2Learning Objectives Explain how and why firms choose to decentralize. Explain the difference between absorption and variable costing. Prepare segmented income statements.Compute and explain return on investment (ROI).Compute and explain residual income and economic value added (EVA).
3Learning ObjectivesExplain the role of transfer pricing in a decentralized firm.(Appendix) Explain the uses of the Balanced Scorecard and compute cycle time, velocity, and manufacturing cycle efficiency (MCE).
4Comment on Decentralization and Responsibility Centers Companies organize around responsibility centersThis is what organization charts representCan become cumbersome for decision makingOrganizations can choose to centralize or decentralizeMost organizations are a mix of both
5What are some reasons to decentralize? It is easier to gather and use local informationIt allows for focusing of central managementIt provides training and motivation for segment managersIt enhances competition by exposing business segments to market forces
7Illustration of PepsiCo's Decentralized Divisions
8Match Definitions Cost Center Revenue Center Profit Center A responsibility center in which the manager is only accountable for salesA responsibility center in which the manager is accountable for both revenues and costsRevenue CenterProfit CenterA responsibility center in which the manager is accountable for revenues, costs and investmentsInvestment CenterA responsibility center in which the manager is only accountable for costs
9Complete the ChartWhat type of accounting information is use for measuring performance?CapitalCenterCostSalesInvestmentOtherRevenueProfitXXXX
10Differentiate Between Product and Period Costs Product costs can be inventoried;they include direct material, direct laborand overhead.Period costs, such as sellingand administrative expenses, areexpensed in the period incurred.
11Complete ChartHow are product and period cost classified under absorption and variable costing? Insert the word “Product” or “Period” were appropriateCosting MethodAbsorptionVariableDirect materialsProductDirect laborVariable overheadFixed overheadPERIODSelling expensesPeriodAdministrative expenses
12How to compute inventory cost under absorption & variable costing. 11-1During the most recent year, Fairchild company had the following data associated with the product it makes.Units in beginning inventory 0Units produced 12,000Units sold ($325 each) 10,000Variable costs per unit:Direct materials $60Direct labor 90Variable overhead 60Fixed costs:Fixed overhead per unit produced $25Fixed selling and administrative 100,000
13How to compute inventory cost under absorption & variable costing. 11-1REQUIRED:How many units are in ending inventory?Using absorption costing, calculate the per-unit product cost. What is the value of ending inventory?Using variable costing, calculate the per-unit product cost. What is the value of ending inventory?Calculations:Units in ending inventory = Units in beginning inventory + Units produced – Units sold= ,000 – 10,000 = 2,000
14How to compute inventory cost under absorption & variable costing. 11-12.Absorption costing3.Variable costingDirect materials$ 60Direct labor90Variable overhead60Fixed overhead25Unit product cost$ 210$ 235Value of ending inventory = 2,000 x $235 = $470,000Value of ending inventory = 2,000 x $210 = $420,000
15How to prepare income statements under absorption & variable costing. 11-2During the most recent year, Fairchild company had the following data associated with the product it makes.Units in beginning inventory 0Units produced 12,000Units sold ($325) 10,000Variable costs per unit:Direct materials $60Direct labor 90Variable overhead 60Fixed costs:Fixed overhead per unit produced $25Fixed selling and administrative 100,000
16How to prepare income statements under absorption & variable costing. 11-2REQUIRED:Calculate the cost of goods sold under absorption costingCalculate the cost of goods sold under variable costingPrepare an income statement under absorption costingPrepare an income statement under variable costingCalculation:Cost of goods sold = Absorption product cost x Units sold= $235 x 10,000 = $2,350,000Cost of goods sold = Variable product cost x Units sold= $210 x 10,000 = $2,100,000
17How to prepare income statements under absorption & variable costing. 11-23.Fairchild CompanyAbsorption-Costing Income StatementSales ($325 x 10,000)$3,250,000Cost of goods sold2,350,000Gross Margin$ 900,000Less: Selling & Administrative Expenses100,000Net income$ 800,000
18How to prepare income statements under absorption & variable costing. 11-24.Fairchild CompanyVariable-Costing Income StatementSales ($325 x 10,000)$3,250,000Less: Variable expenses:Variable cost of goods sold2,100,000Contribution Margin$1,150,000Less: Fixed expenses:Fixed overhead$300,000Fixed selling & administrative100,000400,000Net income$ 750,000
19Review the Relationships Between Production, Sales & Income IFTHEN1.Production > SalesAbsorption net income > Variable net income2.Production < SalesAbsorption net income < Variable net income3.Production = SalesAbsorption net income = Variable net income
20How to prepare a segmented income statement. 11-3Audiomatronics, Inc., produces MP3 players and DVD players in a single factory. The following information was provided for the following year.MP3 Players DVD PlayersSales $400,000 $290,000Variable cost of good sold 200, ,000Direct fixed cost 30,000 20,000A 5% sales commission is paid for each of the two product lines. Direct fixed selling and administrative expense was estimated to be $10,000 for the MP3 line and $15,000 for the DVD line.Common fixed overhead for the factory was estimated at $100,000; common selling and administrative expense was estimated to be $20,000.
