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Fundamental Managerial Accounting ConceptsThomas P. Edmonds

Bor-Yi Tsay

Philip R. Olds

Copyright © Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.2009 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/IrwinMcGraw-Hill/Irwin

Fifth Edition

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CHAPTER 9Responsibility Accounting

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Learning Objective

LO1

Describe theconcept of

decentralization.

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An accounting system thatprovides information . . .

Responsibility Accounting

Relating to theresponsibilities of

individual managers.

To evaluatemanagers on

controllable items.

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Decentralization

Improves qualityof decisions.

Encourages upper-level management toconcentrate on strategic decisions.

Improvesproductivity.

Developslower-levelmanagers.

Improvesperformanceevaluation.

Advantages

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Decision-Making is Pushed Down

S u p erv isor S u p erv isor

M id d leM a na ge m e nt

S u p erv isor S u p erv is or

M id d leM a na ge m e nt

T opM a na ge m e nt

Decentralizationoften occurs asorganizations

continue to grow.

Decentralization

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Learning Objective

LO2

Describe the differences among

cost, profit, and investment centers.

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Organization ChartCorporate headquarters – Panther Holding CompanyCorporate headquarters – Panther Holding Company

Lumber Lumber manufacturing manufacturing

divisiondivision

HomeHomebuildingbuildingdivisiondivision

Furniture Furniture manufacturingmanufacturing

divisiondivision

Wilson Carpet Wilson Carpet CompanyCompany

Selma Sopha Selma Sopha CorporationCorporation

Tables Tables IncorporatedIncorporated

Sales Sales departmentdepartment

Production Production departmentdepartment

Planning Planning departmentdepartment

Accounting Accounting departmentdepartment

Cutting Cutting departmentdepartment

Assembly Assembly departmentdepartment

Finishing Finishing departmentdepartment

ResponsibilityLevel

1

2

3

4

5

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Responsibility Centers

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Learning Objective

LO3

Prepare and use responsibility reports.

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Responsibility Reports

Prepare budgets for each responsibility center.

Prepare timely performance reportscomparing actual amounts with budgeted amounts.

Measure performance ofeach responsibility center.

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Responsibility Reports

Budget Actual VarianceControllable expenses Administrative dividion expenses 20,400$ 31,100$ (10,700)$ U Company president's salary 9,600 9,200 400 F Wilson Carpet Company 82,100 78,400 3,700 F Selma Sopha Corporation 87,200 116,700 (29,500) U Table Incorporated 48,600 51,250 (2,650) U Total 247,900$ 286,650$ (38,750)$ U

Panther Holding CompanySecond Level: Furniture Manufacturing Division

For the Month Ended January 31, 2009

Budget Actual VarianceControllable expenses Administrative dividion expenses 3,000$ 2,800$ 200$ F Department manager's salary 10,000 11,200 (1,200) U Sales department costs 9,100 8,600 500 F Production department costs 13,500 13,750 (250) U Planning department costs 4,800 7,000 (2,200) U Accounting department costs 8,200 7,900 300 F Total 48,600$ 51,250$ (2,650)$ U

Panther Holding CompanyThird Level: Tables Incorporated

For the Month Ended January 31, 2009

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Budget Actual VarianceControllable expenses Administrative dividion expenses 3,000$ 2,800$ 200$ F Department manager's salary 10,000 11,200 (1,200) U Sales department costs 9,100 8,600 500 F Production department costs 13,500 13,750 (250) U Planning department costs 4,800 7,000 (2,200) U Accounting department costs 8,200 7,900 300 F Total 48,600$ 51,250$ (2,650)$ U

Panther Holding CompanyThird Level: Tables Incorporated

For the Month Ended January 31, 2009

Responsibility Reports

Budget Actual VarianceControllable expenses Administrative staff expense 900$ 1,100$ (200)$ U Supervisory salaries 2,800 2,800 - Cutting department costs 1,400 1,200 200 F Assembly department costs 2,800 2,900 (100) U Finishing department costs 5,600 5,750 (150) U Total 13,500$ 13,750$ (250)$ U

Panther Holding CompanyFourth Level: Production DepartmentFor the Month Ended January 31, 2009

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Responsibility Reports

Budget Actual VarianceControllable expenses Administrative staff expense 900$ 1,100$ (200)$ U Supervisory salaries 2,800 2,800 - Cutting department costs 1,400 1,200 200 F Assembly department costs 2,800 2,900 (100) U Finishing department costs 5,600 5,750 (150) U Total 13,500$ 13,750$ (250)$ U

Panther Holding CompanyFourth Level: Production DepartmentFor the Month Ended January 31, 2009

Budget Actual VarianceControllable expenses Wages expense 3,200$ 3,000$ 200$ F Direct materials 1,100 1,400 (300) U Supplies 400 500 (100) U Small tools 600 650 (50) U Other expenses 300 200 100 F Total 5,600$ 5,750$ (150)$ U

Panther Holding CompanyFifth Level: Finishing Department

For the Month Ended January 31, 2009

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Responsibility Reports

Budget Actual Variance Sales 984,300$ 962,300$ (22,000)$ U Variable expenses Variable product costs 343,100 352,250 (9,150) U Variable selling expenses 105,000 98,000 7,000 F Other variable expenses 42,200 51,100 (8,900) U Total variable expenses 490,300 501,350 (11,050) U Contribution magrin 494,000 460,950 (33,050) U Fixed expenses Fixed product cost 54,100 62,050 (7,950) U Fixed selling expenses 148,000 146,100 1,900 F Other fixed expenses 23,000 25,250 (2,250) U Total fixed expenses 225,100 233,400 (8,300) U Net income 268,900$ 227,550$ (41,350)$ U

Panther Holding CompanyIncome Statement for Internal Use

For the Month Ended January 31, 2009

Panther Income Statement (Contribution Margin Format)

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Learning Objective

LO4

Relate management by exception to

responsibility reports.

