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12 Chapter Twelve

Responsibility Accounting
and Performance
Evaluation

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Why Responsibility Centers?

Large complex
businesses are
divided into
responsibility
centers enabling
managers to have
a smaller effective
span of control.

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Advantages of Decentralized Operations

1. Lower-level managers can react more quickly to

problems or changes in operations.
2. Lower-level managers are closer and more
responsive to the customer’s needs.
3. The operation provides a better training ground
for managers.
4. Delegation improves employee morale.
5. Top management is free to devote time to
strategic planning.

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Disadvantages of Decentralized Operations

1. Assets and operating costs are duplicated

(e.g., each division has its own
administrative staff).
2. Managers may pursue their own goals,
instead of company goals.

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Responsibility Centers
A subunit in an organization whose
manager is held accountable for
specified financial results.

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Responsibility Centers
Cost Center Revenue Center
Segment has Segment
control over is responsible
the for the revenue of
incurrence of
costs. a unit.

The Paint Department The Reservations

in an automobile plant. Department of an airline.
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Responsibility Centers
Profit Center Investment Center
Segment has Segment has
control over control over profits
both costs and invested
and revenues. capital.

Company-owned restaurant A division of a

in a fast-food chain. large corporation.
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Summary: Responsibility Centers

Cost Centers
Managers are held accountable for controlling
costs.
Profit Centers
Managers are held accountable for costs and
making decisions that impact revenues favorably.
Investment Centers
Managers are held accountable for costs and
revenues and are also held accountable for the
efficient use of assets.

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Measuring Management Performance

Evaluation Tool
Cost Cost
Center standards
Contribution
Profit
income
Center
statement
Rate of return
Investment on invested
Center funds or
residual income
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Performance Reports
Shows the budgeted and actual
amounts, and the variances
between these amounts, of key
financial results appropriate for
the type of responsibility center.

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Behavioral Effects of
Responsibility Accounting

Controllability

Information Motivating
versus Desired
Blame Behavior

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Linking Goals, Objectives, Measures

and Performance Targets
The links should be causal:
Goal  Objective  Measure  Performance
Target
To be a friend To reduce the Number of To recycle at
of the company’s products least 10% of
environment environmental recycled products sold
risk

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Discussion
Q. What does “an organization will get
what it measures” mean?

A. If performance measures (and incentives)

are based on specific objectives, managers
will be motivated to achieve the objectives
that are being measured.

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Segmented Reporting

A segment is any
part or activity of
an organization
about which a
manager seeks
cost, revenue, or
profit data. The Operating Section
of a hospital

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Segmented Reporting
Product
Lines
Cell Phone
Division •

Systems Personal

U.S. Sales Foreign Sales U.S. Sales Foreign Sales

•
Sales
Territories
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Key Features of Segmented

Reporting

Contribution format.
Controllable versus uncontrollable expenses.
Segmented income statement.

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Segmented Income Statement

Contribution Income Statement
Format Cell Phone
Division Systems Personal
Sales $ 300,000 $ 200,000 $ 100,000
Variable costs (150,000) (95,000) (55,000)
CM 150,000 105,000 45,000
Traceable FC (80,000) (45,000) (35,000)
Segment margin 70,000 60,000 10,000
Common costs 10,000
Net income $ 60,000

Costs that cannot be controlled by

the segment manager are isolated.
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Cost Center Responsibility Accounting

Budget Performance Report
Vice-President, Production
For the Month Ended October 31, 2003
Over Under
Budget Actual Budget Budget
Administration $ 19,500 $ 19,700 $ 200
Plant A 467,475 470,330 2,855
Plant B 395,225 394,300 $925
$882,200 $884,330 $3,550 $925

Each of the line items above will be

supported by a cost center report.

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Cost Center Responsibility Accounting

Budget Performance Report
Vice-President, Production
For the Month Ended October 31, 2003
Over Under
Budget Actual Budget Budget
Administration $ 19,500 $ 19,700 $ 200
Plant A 467,475 470,330 2,855
Plant B 395,225 394,300 $925
$882,200 $884,330 $3,550 $925

This is supported
by a cost center
report for Plant A.

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Cost Center Responsibility Accounting

Budget Performance Report
Manager, Plant A
For the Month Ended October 31, 2003
Over Under
Budget Actual Budget Budget
Administration $ 17,500 $ 17,350 $150
Department 1 109,725 111,280 $1,555
Department 2 190,500 192,600 2,100
Department 3 149,750 149,100 650
$467,475 $470,330 $3,655 $800

This is shown on the

production report.