21How to prepare a segmented income statement. 11-3REQUIRED: Prepare a variable costing segmented income statement for Audiomatronics, Inc., for the coming year.Calculation:MP3 PlayersDVD PlayersTotalSales$ ,000$ ,000$ 770,000Variable cost of goods sold(225,000)(160,000)(385,000)Variable selling expense(22,500)(16,000)(38,500)Contribution margin$ ,500$ ,000346,500Less: direct fixed expenses:Direct fixed overhead(30,000)(20,000)(50,000)Direct sell & admin(10,000)(15,000)(25,000)Segment margin$ ,500$ ,000$ 271,500Less: common fixed expensesCommon fixed overhead(100,000)Common sell & adminNet income$ 151,500
22List Three Ways Investment Centers are Evaluated Economic ValueAddedROIResidual Income
23Match Definitions ROI Sales / Average operating assets Ave. Operating AssetsOperating income / SalesOperating income / Average operating assetsMargin(Beginning net book value + Ending net book value) / 2Turnover
24How to calculate average operating assets, margin, turnover & ROI. 11-4Celimar Company’s Eastern Division earned operating income of $60,000 on Sales of $600,000. At the beginning of the year the net book value of the assets were $305,700, while at the end of the year they were $354,300.REQUIRED: For the Eastern Division calculate:Average operating assetsMarginTurnoverROI
25How to calculate average operating assets, margin, turnover & ROI. 11-4Calculation:Average operating assets = (Beginning assets + ending assets) / 2 = ($305,700 + $354,300) / 2 = $330,000Margin = Operating income / Sales = $60,000 / $600,000 = 10% or 0.10Turnover = Sales / Average operating assets = $600,000 / $330,000 = 1.82 timesROI = Margin x Turnover = .10 x 1.82 = 18.2% or 0.182OR ROI = Operating income / Average operating assets = $60,000 / $330,000 = 18.2%
26What are three advantages 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.It encourages a manager to focus on cost efficiency.It encourages a manager to focus on operating asset efficiency.
27How to calculate residual income. 11-5Celimar Company’s Eastern Division earned operating income of $60,000 on Sales of $600,000. At the beginning of the year the net book value of the assets were $305,700, while at the end of the year they were $354,300. Celimar requires a minimum rate of return of 12%.REQUIRED: For the Eastern Division calculate:Average operating assetsResidual incomeCalculation:Average operating assets = (Beginning assets + ending assets) / 2 = ($305,700 + $354,300) / 2 = $330,000Residual income = Operating income = - (Minimum rate of return x Average operating assets) = $60,000 – (0.12 x $330,000) = $60,000 - $39,600 = $20,400
28How to calculate EVA.11-6Celimar Company’s Eastern Division earned net income last year as shown in the following income statement:Sales$600,000Cost of goods sold330,000Gross Margin$270,000Less: Sell & Admin Exp.210,000Operating income$ 60,000Less: Income18,000Net income$ 42,000Total capital employed equaled $330,000. Celimar’s actual cost of capital is 10%.
29How to calculate EVA.11-6REQUIRED: Calculate EVA for Eastern DivisionCalculation:EVA = After-tax operating income – (Actual percentage cost of capital x Total capital employed)= $42,000 – (10% x $330,000)= $42,000 - $33,000= $9,000
30Discuss Transfer Pricing This represents the charge Bravo Division pays Romeo Division for the use of Romeo Division’s output.It represents a complex issue.It becomes an emotionally charged issue since performance measurement is affected by the value established for the transfer price.A company can not make a profit from itself. Real profits come from selling to third parties.
31Define the three ways to set transfer prices. Market PriceCost-BasedNegociated
32How to calculate transfer prices. 11-7Omni, Inc., has a number of divisions, including Indigo Division, a producer of microcircuit boards and Lima Division a producer of controllers for heating and controlling manufacturers.Indigo produces the bk-912 model that can be used by Lima Division in the production of its control systems for regulating heating and air conditioning systems. The market price of the bk-912 is $15 and the full cost is $8REQUIRED:1. If Omni, Inc. has a transfer pricing policy that requires transfer at full cost, what would the transfer price be? Do you suppose that Indigo and Lima would choose to transfer at that price?
33How to calculate transfer prices. 11-72. If Omni, Inc. has a transfer pricing policy that requires transfer at market price, what would the transfer price be? Do you suppose that Indigo and Lima would choose to transfer at that price?3. Now suppose that Omni, Inc., allows negotiated transfer pricing and that Indigo Division can avoid a $3 selling expense by selling to Lima Division. Which division sets the minimum transfer price, and what is it? Which division sets the maximum transfer price and what is it? Do you suppose that Indigo and Lima Divisions would choose to transfer somewhere in the bargaining range?
34How to calculate transfer prices. 11-7Calculations:The full cost transfer price is $8. Lima Division would be delighted with that price, but Indigo Division would refuse to transfer since $15 could be earned in the outside market.The market price is $15. Both Indigo and Lima divisions would be willing to transfer at that price (since neither division would be worse off than if it bought/sold in the outside market).
35How to calculate transfer prices. 11-73. Minimum transfer price = $15 - $3 = $12The price is set by Indigo Division, the selling division.Maximum transfer price = $15This price is the market price and is set by Lima Division, the buying division.Yes, both divisions would be willing to a accept a transfer price within the bargaining range. Precisely what the transfer price would be depends on the negotiating skills of the Indigo and Lima Division managers.