Wild 6th ed Financial/Managerial Ch 22

Performance Measurement and Responsibility Accounting

Chapter 22

PowerPoint Editor:

Anna Boulware

Copyright © 2016 McGraw-Hill Education. All rights reserved. No

reproduction or distribution without the prior written consent of

McGraw-Hill Education.

Wild, Shaw, and Chiappetta

Financial & Managerial Accounting

6th Edition

By

Geography

By

Product

line

Common ways to

decentralize organizations

Decentralization

2

Providing lower-level managers with decision-making

authority offers several advantages.

Advantages of Decentralization

Timely

access to

information

Enables

top-level

managers

to focus on

long-term

strategy

3

Good

training

for

employees

Boosts

employee

morale and

retention

Decentralization has potential disadvantages which

organizations should consider:

Disadvantages of Decentralization

Department

managers

are too

focused

on own

department

Decisions

of individual

departments

might conflict

with one

another

4

Departments

might

duplicate

certain

activities

Performance Evaluation

The accounting system provides information about

resources used and outputs achieved. Managers use this

information to control operations, appraise performance,

allocate resources, and plan strategy. The type of

accounting information provided depends on whether the

department is a . . .

Evaluated on

ability to

control costs.

Cost

center

Evaluated on ability

to generate revenues

in excess of expenses.

Profit

center

Evaluated on ability

to generate return on

investment in assets.

Investment

center

5

Controllable versusUncontrollable Costs

A cost is controllable if a manager has the power to determine or at least significantly affect the

amount incurred.

Uncontrollable costsare not within the

manager’s control or influence.

The department manager’s own

salary

Supplies used in the manager’s

department6

22-P1: Responsibility Accounting

7

An accounting system that

provides information . . .

Responsibility Accounting System

Relating to the

responsibilities of

individual managers.

To evaluate

managers on

controllable items.

P 18

Successful implementation of responsibility accounting

may use organization charts with clear lines of

authority and clearly defined levels of responsibility.

9P 1

Amount of detail varies accordingto the level in the organization.

A department manager

receives detailed reports.

A store manager receives

summarized information

from each department.

Responsibility AccountingPerformance Reports

10P 1

11

Exhibit 22.2 Responsibility Accounting Performance Reports

P 1

22-C1: Direct and Indirect Expenses

12

Direct expenses areincurred for the solebenefit of a specific

department.

Direct and Indirect Expenses

13

Multiple departments share

rent, electricity, and heat.

Salary of employee who

works in only one

department.

Indirect expenses

benefit more than one

department and are

allocated among

departments benefited.C 1

Illustration of IndirectExpense Allocation, Exhibit 22.3

Classic Jewelry pays its janitorial service $800 per month to clean its store. Management allocates this cost to its three departments according to the floor space each occupies.

14C 1

22-P2: Allocation of Indirect Expenses

15

Allocation of Indirect Expenses

Indirect expenses can be allocated to departments

using a number of allocation bases. Some common indirect

expenses and their allocation bases are:

16P 2

Service department costs are shared, indirect expenses that support the activities of two or

more production departments.

Service Department Expenses

17

Commonly used bases to allocate service department expenses include:

P 2

22-P3: Departmental Income Statements

18

Departmental Income Statements

Let’s prepare departmental income

statements using the following steps:

1. Accumulating revenues and

direct expenses by department.

2. Allocating indirect expenses

across departments.

3. Allocating service department

expenses to operating

departments.

4. Preparing departmental income

statements.

19

P 3

Departmental Income Statements Step 1: Accumulating revenues and

direct expenses by department

Operating Dept.

(Profit Center)Hardware

Operating Dept.

(Profit Center) Housewares

Revenues and Direct Expenses

Revenues and Direct Expenses

Direct Expenses

Direct Expenses

Service Dept.

(Cost Center)

General Office

Service Dept.

(Cost Center)

Purchasing

Revenues and/or Direct expenses are traced

to each department without allocation.

P 320

Indirect expenses are allocated to all departments

using appropriate allocation bases.

Allocation Allocation Allocation Allocation

Service Dept. (Cost Center)

General Office

Service Dept. (Cost Center)

PurchasingOperating

Dept.

(Profit Center)

Hardware

Operating Dept.


21

Departmental Income Statements Step 2: Allocating indirect expenses across departments

P 3

Operating Dept.

(Profit Center)

Hardware

Operating Dept.


Service department total expenses (original direct

expenses + allocated indirect expenses) are

allocated to operating departments.

Allocation Allocation

Service Dept.

(Cost Center)

General Office

Service Dept.

(Cost Center)

Purchasing

22

Departmental Income Statements Step 3: Allocating service department expenses to

operating departments

P 3

Departmental Expense Allocation Spreadsheet

Expense Allocation to Departments

Service Service Sales Sales

Allocation Total Dept. Dept. Dept. Dept.

