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Chapter 24 - Performance Measurement and Responsibility Accounting
CHAPTER 24
PERFORMANCE MEASUREMENT AND
RESPONSIBILITY ACCOUNTING
Related Assignment Materials
Student Learning Objectives Discussion
Questions
Quick
Studies*
Exercises* Problems* Beyond the
Numbers
Conceptual objectives:
C1. Distinguish between direct and
indirect expenses and identify
bases for allocating indirect
expenses to departments
1,2,3,4,5,
6,7,8,9,11,
15,16
24-4, 24-5,
24-6
24-1, 24-8
C2. Appendix 24A--Explain transfer
pricing and methods to set
transfer prices.
12 24-7, 24-16,
24-17
24-18
C3. Appendix 24B--Describe
allocation of joint costs across
products.
13,14 24-8, 24-18
24-19, 24-20 24-5
Analytical objectives:
A1. Analyze investment centers
using return on total assets and
residual income.
24-9, 24-10,
24-11, 24-19
24-8, 24-9,
24-11, 24-12,
24-14
A2. Analyze investment centers
using profit margin and
investment turnover
24-11, 24-12
24-10, 24-11,
24-13, 24-14,
24-21
24-2
A3. Analyze investment centers
using the balance scorecard
24-13, 24-14
24-15
A4. Compute cycle time and cycle
efficiency, and explain their
importance to production
management.
17,18, 19,
20
24-15 24-16, 24-17
Procedural objectives:
P1. Prepare a responsibility report
for a cost center
24-1, 24-2,
24-3
24-1 24-1 24-6, 24-8
P2. Allocate indirect expenses to
departments
24-2, 24-3,
24-4, 24-5
24-2 24-4, 24-5
P3. Prepare departmental income
statements and contribution
reports
10 24-8 24-6, 24-7 24-3, 24-4 24-3, 24-7,
24-9
*See additional information on next page that pertains to these quick studies, exercises and
problems.
24-1
Education.
Chapter 24 - Performance Measurement and Responsibility Accounting
Additional Information on Related Assignment Material
Connect (Available on the instructor’s course-specific website) repeats all numerical Quick Studies, all
Exercises and Problems Set A. Connect provides new numbers each time the Quick Study, Exercise or
Problem is worked. It allows instructors to monitor, promote, and assess student learning. It can be
used in practice, homework, or exam mode.
Corresponding problems in set B also relate to learning objectives identified in grid on previous
page.
Problems 24-2A and 24-3A can be completed using Excel. The Serial Problem for Success Systems
starts in this chapter and continues throughout many chapters of the text.
Synopsis of Chapter Revisions
United By Blue: NEW opener with new entrepreneurial assignment
Added discussion of advantages and disadvantages of decentralization
Reorganized discussion of cost, profit, and investment centers into a bulleted list, with
examples using Kraft Foods Group
Streamlined organization chart for responsibility accounting
Revised discussion of responsibility accounting for cost centers
Revised exhibit on responsibility accounting for cost centers
Edited discussion and exhibits in the allocation of indirect expenses example
Added discussion of the usefulness of departmental income statements in decision-making
Revised discussion of the use of return on investment and residual income in decision-making
Revised example of profit margin and investment turnover calculations, using Walt Disney
Added Sustainability section on Kraft Foods Group
Added several end of chapter assignments
24-2
Education.
Chapter 24 - Performance Measurement and Responsibility Accounting
Chapter Outline
I. Decentralizationcompanies are divided into smaller units called
divisions, departments, segments, or subunits (or divisions) when too
large.
A. Motivation for Decentralization
1. Decisions are made by mangers throughout the company rather
than by a few top executives.
2. Divisions are organized into separate departments for efficiency
and/or effectiveness
3. Divisions are usually organized into separate departments.
4. Each department is often placed under the direction of a manager
with decision making authority.
B. Advantages of Decentralization
1. Low level managers have timely access to detail information
about their departments.
2. Providing lower level managers decision making day to day
decision authority allows managers to focus more on long-term
strategy for the entire organization
3. Managing a division can be good training for those who might
later be promoted to top level management.
4. Having decision making authority boosts employee morale and
retention.
C. Disadvantages of Decentralization
1. When managers are focused on their own department, they might
make decisions that do not reflect the company’s overall strategy.
