Chapter 22 Decentralization and Performance Evaluation

Chapter 22 Decentralization and Performance Evaluation

Related Assignment Materials

Student Learning Objectives Discussion Questions Quick Studies* 22-1 22-1 22-1, 22-2 22-1 22-1, 22-2, 22-3, 22-5 22-6 22-1 22-4 RIA, BW, CIP Exercises* Problems* Beyond the Numbers TIA TIA

Conceptual objectives: C1. Explain departmentalization 1 and the role of departmental accounting. C2. Distinguish between direct and indirect expenses. C3. Identify bases for allocating indirect expenses to departments. C4. Explain controllable costs and 2, 3, 4, responsibility accounting. 5, 6, 10, 11, 15, 16 C5. Explain transfer pricing and 12 methods to set transfer prices. C6. Describe allocation of joint 7, 8, 13, 14 costs across products. Analytical objectives: A1. Analyze investment centers 9 using return on assets, residual income, and balanced scorecard. A2. Analyze investment centers using profit margin and investment turnover. Procedural objectives: P1. Prepare departmental income statements.

22-13, 22-14 22-11 22-8, 22-15 22-12, 22-13 22-5 22-1, 22-7 22-7, 22-8, 22-8, 22-9 22-9, 22-10 22-10, 22-11 22-12 22-9, 22-10 22-9 CIP TTN

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CA, EC, CIP, HTR, ED

P2. Prepare departmental 22-6 22-2, 22-4 contribution reports. *See additional information on next page that pertains to these quick studies, exercises and problems.

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Chapter 22 decentralization and Performance evaluation

Additional Information on Related Assignment Material

Assignment materials that can be completed by students using: Excel templates Problems 22-1A and 22-3A McGraw-Hills Homework Manager All of the Quick Studies, all of the Exercises, and Problems in set A.

Synopsis of Chapter Revision

RockBottomGolf.com NEW opener with new entrepreneurial assignment Enhanced explanation of evaluating investment center performance with financial measures New discussion of residual income Added explanation of economic value added New section on evaluating investment center performance with nonfinancial measures including balanced scorecard New Appendix 22A on transfer pricing Decision Analysis: new explanation of investment center profit margin and investment turnover with new assignments

PowerPoint Show Slides

Chapter Outline Section I. II. III. IV. V. Departmental Accounting and Evaluation Departmental Expense Allocation Financial Performance Evaluation Measures Responsibility Accounting Investment Center Analysis PowerPoint Slides Slides 22-5 through 22-9 22-10 through 22-24 22-25 though 22-27 22-28 through 22-34 22-35 through 22-37

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Chapter 22 Decentralization and Performance Evaluation

Chapter Outline
I. Departmental Accountingdivide company into subunits (or divisions) when too large. Divisions are organized into separate departments. A. Motivation for Departmentalization 1. Each department placed under direction of a manager. 2. Takes advantage of diversified skills managers possess. 3. Promotes efficiency and effectiveness as company grows. B. Departmental Evaluation 1. Prepared for internal managers to help control operations, appraise performance, allocate resources, and plan strategy. 2. Many companies emphasize customer satisfaction as main responsibility of each operating department. 3. Financial information used for evaluation depends on type of center. a. Profit centerincurs costs and generates revenues (e.g. selling department). b. Cost centerincurs cost or expenses without directly generating revenues (e.g. manufacturing department). C. Departmental Reporting and Analysis 1. Information needed depends on focus and philosophy of management. 2. Departmental Spreadsheet Analysisused when separate accounts not maintained in general ledger by department.

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Chapter 22 decentralization and Performance evaluation

Chapter Outline
a. Record sales, sales returns, purchases, purchase returns in general ledger as if company not departmentalized. b. Identify each departments transactions and enter on spreadsheet; spreadsheet totals equal balance of related account. c. Compute gross profit by department. Departmental Expense Allocationaccounting challenges involve allocating expenses across operating departments. A. Direct Expensesreadily traced to department because incurred for sole benefit of department; no allocation required. B. Indirect Expensesare: 1. Incurred for joint benefit of more than one department; cant be readily traced to one department. 2. Allocated across departments benefiting from them. 3. Ideally allocated using a cause-effect relation or, if causeeffect relation cannot be identified, allocated on a basis approximating the benefit received by each department. C. Allocation of Indirect Expensesno standard rule identifies the best basis; judgment required. 1. Wages and salaries: a. Direct expense if time spent entirely in one department; otherwise indirect. b. Bases for allocating when indirect: i. Employeesrelative amount of time spent in each department. ii. Supervisorsnumber of employees (if task is managing) or sales (if job reflects on departments sales). 2. Rent and related expensesportion of floor space occupied. More valuable location may charge department higher rate. 3. AdvertisingDepartmental portion of total sales, or by newspaper space or TV/radio time devoted to products of each department. 4. Equipment and machinery depreciationrelative number of hours used by each department. 5. Utilitiesportion of floor space occupied by departments (if used uniformly); otherwise more complicated. 6. Service department expensessee Exhibit 22.2 for common allocation bases.

Notes

III.

