Chapter 18

Organizational Design, Responsibility Accounting, and

Evaluation of Divisional Performance

Most organizations are divided into smaller units, divisions, segments, business units, work centers, or departments

Most organizations are divided into smaller units, divisions, segments, business units, work centers, or departments

Goal CongruenceGoal Congruence, between units, occurs when the managers of subunits

throughout the organization have incentives to perform in the common

interest of the organization

Goal CongruenceGoal Congruence, between units, occurs when the managers of subunits

throughout the organization have incentives to perform in the common

interest of the organization

BEHAVIORAL CONGRUENCEPerformance evaluation and incentivesystems are designed to encourage

employees to behave as if their goals are congruent with organizational goals

BEHAVIORAL CONGRUENCEPerformance evaluation and incentivesystems are designed to encourage

employees to behave as if their goals are congruent with organizational goals

Decentralized Organizations And Responsibility Accounting

She seems like a team player, but

I’m not sure.

Goal Congruenc

e

Goal Congruenc

e

Behavioral Congruenc

e

Behavioral Congruenc

e

Responsibility Accounting

Various concepts and tools used to measure the

performance of people and the departments in order to foster goal or behavioral congruence

Responsibility Accounting

Various concepts and tools used to measure the

performance of people and the departments in order to foster goal or behavioral congruence

Decentralized Organizations And Responsibility Accounting

CentralizedOrganizations

CentralizedOrganizations

DecentralizedOrganizations

DecentralizedOrganizations

Decisions are handed down from the top

echelon of management and

subordinates carry them out

Decisions are handed down from the top

echelon of management and

subordinates carry them out

Decisions are made at divisional and

departmental levels

Decisions are made at divisional and

departmental levels

Centralization Vs. Decentralization

CostsCosts

Benefits And Costs Of A Decentralized Organization

Benefits• Managers = Specialists• Decision Making Autonomy

= Managerial Training• Decision Making Authority =

Greater Motivation• Delegating = Time Relief• Empowering Employees =

Knowledge & Expertise• Delegating = Timely

Responses to Opportunities & Problems

Benefits• Managers = Specialists• Decision Making Autonomy

= Managerial Training• Decision Making Authority =

Greater Motivation• Delegating = Time Relief• Empowering Employees =

Knowledge & Expertise• Delegating = Timely

Responses to Opportunities & Problems

??Costs

• Managers’ narrow focus is not consistent with organization’s overall goals (suboptimal decision making)

• Narrow Focus = Tendency to ignore the consequences of actions on other units

• Some tasks or services may be duplicated unnecessarily

Costs• Managers’ narrow focus is

not consistent with organization’s overall goals (suboptimal decision making)

• Narrow Focus = Tendency to ignore the consequences of actions on other units

• Some tasks or services may be duplicated unnecessarily

A RESPONSIBILITY CENTER is a subunit in an organization whose manager is held accountable for specified financial and n

onfinancial results of the subunit’s activities

A RESPONSIBILITY CENTER is a subunit in an organization whose manager is held accountable for specified financial and n

onfinancial results of the subunit’s activities

RESPONSIBILITYCENTERS

RESPONSIBILITYCENTERS

Cost CenterCost

Center

Discretionary Cost

Center

Discretionary Cost

CenterRevenue

CenterRevenue

Center

ProfitCenterProfit

Center

Investment Center

Investment Center

Responsibility Accounting

Cost CenterCost

Center

Discretionary Cost Center

Discretionary Cost Center

Revenue Center

Revenue Center

ProfitCenterProfit

Center

Investment Center

Investment Center

• well-defined input-output relationships• the manager is responsible for the cost of activities

• well-defined input-output relationships• the manager is responsible for the cost of activities

• input-output relationships are not well specified• the manager is responsible for the cost of activities• input-output relationships are not well specified

• the manager is responsible for the cost of activities

• the manager is responsible for the revenue of the subunit

• the manager is responsible for the revenue of the subunit

• the manager is responsible for the subunit’s profit • the manager is responsible for the subunit’s profit

• the manager is responsible for the profit and theinvested capital used to generate the profit

• the manager is responsible for the profit and theinvested capital used to generate the profit

Responsibility Accounting

Responsibility Accounting

A performance report shows the budgeted and actual amounts of key financial results appropriate for the

type of responsibility involved.

A performance report shows the budgeted and actual amounts of key financial results appropriate for the

type of responsibility involved.

