c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Learning Objectives
1.
2.
3.
4.
5.
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.
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.
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Centralized and Decentralized Operations
o
In a centralized company, all major planning
and operating decisions are made by top
management.
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Centralized and Decentralized Operations
o 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.
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Advantages of Decentralization
o 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
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Advantages of Decentralization
o Decentralized operations provide excellent
training for managers.
o Delegating responsibility allows managers to
develop managerial experience early in their
careers.
(continued)
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Advantages of Decentralization
o It helps a company retain managers.
o As a result of working closely with customers,
managers become more creative in suggesting
operating and product improvements.
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Disadvantages of Decentralization
o A primary disadvantage is that decisions made
by one manager may negatively affect the
profits of the company.
o Decentralization may result in duplicate assets
and expenses.
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ADVANTAGES AND
DISADVANTAGES OF
DECENTRALIZATION
Responsibility Accounting
o In a decentralized business, accounting assists
managers in evaluating and controlling their
areas of responsibility, called responsibility
centers.
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Responsibility Accounting
o 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
Investment centers
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Responsibility Accounting for Cost Centers
o A cost center manager has responsibility for
controlling costs.
o Cost centers may vary in size from a small
department to an entire manufacturing plant.
o Cost centers may exist within other cost
centers.
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
RESPONSIBILITY
ACCOUNTING FOR
COST CENTERS
RESPONSIBILITY
ACCOUNTING FOR
COST CENTERS
(continued)
RESPONSIBILITY
ACCOUNTING FOR
COST CENTERS
from Manager, Plant A
Budget Performance Report
(continued)
RESPONSIBILITY
ACCOUNTING FOR
COST CENTERS
to Vice President’s Budget
Performance Report
from Supervisor, Department 1 — Plant A’s
Budget Performance Report
(continued)
RESPONSIBILITY
ACCOUNTING FOR
COST CENTERS
to Manager, Plant A’s
Budget Performance Report
(concluded)
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Responsibility Accounting for Profit Centers
o A profit center manager has the responsibility
and authority for making decisions that affect
both costs and revenues and, thus, profits.
o Profit centers may be divisions, departments,
or products.
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Responsibility Accounting for Profit Centers
o Controllable revenues are revenues earned by
the profit center.
o Controllable expenses are costs that can be
influenced (controlled) by the decisions of
profit center managers.
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Service Department Charges
o Examples of service departments include the
following:
Research and Development
Legal
Telecommunications
Information and Computer Systems
Facilities Management
Purchasing
Publications and Graphics
Payroll Accounting
Transportation
Personnel Administration
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Service Department Charges
o Service department charges are indirect
expenses to a profit center.
o Services provided by internal centralized
service departments are often more efficient
than services contracted with outside
providers.
o Service department charges are allocated to
profit centers based on the usage of the
service by each profit center.
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Service Department Charges
o Nova Entertainment Group (NEG) has two
operating divisions: Theme Park Division and
Movie Production Division.
o The revenues and direct operating expenses
for the two divisions are shown below.
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Service Department Charges
o NEG’s service departments and the expenses
they incurred for the year ended December 31,
2014, are as follows:
Purchasing
$400,000
Payroll Accounting
255,000
Legal
250,000
Total
$905,000
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Service Department Charges
o 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)
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Service Department Charges
Service Usage—Purchasing
Theme Park Division
25,000 purchase requisitions
Movie Production Division 15,000
Total
$400,000
40,000 purchase
requisitions
40,000 purchase requisitions
= $10 per purchase requisition
(continued)
Service Department Charges
Service Usage—Payroll Accounting
Theme Park Division
Movie Production Division
Total
12,000 payroll checks
3,000
15,000 payroll checks
$255,000
= $17 per payroll check
15,000 payroll checks
(continued)
Service Department Charges
Service Usage—Legal
Theme Park Division
Movie Production Division
Total
100 billed hours
900
1,000 billed hours
$250,000
= $250 per hour
1,000 hours
SERVICE
DEPARTMENT
CHARGES
PROFIT CENTER
REPORTING
Profit Center Reporting
o The income from operations is a measure of a
manager’s performance.
o In evaluating the profit center manager, the
income from operations should be compared
over time to a budget. However, it should not
be compared across profit centers.
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Responsibility Accounting for Investment
Centers
o 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.
