Decentralization and Performance Evaluation. Responsibility Centers Costs and benefits of...
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![Page 1: Decentralization and Performance Evaluation. Responsibility Centers Costs and benefits of decentralization Return on Investment Residual Income.](https://reader035.fdocuments.in/reader035/viewer/2022062421/56649d965503460f94a7f4c8/html5/thumbnails/1.jpg)
Decentralization and Decentralization and Performance EvaluationPerformance Evaluation
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Decentralization and Performance Evaluation
• Responsibility Centers• Costs and benefits of
decentralization• Return on Investment• Residual Income
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Decentralization and Performance Evaluation
• Responsibility Centers• Costs and benefits of decentralization• Return on Investment• Residual Income
![Page 4: Decentralization and Performance Evaluation. Responsibility Centers Costs and benefits of decentralization Return on Investment Residual Income.](https://reader035.fdocuments.in/reader035/viewer/2022062421/56649d965503460f94a7f4c8/html5/thumbnails/4.jpg)
Responsibility Centers
• Cost Centers
• Revenue Centers
• Profit Centers
• Investment Centers
Responsibility Centers include:
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Responsibility Centers
• Cost Centers
– A cost center is a segment whose manager is
responsible for costs but not for revenues.
• Revenue Centers
• Profit Centers
• Investment Centers
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Responsibility Centers
• Cost Centers
• Revenue Centers
– Revenue center managers are mostly responsible
for generating sales, not for the cost of goods sold.
• Profit Centers
• Investment Centers
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Responsibility Centers
• Cost Centers
• Revenue Centers
• Profit Centers
– Profit center managers are responsible for revenues
as well as costs. These costs may include indirect
costs.
• Investment Centers
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Responsibility Centers• Cost Centers
• Revenue Centers
• Profit Centers
• Investment Centers
– Investment center managers are responsible not
only for revenues and costs, but also for the
investment required to generate profits.
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Responsibility Centers
Levi Strauss
San Francisco
Levi Strauss
Canada
Levi Strauss
U.S.A.
Levi Strauss
Europe
Dockers Jeans
Factories Warehouses
Sales offices
Investment Centers
Profit Centers
Cost Centers
Revenue Centers
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Responsibility Centers
• Cost Centers– report of costs
• Revenue Centers– report of sales
• Profit Centers– Divisional income statement
• Investment Centers– Return on Investment
What reports are used to evaluate these responsibility center managers?
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Decentralization and Performance Evaluation
• Responsibility Centers• Costs and benefits of decentralization• Return on Investment• Residual Income
![Page 12: Decentralization and Performance Evaluation. Responsibility Centers Costs and benefits of decentralization Return on Investment Residual Income.](https://reader035.fdocuments.in/reader035/viewer/2022062421/56649d965503460f94a7f4c8/html5/thumbnails/12.jpg)
Responsibility Centers
• Takes advantage of knowledge and expertise within the organization.
• Autonomy can be an intrinsic reward.
• Places fewer demands on top management.
Benefits of Decentralization:
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Responsibility Centers
• Loss of Control.
• Goal Congruence.
Costs of Decentralization:
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Decentralization and Performance Evaluation
• Responsibility Centers• Costs and benefits of decentralization• Return on Investment• Residual Income
![Page 15: Decentralization and Performance Evaluation. Responsibility Centers Costs and benefits of decentralization Return on Investment Residual Income.](https://reader035.fdocuments.in/reader035/viewer/2022062421/56649d965503460f94a7f4c8/html5/thumbnails/15.jpg)
ROI and Residual IncomeProjectLevel
Measure
DivisionLevel
Measure
Ratio: I RR ROI
DollarReturns: NPV R.I .
Where
IRR = Internal Rate of Return
ROI = Return on Investment
NPV = Net Present Value
R.I. = Residual Income
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Return on Investment (ROI)
Examples of ROI that you may have seen:
ROE = Return on Equity
ROA = Return on Assets
These are usually employed at a firm-wide level for financial statement analysis. In cost accounting, we are usually more interested in ROI calculations for a part of the firm (e.g., a division).
