Cornerstones of cost management 3rd edition hansen mowen chapter 10

DECENTRALIZATION: RESPONSIBILITY ACCOUNTING, PERFORMANCE EVALUATION, AND TRANSFER PRICING CHAPTER 10 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use CHAPTER 10 OBJECTIVES 1 Define responsibility accounting, and describe the four types of responsibility centers 2 Explain why firms choose to decentralize 3 Compute and explain return on investment (ROI), residual income (RI), and economic value added (EVA) 4 Discuss methods of evaluating and rewarding managerial performance © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use CHAPTER 10 OBJECTIVES 4 Explain the role of transfer pricing in a decentralized firm 5 Discuss the methods of setting transfer prices © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use RESPONSIBILITY ACCOUNTING • Responsibility accounting: a system that measures the results of each responsibility center and compares those results with some measure of expected or budgeted outcome • Responsibility center: a part of the business whose manager is accountable for specified activities LO-1 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use RESPONSIBILITY ACCOUNTING Types of Responsibility Centers •Cost center: responsible only for costs •Revenue center: responsible only for revenues •Profit center: responsible for both revenues and costs •Investment center: responsible for revenues, costs, and investments LO-1 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use DECENTRALIZATION • Centralized decision making: decisions are made at the very top level and lower level managers are charged with implementing those decisions • Decentralized decision making: allows managers at lower levels to make and implement key decisions pertaining to their areas of responsibility LO-2 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use DECENTRALIZATION • Decentralization: practice of delegating decision making authority to the lower levels LO-2 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use DECENTRALIZATION Reasons for Decentralization •Better access to local information •Cognitive limitations •More timely response •Focusing of central management •Training and evaluation of segment managers •Motivation of segment managers •Enhanced competition LO-2 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use DECENTRALIZATION The Units of Decentralization •Decentralization is usually achieved by segmenting the company into divisions •Control of cost centers is achieved by evaluating the efficiency and the effectiveness of divisional managers • Efficiency means how well activities are performed • Effectiveness can be defined as whether the manager has performed the right activities LO-2 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use MEASURING THE PERFORMANCE OF INVESTMENT CENTERS Return on Investment •Return on Investment (ROI) is the most common measure of performance for an investment center ROI = Operating income / Average operating assets ROI = (Operating income/ Sales) × (Sales / Average operating assets) ROI = Operating income margin × Operating asset turnover LO-3 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use MEASURING AND REWARDING THE PERFORMANCE OF MANAGERS Noncash Compensation Noncash •Compensation is an important part of the management reward structure •Perquisites are also important LO-4 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use TRANSFER PRICING • Transfer prices are the prices charged for goods produced by one division and transferred to another • The price charged affects the revenues of the transferring division and the costs of the receiving division • Profitability, return on investment, and managerial performance evaluation of both divisions are affected by transfer pricing LO-5 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use EXHIBIT 10.1—IMPACT OF TRANSFER PRICE ON TRANSFERRING DIVISIONS AND THE COMPANY AS A WHOLE LO-5 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use SETTING TRANSFER PRICES • A transfer pricing system should satisfy three objectives • Accurate performance evaluation • Goal congruence • Preservation LO-6 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use SETTING TRANSFER PRICES • The opportunity cost approach identifies the minimum that a selling division would be willing to accept and the maximum price that the buying division would be willing to pay • Minimum transfer price (floor): the transfer price that would leave the selling division no worse off if the good is sold to an internal division • Maximum transfer price (ceiling): the transfer price that would leave the buying division no worse off it an input is purchased from an internal division LO-6 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use SETTING TRANSFER PRICES Market Price If there is an outside market for the good to be transferred and that outside market is perfectly competitive, the correct transfer price is the market price LO-6 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use SETTING TRANSFER PRICES Negotiated Transfer Prices •Advantages 1 Comply with the three criteria of goal congruence, autonomy, and accurate performance evaluation LO-6 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use SETTING TRANSFER PRICES Negotiated Transfer Prices •Disadvantages 1 One divisional manager with private information may take advantage of another divisional manager 2 Performance measures may be distorted by the negotiating skills of managers 3 Negotiation can consume considerable time and resources LO-6 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use EXHIBIT 10.2—SUMMARY OF SALES AND PRODUCTION DATA LO-6 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use EXHIBIT 10.3—COMPARATIVE INCOME STATEMENTS LO-6 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use EXHIBIT 10.4—COMPARATIVE STATEMENTS LO-6 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use SETTING TRANSFER PRICES Cost Based Transfer Prices •Full-cost transfer pricing •Full cost plus markup •Variable cost plus fixed fee LO-6 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use SETTING TRANSFER PRICES • The IRS accepts four transfer pricing policies • • • • Comparable uncontrolled price method Resale price method Cost-plus method Advanced pricing agreements (APAs) LO-6 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use EXHIBIT 10.5—USE OF TRANSFER PRICING TO AFFECT INCOME TAXES PAID LO-6 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use END OF CHAPTER 10 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use ... ACCOUNTING Types of Responsibility Centers ? ?Cost center: responsible only for costs •Revenue center: responsible only for revenues •Profit center: responsible for both revenues and costs •Investment... charged affects the revenues of the transferring division and the costs of the receiving division • Profitability, return on investment, and managerial performance evaluation of both divisions are affected... information •Cognitive limitations •More timely response •Focusing of central management •Training and evaluation of segment managers •Motivation of segment managers ãEnhanced competition LO-2 â 2014 Cengage