978-1111971724 Kinney 9e IM Ch 13 Lecture Note Part 1

Learning Objectives

1. Which factors determine whether a firm should be decentralized or centralized?

2. How are decentralization and responsibility accounting related?

each other?

4. How are revenue variances computed?

RESPONSIBILITY ACCOUNTING, SUPPORT

DEPARTMENT COST ALLOCATIONS,

AND TRANSFER PRICING

CHAPTER

13

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Terminology

Administrative Department: an organizational unit that performs management activities that benefit the

Advance pricing agreement: a binding contract between the IRS and a company that provides details of

Algebraic method: a method of allocating support department costs that considers all interrelationships

Benefits-provided ranking: a listing of support departments in an order that begins with the one

Centralization: term used to describe an organization’s approach to decision making in which top

Cost center: a responsibility center in which the manager has the authority only to incur costs and is

specifically evaluated on the basis of how well costs are controlled

Decentralization: is a transfer of authority, responsibility, and decision-making rights from the top to the

bottom of the organization structure

Direct method: a process of support department cost allocation that assigns support department costs

only to operating areas

Investment center: an organizational unit in which the manager is responsible for managing revenues

and current expenses and has the authority to acquire, use, and dispose of plant assets in a manner that

seeks to earn the highest feasible rate of return on the center’s asset base

Negotiated transfer price: an intracompany charge for goods or services that has been set through a

process of bargaining between the selling and purchasing unit managers

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Responsibility center: a cost object under the control of a manager such as a division, department, or

geographical region

Responsibility report: report that assist each successively higher level of management in evaluating the

performances of its subordinate managers and their respective organizational units

Sales volume variance (SVV): the variance calculated by multiplying the budgeted sales price by the

difference between the actual and budgeted sales volumes; indicates the portion of the total revenue

variance that is related to a change in sales volume

Service department: an organizational unit (e.g., maintenance department) that provides one or more

specific functional tasks for other internal units

Suboptimization: a situation in which individual managers pursue goals and objectives that are in their

own and/or their segments’ particular interests rather than in the company’s best interests

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Lecture Outline

LO.1: Which factors determine whether a firm should be decentralized or centralized?

A. Introduction

centralized organizational structures to highly decentralized structures.

2. This chapter describes the accounting methods that are appropriate in decentralized

B. Decentralization

1. The degree of centralization can be viewed as a continuum.

organization’s activities.

b. Decentralization exists when authority, responsibility, and decision-making rights are

decentralization.

2. Either extreme of the centralization-decentralization continuum represents an undesirable

arrangement.

the goals of the total organization.

c. Most businesses tend to structure themselves according to the pure centralization versus

pure decentralization factors listed in text Exhibit 13.2 (p. 504).

appropriate degree of decentralization.

3. Decentralization does not necessarily mean that a unit manager has the authority to make all of

the decisions concerning a unit, as top management selectively determines the types of authority

b. The need to address environmental issues has presented new challenges when deciding to

centralize or decentralize function addressing these environmental issues. Text Exhibit 13.3

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decision making for environmental issues.

C. Responsibility Accounting Systems

1. A responsibility accounting system facilitates decentralization by providing information about

2. Responsibility reports are reports that assist each successively higher level of management in

evaluating the performances of its subordinate managers and their respective organizational

units.

responsibility reports.

b. A manager’s responsibility report should reflect his or her degree of influence and should

include only the revenues and/or costs under that manager’s control.

3. A responsibility accounting system helps organizational unit managers conduct the following

basic control functions:

expectations and delegate authority;

b. gather actual data classified in accordance with the activities and categories specified in the

plan;

again.

4. Responsibility reports reflect the upward flow of information from operational units to company top

management and illustrate the broadening scope of responsibility.

a. Managers receive detailed information on the performance of their immediate areas of control

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i. Text Exhibit 13.5 (p. 507) presents a responsibility report that illustrates this pyramiding

of information.

c. Variances are itemized in performance reports at the lower levels so that the appropriate

i. Under the management by exception principle, major deviations from expectations are

d. The process of responsibility accounting creates some issues for management.

i. The idea of rolling up information to each successively higher level allows potentially

ii. Assuming different units within the responsibility accounting system are competing with

each other for resources, managers could try to promote their own agendas, thus leading

to a lack of goal congruence between or among organizational units.

