เพจ เรียนบ ัญชีก ัน Kru Prim 0963294624; 0939694599 1/22 Performance measurement in decentralized organizations Decentralization in organizations A decentralized organization does not confine decision-making authority to a few top executives; rather, decision-making authority is spread throughout the organization. The advantages and disadvantages of decentralization are as follows: Advantages of decentralization 1. It enables top management to concentrate on strategy, higher-level decision making, and coordinating activities. 2. It acknowledges that lower-level managers have more detailed information about local conditions that enable them to make better operational decisions. 3. It enables lower-level managers to quickly respond to customers. 4. It provides lower-level managers with the decision-making experience they will need when promoted to higher level positions 5. It often increases motivation, resulting in increased job satisfaction and retention, as well as improved performance. Disadvantages of decentralization 1. Lower-level managers may make decisions without fully understanding the “big picture.” 2. There may be a lack of coordination among autonomous managers. The balanced scorecard can help reduce this problem by communicating a company’s strategy throughout the organization. 3. Lower-level managers may have objectives that differ from those of the entire organization. This problem can be reduced by designing performance evaluation systems that motivate managers to make decisions that are in the best interests of the company. 4. It may be difficult to effectively spread innovative ideas in a strongly decentralized organization.
เพจ เรียนบ ัญชีก ัน Kru Prim 0963294624; 0939694599 2/22 Responsibility accounting Responsibility accounting systems link lower-level managers’ decision-making authority with accountability for the outcomes of those decisions. The term responsibility center is used for any part of an organization whose manager has control over, and is accountable for cost, profit, or investments. The three primary types of responsibility centers are cost centers, profit centers, and investment centers. Cost center The manager of a cost center has control over costs, but not over revenue or investment funds. Service departments such as accounting, general administration, legal, and personnel are Standard cost variances and flexible budget variances, such as those discussed in Chapters 11 and 12, are often used to evaluate cost center performance. Profit center The manager of a profit center has control over both costs and revenue. Profit center managers are often evaluated by comparing actual profit to targeted or budgeted profit. Cost Center Profit Center Investment Center Responsibility Center
เพจ เรียนบ ัญชีก ัน Kru Prim 0963294624; 0939694599 3/22 Investment center The manager of an investment center has control over cost, revenue, and investments in operating assets. Investment center managers are usually evaluated using return on investment (ROI) or residual income, as discussed later in this chapter. An organizational view of responsibility centers Superior Foods Corporation provides an example of the various kinds of responsibility centers that exist in an organization. The President and CEO as well as the Vice President of Operations manage investment centers. The Chief Financial Officer, General Counsel, and Vice President of Personnel all manage cost centers. Each of the three product managers that report to the Vice President of Operations (e.g., salty snacks, beverages, and confections) manages a profit center. The bottling plant manager, warehouse manager, and distribution manager all manage cost centers that report to the Beverages product manager Evaluating investment center performance – return on investment Investment center performance is often evaluating using a measure called return on investment (ROI), which is defined as follows ROI = Net operating income or Income before interest and taxes (EBIT) Average operating assets Average operating assets = Beginning operating assets + Ending operating assets 2 Net operating income is income before taxes and is sometimes referred to as EBIT (earnings before interest and taxes). Operating assets include cash, accounts receivable, inventory, plant and equipment, and all other assets held for operating purposes. 1. Net operating income is used in the numerator because the denominator consists only of operating assets.
