ch13 - Accounting Manajemen

8/10/2019 ch13 - Accounting Manajemen

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13 -1

Performance

Evaluation in

the

Decentralized

Firm

CHAPTER



13 -2

1. Define responsibility accounting, and

describe four types of responsibility centers.

2. Tell why firms choose to decentralize.

3. Compute and explain return on investment

(ROI) and economic value added (EVA).

4. Discuss methods of evaluating and rewarding

managerial performance.

5. Explain the role of transfer pricing in a

decentralized firm.

Objectives

After studying this

chapter, you should

be able to:



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Responsibil i ty accounting is a system that

measures the results of each responsibility

center according to the information managers

need to operate their centers.





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Types of Responsibility Centers

Profit center: A responsibility center in

which a manager is responsible for

both revenues and costs.

Investment center: A responsibility

center in which a manager is

responsible for revenues, costs, and

investments.



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ACCOUNTING INFORMATION USED TO MEASURE

PERFORMANCE

Capital

Cost Sales Investment Other

Cost center x

Revenue center Direct cost xonly

Profit center x x

Investment center x x x x



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Reasons for Decentralization

1. Ease of gathering and using local

information

2. Focusing of central management

3. Training and motivating segment

managers

4. Enhanced competition, exposing segments

to market forces



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Return on Investment

ROI =Operating income

Average operating assets

Beginning net book value +

Ending net book value2



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Comparison of ROI

Electronics Medical Supplies

Divisions Divisions

2003:

Sales $30,000,000 $117,00,000

Operating income 1,800,000 3,510,000Average operating assets 10,000,000 19,500,000

ROI 18 18% %

$1,800,000

$10,000,000



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Comparison of ROI

Electronics Medical Supplies

Divisions Divisions

2004:

Sales $40,000,000 $117,00,000

Operating income 2,000,000 2,925,000Average operating assets 10,000,000 19,500,000

ROI 20 15% %

$2,000,000

$10,000,000



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Margin and Turnover

ROI = Margin x Turnover

Operating Income

Sales

Sales

Average operating assets



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MARGIN AND TURNOVER COMPARISONS

Electronics Medical SuppliesDivision Division

Margin 6.0% 5.0% 3.0% 2.5%Turnover x 3.0 x 4.0 x 6.0 x 6.0

ROI 18.0% 20.0% 18.0% 15.0%

2003 2004 2003 2004



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1. It encourages managers tofocus on the relationshipamong sales, expenses, and

investments.2. It encourages managers to

focus on cost efficiency.

3. It encourages managers tofocus on operating assetefficiency.

Advantages of ROI



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1) It can produce a narrowfocus on divisional profitability at the expense

of profitability for theoverall firm.

2) It encourages managers tofocus on the short run at theexpense of the long run.

Disadvantages of ROI



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Economic value added (EVA) is after-tax operating profit minus the totalannual cost of capital.

EVA = After-tax operating income – (Weighted

average cost of capital x Total capital

employed)



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There are two steps involved in

computing cost of capital:

1. Determine the

weighted average costof capital (a

percentage figure)

2. Determine the totaldollar amount of

capital employed



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Weighted Average Cost of Capital

Suppose that a company has two sources offinancing: $2 million of long-term bonds paying

9 percent interest and $6 million of common

stock, which is considered to be of average risk.

If the company’s tax rate is 40 percent and the

rate of interest on long-term government bonds

is 6 percent, the company’s weighted average

cost of capital is computed as follows:



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Amount Percent x After-Tax Cost = Weighted CostBonds $2,000,000 0.25 0.009(1 – 0.4) = .054 0.0135

Equity 6,000,000 0.75 0.06 + 0.06 = .120 0.0900

Total $8,000,000 0.1035Thus, the company’s

weighted average is

10.35 percent.



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Suppose that Mahalo, Inc., had after-taxoperating income last year of $900,000. Three

sources of financing were used by the company:$2 million of mortgage bonds paying 8 percentinterest, $3 million of unsecured bonds paying10 percent interest, and $10 million in commonstock, which was considered to be no more or

less risky than other stocks. Mahalo, Inc. paysa marginal tax rate of 40 percent.

