Performance Evaluation for Decentralized Operations

1. Performance Evaluation for Decentralized Operations Chapter 23

2. Centralized and Decentralized Operations In a centralized company, all major planning and operating decisions are made by top management. LO 1

3. In a decentralized company, managers of separate divisions or units are delegated operating responsibility. The division (unit) managers are responsible for planning and controlling the operations of their divisions. LO 1 Centralized and Decentralized Operations

4. Advantages of Decentralization For large companies, it is difficult for top management to do the following: Maintain daily contact with all operations Maintain operating expertise in all product lines and services LO 1

5. Advantages of Decentralization Decentralized operations provide excellent training for managers. Delegating responsibility allows managers to develop managerial experience early in their careers. LO 1 (continued)

6. Advantages of Decentralization It helps a company retain managers. As a result of working closely with customers, managers become more creative in suggesting operating and product improvements. LO 1

7. Disadvantages of Decentralization A primary disadvantage is that decisions made by one manager may negatively affect the profits of the company. Decentralization may result in duplicate assets and expenses. LO 1

8. Responsibility Accounting In a decentralized business, accounting assists managers in evaluating and controlling their areas of responsibility, called responsibility centers. LO 1

9. Responsibility Accounting Responsibility accounting is the process of measuring and reporting operating data by responsibility centers. Three common types of responsibility centers are: Cost centers Profit centers Investment centers LO 1

10. Learning Objective 2 Prepare a responsibility accounting report for a cost center.

11. Responsibility Accounting for Cost Centers A cost center manager has responsibility for controlling costs. Cost centers may vary in size from a small department to an entire manufacturing plant. Cost centers may exist within other cost centers. LO 2

12. LO 2 Responsibility Accounting for Cost Centers

13. LO 2 Responsibility Accounting for Cost Centers (continued)

14. LO 2 Responsibility Accounting for Cost Centers from Manager, Plant A Budget Performance Report (continued)

15. LO 2 Responsibility Accounting for Cost Centers to Vice President’s Budget Performance Report from Supervisor, Department 1—Plant A’s Budget Performance Report (continued)

16. LO 2 Responsibility Accounting for Cost Centers to Manager, Plant A’s Budget Performance Report (concluded)

17. Learning Objective 3 Prepare responsibility accounting reports for a profit center.

18. A profit center manager has the responsibility and authority for making decisions that affect both costs and revenues and, thus, profits. Profit centers may be divisions, departments, or products. LO 3 Responsibility Accounting for Profit Centers

19. Controllable revenues are revenues earned by the profit center. Controllable expenses are costs that can be influenced (controlled) by the decisions of profit center managers. LO 3 Responsibility Accounting for Profit Centers

20. Service Department Charges Examples of service departments include: Research and Development Legal Telecommunications Information and Computer Systems Facilities Management Purchasing Publications and Graphics Payroll Accounting Personnel LO 3

21. Service Department Charges Service department charges are indirect expenses to a profit center. Services provided by internal centralized service departments are often more efficient than services contracted with outside providers. Service department charges are allocated to profit centers based on the usage of the service by each profit center. LO 3

22. LO 3 Service Department Charges NEG Nova Entertainment Group (NEG) has two operating divisions: Theme Park Division and Movie Production Division. The revenues and direct operating expenses for the two divisions are shown below.

23. Purchasing $400,000 Payroll Accounting 255,000 Legal 250,000 Total $905,000 LO 3 Service Department Charges NEG NEG’s service departments and the expenses they incurred for the year ended December 31, 2012, are as follows:

24. LO 3 Service Department Charges NEG An activity base for each service department is used to charge service department expenses to the Theme Park and Movie Production divisions. The activity base for each service department is as follows: (continued)

25. $400,000 40,000 purchase requisitions $10 per purchase requisition = LO 3 Service Department Charges NEG Service Usage—Purchasing Theme Park Division 25,000 purchase requisitions Movie Production Division 15,000 Total 40,000 purchase requisitions (continued)