BUDGETED amountsof key financial

results

BUDGETED amountsof key financial

results

ACTUAL amountsof key financial

results

ACTUAL amountsof key financial

results

VARIANCEVARIANCE

Performance Report

Focus on the financial performance measures of cost, revenues, and profit for the subunits

of the organization

Focus on the financial performance measures of cost, revenues, and profit for the subunits

of the organization

Activity-based responsibility systems focus not only on the

cost of performing activities but on the

activities themselves

Activity-based responsibility systems focus not only on the

cost of performing activities but on the

activities themselves

Activity-Based ResponsibilityAccounting

Mail Order Division

Koala Camp Gear Division Retail Division

Sales revenue $350,000,000 $405,000,000 $960,000,000Income 14,000,000 45,000,000 48,000,000Invested capital 70,000,000 300,000,000 480,000,000

Mail Order Division

Koala Camp Gear Division Retail Division

Sales revenue $350,000,000 $405,000,000 $960,000,000Income 14,000,000 45,000,000 48,000,000Invested capital 70,000,000 300,000,000 480,000,000

Return on investment (ROI) = Return on investment (ROI) = IncomeInvested capital

IncomeInvested capital

Return On Investment As A Performance Measure

Capital TurnoverFocuses on the number of sales dollars generated by

each dollar of invested capital

Capital TurnoverFocuses on the number of sales dollars generated by

each dollar of invested capital

Sales MarginMeasures the percentage of each sales dollar that remains as profit

after all expenses are covered

Sales MarginMeasures the percentage of each sales dollar that remains as profit

after all expenses are covered

Factors Underlying ROI

Return on investment Income

Invested CapitalIncome

Sales revenueSales revenue

Invested capital= = X

Return on investment Income

Invested CapitalIncome

Sales revenueSales revenue

Invested capital= = X

Focuses on the number of salesdollars generated by each dollar of

invested capital

Focuses on the number of salesdollars generated by each dollar of

invested capital

Measures the percentage of each sales dollar that remains as

profit after all expenses are covered

Measures the percentage of each sales dollar that remains as

profit after all expenses are covered

Mail-order division

$14,000,000 $350,000,000

$350,000,000 $70,000,000 = 20%

Koala Camp Gear division

$45,000,000 $405,000,000

$405,000,000 $300,000,000 = 15%

Retail division$48,000,000

$960,000,000$960,000,000 $480,000,000 = 10%

Mail-order division

$14,000,000 $350,000,000

$350,000,000 $70,000,000 = 20%

Koala Camp Gear division

$45,000,000 $405,000,000

$405,000,000 $300,000,000 = 15%

Retail division$48,000,000

$960,000,000$960,000,000 $480,000,000 = 10%

SalesMargin

CapitalTurnoverX

XX

XX

XX

Factors Underlying ROI

10% 5% 2Current retaildivision ROI

Improving A Division’s ROI

Retail division’sROI

Sales margin

Capital turnover

X=

10% 5% 2Current retaildivision ROI

Improved retail

division ROI

One way to increase the ROI is to increase the SALES MARGIN.

For example we can increase the sales price, or cut expenses.

One way to increase the ROI is to increase the SALES MARGIN.

For example we can increase the sales price, or cut expenses.

Improving A Division’s ROI

14% 27%7%

Retail division’sROI

Sales margin

Capital turnover

X=

10% 5% 2Current retaildivision ROI

Improved retail

division ROI

Another way to increase the ROI is to increase the CAPITAL TURNOVER.

For example we can increase the sales price, or decrease our total investment.

Another way to increase the ROI is to increase the CAPITAL TURNOVER.

For example we can increase the sales price, or decrease our total investment.

Improving A Division’s ROI

15% 35%

Retail division’sROI

Sales margin

Capital turnover

X=

3

Divisional profit $45,000,000 $50,500,000

Less imputed interest charge: Invested capital $300,000,000 $350,000,000X imputed interest rate x .10 x .10

Imputed interest charge 30,000,000 35,000,000

Without Investment in New CIM Equipment

With Investment in New CIM Equipment

Divisional profit $45,000,000 $50,500,000

Less imputed interest charge: Invested capital $300,000,000 $350,000,000X imputed interest rate x .10 x .10

Imputed interest charge 30,000,000 35,000,000

Without Investment in New CIM Equipment

With Investment in New CIM Equipment

Residual Income=Profit- (Invested Capital x Imputed Interest Rate)

Residual Income=Profit- (Invested Capital x Imputed Interest Rate)

Investment in new equipment raises residual income by $500,000

Residual Income As A Performance Measure

Return On Investment V.S. Residual Income

Advantages of RI

• Goal Congruence

It includes an important piece of data: the firm’s minimum required rate of return.

Advantages of RI

• Goal Congruence

It includes an important piece of data: the firm’s minimum required rate of return.

Disadvantages of RI

• Distort comparisons between investment centers between different sizes.

Disadvantages of RI

• Distort comparisons between investment centers between different sizes.

