Financial and Managerial
Accounting
Wild, Shaw, and Chiappetta
Fourth Edition
McGraw-Hill/Irwin
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 22
Decentralization and
Performance Evaluation
Conceptual Learning
Objectives
C1: Distinguish between direct and indirect expenses
and identify bases for allocating indirect expenses
to departments.
C2: Explain controllable costs and responsibility
accounting.
C3: Appendix 22A: Explain transfer pricing and
methods to set transfer prices.
C4: Appendix 22B: Describe allocation of joint costs
across products.
22-3
Analytical Learning Objectives
A1: Analyze investment centers using
return on total assets, residual income
and balanced scorecard.
A2: Analyze investment centers using
profit margin and investment turnover.
22-4
Procedural Learning
Objectives
P1: Prepare departmental income
statements and contribution reports.
22-5
C1
Departmental Accounting
Primary
goals
Provide information
for managers to use
in performance
evaluation.
To control costs and
expenses and assist
with evaluating
managers
performances.
22-6
Information for
Departmental Evaluation
C1
The accounting system provides information
about resources used and outputs achieved.
Managers use this information to:

Control operations.

Appraise performance.

Allocate resources.

Plan strategy
22-7
C1
Information for
Departmental Evaluation
The type of accounting information provided
depends on whether the department is a . . .
Cost
center
Profit
center
Evaluated on
ability to
control costs.
Evaluated on ability
to generate revenues
in excess of expenses.
22-8
C1
Information for
Departmental Evaluation
Investment Center
Evaluated on their use of center
assets to generate income.
22-9
C1
Departmental Expense
Allocation
Direct expenses are
incurred for the sole
benefit of a specific
department.
Indirect expenses
benefit more than one
department and are
allocated among
departments benefited.
22-10
C1
Illustration of Indirect
Expense Allocation
Classic Jewelry pays its janitorial service
$300 per month to clean its store.
Management allocates this cost to its
three departments according to the floor
space each occupies.
22-11
C1
Illustration of Indirect
Expense Allocation
Classic Jewelry pays its janitorial service
$300 per month to clean its store.
Management allocates this cost to its three
departments according to the floor space
each occupies.
22-12
C1
Illustration of Indirect
Expense Allocation
Classic Jewelry pays its janitorial service
$300 per month to clean its store.
Management allocates this cost to its
three departments according to the floor
space each occupies.
22-13
C1
Bases for Allocating
Service Department Costs
Service department costs are shared,
indirect expenses that support the
activities of two or more production
departments.
22-14
C1
Service Department Costs
Question
ABCO allocates its $300,000 personnel cost to
operating departments based on the number of
employees in each department. The assembly
department has 100 employees and the packing
department has 150 employees. What amount of
cost is allocated to assembly?
a. $100,000
b. $120,000
c. $150,000
d. $180,000
22-15
C1
Service Department Costs
Question
ABCO allocates its $300,000 personnel cost to
operating departments based on the number of
employees in each department. The assembly
department has 100 employees and the packing
department has 150 employees. What amount of
cost is allocated to assembly?
a. $100,000
Assembly percentage
b. $120,000
= 100 ÷ (100 + 150) = 40%
c. $150,000
40% of $300,000 = $120,000
d. $180,000
22-16
P1
Preparing Departmental
Income Statements
Let’s prepare departmental income statements
using the following steps:
 Direct expense accumulation.
 Indirect expense allocation.
 Service department expense allocation.
22-17
P1
Departmental Expense
Allocation Spreadsheet
Expense General
Allocation Account Office
Base
Balance
Dept
Direct expenses
Salaries Expense
Payroll
$ 51,900
Depreciation - Equip Depn records
1,500
Supplies Expense
Requisitions
900
Indirect expenses
Rent Expense
Floor space
12,000
Utilities Expense
Floor space
2,400
Advertising Expense Sales
1,000
Insurance Expense
2,500
Total dept. expenses
$ 72,200
Service dept. expenses
General Office Dept Sales
Purchasing Dept
Purchase Orders
Total expenses Allocated
$ 72,200
Purchasing
Dept
Hardware
Dept
Housewares
Dept
Appliances
Dept.