26. $255,000 15,000 payroll checks =$17 per payroll check LO 3 Service Department Charges NEG Service Usage—Payroll Accounting Theme Park Division 12,000 payroll checks Movie Production Division 3,000 Total 15,000 payroll checks (continued)

27. $250,000 1,000 hours =$250 per hour LO 3 Service Department Charges NEG Service Usage—Legal Theme Park Division 100 billed hours Movie Production Division 900 Total 1,000 billed hours (concluded)

28. LO 3 Service Department Charges NEG

29. EE 23-2

30. Profit Center Reporting 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. However, it should not be compared across profit centers. LO 3

31. Learning Objective 4 Compute and interpret the rate of return on investment, the residual income, and the balanced scorecard for an investment center.

32. Responsibility Accounting for Investment Centers An investment center 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. LO 4

33. Responsibility Accounting for Investment Centers LO 4 DataLink Inc., a cellular phone company, has three regional divisions. These are shown in Exhibit 6. DataLink

34. Rate of Return on Investment 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. It is computed as follows: Income from Operations Invested Assets ROI = LO 4

35. LO 4 Rate of Return on Investment DataLink The invested assets of DataLink’s three divisions are as follows:

36. Sales Invested Assets Income from Operations Sales x ROI = LO 4 Rate of Return on Investment Dupont Formula Investment Turnover Profit Margin

37. The profit margin and the investment turnover reflect the following underlying operating relationships of each division: Profit margin indicates operating profitability by computing the rate of profit earned on each sales dollar. Investment turnover indicates operating efficiency by computing the number of sales dollars generated by each dollar of invested assets. LO 4 Rate of Return on Investment

38. Sales Invested Assets Income from Operations Sales x ROI = $ 70,000 $560,000 $560,000 $350,000 from Exhibit 6 ROI = x 12.5% x 1.6 ROI = LO 4 Rate of Return on Investment DataLink DataLink’s Northern Division ROI ROI =20%

39. Sales Invested Assets Income from Operations Sales x ROI = from Exhibit 6 $ 84,000 $672,000 $672,000 $700,000 12.5% x 0.96 ROI = ROI = x LO 4 Rate of Return on Investment DataLink DataLink’s Central Division ROI ROI =12%

40. Sales Invested Assets Income from Operations Sales x ROI = from Exhibit 6 $ 75,000 $750,000 $750,000 $500,000 10.0% x 1.5 ROI = ROI = x LO 4 Rate of Return on Investment DataLink DataLink’s Southern Division ROI ROI =15%

41. LO 4 Rate of Return on Investment DataLink Assume that the revenues of the Northern Division could be increased by $56,000 through increasing operating expenses, such as advertising, to $385,000. (continued)

42. Increase of $7,000 LO 4 Rate of Return on Investment DataLink Projected Impact of Change Revenues ($560,000 + $56,000) $616,000 Operating expenses 385,000 Income from operations before service department charges $231,000 Service department charges 154,000 Income from operations $ 77,000 (continued)

43. Sales Invested Assets Income from Operations Sales x ROI = $ 77,000 $616,000 $616,000 $350,000 x ROI = 12.5% x 1.76 ROI = 22%(compared to the previous ROI of 20%) ROI = LO 4 Rate of Return on Investment DataLink DataLink’s Northern Division ROI Revised

44. EE 23-4

45. Residual Income Residual income is the excess of income from operations over a minimum acceptable income from operations, as shown below: LO 4

46. A visual portrayal of this useful tool. LO 4 Residual Income

47. LO 4 Residual Income DataLink Datalink Inc. establishes 10% as the minimum acceptable rate of return on divisional assets. The residual incomes for the three divisions are as follows:

48. The major advantage of residual income as a performance measure is that it considers both the minimum acceptable rate of return, invested assets, and the income from operations for each division. LO 4 Residual Income

49. EE 23-5

50. The Balanced Scorecard The balanced scorecard is a set of multiple performance measures for a company. It normally includes performance measures for customer service, innovation and learning, and internal processes, as shown in Exhibit 7 (next slide). LO 4