Chapter 24
Performance Evaluation for Decentralized Operations
Study Guide Solutions
Fill-in-the-Blank Equations
1. Service department expense
2. Income from operations
3. Profit margin
4. Invested assets
5. Variable cost per unit
6. Transfer price
Exercises
1. Determine if each of the following is a characteristic of decentralized operations.
a. Many managers of a company making decisions for their division.
Yes
b. Managers are more able to focus on the needs of customers by division.
Yes
c. Managers report daily to top management regarding changes and decisions to
be made for each division.
No
2. A new company is trying to decide whether to use centralized or decentralized
operations. All branches will be fairly close together, and top management will have
access to each branch when needed and to supervise. To be aware of the operations,
management would like to make the most of the decisions. Would you suggest
centralized or decentralized operations?
Centralized operations
1
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2
Chapter 24
3. Due to recent expansion, the management of a company is trying to decide if
centralized or decentralized operations would be best. Due to recent location openings,
many new managers were hired, but top management is unsure of the customer
demographics of the area. Would you suggest retaining centralized operations or
switching to decentralized operations?
Switching to decentralized operations
Strategy: Under centralized operations, top management has responsibility for all
decisions, meaning all decisions are made in one central location. However decentralized
operations allow for many managers to make decisions for the division for which they
are responsible. Since managers are able to experience first-hand the operations of their
division, the managers are able to adapt to customer preferences and develop better
relationships.
4. The marketing manager of a company looks to find the best marketing opportunities
with the lowest cost for the company. Is this an example of a cost center, profit center,
or investment center manager?
Cost center manager
5. A production manager identifies ways to increase profits by increasing revenue or
decreasing costs, which may include retiring out-of-date machinery and acquiring newer
models. Is this an example of a cost center, profit center, or investment center
manager?
Investment center manager
6. The regional manager of a firm looks for ways to branch into new markets or cut costs
for the division in order to increase profits. Is this an example of a cost center, profit
center, or investment center manager?
Profit center manager
Strategy: A cost manager is responsible solely for the costs of the division, while profit
center managers’ responsibility also include the revenues earned. Investment center
managers incur the most responsibility, over revenues, costs, and investments in assets.
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Performance Evaluation for Decentralized Operations 3
7. For the month of May in 2015, the Mixing Department of the West Plant incurred the
following costs: factory wages, $27,500; materials, $10,600; utilities, $4,100;
depreciation, $1,200; and supervisor salaries, $9,750. Prepare the supervisor’s
responsibility accounting report if the department had the budgeted amounts shown
below.
Factory wages
2,500 hours at $10.00 per hour
Materials
6,000 units at $1.50 per unit
Utilities
$4,150
Depreciation
$1,200
Supervisor salaries
$9,500
Budget Performance Report
Supervisor, Mixing Department—West Plant
For the Month Ended May 31, 2015
Budget Actual Over Budget Under Budget
Factory wages
$25,000 $27,500
$2,500
Supervisor salaries
9,500
9,750
250
Materials
9,000 10,600
1,600
Utilities
4,150
4,100
$50
Depreciation
1,200
1,200
$48,850 $53,150
$4,350
$50
8. For the same month as in Exercise 7, the Bottling Department of the West Plant had the
same budget as the Mixing Department, but incurred the following costs: factory wages,
$22,750; supervisor salaries, $9,750; materials, $10,000; utilities, $3,950; and
depreciation, $1,200. Prepare the supervisor’s responsibility accounting report for the
department and identify the costs that are over budget.
Budget Performance Report
Supervisor, Bottling Department—West Plant
For the Month Ended May 31, 2015
Budget Actual Over Budget Under Budget
Factory wages
$25,000 $22,750
$2,250
Supervisor salaries
9,500
9,750
$ 250
Materials
9,000 10,000
1,000
Utilities
4,150
3,950
200
Depreciation
1,200
1,200
$48,850 $47,650
$1,250
$2,450
The supervisor salaries are over budget by $250 and the materials used are over budget
by $1,000.
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4
Chapter 24
9. Use the information in Exercises 7 and 8 to prepare the responsibility accounting report
for the manager of the West Plant if administration budgeted costs of $10,500 and was
over budget by $650.