เพจ เรียนบ ัญชีก ัน Kru Prim 0963294624; 0939694599 4/22 2. The operating asset base used in the formula is typically computed as the average of the assets between the beginning and the end of the year. Net book value versus gross cost Most companies use the net book value (i.e., acquisition cost less accumulated depreciation) of depreciable assets to calculate average operating assets. With this approach, ROI mechanically increases over time as the accumulated depreciation increases. Replacing a fully-depreciated asset with a new asset will decrease ROI. An alternative to net book value is the gross cost of the asset, which ignores accumulated depreciation. With this approach, ROI does not grow automatically over time, rather it stays constant. Replacing a fully-depreciated asset does not adversely affect ROI. Acquisition cost xxx Less Accumulated depreciation xx Net book value xxx Understanding ROI Du Pont pioneered the use of ROI and recognized the importance of looking at the components of ROI, namely margin and turnover. Margin is computed as shown and is improved by increasing sales or reducing operating expenses. The lower the operating expenses per dollar of sales, the higher the margin earned. Turnover is computed as shown. It incorporates a crucial area of a manager’s responsibility – the investment in operating assets. Excessive funds tied up in operating assets depress turnover and lower ROI. Any increase in ROI must involve at least one of the following – increased sales, reduced operating expenses, or reduced operating assets. The following example shows four different ways to increase ROI:
เพจ เรียนบ ัญชีก ัน Kru Prim 0963294624; 0939694599 5/22 ROI = Net operating income Average operating assets ROI = Margin x Turnover Margin = Net operating income Sales Turnover = Sales Average operating assets Increasing Roi – An Example Regal Company reports the following: Net operating income $30,000 Average operating assets $200,000 Sales $500,000 Operating expense $470,000 What is Regal Company’s ROI? ROI = Margin x Turnover ROI = Net operating income x Sales Sales Average operating assets ROI = ROI = ROI =
เพจ เรียนบ ัญชีก ัน Kru Prim 0963294624; 0939694599 6/22 Example Assume that Regal Company’s manager invests in a $ 30,000 piece of equipment that increases sales $35,000, while increasing operating expenses by $15,000. Regal Company reports the following: Net operating income $50,000 Average operating assets $230,000 Sales $535,000 Operating expense $485,000 What is Regal Company’s new ROI? ROI = Margin x Turnover ROI = Net operating income x Sales Sales Average operating assets ROI = ROI = ROI = Criticisms of ROI Just telling managers to increase ROI may not be enough. Managers may not know how to increase ROI in a manner that is consistent with the company’s strategy. This is why ROI is best used as part of a balanced scorecard. A manager who takes over a business segment typically inherits many committed costs over which the manager has no control. This may make it difficult to assess this manager relative to other managers. A manager who is evaluated based on ROI may reject investment opportunities that are profitable for the whole company but that would have a negative impact on the manager’s performance evaluation.
เพจ เรียนบ ัญชีก ัน Kru Prim 0963294624; 0939694599 7/22 Residual income Residual income is the net operating income that an investment center earns above the minimum required return on its assets. Economic Value Added (EVA®) is an adaptation of residual income. We will not distinguish between these two terms. Residual income = Net operating income – (Average operating assets x Minimum required rate of return) This computation differs from ROI. ROI measures net operating income earned relative to the investment in average operating assets. Residual income measures net operating income earned less the minimum required return on average operating assets. Residual Income – An Example • The Retail Division of Zephyr, Inc. has average operating assets of $100,000 and is required to earn a return of 20% on these assets. • In the current period, the division earns $30,000. Let’s calculate residual income. Operating assets Actual income Required rate of return Minimum required rate of return Minimum required rate of return Residual Income Motivation and Residual Income Residual income encourages managers to make profitable investments that would be rejected by managers using ROI.
