Chapter 24

Centralized and Decentralized Operations

  • Centralized Company: All major planning and operating decisions are made by top management.
  • Decentralized Company: Managers of separate divisions or units are given operating responsibilities.
  • Degree of Decentralization: Depends on unique circumstances of the company.
  • Customer Interaction: Managers in decentralized operations often interact closely with customers.
  • Manager Responsibilities: Division or unit managers are responsible for planning and controlling their operations.
  • Structure of Divisions: Divisions can be organized around products, customers, or regions.

Advantages and Disadvantages of Decentralized Operations

  • Advantages:

    • Helps in retaining skilled managers.
    • Provides excellent training opportunities for managers.
    • Managers can become experts in their specific operational areas.

  • Disadvantages:

    • Possible duplication of assets and expenses.
    • Decisions made by managers may negatively impact overall company profits.

Responsibility Accounting

  • Definition: A process to measure and report operating data by responsibility center in a decentralized business.
  • Types of Responsibility Centers:
    • Cost Centers: Responsible for controlling costs only.
    • Profit Centers: Responsible for revenues and costs, impacting profits.
    • Investment Centers: Responsible for revenues, costs, and investment in assets.
  • Cost Center Management:
    • Focuses on controlling and reporting costs.
    • Budget performance reports compare budgeted vs actual costs for accountability.

Cost Centers and Responsibility Accounting

  • Manager Responsibilities: Control costs within the designated center, which can range in size.
  • Examples of Cost Centers in Organizational Structures (e.g., departments, plants).

Profit Centers and Responsibility Accounting

  • Profit Center Management: Managers have authority to make decisions that affect both costs and revenues.
  • Reporting Focus:
    • Profit center reports typically take the form of income statements.
    • Include only controllable revenues and expenses.
    • Report should exclude non-controllable costs for accurate performance assessments.

Support Department Allocations

  • Definition: Expenses incurred by central support departments that benefit profit centers.
  • Examples of Support Departments: Research & Development, Legal, Telecommunications, and others.
  • Indicator of Performance: How effectively profit centers utilize support services affects their reported operating income.

Profit Center Reporting and Evaluation

  • Operating Income Analysis: Should be compared historically against budgets, not across divisions due to size and operational differences.
  • Divisional Income Statement Preparation: Involves allocation of support department costs based on usage metrics.

Investment Centers and Performance Evaluation

  • Implications for Managers: Should make decisions affecting costs, revenues, and asset management.
  • Performance Measures:
    • Return on Investment (ROI)
    • Residual Income
  • Key Performance Metrics: ROI evaluates divisional asset utilization, while residual income considers the minimum return expectations.

Return on Investment (ROI)

  • Definition: ROI measures operating income generated for each dollar invested.
  • Computational Formula: ROI = Net Income / Invested Assets
  • DuPont Formula: Analyzes ROI by breaking it down into components: Profit Margin and Asset Turnover.

Disadvantages of ROI

  • May dissuade managers from accepting new projects that could be beneficial for the company as a whole due to performance metric bias.

Residual Income

  • Definition: Operating income above the minimum acceptable threshold.
  • Utility: Addresses limitations of ROI by considering both operating income and investment size within decision-making contexts.

Transfer Pricing

  • Purpose: Determines internal pricing for products/services transferred between divisions.
  • Common Approaches:
    • Market Price Approach: Transfer price equals market price of the product.
    • Negotiated Price Approach: Price agreed upon through negotiation between divisions.
    • Cost Price Approach: Uses actual costs or standard costs to set transfer prices.
  • Performance Influence: Selecting a transfer pricing methodology can directly impact divisional income and therefore, overall company profitability.