Horngrenima14e ch10

©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Introduction to Management AccountingIntroduction to Management Accounting 14/e,14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 10 Horngren/Sundem/Stratton/Schatzberg/Burgstahler 10 - - 11

Introduction to Management AccountingIntroduction to Management Accounting


Management Controlin Decentralized Organizations

Introduction to Management Accounting

Chapter Chapter 1010


From 1986 companies revenues increased from $1 billion to over $15 billion

During same period foreign earnings increased from 25% to 63%

What are the keys to success when a company goes global?

Nike decided to delegate decision making to the local market level

One result of this decision was the signing of race car driver Michael Schumacher in Germany

Chapter focuses on management control systems in decentralized organizations


Decentralization

The delegation of freedom to makedecisions is called decentralization.The delegation of freedom to makedecisions is called decentralization.

The lower in the organization thatthis freedom exists, the greater

the decentralization.

The lower in the organization thatthis freedom exists, the greater

the decentralization.

LearningLearningObjective 1Objective 1

The process by which decision making is concentrated within a particular location

or group is called centralization.

The process by which decision making is concentrated within a particular location

or group is called centralization.


Costs and Benefits

Benefits of decentralization:Benefits of decentralization:

Lower-level managers have the bestinformation concerning local conditions.

Lower-level managers have the bestinformation concerning local conditions.

It promotes management skills which,in turn, helps ensure leadership continuity.

It promotes management skills which,in turn, helps ensure leadership continuity.

Managers enjoy higher status from beingindependent and thus are better motivated.

Managers enjoy higher status from beingindependent and thus are better motivated.


Costs and Benefits

Costs of decentralization:Costs of decentralization:

Managers may make decisions that arenot in the organization’s best interests.Managers may make decisions that arenot in the organization’s best interests.

Managers also tend to duplicate servicesthat might be less expensive if centralized.that might be less expensive if centralized.

Managers also tend to duplicate servicesthat might be less expensive if centralized.that might be less expensive if centralized.

Costs of accumulating and processinginformation frequently rise.

Costs of accumulating and processinginformation frequently rise.


Costs and Benefits

Managers in decentralized units may wastetime negotiating with other units about goods

or services one unit provides to the other.

Managers in decentralized units may wastetime negotiating with other units about goods

or services one unit provides to the other.


Middle Ground

Many companies find that decentralizationworks best in part of the company, whilecentralization works better in other parts.

Many companies find that decentralizationworks best in part of the company, whilecentralization works better in other parts.

Decentralization is most successfulwhen an organization’s segments arerelatively independent of one another.

Decentralization is most successfulwhen an organization’s segments arerelatively independent of one another.


Segment Autonomy

If management has decided in favorof heavy decentralization, segment

autonomy, the delegation of decision-making power to managers of segments

of an organization, is also crucial.

If management has decided in favorof heavy decentralization, segment

autonomy, the delegation of decision-making power to managers of segments

of an organization, is also crucial.


Responsibility Centers and Decentralization

Design of a management control system shouldconsider two separate dimensions of control:

Design of a management control system shouldconsider two separate dimensions of control:

Responsibilities

11

Autonomy

22




Profit centersProfit centers DecentralizationnDecentralizationn

These are entirely separate conceptsand one can exist without the other.These are entirely separate conceptsand one can exist without the other.



All control systems are imperfect.All control systems are imperfect.

The choice among systems should bebased on which one will bring more

of the actions top management seeks.

The choice among systems should bebased on which one will bring more

of the actions top management seeks.


Motivation, Performance, and Rewards

Criteria and Choices when DesigningCriteria and Choices when Designinga Management Control Systema Management Control System

Goal Goal CongruenceCongruence

Goal Goal CongruenceCongruence

ActionsActionsActionsActionsPerformancePerformance

MeasuresMeasuresPerformancePerformance

MeasuresMeasuresRewardsRewardsRewardsRewards

Feedback

Motivational criteriaMotivational criteria

ManagerialManagerialEffortEffort

ManagerialManagerialEffortEffort

Feedback

Choice of Responsibility Choice of Responsibility Centers and Incentives Centers and Incentives




Incentives. . .Incentives. . .

Performance-based rewards that enhance

managerial effort toward organizational goals.

Performance-based rewards that enhance

managerial effort toward organizational goals.

RewardsRewardsMotivational Criteria

Motivational Criteria



You get what you measure!You get what you measure!

Therefore, accounting measures,which provide relatively objective

evaluations of performance,are important.

Therefore, accounting measures,which provide relatively objective

evaluations of performance,are important.


Agency Theory, Performance, Rewards, and Risks

Agency theory deals with contracting betweenan organization and the managers that it hires

to make decisions on its behalf.

