ACCT 2200 - Chapter 10

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Chapter 10Decentralized PerformanceEvaluation

ACCT 2200

PROFESSOR THOMAS BOURVEAU

7/23/2019 ACCT 2200 - Chapter 10


List and explain the advantages anddisadvantages of decentralization.

Learning Objective 10-1

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Decentralization of Responsibility

Decentralization often occurs as organizations continue to grow.

Decentralization pushes

decision making down

to lower-level managers.

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Decentralization of Responsibility

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Describe the different types ofresponsibility centers and explain

how managers in each type are

evaluated.


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Responsibility Centers

Responsibility accounting gives managers authorityand responsibility for a particular part of the

organization and then evaluates them based on theresults of that area of responsibility.

Managers of responsibility

centers should be heldresponsible only for thatwhich they can control.

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Describe the four dimensions of thebalanced scorecard and

explain how they are used to

evaluate managerial performance.


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The Balanced ScorecardManagement translates its strategy into

performance measures that employees understand

and accept.

Performancemeasures

Customers

Learning

and growth

Internal

business

processes

Financial

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The Balanced Scorecard

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The Balanced Scorecard

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Compute and interpret return on

investment, investment turnover, and

profit margin.


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Return on Investment (ROI)

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Compute and interpret residual

income.


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Residual Income

Residual income is the organization’s extra

profit, over and above that needed to cover

the required return on invested assets.

The hurdle rate is the required return

on invested assets, sometimes called

the cost of capital.

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Residual Income

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ROI versus Residual Income As the store manager at Apple’s Online Store, you have the opportunity to

invest $1,000,000 in a project promising a return of $150,000 (15percent).

The company requires a minimum return of 10 percent on all projects, sothe project would be acceptable from the company’s perspective.

Would you invest in this project?

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ROI versus Residual Income

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Limitations of Financial

Performance MeasuresBoth ROI and residual income are lagging indicators of

financial performance. These measures tell how well a

company or a division has done in the past but not

necessarily how well it will do in the future.

To improve short-run financial

results, managers may make harmful

decisions to cut costs in areas such

as research and development,employee training, or quality of

manufacturing materials.

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Annual financial data forHotels Desfleurs

for 2011

Let’s assume that the group’s required rate of investments is 12%.

Compute the Return on investment and the residual income for eachhotel of the group.

Assume that the group has an expansion opportunity of Vaison Hotel

that will increase operating profit by €160,000 and increase total assetsby €800,000. Should they do it?

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22

Vaison

Hotel

Perpignan

Hotel

La Rochelle

hotelTotal

Hotel revenues (sales) €1,200,000 €1,400,000 €3,185,000 €5,785,000

Hotel variable costs 310,000 375,000 995,000 1,680,000

Hotel fixed costs 650,000 725,000 1,680,000 3,055,000Hotel operating profit €240,000 €300,000 €510,000 €1,050,000

Interest costs on long-term debt at 10% - - - 450,000

Profit before income taxes - - - 600,000

Income taxes at 30% - - - 180,000

Net profit - - - €420,000

Average book values for 2011

Current assets €400,000 €500,000 €600,000 €1,500,000

Long-term assets 600,000 1,500,000 2,400,000 4,500,000

Total assets €1,000,000 €2,000,000 €3,000,000 €6,000,000

Current Liabilities €50,000 €150,000 €300,000 €500,000

Long-term debt - - - 4,500,000Stockholders' equity - - - 1,000,000

Total liabilities and shareholder equity €6,000,000

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Desfleurs: ROI

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R et ur n o n I nv es tm en t ( RO I)

Hotel Operating profit ÷ Total assets = ROI

Vaison €24 0 0 00 ÷ €1 000 000 = 24%

Perpignan €30 0 0 00 ÷ €2 000 000 = 15%

L a R oc he l le €51 0 0 00 ÷ €3 000 000 = 17%

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Desfleurs: Residual income

24

Hotel Operating Profit -Required rate of return X

investment=

Residual

income

Vaison €240,000 - €120,000 (= 12% x €1,000,000) = €120,000

Perpignan €300,000 - €240,000 (= 12% x €2,000,000) = €60,000

La Rochelle €510,000 - €360,000 (= 12% x €3,000,000) = €150,000

Let’s assume Desfleurs’ required rate of investments is 12%

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Assume◦ Desfleurs requires a rate of return on investment of 12%

◦ Expansion of Vaison Hotel will increase operating profit by €160,000 andincrease total assets by €800,000

For Desfleurs, expansion makes sense:

◦ ROI of expansion is 20% (€160,000 ÷ € 800,000)

For Vaison Hotel?◦ Pre-expansion ROI: €240,000 ÷ € 1,000,000 = 24%

◦ Post-expansion ROI:

25

€240,000 + €160,0000

€1,000,000 + €800,000

€400,000

€1,800,000

= 22.2%

Oh oh! Vaison’s ROI will decrease andmaybe also the managers’ bonus!

Manager is not too happy.

=

Problem ofsuboptimization

ACCT 2200 - Chapter 10

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