$ 13,300 $ 8,200 $ 15,600 $ 7,000 $ 7,800
$
500 $ 300 $
400 $
100 $
200
200
100
300
200
100
600
300
4,860
3,240
2,700
810
540
450
500
300
200
400
200
900
600
400
$ 15,300 $ 9,700 $ 23,370 $ 11,980 $ 11,850
(15,300)
$
0
600
300
7650
4590
3060
(9,700)
3,880
2,630
3,190
$ 0
$ 34,900 $ 19,200 $ 18,100
22-18
P1
Departmental Expense
Allocation Spreadsheet
Allocation
Base
Total
Expense
Direct expenses
Salaries
Payroll $
Depreciation Exp - Equip Depn Records
Supplies
Requisitions
51,900 $
1,500
900
Expense Allocation to Departments
General
PurchHardHouse- AppliOffice
asing
ware
wares ances
Dept.
Dept.
Dept.
Dept
Dept.
13,300 $
500
200
8,200 $ 15,600 $ 7,000 $ 7,800
300
400
100
200
100
300
200
100
Step 1: Direct expenses are traced to service departments
and sales departments without allocation.
22-19
Departmental Expense
Allocation Spreadsheet
P1
Of a total of 12,000 square feet, the service departments
occupy 1,500 square feet each, the hardware department
occupies 4,050 feet, housewares 2,700, and appliances 2250.
Allocation
Base
Utilities
Floor space
Expense
General
Total
Office
Expense Dept.
2,400
300
Allocation to Departments
PurchHardHouseasing
ware
wares
Dept.
Dept.
Dept
300
810
540
Appliances
Dept
450
Step 2: Indirect expenses are allocated to both the service
and the sales departments based on floor space occupied.
22-20
P1
Departmental Expense
Allocation Spreadsheet
Salaries
Supplies
Indirect expenses
Rent
Utilities
Total dept. expenses
Service dept. expenses
Service Dept. One
Service Dept. Two
Total expenses
Payroll
$ 20,000
Requisitions
1,500
$ 1,000
100
$ 2,000
300
$ 6,000
400
Floor space
Floor space
1,000
100
$ 2,200
1,000
100
$ 3,400
3,000
300
$ 9,700
10,000
1,000
$ 32,500
Sales
Employees
(2,200)
$ 32,500
$
0
1,000
$ 3,400
$ 10,700
Step 3: The Service department total expenses (original
direct expenses + allocated indirect expenses) from the
two service departments are allocated to three remaining
operating or sales departments.
22-21
P1
Departmental Income Statements
Sales
$
Cost of goods sold
Gross profit on sales
Hardware
Housewares
Appliances
Dept.
Dept.
Dept.
119,500
$
73,800
$
45,700
71,700
$
43,800
$
27,900
47,800
Combined
$
30,200
$
17,600
147,800
$
Operating expenses
Salaries Expense
239,000
91,200
0
$
15,600
$
7,000
$
7,800
$
30,400
Depreciation Expense
400
100
200
700
Supplies Expense
300
200
100
600
4,860
3,240
2,700
10,800
Utilities Expense
810
540
450
1,800
Advertising Expense
500
300
200
1,000
Insurance Expense
900
600
400
1,900
Share of general office expense
7,650
4,590
3,060
15,300
Share of purchasing expenses
3,880
2,630
3,190
9,700
Rent Expense
Total operating expenses
$
34,900
$
19,200
$
18,100
$
72,200
Net income (loss)
$
10,800
$
8,700
$
(500)
$
19,000
22-22
P2
Departmental Income Statement
Sales
$
Cost of goods sold
Gross profit on sales
Hardware
Housewares
Appliances
Dept.
Dept.
Dept.
119,500
$
73,800
$
45,700
71,700
$
43,800
$
27,900
47,800
Combined
$
30,200
$
17,600
239,000
147,800
$
91,200
Operating expenses
Salaries Expense
0
$
15,600
$
7,000
$
7,800
$
30,400
Depreciation Expense
400
100
200
700
Supplies Expense
300
200
100
600
4,860
3,240
2,700
10,800
Utilities Expense
810
540
450
1,800
Advertising Expense
500
300
200
1,000
Insurance Expense
900
600
400
1,900
Share of general office expense
7,650
4,590
3,060
15,300
Share of purchasing expenses
3,880
2,630
3,190
9,700
Rent Expense
Total operating expenses
$
34,900
$
19,200
$
18,100
$
72,200
Net income
$
10,800
$
8,700
$
(500)
$
19,000
22-23
P1
Departmental Contribution to OH
Sales
$
Cost of goods sold
Gross profit on sales
Hardware
Housewares
Appliances
Dept.
Dept.
Dept.
Combined
47,800
$
119,500
$
73,800
71,700
$
43,800
30,200
239,000
147,800
$
45,700
$
27,900
$
17,600
$
91,200
$
15,600
$
7,000
$
7,800
$
30,400
Operating expenses
Direct Expenses
Salaries Expense
Depreciation Expense
400
100
200
700
Supplies Expense
300
200
100
600
16,300
7,300
8,100
31,700
Total Direct Expenses
Continued….
22-24
P1
Departmental Contribution to OH
Departmental Contributions
To Overhead
29,400
20,600
9,500
59,500
Indirect Expenses:
Rent Expense
10,800
Utilities Expense
1,800
Advertising Expense
1,000
Insurance Expense
1,900
Share of general office expense
15,300
Share of purchasing expenses
9,700
Total operating expenses
$
40,500
Net income
$
19,000
Contribution as percent of sales
24.6%
28.7%
19.9%
24.9%
22-25
Financial Performance
Evaluation Measures
A1