Agency theory deals with contracting betweenan organization and the managers that it hires

to make decisions on its behalf.

IncentiveIncentive RiskRiskCost of measuring

performanceCost of measuring

performance


Measures of Profitability

Profitability does not meanthe same thing to all people.

Profitability does not meanthe same thing to all people.

Is it net income?Income before taxes?

Net income percentage based on revenue?Is it an absolute amount?

A percentage?

Is it net income?Income before taxes?

Net income percentage based on revenue?Is it an absolute amount?

A percentage?



Return on Investment

ROI = Income ÷ InvestmentROI = Income ÷ Investment

ROIROI ==Income

RevenueIncome

Revenue ××Revenue

InvestmentRevenue

Investment


Return on Investment

Division A ROI: = Income ÷ Investment $200,000 ÷ $500,000 = 40%

Division A ROI: = Income ÷ Investment $200,000 ÷ $500,000 = 40%

Division B ROI: = Income ÷ Investment $150,000 ÷ $250,000 = 60%

Division B ROI: = Income ÷ Investment $150,000 ÷ $250,000 = 60%


Capital charge is the cost of capitalmultiplied by the amount of investment..

Capital charge is the cost of capitalmultiplied by the amount of investment..

Residual Income

RI tells you how much a company’safter-tax operating income exceeds

what it is paying for capital.

RI tells you how much a company’safter-tax operating income exceeds

what it is paying for capital.

RI is defined as after-tax net operatingincome less a capital charge.

RI is defined as after-tax net operatingincome less a capital charge.


Economic Value Added

Economic value added (EVA) = Adjusted after-tax operating income– Cost of invested capital (%)× Adjusted average invested capital

Economic value added (EVA) = Adjusted after-tax operating income– Cost of invested capital (%)× Adjusted average invested capital


ROI or Residual Income?

Why do some companies prefereconomic profit (or EVA) to ROI?Why do some companies prefereconomic profit (or EVA) to ROI?

Under ROI, the message is go forth andmaximize your rate of return, a percentage.

Under ROI, the message is go forth andmaximize your rate of return, a percentage.

Under EVA, the message is go forth and maximizeeconomic profit, an absolute dollar amount.

Under EVA, the message is go forth and maximizeeconomic profit, an absolute dollar amount.


Invested Capital

To apply either ROI or residual income,both income and invested capitalmust be measured and defined.

To apply either ROI or residual income,both income and invested capitalmust be measured and defined.

Total assets Total assets employed Total assets less current liabilities Stockholders’ equity

Total assets Total assets employed Total assets less current liabilities Stockholders’ equity



Valuation of Assets

Should values be based on historical costor some version of current value?

Should values be based on historical costor some version of current value?

Practice is overwhelmingly in favor of usingnet book value based on historical cost.net book value based on historical cost.

Practice is overwhelmingly in favor of usingnet book value based on historical cost.net book value based on historical cost.

Most companies use net book value incalculating their investment base.

Most companies use net book value incalculating their investment base.


Transfer Prices

The price that one segment charges anothersegment of the same organization for a

product or service is a transfer price.

The price that one segment charges anothersegment of the same organization for a

product or service is a transfer price.



Purpose of Transfer Pricing

Why do transfer-pricing systems exist?Why do transfer-pricing systems exist?

Management wants to createperformance measurement systems.

Management wants to createperformance measurement systems.

Decisions that maximize a segment’sprofit should also maximize theprofits of the entire company..

Decisions that maximize a segment’sprofit should also maximize theprofits of the entire company..


Purpose of Transfer Pricing

Multinational companies use transferpricing to minimize their worldwide

taxes, duties, and tariffs.

Multinational companies use transferpricing to minimize their worldwide

taxes, duties, and tariffs.


Transfer-pricing Systems

1. Market-based transfer prices2. Cost-based transfer prices

a. Variable Costb. Full cost (possibly pus profit)

3. Negotiated transfer prices

1. Market-based transfer prices2. Cost-based transfer prices

a. Variable Costb. Full cost (possibly pus profit)

3. Negotiated transfer prices


Market-Based Transfer Prices

Using the market price as a transfer price will generally lead to the desired goal

congruence and managerial effort.

Using the market price as a transfer price will generally lead to the desired goal

congruence and managerial effort.

In this case, the market price is equal tothe variable cost plus opportunity cost.In this case, the market price is equal tothe variable cost plus opportunity cost.

If a market price exists, use it.


Market-Based Transfer Prices Drawbacks

Market prices are not always available for items transferred internally.

Market prices are not always available for items transferred internally.

Imperfectly competitive markets exist. Imperfectly competitive markets exist.

When market prices don’t exist, most companies resort to cost-based transfer prices.

