Chapter 1

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Chapter 10
Decentralized Performance Evaluation
PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
McGraw-Hill/Irwin
Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.
Decentralization of Responsibility
Decentralization pushes
decision making down
to lower-level managers.
Decentralization often occurs as organizations continue to grow.
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Learning Objective 10-1
List and explain the advantages and
disadvantages of decentralization.
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Decentralization of Responsibility
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Learning Objective 10-2
Describe the different types of
responsibility centers and explain
how managers in each type are
evaluated.
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Responsibility Centers
Responsibility accounting gives managers authority
and responsibility for a particular part of the
organization and then evaluates them based on the
results of that area of responsibility.
Managers of responsibility
centers should be held
responsible only for that
which they can control.
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Organizational Chart for Apple
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Responsibility Centers
Cost
Center
Revenue
Center
Profit
Center
Investment
Center
Responsibility
Centers
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Cost Centers
Cost center managers have
the authority to incur costs
to support their areas of
responsibility.
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Revenue Centers
Revenue center managers are responsible for
generating revenues within their areas
of the organization.
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Profit Centers
Profit Center
Revenues
Profit center managers
are responsible for
generating a profit
(revenue minus cost)
within their area of the
business.
Sales
Interest
Other
Costs
Mfg. costs
Commissions
Salaries
Other
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Investment Centers
Investment Center
managers are
responsible for
generating a profit and
investing assets.
Investment
Center
Evaluation
Return on investment (ROI)
and residual income
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Learning Objective 10-3
Describe the four dimensions of the
balanced scorecard and
explain how they are used to
evaluate managerial performance.
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The Balanced Scorecard
Management translates its strategy into
performance measures that employees
understand and accept.
Customers
Financial
Internal
business
processes
Performance
measures
Learning
and growth
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The Balanced Scorecard
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The Balanced Scorecard
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Learning Objective 10-4
Compute and interpret return on
investment, investment turnover, and
profit margin.
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Return on Investment (ROI)
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Return on Investment (ROI)
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Return on Investment (ROI)
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Learning Objective 10-5
Compute and interpret residual
income.
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Residual Income
The hurdle rate is the required return
on invested assets, sometimes called
the cost of capital.
Residual income is the organization’s extra
profit, over and above that needed to cover
the required return on invested assets.
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Residual Income
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ROI versus Residual Income
 As
the store manager at Apple’s Online Store, you have
the opportunity to invest $1,000,000 in a project
promising a return of $150,000 (15 percent).
 The
company requires a minimum return of 10 percent
on all projects, so the project would be acceptable from
the company’s perspective.
Would you invest in this project?
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ROI versus Residual Income
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Economic Value Added
Economic value added (EVA™) is used to measure the economic
wealth created when a company’s after-tax net operating income
exceeds its cost of capital. EVA:
• Measures profitability based on after-tax net operating income
rather than pre-tax net operating income.
• Uses the cost of capital as the hurdle rate.
• Uses total capital employed as the measure of investment rather
than average invested assets
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Limitations of Financial Performance
Measures
Both ROI and residual income are lagging indicators
of financial performance.These measures tell how
well a company or a division has done in the past but
not necessarily how well it will do in the future.
To improve short-run financial
results, managers may make
harmful decisions to cut costs in
areas such as research and
development, employee training,
or quality of manufacturing
materials.
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Learning Objective 10-6
Explain how transfer prices are set in
decentralized organizations.
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Transfer Pricing
A transfer price is the amount that one division
charges when it sells goods or services to
another division in the same company.
Selling
Division
Goods and
Services
Buying
Division
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Transfer Pricing
Market
Price
Ceiling
Range of Possible
Transfer Prices
Could fall
anywhere
in between
Variable
Cost
Floor
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Transfer Pricing
What transfer price should
Apple use to record the
purchase of iPads for resale
at an Apple retail store?
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Transfer Pricing
Market
Price
$499
Ceiling
Range of Possible
Transfer Prices
Negotiated transfer
price could fall
anywhere in
between.
Variable $336
Cost
Floor
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Market-Price Method
The market price is the price that a
company would charge to external
customers.
Market price is appropriate when the
selling division has no excess capacity.
With idle capacity, the selling
division can generate
contribution margin for itself
at any price above variable
cost.
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Cost-Based Method
The cost-based method uses either the variable cost or the full
manufacturing cost as the basis for setting the transfer price.
A transfer price above variable
cost will provide contribution
margin to the seller.
Full manufacturing cost
plus a markup is a more
likely outcome.
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Negotiation
Transfer price is determined through discussions
between managers of buying and selling divisions.
Excessive management
time may be used in the
negotiation process.
Conflicts may arise between
negotiating managers that
damage working relationships.
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End of Chapter 10
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