1. Power Notes
Chapter 22
Performance Evaluation for Decentralized Operations
Learning Objectives
1. Centralized and Decentralized Operations
2. Responsibility Accounting for Cost Centers
3. Responsibility Accounting for Profit Centers
4. Responsibility Accounting for Investment Centers
5. Transfer Pricing
C22

2. Power Notes
Chapter 22
Performance Evaluation for Decentralized Operations
Slide # Power Note Topics 2 6 11 17 22
Decentralized Operations
Accounting for Cost Centers
Accounting for Profit Centers
Accounting for Investment Centers
Transfer Pricing
Note: To select a topic, type the slide # and press Enter.

3. Advantages of Decentralized Operations
1. Lower-level managers can react more quickly to problems or changes in operations.
2. Lower-level managers are closer and more responsive to the customer’s needs.
3. The operation provides a better training ground for managers.
4. Delegation improves employee morale.
5. Top managemjent is free to devote time to strategic planning.

4. Disadvantages of Decentralized Operations
1. Assets and operating costs are duplicated (e.g., each division has its own administrative staff).
2. Managers may pursue their own goals, instead of company goals.

5. Responsibility Centers
Cost Centers
Managers are held accountable for controlling costs.
Managers are held accountable for costs and making decisions that impact revenues favorably.
Managers are held accountable for costs and revenues and are also held accountable for the efficient use of assets.
Profit Centers
Investment Centers

6. Cost Center Responsibility Accounting
Budget Performance Report
Vice-President, Production
For the Month Ended October 31, 2003
Over Under
Budget Actual Budget Budget
Administration $ 19,500 $ 19,700 $ 200
Plant A 467, ,330 2,855
Plant B 395, ,300 $925
$882,200 $884,330 $3,550 $925
Each of the line items above will be supported by a cost center report.

7. Cost Center Responsibility Accounting
Budget Performance Report
Vice-President, Production
For the Month Ended October 31, 2003
Over Under
Budget Actual Budget Budget
Administration $ 19,500 $ 19,700 $ 200
Plant A 467, ,330 2,855
Plant B 395, ,300 $925
$882,200 $884,330 $3,550 $925
This is supported by a cost center report for Plant A.

8. Cost Center Responsibility Accounting
Budget Performance Report
Manager, Plant A
For the Month Ended October 31, 2003
Over Under
Budget Actual Budget Budget
Administration $ 17,500 $ 17,350 $150
Department 1 109, ,280 $1,555
Department , ,600 2,100
Department , ,
$467,475 $470,330 $3,655 $800
This is shown on the production report.

9. Cost Center Responsibility Accounting
Budget Performance Report
Manager, Plant A
For the Month Ended October 31, 2003
Over Under
Budget Actual Budget Budget
Administration $ 17,500 $ 17,350 $150
Department 1 109, ,280 $1,555
Department , ,600 2,100
Department , ,
$467,475 $470,330 $3,655 $800
This is supported by a cost center report for Department 1.

10. Cost Center Responsibility Accounting
Budget Performance Report
Supervisor, Department 1—Plant A
For the Month Ended October 31, 2003
Over Under
Budget Actual Budget Budget
Factory wages $ 58,100 $ 58,000 $150
Materials 32,500 34,225 $1,725
Supervisory salaries 6,400 6,400
Power and light 5,750 5,
Depreciation 4,000 4,000
Maintenance 2,000 1,
Insurance, taxes
$109,725 $111,280 $1,725 $170
This is shown on Plant A’s report.

11. Profit Center Responsibility Accounting
Nova Entertainment Group
Divisional Income Statements
For the Year Ended December 31, 2003
Theme Movie
Park Production
Division Division
Revenues $6,000,000 $2,500,000
Operating expenses 2,495, ,000
Income from operations $3,505,000 $2,095,000
Income from operations before service department charges.

12. Service Department Charges to Profit Centers
Nova Entertainment Group
Service Department Charges to NEG Divisions
For the Year Ended December 31, 2003
Theme Movie
Park Production
Service Department Division Division
Purchasing $250,000 $150,000
Payroll accounting 204,000 51,000
Legal 25, ,000
Total charges $479,000 $426,000
These costs are charged to the divisions based on the activity base of the service department.