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Amount of detail varies according to level in an organization.

Departmentmanager receives detailed reports.

Store manager receives summarized information from each department.

Management by Exception

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The vice president of operations receives summarized information

from each unit.

Management by exception Upper-level management

does not receive operating detail unless problems arise.

Amount of detail varies according to level in an organization.

Management by Exception

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Since the exercise of control may be clouded,managers are usually held responsible for items

over which they have predominant ratherthan absolute control.

I’m in control

Controllability Concept

Managers shouldonly be evaluated on

revenues or coststhey control.

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To be of maximum benefit, responsibility reports should . . .Be timelyBe issued regularlyBe understandableCompare budgeted

and actual amountsof controllable items

Qualitative Reporting Features

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CostCenter

ProfitCenter

InvestmentCenter

Evaluation Measures

Profitability

Return on investment (ROI) Residual income (RI)

Cost controlQuantity and qualityof services

Managerial Performance Measurement

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Learning Objective

LO5

Evaluate investment opportunities using

return on investment.

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Return on Investment Return on investment is the ratio of Return on investment is the ratio of

income to the investment used to income to the investment used to generate the income.generate the income.

ROI = Operating IncomeOperating Assets

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Return on InvestmentPanther Holding Company provides the following

information for the company’s second level investment centers.

Lumber Manufacturing

Division

Home Building Division

Furniture Manufacturing

Division Operating income 60,000$ 46,080$ 81,940$ Operating assets 300,000 256,000 482,000

Let’s calculate ROI.

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Return on Investment

LumberManufacturing

Home Building

Furniture Manufacturing

=

=

=

$60,000$300,000

$46,080$256,000

$81,940$482,000

= 20%

= 18%

= 17%

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Measuring Operating Assets

Using the book value of operating assets to calculate ROI will result in a higher ROI.

Acquisition costLess: Accumulated depreciationBook value

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Learning Objective

LO6

Identify factors that affect return on

investment.

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ROI = Operating IncomeOperating Assets

Margin Turnover

Factors Affecting ROI

ROI = × SalesOperating Assets

Operating IncomeSales

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The Lumber Manufacturing Division reported the following information:

Operating IncomeOperating Income $ 60,000$ 60,000 SalesSales $ 600,000$ 600,000 Operating AssetsOperating Assets $ 300,000$ 300,000

Let’s calculate ROI usingthe expanded equation.

Factors Affecting ROI

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ROI = .10 × 2ROI = .10 × 2 = = 20%20%

Factors Affecting ROI

ROI = $60,000$600,000 × $600,000

$300,000

ROI = × SalesOperating Assets

Operating IncomeSales

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Factors Affecting ROI

Three ways to improve ROI

Increase Sales

Reduce Expenses

Reduce Operating Assets

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The Lumber Manufacturing Division was able to increase sales to $660,000 which increased operating income to $79,200.

There was no change in operating assets.

Let’s calculate the new ROI.

Factors Affecting ROI

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The division’s ROI increased from 20% to 26.4%.

Factors Affecting ROI

ROI = .12 × 2.2 = 26.4%

ROI = $79,200$660,000 × $660,000

$300,000

ROI = × SalesOperating Assets

Operating IncomeSales

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ROI - A Major Drawback As division manager in Lumber Manufacturing,As division manager in Lumber Manufacturing,

your compensation package includesyour compensation package includesa salary plus bonus based on your division’sa salary plus bonus based on your division’sROI -- the higher your ROI, the bigger your bonus.ROI -- the higher your ROI, the bigger your bonus.

The company requires an ROI of 20% on all new The company requires an ROI of 20% on all new investments -- your division has been producing an investments -- your division has been producing an ROI of 30%.ROI of 30%.

You have an opportunity to invest in a new project You have an opportunity to invest in a new project that will produce an ROI of 25%.that will produce an ROI of 25%.

As division manager, would you invest in this project?

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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!

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Learning Objective

LO7

Evaluate investment opportunities using

residual income.

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Residual Income Operating Income– Investment charge = Residual income

Operating Assets× Desired ROI = Investment charge

Investment center’scost of acquiring

investment capital

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Residual IncomeThe Lumber Manufacturing Division The Lumber Manufacturing Division

currently earns $60,000 of operating currently earns $60,000 of operating income with the $300,000 of income with the $300,000 of operating assets it controls. operating assets it controls.

Panther has a 18% desired ROI. Panther has a 18% desired ROI.

Let’s calculate residual income.Let’s calculate residual income.

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Residual Income

Panther’s desiredreturn on investment.

Operating income = $60,000– Desired income = 54,000 = Residual income = $ 6,000

Operating assets = $300,000× Desired ROI = 18% = Desired income = $ 54,000

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Residual Income

Residual income encourages managers to make profitable investments that would

be rejected by managers using ROI.

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Responsibility Accounting and the Balanced Scorecard

The balanced scorecard is a holisticapproach to evaluating managers.

BalancedScorecard

Multiplefinancial

measures

Multiplenon-financial

measures

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Learning Objective

LO8

Describe how transfer prices may

be established. (Appendix)

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Transfer Pricing

Goods and services are often transferred internally from one

division (selling division) to another (buying division).

The transfer price can be the subject of considerable

controversy.

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Transfer Pricing

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End of Chapter 9