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Cost Center Responsibility Accounting

Budget Performance Report
Manager, Plant A
For the Month Ended October 31, 2003
Over Under
Budget Actual Budget Budget
Administration $ 17,500 $ 17,350 $150
Department 1 109,725 111,280 $1,555
Department 2 190,500 192,600 2,100
Department 3 149,750 149,100 650
$467,475 $470,330 $3,655 $800

This is supported by
a cost center report
for Department 1.

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Cost Center Responsibility Accounting

Budget Performance Report
Supervisor, Department 1—Plant A
For the Month Ended October 31, 2003
Over Under
Budget Actual Budget Budget
Factory wages $ 58,100 $ 58,000 $150
Materials 32,500 34,225 $1,725
Supervisory salaries 6,400 6,400
Power and light 5,750 5,690 650
Depreciation 4,000 4,000
Maintenance 2,000 1,990 10
Insurance, taxes 975 975
$109,725 $111,280 $1,725 $170

This is shown on Plant A’s report.

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Profit Center Responsibility Accounting

Nova Entertainment Group
Divisional Income Statements
For the Year Ended December 31, 2003
Theme Movie
Park Production
Division Division
Revenues $6,000,000 $2,500,000
Operating expenses 2,495,000 405,000
Income from operations $3,505,000 $2,095,000

Income from operations before service department charges.

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Service Department Charges to Profit Centers

Nova Entertainment Group
Service Department Charges to NEG Divisions
For the Year Ended December 31, 2003
Theme Movie
Park Production
Service Department Division Division
Purchasing $250,000 $150,000
Payroll accounting 204,000 51,000
Legal 25,000 225,000
Total charges $479,000 $426,000

These costs are charged to the divisions based

on the activity base of the service department.

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Service Department Charges to Profit Centers

Nova Entertainment Group
Service Department Charges to NEG Divisions
For the Year Ended December 31, 2003
Theme Movie
Park Production
Service Department Division Division
Purchasing $250,000 $150,000
Payroll accounting 204,000 51,000
Legal 25,000 225,000
Total charges $479,000 $426,000

25,000 purchase requisitions x $10 per requisition = $250,000

15,000 purchase requisitions x $10 per requisition = $150,000

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Service Department Charges to Profit Centers

Nova Entertainment Group
Service Department Charges to NEG Divisions
For the Year Ended December 31, 2003
Theme Movie
Park Production
Service Department Division Division
Purchasing $250,000 $150,000
Payroll accounting 204,000 51,000
Legal 25,000 225,000
Total charges $479,000 $426,000

12,000 payroll checks x $17 per check = $204,000

3,000 payroll checks x $17 per check = $51,000

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Service Department Charges to Profit Centers

Nova Entertainment Group
Service Department Charges to NEG Divisions
For the Year Ended December 31, 2003
Theme Movie
Park Production
Service Department Division Division
Purchasing $250,000 $150,000
Payroll accounting 204,000 51,000
Legal 25,000 225,000
Total charges $479,000 $426,000

100 hours x $250 per hour = $25,000

900 hours x $250 per hour = $225,000

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Profit Center Responsibility Accounting
Nova Entertainment Group
Divisional Income Statements
For the Year Ended December 31, 2003
Theme Movie
Park Production
Revenues $6,000,000 $2,500,000
Operating expenses 2,495,000 405,000
Income from operations before
service department charges $3,505,000 $2,095,000
Less service dept. charges:
Purchasing $ 250,000 $ 150,000
Payroll accounting 204,000 51,000
Legal 25,000 225,000
Total service dept. charges $ 479,000 $ 426,000
Income from operations $3,026,000 $1,669,000

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Return on Investment (ROI)
Traditionally the most common performance measure

ROI

= Operating Income
Average Assets Invested

= Operating Income x Sales

Sales Average Assets Invested

= Profit Margin x Asset Turnover

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Investment Center Responsibility Accounting
DataLink Inc.
Divisional Income Statements
For the Year Ended December 31, 2003
Northern Central Southern
Division Division Division
Revenues $560,000 $672,000 $750,000
Operating expenses 336,000 470,400 562,500
Income from operations
before service dept. charges $224,000 $201,600 $187,500
Service department charges 154,000 117,600 112,500
Income from operations $ 70,000 $ 84,000 $ 75,000
Invested assets $350,000 $700,000 $500,000
Rate of return on investment 20% 12% 15%
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Investment Center Responsibility Accounting
Northern Central Southern
Profit Margin Division Division Division
Income from operations $ 70,000 $ 84,000 $ 75,000
Revenues (Sales) $560,000 $672,000 $750,000
Profit margin 12.5% 12.5% 10.0%
Investment Turnover
Revenues (Sales) $560,000 $672,000 $750,000
Invested assets $350,000 $700,000 $500,000
Investment turnover 1.6 .96 1.5
Rate of Return (ROI)
Income from operations $ 70,000 $ 84,000 $ 75,000
Invested assets $350,000 $700,000 $500,000
Rate of return on investment 20% 12% 15%

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Rate of Return on Investment

DataLink Inc.
Divisional Income Statements
For the Year Ended December 31, 2003

Northern Central Southern

Division Division Division
Profit margin 12.5% 12.5% 10.0%
Investment turnover x 1.6 x .96 x 1.5
Rate of return on investment 20% 12% 15%

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Residual Income
 The operating income earned above a minimum desired return on invested
assets.