13. Service Department Charges to Profit Centers
Nova Entertainment Group
Service Department Charges to NEG Divisions
For the Year Ended December 31, 2003
Theme Movie
Park Production
Service Department Division Division
Purchasing $250,000 $150,000
Payroll accounting 204,000 51,000
Legal 25, ,000
Total charges $479,000 $426,000
25,000 purchase requisitions x $10 per requisition = $250,000
15,000 purchase requisitions x $10 per requisition = $150,000

14. Service Department Charges to Profit Centers
Nova Entertainment Group
Service Department Charges to NEG Divisions
For the Year Ended December 31, 2003
Theme Movie
Park Production
Service Department Division Division
Purchasing $250,000 $150,000
Payroll accounting 204,000 51,000
Legal 25, ,000
Total charges $479,000 $426,000
12,000 payroll checks x $17 per check = $204,000
3,000 payroll checks x $17 per check = $51,000

15. Service Department Charges to Profit Centers
Nova Entertainment Group
Service Department Charges to NEG Divisions
For the Year Ended December 31, 2003
Theme Movie
Park Production
Service Department Division Division
Purchasing $250,000 $150,000
Payroll accounting 204,000 51,000
Legal 25, ,000
Total charges $479,000 $426,000
100 hours x $250 per hour = $25,000
900 hours x $250 per hour = $225,000

16. Profit Center Responsibility Accounting
Nova Entertainment Group
Divisional Income Statements
For the Year Ended December 31, 2003
Theme Movie
Park Production
Revenues $6,000,000 $2,500,000
Operating expenses 2,495, ,000
Income from operations before
service department charges $3,505,000 $2,095,000
Less service dept. charges:
Purchasing $ 250,000 $ 150,000
Payroll accounting 204,000 51,000
Legal 25, ,000
Total service dept. charges $ 479,000 $ 426,000
Income from operations $3,026,000 $1,669,000

17. Investment Center Responsibility Accounting
DataLink Inc.
Divisional Income Statements
For the Year Ended December 31, 2003
Northern Central Southern
Division Division Division
Revenues $560,000 $672,000 $750,000
Operating expenses 336, , ,500
Income from operations
before service dept. charges $224,000 $201,600 $187,500
Service department charges 154, , ,500
Income from operations $ 70,000 $ 84,000 $ 75,000
Invested assets $350,000 $700,000 $500,000
Rate of return on investment 20% 12% 15%

18. Investment Center Responsibility Accounting
Northern Central Southern
Division Division Division
Profit Margin
Income from operations $ 70,000 $ 84,000 $ 75,000
Revenues (Sales) $560,000 $672,000 $750,000
Profit margin 12.5% 12.5% 10.0%
Invested assets $350,000 $700,000 $500,000
Investment turnover
Rate of return on investment 20% 12% 15%
Investment Turnover
Rate of Return (ROI)

19. Rate of Return on Investment
DataLink Inc.
Divisional Income Statements
For the Year Ended December 31, 2003
Northern Central Southern
Division Division Division
Profit margin 12.5% 12.5% 10.0%
Investment turnover x x x 1.5
Rate of return on investment 20% 12% 15%

20. Divisional Income Statements For the Year Ended December 31, 2003
Residual Income
DataLink Inc.
Divisional Income Statements
For the Year Ended December 31, 2003
Northern Central Southern
Division Division Division
Income from operations $ 70,000 $ 84,000 $ 75,000
Invested assets $350,000 $700,000 $500,000
Minimum desired return 10.0% 10.0% 10.0%
Minimum desired income $ 35,000 $ 70,000 $ 50,000
Residual income $ 35,000 $ 14,000 $ 20,000
How can Northern Division have the highest residual income when they have the lowest income from operations?

21. Nonfinancial Performance Measurement
Nonfinancial performance measures combined with conventional financial measures provide a balanced performance perspective.
1. Measures of product quality
2. Customer complaints and warranty experience
3. Customer satisfaction and retention rates
4. Product availability and on-time performance
5. New product time to market and market share

22. Benefits 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.

23. Commonly Used Transfer Prices
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 uses a variety of cost concepts for setting the transfer price.
Commonly Used Transfer Prices
Variable Cost
per Unit $10
Full Cost
per Unit $13
Market Price
per Unit $20
Negotiated Price

24. Transfer Pricing—Negotiated Price Approach
Assumptions
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.
Variable Cost
per Unit $10
Market Price
per Unit $20
Negotiated Price
If the division managers agree on a price of $18 per unit, how much will each division’s income increase? How much for the overall company?
Division M
Division N

25. Power Notes This is the last slide in Chapter 22. Chapter 22
Performance Evaluation for Decentralized Operations
This is the last slide in Chapter 22.
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