Performance Measurement and Responsibility Accounting

Performance Evaluation

• Large companies are easier to manage when divided into smaller units called divisions, segments, or departments.
• In decentralized organizations:
  • Decisions are made by unit managers.
  • Top management evaluates the performance of unit managers.
  • Managers are evaluated on their success in controlling actual vs. budgeted costs.
  • Cost center: Evaluated on their success in controlling actual vs. budgeted costs.
  • Profit center: Evaluated on their success in generating income.
  • Investment center: Evaluated on use of assets to generate income.

Controllable versus Uncontrollable Costs

• Controllable costs: Costs a manager can determine or influence.
• Uncontrollable costs: Costs not within the manager’s control or influence.
  • Examples of controllable costs:
    • The department manager’s own salary.
    • Supplies used in the manager’s department.

Responsibility Accounting

• Recognizes that control over costs and expenses belongs to several levels of management.
• Responsibility accounting performance reports are generated.

Direct and Indirect Expenses

• Direct expenses: Costs traced to a department because they are incurred for that department’s sole benefit.
• Indirect expenses: Costs incurred for the joint benefit of multiple departments; they cannot be traced to only one department.

Allocating Indirect Expenses

• Indirect and service department expenses are allocated to departments that benefit from them.
• Service department costs are shared by two or more departments.
  • Service departments include personnel, payroll, and purchasing.

Cost Allocation Demonstration

• A retail store pays an outside company to clean for a total cost of 800 per month.
• Management allocates cost across the store’s three departments based on square feet.

Investment Centers

• Investment center managers are responsible for revenues, costs, and the investment in operating assets.

Transfer Pricing

• A transfer price is the price used to record transfers of goods across divisions of the same company.

Transfer Pricing: No Excess Capacity

• The LCD division is producing and selling 100,000 units to outside customers (no excess capacity).
• Transfer price = 80
• With no excess capacity, the LCD manager will not accept a transfer price less than 80 per screen, which is a market-based transfer price.

Transfer Pricing: Excess Capacity

• The LCD division is producing and selling less than 100,000 units to outside customers (excess capacity).
• Transfer price = 50 to 80
• At a transfer price greater than 50, the LCD division can cover variable costs and this is cost-based transfer pricing.
• A negotiated price between variable cost and market price is called a negotiated transfer price.

Joint Costs and Their Allocation

• Joint costs are costs incurred to produce or purchase two or more products at the same time.
• Consider a dairy company that incurs joint costs when it processes raw milk. How should the joint costs be allocated to the different products?

Allocating Joint Costs on a Value Basis

• Joint costs of a dairy company include whole milk, 2% milk, 1% milk, and skim milk. This joint cost of 30,000 will be allocated to the different products based on the sales value of each product at the split-off point.
• 12,000 ÷ 50,000 = 24\%. 24\% of 30,000 = 7,200