invested assets x ROI = 12% 23-4

Click to edit Master title style ROI = $ 75,000 $750,000 x $500,000 ROI = 10% x 1.5 DuPont’s Southern Division (ROI) Income from operation Sales Invested assets x ROI = 15% 23-4

Click to edit Master title style Example Exercise 23-4 Campbell Company has income from operations of $35,000, invested in assets of $140,000, and sales of $437,500. Use the DuPont formula to compute the rate of return on investment and show (a) the profit margin, (b) the investment turnover, and (c) the rate of return on investment.

Click to edit Master title style 35 For Practice: PE23-4A, PE23-4B Follow My Example a. Profit margin = $35,000 $437,500 = 8% b. Investment turnover = $437,500 $140,000 = c. Rate of return on investment = 8% x = 25%

Click to edit Master title style Residual Income Residual income is the excess of income from operations over a minimum acceptable income from operations. 23-4

Click to edit Master title style NorthernCentralSouthern DivisionDivisionDivision Income from operations$70,000$84,000$75,000 Minimum acceptable income from operations as a percent of assets: $700,000 x 10%70,000 $500,000 x 10%50,000 Residual income$35,000$14,000$25,000 $350,000 x 10%35,

Click to edit Master title style Example Exercise 23-5 The Wholesale Division of PeanutCo has income from operations of $87,000 and assets of $240,000. The minimum acceptable rate of return on assets is 12%. What is the residual income for the division?

Click to edit Master title style 39 For Practice: PE23-5A, PE23-5B Follow My Example Income from operations$87,000 Minimum acceptable income from operations as a percent of assets: $240,000 x 12% (28,800) Residual income$58,200

Click to edit Master title style 40 The balanced scorecard is a set of financial and nonfinancial measures that reflect multiple performance dimensions of a business. The Balanced Scorecard 23-4

Click to edit Master title style 41 The Balanced Scorecard

Click to edit Master title style 42 When divisions transfer products or render services to each other, a transfer pricing is used to charge for the products or services Transfer Pricing 23-5

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Click to edit Master title style 44 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. 23-5

Click to edit Master title style 45 Negotiated Price Approach The negotiated price approach allows the managers of decentralized units to agree (negotiate) among themselves as to the transfer price. 23-5

Click to edit Master title style 46 Cost Price Approach Under the cost price approach, cost is used to set transfer prices. Cost may refer to either total product cost per unit or variable cost per unit. 23-5