9-1 Fundamental Managerial Accounting Concepts Thomas P. Edmonds Bor-Yi Tsay Philip R. Olds Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Fifth Edition

9-2 CHAPTER 9 Responsibility Accounting

9-3 Learning Objective LO1 Describe the concept of decentralization.

9-4 An accounting system that provides information... Responsibility Accounting Relating to the responsibilities of individual managers. To evaluate managers on controllable items.

9-5 Decentralization Improves quality of decisions. Encourages upper-level management to concentrate on strategic decisions. Improves productivity. Develops lower-level managers. Improves performance evaluation. Advantages

9-6 Decision-Making is Pushed Down Decentralization often occurs as organizations continue to grow. Decentralization

9-7 Learning Objective LO2 Describe the differences among cost, profit, and investment centers.

9-8 Organization Chart Corporate headquarters – Panther Holding Company Lumber manufacturing division Home building division Furniture manufacturing division Wilson Carpet Company Selma Sopha Corporation Tables Incorporated Sales department Production department Planning department Accounting department Cutting department Assembly department Finishing department Responsibility Level

9-9 Responsibility Centers Investment Center Profit CenterCost Center

9-10 Learning Objective LO3 Prepare and use responsibility reports.

9-11 Responsibility Reports  Prepare budgets for each responsibility center.  Prepare timely performance reports comparing actual amounts with budgeted amounts.  Measure performance of each responsibility center.

9-12 Responsibility Reports

9-13 Responsibility Reports

9-14 Responsibility Reports

9-15 Responsibility Reports Panther Income Statement (Contribution Margin Format)

9-16 Learning Objective LO4 Relate management by exception to responsibility reports.

9-17 Amount of detail varies according to level in an organization. Department manager receives detailed reports. Store manager receives summarized information from each department. Management by Exception

9-18 The vice president of operations receives summarized information from each unit. Management by exception Upper-level management does not receive operating detail unless problems arise. Amount of detail varies according to level in an organization. Management by Exception

9-19 Since the exercise of control may be clouded, managers are usually held responsible for items over which they have predominant rather than absolute control. I’m in control Controllability Concept Managers should only be evaluated on revenues or costs they control.

9-20 To be of maximum benefit, responsibility reports should... Be timely Be issued regularly Be understandable Compare budgeted and actual amounts of controllable items Qualitative Reporting Features

9-21 Cost Center Profit Center Investment Center Evaluation Measures Profitability Return on investment (ROI) Residual income (RI) Cost control Quantity and quality of services Managerial Performance Measurement

9-22 Learning Objective LO5 Evaluate investment opportunities using return on investment.

9-23 Return on Investment Return on investment is the ratio of income to the investment used to generate the income. Return on investment is the ratio of income to the investment used to generate the income. ROI = Operating Income Operating Assets

9-24 Return on Investment Panther Holding Company provides the following information for the company’s second level investment centers. Let’s calculate ROI.

9-25 Return on Investment Lumber Manufacturing Home Building Furniture Manufacturing = = = $60,000 $300,000 $46,080 $256,000 $81,940 $482,000 = 20% = 18% = 17%

9-26 Measuring Operating Assets Using the book value of operating assets to calculate ROI will result in a higher ROI.

9-27 Learning Objective LO6 Identify factors that affect return on investment.

9-28 ROI = Operating Income Operating Assets Margin Turnover Factors Affecting ROI ROI = × Sales Operating Assets Operating Income Sales

9-29 The Lumber Manufacturing Division reported the following information: Operating Income$ 60,000 Sales$ 600,000 Sales$ 600,000 Operating Assets$ 300,000 Operating Assets$ 300,000 Let’s calculate ROI using the expanded equation. Factors Affecting ROI

9-30 ROI =.10 × 2 = 20% Factors Affecting ROI ROI = $60,000 $600,000 × $300,000 ROI = × Sales Operating Assets Operating Income Sales

9-31 Factors Affecting ROI Three ways to improve ROI  Increase Sales  Reduce Expenses  Reduce Operating Assets

9-32 The Lumber Manufacturing Division was able to increase sales to $660,000 which increased operating income to $79,200. There was no change in operating assets. The Lumber Manufacturing Division was able to increase sales to $660,000 which increased operating income to $79,200. There was no change in operating assets. Let’s calculate the new ROI. Factors Affecting ROI

9-33 The division’s ROI increased from 20% to 26.4%. Factors Affecting ROI ROI =.12 × 2.2 = 26.4% ROI = $79,200 $660,000 × $300,000 ROI = × Sales Operating Assets Operating Income Sales

9-34 ROI - A Major Drawback As division manager in Lumber Manufacturing, your compensation package includes a salary plus bonus based on your division’s ROI -- the higher your ROI, the bigger your bonus. As division manager in Lumber Manufacturing, 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%. 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%. You have an opportunity to invest in a new project that will produce an ROI of 25%. As division manager in Lumber Manufacturing, your compensation package includes a salary plus bonus based on your division’s ROI -- the higher your ROI, the bigger your bonus. As division manager in Lumber Manufacturing, 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%. 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%. 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?

9-35 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!

9-36 Learning Objective LO7 Evaluate investment opportunities using residual income.

9-37 Residual Income Operating Income – Investment charge = Residual income Operating Assets × Desired ROI = Investment charge Investment center’s cost of acquiring investment capital

9-38 Residual Income The Lumber Manufacturing Division currently earns $60,000 of operating income with the $300,000 of operating assets it controls. The Lumber Manufacturing Division currently earns $60,000 of operating income with the $300,000 of operating assets it controls. Panther has a 18% desired ROI. Panther has a 18% desired ROI. The Lumber Manufacturing Division currently earns $60,000 of operating income with the $300,000 of operating assets it controls. The Lumber Manufacturing Division currently earns $60,000 of operating income with the $300,000 of operating assets it controls. Panther has a 18% desired ROI. Panther has a 18% desired ROI. Let’s calculate residual income.

9-39 Residual Income Panther’s desired return on investment. Operating income= $60,000 – Desired income = 54,000 = Residual income= $ 6,000 Operating assets = $300,000 × Desired ROI = 18% = Desired income = $ 54,000

9-40 Residual Income Residual income encourages managers to make profitable investments that would be rejected by managers using ROI.

9-41 Responsibility Accounting and the Balanced Scorecard The balanced scorecard is a holistic approach to evaluating managers. Balanced Scorecard Multiple financial measures Multiple non-financial measures

9-42 Learning Objective LO8 Describe how transfer prices may be established. (Appendix)

9-43 Transfer Pricing Goods and services are often transferred internally from one division (selling division) to another (buying division). The transfer price can be the subject of considerable controversy.

9-44 Transfer Pricing Market- Based Prices Negotiated Prices Cost-Based Prices

9-45 End of Chapter 9