Chapter 22
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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.

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Chapter 22

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Chapter 22

Chapter 22

Decentralization and Performance Evaluation


Conceptual learning objectives

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.

22-2


Analytical learning objectives

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.

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Procedural learning objectives

Procedural Learning Objectives

P1: Prepare departmental income statements and contribution reports.

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Departmental accounting

Provide informationfor managers to usein performanceevaluation.

To control costs and

expenses and assist

with evaluating

managers

performances.

Departmental Accounting

C1

Primarygoals

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Information for departmental evaluation

Information forDepartmental 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

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Information for departmental evaluation1

Costcenter

Profitcenter

Evaluated on ability tocontrol costs.

Evaluated on abilityto generate revenuesin excess of expenses.

Information forDepartmental Evaluation

C1

The type of accounting information provided depends on whether the department is a . . .

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Information for departmental evaluation2

Information forDepartmental Evaluation

C1

Investment Center

Evaluated on their use of center assets to generate income.

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Departmental expense allocation

Departmental Expense Allocation

C1

Direct expensesare incurred for the sole benefit of a specific department.

Indirect expensesbenefit more than one department and are allocated among departments benefited.

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Illustration of indirect expense allocation

Illustration of IndirectExpense Allocation

C1

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.

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Illustration of indirect expense allocation1

Illustration of IndirectExpense Allocation

C1

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.

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Illustration of indirect expense allocation2

Illustration of IndirectExpense Allocation

C1

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.

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Bases for allocating service department costs

Bases for AllocatingService Department Costs

C1

Service department costs are shared, indirect expenses that support the activities of two or more production departments.

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Service department costs question

Service Department CostsQuestion

C1

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

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Service department costs question1

Service Department CostsQuestion

C1

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

Assembly percentage= 100 ÷ (100 + 150) = 40%

40% of $300,000 = $120,000

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Preparing departmental income statements

  • Let’s prepare departmental income statements using the following steps:

    • Direct expense accumulation.

    • Indirect expense allocation.

    • Service department expense allocation.

Preparing DepartmentalIncome Statements

P1

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Departmental expense allocation spreadsheet

Departmental ExpenseAllocation Spreadsheet

P1

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Departmental expense allocation spreadsheet1

Departmental ExpenseAllocation Spreadsheet

P1

Step 1:Direct expensesaretracedto service departments and sales departments without allocation.

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Departmental expense allocation spreadsheet2

Departmental ExpenseAllocation 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.

Step 2:Indirect expensesare allocatedto both the service and the sales departments based on floor space occupied.

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Departmental expense allocation spreadsheet3

Departmental ExpenseAllocation Spreadsheet

P1

Step 3: The Service departmenttotal expenses(original direct expenses + allocated indirect expenses) from the two service departments areallocatedto three remaining operating or sales departments.

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Departmental income statements

Departmental Income Statements

P1

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Departmental income statement

Departmental Income Statement

P2

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Departmental contribution to oh

P1

Departmental Contribution to OH

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Financial performance evaluation measures

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:

Investment center net income Investment center average invested assets

ROI =

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Financial performance evaluation measures1

Financial Performance Evaluation Measures

A1

  • Another measure of evaluating financial performance is by computing the investment center’s residual income.

Investment Center - Target investment net income center net income

Residual Income =

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Balanced scorecard

Balanced Scorecard

A1

  • The Balanced Scorecard is a system of performance measures, including non-financial measures.

  • It Is used to assess company and division performance based on four perspectives:

  • Customer

  • Internal processes

  • Innovation and Learning

  • Financial

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Responsibility accounting

Relating to theresponsibilities ofindividual managers.

To evaluatemanagers oncontrollable items.

Responsibility Accounting

C2

An accounting system thatprovides information . . .

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Controllable costs

Controllable Costs

C2

I’m in control

Costs are controllableif the managerhas the power to determine, or strongly influence, the amounts incurred.

A manager’s performance evaluation should be based on controllable costs.

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Distinguishing controllable and direct costs

Distinguishing Controllableand Direct Costs

C2

Direct costs are traced to departments, but may not be controllable by the department manager.

  • Example: Department managers usuallyhave 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.

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Chapter 22

Responsibility Accounting

C2

Successful implementation ofresponsibility accountingmay use organization charts with clear lines of authority and clearly defined levels of responsibility.

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Responsibility accounting performance reports

Responsibility AccountingPerformance Reports

C2

Amount of detail varies according to level in organization.

A store manager receives summarized information from each department.

A department manager receives detailed reports.

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Responsibility accounting performance reports1

Responsibility AccountingPerformance Reports

C2

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.

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Responsibility accounting performance reports2

Responsibility AccountingPerformance Reports

C2

To be of maximum benefit, responsibility reports should . . .

  • Be timely.

  • Be issued regularly.

  • Beunderstandable.

  • Comparebudgetedand actual amounts.

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Investment center analysis

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.

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Profit margin

Profit Margin

A2

  • 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

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Investment turnover

Investment Turnover

A2

  • 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

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End of chapter 22

End of Chapter 22

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