EVA Example



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WeightedAmount Percent x After-Tax Cost = Cost

Mortgage

bonds $ 2,000,000 0.133 0.048 0.006

Unsecured bonds 3,000,000 0.200 0.060 0.012

Common

stock 10,000,000 0.667 0.120 0.080

Total $15,000,000Weighted average cost of capital 0.098



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Mahalo’s EVA is calculated as follows:

After tax operating income $900,000

Less: Cost of capital 784,000

EVA $116,000

EVA Example



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A number of companies have discovered thatEVA helps to encourage the right kind of behavior from their divisions in a way thatemphasis on operating income alone cannot.The underlying reason is EVA’s reliance on thetrue cost of capital.

Behavioral Aspects of EVA



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Behavioral Aspects of EVA

In many companies, the responsibility for

investment decisions rests with corporatemanagement. As a result, the cost of capital isconsidered a corporate expense. If a division

builds inventories and investment, the cost offinancing that investment is passed along to theoverall income statement and does not show upas a reduction from the division’s operating

income.



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Why would managers not provide good service?

There are three reasons:

1. They may have low abil i ty

2. They may prefer not to work as hard as

needed

3. They may prefer to spend company resources

on perquisi tes

Incentive Pay for Managers



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Incentive Pay for Managers

Perquisites are a type of fringe benefit given

to managers over and above a salary.

A nice office

Use of a company car or jet

Expense accounts

Paid country club memberships



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The value of a

transferred good is

revenue to the sellingdivision and cost to the

buying division. This

value is called transfer pricing .

Transfer Pricing



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(1) divisional performance measures

(2) firmwide profits

(3) divisional autonomy

Transfer Pricing

Transfer pricing affects both transferring divisions

and the firm as a whole through its impact on--



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Opportunity Cost Approach

This approach identifies the minimum and

maximum price that a selling division would be

willing to accept and the maximum price that a

buying division would be willing to pay.

The minimum transfer pr ice is the transfer price that

would leave the selling division no worse off if the

goods were sold to an internal division than if thegood were sold to an external party (floor) .

The maximum transfer price is the transfer price that

would leave the buying division no worse off if an

input were purchased from an internal division than ifthe good were purchased externally (ceiling) .



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The Transfer Pricing Illustration

Tyson Manufacturers

produces small appliances.

The Small Parts Division

produces parts used by theSmall Motors Division.

The parts also are sold to

other manufacturers and

wholesalers.



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The Small Motors Division is

operating at 70 percent

capacity. A request is received

for 100,000 units of a certain

model at $30 per unit. Acomponent for this motor can

be supplied by the Small Parts

Division. The transfer price is

$8 despite the Small PartsDivision only experiencing a

cost of $5 per unit.



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Using the $8 transfer price, thetotal cost is $31 per unit,

calculated as follows:

Direct materials $10Transferred-in component 8

Direct labor 2

Variable overhead 1

Fixed overhead 10Total cost $31



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The Small Motors Division is

operating at 70 percent capacity,

so the $10 fixed cost is not

relevant. Recalculating the cost--

The Small Motors Division can pay the Small Parts

Division $8 per unit and still make a substantial

contribution to the overall profitability of the Division.

Direct materials $10Transferred-in component 8

Direct labor 2

Variable overhead 1

Total cost $21



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Negotiated Transfer Prices

When imperfections exist in

competitive markets for the

intermediate product, market price

may no longer be suitable.



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Negotiated Transfer Prices

In this case, negotiated transfer

prices may be a practical

alternative. Opportunity costs can

be used to define the boundaries of

the negotiation set.



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Disadvantages of Negotiated

Transfer Prices

1. A division manager who has private

information may take advantage of another

divisional manager.

2. Performance measures may be distorted by

the negotiated skills of managers.

3. Negotiation can consume considerable time

and resources.



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Despite the disadvantages,

negotiated price transfer prices offer

some hope of complying with thethree criteria of goal congruence,

autonomy, and accurate

performance evaluation.



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The End

Chapter Thirteen



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ch13 - Accounting Manajemen