Managerial Accounting: An Introduction To Concepts, Methods, And Uses Chapter 11 Investment Center Performance Evaluation Maher, Stickney and Weil

Learning Objectives (Slide 1 of 3)  Identify the benefits and disadvantages of decentralization.  Identify the issues that must be addressed when using return on investment as a divisional performance measure.  Identify examples of differential analysis to make-or-buy decisions with different transfer prices.  Discuss transfer pricing issues and methods.

Learning Objectives (Slide 2 of 3)  Discuss multinational transfer prices.  Identify types of costs to be considered in measuring divisional operating cost.  Identify issues in measuring the investment base for calculating return on investment.  Explain the contribution approach alternative to return on investment for division performance measurement.

Learning Objectives (Slide 3 of 3)  Describe the purpose of the return on investment calculation, and identify its shortcomings.  Explain how to calculate economic value added, and identify its use.

Discuss the Nature of Divisionalized Organizations

Define Divisional Return on Investment (Slide 1 of 2)

Define Divisional Return on Investment ( Slide 2 of 2)

What is transfer pricing? (Slide 1 of 2)

What is transfer pricing? (Slide 2 of 2)

Explain Alternative Ways to Set Transfer Prices

Explain Top Management Intervention

Explain Centrally Established Transfer Price Policies (Slide 1 of 4)

Explain Centrally Established Transfer Price Policies (Slide 2 of 4)

Explain Centrally Established Transfer Price Policies (Slide 3 of 4)

Explain Centrally Established Transfer Price Policies (Slide 4 of 4)  Transfer prices based on costs could be based on what?

Review Motivational Aspects of Transfer Pricing (Slide 1 of 2)

Review Motivational Aspects of Transfer Pricing (Slide 2 of 2)

Division Managers Negotiate Transfer Prices  Under this system, managers act as if they managed independent companies  Advantage - preserves autonomy of division managers  Disadvantages  May require a great deal of management effort  Final price may depend more on negotiating skills rather than on what is best for the company

Comment on Global Transfer Pricing (Slide 1 of 2)

Comment on Global Transfer Pricing (Slide 2 of 2)

Measuring Division Operating Profits (Slide 1 of 5) In measuring divisional operating costs, management must decide how to treat the following costs:  Controllable direct operating costs  Noncontrollable direct operating costs  Controllable indirect operating costs  Noncontrollable indirect operating costs

Measuring Division Operating Profits (Slide 2 of 5)  The issue is whether to include these costs in determining division operating profits for purposes of performance evaluation  Direct versus indirect refers to whether the cost associates directly with the division  Controllable versus noncontrollable refers to whether the manager can affect the cost

Measuring Division Operating Profits (Slide 3 of 5)  Direct costs - almost always deducted in determining division operating profits  Can separate out costs assigned to a division from those assigned to a manager  Could, for example, exclude costs that can’t be controlled by a manager from that manager’s performance evaluation

Measuring Division Operating Profits (Slide 4 of 5)  Indirect controllable operating costs- may be at least partially controllable by division managers  Example: Centralized service department costs such as the training function  If division is charged for use of services of these departments, division may avoid using them  Could be counter-productive

Measuring Division Operating Profits (Slide 5 of 5)  Indirect noncontrollable operating costs  May be necessary costs but division manager lacks the ability to control these costs (e.g., salaries of top corporate management)  May want to allocate these costs to divisions to raise awareness that sales revenue must cover not only divisional costs but also those of central headquarters

Assets Included in Investment Base  When calculating ROI, assets to be included in the denominator must be determined and valued  Most firms use acquisition cost  Using book value can cause problems  Managers may be reluctant to replace older assets due to the negative impact on ROI

Components of Return on Investment  Return on Investment (ROI) What is the equation?

Economic Value Added  An alternative to ROI is Economic Value Added (EVA) What is the equation?

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