Chapter 22 Power Notes

Performance Evaluation for Decentralized Operations

Learning Objectives
1. Centralized and Decentralized Operations
2. Responsibility Accounting for Cost Centers
3. Responsibility Accounting for Profit Centers
4. Responsibility Accounting for Investment Centers
5. Transfer Pricing
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Chapter 22 Power Notes
Performance Evaluation for Decentralized Operations

Slide # Power Note Topics

2 • Decentralized Operations
6 • Accounting for Cost Centers
11 • Accounting for Profit Centers
17 • Accounting for Investment Centers
22 • Transfer Pricing

Note: To select a topic, type the slide # and press Enter.

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Advantages of Decentralized Operations

1. Lower-level managers can react more quickly to

problems or changes in operations.
2. Lower-level managers are closer and more
responsive to the customer’s needs.
3. The operation provides a better training ground
for managers.
4. Delegation improves employee morale.
5. Top managemjent is free to devote time to
strategic planning.

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Disadvantages of Decentralized Operations

1. Assets and operating costs are duplicated

(e.g., each division has its own
administrative staff).
2. Managers may pursue their own goals,
instead of company goals.

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 Responsibility Centers

Cost Centers
Managers are held accountable for controlling
costs.
Profit Centers
Managers are held accountable for costs and
making decisions that impact revenues favorably.
Investment Centers
Managers are held accountable for costs and
revenues and are also held accountable for the
efficient use of assets.

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 Cost Center Responsibility Accounting
Budget Performance Report
Vice-President, Production
For the Month Ended October 31, 2003
Over Under
Budget Actual Budget Budget
Administration $ 19,500 $ 19,700 $ 200
Plant A 467,475 470,330 2,855
Plant B 395,225 394,300 $925
$882,200 $884,330 $3,550 $925

Each of the line items above will be

supported by a cost center report.

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 Cost Center Responsibility Accounting
Budget Performance Report
Vice-President, Production
For the Month Ended October 31, 2003
Over Under
Budget Actual Budget Budget
Administration $ 19,500 $ 19,700 $ 200
Plant A 467,475 470,330 2,855
Plant B 395,225 394,300 $925
$882,200 $884,330 $3,550 $925

This is supported
by a cost center
report for Plant A.

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 Cost Center Responsibility Accounting
Budget Performance Report
Manager, Plant A
For the Month Ended October 31, 2003
Over Under
Budget Actual Budget Budget
Administration $ 17,500 $ 17,350 $150
Department 1 109,725 111,280 $1,555
Department 2 190,500 192,600 2,100
Department 3 149,750 149,100 650
$467,475 $470,330 $3,655 $800

This is shown on the

production report.

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 Cost Center Responsibility Accounting
Budget Performance Report
Manager, Plant A
For the Month Ended October 31, 2003
Over Under
Budget Actual Budget Budget
Administration $ 17,500 $ 17,350 $150
Department 1 109,725 111,280 $1,555
Department 2 190,500 192,600 2,100
Department 3 149,750 149,100 650
$467,475 $470,330 $3,655 $800

This is supported by
a cost center report
for Department 1.

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 Cost Center Responsibility Accounting
Budget Performance Report
Supervisor, Department 1—Plant A
For the Month Ended October 31, 2003
Over Under
Budget Actual Budget Budget
Factory wages $ 58,100 $ 58,000 $150
Materials 32,500 34,225 $1,725
Supervisory salaries 6,400 6,400
Power and light 5,750 5,690 650
Depreciation 4,000 4,000
Maintenance 2,000 1,990 10
Insurance, taxes 975 975
$109,725 $111,280 $1,725 $170

This is shown on Plant A’s report.

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 Profit Center Responsibility Accounting
Nova Entertainment Group
Divisional Income Statements
For the Year Ended December 31, 2003
Theme Movie
Park Production
Division Division
Revenues $6,000,000 $2,500,000
Operating expenses 2,495,000 405,000
Income from operations $3,505,000 $2,095,000

Income from operations before service department charges.

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Service Department Charges to Profit Centers
Nova Entertainment Group
Service Department Charges to NEG Divisions
For the Year Ended December 31, 2003
Theme Movie
Park Production
Service Department Division Division
Purchasing $250,000 $150,000
Payroll accounting 204,000 51,000
Legal 25,000 225,000
Total charges $479,000 $426,000

These costs are charged to the divisions based

on the activity base of the service department.

