Delegation of Decision Making

(Decentralization)
Decision Making
is pushed down.

Top
Management

Middle
Management

Supervisor

Supervisor

Middle
Management

Supervisor

Supervisor

Decentralization often occurs as organizations continue to grow.

13-2

Decentralization

Advantages
Allows organization
to respond more
quickly to events.

Uses specialized
knowledge and
skills of managers.

Frees top management

from day-to-day
operating activities.

13-3

Decentralization

Challenge
Goal Congruence:
Managers of the subunits
make decisions that achieve
top-management goals.

13-4

Measuring Performance
in Investment Centers
Investment Center
managers make
decisions that
affect both profit
and invested
capital.
Investmen
t
Center
Evaluation

Corporate Headquarters
Return on
investment,
residual income, or
economic value
added

13-5

Return on Investment (ROI)

ROI
=

Income
Invested Capital

Sales Revenue
Income
ROI = Sales Revenue Invested Capital
Sales
Margin

Capital
Turnover
13-6

Economic Value Added

Economic value added tells us how much
shareholder wealth is being created.

13-7

Economic Value Added

Investment centers after-tax operating income
Investment charge
= Economic Value Added

(
(

Investment
centers
total assets

Investment
centers
current liabilities

After-tax
Market
cost of
e

valu
debt

) (

of debt
Market
value
of debt

Weighted
average
cost of capital

Cost
of
equi
ty
value Market
capital
Market
value
of equity

of equity

13-8

Improving R0I
Decrease
Expenses
Increase
Sales
Prices

Lower
Invested
Capital

Three ways to improve ROI

13-9

Residual Income
Investment center profit
Investment charge
= Residual income
Investment capital
Imputed interest rate
= Investment charge
Investment centers
minimum required
rate of return
13-10

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

13-11

Issues: Measuring Investment

Capital
Three issues must be considered before
we can properly measure the investment
capital:
What assets should be included?
1.
2.
3.
4.

Total assets.
Total productive assets.
Total assets less current liabilities.
Only the assets controllable by the manager
being evaluated.
13-12

Measuring Investment Capital

The Second Issue
1. Should we measure the investment at the
beginning or end-of-period amount, or
should we use an average of beginning
and end-of- period amounts?
2. Should the assets be shown at historical
or current cost?
13-13

Measuring Investment
Center Income
Division managers should be evaluated on
profit margin they control.
Exclude these costs:
Costs traceable to the division but not
controlled by the division manager.
Common costs incurred elsewhere and
allocated to the division.

The key issue is controllability.

13-14

Inflation: Historical Cost versus

Current-Value Accounting
Use of current-value accounting impacts the
amount of:
1. Invested capital.
2. Income.

13-15