เพจ เรียนบ ัญชีก ัน Kru Prim 0963294624; 0939694599 8/22 Quick Check ✓ 1. Redmond Awnings, a division of Wrap-up Corp., has a net operating income of $60,000 and average operating assets of $300,000. The required rate of return for the company is 15%. What is the division’s ROI? a. 25% b. 5% c. 15% d. 20% 2. Redmond Awnings, a division of Wrap-up Corp., has a net operating income of $60,000 and average operating assets of $300,000. If the manager of the division is evaluated based on ROI, will she want to make an investment of $100,000 that would generate additional net operating income of $18,000 per year? a. Yes b. No 3. The company’s required rate of return is 15%. Would the company want the manager of the Redmond Awnings division to make an investment of $100,000 that would generate additional net operating income of $18,000 per year? a. Yes b. No 4. Redmond Awnings, a division of Wrap-up Corp., has a net operating income of $60,000 and average operating assets of $300,000. The required rate of return for the company is 15%. What is the division’s residual income? a. $240,000 b. $45,000 c. $15,000 d. $51,000
เพจ เรียนบ ัญชีก ัน Kru Prim 0963294624; 0939694599 9/22 5. If the manager of the Redmond Awnings division is evaluated based on residual income, will she want to make an investment of $100,000 that would generate additional net operating income of $18,000 per year? a. Yes b. No Delivery Performance Measures Manufacturing Cycle Efficiency = Value-added time Manufacturing cycle time Order Received Production Started Goods Shipped Throughput Time Delivery Cycle Time Process Time + Inspection Time + Move Time + Queue Time Wait Time
เพจ เรียนบ ัญชีก ัน Kru Prim 0963294624; 0939694599 10/22 Quick Check ✓ 1. A TQM team at Narton Corp has recorded the following average times for production: Wait 3.0 days Move 0.5 days Inspection 0.4 days Queue 9.3 days Process 0.2 days What is the throughput time? a. 10.4 days. b. 0.2 days. c. 4.1 days. d. 13.4 days. 2. A TQM team at Narton Corp has recorded the following average times for production: Wait 3.0 days Move 0.5 days Inspection Process 0.4 days 0.2 days Queue 9.3 days What is the Manufacturing Cycle Efficiency (MCE)? a. 50.0%. b. 1.9%. c. 52.0%. d. 5.1%. 3. A TQM team at Narton Corp has recorded the following average times for production: Wait 3.0 days Move 0.5 days Inspection Process 0.4 days 0.2 days Queue 9.3 days What is the delivery cycle time (DCT)? a. 0.5 days. b. 0.7 days. c. c. 13.4 days. d. d. 10.4 days.
เพจ เรียนบ ัญชีก ัน Kru Prim 0963294624; 0939694599 11/22 The Balanced Scorecard Management translates its strategy into performance measures that employees understand and influence. The Balanced Scorecard: From Strategy to Performance Measures Performance Measures Financial Internal business processes Customer Learning and growth Performance measures Financial Has our financial performance improved? Customer Do customers recognize that we are delivering more value? Internal Business Processes Have we improved key business processes so that we can deliver more value to customers? Learning and Growth Are we maintaining our ability to change and improve? What are our financial goals? What customers do we want to serve and how are we going to win and retain them? What internal business processes are critical to providing value to customers? Vision and Strategy
เพจ เรียนบ ัญชีก ัน Kru Prim 0963294624; 0939694599 12/22 The Balanced Scorecard: Non-financial Measures The balanced scorecard relies on non-financial measures in addition to financial measures for two reasons: ❶ Financial measures are lag indicators that summarize the results of past actions. Non-financial measures are leading indicators of future financial performance. ❷ Top managers are ordinarily responsible for financial performance measures – not lower level managers. Non-financial measures are more likely to be understood and controlled by lower level managers. The entire organization should have an overall balanced scorecard. Each individual should have a personal balanced scorecard. A personal scorecard should contain measures that can be influenced by the individual being evaluated and that support the measures in the overall balanced scorecard.