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Service Department Charges to Profit Centers
Nova Entertainment Group
Service Department Charges to NEG Divisions
For the Year Ended December 31, 2003
Theme Movie
Park Production
Service Department Division Division
Purchasing $250,000 $150,000
Payroll accounting 204,000 51,000
Legal 25,000 225,000
Total charges $479,000 $426,000

25,000 purchase requisitions x $10 per requisition = $250,000

15,000 purchase requisitions x $10 per requisition = $150,000

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Service Department Charges to Profit Centers
Nova Entertainment Group
Service Department Charges to NEG Divisions
For the Year Ended December 31, 2003
Theme Movie
Park Production
Service Department Division Division
Purchasing $250,000 $150,000
Payroll accounting 204,000 51,000
Legal 25,000 225,000
Total charges $479,000 $426,000

12,000 payroll checks x $17 per check = $204,000

3,000 payroll checks x $17 per check = $51,000

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Service Department Charges to Profit Centers
Nova Entertainment Group
Service Department Charges to NEG Divisions
For the Year Ended December 31, 2003
Theme Movie
Park Production
Service Department Division Division
Purchasing $250,000 $150,000
Payroll accounting 204,000 51,000
Legal 25,000 225,000
Total charges $479,000 $426,000

100 hours x $250 per hour = $25,000

900 hours x $250 per hour = $225,000

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 Profit Center Responsibility Accounting
Nova Entertainment Group
Divisional Income Statements
For the Year Ended December 31, 2003
Theme Movie
Park Production
Revenues $6,000,000 $2,500,000
Operating expenses 2,495,000 405,000
Income from operations before
service department charges $3,505,000 $2,095,000
Less service dept. charges:
Purchasing $ 250,000 $ 150,000
Payroll accounting 204,000 51,000
Legal 25,000 225,000
Total service dept. charges $ 479,000 $ 426,000
Income from operations $3,026,000 $1,669,000

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 Investment Center Responsibility Accounting
DataLink Inc.
Divisional Income Statements
For the Year Ended December 31, 2003
Northern Central Southern
Division Division Division
Revenues $560,000 $672,000 $750,000
Operating expenses 336,000 470,400 562,500
Income from operations
before service dept. charges $224,000 $201,600 $187,500
Service department charges 154,000 117,600 112,500
Income from operations $ 70,000 $ 84,000 $ 75,000
Invested assets $350,000 $700,000 $500,000
Rate of return on investment 20% 12% 15%
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 Investment Center Responsibility Accounting
Northern Central Southern
Profit Margin Division Division Division
Income from operations $ 70,000 $ 84,000 $ 75,000
Revenues (Sales) $560,000 $672,000 $750,000
Profit margin 12.5% 12.5% 10.0%
Investment Turnover
Revenues (Sales) $560,000 $672,000 $750,000
Invested assets $350,000 $700,000 $500,000
Investment turnover 1.6 .96 1.5
Rate of Return (ROI)
Income from operations $ 70,000 $ 84,000 $ 75,000
Invested assets $350,000 $700,000 $500,000
Rate of return on investment 20% 12% 15%

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 Rate of Return on Investment
DataLink Inc.
Divisional Income Statements
For the Year Ended December 31, 2003

Northern Central Southern

Division Division Division
Profit margin 12.5% 12.5% 10.0%
Investment turnover x 1.6 x .96 x 1.5
Rate of return on investment 20% 12% 15%

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 Residual Income
DataLink Inc.
Divisional Income Statements
For the Year Ended December 31, 2003

Northern Central Southern

Division Division Division
Income from operations $ 70,000 $ 84,000 $ 75,000
Invested assets $350,000 $700,000 $500,000
Minimum desired return 10.0% 10.0% 10.0%
Minimum desired income $ 35,000 $ 70,000 $ 50,000
Residual income $ 35,000 $ 14,000 $ 20,000

How can Northern Division have the highest residual income

when they have the lowest income from operations?

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Nonfinancial Performance Measurement

Nonfinancial performance measures combined

with conventional financial measures provide a
balanced performance perspective.
1. Measures of product quality
2. Customer complaints and warranty experience
3. Customer satisfaction and retention rates
4. Product availability and on-time performance
5. New product time to market and market share

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 Benefits of Transfer Pricing

1. Divisions can be evaluated as profit or

investment centers.
2. Divisions are forced to control costs and
operate competitively.
3. If divisions are permitted to buy component
parts wherever they can find the best price
(either internally or externally), transfer pricing
will allow a company to maximize its profits.

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 Commonly Used Transfer Prices
1. Market price approach sets the price at which the
product transferred could be sold to outside buyers.
2. Negotiated price approach allows decentralized
managers to agree (negotiate) among themselves.
3. Cost price approach uses a variety of cost concepts
for setting the transfer price.

Commonly Used Transfer Prices

Variable Cost Full Cost Market Price

per Unit $10 per Unit $13 per Unit $20

Negotiated Price

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 Transfer Pricing—Negotiated Price Approach
Assumptions
1. Division M produces a product with a variable cost
of $10 per unit. Division M has unused capacity.
2. Division N purchases 20,000 units of the same
product at $20 per unit from an outside source.
Variable Cost Market Price
per Unit $10 per Unit $20
Negotiated Price

If the division managers agree on a

price of $18 per unit, how much will
Division M each division’s income increase? Division N
How much for the overall company?

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Chapter 22 Power Notes
Performance Evaluation for Decentralized Operations

This is the last slide in Chapter 22.

Note: To see the topic slide, type 2 and press Enter.

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