Budget Performance Report
Manager, West Plant
For the Month Ended May 31, 2015
Budget
Actual
Over Budget Under Budget
Administration
$ 10,500 $ 11,150
$ 650
Mixing Department
48,850
53,150
4,300
Bottling Department
48,850
47,650
$1,200
$108,200 $111,950
$4,950
$1,200
Strategy: A budget performance report compares budgeted and actual costs. By having
columns for the amount over or under budget, the users of the information can easily
identify which costs should be investigated. As the area reported increases, the report
gives less detail. For example, the individual costs will be listed for a department, while
the costs of each department will be listed for a plant, and the costs of each plant for the
production of the company.
10. Determine if a profit center manager of a division of a picture frame manufacturer has
control over each of the following costs and expenses.
a. Cost of materials used for the division’s production department
Yes
b. Sales goals for the division’s top selling product
Yes
c. Cost of employees’ hourly wage in the department
Yes
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Performance Evaluation for Decentralized Operations 5
11. A profit center manager of a company’s eastern sales division is looking at decreasing
the following costs: direct labor, utilities, and purchasing, which is allocated by the
number of requisitions. To do so, the manager plans to do the following: increase
efficiency in production to decrease the number of hours needed, thus decreasing the
direct labor and utilities and ordering larger quantities each purchase to decrease the
number of purchase orders. Are all of the costs the manager would like to decrease
controllable costs?
Yes, because he has the power to decrease the number of purchase orders.
12. The profit manager of a company would like to decrease the following costs: legal,
purchasing, and direct labor. The company allocates legal by hours billed and purchasing
by number of purchase orders. The company requires that each division meet with the
lawyer for at least twenty hours but allows the manager to make purchase orders. Are
all costs the manager would like to decrease controllable costs?
No, the legal expenses are not controllable costs because the company requires a
certain number of hours.
Strategy: Profit center managers have responsibility for controllable revenues and
expenses. Controllable revenues are the revenues earned by the manager’s profit center.
Controllable expenses include the expenses incurred by the manager’s profit center that
the manager has the ability to change. Service department charges are controllable by
the profit center manager if the profit center manager is able to control how much of the
service is used, usually the activity base of the service department charge.
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Chapter 24
13. Lazy Day Chairs has two divisions, South and North. The company’s service departments
include Purchasing, Advertising, and Research and Development, which allocate
expenses by number of purchase requisitions, number of advertising promotions, and
number of hours, respectively. The Purchasing Department incurred expenses of
$24,000, while Advertising incurred $14,000, and Research and Development incurred
$16,000. Using the information shown below, allocate the service department expenses
among the divisions.
Service Usage
Division
South
North
Total
Charge
Rates
1,200
1,800
3,000
Purchasing
Purchase requisitions
$8 $24,000/3,000
Advertising
25 Promotions
75
100
Research and
Development
3,200 Hours
800
4,000
$140 $14,000/100
$4 $16,000/4,000
Service Department
South
North
Total
Purchasing
$ 9,600 $14,400 $24,000
Advertising
3,500 10,500 14,000
R&D
12,800
3,200 16,000
Total
$25,900 $28,100 $54,000
14. Prepare the divisional income statements for the year ending December 31, 2015, for
Lazy Day Chairs using the information in Exercise 13. The South Division earned
revenues of $152,600 while North earned revenues of $175,800. South incurred
operating expenses of $49,100 while North incurred expenses of $62,300.
Lazy Day Chairs
Divisional Income Statements
For the Year Ended December 31, 2015
South Division North Division
Revenues
$152,600
$175,800
Operating expenses
49,100
62,300
Income from operations before service department charges
$103,500
$113,500
Less service department charges
Research and Development
$ 12,800
$ 3,200
Purchasing
9,600
14,400
Advertising
3,500
10,500
Total service department charges
$ 25,900
$ 28,100
Income from operations
$ 77,600
$ 85,400
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Performance Evaluation for Decentralized Operations 7
15. Clean It Corp. has two sales divisions, CleanPro and Magic Clean. The service
departments of the company include Payroll Accounting, Research and Development,
and Legal, which all allocate expenses by number of payroll checks, hours, and hours
billed. Service departments incurred the following expenses: Payroll Accounting,
$12,000; Research and Development, $28,000; and Legal, $20,000. Use the information
below to allocate the service department expenses among the divisions.
