Chapter 23

Performance Evaluation for

Decentralized Operations
Accounting, 21st Edition
Warren Reeve Fess

© Copyright 2004 South-Western, a division

PowerPoint Presentation by Douglas Cloud
Professor Emeritus of Accounting
Pepperdine University
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Some
Some of of the
the action
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automated,
so
so click
click the
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 Objectives
Objectives
1. List and explain the advantages and
disadvantages of decentralized
After
After studying
studying thisoperations.
this
2. Prepare a responsibility
chapter, accounting
you should report for a
cost center. chapter, you should
be
be able
3. Prepare responsibility able to:
to:
accounting reports for a
profit center.
4. Compute and interpret the rate of return on
investment, the residual income, and the
balanced scorecard for an investment center.
 Objectives
Objectives
5. Explain how the market price,
negotiated price, and cost price
approaches to transfer pricing may be
used by decentralized segments of a
business.
Centralized and
Decentralized
Operations
 Advantages
Advantages ofof
Decentralization
Decentralization
 It allows managers to focus on acquiring expertise in
their areas of responsibility.
 Decentralizing decision making provides excellent
training for managers.
 Delegation improves employee morale.
 Decentralization helps managers create good customer
relations by responding quickly to customers’ needs.
 Managers become more creative in suggesting operating
and product improvement.
 Disadvantages
Disadvantages of
of
Decentralized
Decentralized Operations
Operations
 Decisions made by one manager may
negatively affect the profitability of the
entire organization.
 Assets and operating costs are duplicated
(e.g., each division has its own
administrative office staff).
 Responsibility
Responsibility Centers
Centers
Cost Centers
Managers are held accountable for controlling costs.

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

Investment Centers
Managers are held accountable for costs and revenues and
are also held accountable for the efficient use of assets.
 Responsibility
Responsibility Accounting
Accounting
for
for Cost
Cost Centers
Centers
COST CENTERS IN A UNIVERSITY
UNIVERSITY COLLEGE

College of Dept. of Marketing

College of Business
Engineering
College of Arts
and Sciences

Dept. of Accounting
Dept. of Management
Responsibility
Responsibility Accounting
Accounting
for
for Cost
Cost Centers
Centers
COST CENTERS IN A UNIVERSITY
DEPARTMENT

Department
of
Accounting
 Cost Centers
Budget Performance Report
Supervisor, Department 1—Plant A
For the Month Ended October 31, 2006
Over Under
Budget Actual Budget Budget
Factory wages $ 58,100 $ 58,000 $100
Materials 32,500 34,225 $1,725
Supervisory salaries 6,400 6,400
Power and light 5,750 5,690 60
Depreciation 4,000 4,000
Maintenance 2,000 1,990 10
Insurance, taxes 975 975
$109,725
$109,725 $111,280
$111,280 $1,725
$1,725 $170
$170

These
These totals
totals are
are shown
shown on
on the
the Manager,
Manager, Plant
Plant
A’s
A’s budget
budget performance
performance report
report (Slide
(Slide 13).
13).
 Cost Centers
Budget Performance Report
Manager, Plant A
For the Month Ended October 31, 2006
Over Under
Budget Actual Budget Budget

Administration $ 17,500 $ 17,350 $150

Department
Department1 1 109,725 111,280
109,725 111,280 $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
From
From the
the Supervisor—Department
Supervisor—Department 1, 1, Plant
Plant A
A
budget
budget performance
performance report
report (Slide
(Slide 12).
12).
 Cost Centers
Budget Performance Report
Manager, Plant A
For the Month Ended October 31, 2006
Over Under
Budget Actual Budget Budget

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
This isis shown
shown on
on the
the Vice-President’s
Vice-President’s
budget
budget production
production report
report (Slide
(Slide 16).
16).
 Cost Centers
Budget Performance Report
Vice-President, Production
For the Month Ended October 31, 2006
Over Under
Budget Actual Budget Budget
Administration $ 19,500 $ 19,700 $ 200
PlantAA
Plant 467,475
467,475 470,330470,330
2,855 2,855
Plant B 395,225 394,300 $925
$882,200 $884,330 $3,055 $925

Note that Over Budget is a net figure.

