Chapter 24
Responsibility Accounting and Performance Evaluation
Review Questions
1. Explain the difference between a centralized company and a decentralized company.
In a small company, the owner or top manager often makes all planning and controlling decisions.
2. List the advantages of decentralization.
The advantages of decentralization include the freeing of top management’s time, supporting use of
3. List the disadvantages of decentralization.
The disadvantages of decentralization include duplication of costs and problems achieving goal
congruence.
4. What is goal congruence?
5. Usually, which outweighs the other in decentralization—advantages or disadvantages?
The advantages of decentralization usually outweigh the disadvantages.
6. What is the purpose of a responsibility accounting system?
The purpose of the responsibility accounting system is to provide relevant information to managers
7. What is a responsibility center?
A responsibility center is a part of the organization for which a manager has decision-making
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8. List the four types of responsibility centers, and briefly describe each.
The four types of responsibility centers are cost center, revenue center, profit center and investment
center.
9. What is a performance evaluation system?
10. What are the goals of a performance evaluation system?
11. Explain the difference between a lag indicator and a lead indicator.
A lag indicator is a performance measure that indicates past performance. A lead indicator forecasts
future performance.
12. How is the use of a balanced scorecard as a performance evaluation system helpful to companies?
The balanced scorecard represents a major shift in corporate performance measurement. Rather than
13. What is a key performance indicator?
14. What are the four perspectives of the balanced scorecard? Briefly describe each.
The four perspectives of the balance scorecard are financial, customer, internal business, and
learning and growth.
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15. Explain the difference between a controllable and a noncontrollable cost.
16. What is the typical focus of responsibility reports for cost centers, revenue centers, and profit
centers?
Cost center responsibility reports typically focus on the flexible budget variance—the difference
17. What are two key performance indicators used to evaluate investment centers?
18. Describe the two ways ROI can be calculated.
Return on investment can be calculated by dividing operating income by average total assets. The
19. What does ROI measure?
ROI measures profitability and efficiency.
20. What is the biggest disadvantage of using ROI to evaluate investment centers?
ROI has one major drawback. Evaluating division managers based solely on ROI gives them an
21. How is RI calculated?
22. What does RI measure?
RI measures the division’s profitability and the efficiency with which the division uses its average
23. What is the biggest advantage of using RI to evaluate investment centers?
RI is more likely to lead to goal congruence than ROI.
24. What are some limitations of financial performance measures?
25. What is a transfer price?
The transfer price is the transaction amount of one unit of goods when the transaction occurs
between divisions within the same company.
26. Explain the difference between market-based transfer prices and cost-based transfer prices.
27. How does capacity affect transfer pricing decisions?
If the division is operating at capacity, it has a choice of who to sell to––customers outside the
Short Exercises
S24-1 Explaining decentralization
Learning Objective 1
Decentralization divides company operations into various reporting units. Most decentralized subunits
can be described as one of four different types of responsibility centers.
Requirements
1. Explain why companies decentralize. Describe some typical methods of decentralization.
2. List the four most common types of responsibility centers, and describe their responsibilities.
SOLUTION
Requirement 1
When a company grows, it is impossible for a single person to manage the entire organization’s daily
Requirement 2
Responsibility
Center
Manager’s Responsibility
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S24-2 Classifying responsibility centers
Learning Objective 1
Each of the following managers works for a national chain of hotels and has been given certain decision-
making authority. Classify each of the managers according to the type of responsibility center he or she
manages.
a. Manager of the Central Reservation Office
b. Managers of various corporate-owned hotel locations
c. Manager of the H1 Corporate Division
d. Manager of the Housekeeping Department at one hotel
e. Manager of the H2 Corporate Division
f. Manager of the complimentary breakfast buffet at one hotel
SOLUTION
Manager
Responsibility Center
Revenue center
Profit center
Investment center
Cost center
Investment center
Cost center
S24-3 Explaining why companies use performance evaluation systems
Learning Objective 2
Well-designed performance evaluation systems accomplish many goals. Consider the following actions,
and state which goal is being achieved by the action:
a. Comparing targets to actual results
b. Providing subunit managers with performance targets
c. Comparing actual results with industry standards
d. Providing bonuses to subunit managers who achieve performance targets
e. Aligning subunit performance targets with company strategy
f. Comparing actual results of competitors
g. Taking corrective actions
h. Using the adage “you get what you measure” when designing the performance evaluation system
SOLUTION
Action
a.
c.
e.
