1. Financial and Managerial Accounting Wild, Shaw, and Chiappetta Fourth Edition Wild, Shaw, and Chiappetta Fourth Edition McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Chapter 22 Decentralization and Performance Evaluation

3. Conceptual Learning Objectives C1: Distinguish between direct and indirect expenses and identify bases for allocating indirect expenses to departments. C2: Explain controllable costs and responsibility accounting. C3: Appendix 22A: Explain transfer pricing and methods to set transfer prices. C4: Appendix 22B: Describe allocation of joint costs across products. 22-3

4. A1: Analyze investment centers using return on total assets, residual income and balanced scorecard. A2: Analyze investment centers using profit margin and investment turnover. Analytical Learning Objectives 22-4

5. P1: Prepare departmental income statements and contribution reports. Procedural Learning Objectives 22-5

6. Provide information for managers to use in performance evaluation. To control costs and expenses and assist with evaluating managers performances. To control costs and expenses and assist with evaluating managers performances. Primary goals Departmental Accounting C1 22-6

7. Managers use this information to :  Control operations.  Appraise performance.  Allocate resources.  Plan strategy The accounting system provides information about resources used and outputs achieved. Information for Departmental Evaluation C1 22-7

8. The type of accounting information provided depends on whether the department is a... Evaluated on ability to control costs. Evaluated on ability to generate revenues in excess of expenses. Cost center Profit center Information for Departmental Evaluation C1 22-8

9. Information for Departmental Evaluation Investment Center Evaluated on their use of center assets to generate income. C1 22-9

10. Direct expenses are incurred for the sole benefit of a specific department. Indirect expenses benefit more than one department and are allocated among departments benefited. Departmental Expense Allocation C1 22-10

11. Classic Jewelry pays its janitorial service $300 per month to clean its store. Management allocates this cost to its three departments according to the floor space each occupies. Illustration of Indirect Expense Allocation C1 22-11

12. Classic Jewelry pays its janitorial service $300 per month to clean its store. Management allocates this cost to its three departments according to the floor space each occupies. Illustration of Indirect Expense Allocation C1 22-12

13. Classic Jewelry pays its janitorial service $300 per month to clean its store. Management allocates this cost to its three departments according to the floor space each occupies. Illustration of Indirect Expense Allocation C1 22-13

14. Service department costs are shared, indirect expenses that support the activities of two or more production departments. Bases for Allocating Service Department Costs C1 22-14

15. ABCO allocates its $300,000 personnel cost to operating departments based on the number of employees in each department. The assembly department has 100 employees and the packing department has 150 employees. What amount of cost is allocated to assembly? a.$100,000 b.$120,000 c.$150,000 d. $180,000 ABCO allocates its $300,000 personnel cost to operating departments based on the number of employees in each department. The assembly department has 100 employees and the packing department has 150 employees. What amount of cost is allocated to assembly? a.$100,000 b.$120,000 c.$150,000 d. $180,000 Service Department Costs Question C1 22-15

16. ABCO allocates its $300,000 personnel cost to operating departments based on the number of employees in each department. The assembly department has 100 employees and the packing department has 150 employees. What amount of cost is allocated to assembly? a.$100,000 b.$120,000 c.$150,000 d. $180,000 ABCO allocates its $300,000 personnel cost to operating departments based on the number of employees in each department. The assembly department has 100 employees and the packing department has 150 employees. What amount of cost is allocated to assembly? a.$100,000 b.$120,000 c.$150,000 d. $180,000 Assembly percentage = 100 ÷ (100 + 150) = 40% 40% of $300,000 = $120,000 Service Department Costs Question C1 22-16

17. Let’s prepare departmental income statements using the following steps: Ê Direct expense accumulation. Ë Indirect expense allocation. Ì Service department expense allocation. Preparing Departmental Income Statements P1 22-17

18. Departmental Expense Allocation Spreadsheet P1 22-18

19. Departmental Expense Allocation Spreadsheet Step 1: Direct expenses are traced to service departments and sales departments without allocation. P1 22-19

20. Departmental Expense Allocation Spreadsheet Step 2: Indirect expenses are allocated to both the service and the sales departments based on floor space occupied. Of a total of 12,000 square feet, the service departments occupy 1,500 square feet each, the hardware department occupies 4,050 feet, housewares 2,700, and appliances 2250. P1 22-20

21. Step 3: The Service department total expenses (original direct expenses + allocated indirect expenses) from the two service departments are allocated to three remaining operating or sales departments. Departmental Expense Allocation Spreadsheet P1 22-21

22. Departmental Income Statements HardwareHousewaresAppliances Dept. Combined Sales $ 119,500 $ 71,700 $ 47,800 $ 239,000 Cost of goods sold 73,800 43,800 30,200 147,800 Gross profit on sales $ 45,700 $ 27,900 $ 17,600 $ 91,200 Operating expenses 0 Salaries Expense $ 15,600 $ 7,000 $ 7,800 $ 30,400 Depreciation Expense 400 100 200 700 Supplies Expense 300 200 100 600 Rent Expense 4,860 3,240 2,700 10,800 Utilities Expense 810 540 450 1,800 Advertising Expense 500 300 200 1,000 Insurance Expense 900 600 400 1,900 Share of general office expense 7,650 4,590 3,060 15,300 Share of purchasing expenses 3,880 2,630 3,190 9,700 Total operating expenses $ 34,900 $ 19,200 $ 18,100 $ 72,200 Net income (loss) $ 10,800 $ 8,700 $ (500) $ 19,000 P1 22-22

