Cornerstones of Managerial Accounting, 3rd edition

Mowen/Hansen/Heitger

Chapter 12
Learning Objectives

LO1. Explain how and why firms choose to decentralize.

 In a decentralized organization, lower-level managers make and implement
decisions. In a centralized organization, lower-level managers are responsible
only for implementing decisions.
 Reasons why companies decentralize:
 Local managers can make better decisions using local information.
 Local managers can provide a more timely response.
 It is impossible for any one central manager to be fully knowledgeable
about all products and markets.
 Decentralization can train and motivate local managers and free top
management from day-to-day operating conditions so that they can spend time
on more long-range activities, such as strategic planning. Managerial
accounting plays an important role in designing effective performance
measures and incentive systems to help ensure that managers in a
decentralized organization use their decision-making authority in a way that
improves the organization’s performance.
 Four types of responsibility centers are:
 Cost centers—manager is responsible for costs.
 Revenue centers—manager is responsible for price and quantity sold.
 Profit centers—manager is responsible for costs and revenues.
 Investment centers—manager is responsible for costs, revenues, and
investment.
LO2. Compute and explain return on investment.
 ROI is the ratio of operating income to average operating assets.
 Margin is operating income divided by sales or margin times turnover.
  Turnover is sales divided by average operating assets.
 Advantage: ROI encourages managers to focus on improving sales,
controlling costs, and using assets efficiently.
 Disadvantage: ROI can encourage managers to sacrifice long-run benefits for
short-run benefits.
LO3. Compute and explain residual income and economic value added.
 Residual income is operating income minus a minimum percentage cost of
capital times capital employed.
 If residual income > 0, then the division is earning more than the
minimum cost of capital.
 If residual income < 0, then the division is earning less than the minimum
cost of capital.
 If residual income = 0, then the division is earning just the minimum cost
of capital.
 Economic value added is after-tax operating profit minus the actual total
annual cost of capital.
 If EVA > 0, then the company is creating wealth (or value).
 If EVA < 0, then the company is destroying wealth.
LO4. Explain the role of transfer pricing in a decentralized firm.
 Transfer price is charged by the selling division of a company to a buying
division of the same company.
 Increases revenue to the selling division.
 Increases cost to the buying division.
 Common transfer pricing policies are:
 Cost based (e.g., total product cost).
 Market based (price charged in the outside market).
 Negotiated (between the buying and selling divisions’ managers).

Appendix: Summary of Learning Objectives

LO5. Explain the uses of the Balanced Scorecard, and compute cycle time, velocity,
and manufacturing cycle efficiency.
 Balanced Scorecard is a strategic management system.
 Objectives and measures are developed for four perspectives:
 Financial perspective
 Customer perspective
 Process perspective
 Learning and growth perspective
 Velocity is the number of units produced in a period of time.
 Cycle time is the time needed to produce one unit.
 MCE is measured as value-added time divided by total time. The higher the
MCE, the greater the firm’s efficiency.