เพจ เรียนบ ัญชีก ัน Kru Prim 0963294624; 0939694599 13/22 A balanced scorecard should have measures that are linked together on a cause-and-effectbasis. The balanced scorecard lays out concrete actions to attain desired outcomes. If we improve one performance measure . . . Another desired performance measure will improve. Then
เพจ เรียนบ ัญชีก ัน Kru Prim 0963294624; 0939694599 14/22 Transfer Pricing Key Concepts/Definitions A transfer price is the price charged when one segment of a company provides goods or services to another segment of the company. The fundamental objective in setting transfer prices is to motivate managers to act in the best interests of the overall company. Negotiated Transfer Prices A negotiated transfer price results from discussions between the selling and buying divisions. Advantages of negotiated transfer prices: 1. They preserve the autonomy of the divisions, which is consistent with the spirit of decentralization. 2. The managers negotiating the transfer price are likely to have much better information about the potential costs and benefits of the transfer than others in the company. Upper limit is determined by the buying division. Lower limitis determined by the selling division. Range ofAcceptable Transfer Prices
เพจ เรียนบ ัญชีก ัน Kru Prim 0963294624; 0939694599 15/22 Grocery Storehouse – An Example Assume the information as shown with respect to West Coast Plantations and Grocery Mart (both companies are owned by Grocery Storehouse). West Coast Plantations: Naval orange harvest capacity per month 10,000 crates Variable cost per crate of navel oranges $ 10 Per crate Fixed costs per month $ 100,000 Selling price of navel oranges on the outside market $ 25 Per crate Grocery Mart: Purchase price of current navel oranges $ 20 Per crate Monthly sales of navel oranges 1,000 crates Let’s calculate the lowest and highest acceptable transfer prices under three scenarios. The buying division’s (Grocery Mart) highest acceptable transfer price is calculated as: If an outside supplier does not exist, the highest acceptable transfer price is calculated as: The selling division’s (West Coast Plantations) lowest acceptable transfer price is calculated as: Transfer Price ≤ Cost of buying from outside supplier Transfer Price ≥ Variable cost per unit + Total contribution margin on lost sales Number of units transferred Transfer Price ≤ Profit to be earned per unit sold (not including the transfer price)
เพจ เรียนบ ัญชีก ัน Kru Prim 0963294624; 0939694599 16/22 Grocery Storehouse – An Example If West Coast Plantations has sufficient idle capacity (3,000 crates) to satisfy Grocery Mart’s demands (1,000 crates), without sacrificing sales to other customers, then the lowest and highest possible transfer prices are computed as follows: Selling division’s lowest possible transfer price: Transfer Price ≥ Variable cost per unit + Total contribution margin on lost sales Number of units transferred Transfer Price ≥ Transfer Price ≤ Cost of buying from outside supplier = Grocery Storehouse – An Example If West Coast Plantations has no idle capacity (0 crates) and must sacrifice other customer orders (1,000 crates) to meet Grocery Mart’s demands (1,000 crates), then the lowest and highest possible transfer prices are computed as follows: Selling division’s lowest possible transfer price: Transfer Price ≥ Variable cost per unit + Total contribution margin on lost sales Number of units transferred Transfer Price ≥ Transfer Price ≤ Cost of buying from outside supplier =
เพจ เรียนบ ัญชีก ัน Kru Prim 0963294624; 0939694599 17/22 Grocery Storehouse – An Example If West Coast Plantations has some idle capacity (500 crates) and must sacrifice other customer orders (500 crates) to meet Grocery Mart’s demands (1,000 crates), then the lowest and highest possible transfer prices are computed as follows: Selling division’s lowest possible transfer price: Transfer Price ≥ Variable cost per unit + Total contribution margin on lost sales Number of units transferred Transfer Price ≥ Transfer Price ≤ Cost of buying from outside supplier = Evaluation of Negotiated Transfer Prices If a transfer within a company would result in higher overall profits for the company, there is always a range of transfer prices within which both the selling and buying divisions would have higher profits if they agree to the transfer. If managers are pitted against each other rather than against their past performance or reasonable benchmarks, a noncooperative atmosphere is almost guaranteed. Given the disputes that often accompany the negotiation process, most companies rely on some other means of setting transfer prices. Transfers at the Cost to the Selling Division Many companies set transfer prices at either the variable cost or full (absorption) cost incurred by the selling division. Drawbacks of this approach include: 1. Using full cost as a transfer price can lead to sub optimization. 2. The selling division will never show a profit on any internal transfer. 3. Cost-based transfer prices do not provide incentives to control costs.
