CHAPTER 9 Responsibility Accounting
Learning Objective To describe the concept ofdecentralization LO1
Relating to theresponsibilities ofindividual managers. To evaluatemanagers oncontrollable items. Responsibility Accounting An accounting system thatprovides information . . .
Advantages Decentralization Improves qualityof decisions. Improvesproductivity. Improvesperformanceevaluation. Developslower-levelmanagers. Encourages upper-level management toconcentrate on strategic decisions.
Decision Making is Pushed Down Decentralization Decentralizationoften occurs asorganizationscontinue to grow.
Learning Objective To describe the differences among cost, profit, and investment centers LO2
Organization Chart ResponsibilityLevel 1 Corporate headquarters – Panther Holding Company 2 Lumber manufacturing division Homebuildingdivision Furniture manufacturingdivision 3 Wilson Carpet Company Selma Sopha Corporation Tables Incorporated 4 Sales department Production department Planning department Accounting department 5 Cutting department Finishing department Assembly department
Learning Objective To prepare and use responsibility reports LO3
Responsibility Reports • Prepare budgets for each responsibility center. • Measure performance ofeach responsibility center. • Prepare timely performance reportscomparing actual amounts with budgeted amounts.
Responsibility Reports Panther Income Statement (Contribution Margin Format)
Learning Objective To relate management by exception to responsibility reports LO4
Management by Exception Amount of detail varies according to level in an organization. Departmentmanager receives detailed reports. Store manager receives summarized information from each department.
Management by Exception Amount of detail varies according to level in an organization. Management by exception Upper-level management does not receive operating detail unless problems arise. The vice president of operations receives summarized information from each unit.
I’m in control Controllability Concept Managers shouldonly be evaluated onrevenues or coststhey control. Since the exercise of control may be clouded,managers are usually held responsible for itemsover which they have predominant ratherthan absolute control.
Qualitative Reporting Features To be of maximum benefit, responsibility reports should . . . • Betimely • Be issued regularly • Be understandable • Compare budgetedand actual amountsof controllable items
Cost control Quantity and qualityof services Profitability Return on investment (ROI) Residual income (RI) Managerial Performance Measurement Evaluation Measures Cost Center Profit Center Investment Center
Learning Objective To evaluate investment opportunities using return on investment LO5
Return on investment is the ratio of income to the investment used to generate the income. Operating Income Operating Assets Return on Investment ROI =
Return on Investment Panther Holding Company provides the following information for the company’s second level investment centers. Let’s calculate ROI
Return on Investment $60,000$300,000 LumberManufacturing = = 20% Home Building $46,080$256,000 = = 18% Furniture Manufacturing $81,940$482,000 = = 17%
Measuring Operating Assets Using the book value of operating assets to calculate ROI will result in a higher ROI.
Learning Objective To identify factors that affect return on investment LO6
Operating Income Operating Assets ROI = Sales Operating Assets Operating Income Sales ROI = × Margin Turnover Factors Affecting ROI
Factors Affecting ROI The Lumber Manufacturing Division reported the following information: Operating Income $ 60,000 Sales $ 600,000 Operating Assets $ 300,000 Let’s calculate ROI usingthe expanded equation.
ROI = × $60,000 $600,000 Sales Operating Assets $600,000 $300,000 Operating Income Sales ROI = × Factors Affecting ROI ROI = .10 × 2= 20%
Factors Affecting ROI Reduce Expenses Three ways to improve ROI Reduce Operating Assets Increase Sales
Factors Affecting ROI • The Lumber Manufacturing Division was able to increase sales to $660,000 which increased operating income to $79,200. • There was no change in operating assets. Let’s calculate the new ROI.
ROI = × $79,200 $660,000 Sales Operating Assets $660,000 $300,000 Operating Income Sales ROI = × Factors Affecting ROI ROI = .12 × 2.2= 26.4% The divisions ROI increased from 20% to 26.4%.
ROI - A Major Drawback • As division manager in Lumber Manufacturing,your compensation package includesa salary plus bonus based on your division’sROI -- the higher your ROI, the bigger your bonus. • The company requires an ROI of 20% on all new investments -- your division has been producing an ROI of 30%. • You have an opportunity to invest in a new project that will produce an ROI of 25%. As division manager would you invest in this project?
Gee . . . I thought we were supposed to do what was best for the company! As division manager, I wouldn’t invest in that project because it would lower my pay! ROI - A Major Drawback
Learning Objective To evaluate investment opportunities using residual income LO7
Operating Assets ×Desired ROI = Investment charge Investment center’scost of acquiring investment capital Residual Income Operating Income – Investment charge = Residual income
Residual Income • The Lumber Manufacturing Division currently earns $60,000 of operating income with the $300,000 of operating assets it controls. • Panther has a 18% desired ROI. Let’s calculate residual income.
Operating income = $60,000 – Desired income = 54,000 = Residual income = $ 6,000 Residual Income Operating assets = $300,000 ×Desired ROI = 18% = Desired income = $ 54,000 Panther’s desiredreturn on investment.
Residual Income Residual income encourages managers to make profitable investments that would be rejected by managers using ROI.
Responsibility Accounting and the Balanced Scorecard The balanced scorecard is a holisticapproach to evaluating managers. BalancedScorecard Multiple financialmeasures Multiple non-financialmeasures