2. When there are several departments, decisions of individual
departments may conflict with one another.
3. Departments may duplicate certain activities, such as payroll or
purchasing. Duplication of activities increases costs. In many
decentralized organizations, those activities like payroll and
purchasing are centralized to reduce costs.
D. Performance Evaluation
1. Prepared for internal managers to help control operations,
appraise performance, allocate resources, and plan strategy.
2. Financial information used for evaluation depends on type of
center.
a. Cost centerincurs cost or expenses without directly
generating revenues (e.g. manufacturing department and
service department)
b. Profit centerincurs costs and generates revenues (e.g. selling
department).
c. Investment centerincurs costs, generates revenues and is
responsible for effectively using center assets.
Notes
Chapter Outline Notes
24-3
3. Basis for evaluating performance:
a. Cost center: ability to control costs.
b. Profit center: ability to generate more revenue than expenses.
c. Investment center: use of investment center assets to generate
income.
II. Responsibility Accounting
A. Controllable versus Uncontrollable Costs
1. Controllable costs are those which a manager has the power to
determine or at least significantly affect the amount incurred.
2. Uncontrollable costs are not within the manager’s control.
3. A manager’s performance is evaluated using responsibility
reports that describe the department’s activities in terms of
controllable costs
4. Distinguishing between controllable and uncontrollable costs
depends on the particular manager and the time period under
analysis.
5. All costs are controllable at some level of management if the time
period is sufficiently long;
6. Good judgment is required when identifying controllable costs.
B. Responsibility Accounting System
1. Responsibility accounting system assigns managers the
responsibility for costs and expenses under their control.
2. Responsibility accounting budgets identify costs and expenses
under the manager’s control; typically based on flexible
budgeting approach shown in Chapter 23
3. Responsibility accounting performance reports (Exhibit 24.2):
a. Accumulate and report costs for which a manager is
responsible and their budgeted amounts.
b. Management’s analysis of differences between actual and
budget often results in corrective actions.
c. Used by upper management to evaluate effectiveness of
lower-level managers in controlling costs.
d. Recognizes that control over costs and expenses belongs to
several layers of management.
4. Responsibility Accounting Report
a. Provide relevant information for each management level.
b. At lower levels, managers have limited responsibilities and
therefore fewer controllable costs.
c. Responsibility and control broaden for higher-level
managers.
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Education.
Chapter 24 - Performance Measurement and Responsibility Accounting
Chapter Outline
III. Profit Centers
A. The responsibility report focuses on how well each department
controlled costs and generated revenues.
B. The departmental income statement is a common way to report profit
center performance.
C. When computing department profits, challenges involve allocating
expenses across operating departments
D. Direct and Indirect Expenses
1. Direct Expenses are readily traced to a department.
a. Incurred for sole benefit of that one department; no allocation
required.
b. Often, but not always, controllable costs.
2. Indirect Expenses are incurred for joint benefit of more than one
department; can’t be readily traced to just one department.
a. Allocated across departments benefiting from them.
b. Ideally allocated using a cause-effect relation or, if cause-
effect relation cannot be identified, allocated on a basis
approximating the benefit received by each department.
c. typically considered uncontrollable costs
E. Allocation of Indirect Expensesno standard rule identifies the best
basis; judgment required.
1. Wages and salaries:
a. Direct expense of the department if time spent entirely in one
department; otherwise indirect.
b. Basis for allocating when indirect:
i. Employeesrelative amount of time spent in each
department.
ii. Supervisorsnumber of employees (if task is managing) or
sales (if job reflects on departments’ sales).
3. Rent and related expensesportion of floor space occupied.
More valuable location may charge department higher rate.
4. AdvertisingDepartmental portion of total sales, or by
newspaper space or TV/radio time devoted to products of
each department.
5. Equipment and machinery depreciationrelative number of
hours used by each department.
a. Direct expense of the department if the asset is used only
in that department
b. Indirect expense when the asset is used by more than one
department.
Notes
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Chapter 24 - Performance Measurement and Responsibility Accounting
Chapter Outline
6. Utilities expenseportion of floor space occupied by departments
(if used uniformly); otherwise more complicated
7. Service Department expenses – (provide support to an
organization’s operating departments) See Exhibit 24.4 for
common allocation bases
F. Departmental Income Statements
1. Departmental income statements are prepared after all expenses
have been assigned to the departments.
a. Direct expenses are accumulated by department.
b. Indirect expenses – all the direct and indirect expenses
incurred in service departments are compiled and then
allocated to the operating departments.