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
RESPONSIBILITY
ACCOUNTING FOR
INVESTMENT CENTERS
DataLink Inc., a cellular phone company, has three
regional divisions. These are shown in Exhibit 6.
Rate of Return on Investment
o 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:
Income from Operations
ROI =
Invested Assets
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Rate of Return on Investment
o The invested assets of DataLink’s three
divisions are as follows:
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Rate of Return on Investment
Dupont Formula
Sales
Income from Operations
x
ROI =
Invested Assets
Sales
Profit Margin
Investment
Turnover
Rate of Return on Investment
o 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.
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Rate of Return on Investment
o DataLink’s Northern Division ROI
ROI =
Income from Operations
Sales
$ 70,000
ROI =
$560,000
x
$560,000
$350,000
Sales
x
Invested Assets
from Exhibit 6
ROI = 12.5% x 1.6
ROI = 20%
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Rate of Return on Investment
o DataLink’s Central Division ROI
ROI =
Income from Operations
Sales
$ 84,000
ROI =
$672,000
x
Sales
x
Invested Assets
$672,000
$700,000
ROI = 12.5% x 0.96
ROI = 12%
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Rate of Return on Investment
o DataLink’s Southern Division ROI
ROI =
Income from Operations
Sales
$ 75,000
ROI =
$750,000
x
Sales
x
Invested Assets
$750,000
$500,000
ROI = 10.0% x 1.5
ROI = 15%
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Rate of Return on Investment
o 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)
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Rate of Return on Investment
o Projected Impact of Change
Revenues ($560,000 + $56,000)
Operating expenses
Income from operations before
service department charges
Service department charges
Income from operations
Increase of
$7,000
$616,000
385,000
$231,000
154,000
$ 77,000
(continued)
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Rate of Return on Investment
o DataLink’s Northern Division ROI Revised
ROI =
Income from Operations
Sales
$ 77,000
ROI =
$616,000
x
x
Sales
Invested Assets
$616,000
$350,000
ROI = 12.5% x 1.76
ROI = 22% (compared to the previous ROI of 20%)
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Residual Income
o Residual income is the excess of income from
operations over a minimum acceptable income
from operations, as shown below:
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Residual Income
o Datalink Inc. establishes 10% as the minimum
acceptable rate of return on divisional assets.
The residual incomes for the three divisions
are as follows:
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Residual Income
o 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.
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The Balanced Scorecard
o The balanced scorecard is a set of multiple
performance measures for a company.
o It normally includes performance measures for
customer service, innovation and learning, and
internal processes, as shown in Exhibit 7 (next
slide).
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THE BALANCED
SCORECARD
The Balanced Scorecard
o Some common performance measures used in
the balanced scorecard approach are shown
below.
(continued)
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The Balanced Scorecard
o Some common performance measures used in
the balanced scorecard approach are shown
below.
(continued)
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The Balanced Scorecard
o Some common performance measures used in
the balanced scorecard approach are shown
below.
(continued)
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The Balanced Scorecard
o Some common performance measures used in
the balanced scorecard approach are shown
below.
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c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Transfer Pricing
o When divisions transfer products or render
services to each other, a transfer price is used
to charge for the products or services.
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Transfer Pricing
o
Three common approaches to setting transfer
prices are as follows:
Market price approach
Negotiated price approach
Cost approach
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TRANSFER PRICING
TRANSFER PRICING
Market Price Approach
o Using the market price approach, the transfer
price is the price at which the product or
service transferred could be sold to outside
buyers.
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Negotiated Price Approach
o The negotiated price approach allows the
managers of decentralized units to agree
(negotiate) among themselves on a transfer
price.
o 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.
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NEGOTIATED PRICE
APPROACH
Negotiated Price Approach
o Comparison of Exhibits 9 and 10
Income from Operations
Eastern Division
Western Division
Wilson Company
No Units
Transferred
(Exhibit 9)
20,000 Units
Transferred at
$15 per Unit
(Exhibit 10)
Increase
(Decrease)
$200,000
100,000
$300,000
$300,000
200,000
$500,000
$100,000
100,000
$200,000
Variable Costs per Unit < Transfer Price < Market Price
$10 < Transfer Price < $20
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Cost Price Approach
o 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
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Cost Price Approach
o If total product cost per unit is used, direct
materials, direct labor, and factory overhead
are included in the transfer price.
o If variable product cost per unit is used, the
fixed factory overhead cost is excluded from
the transfer price.
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
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