1. Organizational Design, Responsibility Accounting and Evaluation of Divisional Performance Chapter 18

2. To “de” or not to “de”  Centralized  Top-down approach  Upper management makes decisions, lower management carries them out  Keeps organization focused on common goals  Can be very bureaucratic and slow moving

3. To “de” or not to “de”  Decentralized  Responsibility for decisions pushed down to lower levels  Takes advantage of local knowledge, specialization  More timely response to issues  Better motivation  May lose sight of the “big picture”  May result in duplication of effort

4. Responsibility centers  Cost center  Responsible for costs incurred  Well-defined relationship between inputs and outputs  Manufacturing, etc.  Discretionary cost center  Relationship between inputs and outputs not well-defined  Marketing, etc.

5. Responsibility centers  Revenue center  Responsible for revenue generated by the center  Profit center  Responsible for both revenue and costs related to the center  Investment center  Responsible for capital investments and profit

6. Responsibility reporting  Performance reports  Show budgeted and actual amounts and variances  “Roll-up” to the next higher level  Totals from lower levels become line items on performance report of next higher level

7. Goals of responsibility reporting  Should provide information on performance  Should distinguish between controllable and uncontrollable costs and revenues  Should motivate desired behavior

8. Investment center performance  Return on investment  Ability to use assets to generate profits  Residual income  Excess of profit over required return on invested capital  Economic value added  Excess of after-tax operating profit over the weighted average cost of invested capital (less current liabilities)

9. Return on investment  Economic profit after all costs including opportunity cost of capital  Function of asset turnover and profit margin  How efficiently does the center use its assets to generate sales?  Asset turnover  What percentage of sales is profit?  Profit margin

10. Return on investment

11. Residual income  Amount of profit remaining after subtracting the minimum required rate of return on the invested capital

12. Economic value added  Seeks to measure the amount of economic value (as opposed to accounting value) added  Adjusts accounting income for various “distortions”  Capitalize R&D, advertising, training, etc. that benefit future years  Use price level adjustments to restate to current year values  Etc, as many as 160 adjustments

13. Economic value added  Basic formula

14. Economic value added  Calculation of weighted average cost of capital

15. Some considerations  Invested capital  Use average of beginning and end-of year balances  Which assets to include?  Total assets?  Total productive assets?  Total assets less current liabilities?  Gross or net book value?

16. Some considerations  Different measures may motivate different behaviors  Example: A project that will return more than the minimum cost of capital, but less than current ROI  Will increase residual income  Will decrease ROI