Performance Measurement and Responsibility Accounting Chapter 22 PowerPoint Editor: Anna Boulware Copyright © 2016 McGraw-Hill Education. All rights reserved

Performance Measurement and Responsibility AccountingChapter 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 ChiappettaFinancial & Managerial Accounting6th Edition

Wild, Shaw, and ChiappettaFinancial & Managerial Accounting6th Edition

By Geography

By Geography

By Product line

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

Boostsemployee

morale and retention

Decentralization has potential disadvantages which organizations should consider:

Disadvantages of Decentralization

Departmentmanagers

are too focusedon own

department

Decisions of individual departmentsmight 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.

Costcenter

Evaluated on abilityto generate revenues

in excess of expenses.

Profitcenter

Evaluated on abilityto generate return on investment in assets.

Investmentcenter

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 thatprovides information . . .

Responsibility Accounting System

Relating to theresponsibilities of

individual managers.

To evaluatemanagers 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 according to 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 are incurred for the sole benefit 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

Dept. % of Total AllocatedDepartment Sq. Feet Total Sq. Ft Cost CostJewelry 2,400 60% × 800$ = 480$ Watch repair 600 15% × 800 = 120 China and silver 1,000 25% × 800 = 200 Total 4,000 100% 800$

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 Expense Common Allocation BasesWages and Salaries Hours worked in each

department

Rent and Related Expenses Floor space occupied

Advertising Expenses Amount of sales revenue

Equipment Depreciation Hours used in each department

Utilities Expenses Floor space occupied

Indirect expenses can be allocated to departmentsusing a number of allocation bases. Some common indirect

expenses and their allocation bases are:

16P 2

Service Department Common Allocation BasesOffice expenses Number of employeesPersonnel expenses Number of employeesPayroll expenses Number of employeesPurchasing costs Number of Purchase OrdersMaintenance expenses Floor space occupied

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 tracedto each department without allocation.

P 320

Indirect expenses are allocated to all departmentsusing appropriate allocation bases.

Allocation Allocation Allocation Allocation

Service Dept. (Cost Center) General Office

Service Dept. (Cost Center)

PurchasingOperating

Dept. (Profit Center)Hardware

Operating Dept.

(Profit Center) Housewares

21

Departmental Income Statements Step 2: Allocating indirect expenses across departments

P 3

Operating Dept.

(Profit Center)Hardware

Operating Dept.

(Profit Center) Houseware

s

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 DepartmentsService 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 Salaries Payroll 20,000$ 1,000$ 2,000$ 6,000$ 11,000$ Supplies Requisitions 1,500 100 300 400 700 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 ft X $10,000 = $1,000P 3




Service dept. expenses Service Dept. One Sales (2,200) 1,000 1,200 Service Dept. Two EmployeesTotal 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 sales X $2,200 = $1,000P 3

Departmental Expense Allocation SpreadsheetExpense Allocation to DepartmentsService Service Sales Sales



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 employees X $3,400 = $1,400P 3

DepartmentalIncome Statements for

Ames Hardware Company

Sales SalesCombined 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

Sales SalesCombined 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$ Direct expenses Salaries 17,000$ 6,000$ 11,000$ Supplies 1,100 400 700 Total direct expenses 18,100$ 6,400$ 11,700$ Departmental Contribution 31,900$ 13,600$ 18,300$ Indirect expenses Rent 8,000 Utilities 800 Service Department One 2,200 Service Department Two 3,400 Total indirect expenses 14,400$ Net Income 17,500$

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 lessefficient in using its assets to generate income compared

to S-Phone Division.

32A 1

ResidualIncome

Investment CenterNet Income

Target InvestmentCenter 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) 450,000 Residual 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 oninvestment (ROI) =

ProfitMargin

Investmentturnover

×

Investment center salesInvestment center average assets

Investment center incomeInvestment 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 Average Invested Assets

$50,000 $10,000 5


NEED-TO-KNOW

A 2

Need to Know (24-2c)



Return on investment = Net Income Average Invested Assets

$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?

Internal Processes

In which activities must we excel?

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

PerformanceIndicators

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

CycleEfficiency

Value-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 onedivision sells goods or services to another division.

LCD Displays

LCD DivisionS-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 DisplaysLCD 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. 51

C 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

Documents

Performance Measurement and Responsibility Accounting Chapter 22 PowerPoint Editor: Anna Boulware Copyright © 2016 McGraw-Hill Education. All rights reserved