Chapter 11
Lecture Notes
Chapter theme: Managers in large organizations have to
delegate some decisions to those who are at lower levels in
I. Decentralization in organizations
A. A decentralized organization does not confine
decision-making authority to a few top executives;
disadvantages of decentralization are as follows:
i. Advantages of decentralization
1. It enables top management to concentrate
on strategy, higher-level decision making,
and coordinating activities.
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ii. 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
3. Lower-level managers may have objectives
that differ from those of the entire
organization.
a. This problem can be reduced by
II. Responsibility accounting
A. Responsibility accounting systems link lower-level
managers’ decision-making authority with
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i. Cost center
1. The manager of a cost center has control
over costs, but not over revenue or
investment funds.
a. Service departments such as
accounting, general administration,
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ii. Profit center
1. The manager of a profit center has control
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iii. Investment center
1. The manager of an investment center has
control over cost, revenue, and
investments in operating assets.
a. Investment center managers are
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investment (ROI) or residual income,
as discussed later in this chapter.
III. Evaluating investment center performance – return on
investment
A. Key concepts/definitions
i. Investment center performance is often
evaluated using a measure called return on
investment (ROI), which is defined as
follows:
ii. 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.
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iii. Net book value versus gross cost
1. Most companies use the net book value
(i.e., acquisition cost less accumulated
depreciation) of depreciable assets to
2. An alternative to net book value is the gross
cost of the asset, which ignores
accumulated depreciation.
a. With this approach, ROI does not grow
B. Understanding ROI
i. Du Pont pioneered the use of ROI and
recognized the importance of looking at the
components of ROI, namely margin and
turnover.
2. 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.
ii. To illustrate how to increase ROI, assume that
Regal Company reports the results shown:
1. Given this information, its current ROI is
15%.
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C. Criticisms of ROI
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1. This is why ROI is best used as part of a
balanced scorecard.
Helpful Hint: When discussing the criticisms of ROI
and other measures of profitability, ask students to play
the role of a manager who anticipates a short tenure.
This manager will want to increase ROI as quickly as
possible. Ask students to list the activities that could be
undertaken to increase ROI that, in reality, would hurt
the company as a whole.
IV. Residual income
B. Calculating residual income
i. The equation for computing residual income is
as shown. Notice:
ii. Zepher, Inc. – an example
1. Assume the information as given for a
division of Zepher, Inc.
2. The residual income ($10,000) is computed
by subtracting the minimum required return
($20,000) from the actual income ($30,000).
C. Motivation and residual income
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Quick Check – ROI versus residual income
D. Divisional comparison and residual income
ii. Zepher, Inc. – continued
1. Recall that the Retail Division of Zepher had
average operating assets of $100,000, a
minimum required rate of return of 20%, net
operating income of $30,000, and residual
income of $10,000.
2. Assume that the Wholesale Division of
Zepher had average operating assets of
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simply because it is a bigger
division.
V. Operating performance measures
A. Key definitions/concepts
i. Delivery cycle time is the elapsed time from when
a customer order is received to when the completed
order is shipped.
ii. Throughput (manufacturing cycle) time is the
amount of time required to turn raw materials into
completed products.
Quick Check – internal business process measures
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VI. Balanced scorecard
Learning Objective 4: Understand how to construct and
use a balanced scorecard.
A. Key concepts
ii. The balanced scorecard enables top management to
translate its strategy into four groups of
performance measures – financial, customer,
internal business process, and learning and
growth − that employees can understand and
influence.
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iii. The balance scorecard relies on non-financial
measures in addition to financial measures for two
reasons:
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iv. While the entire organization has an overall
balanced scorecard, each responsible individual
should have his or her own personal scorecard as
well.
v. A balanced scorecard, whether for an individual or
the company as a whole, should have measures that
are linked together on a cause-and-effect basis.
1. Each link can be read as a hypothesis in the
form “If we improve this performance