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Chapter 10. Decentralized Performance Evaluation. Decentralization of Responsibility. Decentralization pushes decision making down to lower-level managers. Decentralization often occurs as organizations continue to grow. Learning Objective 10-1.
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Chapter 10 Decentralized Performance Evaluation
Decentralization of Responsibility Decentralization pushesdecision making downto lower-level managers. Decentralization often occurs as organizations continue to grow.
Learning Objective 10-1 List and explain the advantages and disadvantages of decentralization.
Learning Objective 10-2 Describe the different types of responsibility centers and explain how managers in each type are evaluated.
Responsibility Centers Responsibility accounting gives managers authority and responsibility for a particular part of the organization and then evaluates them based on the results of that area of responsibility. Managers of responsibility centers should be held responsible only for that which they can control.
Responsibility Centers Cost Center Revenue Center Profit Center Investment Center Responsibility Centers
Cost Centers Cost center managers have the authority to incur costs to support their areas of responsibility.
Revenue Centers Revenue center managers are responsible for generating revenues within their areas of the organization.
Revenues Sales Interest Other Costs Mfg. costs Commissions Salaries Other Profit Centers Profit Center Profit center managers are responsible for generating a profit (revenue minus cost) within their area of the business.
Return on investment (ROI)and residual income Investment Centers Investment Center managers are responsible for generating a profit and investing assets. Investment CenterEvaluation
Learning Objective 10-3 Describe the four dimensions of the balanced scorecard and explain how they are used to evaluate managerial performance.
Customers Financial Learningand growth Internalbusinessprocesses The Balanced Scorecard Management translates its strategy into performance measures that employees understand and accept. Performancemeasures
Learning Objective 10-4 Compute and interpret return on investment, investment turnover, and profit margin.
Learning Objective 10-5 Compute and interpret residual income.
Residual Income The hurdle rate is the required return on invested assets, sometimes called the cost of capital. Residual income is the organization’s extra profit, over and above that needed to cover the required return on invested assets.
As the store manager at Apple’s Online Store, you have the opportunity to invest $1,000,000 in a project promising a return of $150,000 (15 percent). The company requires a minimum return of 10 percent on all projects, so the project would be acceptable from the company’s perspective. ROI versus Residual Income Would you invest in this project?
Economic Value Added • Economic value added (EVA™) is used to measure the economic wealth created when a company’s after-tax net operating income exceeds its cost of capital. EVA: • Measures profitability based on after-tax net operating income rather than pre-tax net operating income. • Uses the cost of capital as the hurdle rate. • Uses total capital employed as the measure of investment rather than average invested assets
Limitations of Financial Performance Measures Both ROI and residual income are lagging indicators of financial performance. These measures tell how well a company or a division has done in the past but not necessarily how well it will do in the future. To improve short-run financial results, managers may make harmful decisions to cut costs in areas such as research and development, employee training, or quality of manufacturing materials.
Learning Objective 10-6 Explain how transfer prices are set in decentralized organizations.
Goods andServices Transfer Pricing A transfer price is the amount that one division charges when it sells goods or services to another division in the same company. Selling Division Buying Division
Transfer Pricing MarketPrice Ceiling Range of PossibleTransfer Prices Could fallanywherein between VariableCost Floor
Transfer Pricing What transfer price should Apple use to record the purchase of iPads for resale at an Apple retail store?
Transfer Pricing $499 MarketPrice Ceiling Range of PossibleTransfer Prices Negotiated transfer price could fallanywhere inbetween. VariableCost $336 Floor
Market-Price Method The market price is the price that a company would charge to external customers. Market price is appropriate when theselling division has no excess capacity. With idle capacity, the selling division can generate contribution margin for itself at any price above variable cost.
Cost-Based Method The cost-based method uses either the variable cost or the full manufacturing cost as the basis for setting the transfer price. A transfer price above variable cost will provide contribution margin to the seller. Full manufacturing cost plus a markup is a more likely outcome.
Negotiation Transfer price is determined through discussions between managers of buying and selling divisions. Excessive managementtime may be used in thenegotiation process. Conflicts may arise betweennegotiating managers thatdamage working relationships.