Residual Income = Operating Income – (Desired ROI x Average Assets Invested)

 Residual income eliminates the possibility of missed income opportunities that

exist if ROI is used as a performance measure. BUT residual income does not
provide a meaningful comparison between investment centers of a different size
because residual income shows absolute dollars not a percentage.

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Economic Value Added – the shareholder

wealth created by an investment center.

Cost of Capital – the minimum desired rate of

return on an investment.

EVA = After Tax Operating Income

– [Cost of Capital x (Total Assets – Current
Liabilities)]

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Residual Income
DataLink Inc.
Divisional Income Statements
For the Year Ended December 31, 2003

Northern Central Southern

Division Division Division
Income from operations $ 70,000 $ 84,000 $ 75,000
Invested assets $350,000 $700,000 $500,000
Minimum desired return 10.0% 10.0% 10.0%
Minimum desired income $ 35,000 $ 70,000 $ 50,000
Residual income $ 35,000 $ 14,000 $ 25,000

How can Northern Division have the highest residual income

when they have the lowest income from operations?

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Activity-Based Responsibility
Accounting
Traditional responsibility-accounting systems
tend to focus on the financial performance
measures of cost, revenue, and profit for
subunits of the organization.

Activity-based costing systems associate costs

with the activities that drive those costs. In
activity-based responsibility accounting
attention is directed not only to costs incurred
but also to the activity creating the cost.
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Nonfinancial Performance Measurement

Nonfinancial performance measures combined

with conventional financial measures provide a
balanced performance perspective.
1. Measures of product quality
2. Customer complaints and warranty experience
3. Customer satisfaction and retention rates
4. Product availability and on-time performance
5. New product time to market and market share

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Discussion
Q. Why should multiple performance
measures be used to evaluate
investment center performance?

A. Because any one performance measure

tends to emphasize only one particular
aspect of performance.

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Transfer Prices

The amount charged when one division sells

goods or services to another division.

Batteries

Battery Division Auto Division

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Transfer Prices

The transfer price affects the profit measure

for both buying and selling divisions.

A higher transfer
price for batteries
means . . .

. . . greater
Battery Division profits for the Auto Division
Battery Division.
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Transfer Prices

The transfer price affects the profit measure

for both buying and selling divisions.

A higher transfer
price for batteries
means . . .

. . . lower
Battery Division profits for the Auto Division
Auto Division.
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Benefits of Transfer Pricing

1. Divisions can be evaluated as profit or

investment centers.
2. Divisions are forced to control costs and
operate competitively.
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.

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Commonly Used Transfer Prices
1. Market price approach sets the price at which the
product transferred could be sold to outside buyers.
2. Negotiated price approach allows decentralized
managers to agree (negotiate) among themselves.
3. Cost price approach uses a variety of cost concepts
for setting the transfer price.

Commonly Used Transfer Prices

Variable Cost Full Cost Market Price

per Unit $10 per Unit $13 per Unit $20

Negotiated Price

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Transfer Prices
When the external
market value of goods
transferred is unavailable . . .

Negotiated Cost-plus
transfer transfer
price price

Transfer prices have no direct effect upon

the company’s overall net income.
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Transfer Pricing—Negotiated Price Approach
Assumptions
1. Division M produces a product with a variable cost
of $10 per unit. Division M has unused capacity.
2. Division N purchases 20,000 units of the same
product at $20 per unit from an outside source.
Variable Cost Market Price
per Unit $10 per Unit $20
Negotiated Price

If the division managers agree on a

price of $18 per unit, how much will
Division M each division’s income increase? Division N
How much for the overall company?

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International Transfer Price(s)

Price: ?
Cost:?
sing Tax: 0%
EAT:…

?
indonesia USA

Price: Rp20.000 Price: Rp40.000

Cost:Rp15.000 Cost:Rp25.000
Tax:10% Tax:5%
EAT:Rp4.500 EAT:Rp14.250

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Power Notes
Performance Evaluation for Decentralized Operations

This is the last slide

Note: To see the topic slide, type 2 and press Enter.

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