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S24-4 Describing the balanced scorecard and identifying key performance indicators for each
perspective
Learning Objective 2
Consider the following key performance indicators, and classify each according to the balanced
scorecard perspective it addresses. Choose from financial perspective, customer perspective, internal
business perspective, or learning and growth perspective.
a. Number of employee suggestions implemented
b. Revenue growth
c. Number of on-time deliveries
d. Percentage of sales force with access to real-time inventory levels
e. Customer satisfaction ratings
f. Number of defects found during manufacturing
g. Number of warranty claims
h. Return on investment
i. Variable cost per unit
j. Percentage of market share
k. Number of hours of employee training
l. Number of new products developed
m. Yield rate (number of units produced per hour)
n. Average repair time
o. Employee satisfaction
p. Number of repeat customers
SOLUTION
Key Performance Indicator
Perspective
a. Number of employee suggestions implemented
Learning and growth
Financial
c. Number of on time deliveries
Customer
Learning and growth
e. Customer satisfaction ratings
Customer
Internal business
Internal business
Financial
Financial
Customer
Learning and growth
Internal business
Internal business
Internal business
Learning and growth
Customer
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S24-5 Using performance reports to evaluate cost, revenue, and profit centers
Learning Objective 3
Management by exception is a term often used in performance evaluation. Describe management by
exception and how it is used in the evaluation of cost, revenue, and profit centers.
SOLUTION
Managers use management by exception to determine which variances in the performance report are
S24-6 Evaluating investment centers
Learning Objective 4
Consider the following data, and determine which of the corporate divisions is more profitable. Explain
your reasoning.
SOLUTION
ROI
=
Operating income
Average total assets
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S24-7 Using ROI and RI to evaluate investment centers
Learning Objective 4
Accel Sports Company makes snowboards, downhill skis, cross-country skis, skateboards, surfboards,
and inline skates. The company has found it beneficial to split operations into two divisions based on the
climate required for the sport: Snow Sports and Non-snow Sports. The following divisional information
is available for the past year:
Accel’s management has specified a 15% target rate of return. Calculate each division’s profit margin
ratio. Interpret your results.
SOLUTION
Profit margin ratio
=
Operating income
Net sales
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Note: Short Exercise S24-7 must be completed before attempting Short Exercise S24-8.
S24-8 Using ROI and RI to evaluate investment centers
Learning Objective 4
Refer to the information in Short Exercise S24-7.
Requirements
1. Compute each division’s asset turnover ratio (round to two decimal places). Interpret your results.
2. Use your answers to Requirement 1, along with the profit margin ratio, to recalculate ROI using the
expanded formula. Do your answers agree with the basic ROI in Short Exercise S24-7?
SOLUTION
Requirement 1
Asset turnover ratio
=
Net sales
Average total assets
=
Requirement 2
Profit
margin ratio
×
Asset
turnover ratio
=
ROI
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Note: Short Exercise S24-7 must be completed before attempting Short Exercise S24-9.
S24-9 Using ROI and RI to evaluate investment centers
Learning Objective 4
Refer to the information in Short Exercise S24-7. Compute each division’s RI. Interpret your results.
Are your results consistent with each division’s ROI?
SOLUTION
RI
=
Operating income
–
(Target rate of return × Average total assets)
–
–
–
–
S24-10 Transfer pricing
Learning Objective 5
Henderson Company manufactures electronics. The Calculator Division (an investment center)
manufactures handheld calculators. The division can purchase the batteries used in the calculators from
the Battery Division (another investment center) or from an outside vendor. The cost to purchase
batteries from the outside vendor is $5. The transfer price to purchase from the Battery Division is $6.
The Battery Division also sells to outside customers. The sales price is $6, and the variable cost is $3.
The Battery Division has excess capacity.
Requirements
1. Should the Calculator Division purchase from the Battery Division or the outside vendor?
2. If Henderson Company allows division managers to negotiate transfer prices, what is the maximum
transfer price the manager of the Calculator Division should consider?
3. What is the minimum transfer price the manager of the Battery Division should consider?
4. Does your answer to Requirement 3 change if the Battery Division is operating at capacity?
SOLUTION
Requirement 1
Requirement 2
Requirement 3
The minimum transfer price the Battery Division should consider is $3.00, its variable cost.
Requirement 4
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Exercises
E24-11 Identifying responsibility centers after decentralization
Learning Objective 1
Grandpa Jim’s Cookie Company sells homemade cookies made with organic ingredients. His sales are
strictly Web based. The business is taking off more than Grandpa Jim ever expected, with orders coming
from across the country from both consumers and corporate event planners. Grandpa decides to
decentralize and hires a full-time baker who will manage production and product costs and a Web site
designer/sales manager who will focus on increasing sales through the Web site. Grandpa Jim can no
longer handle the business on his own, so he hires a business manager to work with the other employees
to ensure the company is best utilizing its assets to produce profit. Grandpa will then have time to focus
on new product development.
