Performance Evaluation for Decentralized Operations 24

Performance Evaluation for Decentralized Operations AC239 Seminar 8

Describe the advantages and disadvantages of decentralized operations. 24-4

In a decentralized company, managers of separate divisions or units are delegated operating responsibility. The division (unit) managers are responsible for planning and controlling the operations of their divisions. Decentralized Operations 1

Allows managers closest to the operations to make decisions 2.Provides excellent training for managers 3.Allows managers to become experts in their area of operation 4.Helps retain managers 5.Improves creativity and customer relations Advantages of Decentralization 1 Exhibit 1 Advantages and Disadvantages of Decentralized Operations (continued)

Decisions made by managers may negatively affect the profits of the company 2.Duplicates assets and expenses 1 Disadvantages of Decentralization Exhibit 1 Advantages and Disadvantages of Decentralized Operations (continued)

Responsibility Accounting In a decentralized business, accounting assists managers in evaluating and controlling their areas of responsibility, called responsibility centers. 1

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 1

The area of responsibility for each center is shown below. Cost Center Profit Center Investment Center Cost Revenue – Cost Profit Revenue – Cost Profit Investment in assets 1

Prepare a responsibility accounting report for a cost center

Responsibility Accounting for Cost Centers A cost center manager has responsibility for controlling the costs. 2

Cost Centers in a University Exhibit 2 2

Responsibility Accounting Reports for Cost Centers (continued) Exhibit 3 2

from Manager, Plant A Budget Performance Report (continued) Responsibility Accounting Reports for Cost Centers (continued) Exhibit 3 2

To Vice President’s Budget Performance Report from Supervisor, Department 1, Plant A’s Budget Performance Report (continued) Responsibility Accounting Reports for Cost Centers (continued) Exhibit 3 2

To Manager, Plant A’s Budget Performance Report Responsibility Accounting Reports for Cost Centers (concluded) Exhibit 3 2

Prepare responsibility accounting reports for a profit center

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). Profit Center 3

Controllable revenues are revenues earned by the profit center. 3 Controllable expenses are costs that can be influenced (controlled) by the decisions of profit center managers.

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. 3

Payroll Accounting Department Charges to NEG’s Theme Park and Movie Production Divisions Exhibit 4 3

NEG Example NEG’s expenses for the year ended Decem- ber 31, 2010 for each service department are as follows: Purchasing$400,000 Payroll Accounting255,000 Legal 250,000 Total$905,000 (continued) 3

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 (continued) 3

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 3 (continued)

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 (continued) 3

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 (continued) 3

Service Department Charges to NEG Divisions Exhibit 5 3

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. However, it should not be compared across profit centers. 3

Divisional Income Statements—NEG Exhibit 6 3

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

An investment center 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. 4 Investment Center

Exhibit 7 Divisional Income Statements—Datalink Inc. 4

Revenue s 4

Investment Turnover Profit Margin Profit $$$ 4

Investment Turnover Profit Margin Profit margin is the ratio of income from operations to sales 4

Investment turnover is the ratio of sales to invested assets Investment Turnover 4

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. ROI = Income from Operations Invested Assets 4

Income from Operations Sales Invested Assets × ROI = DuPont Formula Profit Margin Investment Turnover 4

ROI = $ 70,000 $560,000 × $350,000 ROI = 12.5% × 1.6 DataLink’s Northern Division (ROI) Income from Operations Sales Invested Assets × ROI = 20% 4

ROI = $ 84,000 $672,000 × $700,000 ROI = 12.5% × 0.96 Income from Operations Sales Invested Assets × ROI = 12% DataLink’s Central Division (ROI) 4

ROI = $ 75,000 $750,000 × $500,000 ROI = 10% × 1.5 Income from Operations Sales Invested Assets × ROI = 15% DataLink’s Southern Division (ROI) 4

DataLink’s Northern Division Proposal Assume that the revenues of the Northern Division could be increased by $56,000 through increasing advertising to $385,000. 4

Revenues ($560,000 + $56,000)$616,000 Operating expenses 385,000 Income from operations before service department charges$231,000 Service department charges 154,000 Income from operations$ 77,000 Projected Impact of Change Increase of $7,000 4

ROI = $ 77,000 $616,000 × $350,000 ROI = 12.5% × 1.76 DataLink’s Northern Division (ROI) Revised Income from Operations Sales Invested Assets × ROI = 22% 4

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

When divisions transfer products or render services to each other, a transfer price is used to charge for the products or services. Transfer Pricing 5

Three Methods of Transfer Pricing 1.Market price approach 2.Negotiated price approach 3.Cost price approach 5

Exhibit 9 Commonly Used Transfer Prices 5

Income Statement—No Transfers Between Divisions Exhibit 10 5

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. 5

The negotiated price approach allows the managers of decentralized units to agree (negotiate) among themselves as to the transfer price. Negotiated Price Approach 5

Income Statements— Negotiated Transfer Price Exhibit 11 5

Comparison of Exhibits 10 and 11 Income from Operations No Units Transferred (Exhibit 10) 20,000 Units Transferred at $15 per Unit (Exhibit 11) Increase (Decrease) Eastern Division$200,000$300,000$100,000 Western Division 100, , ,000 Wilson Company$300,000$500,000$200,000 Variable Costs per Unit < Transfer Price < Market Price $10 < Transfer Price < $20 5

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. 5

4-55 Any Questions????