Base Expense One Two One Two

Direct expenses

Salaries Payroll 20,000$ 1,000$ 2,000$ 6,000$ 11,000$

Supplies Requisitions 1,500 100 300 400 700

Step 1: Direct expenses are traced to service departments

and sales departments without allocation.

23P 3






Direct expenses



Indirect expenses

Rent Floor space 10,000 1,000 1,000 3,000 5,000

Utilities Floor space 1,000 100 100 300 500

Total dept. expenses 32,500$ 2,200$ 3,400$ 9,700$ 17,200$

Step 2: Indirect expenses are allocated to both the service

and the sales departments based on floor space occupied.

Of a total of 2,000 square feet, the service departments occupy 200 square feet

each, Sales Department One occupies 600 square feet, and Sales Department

Two occupies 1,000 square feet.

24

Ex. 200 sq ft

2000 sq ftX $10,000 = $1,000P 3





Direct expenses



Indirect expenses

Rent Floor space 10,000 1,000 1,000 3,000 5,000



Service dept. expenses

Service Dept. One Sales (2,200) 1,000 1,200

Service Dept. Two Employees

Total expenses 32,500$ $ 0 3,400$ 10,700$ 18,400$

Sales department one has $40,000 in sales and sales department two

has $48,000 in sales. Total sales = $88,000

Step 3: Service department total expenses (original direct expenses +

allocated indirect expenses) are allocated to sales departments.

(In this example, based on sales dollars for each department)


25

Ex. $40,000 sales dept. one

$88,000 total salesX $2,200 = $1,000P 3






Direct expenses



Indirect expenses

Rent Floor space 10,000 1,000 1,000 3,000 5,000



Service dept. expenses

Service Dept. One Sales (2,200) 1,000 1,200

Service Dept. Two Employees (3,400) 1,400 2,000

Total expenses 32,500$ $ 0 $ 0 12,100$ 20,400$

Sales department one has 28 employees and sales department two

has 40 employees. Total employees = 68

Step 3 (cont.): Service department total

expenses (original direct expenses +

allocated indirect expenses) are allocated to

sales departments.

(In this example, the allocation is based on

number of employees.)

26

Ex. 28 employees sales dept. one

68 total employeesX $3,400 = $1,400P 3

DepartmentalIncome Statements for

Ames Hardware Company

Sales Sales

Combined Dept. One Dept. Two

Sales 88,000$ 40,000$ 48,000$

Cost of goods sold 38,000 20,000 18,000

Gross profit on sales 50,000$ 20,000$ 30,000$

Operating expenses

Salaries 17,000$ 6,000$ 11,000$

Supplies 1,100 400 700

Rent 8,000 3,000 5,000

Utilities 800 300 500

Service Department One 2,200 1,000 1,200

Service Department Two 3,400 1,400 2,000

Total operating expenses 32,500$ 12,100$ 20,400$

Net income 17,500$ 7,900$ 9,600$

27

Direct

Expenses

Allocated

Indirect

Expenses

Allocated

service

dept.

expenses

P 3

Departmental contribution . . .

– Is used to evaluate departmental performance.

– Is not a function of arbitrary allocations of

indirect expenses.

Departmental revenue

– Direct expenses

= Departmental contribution to overhead

Departmental Contributionto Overhead

A department may be a candidate for elimination

when its departmental contribution is negative.

28P 3

Departmental Contributionto Overhead

Net income for the company is still $17,500.

Departmental contributions to indirect expenses (overhead) are

emphasized. Departmental contributions are positive so neither

department is a candidate for elimination.

29P 3

22-A1: Evaluating Investment Center Performance

30

Evaluating Investment Center Performance

Investment center managers are responsible for generating profit and for the investment of assets. They will be evaluated based on their ability to generate enough operating income to justify the investment in assets used to generate the operating income.

31

Two performance measures are:•Investment Center Return on Assets•Investment Center Residual Income

A 1

Investment Center Returnon Assets Invested (ROI)

ROI = Investment Center Net Income

Investment Center Average Invested Assets

LCD Division earned more dollars of income, but it was less

efficient in using its assets to generate income compared

to S-Phone Division.

32A 1

Residual

Income

Investment Center

Net Income

Target Investment

Center Net Income= –

Investment CenterResidual Income

33A 1

NEED-TO-KNOW

Return on Investment (ROI) represents the earnings power of invested assets.

Return on investment = Net Income

Average Invested Assets

$600,000

$7,500,000

8%

The media division of a company reports income of $600,000, average invested assets of

$7,500,000, and a target income of 6% of invested assets. Compute the division’s

(a) return on investment and (b) residual income.

A 1

Residual income is the amount earned above a targeted amount.

Net income $600,000

Target income ($7,500,000 x .06) 450,000Residual income $150,000

The media division of a company reports income of $600,000, average invested assets of

$7,500,000, and a target income of 6% of invested assets. Compute the division’s

(a) return on investment and (b) residual income.