 Cost Centers
Budget Performance Report
Vice-President, Production
For the Month Ended October 31, 2006
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 $3,055 $925

Each of the line items above is

supported by a cost center report.
 Responsibility
Responsibility
Accounting
Accounting for
for
Profit
Profit Centers
Centers
In a profit center, the unit manager has the
responsibility and the authority to make
decisions that affect both costs and revenues.
Profit
Profit centers
centers may
may be
be
divisions,
divisions, departments,
departments,
or
or products.
products.
 Profit Centers

NEG,
NEG, aa diversified
diversified entertainment
entertainment company,
company,
has
has two
two profit
profit centers:
centers: the
the Theme
Theme Park
Park
Division
Division and
and the
the Movie
Movie Production
Production Division.
Division.

Theme Park Movie Production

Division Division
Revenues $6,000,000 $2,500,000
Operating expenses 2,495,000 405,000
 Profit Centers
Charging
Charging Service
Service Department
Department Costs
Costs
to
to Production
Production Divisions
Divisions
Purchasing Department: $400,000
(Activity base: number of purchase requisitions)
Theme Park Division 25,000 purchase requisitions
Movie Production Division: 15,000 purchase requisitions
Total 40,000
$400,000
= $10 per purchase
40,000 purchase requisitions requisition
 Profit Centers
Charging
Charging Service
Service Department
Department Costs
Costs
to
to Production
Production Divisions
Divisions
Payroll Accounting: $255,000
(Activity base: number of payroll checks)
Theme Park Division 12,000 payroll checks
Movie Production Division: 3,000 payroll checks
Total 15,000
$255,000
= $17 per payroll check
15,000 payroll checks
 Profit Centers
Charging
Charging Service
Service Department
Department Costs
Costs
to
to Production
Production Divisions
Divisions
Legal Department: $250,000
(Activity base: number of payroll checks)
Theme Park Division 100 billed hours
Movie Production Division: 900 billed hours
Total 1,000
$250,000
= $250 per hour
1,000 hours
 Profit Centers
Nova Entertainment Group
Service Department Charges to NEG Divisions
For the Year Ended December 31, 2006
Theme Movie
Park Production
Service Department Division Division
Purchasing $250,000 $150,000

25,000
25,000purchase15,000
purchase15,000purchase
purchase
requisitions
requisitionsxrequisitions
$10
xrequisitions
$10 xx$10
$10
per
perpurchase
purchaseperperpurchase
purchase
requisition
requisition requisition
requisition
 Profit Centers
Nova Entertainment Group
Service Department Charges to NEG Divisions
For the Year Ended December 31, 2006
Theme Movie
Park Production
Service Department Division Division
Purchasing $250,000 $150,000
Payroll accounting 204,000 51,000

12,000
12,000payroll3,000
payroll3,000payroll
payroll
checks
checksxx$17
$17checks
per
per xx$17
checks $17per
per
payroll
payrollcheck
checkpayroll
payrollcheck
check
 Profit Centers
Nova Entertainment Group
Service Department Charges to NEG Divisions
For the Year Ended December 31, 2006
Theme Movie
Park Production
Service Department Division Division
Purchasing $250,000 $150,000
Payroll accounting 204,000 51,000
Legal 25,000 225,000

100
100hours
hoursxx$250
900
900hours
$250 hoursxx$250
$250
per
perhour
hour per
perhour
hour
 Profit Centers
Nova Entertainment Group
Service Department Charges to NEG Divisions
For the Year Ended December 31, 2006
Theme Movie
Park Production
Service Department Division Division
Purchasing $250,000 $150,000
Payroll accounting 204,000 51,000
Legal 25,000 225,000
Total service department charges $479,000 $426,000
 Nova Entertainment Group
Divisional Income Statements
For the Year Ended December 31, 2006
Theme Park Division Movie Production Division
Revenues $6,000,000 $2,500,000
Operating expenses 2,495,000 405,000
Income from operations $3,505,000 $2,095,000

Income
Income from
fromoperations
operations before
before
service
service department
department charges.
charges.
 Nova Entertainment Group
Divisional Income Statements
For the Year Ended December 31, 2006
Theme Park Division Movie Production Division
Revenues $6,000,000$2,500,000
Operating expenses 2,495,000 405,000
Income from operations $3,505,000$2,095,000

