PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter 10 Decentralized Performance Evaluation

10- 3 Decentralization of Responsibility Decentralization often occurs as organizations continue to grow. Decentralization pushes decision making down to lower-level managers.

10- 4 Decentralization of Responsibility

10- 5 Responsibility Centers Responsibility accounting gives managers authority and responsibility for a particular part of the organization and then evaluates them based on the results of that area of responsibility. Managers of responsibility centers should be held responsible only for that which they can control.

10- 6 Responsibility Centers Responsibility Centers Cost Center Cost Center Profit Center Profit Center Investment Center Investment Center Revenue Center Revenue Center Responsibility Centers

10- 7 Cost Centers Cost center managers have the authority to incur costs to support their areas of responsibility.

10- 8 Revenue Centers Revenue center managers are responsible for generating revenues within their areas of the organization.

10- 9 Revenues Sales Interest Other Costs Mfg. costs Commissions Salaries Other Profit Centers Profit center managers are responsible for generating a profit (revenue minus cost) within their area of the business. Profit Center

Investment Centers Investment Center managers are responsible for generating a profit and investing assets. Investment Center Evaluation Return on investment (ROI) and residual income

The Balanced Scorecard Management translates its strategy into performance measures that employees understand and accept. Performance measures Customers Learning and growth Internal business processes Financial

The Balanced Scorecard

Return on Investment (ROI)

Residual Income Residual income is the organization’s extra profit, over and above that needed to cover the required return on invested assets. The hurdle rate is the required return on invested assets, sometimes called the cost of capital.

Economic Value Added Economic value added (EVA™) is used to measure the economic wealth created when a company’s after-tax net operating income exceeds its cost of capital. EVA: Measures profitability based on after-tax net operating income rather than pre-tax net operating income. Uses the cost of capital as the hurdle rate. Uses total capital employed as the measure of investment rather than average invested assets

Limitations of Financial Performance Measures Both ROI and residual income are lagging indicators of financial performance. These measures tell how well a company or a division has done in the past but not necessarily how well it will do in the future. To improve short-run financial results, managers may make harmful decisions to cut costs in areas such as research and development, employee training, or quality of manufacturing materials.

Transfer Pricing A transfer price is the amount that one division charges when it sells goods or services to another division in the same company. Goods and Services Selling Division Buying Division

Range of Possible Transfer Prices Ceiling Floor Variable Cost Market Price Could fall anywhere in between Transfer Pricing

End of Chapter 10