1. Performance Evaluation for Decentralized Operations
Chapter 24
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2. Learning Objective 1
Describe the advantages and disadvantages of decentralized operations.

3. Centralized and Decentralized Operations
LO 1
Centralized and Decentralized Operations
In a centralized company, all major planning and operating decisions are made by top management.
In a decentralized company, managers of separate divisions or units are delegated operating responsibility. The division (unit) managers are responsible for planning and controlling the operations of their divisions.

4. Advantages of Decentralization
LO 1
Advantages of Decentralization
For large companies, it is difficult for top management to do the following:
Maintain daily contact with all operations
Maintain operating expertise in all product lines and services
Decentralized operations provide excellent training for managers.
Delegating responsibility allows managers to develop managerial experience early in their careers.

5. Advantages and Disadvantages
LO 1
Advantages and Disadvantages
It helps a company retain managers.
As a result of working closely with customers, managers become more creative in suggesting operating and product improvements.
A primary disadvantage is that decisions made by one manager may negatively affect the profits of the company.
Decentralization may result in duplicate assets and expenses.

6. Responsibility Accounting
LO 1
Responsibility Accounting
In a decentralized business, accounting assists managers in evaluating and controlling their areas of responsibility, called responsibility centers.
Responsibility accounting is the process of measuring and reporting operating data by responsibility centers. Three common types of responsibility centers are cost centers, profit centers, and investment centers.

7. Learning Objective 2
Describe the advantages and disadvantages of decentralized operations.
Prepare a responsibility accounting report for a cost center.

8. Responsibility Accounting for Cost Centers
LO 2
Responsibility Accounting for Cost Centers
A cost center manager has responsibility for controlling costs.
Cost centers may vary in size from a small department to an entire manufacturing plant.
Cost centers may exist within other cost centers.

9. Learning Objectives
Describe the advantages and disadvantages of decentralized operations.
Prepare a responsibility accounting report for a cost center.
Prepare responsibility accounting reports for a profit center.

10. Responsibility Accounting for Profit Centers
LO 3
Responsibility Accounting for Profit Centers
A profit center manager has the responsibility and authority for making decisions that affect both costs and revenues and, thus, profits.
Profit centers may be divisions, departments, or products.
Controllable revenues are revenues earned by the profit center.
Controllable expenses are costs that can be influenced (controlled) by the decisions of profit center managers.

11. Service Department Charges
LO 3
Service Department Charges
Examples of service departments include the following:
Research and Development
Legal
Telecommunications
Information and Computer Systems
Facilities Management
Purchasing
Publications and Graphics
Payroll Accounting
Personnel

12. Service Department Charges
LO 3
Service Department Charges
Service department charges are indirect expenses to a profit center.
Services provided by internal centralized service departments are often more efficient than services contracted with outside providers.
Service department charges are allocated to profit centers based on the usage of the service by each profit center.

13. Service Department Charges
LO 3
Service Department Charges
Nova Entertainment Group (NEG) has two operating divisions: Theme Park Division and Movie Production Division. The revenues and direct operating expenses for the two divisions are shown below.
(continued)

14. Service Department Charges
LO 3
Service Department Charges
NEG’s service departments and the expenses they incurred for the year ended December 31, 2012, are as follows:
Purchasing $400,000
Payroll Accounting 255,000
Legal 250,000
Total $905,000
(continued)

15. Service Department Charges
LO 3
Service Department Charges
An activity base for each service department is used to charge service department expenses to the Theme Park and Movie Production divisions. The activity base for each service department is as follows:
(continued)

16. Service Usage—Purchasing
LO 3
Service Department Charges
Service Usage—Purchasing
Theme Park Division 25,000 purchase requisitions
Movie Production Division 15,000
Total 40,000 purchase requisitions
$400,000
40,000 purchase requisitions
= $10 per purchase requisition
(continued)

17. Service Usage—Payroll Accounting
LO 3
Service Department Charges
Service Usage—Payroll Accounting
Theme Park Division 12,000 payroll checks
Movie Production Division 3,000
Total 15,000 payroll checks
$255,000
15,000 payroll checks
= $17 per payroll check
(continued)

18. Service Department Charges
LO 3
Service Department Charges
Service Usage—Legal
Theme Park Division billed hours
Movie Production Division
Total 1,000 billed hours
$250,000
1,000 hours
= $250 per hour

19. Learning Objective 4
Describe the advantages and disadvantages of decentralized operations.
Prepare a responsibility accounting report for a cost center.
Prepare responsibility accounting reports for a profit center.
Compute and interpret the rate of return on investment, the residual income, and the balanced scorecard for an investment center.