One of the ways to evaluate
investment center managers is to use
a measure called return on investment
(or return on assets.)
The formula for ROI is as follows:
ROI =
Investment center net income
Investment center average invested assets
22-26
Financial Performance
Evaluation Measures
A1

Another measure of evaluating
financial performance is by computing
the investment center’s residual
income.
Residual
Income =
Investment Center - Target investment
net income
center net income
22-27
A1
Balanced Scorecard


The Balanced Scorecard is a system of
performance measures, including nonfinancial measures.
It Is used to assess company and division
performance based on four perspectives:
1. Customer
2. Internal processes
3. Innovation and Learning
4. Financial
22-28
C2
Responsibility Accounting
An accounting system that
provides information . . .
Relating to the
responsibilities of
individual managers.
To evaluate
managers on
controllable items.
22-29
C2
Controllable Costs
Costs are controllable
if the manager
has the power to
determine, or strongly
influence, the
amounts incurred.
I’m in
control
A manager’s
performance
evaluation should be
based on controllable
costs.
22-30
Distinguishing Controllable
and Direct Costs
C2
Direct costs are traced to departments,
but may not be controllable by the
department manager.

Example: Department managers usually
have no control over their own salaries.
Controllable costs are identified with a
particular manager and a definite time
period.

All costs are controllable at some level of
management if the time period is long enough.
22-31
C2
Responsibility Accounting
Successful implementation of responsibility accounting may
use organization charts with clear lines of authority and clearly
defined levels of responsibility.
Board of Directors
President
Vice President
of Finance
Vice President
of Operations
Vice President
of Marketing
Store Manager
Department Manager
22-32
C2
Responsibility Accounting
Performance Reports
Amount of detail varies according
to level in organization.
A department manager
receives detailed reports.
A store manager receives
summarized information
from each department.
22-33
C2
Responsibility Accounting
Performance Reports
Amount of detail varies according
to level in organization.
Management by exception:
Upper-level management
does not receive operating
detail unless problems arise.
The vice president of operations
receives summarized information
from each store.
22-34
C2
Responsibility Accounting
Performance Reports
To be of maximum benefit,
responsibility reports should . . .




Be timely.
Be issued regularly.
Be understandable.
Compare budgeted
and actual amounts.
22-35
Investment Center – Analysis
A2

We can further examine investment
center performance by splitting down
return on investment into profit margin
and investment turnover:
ROI = Profit Margin X Investment Turnover

This will provide further information on
the performance of the unit.
22-36
A2
Profit Margin

The profit margin is the first
component in the expanded equation
and measures the income earned per
dollar of sales.
Profit margin = Investment Center Net Income
Investment Center Sales
22-37
A2
Investment Turnover


The investment turnover measures
how efficiently the company generates
sales from its invested assets.
It is used in the second half of the
expanded ROI formula.
Investment = Investment Center Sales
Turnover Investment Center Average Assets
22-38
End of Chapter 22
22-39