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Chapter 22 Decentralization and Performance Evaluation

Chapter Outline
D. Departmental Income Statements 1. Departmental income statements are prepared after all expenses have been assigned to the departments. a. Direct expenses are accumulated by department. b. Indirect expenses full amount of expenses incurred in service departments compiled, then allocated to operating department. 2. Four Steps to allocating costs and preparing departmental Income statements. a. Step one accumulate direct expenses for each service and selling department. b. Step two allocate indirect expenses across all departments using allocation base identified for each expense. c. Step threeallocate expenses of service departments to operating departmentsdepartmental expense allocation spreadsheet may be used. d. Step four ---use departmental expense allocation to prepare departmental income statement. E. Departmental Contribution to Overhead 1. Departmental income statements not always best for evaluating each departments performance (especially when departments expenses are mostly indirect). 2. Evaluate using departmental contributions to overheada report of the amount of sales less direct expenses (indirect expenses are often considered overhead). Evaluating Investment Center Performance -financial and nonfinancial measures of investment center performance. A. Investment center return on total assets B. Investment center residual income C. Balanced scorecard Responsibility Accountingevaluates a managers performance using reports that describe a departments activities in terms of controllable costs. A. Controllable versus Direct Costs direct costs are readily traced to department, but may not be under control of department manager; cost is controllable if manager has power to determine (or at least strongly affect) amount incurred. All costs are controllable at some level of management if the time period is sufficiently long; judgment is required. B. Responsibility Accounting System 1. Responsibility accounting system assigns managers the responsibility for costs and expenses under their control. 2. Responsibility accounting performance reports

Notes

III.

IV.

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Chapter 22 decentralization and Performance evaluation

Chapter Outline
a. Accumulates and reports costs a manager is responsible for and their budgeted amounts. b. Managements analysis of differences between actual and budget often results in corrective actions. c. Used by upper management to evaluate effectiveness of lower-level managers in controlling costs. Transfer Pricing (Appendix 22A) Transfer pricing determines the price that should be used to record transfers between divisions in the same company. 1. No Excess Capacity-a market-based transfer price is preferred. 2. Excess Capacity-a cost-based transfer price is preferred. Joint Costs and Their Allocation (Appendix 22B) Costs incurred to produce or purchase two or more products at the same time; similar to indirect expense in that its shared across more than one cost object. 1. Ignored when deciding to sell product as is or process further. 2. Allocated to different products produced from it when total cost of each product must be estimated (e.g., preparation of GAAP financial statements). 3. Allocation bases a. Physical basisallocates joint costs using physical characteristics such as ratio of pounds, cubic feet or gallons of each joint product to the total pounds, cubic feet or gallons of all joint products flowing from the cost; not the preferred method. b. Value basisallocates joint cost in proportion to the sales value of the output produced by the process at the splitoff point.

Notes

V.

VI.

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Alternate Demo Problem Jack and Susan Roberts own a farm that produces potatoes. Based on a review of the income statement shown below, Jack remarked that they should have fed the No. 3 potatoes to the pigs; then they would have avoided the loss from the sale of the those potatoes. JACK AND SUSAN ROBERTS Income from the Production and Sale of Potatoes For Year Ended December 31, 2009 No. 1 Sales by grades: No. 1, 300,000 lbs. $0.045 per lb. No. 2, 500,000 lbs. $0.04 per lb. No. 3, 200,000 lbs. $0.03 per lb. Combined Costs: Land preparation, seed, planting, cultivating @ $0.01422 per lb. Harvesting, sorting, grading @ $0.01185 per lb. Marketing @ $0.00415 per lb. Total costs Net income (or loss) $13,500 $20,000 $6,000 $39,500 4,266 7,110 2,844 14,220 11,850 4,150 30,220 $ 9,280 Results by Grade No. 2 No. 3 Combined

3,555 5,925 2,370 1,245 2,075 830 9,066 15,110 6,044 $ 4,434 $ 4,890 $ (44)

Jack and Susan divided their costs among the grades on a per pound basis, because their records do not show cost per grade. However, their records did show that $4,020 of the $4,150 of marketing costs represented the cost of placing the No. 1 and No. 2 potatoes in bags and hauling them to the warehouse of the produce buyer. Bagging and hauling costs were the same for both grades. The remaining $130 represented the cost of loading the No. 3 potatoes into the trucks of the potato starch factory that bought these potatoes in bulk and picked them up at the farm. Required: Prepare an income statement that will better show the results of producing and marketing each of the grades of potatoes.

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Solution: Alternate Demo Problem JACK AND SUSAN ROBERTS Income from the Production and Sale of Potatoes For Year Ended December 31, 2009 Results by Grade No. 1 No. 2 No. 3 Combined $13,500 $20,000 $6,000 $39,500 4,860 7,200 2,160 4,050 6,000 1,800 1,620 2,400 130 10,530 15,600 4,090 $ 2,970 $ 4,400 $1,910 14,220 11,850 4,150 30,220 $ 9,280

Revenue from sales: Costs: Land preparation, seed, planting, cultivating Harvesting, sorting, grading Marketing Total costs Net income

COST ALLOCATIONS Land preparation, seed, planting, and cultivating: No. 1: $13,500 / $39,500 x $14,220 = No. 2: $20,000 / $39,500 x $14,220 = No. 3: $ 6,000 / $39,500 x $14,220 = Harvesting, sorting, and grading: No. 1: $13,500 / $39,500 x $11,850 = No. 2: $20,000 / $39,500 x $11,850 = No. 3: $ 6,000 / $39,500 x $11,850 = Marketing: No. 1: $13,500 / $33,500 x $4,020 = No. 2: $20,000 / $33,500 x $4,020 = Subtotal bagging and hauling costs No. 3: Loading costs

$ 4,860 7,200 2,160 $14,220 $ 4,050 6,000 1,800 $11,850 $1,620 2,400 4,020 130 $4,150

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