Less service dept. charges:

Purchasing $ 250,000$ 150,000
Payroll accounting 204,00051,000
Legal 25,000 225,000
Total service department charges$ 479,000 $ 426,000
Income from operations $3,026,000$1,669,000
 Responsibility
Responsibility
Accounting
Accounting for
for
Investment
Investment Centers
Centers
In an investment center, the unit 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.
 Investment Centers
Datalink Inc.
Divisional Income Statements
For the Year Ended December 31, 2006
Northern Central Southern
Division 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%
20% 12%
12% 15%
15%
Rate
Rate of
of Return
Return on
on Investment
Investment (ROI)
(ROI)
Revenues
Rate
Rate of
of Return
Return on
on Investment
Investment (ROI)
(ROI)

Profit

Profit
Margin
Investment
Turnover
 Rate
Rate of
of Return
Return on
on Investment
Investment (ROI)
(ROI)
The profit margin
indicates the rate of profit
on each sales dollar.
The
investment
turnover
indicates
the rate of
sales on Profit
each dollar Investment
Margin
of invested Turnover
assets.
Rate
Rate of
of Return
Return on
on Investment
Investment (ROI)
(ROI)

ROI = Income from operation x Sales

Sales Invested assets
$ 70,000 $560,000
ROI = x
$560,000 $350,000
ROI = 12.5% x 1.6 = 20%
Rate
Rate of
of Return
Return on
on Investment
Investment (ROI)
(ROI)

ROI = Income from operation x Sales

Sales Invested assets

Profit
Profit Inventory
Inventory
Margin
Margin Turnover
Turnover
 Northern Central Southern
Profit Margin Division Division Division
Income from operations $ 70,000$ 84,000 $ 75,000
Revenues (Sales) $560,000$672,000$750,000
Profit margin 12.5%12.5%10.0%
Investment Turnover
Revenues (Sales) $560,000$672,000$750,000
Invested assets $350,000$700,000$500,000
Investment turnover 1.6 .96 1.5
Return on Investment (ROI)
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%
 Minimum
Income Acceptable
– Residual
from Rate of =
Income
Operations Return on
Assets
 Baldwin Company
Divisional Income Statements
For the Year Ended December 31, 2006

Northern Central Southern

Division Division Division
Income from operations $70,000 $84,000 $75,000
Minimum acceptable income
from operations as a percent
of invested assets:
$350,000 x 10% 35,000
$700,000 x 10% 70,000
$500,000 x 10% 50,000
Residual income $35,000 $14,000 $25,000
 The
The balance
balance scorecard
scorecard isis aa set
set of
of
financial
financial and
and nonfinancial
nonfinancial measures
measures
that
that reflect
reflect multiple
multiple performance
performance
dimensions
dimensions of of aa business.
business.
 Innovation
Innovation and
and
Learning
Learning
•• R&D
R&Dinvestment
investment
•• R&D
R&Dpipeline
pipeline
•• Skills
Skillsand
andtraining
training
•• Time
Timeto tomarket
market

Customer
Customer Internal
•• Satisfaction
Satisfaction Process
•• Loyalty •• Efficiency
Efficiency
Loyalty
•• Perception •• Quality
Quality
Perception
•• Time
Time
Financial
Financial
•• ROI
ROI
•• Residual
Residualincome
income
•• Profit
Profit
•• Cost
Cost
•• Sales
Sales
Transfer
Transfer Pricing
Pricing
 Transfer
Transfer Pricing
Pricing
When
When divisions
divisions transfer
transfer products
products or or
render
render services
services to to each
each other,
other, aa
transfer
transfer pricing
pricing isis used
used to
to charge
charge forfor
the
the products
products or or services
services
 Benefits
Benefits of
of Transfer
Transfer Pricing
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.
 Commonly
Commonly Used
Used Transfer
Transfer Prices
Prices
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 (variable or full) uses a variety of cost concepts for setting the transfer price.
 Commonly
Commonly Used
Used Transfer
Transfer Prices
Prices

Variable Cost Full Cost Market Price

per Unit $10 per Unit $13 per Unit $20

Negotiated Price
Chapter 22

The
The End
End