1. AC239 Managerial Accounting Seminar 8 Jim Eads, CPA, MST, MSF Performance Evaluation for Decentralized Operations 1

2. Decentralization Separating a business into divisions or operating units and delegating responsibility to unit managers is called decentralization. 2

3. Advantages of Decentralization  It allows managers to focus on acquiring expertise in their areas of responsibility.  Decentralizing decision making provides excellent training for managers.  Decentralization helps managers create good customer relations by responding quickly to customers’ needs.  Managers often become more creative in suggesting operating and product improvement. 3

4. Disadvantages of Decentralization  Decisions made by one manager may negatively affect the profitability of the entire company.  A potential disadvantage is duplication of assets and costs in operating divisions (e.g., each manager of a product line might have a separate sales force and administrative staff ). 4

5. Responsibility Centers Responsibility center: an area of management responsibility. Three common types of responsibility centers are Responsibility center: an area of management responsibility. Three common types of responsibility centers are  Cost Centers  Responsible for costs  Profit Centers  Responsible for revenues and costs  Investment Centers  Responsible for revenues, costs and investment in assets 5

6. Responsibility Centers Responsibility accounting: the process of measuring and reporting operating data by responsibility center. Responsibility accounting: the process of measuring and reporting operating data by responsibility center. 6

7. Cost Center In a cost center, the unit manager has responsibility and authority for controlling the costs incurred. 7

8. Cost Center Please turn to Exhibit 3 on page 1090 in the text. 8

9. Service Departments Service departments are centralized departments such as payroll, purchasing and information systems. Service department charges are allocated to profit centers based on some activity base. 9

10. Service Departments 10

11. 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). 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). Controllable revenues are revenues earned by the profit center. Controllable expenses are costs that can be influenced (controlled) by the decisions of the profit center managers Controllable revenues are revenues earned by the profit center. Controllable expenses are costs that can be influenced (controlled) by the decisions of the profit center managers 11

12. Profit Center 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. 12

13. Profit Center 13

14. Investment Center In an investment center, the unit 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. 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. 14

15. Return on Investment Rate of return on investment (ROI) is one of the most widely used measures for investment centers and is computed as follows: ROI = Income / Assets 15

16. 16 Northern Division Central Division Southern Division Revenue$560,000$672,000$750,000 Operating expenses336,000470,000562,000 Service department charges224,000201,600187,500 Income from operations$70,000$84,000$75,000 Invested Assets$350,000$700,000$500,000 ROI20%12%15%

17. DuPont Formula ROI = Profit Margin x Investment Turnover Profit Margin = Income / Sales Investment Turnover = Sales / Invested Assets ROI = (Income / Sales) x (Sales / Invested Assets) 17

18. Exercise 24-4 (page 1099) Campbell Company has income from operations of $35,000, invested in assets of $140,000, and sales of $437,500. Use the DuPont formula to compute the rate of return on investment and show (a) the profit margin, (b) the investment turnover, and (c) the rate of return on investment. 18

19. Exercise 24-4 (page 1099) Profit Margin = $35,000 / $437,500 = 8% Investment Turnover = $437,500 / $140,000 = 3.125 ROI = 8% x 3.125 = 25% Also: ROI = Income / Invested Assets ROI = $35,000 / $140,000 = 25% 19

20. Residual Income Residual income is the excess of income from operations over a minimum acceptable income from operations. 20

21. Exercise 24-5 (page 1101) The Wholesale Division of PeanutCo has income from operations of $87,000 and assets of $240,000. The minimum acceptable rate of return on assets is 12%. What is the residual income for the division? 21

22. Exercise 24-5 (page 1101) Minimum acceptable return on assets = $240,000 x 12% = $28,000. Residual Income = $87,000 - $28,800 = $58,200. 22

23. Balanced Scorecard The balanced scorecard is a set of financial and nonfinancial measures that reflect multiple performance dimensions of a business. 23

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25. Transfer Pricing When divisions transfer products or render services to each other, a transfer pricing is used to charge for the products or services. –Market price approach –Negotiated price approach –Cost price approach 25

26. Transfer Pricing Market Price Approach: The price at which the product/service could be sold to outside buyers. Negotiated Price Approach: The managers of the units involved agree on the transfer price. Cost Price Approach: Product/service is sold from one division to another at cost. 26

27. Questions? 27

28. One last thought…. Make sure you read through Chapter 25 before next week’s seminar. 28