When market prices don’t exist, most companies resort to cost-based transfer prices.


Variable-Cost Pricing

This transfer pricing system ismost appropriate when theselling division forgoes no

opportunity when it transfersthe item internally.

This transfer pricing system ismost appropriate when theselling division forgoes no

opportunity when it transfersthe item internally.

Cost-based transfer prices lead todysfunctional decisions - decisions in

conflict with the company’s goals.

Cost-based transfer prices lead todysfunctional decisions - decisions in

conflict with the company’s goals.


Full-Cost Pricing

This transfer pricing system includes not onlyvariable cost but also an allocation of fixedcosts (and, if included, the profit mark-up.)It is implicitly assumed that the allocation

is a good approximation of the opportunity cost.

This transfer pricing system includes not onlyvariable cost but also an allocation of fixedcosts (and, if included, the profit mark-up.)It is implicitly assumed that the allocation

is a good approximation of the opportunity cost.

Dysfunctional decisions arise with full-cost transfer prices when the selling segment has

opportunity costs that differ significantly from the allocation of fixed costs and profit.

Dysfunctional decisions arise with full-cost transfer prices when the selling segment has

opportunity costs that differ significantly from the allocation of fixed costs and profit.


Negotiated Transfer Prices

Companies heavily committed to segmentautonomy often allow managers

to negotiate transfer prices.

Companies heavily committed to segmentautonomy often allow managers

to negotiate transfer prices.

Virtually any type of transfer pricing policycan lead to dysfunctional behavior – actionstaken in conflict with organizational goals.

Virtually any type of transfer pricing policycan lead to dysfunctional behavior – actionstaken in conflict with organizational goals.


The Need for Many Transfer Prices

The “correct” transfer price depends onthe economic and legal circumstances

and the decision at hand.

The “correct” transfer price depends onthe economic and legal circumstances

and the decision at hand.

Organizations may have to make trade-offsbetween pricing for congruence and

pricing to spur managerial effort.pricing to spur managerial effort.

Organizations may have to make trade-offsbetween pricing for congruence and

pricing to spur managerial effort.pricing to spur managerial effort.

State fair-trade laws and national antitrustacts can also influence transfer pricing.

State fair-trade laws and national antitrustacts can also influence transfer pricing.


Multinational Transfer Pricing Example

A high-end running shoe produced by an IrishNike division with a 12% income tax rate.

A high-end running shoe produced by an IrishNike division with a 12% income tax rate.

It is transferred to a division in Germany with a 40% income tax rate.

It is transferred to a division in Germany with a 40% income tax rate.

An import duty equal to 20% of the price of the item is imposed by Germany.

An import duty equal to 20% of the price of the item is imposed by Germany.

Full unit cost is $100, and variable cost is$60 (either transfer price could be chosen).

Full unit cost is $100, and variable cost is$60 (either transfer price could be chosen).




Which transfer price should be chosen?Which transfer price should be chosen?

Tax authorities allow either variable- orfull-cost transfer prices.

Tax authorities allow either variable- orfull-cost transfer prices.



Income of the Irish division is $40 higher:12% × $40 = ($4.80) higher taxes

Income of the Irish division is $40 higher:12% × $40 = ($4.80) higher taxes

Income of the German division is $40 lower:40% × $40 = $16 lower taxes

Income of the German division is $40 lower:40% × $40 = $16 lower taxes

Import duty paid by German division:20% × $40 = ($8)

Import duty paid by German division:20% × $40 = ($8)

Net savings = $3.20 Net savings = $3.20


Management by Objectives

MBO describes the joint formulation bya manager and his or her superior of a

set of goals and plans for achievingthe goals for a forthcoming period.

MBO describes the joint formulation bya manager and his or her superior of a

set of goals and plans for achievingthe goals for a forthcoming period.

The manager’s performance is thenevaluated in relation to these

agreed-upon budgeted objectives.

The manager’s performance is thenevaluated in relation to these

agreed-upon budgeted objectives.



Budgets, Performance Targets, and Ethics

Many of the troublesome motivationaleffects of performance evaluation

systems can be minimized bythe astute use of budgets.

Many of the troublesome motivationaleffects of performance evaluation

systems can be minimized bythe astute use of budgets.

The desirability of tailoring a budgetto particular managers cannot

be overemphasized.

The desirability of tailoring a budgetto particular managers cannot

be overemphasized.


Budgets, Performance Targets, and Ethics

Using budgets as performancetargets also has its danger.

Using budgets as performancetargets also has its danger.

Companies that make meetinga budget too important can

motivate unethical behavior.

Companies that make meetinga budget too important can

motivate unethical behavior.


End of Chapter 10

The EndThe End

Documents

Horngrenima14e ch10