EVA analysis tells us how much shareholder wealth is being

created

EVA analysis tells us how much shareholder wealth is being

created

Economic Value Added (EVA) As A Performance Measure

EVA = After-tax income profit - [ (TA-CL) x W-A Cost of Capital ]

EVA = After-tax income profit - [ (TA-CL) x W-A Cost of Capital ]

Weightedaveragecost of capital Market

valueof debt

Market value ofequity

+

After-taxcost of

debtcapital

Market value

of debt

Cost ofequitycapital

Market value ofequity

+

=

.0972

.063 $400,000,000 .12 $600,000,000+

=

$400,000,000 $600,000,000+

Weighted Average Cost Of Capital

Division Current LiabilitiesMail-Order $6,000,000Koala Camp Gear 5,000,000Retail 9,000,000

Economicvalueadded

Investmentcenter’s after-tax operating

profit

Investmentcenter’s

total assets

Investmentcenter’s current

liabilities

Weighted-averagecost ofcapital

= -- X

Outback Outfittershas $20 million incurrent liabilities

Outback Outfittershas $20 million incurrent liabilities

Economic Value Added For Outback

Mail-order $14 X (1 - .30) - [($ 70 - $6) X .0972] = $3,579,200Koala Camp Gear $45 X (1 - .30) - [($300 - $5) X .0972] = $2,826,000Retail $48 X (1 - .30) - [($480 - $9) X .0972] =$(12,181,200)

Mail-order $14 X (1 - .30) - [($ 70 - $6) X .0972] = $3,579,200Koala Camp Gear $45 X (1 - .30) - [($300 - $5) X .0972] = $2,826,000Retail $48 X (1 - .30) - [($480 - $9) X .0972] =$(12,181,200)

Total productiveassets

Total productiveassets

Total assetsTotal assets

Total assets lesscurrent liabilities

Total assets lesscurrent liabilities

Appropriate if the division manager has considerable authority in makingdecisions about all of the division’s

assets, including nonproductive assets

Appropriate if the division manager has considerable authority in makingdecisions about all of the division’s

assets, including nonproductive assets

Appropriate if the division manager has been directed by top level management

to keep nonproductive assets in progress, making it appropriate to exclude

nonproductive assets from the measure of invested capital

Appropriate if the division manager has been directed by top level management

to keep nonproductive assets in progress, making it appropriate to exclude

nonproductive assets from the measure of invested capital

Appropriate if the division manager has authority to secure short-term bank

loans and other short-term credit

Appropriate if the division manager has authority to secure short-term bank

loans and other short-term credit

What Is The Division’s Invested Capital?

Advantages of net book value; disadvantages

of gross book value

Advantages of net book value; disadvantages

of gross book value

Advantages of gross book value; disadvantages

of net book value

Advantages of gross book value; disadvantages

of net book value

Net Book Value Versus Gross Book Value

• The usual methods of computing depreciation are arbitrary and should not be allowed to affect ROI, residual income, or EVA calculations

• When long lived assets are depreciated, their net book value declines over time resulting in a misleading increase in ROI, residual income, and EVA across time

• The usual methods of computing depreciation are arbitrary and should not be allowed to affect ROI, residual income, or EVA calculations

• When long lived assets are depreciated, their net book value declines over time resulting in a misleading increase in ROI, residual income, and EVA across time

• Using net book value maintains consistency with the balance sheet prepared for external reporting purposes

• Using net book value to measure invested capital is also more consistent with the definition of income, which is the numerator in ROI calculations

• Using net book value maintains consistency with the balance sheet prepared for external reporting purposes

• Using net book value to measure invested capital is also more consistent with the definition of income, which is the numerator in ROI calculations

Example-18.27

• R Company manufactures clothing in Buenos Aires, Argentina. The company’s outer wear division is considering the acquisition of a new asset that will cost 360,000 and have a cash flow of 140,000 per year for each of the five years of its life. Depreciation is computed on a straight-line method with no salvage value.

Required:1. What is the ROI for each year of the asset’s life if the division

uses beginning-of-year asset balances and net book value for the computation?

2. What is the residual income each year if the imputed interest rate is 25%?

Example- 18.33

• ABC Corporation, has two sources of long-term capital: debt and equity. ABC’s cost of issuing debt is the after-tax cost of the interest payment on the debt, considering the fact that interest payments are tax deductible. ABC’s cost of equity capital is the investment opportunity rate of ABC’s investors, that is, the rate they could earn on investment of similar risk to that of investing in ABC. The interest rate on ABC’s $60 million of long-term debt is 10 percent, and the company’s tax rate is 40 percent. ABC’s cost of equity capital is 15 percent. Moreover, its market value (and book value) of equity is $90 million.

Required:

Calculate ABC’s weighted-average cost of capital.

Conclusion

1. 在 ROI 法下，若管理人員減少其流動或固定資產之投資，即可提升 ROI 。

2. 剩餘利益法可促使管理人員追求絕對數額 ( 剩餘利益金額 ) 最大化，而非盡量提高某一百分比 (ROI) ，只要某方案所賺得之報酬率超過投資之必要報酬率 ( 而非現有 ROI) ，該方案即應被採行。

3. EVA 之下，當稅後利益超過投資資金之成本時，才會創造出股東價值。為改善 EVA ，管理人員應在相同或較少資本下賺取更高之營業利益，或投資其資本於更高報酬率之計畫。

4. ROI 衡量產生決策次佳化的問題，可藉由 EVA 及 RI 克服；另外，許多管理人員喜歡使用 EVA ，因其考慮了稅的影響。