chapter
24
Performance Evaluation for
Decentralized Operations
2. Prepare a responsibility accounting report for a cost center.
4. Compute and interpret the rate of return on investment, the residual income, and the balanced
scorecard for an investment center.
5. Describe and illustrate how the market price, negotiated price, and cost price approaches to transfer
pricing may be used by decentralized segments of a business.
94 Chapter 24 Performance Evaluation for Decentralized Operations
STUDENT FAQS
• Why is decentralized management used when the managers usually don’t have the experience or
training?
• What is the best type of responsibility accounting center and why?
• What are considered invested assets on the balance sheet?
• Does management actually use all these formulas to determine if a company is doing well or not?
• Besides comparing to years in the past for a company, where do you get industrial averages?
TM 24-4 presents various divisions/departments that would be found in a typical department store. Give
1. Each of the five stores in the chain – Profit center or Investment center (see below)
3. Ladies clothing department – Profit center
5. Credit and collection department – Cost center
As students share their answers, emphasize the level of authority given to the manager of each unit based
on the type of responsibility center. For example, if your students determine that each store in the chain
should be an investment center, each store manager must have authority to make decisions regarding
costs, sales strategies, and fixed assets purchased by his or her store (within company guidelines). If
TM 24-5 provides the organization chart for the accounting function of a corporation. Use this chart to
illustrate that cost centers may exist within cost centers.
TM 24-6 shows budget performance reports for the accounting departments that report to the controller.
Divide your class into small groups and instruct each group to prepare the responsibility accounting report
that would be given to the corporate controller. A solution is displayed on TM 24-7.
This exercise will allow you to emphasize that upper-level managers receive summarized cost data. When
reviewing TM 24-7, ask your students which departments the controller should question regarding their
department or the division, as well as service department charges. A charge allocated to a profit center
from a service department (such as Personnel or Maintenance) is an example of an indirect expense. That
charge is controllable if the profit center manager is free to choose how much of the service is used.
Use the Group Learning Activity below to cover the preparation of divisional income statements for profit
centers.
evaluate their performance. In theory, these costs should appear only on a consolidated income statement
for the entire company.
You may want to point out that, unfortunately, many organizations allocate uncontrollable charges to
departments or divisions. This often leads to frustration for managers who must explain costs that are
beyond their control.
1. Why would an organization charge indirect service costs to the departments that use these services?
2. Should any university administrative overhead be charged to academic departments or other
responsibility centers? (Answer: yes. There are many university services that could be directly
3. What would be an appropriate activity base for charging central telephone services to departments
within an organization? (Answer: number of phone lines)
4. Give an example of a noncontrollable cost for a manager of a McDonald’s franchise. (Answer:
Corporate advertising would not be controllable.)
OBJECTIVE 4
Compute and interpret the rate of return on investment, the residual income, and the
balanced scorecard for an investment center.
or residual income is used to gauge asset efficiency.
Responsibility reports that show controllable revenues and controllable expenses by investment center are
prepared using the same techniques covered in Objective 3. Use the following Demonstration Problem to
illustrate rate of return on investment and residual income measures. After demonstrating these measures,
use TM 24-9 to discuss the advantages and disadvantages of using rate of return on investment and
Division B 800,000 144,000 600,000
Give your students a minute to calculate the rate of return on assets for each division and write the answer
in their notes. (Answer: Division A = 22.5 percent, Division B = 24.0 percent)
From this calculation, it appears that Division B is providing a greater return on the company’s
investment than Division A. This greater return could occur for one of two reasons: (1) Division B is
divisions. This analysis should yield the following information:
Profit Investment Rate of Return
Margin Turnover on Investment
Division A 18% 1.25 22.5%
Division B 18% 1.33 24.0%
Ask your students to calculate the residual income for Divisions A and B, assuming that the company’s
minimum rate of return is 15 percent.
Controllable Minimum
Operating Acceptable Residual
Income Income Income
(2) Customer Service, (3) Internal Processes, and (4) Financial Performance.
100 Chapter 24 Performance Evaluation for Decentralized Operations
Choose an organization (such as your college or university) and ask students to develop at least one
measure in each of the four components of the balanced scorecard. For example, a measure in the
innovation and learning category might be the number of classrooms converted for multimedia
TM 24-10 lists the benefits that are gained when transfer pricing is used in intercompany transfers. The
1. Divisions can be evaluated as profit or investment centers.
Chapter 24 Performance Evaluation for Decentralized Operations 101
3. If divisions are permitted to buy component parts wherever they can find the best price (either
internally or externally), transfer pricing will allow a company to maximize its profits.
If a component part can be produced cheaper by an outside company than an internal division, that
part will be purchased from the outside. This forces the internal division to cut costs to the point that
it competes with outside firms or is discontinued. In addition, the division manufacturing the
activity.
Explain to your students that they are managers of two divisions of a company that manufactures power
tools. One manages the division that produces the small engines that drive the tools. The other manages
the division that assembles the tools. Although the assembly division needs engines, it is free to purchase
them from the engine division or an outside company, wherever the best price can be obtained.
engine, and the assembly division manager will not pay more than $50, the two should settle on the
market price of $50 for the transfer. After the trade is negotiated, share with the class the facts given to
each manager. This will allow you to emphasize that a company can set transfer prices at market prices if
divisions are operating at full capacity and can sell all their products.
