10 - 1 ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Chapter 16 Management Control In.

10 - 1©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton

Chapter 16

Management Control In

Decentralized Organizations

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 10 - 2

Learning Objective 1

Define decentralization and

identify its expected

benefits and costs.


Decentralization

The delegation of freedom to make decisionsis called decentralization.

The lower in the organization that this freedomexists, the greater the decentralization.


Centralization versus Decentralization

Maximum ConstraintsMinimum Freedom

Centralization Decentralization

Minimum ConstraintsMaximum Freedom


Costs and Benefits

Benefits of decentralization:

Lower-level managers have the bestinformation concerning local conditions.

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

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


Costs and Benefits

Costs of decentralization:

Managers may make decisions that are notin the organization’s best interests.

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

Costs of accumulating and processinginformation frequently rise.


Costs and Benefits

Managers in decentralized units may wastetime negotiating with other units about goodsor services one unit provides to the other.


Middle Ground

Cost-benefit considerations usually require that some management decisions be highly decentralized and others centralized.

Decentralization is most successful when an organization’s segments are relatively independent of one another.


Segment Autonomy

If management has decided in favor of heavydecentralization, segment autonomy, the delegationof decision-making power to managers of segmentsof an organization, is also crucial.



Distinguish between profit

centers and decentralization.


Profit Centers and Decentralization

Profit centersAccountability forrevenue and expenses

DecentralizationFreedom to makedecisions

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


Profit Centers and Decentralization

All control systems are imperfect.

Judgments about their merits shouldconcentrate on which alternativesystem will bring more of theactions top management seeks.



Define transfer prices and

identify their purpose.


Transfer Prices

Transfer prices are the amounts charged by one segment of an organization for a product or service that it supplies to another segment of the same organization.


Purpose of Transfer Pricing

Why do transfer-pricing systems exist?

– to communicate data that will lead to goal-congruent decisions

– to evaluate segment performance and thus motivate managers toward goal-congruent decisions


Purpose of Transfer Pricing

Multinational companies use transferpricing to minimize their worldwidetaxes, duties, and tariffs.



Identify the relative advantages

and disadvantages of basing

transfer prices on total

costs, variable costs,

and market prices.


Transfers at Cost

About half of the major companies in the world transfer items at cost.


Transfers at Cost

Variable costs

Full cost

Full cost plus a profit markup

Standard costs

Actual costs

What are some examples?


Market-Based Transfer Prices

If there is a competitive market for the productor service being transferred internally, usingthe market price as a transfer price willgenerally lead to the desired goalcongruence and managerial effort.


Market-Based Transfer Prices

The major drawback to market-based prices is that market prices are not always available for items transferred internally.


Variable-Cost Pricing

When market prices cannot be used, versions of “cost-plus-a-profit” are often used as a fair substitute.


Variable-Cost Pricing

In situations where idle capacity exists,variable cost would generally be thebetter basis for transfer pricing andwould lead to the optimum decisionfor the firm as a whole.


Negotiated Transfer Prices

Companies heavily committed to segment autonomy often allow managers to negotiate transfer prices.


Dysfunctional Behavior

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 on the economic and legal circumstances and the decision at hand.

Organizations may have to make trade-offs between pricing for congruence and pricing to spur managerial effort.



Identify the factors affecting

multinational transfer prices.


Multinational Transfer Pricing Example

An item is produced by Division A in a country with a 25% income tax rate.

It is transferred to Division B in a country with a 50% income tax rate.

An import duty equal to 20% of the price of the item is assessed.

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



Which transfer price should be chosen?

$100 Why?



Income of A is $40 higher:25% × $40 = ($10) higher taxes

Income of B is $40 lower:50% × $40 = $20 lower taxes

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

Net savings = $2



Explain how the linking of

rewards to responsibility

center results affects

incentives and risk.


Link Rewards to Results

Choices of Responsibility Motivational Criteria Centers and Incentives

Choices of Responsibility Motivational Criteria Centers and Incentives

GoalCongruence

GoalCongruence

ManagerialEffort

ManagerialEffort

PerformanceMeasures

PerformanceMeasures RewardsRewards

Feedback

Feedback


Link Rewards to Results

Research shows that the more objective the measures of performance, the more likely the manager will provide effort.

Thus accounting measures, which provide relatively objective evaluations of performance, are important.


Agency Theory

Economists describe the formalchoices of performance measuresand rewards as agency theory.

Employment contracts willtrade off three factors:

2 – Incentive 3 – Risk

1 – Cost of measuring performance



Compute ROI, residual income,

and economic value added (EVA)

and contrast them as criteria for

judging the performance of

organization segments.


Measures of Profitability

Segment managers in decentralized organizations are often evaluated based on their segment’s profitability.

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 ÷ Investment

ROI = IncomeRevenue

RevenueInvestment×


Return on Investment

Project A: Operating income ÷ Investment required

$200,000 ÷ $500,000 = 40%

Project B: Operating income ÷ Investment required

$150,000 ÷ $250,000 = 60%


Residual Income

RI = Net operating income – Imputed interest

Imputed interest refers to the cost of capital.

RI tells you how much your company’s operating income exceeds what it ispaying for capital.


Economic Value Added

Economic value added= Income– After-tax cost of capital× (Long-term liabilities + Stockholders’ equity)



Compare the advantages and

disadvantages of various bases

for measuring the invested

capital used by organization

segments.


ROI or Residual Income?

Why do some companies prefer residual income (or EVA) to ROI?

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

Under RI, the message is go forth and maximizeresidual income, an absolute amount.


Invested Capital

To apply either ROI or residual income,both income and invested capital mustbe measured and defined.

Total assets Total assets employed

Total assets less current liabilities

Stockholders’ equity


Asset Allocation to Divisions

Commonly used bases for allocation, when assets are not directly identifiable with a specific division, include:

Asset ClassCorporate cashReceivablesInventoriesPlant and equipment

Possible Allocation BaseBudgeted cash needsSales weighted by termsBudgeted sales or usageUsage of services


Valuation of Assets

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.

Most companies use net book value incalculating their investment base.



Understand the role of

management control systems

in decentralized organizations.


Keys to SuccessfulManagement Control Systems

Successful management control systemshave several key factors in addition toappropriate measures of profitability.

Controllability Management by objectives

Tailoring budgets for managers


Focus on Controllability

A distinction should be made between the performance of the division manager and the performance of the division as an investment by the corporation.

Managers should be evaluated on the basis of their controllable performance.


Management by Objectives

MBO describes the joint formulation bya manager and his or her superior of aset of goals and plans for achievingthe goals for a forthcoming period.

The manager’s performance is thenevaluated in relation to theseagreed-upon budgeted objectives.


Tailoring Budgets for Managers

Many of the troublesome motivational effects of performance evaluation systems can be minimized by the astute use of budgets.

The desirability of tailoring a budget to particular managers cannot be overemphasized.

10 - 51©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton

End of Chapter 10

10 - 1 ©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Chapter 16 Management Control In.

Documents

management accounting

management decisions

management control

management skills

horngrensundemstratton

benefits managers

managers of segments

delegation of freedom