20. Responsibility Accounting for Investment Centers
LO 4
Responsibility Accounting for Investment Centers
An investment center manager has the responsibility and the authority to make decisions that affect not only costs and revenues, but also the assets invested in the center.

21. Rate of Return on Investment
LO 4
Rate of Return on Investment
One measure that considers the amount of assets invested in an investment center is the rate of return on investment (ROI) or rate of return on assets. It is computed as follows:
ROI =
Income from Operations
Invested Assets

22. Income from Operations
LO 4
Rate of Return on Investment
Dupont Formula
Income from Operations
Sales
Invested Assets x
ROI =
Profit Margin
Investment Turnover

23. Rate of Return on Investment
LO 4
Rate of Return on Investment
The profit margin and the investment turnover reflect the following underlying operating relationships of each division:
Profit margin indicates operating profitability by computing the rate of profit earned on each sales dollar.
Investment turnover indicates operating efficiency by computing the number of sales dollars generated by each dollar of invested assets.

24. DataLink’s Northern Division ROI
LO 4
Rate of Return on Investment
DataLink’s Northern Division ROI
Income from Operations
Sales
Invested Assets x
ROI =
ROI =
$ 70,000
$560,000 x
$350,000
from Exhibit 6
ROI =
12.5% x 1.6
ROI = 20%

25. DataLink’s Central Division ROI
LO 4
Rate of Return on Investment
DataLink’s Central Division ROI
Income from Operations
Sales
Invested Assets x
ROI =
ROI =
$ 84,000
$672,000 x
$700,000
ROI =
12.5% x 0.96
ROI = 12%

26. DataLink’s Southern Division ROI
LO 4
Rate of Return on Investment
DataLink’s Southern Division ROI
Income from Operations
Sales
Invested Assets x
ROI =
ROI =
$ 75,000
$750,000 x
$500,000
ROI =
10.0% x 1.5
ROI = 15%

27. Rate of Return on Investment
LO 4
Rate of Return on Investment
Assume that the revenues of the Northern Division could be increased by $56,000 through increasing operating expenses, such as advertising, to $385,000.
(continued)

28. Projected Impact of Change
LO 4
Rate of Return on Investment
Projected Impact of Change
Revenues ($560,000 + $56,000) $616,000
Operating expenses 385,000
Income from operations before service department charges $231,000
Service department charges 154,000
Income from operations $ 77,000
Increase of $7,000
(continued)

29. DataLink’s Northern Division ROI Revised
LO 4
Rate of Return on Investment
DataLink’s Northern Division ROI Revised
Income from Operations
Sales
Invested Assets x
ROI =
ROI =
$ 77,000
$616,000 x
$350,000
ROI =
12.5% x 1.76
ROI =
22% (compared to the previous ROI of 20%)

30. LO 4
Residual Income
Residual income is the excess of income from operations over a minimum acceptable income from operations, as shown below:

31. LO 4
Residual Income
Datalink Inc. establishes 10% as the minimum acceptable rate of return on divisional assets. The residual incomes for the three divisions are as follows:

32. LO 4
Residual Income
The major advantage of residual income as a performance measure is that it considers both the minimum acceptable rate of return, invested assets, and the income from operations for each division.

33. The Balanced Scorecard
LO 4
The Balanced Scorecard
The balanced scorecard is a set of multiple performance measures for a company.

34. Learning Objective 5
Describe and illustrate how the market price, negotiated price, and cost price approaches to transfer pricing may be used by decentralized segments of a business.

35. LO 5
Transfer Pricing
When divisions transfer products or render services to each other, a transfer price is used to charge for the products or services.
Three common approaches to setting transfer prices are as follows:
Market price approach
Negotiated price approach
Cost approach

36. LO 5
Market Price Approach
Using the market price approach, the transfer price is the price at which the product or service transferred could be sold to outside buyers.

37. Negotiated Price Approach
LO 5
Negotiated Price Approach
The negotiated price approach allows the managers of decentralized units to agree (negotiate) among themselves on a transfer price.
The only constraint is that the transfer price be less than the market price, but greater than the supplying division’s variable costs per unit.

38. LO 5
Cost Price Approach
Under the cost price approach, cost is used to set transfer prices. A variety of costs may be used in this approach, including the following:
Total product cost per unit
Variable product cost per unit

39. LO 5
Cost Price Approach
If total product cost per unit is used, direct materials, direct labor, and factory overhead are included in the transfer price.
If variable product cost per unit is used, the fixed factory overhead cost is excluded from the transfer price.

40. Performance Evaluation for Decentralized Operations
The End