Division
CleanPro
Magic Clean
Total
Charge Rates
Payroll Accounting
3,400 Payroll checks
2,600
6,000
$2 $12,000/6,000
Service Department
Payroll Accounting
R&D
Legal
Total
Service Usage
Research and Development
480 Hours
320
800
$35 $28,000/800
CleanPro
$ 6,800
16,800
14,000
$37,600
Magic Clean
$ 5,200
11,200
6,000
$22,400
Legal
350 Hours billed
150
500
$40 $20,000/500
Total
$12,000
28,000
20,000
$60,000
16. Use the information in Exercise 15 to prepare the divisional income statement for Clean
It Corp. for the year ending September 30, 2015. The Clean Pro division earned revenues
of $125,200 and incurred operating expenses of $50,150. The Magic Clean division
earned revenues of $105,300 and incurred operating expenses of $47,300.
Clean It Corp.
Divisional Income Statements
For the Year Ended September 30, 2015
CleanPro Magic Clean
Revenues
$125,200
$105,300
Operating expenses
50,150
47,000
Income from operations before service department charges $ 75,050
$ 58,300
Less service department charges
Research and Development
$ 16,800
$ 11,200
Legal
14,000
6,000
Payroll Accounting
6,800
5,200
Total service department charges
$ 37,600
$ 22,400
Income from operations
$ 37,450
$ 35,900
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Chapter 24
17. Shooz Manufacturing has two divisions, East and West. The service departments used
by the divisions include Advertising, Facilities Management, and Purchasing. Advertising
incurred total expenses of $22,000, while Facilities Management incurred $24,000 and
Purchasing incurred $52,000. Advertising allocates costs by number of advertising
promotions, while Facilities Management allocates costs by hours of assistance, and
Purchasing allocates costs by number of purchase requisitions. Determine the costs to
be allocated to each division using the information shown.
Division
East
West
Total
Charge Rates
Advertising
450 Promotions
350
800
$27.50 $22,000/800
Service Usage
Facilities Management
330 Hrs. of assistance
420
750
$32.00 $24,000/750
Purchasing
2,200 Purchase requisitions
1,800
4,000
$13.00 $52,000/4,000
Service Department
East
West
Total
Advertising
$12,375 $ 9,625 $22,000
Facilities Management 10,560 13,440 24,000
Purchasing
28,600 23,400 52,000
Total
$51,535 $46,465 $98,000
Strategy: First, determine the rate of the service department charges by dividing the
expenses incurred by the total of the activity base. To allocate the expenses to each
department, multiply the charge rate by the activity base of that department. As a
check, make sure that the total charged to the departments equals the expenses
incurred by the service department.
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Performance Evaluation for Decentralized Operations 9
18. Prepare Shooz Manufacturing’s divisional income statements for the year ending
December 31, 2015, using the information in Exercise 17. The East Division earned
$194,700 of revenues and incurred $57,200 of operating expenses while the West
Division earned $165,300 of revenue and incurred $41,500 of expenses.
Shooz Manufacturing
Divisional Income Statements
For the Year Ended September 30, 2015
East
West
Revenues
$194,700 $165,300
Operating expenses
57,200
41,500
Income from operations before service department charges $137,500 $123,800
Less service department charges
Purchasing
$28,600 $23,400
Advertising
12,375
9,625
Facilities management
10,560
13,440
Total service department charges
$51,535 $46,465
Income from operations
$85,965 $77,335
Strategy: A divisional income statement calculates the income from operations by
division, with distinction between operating expenses and service department charges.
Begin with revenues earned and subtract the operating expenses to arrive at the income
from operations before service department charges. Next, subtract the service
department charges allocated to the division to arrive at income from operations.