 Goal congruence exists when the personal and organizational goals of decision

interdependencies among units might be obscured.

e. Responsibility accounting’s focus is on the manager who has control over a particular cost

object.

i. In a decentralized company, the cost object is an organizational unit or responsibility

center.

LO.3: What are the four primary types of responsibility centers, and what distinguishes them from

each other?

D. Types of responsibility centers

1. Responsibility accounting systems identify, measure, and report on the performance of

responsibility centers and their managers.

2. Cost Center

a. A cost center is a responsibility center in which the manager has the authority only to incur

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b. Cost centers commonly include service and administrative departments.

c. In the traditional manufacturing environment, the production department is the largest cost

center.

i. Cost center managers often concentrate only on the unfavorable standard cost variances

and ignore the efficient performance indicated by favorable variances.

ii. If the management by exception principle is applied properly, top management should

LO.4: How are revenue variances computed?

3. Revenue Center

a. A revenue center is an organizational unit for which a manager is accountable only for the

expectations.

c. Budgeted and actual revenues may differ either because of volume of units sold or price of

units sold.

i. The sales price variance is calculated by multiplying the actual number of units sold by

the difference between actual and budgeted sales prices. This variance indicates the

ASP x ASV BSP x ASV BSP x BSV

Sales Price Variance Sales Volume Variance

Total Revenue Variance

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responsible for managing some costs in their centers. Thus, a more appropriate term for

this organizational unit is a revenue and limited cost center.

4. Profit Center

a. A profit center is a responsibility center in which the manager is responsible for generating

5. Investment Center

asset base.

interests.

6. A unique challenge for the design of responsibility centers arises from the instance in which one

center supplies its outputs largely to other internal centers.

a. Top management must make judgments about the nature and extent of the costs and

revenues to include in such responsibility centers.

LO.5: Why and how are support department costs allocated to operating departments?

E. Support Department Cost Allocation

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1. General

a. Organizations incur two types of overhead costs: those directly related to the operating (or

b. As the number of product lines or service types increases, so does the need for additional

functional tasks for other internal units.

ii. An administrative department is an organizational unit that performs management

c. All support department costs must be covered in the long run by sales of products and

services.

making.

ii. See text Exhibit 13.7 (p. 511) for the reasons for and against allocating support

department costs.

2. Allocation Bases

a. Four criteria must be considered in determining a rational and systematic allocation base:

costs incurred in the support department;

iii. reflect the fairness or equity of the allocations between operating departments; and

iv. measure the ability of operating departments to bear the allocated costs.

b. Text Exhibit 13.8 (p. 512) provides alternative bases for assigning various types of support

department costs.

3. Methods of Allocating Support Department Costs

units.

b. Three basic methods are used to allocate the pooled support department costs to the

operating departments:

i. The direct method assigns support department costs only to operating areas;

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 This is the simplest method but may result in distorted cost allocations if there is

significant exchange of services among support departments as well as operating

departments.

ii. The step method allows a partial recognition of the effects of interactions among support

departments in assigning costs; and

 A benefits-provided ranking is a listing of support departments in an order that

begins with the one providing the most service to all other support areas and ends

reflects these relationships in simultaneous equations.

 The algebraic method is the most complex method but it is also the most theoretically

correct and, if relationships are properly formulated, provides the most accurate and

reliable allocations.

F. Support Department Cost Allocation Illustration

application rate.

b. Text Exhibit 13.9 (p. 513) provides an abbreviated budget of the direct and indirect costs for

each support department and operating division of ASC.

c. Text Exhibit 13.10 (p. 514) presents the bases selected for allocating ASC’s support

department costs. These bases are proxies for the quantity of services consumed by each

service area and operating division.

2. Direct Method Allocation

costs to operating areas at ASC.

c. Text Exhibit 13.12 (p. 515) presents the company’s total budget pre-tax profits by operating

area if support department costs are allocated using the direct method.

3. Step Method Allocation

a. The step method assigns support department costs to operating departments as well as to

certain other support departments.