NEED-TO-KNOW

A 1

22-A2: Investment Center Profit Margin and Investment

Turnover

36

Investment Center Profit Marginand Investment Turnover

Return on

investment (ROI)=

Profit

Margin

Investment

turnover×

Investment center sales

Investment center average assets

Investment center income

Investment center sales

Media Networks ROI = 23.78%

Parks and Resorts ROI= 10.4%37

A 2

Profit margin measures the income earned per dollar of sales.

Profit margin = Net Income

Sales

$2,000

$50,000

4%

A division reports sales of $50,000, income of $2,000, and average invested assets of $10,000.

Compute the division’s (a) profit margin, (b) investment turnover, and (c) return on investment.

NEED-TO-KNOW

A 2

Need to Know (24-2b)

Investment turnover measures how efficiently an investment center generates

sales from its invested assets.

Investment turnover = Sales


$50,000

$10,000

5



NEED-TO-KNOW

A 2

Need to Know (24-2c)




Return on investment = Net Income


$2,000

$10,000

20%

NEED-TO-KNOW

A 2

Need to Know (24-2d)




Return on investment = Profit Margin x Investment Turnover

Net Income = Net Income Sales

Average Invested Assets Sales Average Invested Assets

20% = 4% x 5

NEED-TO-KNOW

A 2

22-A3: Nonfinancial Performance Evaluation

Measures

42

Innovation/LearningHow can we continually

improve and create value?

InternalProcesses

In which activitiesmust we excel?

Balanced ScorecardCollects information on several key performance indicators within each of the four perspectives.

Performance

Indicators

Financial PerspectiveHow do we look

to the firm’s owners?

Customer PerspectiveHow do our

customers see us?

43A 3

Global ViewL’Oreal is an international cosmetics company incorporated in France.

With multiple brands and operations in over 100 countries, the

company uses concepts of departmental accounting and controllable

costs to evaluate performance. A recent annual report shows the

following for the major divisions in L’Oreal’s cosmetics branch:

Division

Consumer products 2,051€

Professional products 615

Luxury products 1,077

Active cosmetics 311 4,054$

Non-allocated costs (577)

Cosmetics branch total 3,477€

Operating Profit (€ millions)

L’Oreal’s non-allocated costs include costs that are not controllable by

division managers. Excluding noncontrollable costs enables L’Oreal to

prepare more meaningful division performance evaluations. 44

22-A4: Cycle Time and Cycle Efficiency

45

Process time is the time spent producing the

product and it is the only value-added time!

Order Received

ProductionStarted

Goods Shipped

Manufacturing Cycle Time

Cycle Time and Cycle EfficiencyA metric that measures the time involved in

manufacturing a product.

Total Time

46

Process Time + Inspection Time

+ Move Time + Wait Time

A 4

Cycle

EfficiencyValue-added time

Cycle time=

Cycle Time and Cycle Efficiency

Process Time + Inspection Time

+ Move Time + Wait Time

Order Received

ProductionStarted

Goods Shipped

Manufacturing Cycle Time

Total Time

47A 4

22-C2 (Appendix 22A):Transfer Pricing

48

A transfer price is the amount charged when one

division sells goods or services to another division.

LCD Displays

LCD Division

S-Phone Division

Appendix 22A: Transfer Pricing

S-Phone can

purchase displays

for $80 from other

companies.

49C 2

Appendix 22A: Transfer PricingThe 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 monitor. The S-Phone manager

cannot buy monitors for less than $80 from outside suppliers, so

the $80 price is acceptable.

LCD Displays

LCD Division S-Phone Division

50C 2

Appendix 22A: Transfer Pricing

Transfer price = $40 to $80

LCD Displays

LCD Division S-Phone Division

The LCD division is producing and selling less than100,000 units

to outside customers. (Excess capacity)

At a transfer price greater than $40, the LCD division receives

contribution margin. At a transfer price less than $80, the S-Phone

division manager is pleased to buy from the LCD division, since that

price is below the market price of $80. 51C 2

22-C3 (Appendix 22B):Joint Costs and Their Allocation

52

Appendix 22B: Joint Costsand Their Allocation

Joint costs are costs incurred to produce or purchase two or more

products at the same time. Consider a sawmill company:

How should the joint costs be allocated to the different products?

53C 3

Appendix 22B: Joint Costs and Their AllocationPhysical Basis Allocation of Joint Cost

10,000 ÷ 100,000 = 10% 10% of $30,000 = $3,000

54

In this sawmill, joint costs include the logs and their being cut into

boards. This joint cost will need to be allocated to the different

products resulting from it. We will focus on board feet produced…

C 3

Appendix 22B: Joint costs and Their AllocationAllocating Joint Costs on a Value Basis

$12,000 ÷ $50,000 = 24% 24% of $30,000 = $7,200

55

In this sawmill, joint costs include the logs and their being cut into

boards. This joint cost will need to be allocated to the different

products resulting from it. We will focus on sales value…

C 3

End of Chapter 22

56