เพจ เรียนบ ัญชีก ัน Kru Prim 0963294624; 0939694599 18/22 Transfers at Market Price A market price (i.e., the price charged for an item on the open market) is often regarded as the best approach to the transfer pricing problem. 1. A market price approach works best when the product or service is sold in its present form to outside customers and the selling division has no idle capacity. 2. A market price approach does not work well when the selling division has idle capacity. Divisional Autonomy and Sub optimization The principles of decentralization suggest that companies should grant managers autonomy to set transfer prices and to decide whether to sell internally or externally, even if this may occasionally result in suboptimal decisions. This way top management allows subordinates to control their own destiny.
เพจ เรียนบ ัญชีก ัน Kru Prim 0963294624; 0939694599 19/22 Exercise 1. The head of the expanding IT department of AmCo Limited has been asked to develop a scorecard for its division and staff members. Which of the following issues are important for the scorecard system to be designed for the IT department? I. Addressing AmCo Limited’s vision II. Addressing IT department’s objectives III. Addressing other departments’, IT related requirements IV. Reducing total costs of the company A) All of them B) I, II, III C) I, II, IV D) I, III, IV E) Other combination not listed above 2. Which of the following statements is FALSE? A) A good balanced scorecard assists in communicating the strategy to all members of the organization by translating the strategy into a coherent and linked set of measurable operational targets. B) The learning and growth perspective measures employees’ skills, knowledge, motivation, and empowerment. C) Since financial measures tend to be lead indicators, rather than lag indicators, the financial perspective of the balanced scorecard is normally very useful for management to understand the result of past decisions. D) The balanced scorecard should be custom-tailored to the company’s strategic objectives and is subject to change if necessary. E) None of the above
เพจ เรียนบ ัญชีก ัน Kru Prim 0963294624; 0939694599 20/22 3. Which of the following is (are) NOT true of the balanced scorecard? A) It always facilitates the direct communication of corporate strategy to all members of the organization. B) Cause-and-effect linkages may not be precise and should evolve over time. C) Objective measures should be used and subjective measures should be avoided. D) It uses nonfinancial measures to serve as leading indicators of future performance. E) Incentive compensation should be linked to balanced scorecard performance measures. However, this should only be done after the organization has been successfully managed with the scorecard for some time, perhaps a year or more. 4. CU Company has a contribution margin of 9%. Sales are $377,000, net operating income is $33,930, and average operating assets are $128,000. What is the company’s return on investment (ROI)? A) 2.9% B) 9.0% C) 26.5% D) 0.3% 5. The following information relates to last year’s operations at the CU Division of CUACC Corporation. Minimum required rate of return 6% Return on investment (ROI) 7.8% Sales $840,000 Turnover (on operating assets) 2 times What was the CU Division net operating income last year? A) $65,520 B) $50,400 C) $15,120 D) $32,760
เพจ เรียนบ ัญชีก ัน Kru Prim 0963294624; 0939694599 21/22 6. CU is a division of a major corporation. The following data are for the most recent year of operation: Sale $36,780,000 Net operating income $2,958,960 Average operating assets $8,300,000 The company’s minimum required rate of return 16% The division’s residual income is closest to: A) $2,958,960 B) $4,286,960 C) $(3,177,840) D) $1,630,960 7. The following data are for the CU Division of Consolidated ACCCLUB; Incorporated; Sale $830,000 Net operating income $61,000 Average operating assets $330,000 Stockholders’ equity $83,000 Residual income $23,000 For the past year, the minimum required rate of return was; A) 46% B) 11.52% C) 24.10% D) 7.35%
เพจ เรียนบ ัญชีก ัน Kru Prim 0963294624; 0939694599 22/22 8. The CU Division of ACCCLUB Company makes and sells a single product, which is a part used in manufacturing trucks. The annual production capacity is 32,000 units and the variable cost of each unit is $37. Presently the CU Division sells 27,000 units per year to outside customers at $49 per units. ACC Division of ACCCLUB Company would like to buy 16,000 units a year from CU Division to use in its production. These would be no savings in variable costs from transferring the units internally rather than selling them extremally. The lowest acceptable transfer price from the standpoint of the CU Division should be closest to: A) $45.25 per unit B) $37.00 per unit C) $49.00 per unit D) $20.25 per unit