14-1 Visit UMT online at ACCT125© 2006 UMT ACCOUNTING FUNDAMENTALS FOR MANAGERS University of Management and Technology 1901 North Fort Myer Drive Arlington, VA Voice: (703) Fax: (703) Website:

14-2 Visit UMT online at ACCT125© 2006 UMT Carl S. Warren Survey of Accounting (2 nd ed.) © 2004 South-Western

Visit UMT online at ACCT125© 2006 UMT Task Force Clip Art included in this electronic presentation is used with the permission of New Vision Technology of Nepean Ontario, Canada.

14-4 Visit UMT online at ACCT125© 2006 UMT Chapter 14 Performance Evaluation for Decentralized Operations

Visit UMT online at ACCT125© 2006 UMT ContinuedContinued Learning Objectives 1.List and explain the advantages and disadvantages of decentralized operations. 2.Prepare a responsibility accounting report for a cost center. 3.Prepare responsibility accounting reports for a profit center. After studying this chapter, you should be able to:

Visit UMT online at ACCT125© 2006 UMT Learning Objectives 4.Compute and interpret the rate of return on investment, the residual income, and the balanced scorecard for an investment center. 5.Explain how the market price, negotiated price, and cost price approaches to transfer pricing can be used by decentralized segments of a business.

Visit UMT online at ACCT125© 2006 UMT 1 List and explain the advantages and disadvantages of decentralized operations. Learning Objective

Visit UMT online at ACCT125© 2006 UMT Advantages of Decentralized Operations 1.Lower-level managers can react more quickly to problems or changes in operations. 2.Lower-level managers are closer and more responsive to the customers needs. 3.The operation provides a better training ground for managers. 4.Delegation improves employee morale. 5.Top managemjent is free to devote time to strategic planning.

Visit UMT online at ACCT125© 2006 UMT Disadvantages of Decentralized Operations 1.Assets and operating costs are duplicated (e.g., each division has its own administrative staff). 2.Managers may pursue their own goals, instead of company goals.

Visit UMT online at ACCT125© 2006 UMT Prepare a responsibility accounting report for a cost center. 2 Learning Objective

Visit UMT online at ACCT125© 2006 UMT Responsibility Centers Managers are held accountable for controlling costs. Managers are held accountable for costs and making decisions that impact revenues favorably. Managers are held accountable for costs and revenues and are also held accountable for the efficient use of assets. Cost Centers Cost Centers Investment Centers Investment Centers Profit Centers Profit Centers

Visit UMT online at ACCT125© 2006 UMT Budget Performance Report Vice-President, Production For the Month Ended October 31, 2004 OverUnder BudgetActualBudgetBudget Administration$ 19,500$ 19,700$ 200 Plant A467,475470,3302,855 Plant B395,225394,300$925 $882,200$884,330$3,550$925 Each of the line items above will be supported by a cost center report. Cost Center Responsibility Accounting

Visit UMT online at ACCT125© 2006 UMT OverUnder BudgetActualBudgetBudget Administration$ 19,500$ 19,700$ 200 Plant A467,475470,3302,855 Plant B395,225394,300$925 $882,200$884,330$3,550$925 This is supported by a cost center report for Plant A. Budget Performance Report Vice-President, Production For the Month Ended October 31, 2004 Cost Center Responsibility Accounting

Visit UMT online at ACCT125© 2006 UMT OverUnder BudgetActualBudgetBudget Administration$ 17,500$ 17,350$150 Department 1109,725111,280$1,555 Department 2 190,500192,6002,100 Department 3 149,750149, $467,475$470,330$3,655$800 This is shown on the production report. Cost Center Responsibility Accounting Budget Performance Report Manager, Plant A For the Month Ended October 31, 2004

