1. Contemporary accounting problems The first topic THE PART 2 Responsibility Accounting

2. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-2 Relating to the responsibilities of individual managers. To evaluate managers on controllable items. An accounting system that provides information... Responsibility Accounting

3. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-3 Decision Making is Pushed Down Decentralization often occurs as organizations continue to grow. Decentralization

4. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-4 Decentralization Promotes better decision making. Allows upper-level management to concentrate on strategic decisions. Improves productivity. Develops lower-level managers. Improves performance evaluation. Advantages

5. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-5 Cost Responsibility Reports Prepared for each individual who has control over revenue or expense items

6. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-6 Responsibility Reports  Prepare budgets for each responsibility center.  Prepare timely performance reports comparing actual amounts with budgeted amounts.  Measure performance of each responsibility center.

7. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-7 Successful implementation of responsibility accounting depends on clear lines of authority and clearly defined levels of responsibility. The Controllability Concept

8. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-8 Amount of detail varies according to level in organization. Department manager receives detailed reports. Store manager receives summarized information from each department. Management by Exception and the Degree of Summarization

9. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-9 Management by Exception and the Degree of Summarization The vice president of operations receives summarized information from each store. Management by exception Upper-level management does not receive operating detail unless problems arise. Amount of detail varies according to level in organization.

10. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-10 Reporting System

11. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-11 To be of maximum benefit, responsibility reports should...  Be timely.  Be issued regularly.  Be understandable.  Compare budgeted and actual amounts. Qualitative Reporting Features

12. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-12 Responsibility Centers A responsibility center is the point in an organization where the control over revenue or expense is located, e.g. division,department or a single machine. A responsibility center may be divided into three categories  cost  profit  investment

13. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-13 Cost Types of Responsibility Centers Cost Center A business segment that incurs expenses but does not generate revenue.

14. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-14 Profit Center A part of the business that has control over both revenues and expenses, but no control over investment funds. Revenues Sales Interest Other Expenses Manufacturing Commissions Salaries Other Types of Responsibility Centers

15. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-15 Investment Center A profit center where management also makes capital investment decisions. Corporate Headquarters Types of Responsibility Centers

16. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-16

17. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-17 Measuring Managerial Performance Return on investment (ROI) Residual income (RI) Cost Center Cost control Quantity and quality of services Profit Center Investment Center Evaluation Measures Profitability

18. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-18 Return on investment is the ratio of income to the investment used to generate the income. ROI = Net Income Investment Return on Investment

19. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-19 ROI = Net Income Investment ROI = Net Income Sales × Investment Margin Turnover Return on Investment

20. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-20 Cola Company reports the following: Net Income $ 30,000 Sales $ 500,000 Investment $ 200,000 Let’s calculate ROI. Return on Investment

21. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-21 ROI = 6% × 2.5 = 15% Return on Investment ROI = Net Income Sales × Investment ROI = $30,000 $500,000 × $200,000

22. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-22 Improving R0I Three ways to improve ROI Ê Increase Sales Ë Reduce Expenses Ì Reduce Investment

23. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-23 Cola Company’s manager was able to increase sales to $600,000 which increased net income to $42,000. There was no change in investment. Let’s calculate the new ROI. Improving R0I

24. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-24 Cola Company increased ROI from 15% to 21%. ROI = 7% × 3 = 21% ROI = Net Income Sales × Investment ROI = $42,000 $600,000 × $200,000 Improving R0I

25. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-25 ROI - A Major Drawback As division manager at Cola Company, your compensation package includes a salary plus bonus based on your division’s ROI -- 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?

26. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-26 ROI - A Major Drawback As division manager, I wouldn’t invest in that project because it would lower my pay! Gee... I thought we were supposed to do what was best for the company!

27. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-27 Residual Income Earned Income – Investment charge = Residual income Investment × Desired ROI = Investment charge Investment center’s cost of acquiring investment capital

28. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-28 Residual Income Cola Company has an opportunity to invest $100,000 in a project that will earn $25,000. Cola Company has a 20 percent desired ROI and a 30 percent ROI on existing business. Let’s calculate residual income.

29. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-29 Residual Income Investment = $100,000 × Desired ROI = 20% = Investment charge = $ 20,000 Investment center’s cost of acquiring investment capital

30. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-30 Residual Income Earned Income= $25,000 – Investment charge = 20,000 = Residual income= $ 5,000 Investment = $100,000 × Desired ROI = 20% = Investment charge = $ 20,000 Investment center’s cost of acquiring investment capital

31. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-31 Residual Income As a manager at Cola Company, would you invest the $100,000 if you were evaluated using residual income? Would your decision be different if you were evaluated using ROI?

32. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-32 Residual Income Residual income encourages managers to make profitable investments that would be rejected by managers using ROI.

33. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-33 Transfer Pricing Let’s change topics!

34. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-34 Transfer Pricing Batteries The amount charged when one division sells goods or services to another division. Battery DivisionAuto Division

35. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-35 Transfer Pricing Battery DivisionAuto Division A higher transfer price for batteries means... The transfer price affects the profit measure for both the selling division and the buying division. lower profits for the auto division. greater profits for the battery division.

36. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-36 The ideal transfer price allows each division manager to make decisions that maximize the company’s profit, while attempting to maximize the division’s profit. Transfer Pricing

37. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-37 Market-based transfer prices are preferred because they promote efficiency and fairness. Setting Transfer Prices When market prices are not available, companies may use...  Cost-based prices  Negotiated prices

38. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-38 Negotiated Transfer Price A system where transfer prices are arrived at through negotiation between managers of buying and selling divisions. Excessive management time may be used in the negotiation process. May not be in the best interest of the company.

39. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-39 Cost-Based Transfer Prices When used, cost-based transfer prices...  Are either variable cost or full cost.  Should use standard rather than actual costs. When used, cost-based transfer prices...  Are either variable cost or full cost.  Should use standard rather than actual costs. Cost-based transfer prices are the least desirable because the incentive to control cost is diminished.

40. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-40 Conflicts may arise between the company’s interests and an individual manager’s interests when transfer-price- based performance measures are used. Setting Transfer Prices

41. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-41 The end of the chapter Let’s transfer some of your capital to me so that my rate of return will be higher!