2. Four Steps for allocating costs and preparing departmental
income statements.
a. Step one – accumulate revenues and direct expenses for each
service and selling department.
i. Cost centers do not generate revenues
ii. Direct expenses include wages, salaries, and other
expenses that a department incurs but does not share with
any other department.
b. Step two – allocate indirect expenses across all service and
operating departments
i. Can include items such as depreciation, rent, advertising
and other indirect expenses.
ii. The indirect expenses are recorded in company accounts
and an allocation based is identified to allocate the costs
to the departments on a departmental expense allocation
spreadsheet
c. Step three – allocate service department expenses to
operating departments using a departmental expense
allocation spreadsheet. (Review Exhibits 24.6 through 24.14).
d. Step four – the departmental expense allocation spreadsheet
can be used to prepare departmental performance reports for
the company’s service and operating departments.
i. Actual service department expenses are compared with
budgeted amounts to help assess cost center performance.
ii. Amounts in the operating department columns are used to
prepare departmental income statements. (Exhibit 24.15)
G. Departmental Contribution to Overhead (see Exhibit 24.16)
1. Departmental income statements not always best for evaluating
each profit center’s performance especially when indirect
expenses are a large portion of total expenses.
2. Evaluate using departmental contributions to overheada report
of the amount of sales less direct expenses (indirect expenses are
often considered “overhead”).
Notes
24-6
Chapter 24 - Performance Measurement and Responsibility Accounting
Chapter Outline
3. Balanced Scorecard: system of performance measures,
including nonfinancial measures used to assess company and
division manager performance. Requires managers to think of
their company from four perspectives.
a. Customer: what do they think of us?
b. Internal process: which of our operations are critical?
c. Innovation and learning: how can we improve?
d. Financial: what do our owners think of us?
IV. Decision Analysis Cycle Time and Cycle Efficiency
A. As lean manufacturing practices help companies move toward just in
time manufacturing it is important for companies to reduce the time
it takes to manufacture its products and improve efficiency.
1. Cycle time measures the time element which describes the time
it takes to produce a product or service.
Cycle time = Process + Inspection + Move + Wait
Time Time Time Time
a. Process time is considered value-added time – it is the only
activity in cycle time that adds value to the product from the
customer’s perspective. The other three activities are
considered non-value-added time: they add no value to the
customer.
2. Cycle Efficiency measures production efficiency. It is the ratio
of value added time to total cycle time.
Cycle Efficiency = Value added time
cycle time
a. If the cycle efficiency is low, the company should evaluate
the production process to see if it can identify ways to
reduce the non-value added activities.
V. Appendix 24A – Transfer Pricing
A. The price used to record transfers between divisions in the same
company is called a transfer price. Can be used in cost, profit and
investment centers.
1. If there is no excess capacity, the internal supplier will not accept
a transfer price less than the market price. This is called market
based transfer pricing.
2. If there is excess capacity, the internal supplier should accept a
price between the costs to manufacturer the part and the market
price. This is called cost based transfer pricing.
Notes
24-7
24-8
Chapter 24 - Performance Measurement and Responsibility Accounting
Chapter Outline
3. Other issues to consider in determining transfer prices include:
a. Market price may not exist
b. Cost controls
c. Division managers’ negotiation
d. Nonfinancial factors to consider include: quality control,
reduced lead times and impact on employee morale.
III. Appendix 24B – Joint Costs
A. Joint Coststhe costs incurred to produce or purchase two or more
products at the same time; similar to indirect expense in that it’s
shared across more than one cost object.
1. Ignored when deciding to sell product as is or process further.
2. Allocated to different products produced from it when total cost
3. Allocation bases
a. Physical basisallocates joint costs using physical
characteristics such as ratio of pounds, cubic feet or gallons
of each joint product to the total pounds, cubic feet or
gallons of all joint products flowing from the cost; does not
reflect the extra value flowing into some products or the
inferior value flowing into others. Not the preferred method.
b. Value basisallocates joint cost in proportion to the sales
value of the output produced by the process at the “split-off
point”.
Notes
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