Now that Grandpa Jim’s Cookie Company has decentralized, identify the type of responsibility center
that each manager is managing.
SOLUTION
Manager
Responsibility Center
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E24-12 Explaining why companies use performance evaluation systems
Learning Objective 2
Financial performance is measured in many ways.
Requirements
1. Explain the difference between lag and lead indicators.
2. The following is a list of financial measures. Indicate whether each is a lag or a lead indicator:
a. Income statement shows net income of $100,000
b. Listing of next week’s orders of $50,000
c. Trend showing that average hits on the redesigned Web site are increasing at 5% per week
d. Price sheet from vendor reflecting that cost per pound of sugar for the next month is $2
e. Contract signed last month with large retail store that guarantees a minimum shelf space for
Grandpa’s Overloaded Chocolate Cookies for the next year
SOLUTION
Requirement 1
A lag indicator is a performance measure that indicates past performance. A lead indicator forecasts
Requirement 2
Financial Measures
Indicator
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E24-13 Explaining why companies use performance evaluation systems
Learning Objective 2
Well-designed performance evaluation systems accomplish many goals. Describe the potential benefits
performance evaluation systems offer.
SOLUTION
Well-designed performance evaluation systems offer companies many benefits. Management uses
E24-14 Describing the balanced scorecard and identifying key performance indicators for each
perspective
Learning Objective 2
Consider the following key performance indicators, and classify each indicator according to the
balanced scorecard perspective it addresses. Choose from the financial perspective, customer
perspective, internal business perspective, and the learning and growth perspective.
SOLUTION
Key Performance Indicator
Perspective
a. Number of customer complaints
Customer
b. Number of information system upgrades completed
Learning and growth
c. Residual income
Financial
d. New product development time
Internal business
e. Employee turnover rate
Learning and growth
Internal business
g. Customer retention
Customer
h. Percentage of compensation based on performance
Learning and growth
Internal business/Customer
Financial
Learning and growth
Internal business
n. Earnings growth
Financial
o. Average machine setup time
Internal businesses
p. Number of new customers
Customer
q. Employee promotion rate
Learning and growth
Financial
Customer
Internal business
u. Finished products per day per employee
Internal business
v. Percentage of employees with access to upgraded system
Learning and growth
Internal business
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E24-15 Using responsibility reports to evaluate cost, revenue, and profit centers
Learning Objective 3
1. Direct Materials 8.05% U
(Requirement 1 only)
One subunit of Xtreme Sports Company had the following financial results last month:
Requirements
1. Complete the performance evaluation report for this subunit. Enter the variance percent as a
percentage rounded to two decimal places.
2. Based on the data presented, what type of responsibility center is this subunit?
3. Which items should be investigated if part of management’s decision criteria is to investigate all
variances exceeding $2,500 or 10%?
4. Should only unfavorable variances be investigated? Explain.
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SOLUTION
Requirement 1
Xtreme-Subunit X
Actual
Flexible
Budget
Flexible
Budget
Variance
(F or U)
% Variance
(F or U)
Requirement 2
Based on the data presented, the responsibility center is a cost center.
Requirement 3
Requirement 4
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E24-16 Using responsibility reports to evaluate cost, revenue, and profit centers
Learning Objective 3
The accountant for a subunit of Accel Sports Company went on vacation before completing the
subunit’s monthly responsibility report. This is as far as she got:
Requirements
1. Complete the responsibility report for this subunit.
2. Based on the data presented, what type of responsibility center is this subunit?
3. Which items should be investigated if part of management’s decision criteria is to investigate all
variances exceeding $10,000?
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SOLUTION
Requirement 1
Accel—
Subunit X
Revenue by
Product
Actual
Results
Flexible
Budget
Variance
Flexible
Budget
Sales
Volume
Variance
Static
Budget
Downhill-RI
$ 323,000
(a) $ 5,000 F
(b) $ 318,000
$ 20,000 F
$ 298,000
Downhill-RII
(c) 12,000 U
Cross-EXI
Cross-EXII
Snow-LXI
(g) 422,000
Total
(i) $ 1,000 F
(j) $1,434,000
$ 1,414,500
$323,000 – $318,000 [from (b)]
F
$20,000 + $298,000
$152,000 – $164,000
U
$164,000 – $147,000
F
$282,000 – $300,000
U
$253,000 – $248,000
F
$426,000 – $4,000
$422,000 [from (g)] – $405,000
F
Net of the column
F
Sum of the column
1,434,000
Net of the column
F
Requirement 2
The responsibility center for the subunit is a revenue center.
Requirement 3