Next, privately tell the engine division manager to assume that his or her division is not producing at full
LECTURE AID — Transfer Pricing at Cost
Remind students that some companies transfer products at their cost. This cost may be the division’s
variable cost per unit or the total cost per unit. In addition, the products may be transferred at actual or
standard cost.
Most companies tend to transfer products at standard cost. If actual cost is used, divisions are permitted to
Sales salaries 32,000 45,000
Property taxes, utilities, and depreciation 16,000 19,000
Miscellaneous operating expenses 1,000 2,000
The following indirect costs were incurred by service departments at Watson Clothiers in the
current year:
Required: Prepare divisional income statements for Watson Clothiers, showing each store’s
income from operations. In accordance with responsibility accounting, include only controllable
revenues and controllable expenses.
center
center
center
and ROI
and ROI
centers
activity bases
department charges
Service department charges and
activity bases
HOMEWORK CHART WITH LEARNING OUTCOMES TAGGING
DIFFICULTY BUSPROG ACBSP IMA BLOOM’S TIME
Ex24-7 24-3
service department charges
Moderate Analytic Budgeting and Responsibility Performance Measurement Application 20 min. X
Corrections to service department
Ex24-8 24-3
charges
Moderate Analytic Budgeting and Responsibility Performance Measurement Application 30 min.
Ex24-9 24-3 Profit center responsibility reporting Moderate Analytic Budgeting and Responsibility Performance Measurement Application 30 min. X
Ex24-10 24-4 Rate of return on investment Easy Analytic Budgeting and Responsibility Performance Measurement Application 15 min.
Ex24-11 24-4 Residual income Easy Analytic Budgeting and Responsibility Performance Measurement Application 15 min.
Determining missing items in rate of
Ex24-12 24-4
return computation
Easy Analytic Budgeting and Responsibility Performance Measurement Application 10 min.
Ex24-13 24-4
Profit margin, investment turnover,
and rate of return on investment
Moderate Analytic Budgeting and Responsibility Performance Measurement Application 20 min.
Ex24-14 24-4 Rate of return on investment Moderate Analytic Budgeting and Responsibility Performance Measurement Application 15 min.
Ex24-15 24-4
computations
Moderate Analytic Budgeting and Responsibility Performance Measurement Application 15 min.
Ex24-16 24-4
computations
Moderate Analytic Budgeting and Responsibility Performance Measurement Application 20 min.
Determining missing items from
Ex24-17 24-4
residual income
Moderate Analytic Budgeting and Responsibility Performance Measurement Application 15 min.
Ex24-18 24-4 Balanced scoreboard Easy Analytic Budgeting and Responsibility Performance Measurement Application 10 min.
Ex24-19 24-4 Balanced scoreboard Moderate Analytic Budgeting and Responsibility Performance Measurement Application 15 min.
Ex24-21 24-5 Decision on transfer pricing Easy Analytic Budgeting and Responsibility Performance Measurement Application 25 min.
Budget performance report for a
Pr24-2A 24-3 Profit center responsibility reporting Moderate Analytic Budgeting and Responsibility Performance Measurement Application 1 hour X
Pr24-3A 24-4
rate of return on investment analysis
Moderate Analytic Budgeting and Responsibility Performance Measurement Application 45 min. X
Pr24-4A 24-4
performance
Moderate Analytic Budgeting and Responsibility Performance Measurement Application 1.5 hours X
Pr24-5A 24-4
evaluation
Moderate Analytic Budgeting and Responsibility Performance Measurement Application 1 hour X
Pr24-6A 24-5 Transfer pricing Moderate Analytic Budgeting and Responsibility Performance Measurement Application 1.5 hours X
Pr24-1B 24-2
cost center
Moderate Analytic Budgeting and Responsibility Performance Measurement Application 1 hour X
Pr24-2B 24-3 Profit center responsibility reporting Moderate Analytic Budgeting and Responsibility Performance Measurement Application 1 hour X
DIFFICULTY BUSPROG ACBSP IMA BLOOM’S TIME
Pr24-3B 24-4
rate of return on investment analysis
Moderate Analytic Budgeting and Responsibility Performance Measurement Application 45 min. X
Pr24-4B 24-4
performance
Moderate Analytic Budgeting and Responsibility Performance Measurement Application 1.5 hours X
Pr24-5B 24-4
evaluation
Moderate Analytic Budgeting and Responsibility Performance Measurement Application 1 hour X
CP24-1 24-5
business
Easy Ethics Budgeting and Responsibility Performance Measurement Analysis 20 min.
CP24-2 24-3 Service department charges Easy Analytic Budgeting and Responsibility Performance Measurement Analysis 15 min.
CP24-3 24-4 Evaluating divisional performance Moderate Analytic Budgeting and Responsibility Performance Measurement Evaluation 30 min.
CP24-5 24-4 Evaluating division performance Moderate Analytic Budgeting and Responsibility Performance Measurement Evaluation 45 min.