23. Departmental Income Statement HardwareHousewaresAppliances Dept. Combined Sales $ 119,500 $ 71,700 $ 47,800 $ 239,000 Cost of goods sold 73,800 43,800 30,200 147,800 Gross profit on sales $ 45,700 $ 27,900 $ 17,600 $ 91,200 Operating expenses 0 Salaries Expense $ 15,600 $ 7,000 $ 7,800 $ 30,400 Depreciation Expense 400 100 200 700 Supplies Expense 300 200 100 600 Rent Expense 4,860 3,240 2,700 10,800 Utilities Expense 810 540 450 1,800 Advertising Expense 500 300 200 1,000 Insurance Expense 900 600 400 1,900 Share of general office expense 7,650 4,590 3,060 15,300 Share of purchasing expenses 3,880 2,630 3,190 9,700 Total operating expenses $ 34,900 $ 19,200 $ 18,100 $ 72,200 Net income $ 10,800 $ 8,700 $ (500) $ 19,000 P2 22-23

24. Departmental Contribution to OH P1 HardwareHousewaresAppliances Dept. Combined Sales $ 119,500 $ 71,700 $ 47,800 $ 239,000 Cost of goods sold 73,800 43,800 30,200 147,800 Gross profit on sales $ 45,700 $ 27,900 $ 17,600 $ 91,200 Operating expenses Direct Expenses Salaries Expense $ 15,600 $ 7,000 $ 7,800 $ 30,400 Depreciation Expense 400 100 200 700 Supplies Expense 300 200 100 600 Total Direct Expenses 16,300 7,300 8,100 31,700 22-24 Continued….

25. Departmental Contribution to OH P1 Departmental Contributions To Overhead 29,400 20,600 9,500 59,500 Indirect Expenses: Rent Expense 10,800 Utilities Expense 1,800 Advertising Expense 1,000 Insurance Expense 1,900 Share of general office expense 15,300 Share of purchasing expenses 9,700 Total operating expenses $ 40,500 Net income $ 19,000 Contribution as percent of sales24.6%28.7%19.9%24.9% 22-25

26. Financial Performance Evaluation Measures One of the ways to evaluate investment center managers is to use a measure called return on investment (or return on assets.) The formula for ROI is as follows: A1 Investment center net income Investment center average invested assets ROI = 22-26

27. Another measure of evaluating financial performance is by computing the investment center’s residual income. Financial Performance Evaluation Measures A1 Investment Center - Target investment net income center net income Residual Income = 22-27

28. Balanced Scorecard The Balanced Scorecard is a system of performance measures, including non- financial measures. It Is used to assess company and division performance based on four perspectives: A1 1.Customer 2.Internal processes 3.Innovation and Learning 4.Financial 22-28

29. An accounting system that provides information... Responsibility Accounting Relating to the responsibilities of individual managers. To evaluate managers on controllable items. C2 22-29

30. Costs are controllable if the manager has the power to determine, or strongly influence, the amounts incurred. A manager’s performance evaluation should be based on controllable costs. I’m in control Controllable Costs C2 22-30

31. Direct costs are traced to departments, but may not be controllable by the department manager.  Example: Department managers usually have no control over their own salaries. Controllable costs are identified with a particular manager and a definite time period.  All costs are controllable at some level of management if the time period is long enough. Distinguishing Controllable and Direct Costs C2 22-31

32. Responsibility Accounting Successful implementation of responsibility accounting may use organization charts with clear lines of authority and clearly defined levels of responsibility. C2 22-32

33. Amount of detail varies according to level in organization. A department manager receives detailed reports. A store manager receives summarized information from each department. Responsibility Accounting Performance Reports C2 22-33

34. The vice president of operations receives summarized information from each store. Management by exception: Upper-level management does not receive operating detail unless problems arise. Amount of detail varies according to level in organization. Responsibility Accounting Performance Reports C2 22-34

35. To be of maximum benefit, responsibility reports should...  Be timely.  Be issued regularly.  Be understandable.  Compare budgeted and actual amounts. Responsibility Accounting Performance Reports C2 22-35

36. Investment Center – Analysis We can further examine investment center performance by splitting down return on investment into profit margin and investment turnover: A2 ROI = Profit Margin X Investment Turnover This will provide further information on the performance of the unit. 22-36

37. Profit Margin The profit margin is the first component in the expanded equation and measures the income earned per dollar of sales. A2 Profit margin = Investment Center Net Income Investment Center Sales 22-37

38. Investment Turnover The investment turnover measures how efficiently the company generates sales from its invested assets. It is used in the second half of the expanded ROI formula. A2 Investment = Investment Center Sales Turnover Investment Center Average Assets 22-38

39. End of Chapter 22 22-39