19. Use the operating income determined in Exercise 14 for Lazy Day Chairs to calculate the
rate of return on investment for each division. The South Division owns $208,600 of
invested assets while the North Division owns $230,000. Round percentages to two
decimal places. Which division utilizes its assets more efficiently?
South
North
Income from
operations
$77,600
85,400
Invested
assets
$208,600
230,000
Rate of return on
investment
37.20%
37.13%
Since the South Division generates a higher rate of return on investment, it utilizes its
assets more efficiently to generate income.
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10
Chapter 24
20. Use the information in Exercises 14 and 19 to calculate each division of Lazy Day Chairs’
residual income. The company requires a 25% return for invested assets.
South
North
Income from
operations
$77,600
85,400
Invested
assets
$208,600
230,000
Minimum acceptable
income
$52,150
57,500
Residual income
$25,450
27,900
21. Use the information shown below to calculate the profit margin, investment turnover,
and rate of return on investment using the DuPont formula for the company in 2015 and
2016. Determine if changes in the rate of return on investment are favorable or
unfavorable. Round answers to two decimal places.
2016
2015
$ 456,000 $ 420,000
320,000
305,700
1,270,000 1,255,000
Sales
Income from operations
Invested assets
Profit margin
Investment turnover
Rate of return on investment
0.70
0.36
0.25
0.73
0.33
0.24
The increase in the rate of return on investment is a favorable trend for the company.
22. Using the information in Exercise 21 and a 15% required rate of return, calculate the
residual income.
Minimum acceptable income $190,500 $188,250
Residual return
129,500 117,450
23. Use the information in Exercise 18 to calculate the rate of return on investment for the
divisions of Shooz Manufacturing. The East Division holds $120,000 of invested assets
while the West Division holds $117,000. Round percentages to two decimal places.
East
West
Income from
operations
$85,965
77,335
Invested
assets
$120,000
117,000
Rate of return on
investment
71.64%
66.10%
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Performance Evaluation for Decentralized Operations 11
Strategy: The rate of return on investment gives the income earned per dollar of
invested assets. A higher rate of return indicates more efficiency in utilizing the invested
assets by generating revenue and controlling costs. The rate of return on investment can
be calculated by dividing income from operations by invested assets or using the DuPont
formula. The DuPont formula multiplies the profit margin by the investment turnover,
which is sales divided by invested assets. Profit margin is calculated by finding the ratio
of income from operations to sales.
24. Use the information in Exercises 18 and 23 for Shooz Manufacturing to determine the
residual income for each division. The company requires an 18% rate of return on
invested assets.
East
West
Income from
operations
$85,965
77,335
Invested assets
$120,000
117,000
Minimum
acceptable income
$21,600
21,060
Residual
income
$64,365
56,275
Strategy: Residual income determines the profit center manager’s ability to produce
excess income over a minimum acceptable amount of income in his department. The
minimum acceptable income is what the company expects the division should produce
with the amount of given assets and is calculated by multiplying the required rate of
return by the amount of invested assets. The difference between the income from
operations generated and the minimum acceptable income from operations is the
residual income.
25. Determine if each of the following performance measures would be related to
innovation and learning, internal processes, customer service, or financial performance
on a balanced scorecard.
a. Cost variances from budgeted amounts
Financial performance
b. Number of finished goods produced in a day
Internal processes
c. Number of new product lines
Innovation and learning
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12
Chapter 24
26. Would each of the following be found in the innovation and learning, internal processes,
customer service, or financial performance section of a balanced scorecard?
a. Waste and scrap
Internal processes
b. Number of complaints
Customer service
c. Operating costs
Financial performance
27. Determine if each of the following performance measures would be related to
innovation and learning, internal processes, customer service, or financial performance
on a balanced scorecard.
a. Developing a new market
Innovation and learning
b. Employee turnover
Innovation and learning
c. Number of sales returns
Customer service
Strategy: The balanced scorecard provides nonfinancial information to management to
determine if the company is meeting its goals. Innovation and learning includes
measures related to new products provided to customers and training of employees.
Customer service relates to items that would affect a customer’s relationship with the
company. Internal processes include the ability to produce the correct number of goods
efficiently. Financial performance relates to numbers and ratios calculated from the
income statement.
