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Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-2
Relating to theresponsibilities of
individual managers.
To evaluatemanagers on
controllable items.
An accounting system thatprovides information . . .
Responsibility Accounting
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-3
Decision Making is Pushed Down
S u p erviso r S u p erviso r
M id d leM an ag em en t
S u p erviso r S u p erviso r
M id d leM an ag em en t
TopM an ag em en t
Decentralizationoften occurs asorganizations
continue to grow.
Decentralization
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-4
Decentralization
Promotes betterdecision making.
Allows upper-level management toconcentrate on strategic decisions.
Improvesproductivity.
Developslower-levelmanagers.
Improvesperformanceevaluation.
Advantages
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-5
Cost
Responsibility Reports
Responsibility Reports
Prepared for each individual who
has control over revenue or
expense items
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-6
Responsibility Reports
Prepare budgets for each responsibility center.
Prepare timely performance reportscomparing actual amounts with budgeted amounts.
Measure performance ofeach responsibility center.
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-7
Successful implementation of responsibility accounting depends on clear lines of authority
and clearly defined levels of responsibility.
Successful implementation of responsibility accounting depends on clear lines of authority
and clearly defined levels of responsibility.
Vice Presidentof F ina nce
D epa rtm ent Ma na ger
Store Ma na ger
V ice Presidentof O pera tions
V ice Presidentof Ma rketing
President
B oa rd of D irectors
The Controllability Concept
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-8
Amount of detail varies according to level in organization.
Departmentmanager receives detailed reports.
Store manager receives summarized information from each department.
Management by Exception and the Degree of Summarization
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-9
Management by Exception and the Degree of Summarization
The vice president of operations receives summarized information
from each store.
Management by exception
Upper-level management does not receive operating
detail unless problems arise.
Amount of detail varies according to level in organization.
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-11
To be of maximum benefit, responsibility reports should . . . Be timely. Be issued regularly. Be understandable. Compare budgeted
and actual amounts.
Qualitative Reporting Features
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-12
Responsibility Centers
A responsibility center is the point in an organization where the control over revenue or expense is located, e.g. division,department or a single machine.
A responsibility center may be divided into three categories cost profit investment
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-13
Cost
Types of Responsibility Centers
Cost Center A business segment that
incurs expenses but does not
generate revenue.
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-14
Profit Center A part of the
business that has control over both
revenues and expenses, but no
control over investment funds.
RevenuesSalesInterestOther
ExpensesManufacturingCommissionsSalariesOther
Types of Responsibility Centers
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-15
Investment Center
A profit center where
management also makes capital
investment decisions.
Corporate Headquarters
Types of Responsibility Centers
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-17
Measuring Managerial Performance
Return on investment (ROI) Residual income (RI)
CostCenter
Cost controlQuantity and qualityof services
ProfitCenter
InvestmentCenter
Evaluation Measures
Profitability
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-18
Return on investment is the ratio of income to the investment used to
generate the income.
ROI = Net Income Investment
Return on Investment
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-19
ROI = Net IncomeInvestment
ROI = Net IncomeSales
× SalesInvestment
MarginMargin TurnoverTurnover
Return on Investment
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-20
Cola Company reports the following:
Net Income $ 30,000
Sales $ 500,000
Investment $ 200,000
Let’s calculate ROI.
Return on Investment
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-21
ROI = 6% × 2.5 = 15%
Return on Investment
ROI = Net IncomeSales
× SalesInvestment
ROI = $30,000$500,000
× $500,000$200,000
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-22
Improving R0I
Three ways to improve ROI
Increase Sales
Reduce Expenses
Reduce Investment
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-23
Cola Company’s manager was able to increase sales to $600,000 which increased net income to $42,000.
There was no change in investment.
Let’s calculate the new ROI.
Improving R0I
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-24
Cola Company increased ROI from 15% to 21%.
ROI = 7% × 3 = 21%
ROI = Net IncomeSales
× SalesInvestment
ROI = $42,000$600,000
× $600,000$200,000
Improving R0I
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-25
ROI - A Major Drawback As division manager at Cola Company,
your compensation package includesa salary plus bonus based on your division’sROI -- the higher your ROI, the bigger your bonus.
The company requires an ROI of 20% on all new investments -- your division has been producing an ROI of 30%.
You have an opportunity to invest in a new project that will produce an ROI of 25%.
As division manager would you invest in this project?
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-26
ROI - A Major Drawback
As division manager,I wouldn’t invest in
that project becauseit would lower my pay!
Gee . . .I thought we were
supposed to do what was best for the
company!
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-27
Residual Income
Earned Income– Investment charge = Residual income
Investment× Desired ROI = Investment charge
Investment center’scost of acquiring
investment capital
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-28
Residual Income
Cola Company has an opportunity to invest $100,000 in a project that willearn $25,000.
Cola Company has a 20 percent desired ROI and a 30 percent ROI on existing business.
Let’s calculate residual income.
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-29
Residual Income
Investment = $100,000× Desired ROI = 20% = Investment charge = $ 20,000
Investment center’scost of acquiring
investment capital
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-30
Residual Income
Earned Income = $25,000– Investment charge = 20,000 = Residual income = $ 5,000
Investment = $100,000× Desired ROI = 20% = Investment charge = $ 20,000
Investment center’scost of acquiring
investment capital
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-31
Residual Income
As a manager at Cola Company, would you invest the $100,000 ifyou were evaluatedusing residual income?
Would your decision be different if you were evaluated using ROI?
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-32
Residual Income
Residual income encourages managers to make profitable investments that would
be rejected by managers using ROI.
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-34
Transfer Pricing
Batteries
The amount charged when one divisionsells goods or services to another division.
The amount charged when one divisionsells goods or services to another division.
Battery Division Auto Division
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-35
Transfer Pricing
Battery Division Auto Division
A higher transferprice for batteries
means . . .
The transfer price affects the profit measure forboth the selling division and the buying division.
The transfer price affects the profit measure forboth the selling division and the buying division.
lower profits forthe auto division.
greater profits forthe battery division.
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-36
The ideal transfer price allowseach division manager to make
decisions that maximize thecompany’s profit, while
attempting to maximize thedivision’s profit.
The ideal transfer price allowseach division manager to make
decisions that maximize thecompany’s profit, while
attempting to maximize thedivision’s profit.
Transfer Pricing
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-37
Market-based transfer prices arepreferred because they promote
efficiency and fairness.
Market-based transfer prices arepreferred because they promote
efficiency and fairness.
Setting Transfer Prices
When market prices are not available,companies may use . . . Cost-based prices Negotiated prices
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-38
Negotiated Transfer Price
A system where transfer prices are arrived at through negotiation between managers of
buying and selling divisions.
A system where transfer prices are arrived at through negotiation between managers of
buying and selling divisions.
Excessive managementtime may be used in the
negotiation process.
Excessive managementtime may be used in the
negotiation process.May not be in the
best interest ofthe company.
May not be in thebest interest ofthe company.
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-39
Cost-Based Transfer Prices
When used, cost-based transfer prices . . . Are either variable cost or full cost. Should use standard rather than actual costs.
When used, cost-based transfer prices . . . Are either variable cost or full cost. Should use standard rather than actual costs.
Cost-based transfer prices are theleast desirable because the incentive
to control cost is diminished.
Cost-based transfer prices are theleast desirable because the incentive
to control cost is diminished.
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-40
Conflicts may arise between the company’s interests and an individual manager’s interests when transfer-price-based
performance measures are used.
Setting Transfer Prices