contemporary accounting problems the first topic the part 2 responsibility accounting

Contemporary accounting problems

The first topic

THE PART 2Responsibility Accounting

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-2

Relating to theresponsibilities of

individual managers.

To evaluatemanagers on

controllable items.

An accounting system thatprovides information . . .

Responsibility Accounting


Decision Making is Pushed Down

S u p erviso r S u p erviso r

M id d leM an ag em en t

S u p erviso r S u p erviso r

M id d leM an ag em en t

TopM an ag em en t

Decentralizationoften occurs asorganizations

continue to grow.

Decentralization


Decentralization

Promotes betterdecision making.

Allows upper-level management toconcentrate on strategic decisions.

Improvesproductivity.

Developslower-levelmanagers.

Improvesperformanceevaluation.

Advantages


Cost

Responsibility Reports


Prepared for each individual who

has control over revenue or

expense items



Prepare budgets for each responsibility center.

Prepare timely performance reportscomparing actual amounts with budgeted amounts.

Measure performance ofeach responsibility center.


Successful implementation of responsibility accounting depends on clear lines of authority

and clearly defined levels of responsibility.

Successful implementation of responsibility accounting depends on clear lines of authority

and clearly defined levels of responsibility.

Vice Presidentof F ina nce

D epa rtm ent Ma na ger

Store Ma na ger

V ice Presidentof O pera tions

V ice Presidentof Ma rketing

President

B oa rd of D irectors

The Controllability Concept


Amount of detail varies according to level in organization.

Departmentmanager receives detailed reports.

Store manager receives summarized information from each department.

Management by Exception and the Degree of Summarization


Management by Exception and the Degree of Summarization

The vice president of operations receives summarized information

from each store.

Management by exception

Upper-level management does not receive operating

detail unless problems arise.

Amount of detail varies according to level in organization.


Reporting System


To be of maximum benefit, responsibility reports should . . . Be timely. Be issued regularly. Be understandable. Compare budgeted

and actual amounts.

Qualitative Reporting Features


Responsibility Centers

A responsibility center is the point in an organization where the control over revenue or expense is located, e.g. division,department or a single machine.

A responsibility center may be divided into three categories cost profit investment


Cost

Types of Responsibility Centers

Cost Center A business segment that

incurs expenses but does not

generate revenue.


Profit Center A part of the

business that has control over both

revenues and expenses, but no

control over investment funds.

RevenuesSalesInterestOther

ExpensesManufacturingCommissionsSalariesOther



Investment Center

A profit center where

management also makes capital

investment decisions.

Corporate Headquarters



Measuring Managerial Performance

Return on investment (ROI) Residual income (RI)

CostCenter

Cost controlQuantity and qualityof services

ProfitCenter

InvestmentCenter

Evaluation Measures

Profitability


Return on investment is the ratio of income to the investment used to

generate the income.

ROI = Net Income Investment

Return on Investment


ROI = Net IncomeInvestment

ROI = Net IncomeSales

× SalesInvestment

MarginMargin TurnoverTurnover



Cola Company reports the following:

Net Income $ 30,000

Sales $ 500,000

Investment $ 200,000

Let’s calculate ROI.



ROI = 6% × 2.5 = 15%



× SalesInvestment

ROI = $30,000$500,000

× $500,000$200,000


Improving R0I

Three ways to improve ROI

Increase Sales

Reduce Expenses

Reduce Investment


Cola Company’s manager was able to increase sales to $600,000 which increased net income to $42,000.

There was no change in investment.

Let’s calculate the new ROI.

Improving R0I


Cola Company increased ROI from 15% to 21%.

ROI = 7% × 3 = 21%


× SalesInvestment

ROI = $42,000$600,000

× $600,000$200,000

Improving R0I


ROI - A Major Drawback As division manager at Cola Company,

your compensation package includesa salary plus bonus based on your division’sROI -- the higher your ROI, the bigger your bonus.

The company requires an ROI of 20% on all new investments -- your division has been producing an ROI of 30%.

You have an opportunity to invest in a new project that will produce an ROI of 25%.

As division manager would you invest in this project?


ROI - A Major Drawback

As division manager,I wouldn’t invest in

that project becauseit would lower my pay!

Gee . . .I thought we were

supposed to do what was best for the

company!


Residual Income

Earned Income– Investment charge = Residual income

Investment× Desired ROI = Investment charge

Investment center’scost of acquiring

investment capital


Residual Income

Cola Company has an opportunity to invest $100,000 in a project that willearn $25,000.

Cola Company has a 20 percent desired ROI and a 30 percent ROI on existing business.

Let’s calculate residual income.


Residual Income

Investment = $100,000× Desired ROI = 20% = Investment charge = $ 20,000


investment capital


Residual Income

Earned Income = $25,000– Investment charge = 20,000 = Residual income = $ 5,000

Investment = $100,000× Desired ROI = 20% = Investment charge = $ 20,000


investment capital


Residual Income

As a manager at Cola Company, would you invest the $100,000 ifyou were evaluatedusing residual income?

Would your decision be different if you were evaluated using ROI?


Residual Income

Residual income encourages managers to make profitable investments that would

be rejected by managers using ROI.


Transfer Pricing

Let’s change topics!


Transfer Pricing

Batteries

The amount charged when one divisionsells goods or services to another division.

The amount charged when one divisionsells goods or services to another division.

Battery Division Auto Division


Transfer Pricing

Battery Division Auto Division

A higher transferprice for batteries

means . . .

The transfer price affects the profit measure forboth the selling division and the buying division.

The transfer price affects the profit measure forboth the selling division and the buying division.

lower profits forthe auto division.

greater profits forthe battery division.


The ideal transfer price allowseach division manager to make

decisions that maximize thecompany’s profit, while

attempting to maximize thedivision’s profit.

The ideal transfer price allowseach division manager to make

decisions that maximize thecompany’s profit, while

attempting to maximize thedivision’s profit.

Transfer Pricing


Market-based transfer prices arepreferred because they promote

efficiency and fairness.

Market-based transfer prices arepreferred because they promote

efficiency and fairness.

Setting Transfer Prices

When market prices are not available,companies may use . . . Cost-based prices Negotiated prices


Negotiated Transfer Price

A system where transfer prices are arrived at through negotiation between managers of

buying and selling divisions.

A system where transfer prices are arrived at through negotiation between managers of

buying and selling divisions.

Excessive managementtime may be used in the

negotiation process.

Excessive managementtime may be used in the

negotiation process.May not be in the

best interest ofthe company.

May not be in thebest interest ofthe company.


Cost-Based Transfer Prices

When used, cost-based transfer prices . . . Are either variable cost or full cost. Should use standard rather than actual costs.

When used, cost-based transfer prices . . . Are either variable cost or full cost. Should use standard rather than actual costs.

Cost-based transfer prices are theleast desirable because the incentive

to control cost is diminished.

Cost-based transfer prices are theleast desirable because the incentive

to control cost is diminished.


Conflicts may arise between the company’s interests and an individual manager’s interests when transfer-price-based

performance measures are used.

Setting Transfer Prices


The end of the chapter

Let’s transfer some ofyour capital to me sothat my rate of return

will be higher!

contemporary accounting problems the first topic the part 2 responsibility accounting

Documents

mcgrawhill ryerson limited

mettop management

timely performance reports

detailed reports

lowerlevel managers

actual amounts

budgeted amounts

summarized information