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Duchac 2,210 solutions Decentralized Organization A structure in which decision-making authority is delegated as far down the chain of command as possible -All large organizations are de-centralized to some extent Advantages of decentralization: Disadvantages of decentralization: -Responsibility Center: Any part of an organization whose manager has control over and is accountable for cost, profit, or investments Cost Center -The manager of a cost center has control over costs, but NOT over revenue or the use of investment funds. -Usually service departments like accounting, finance, general administration, legal, and personnel -They are expected to minimize costs while providing the level of products and services needed by other parts of the organization. -These managers do not have much control over revenue, so they are evaluated on their ability to control and contain costs. -For example, the manager of a manufacturing facility would be evaluated by comparing actual costs to how much costs should have been for the actual level of output during the period. Profit Center -The manager of a profit center has control over both costs and revenue, but NOT investment funds. example: The manager of Six Flags would be responsible for the revenues and costs, and hence the profits, but not have control over major investments. -Profit center managers are often evaluated by comparing actual profit to targeted or budgeted profit -Evaluations involve comparing actual net income to budgeted net income Investment Center -The manager of an investment center has control over all 3-costs, revenue, and investments in operating assets. example: General Motors VP would have a great deal of discretion over investments in manufacturing, such as investing in equipment to produce more fuel efficient engines. -Responsible for earning an adequate return on investment, once top level managers and board of directors approve -Investment center managers are often evaluated using ROI or residual income measures Why do Decentralized Organizations NEED Responsibility Accounting Systems? -To link lower level managers' decision-making authority with accountability for the outcomes of those decisions. Return on Investment (ROI) -The higher the ROI, the greater the profit earned per dollar invested in the segment's operating assets. ROI = NOI / Average Operating Assets -NOI is income before interest and taxes and sometimes referred to as EBIT (earnings before interest and taxes) -Operating Assets include cash, accounts receivable, inventory, plant and equipment, and all other assets held for operating purposes -NOT included in Operating Assets is land held for future use, an investment in another company, investment in bonds, or a building rented to someone else. Net Book Value -Most companies use the NBV (acquisition cost less accumulated depreciation) of depreciable assets to calculate average operating assets. -Downside is that it INCREASES ROI -Most companies use Net Book Value to compute average operating assets because: -However, using the gross cost of operating assets when calculating ROI is preferable to using NBV because replacing an existing asset will not automatically decrease ROI. -NBV discourages equipment replacement ROI can also be expressed in terms of margin and turnover ROI = Margin x Turnover Margin = Net Operating Income / Sales In other words, ROI = (NOI/Sales) x (Sales/Average Operating Assets) ROI Example Montvale burgers expects the following operating results next month: Sales............100,000 ROI = Margin x Turnover ROI=(10,000/100,000) x (100,000/50,000) Disadvantages of ROI 1) Just telling managers to increase ROI may not be enough because they may not know how to do it or may be inconsistent with the company's strategy. 2) A manager who takes over a business segment typically inherits many committed costs over which they have no control. 3) A manager who is evaluated based on ROI may reject investment opportunities that are profitable for the whole company, but would have a negative impact on the manager's performance evaluation. Residual Income -Another way to measure an investment center's performance -It is the NOI that an investment center earns above the minimum required return on its operating assets. Residual Income = Net Operating Income - -Management should focus on the percentage change in residual income from year to year rather than on absolute amounts when evaluating divisions of different sizes. Economic Value Added (EVA) -An adaptation of residual income that has been adopted by many companies, which modify their accounting principles in various ways. -For example, funds used for research and development are often treated as investments rather than as expenses. -When EVA or Residual Income is used to measure performance, the objective is to maximize the total amount of Residual Income or EVA, not to maximize ROI. Pros and Cons of Residual Income approach -Encourages managers to make decisions that are profitable for the entire company but that would be rejected by managers who are evaluated using the ROI formula. -Major disadvantage is that it cannot be used to compare the performance of divisions of different sizes. Throughput Time (Manufacturing Cycle Time) The elapsed time from when production is started until finished goods are shipped to customers example: Throughput time would occur if I ordered some new Mario Badescu products that had not yet been produced. It would involve the time it takes to produce the products until the time they were shipped out to me Throughput Time = Process time + Inspection time + Move time + Queue time Delivery Cycle Time The elapsed time from when a customer order is received until the finished goods are shipped; the goal is to reduce this measure. example: Delivery cycle time would be the elapsed time from when my Mario Badescu order is processed, until they ship my box out. Delivery Cycle Time = Wait time + Throughput time Manufacturing Cycle Efficiency (MCE) -Computed by relating the value-added time to the throughput time MCE = Value-added time (Process time) / Throughput time -A MCE less than 1 indicates that non-value added time is present -If the MCE is 40%, that means that value-added activities are being performed 40% of the time, meaning that the typical order is being worked on 40% of the time. Balanced Scorecard -Measures like throughput time, delivery cycle time, and MCE are an integrated set of performance measures that are derived from and support a company's strategy. 1) Financial -Compensation should only be tied to balanced scorecard measures after the organization has been successfully managed with it for some time. -If well constructed, the performance measures should link together on cause and effect basis Financial Measures "Has our financial performance improved? What are our financial goals?" -All companies, including non-profits, must generate enough financial resources to stay in operation. -Financial measures are the responsibility of Top Managers Customer Measures "Do customers recognize that we are delivering more value? What customers do we want to serve and how are we going to win and retain them?" Examples: Internal Business Processes Measures "Have we improved key business processes so that we can deliver more value to customers?" -This is what the company does in attempt to satisfy customers, like assembling products in a manufacturing company or handling baggage in an airline company. Examples: Learning and Growth Measures "Are we maintaining our ability to change and improve?" Examples: How can a company increase its Return on Investment (ROI)? Increase sales and reduce operating expenses ROI Example: Last year, Valley reported sales of 800,000, Net Operating Income of 40,000, and Average Operating Assets of 400,000. The company is considering purchase of equipment that will reduce expenses by 20,000 and increase average operating assets by 100,000 and will be purchased using notes payable. Sales will remain unchanged. -How will ROI change if the project is accepted? ROI=Margin x Turnover ROI=(40k/800k) x (800k/400k) = 0.10 ROI
with reduced expenses by 20k and increased aoa by 100,000 ROI will increase from 10% to 12% Why is using the gross cost to measure operating assets when calculating ROI preferable to using the net book value?Why is using the gross cost of operating assets when calculating preferable to using the net book value? Ignores accumulated depreciation, stays constant over time and does not make ROI grow automatically over time and replacing a full depreciated asset with a comparably priced new asset will not adversely affect ROI.
How can a company increase its return on investment ROI quizlet?A manager can always increase his/her return on investment (ROI) by: increasing the operating profit margin.
Which of the following is not one of the three primary types of responsibility centers multiple choice question?The correct answer is d.
There are three types of responsibility centers. These are the investment center, cost center, and profit center. Budget center is not a type of responsibility center.
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Why is using the gross cost of operating assets when calculating ROI preferable to using the net book value quizlet?
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