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Performance Evaluation, Variable Costing, and Decentralization Management Accounting: The Cornerstone for Business Decisions Copyright ©2006 by South-Western,

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Presentation on theme: "Performance Evaluation, Variable Costing, and Decentralization Management Accounting: The Cornerstone for Business Decisions Copyright ©2006 by South-Western,"— Presentation transcript:

1 Performance Evaluation, Variable Costing, and Decentralization Management Accounting: The Cornerstone for Business Decisions Copyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved.

2 Learning Objectives 1.Explain how and why firms choose to decentralize. 2.Explain the difference between absorption and variable costing. Prepare segmented income statements. 3.Compute and explain return on investment (ROI). 4.Compute and explain residual income and economic value added (EVA).

3 Learning Objectives 5.Explain the role of transfer pricing in a decentralized firm. 6.(Appendix) Explain the uses of the Balanced Scorecard and compute cycle time, velocity, and manufacturing cycle efficiency (MCE).

4 Comment on Decentralization and Responsibility Centers

5 What are some reasons to decentralize?

6 Illustrate Centralization Vs. Decentralization

7 Illustration of PepsiCo's Decentralized Divisions

8 Match Definitions Cost Center Revenue Center A responsibility center in which the manager is only accountable for sales A responsibility center in which the manager is accountable for both revenues and costs Investment Center Profit Center A responsibility center in which the manager is accountable for revenues, costs and investments A responsibility center in which the manager is only accountable for costs

9 Complete the Chart What type of accounting information is use for measuring performance? Capital CenterCostSalesInvestmentOther Cost Revenue Profit Investment

10 Differentiate Between Product and Period Costs

11 Complete Chart How are product and period cost classified under absorption and variable costing? Insert the word “Product” or “Period” were appropriate Costing Method AbsorptionVariable Direct materials Direct labor Variable overhead Fixed overhead Selling expenses Administrative expenses

12 How to compute inventory cost under absorption & variable costing. During the most recent year, Fairchild company had the following data associated with the product it makes. Units in beginning inventory0 Units produced12,000 Units sold ($325 each)10,000 Variable costs per unit: Direct materials$60 Direct labor90 Variable overhead60 Fixed costs: Fixed overhead per unit produced$25 Fixed selling and administrative100,

13 REQUIRED: 1.How many units are in ending inventory? 2.Using absorption costing, calculate the per- unit product cost. What is the value of ending inventory? 3.Using variable costing, calculate the per-unit product cost. What is the value of ending inventory? Calculations: 11-1 How to compute inventory cost under absorption & variable costing.

14 Absorption costing3.Variable costing

15 How to prepare income statements under absorption & variable costing During the most recent year, Fairchild company had the following data associated with the product it makes. Units in beginning inventory0 Units produced12,000 Units sold ($325)10,000 Variable costs per unit: Direct materials$60 Direct labor90 Variable overhead60 Fixed costs: Fixed overhead per unit produced$25 Fixed selling and administrative100,000

16 REQUIRED: 1.Calculate the cost of goods sold under absorption costing 2.Calculate the cost of goods sold under variable costing 3.Prepare an income statement under absorption costing 4.Prepare an income statement under variable costing Calculation: How to prepare income statements under absorption & variable costing. 11-2

17 How to prepare income statements under absorption & variable costing Fairchild Company Absorption-Costing Income Statement

18 How to prepare income statements under absorption & variable costing Fairchild Company Variable-Costing Income Statement

19 Review the Relationships Between Production, Sales & Income IF THEN 1.Production > Sales 2.Production < Sales 3.Production = Sales

20 How to prepare a segmented income statement. Audiomatronics, Inc., produces MP3 players and DVD players in a single factory. The following information was provided for the following year. MP3 PlayersDVD Players Sales$400,000$290,000 Variable cost of good sold200,000150,000 Direct fixed cost30,00020,000 A 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,

21 How to prepare a segmented income statement. REQUIRED: Prepare a variable costing segmented income statement for Audiomatronics, Inc., for the coming year Calculation: MP3 PlayersDVD PlayersTotal Sales Variable cost of goods sold Variable selling expense Contribution margin Less: direct fixed expenses: Direct fixed overhead Direct sell & admin Segment margin Less: common fixed expenses Common fixed overhead Common sell & admin Net income

22 List Three Ways Investment Centers are Evaluated

23 Match Definitions ROI Ave. Operating Assets Sales / Average operating assets Operating income / Sales Turnover Margin Operating income / Average operating assets (Beginning net book value + Ending net book value) / 2

24 How to calculate average operating assets, margin, turnover & ROI. Celimar 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: 1.Average operating assets 2.Margin 3.Turnover 4.ROI 11-4

25 Calculation: 1.Average operating assets = 2.Margin = 3.Turnover = 4.ROI = How to calculate average operating assets, margin, turnover & ROI. 11-4

26 What are three advantages of ROI?

27 How to calculate residual income. Celimar 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: 1.Average operating assets 2.Residual income Calculation: 11-5

28 How to calculate EVA Sales $600,000 Cost of goods sold 330,000 Gross Margin $270,000 Less: Sell & Admin Exp. 210,000 Operating income $ 60,000 Less: Income 18,000 Net income $ 42,000 Celimar Company’s Eastern Division earned net income last year as shown in the following income statement: Total capital employed equaled $330,000. Celimar’s actual cost of capital is 10%.

29 REQUIRED: Calculate EVA for Eastern Division Calculation: How to calculate EVA. 11-6

30 Discuss Transfer Pricing

31 Define the three ways to set transfer prices.

32 How to calculate transfer prices. Omni, 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 $8 REQUIRED: 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? 11-7

33 2. 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? How to calculate transfer prices. 11-7

34 Calculations: How to calculate transfer prices. 11-7


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