Visit UMT online at ACCT125© 2006 UMT OverUnder BudgetActualBudgetBudget Administration$ 17,500$ 17,350$150 Department 1109,725111,280$1,555 Department 2 190,500192,6002,100 Department 3 149,750149, $467,475$470,330$3,655$800 This is supported by a cost center report for Department 1. Cost Center Responsibility Accounting Budget Performance Report Manager, Plant A For the Month Ended October 31, 2004

Visit UMT online at ACCT125© 2006 UMT OverUnder BudgetActualBudgetBudget Cost Center Responsibility Accounting Budget Performance Report Supervisor, Department 1Plant A For the Month Ended October 31, 2004 This is shown on Plant As report. Factory wages$ 58,100$ 58,000$150 Materials32,50034,225$1,725 Supervisory salaries6,4006,400 Power and light5,7505, Depreciation4,0004,000 Maintenance2,0001,99010 Insurance, taxes $109,725$111,280$1,725$170

Visit UMT online at ACCT125© 2006 UMT Prepare responsibility accounting reports for a profit center. 3 Learning Objective

Visit UMT online at ACCT125© 2006 UMT Nova Entertainment Group Divisional Income Statements For the Year Ended December 31, 2004 ThemeMovie ParkProductionDivision Revenues$6,000,000$2,500,000 Operating expenses2,495,000405,000 Income from operations$3,505,000$2,095,000 Profit Center Responsibility Accounting Income from operations before service department charges.

Visit UMT online at ACCT125© 2006 UMT Nova Entertainment Group Service Department Charges to NEG Divisions For the Year Ended December 31, 2004 ThemeMovie ParkProduction Service DepartmentDivisionDivision Purchasing$250,000$150,000 Payroll accounting204,00051,000 Legal25,000225,000 Total charges$479,000$426,000 Service Department Charges to Profit Centers These costs are charged to the divisions based on the activity base of the service department.

Visit UMT online at ACCT125© 2006 UMT Nova Entertainment Group Service Department Charges to NEG Divisions For the Year Ended December 31, 2004 ThemeMovie ParkProduction Service DepartmentDivisionDivision Purchasing$250,000$150,000 Payroll accounting204,00051,000 Legal25,000225,000 Total charges$479,000$426,000 25,000 purchase requisitions x $10 per requisition = $250,000 15,000 purchase requisitions x $10 per requisition = $150,000 25,000 purchase requisitions x $10 per requisition = $250,000 15,000 purchase requisitions x $10 per requisition = $150,000 Service Department Charges to Profit Centers

Visit UMT online at ACCT125© 2006 UMT Nova Entertainment Group Service Department Charges to NEG Divisions For the Year Ended December 31, 2004 ThemeMovie ParkProduction Service DepartmentDivisionDivision Purchasing$250,000$150,000 Payroll accounting204,00051,000 Legal25,000225,000 Total charges$479,000$426,000 12,000 payroll checks x $17 per check = $204,000 3,000 payroll checks x $17 per check = $51,000 12,000 payroll checks x $17 per check = $204,000 3,000 payroll checks x $17 per check = $51,000 Service Department Charges to Profit Centers

Visit UMT online at ACCT125© 2006 UMT Nova Entertainment Group Service Department Charges to NEG Divisions For the Year Ended December 31, 2004 ThemeMovie ParkProduction Service DepartmentDivisionDivision Purchasing$250,000$150,000 Payroll accounting204,00051,000 Legal25,000225,000 Total charges$479,000$426, hours x $250 per hour = $25, hours x $250 per hour = $225, hours x $250 per hour = $25, hours x $250 per hour = $225,000 Service Department Charges to Profit Centers

Visit UMT online at ACCT125© 2006 UMT Nova Entertainment Group Divisional Income Statements For the Year Ended December 31, 2004 ThemeMovie ParkProduction Profit Center Responsibility Accounting Revenues$6,000,000$2,500,000 Operating expenses2,495,000405,000 Income from operations before service department charges$3,505,000$2,095,000 Less service dept. charges: Purchasing$ 250,000$ 150,000 Payroll accounting204,00051,000 Legal25,000225,000 Total service dept. charges$ 479,000$ 426,000 Income from operations$3,026,000$1,669,000