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Performance Evaluation for Decentralized Operations 13
28. The South Department of a company has the option to purchase 15,000 units of
materials from outside suppliers for $20 per unit or from the company’s North
Department, which sells the products for $15 per unit to outsiders. The North
Department currently produces and sells 40,000 units but has capacity to produce
60,000 units. The department incurs variable costs of $5 per units and total fixed costs
of $25,000. Determine the change in income for each department using the following
methods:
a. Market price
Division Change in Income
North
$150,000 ($15 – $5) × 15,000 units Increase in profit
South
75,000 ($20 – $15) × 15,000 units Decrease in costs
b. Negotiated price of $17.50
Division Change in Income
North
$187,500 ($17.50 – $5) × 15,000 units
Increase in profit
South
37,500 ($20 – $17.50) × 15,000 units Decrease in costs
c. Cost approach using the variable product cost per unit
Division Change in Income
North
$0 ($5 – $5) × 15,000 units
Increase in profit
South
225,000 ($20 – $5) × 15,000 units Decrease in costs
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14
Chapter 24
29. The Red Department has the option to purchase 5,000 units of materials from outside
suppliers for $25 per unit or the Blue Department of the company, which sells to outside
buyers for $22 per unit. The Blue Department is currently at full capacity, producing and
selling 25,000 units and incurring fixed costs of $28,000 and variable costs of $15 per
unit. Determine the change in income for each department using the following
methods:
a. Market price
Division Change in Income
Red
$15,000 ($25 – $22) × 5,000 units Decrease in costs
Blue
0
Increase in profits
Since the Blue Department would sell the products for the same price, there will
be no change in sales or costs incurred because it is producing at capacity.
b. Negotiated price of $22.50
Division Change in Income
Red
$12,500 ($25 – $22.50) × 5,000 units Decrease in costs
Blue
2,500 ($22.50 – $22) × 5,000 units Increase in profits
Since Blue would normally sell the products for $22 each, the increase in profits
will be the increase in sales revenue because it will incur the same variable costs
regardless of the price sold.
c. Cost approach using the total cost per unit
Division Change in Income
Red
$44,400 ($25 – $16.12) × 5,000 units Decrease in costs
Blue
(29,400) ($16.12 – $22) × 5,000 units Decrease in profits
Using the cost approach would decrease the selling price below what the Blue
Department would normally sell the goods for to its current buyers, so the department’s
profits would actually decrease.
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Performance Evaluation for Decentralized Operations 15
30. The Purchasing Department can either buy 2,000 units of materials from outside
suppliers for $15 per product or from the company’s Production Department. The
Production Department typically sells finished goods to outside buyers for $10 each. The
Production Department is currently at capacity, producing and selling 10,000 products
each period at a variable cost of $6 per product and incurring total fixed costs of
$22,000. Determine the change in income for each department using the following
methods:
a. Market approach
Division
Change in Income
Purchasing
$10,000 ($15 – $10) × 2,000 units Decrease in costs
Production
0
Increase in profits
Since the Production Department would sell the products for the same price,
there will be no change in sales or costs incurred because it is producing at
capacity.
b. Negotiated price of $13.00
Division
Change in Income
Purchasing
$4,000 ($15 – $13) × 2,000 units Decrease in costs
Production
6,000 ($13 – $10) × 2,000 units Increase in profits
c. Cost approach using the variable cost per unit
Division
Change in Income
Purchasing
$18,000
Production
(8,000)
($15 – $6) × 2,000 units Decrease in costs
($6 – $10) × 2,000 units Decrease in profits
Since the Production Department is currently producing and selling at capacity, the
department would lose profit due to the decrease in selling price.
Strategy: The different methods of setting transfer prices will cause various changes in
income for the purchasing and supplying department. Under the market price approach,
the cost is set by what the supplying department would sell the good to outsiders. Using
the negotiated price approach, the purchasing and supplying departments negotiate a
price between the variable costs to produce the unit and the market price. If the
company uses the cost price approach, the selling price could be equal to the variable
cost per unit, or the total costs per unit. Whether or not the supplying department is
producing at capacity should also be considered when choosing which approach to use.
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