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CHAPTER 12:
PERFORMANCE EVALUATION
AND DECENTRALIZATION
Cornerstones of Managerial
Accounting, 6e
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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 choose
one of two decision-making approaches to
manage their diverse and complex activities:
centralized or decentralized.
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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.
 Allows managers at lower levels to make and
implement key decisions pertaining to their
areas of responsibility.
 Delegating decision-making authority to the
lower levels of management in a company is
called decentralization.
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license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Centralization and Decentralization
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Reasons for Decentralization
 Firms decide to decentralize for several reasons,
including the following:
 ease of gathering and using local information
 focusing of central management
 training and motivating of segment managers
 enhanced competition, exposing segments to market
forces
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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.
 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
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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 computed as follows:
Operating income ÷ Average Operating Assets
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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
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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 into margin and turnover:
Operating income ÷ Average operating assets
 Margin is the ratio of operating income to sales.
 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.
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© 2016 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:
ROI = Operating Income X
Sales
Turnover:
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.
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license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Average Operating Assets, Margin,
Turnover, and Return on Investment
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license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Advantages of Return on
Investment
 At least three positive results stem from the
use of ROI:
 It encourages managers to focus on the
relationship among sales, expenses, and
investment, as should be the case for a manager
of an investment center.
 Managers focus on cost efficiency.
 It encourages managers to focus on operating
asset efficiency.
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license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Disadvantages of the
Return on Investment Measure
 Overemphasis on ROI can produce myopic
behavior.
 Two negative aspects associated with ROI
frequently are:
 It can produce a narrow focus on divisional profitability
at the expense of profitability for the overall firm.
 It encourages managers to focus on the short run at
the expense of the long run.
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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
 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)
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© 2016 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.
Calculating Residual Income
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© 2016 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.