Visit UMT online at ACCT125© 2006 UMT Compute and interpret the rate of return on investment, the residual income, and the balanced scorecard for an investment center. 4 Learning Objective

Visit UMT online at ACCT125© 2006 UMT DataLink Inc. Divisional Income Statements For the Year Ended December 31, 2004 NorthernCentralSouthern DivisionDivisionDivision Revenues$560,000$672,000$750,000 Operating expenses336,000470,400562,500 Income from operations before service dept. charges$224,000$201,600$187,500 Service department charges154,000117,600112,500 Income from operations$ 70,000$ 84,000$ 75,000 Invested assets$350,000$700,000$500,000 Rate of return on investment20% 12% 15% Investment Center Responsibility Accounting

Visit UMT online at ACCT125© 2006 UMT NorthernCentralSouthern DivisionDivisionDivision Profit Margin Profit Margin Investment Turnover Investment Turnover Rate of Return (ROI) Rate of Return (ROI) Investment Center Responsibility Accounting Income from operations $ 70,000$ 84,000$ 75,000 Revenues (Sales) $560,000$672,000$750,000 Profit margin12.5%12.5%10.0% Revenues (Sales) $560,000$672,000$750,000 Invested assets$350,000$700,000$500,000 Investment turnover Income from operations $ 70,000$ 84,000$ 75,000 Invested assets$350,000$700,000$500,000 Rate of return on investment 20% 12% 15%

Visit UMT online at ACCT125© 2006 UMT NorthernCentralSouthern DivisionDivisionDivision Profit margin12.5%12.5%10.0% Investment turnoverx 1.6 x.96 x 1.5 Rate of return on investment20% 12% 15% Rate of Return on Investment DataLink Inc. Divisional Income Statements For the Year Ended December 31, 2004

Visit UMT online at ACCT125© 2006 UMT NorthernCentralSouthern DivisionDivisionDivision Residual Income DataLink Inc. Divisional Income Statements For the Year Ended December 31, 2004 How can Northern Division have the highest residual income when they have the lowest income from operations? Income from operations$ 70,000$ 84,000$ 75,000 Invested assets$350,000$700,000$500,000 Minimum desired return10.0%10.0%10.0% Minimum desired income $ 35,000$ 70,000$ 50,000 Residual income$ 35,000$ 14,000$ 20,000

Visit UMT online at ACCT125© 2006 UMT Explain how the market price, negotiated price, and cost price approaches to transfer pricing can be used by decentralized segments of a business. 5 Learning Objective

Visit UMT online at ACCT125© 2006 UMT Benefits of Transfer Pricing 1.Divisions can be evaluated as profit or investment centers. 2.Divisions are forced to control costs and operate competitively. 3.If divisions are permitted to buy component parts wherever they can find the best price (either internally or externally), transfer pricing will allow a company to maximize its profits.

Visit UMT online at ACCT125© 2006 UMT Commonly Used Transfer Prices Variable Cost per Unit $10 Market Price per Unit $20 Full Cost per Unit $13 Commonly Used Transfer Prices Commonly Used Transfer Prices Negotiated Price 1.Market price approach sets the price at which the product transferred could be sold to outside buyers. 2.Negotiated price approach allows decentralized managers to agree (negotiate) among themselves. 3.Cost price approach uses a variety of cost concepts for setting the transfer price.

Visit UMT online at ACCT125© 2006 UMT Transfer PricingNegotiated Price Approach 1.Division M produces a product with a variable cost of $10 per unit. Division M has unused capacity. 2.Division N purchases 20,000 units of the same product at $20 per unit from an outside source. Variable Cost per Unit $10 Assumptions Assumptions Market Price per Unit $20 Negotiated Price If the division managers agree on a price of $18 per unit, how much will each divisions income increase? How much for the overall company? Division MDivision N