ROI = Some Measure of InvestmentSome Measure of Income
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Return On Investment (ROI)
ROI = Divisional Investment
= Operating Profit
Division Revenuesx Divisional Revenues
Divisional Investmt
Operating Profit
= Return on Sales x Turnover Ratio
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Return On Investment (ROI)
ADVANTAGES:ROI is a measure of profitability that is independent of the size of the division.
DISADVANTAGES:Can encourage divisional managers to reject good investments.
ROI = Division Investment
Operating Profit
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Decentralization and Performance Evaluation
• Responsibility Centers• Costs and benefits of decentralization• Return on Investment• Residual Income
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Residual Income (RI)
ADVANTAGES:
Some argue that Residual Income comes very close to what investors care about.
RI = Profits - (Hurdle Rate x Investment)
This hurdle rate usually should be equal to or greater than the cost of capital.
E.V.A. (Economic Value Added) is a type of Residual Income calculation.
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Measurement IssuesIncome:
Residual Income should exclude interest on debt.
Both RI and ROI might include some allocated corporate costs.
Investment:
Always includes identifiable assets.
Can also include some allocated corporate assets.Fixed assets might be stated at Original Cost Original cost less accumulated depreciation (book value) Current replacement cost
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Cat Food Company has two divisions, Turkey and Fish. Operating results for the two divisions are as follows:
Turkey FishNet Operating Income $50,000 $60,000Average Operating Assets $250,000 $400,000
The required rate of return, which is the cost of capital, for the Cat Food Company is 18%.
What is the residual income for the Fish Division?
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Cat Food Company has two divisions, Turkey and Fish. Operating results for the two divisions are as follows:
Turkey FishNet Operating Income $50,000 $60,000Average Operating Assets $250,000 $400,000
The required rate of return, which is the cost of capital, for the Cat Food Company is 18%.
What is the residual income for the Fish Division?
operating income - (average investment x cost of capital)= $60,000 - ($400,000 x 18%)= $60,000 - $72,000= ($12,000)
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Cat Food Company has two divisions, Turkey and Fish. Operating results for the two divisions are as follows:
Turkey FishNet Operating Income $50,000 $60,000Average Operating Assets $250,000 $400,000
The required rate of return, which is the cost of capital, for the Cat Food Company is 18%.
What is the return on investment (ROI) for the Turkey Division?
![Page 25: Decentralization and Performance Evaluation. Responsibility Centers Costs and benefits of decentralization Return on Investment Residual Income.](https://reader035.fdocuments.in/reader035/viewer/2022062421/56649d965503460f94a7f4c8/html5/thumbnails/25.jpg)
Cat Food Company has two divisions, Turkey and Fish. Operating results for the two divisions are as follows:
Turkey FishNet Operating Income $50,000 $60,000Average Operating Assets $250,000 $400,000
The required rate of return, which is the cost of capital, for the Cat Food Company is 18%.
What is the return on investment (ROI) for the Turkey Division?
operating income ÷ average operating assets= $50,000 ÷ $250,000 = 20%
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Cat Food Company has two divisions, Turkey and Fish. Operating results for the two divisions are as follows:
Turkey FishNet Operating Income $50,000 $60,000Average Operating Assets $250,000 $400,000
The required rate of return, which is the cost of capital, for the Cat Food Company is 18%.
A project with a return of $36K on an investment of $200K exists. If divisions are evaluated based on residual income, which divisions would accept the project?
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Cat Food Company has two divisions, Turkey and Fish. Operating results for the two divisions are as follows:
Turkey FishNet Operating Income $ 50,000 $ 60,000Average Operating Assets $250,000 $400,000
The required rate of return, which is the cost of capital, for the Cat Food Company is 18%.
A project with a return of $36,000 on an investment of $200,000 exists. If divisions are evaluated based on residual income, which divisions would accept the project?
$36,000 - ($200,000 x 18%) = $0.Both Turkey division and Fish division are indifferent.