Download Chapter 14 - Fisher College of Business

Performance Evaluation for
Decentralized Operations
Chapter 14
Centralized and Decentralized Businesses
Centralized business – all major planning and
operating decisions are made by top
management.
Decentralized business – separating a business
into segments/divisions and delegating
responsibility to segment managers.
Segments can be structured around common functions,
products, or regions.
Decentralization
Advantages of Decentralization
Delegating authority to unit managers:
can result in better decisions because these managers
anticipate and react to operating data more quickly.
allows managers to focus on their area of expertise.
provides excellent manager training.
Disadvantages of Decentralization
Decisions made by one manager may negatively affect
the profitability of the entire organization.
Possible duplication of assets and costs in operating
divisions.
Responsibility Accounting in Decentralized
Operations
• In a decentralized business, an important function of
accounting is to assist unit managers in evaluating and
controlling their areas of responsibility.
• A responsibility center is the area/function for which a
unit manager is responsible.
• Responsibility accounting is the process of measuring
and reporting operating data by responsibility center.
Types of Responsibility Centers
Responsibility Accounting for Cost Centers
Cost Centers in a University
Unit manager only
has responsibility
and authority for
controlling costs.
Responsibility Accounting for Profit
Centers
• Unit manager has responsibility and
authority for controlling costs and
generating revenues.
• Focus is on controllable revenues and
expenses.
• We will illustrate profit center income
reporting for the Nova Entertainment
Group (NEG).
Responsibility Accounting for Profit
Centers
Nova Entertainment Group has two profit
centers.
Service Departments
• In addition to direct expenses, divisions
may also have expenses for services
provided by centralized service
departments.
• Examples include:
•
•
•
•
Research and development
Purchasing
Payroll accounting
Information systems
• A profit center’s income needs to reflect
the costs for any such services used.
Allocating Service Charges
• An activity base for each service department is used to
charge service department expenses to profit centers.
• The activity bases for the centralized services NEG uses
are as follows:
Allocating Service Charges
NEG service usages:
Service department charge rates determine how much to
allocate to each division.
Rate calculation: Total service department expense
Total service usage
The divisional income statements include
the service department charges.
Responsibility Accounting for Investment
Centers
• Unit manager has responsibility and authority
for controlling costs, generating revenues, and
efficiently managing the assets invested in the
center.
• Income from operations is important, but so is
the rate of return on investment.
Rate of Return
on Investment (ROI)
ROI = Income from Operations
Invested Assets
We’ll use Datalink Inc., a cellular phone company,
to illustrate the accounting for investment centers.
Responsibility Accounting for Investment
Centers
Datalink has three investment centers.
The Central Division seems to be the most profitable.
Rate of Return
on Investment (ROI)
ROI = Income from Operations
Invested Assets
The Central Division is the least profitable when
using ROI as the measure of profitability.
The DuPont Formula
• An expanded ROI formula using two factors:
• Ratio of income from operations to sales (often
called the profit margin).
• Ratio of sales to invested assets (often called the
investment turnover).
• ROI = Profit Margin X Investment Turnover
• ROI can be improved by increasing the profit margin or
investment turnover.
The DuPont Formula
ROI = Income from Operations
Sales
×
Sales
Invested Assets
The ending result will be the same as the more
basic ROI formula, but this method allows for
greater analysis by separating profitability and
investment turnover.
Analyzing Datalink’s Investment Centers
DuPont ROI
RATE
(Profit Margin × Investment Turnover)
Northern
Central
Southern
70K /560K × 560K /350K
12.5% × 1.6
84K/672K × 672K/700K
12.5% × 0.96
20%
75K/750K × 750K/500K
10% × 1.5
15%
12%
Analyzing Datalink’s Investment Centers
• Although the Northern and Central Divisions have the
same profit margin (12.5%), the Northern Division uses
its assets more efficiently (1.6 compared with 0.96)
• The Southern Division is not as profitable and uses its
assets less efficiently than the Northern Division.
ROI - A Major Drawback
As division manager at Northern, your compensation
package includes a salary plus bonus based on your
division’s ROI -- i.e., the higher your ROI, the bigger
your bonus.
The company requires an ROI of 10% on all new
investments -- your division has been producing an ROI
of 20%.
You have an opportunity to invest in a new project that
will produce an ROI of 18%.
As division manager would you invest in this project?
Residual Income
Excess of income from operations over a
minimum acceptable rate of return on
assets.
Datalink’s Residual Income
(Assuming a 10% minimum return rate)
The Northern Division has the highest residual
income.
The Balanced Scorecard
Customer Service
Customer Satisfaction
Delivery Performance
Build to Schedule
Customer Complaints
Financial Measures
Cash Flow
Income
Residual Income
ROI
Internal Processes
Lead Time
Manufacturing Cycle Time
Productivity
Quality and Safety
Innovation and Learning
R&D Investment
Training Per Employee
Employee Training
Employee Turnover
Key Concepts/Definitions
A transfer price is the price
charged when one segment
of a company provides
goods or services to
another segment of the
company.
The fundamental objective
in setting transfer prices
is to motivate managers to
act in the best interests of
the overall company.
Transfer Pricing
Wilson Company
Divisional Income Statement
For the Year Ended December 31, 2002
Eastern Division
Western Division
Sales:
50,000 units x $20 per unit
20,000 units x $40 per unit
Expenses:
Variable:
50,000 units x $10 per unit
20,000 units x $30* per unit
Fixed
Total Expenses
Income From Operations
$1,000,000
$800,000
$500,000
$300,000
$800,000
$200,000
$600,000
$100,000
$700,000
$100,000
Total
$1,000,000
$800,000
$1,800,000
$500,000
$600,000
$400,000
$1,500,000
$300,000
*$20 of the $30 per unit represents materials costs, and the remaining $10
per unit represents other expenses incurred within the Western Division.
Wilson Company
Divisional Income Statement
For the Year Ended December 31, 2002
Eastern Division
Western Division
Total
Sales:
50,000 units x $20 per unit
20,000 units x $15 per unit
$1,000,000
$300,000
20,000 units x $40 per unit
$1,300,000
$1,000,000
$300,000
$800,000
$800,000
$800,000
$2,100,000
Expenses:
Variable:
70,000 units x $10 per unit
$700,000
20,000 units x $25* per unit
Fixed
Total Expenses
Income From Operations
$700,000
$500,000
$500,000
$300,000
$100,000
$400,000
$1,000,000
$600,000
$1,600,000
$300,000
$200,000
$500,000
*$10 of the $25 is incurred solely within the Western Division, and $15 per
unit represents the transfer price per unit from the Eastern Division.