Learning Objectives

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Learning Objectives

Power Notes

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

Chapter M7

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Performance Evaluation for Decentralized OperationsPerformance Evaluation for Decentralized Operations

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• Decentralized Operations

• Accounting for Cost Centers

• Accounting for Profit Centers

• Accounting for Investment Centers

• Transfer Pricing

Slide # Power Note Topics

Power Notes

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Chapter M7

Performance Evaluation for Decentralized OperationsPerformance Evaluation for Decentralized Operations

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

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Advantages of Decentralized OperationsAdvantages 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 OperationsDisadvantages 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 CentersResponsibility Centers

Managers are held accountable for controlling costs.

Managers are held accountable for costs and making decisions that impact revenues favorably.

Managers are held accountable for costs and revenues and are also held accountable for the efficient use of assets.

Cost CentersCost Centers

Investment CentersInvestment Centers

Profit CentersProfit Centers

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Budget Performance ReportVice-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.

Each of the line items above will be supported by a cost center report.

Cost Center Responsibility AccountingCost Center Responsibility Accounting

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Administration $ 19,500 $ 19,700 $ 200

Plant APlant A 467,475467,475 470,330470,330 2,8552,855

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.

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

Budget Performance ReportVice-President, Production



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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$467,475 $470,330$470,330 $3,655$3,655 $800$800

This is shown on the production report.

This is shown on the production report.


Budget Performance ReportManager, Plant A


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Administration $ 17,500 $ 17,350 $150

Department 1Department 1 109,725109,725 111,280111,280 $1,555$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.

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


Budget Performance ReportManager, Plant A


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Budget Performance ReportSupervisor, Department 1—Plant A


This is shown on Plant A’s report.This is shown on Plant A’s report.

Factory wages $ 58,100 $ 58,000 $150Materials 32,500 34,225 $1,725Supervisory salaries 6,400 6,400 Power and light 5,750 5,690 650Depreciation 4,000 4,000 Maintenance 2,000 1,990 10Insurance, taxes 975 975

$109,725$109,725 $111,280$111,280 $1,725$1,725 $170$170

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Nova Entertainment GroupDivisional Income Statements

For the Year Ended December 31, 2003

Theme Movie Park Production

Division Division

Revenues $6,000,000 $2,500,000Operating expenses 2,495,000 405,000Income from operations $3,505,000 $2,095,000

Profit Center Responsibility AccountingProfit Center Responsibility Accounting

Income from operations before service department charges.Income from operations before service department charges.

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Nova Entertainment GroupService Department Charges to NEG Divisions



Service Department Division Division

Purchasing $250,000 $150,000Payroll accounting 204,000 51,000Legal 25,000 225,000 Total charges $479,000 $426,000

Service Department Charges to Profit CentersService Department Charges to Profit Centers

These costs are charged to the divisions based on the activity base of the service department.

These costs are charged to the divisions based on the activity base of the service department.

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PurchasingPurchasing $250,000$250,000 $150,000$150,000Payroll accounting 204,000 51,000Legal 25,000 225,000 Total charges $479,000 $426,000

25,000 purchase requisitions x $10 per requisition = $250,00015,000 purchase requisitions x $10 per requisition = $150,000

25,000 purchase requisitions x $10 per requisition = $250,00015,000 purchase requisitions x $10 per requisition = $150,000


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Purchasing $250,000 $150,000Payroll accountingPayroll accounting 204,000204,000 51,00051,000Legal 25,000 225,000 Total charges $479,000 $426,000

12,000 payroll checks x $17 per check = $204,0003,000 payroll checks x $17 per check = $51,000

12,000 payroll checks x $17 per check = $204,0003,000 payroll checks x $17 per check = $51,000


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Purchasing $250,000 $150,000Payroll accounting 204,000 51,000LegalLegal 25,00025,000 225,000225,000 Total charges $479,000 $426,000

100 hours x $250 per hour = $25,000900 hours x $250 per hour = $225,000

100 hours x $250 per hour = $25,000900 hours x $250 per hour = $225,000


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Nova Entertainment GroupDivisional Income Statements



Profit Center Responsibility AccountingProfit Center Responsibility Accounting

Revenues $6,000,000$2,500,000Operating expenses 2,495,000405,000Income from operations before service department charges $3,505,000$2,095,000Less service dept. charges: Purchasing $ 250,000$ 150,000 Payroll accounting 204,00051,000 Legal 25,000225,000 Total service dept. charges $ 479,000$ 426,000Income from operations $3,026,000$1,669,000

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DataLink Inc.Divisional Income Statements


Northern Central SouthernDivision 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%

Investment Center Responsibility AccountingInvestment Center Responsibility Accounting

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Northern Central SouthernDivision Division Division Profit MarginProfit Margin

Investment TurnoverInvestment Turnover

Rate of Return (ROI)Rate of Return (ROI)

Investment Center Responsibility AccountingInvestment Center Responsibility Accounting

Income from operations $ 70,000 $ 84,000 $ 75,000Revenues (Sales) $560,000 $672,000 $750,000

Profit margin 12.5% 12.5% 10.0%

Revenues (Sales) $560,000 $672,000 $750,000Invested assets $350,000 $700,000 $500,000

Investment turnover 1.6 .96 1.5

Income from operations $ 70,000 $ 84,000 $ 75,000Invested assets $350,000 $700,000 $500,000


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Profit margin 12.5% 12.5% 10.0%

Investment turnover x 1.6 x .96 x 1.5


Rate of Return on InvestmentRate of Return on Investment



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Residual IncomeResidual Income



How can Northern Division have the highest residual income when they have the lowest income from operations?

How can Northern Division have the highest residual income when they have the lowest income from operations?

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

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Nonfinancial Performance MeasurementNonfinancial Performance Measurement

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

Nonfinancial performance measures combined with conventional financial measures provide a balanced performance perspective.

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Benefits of Transfer PricingBenefits 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 PricesCommonly Used Transfer Prices

Variable Costper Unit $10

Market Priceper Unit $20

Full Costper Unit $13

Commonly Used Transfer PricesCommonly Used Transfer Prices

Negotiated Price

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.

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Transfer Pricing—Negotiated Price ApproachTransfer Pricing—Negotiated Price Approach

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 Costper Unit $10

AssumptionsAssumptions

Market Priceper Unit $20

Negotiated Price

If the division managers agree on a price of $18 per unit, how much will each division’s income increase? How much for the overall company?

If the division managers agree on a price of $18 per unit, how much will each division’s income increase? How much for the overall company?

Division M Division N

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This is the last slide in Chapter M7. This is the last slide in Chapter M7.

Power NotesChapter M7

Performance Evaluation for Decentralized Performance Evaluation for Decentralized OperationsOperations

Learning Objectives

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