1. CORNERSTONES of Managerial Accounting, 5e

2. © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. CHAPTER 12: PERFORMANCE EVALUATION AND DECENTRALIZATION Cornerstones of Managerial Accounting, 5e

3. © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Decentralization and Responsibility Centers  A company is organized along lines of responsibility.  Most companies use a more flattened hierarchy that emphasizes teams.  Firms with multiple responsibility centers usually choose one of two decision-making approaches to manage their diverse and complex activities: centralized or decentralized. LO-1

4. © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Decentralization and Responsibility Centers (cont.)  In centralized decision making, decisions are made at the very top level, and lower level managers are charged with implementing these decisions.  Decentralized decision making allows managers at lower levels to make and implement key decisions pertaining to their areas of responsibility. The practice of delegating decision-making authority to the lower levels of management in a company is called decentralization. LO-1

5. © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Centralization and Decentralization LO-1

6. © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Divisions in the Decentralized Firm  Decentralization involves a cost-benefit trade-off.  As a firm becomes more decentralized, it passes more decision authority down the managerial hierarchy.  Decentralization usually is achieved by creating units called divisions.  Divisions can be differentiated a number of different ways, including the following:  types of goods or services  geographic lines  responsibility centers LO-1

7. © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Responsibility Centers  Another way divisions differ is by the type of responsibility given to the divisional manager.  A responsibility center is a segment of the business whose manager is accountable for specified sets of activities. LO-1

8. © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Responsibility Centers (cont.)  The four major types of responsibility centers are as follows:  Cost center: Manager is responsible only for costs.  Revenue center: Manager is responsible only for sales, or revenue.  Profit center: Manager is responsible for both revenues and costs.  Investment center: Manager is responsible for revenues, costs, and investments. LO-1

9. © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Return on Investment  One way to relate operating profits to assets employed is to compute the return on investment (ROI), which is the profit earned per dollar of investment.  ROI is the most common measure of performance for an investment center and is computed as follows: Operating income ÷ Average Operating Assets LO-2

10. © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Return on Investment (cont.)  Operating income refers to earnings before interest and taxes.  Operating assets are all assets acquired to generate operating income, including cash, receivables, inventories, land, buildings, and equipment.  Average operating assets is computed as: (Beginning assets + Ending assets) ÷ 2 LO-2

11. © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Margin and Turnover  A second way to calculate ROI is to separate the formula (Operating income ÷ Average operating assets) into margin and turnover.  Margin is the ratio of operating income to sales.  It tells how many cents of operating income result from each dollar of sales; it expresses the portion of sales that is available for interest, taxes, and profit.  Turnover is sales ÷ average operating assets.  Turnover tells how many dollars of sales result from every dollar invested in operating assets. LO-2

12. © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Margin and Turnover (cont.)  The equation that yields ROI from the Margin and Turnover is as follows: Margin: Turnover: ROI = Operating Income X Sales Sales Average Operating Assets Notice that ‘‘Sales’’ in the above formula can be cancelled out to yield the original ROI formula of Operating income/Average operating assets. LO-2

13. © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Residual Income  Companies have adopted alternative performance measures such as residual income.  ROI can discourage investments that are profitable for a company but lowers a division’s ROI LO-3

14. © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Residual Income (cont.)  Residual income is the difference between operating income and the minimum dollar return required on a company’s operating assets: Residual income = Operating income – (Minimum rate of return x Average operating assets) LO-3

15. © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Economic Value Added (EVA)  Another financial performance measure that is similar to residual income is economic value added.  Economic value added (EVA) is after tax operating income minus the dollar cost of capital employed.  The dollar cost of capital employed is the actual percentage cost of capital multiplied by the total capital employed. LO-3

16. © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Economic Value Added (EVA) (cont.)  EVA is expressed as follows: LO-3

17. © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Transfer Pricing  In decentralized organizations, the output of one division is used as the input of another.  The value of the transferred good is revenue to the selling division and cost to the buying division.  This value, or internal price, is called the transfer price.  Transfer price is the price charged for a component by the selling division to the buying division of the same company. LO-4

18. © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Transfer Pricing Policies  Several transfer pricing policies are used in practice, including:  market price  cost-based transfer prices  negotiated transfer prices LO-4

19. © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Appendix 12A: The Balanced Scorecard – Basic Concepts  Segment income, ROI, residual income, and EVA are important measures of managerial performance, but they lead managers to focus only on dollars. LO-5

20. © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Appendix 12A: The Balanced Scorecard – Basic Concepts  Balanced Scorecard translates an organization’s mission and strategy into operational objectives and performance measures for the following four perspectives:  The financial perspective describes the economic consequences of actions taken in the other three perspectives. LO-5

21. © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Appendix 12A: The Balanced Scorecard – Basic Concepts  The customer perspective defines the customer and market segments in which the business unit will compete.  The internal business process perspective describes the internal processes needed to provide value for customers and owners.  The learning and growth perspective defines the capabilities that an organization needs to create long- term growth and improvement. LO-5

22. © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. The Balanced Scorecard – An Example LO-5

23. © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. The Role of Performance Measures  The Balanced Scorecard is not simply a collection of critical performance measures.  The performance measures are derived from a company’s vision, strategy, and objectives. LO-5

24. © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. The Role of Performance Measures (cont.)  These measures must be balanced between the following measures:  performance driver measures (i.e., lead indicators of future financial performance) and outcome measures (i.e., lagged indicators of financial performance)  objective and subjective measures  external and internal measures  financial and nonfinancial measures LO-5

25. © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Linking Performance Measures to Strategy  Balancing outcome measures with performance drivers is essential to linking with the organization’s strategy.  Performance drivers make things happen and are indicators of how the outcomes are going to be realized. LO-5

26. © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Linking Performance Measures to Strategy (cont.)  Outcome measures are also important because they reveal whether the strategy is being implemented successfully with the desired economic consequences.  A testable strategy can be defined as a set of linked objectives aimed at an overall goal. LO-5

27. © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. A Testable Strategy Example LO-5

28. © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. The Four Perspectives and Performance Measures  The four perspectives define the strategy of an organization and provide the structure or framework for developing an integrated, set of performance measures.  These measures become the means for articulating and communicating the strategy of the organization to its employees and managers. LO-5

29. © 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. The Four Perspectives and Performance Measures (cont.)  The measures also serve the purpose of aligning individual objectives and actions with organizational objectives and initiatives. LO-5