Managerial Accounting

Wild and Shaw

2010 Edition
McGraw-Hill/Irwin

Copyright 2010 by The McGraw-Hill Companies, Inc. All

Chapter 9
Decentralization and
Performance Evaluation

Conceptual Learning
Objectives
C1: Explain departmentalization and the role of
departmental accounting .
C2: Distinguish between direct and indirect expenses.
C3: Identify bases for allocating indirect expenses to
departments.
C4: Explain controllable costs and responsibility
accounting.
C5: Appendix 9A: Explain transfer pricing and methods
to set transfer prices.
C6: Appendix 9B: Describe allocation of joint costs
across products.
9-3

Analytical Learning Objectives

A1: Analyze investment centers using
return on total assets, residual income
and balanced scorecard.
A2: Analyze investment centers using
profit margin and investment turnover.

9-4

Procedural Learning
Objectives
P1: Prepare departmental income
statements.
P2: Prepare departmental contribution
reports.

9-5

C1

Departmental Accounting
Primary
goals

Provide
Provide information
information
for
for managers
managers to
to use
use
in
in performance
performance
evaluation.
evaluation.

To
Tocontrol
control costs
costs and
and
expenses
expenses and
and assist
assist
With
With evaluating
evaluating
managers
managers
performances.
performances.
9-6

C1

Departmental Accounting
Large complex
businesses are
divided into
departments
enabling managers
to have a smaller
effective span of
control.
9-7

Information for
Departmental Evaluation

C1

The
The accounting
accounting system
system provides
provides information
information
about
about resources
resources used
used and
and outputs
outputs
achieved.
achieved.
Managers use this information to:

Control operations.

Appraise performance.

Allocate resources.

Plan strategy
9-8

C1

Information for
Departmental Evaluation
The
The type
type of
of accounting
accounting information
information provided
provided
depends
depends on
on whether
whether the
the department
department is
is aa .. .. ..
Cost
center

Profit
center

Evaluated
Evaluatedon
on
ability
abilityto
to
control
controlcosts.
costs.

Evaluated
Evaluatedon
onability
ability
to
togenerate
generaterevenues
revenues
in
in excess
excessof
ofexpenses.
expenses.
9-9

C1

Information for
Departmental Evaluation
Investment Center
Evaluated on their use of center
assets to generate income.

9-10

C2

Departmental Expense
Allocation
Direct expenses are
incurred for the sole
benefit of a specific
department.
Indirect expenses
benefit more than one
department and are
allocated among
departments benefited.
9-11

C2

Illustration of Indirect
Expense Allocation
Classic Jewelry pays its janitorial service $300
per month to clean its store. Management
allocates this cost to its three departments
according to the floor space each occupies.

Department
Jewelry
Watch repair
China and silver
Total

Square
Feet
2,400
600
1,000
4,000

Percent
of Total
?

100%

Total
Cost
?
?
?

Allocated
Cost
=
?
=
?
=
?

9-12

C2

Illustration of Indirect
Expense Allocation
Classic Jewelry pays its janitorial service $300
per month to clean its store. Management
allocates this cost to its three departments
according to the floor space each occupies.

Department
Jewelry
Watch repair
China and silver
Total

Square
Feet
2,400
600
1,000
4,000

Percent
Total
Allocated
of Total
Cost
Cost
60% $
300 = $
180
?

?
=
?
?

?
=
?
100%
9-13

C2

Illustration of Indirect
Expense Allocation
Classic Jewelry pays its janitorial service $300
per month to clean its store. Management
allocates this cost to its three departments
according to the floor space each occupies.

Department
Jewelry
Watch repair
China and silver
Total

Square
Feet
2,400
600
1,000
4,000

Percent
Total
Allocated
of Total
Cost
Cost
60% $
300 = $
180
15%
300 =
45
25%
300 =
75
100%
$
300
9-14

C3

Bases for Allocating

Service Department Costs
Service department costs are shared, indirect
expenses that support the activities of two or
more production departments.
Service Department
Office expenses
Personnel expenses
Payroll expenses
Advertising expenses
Purchasing costs
Cleaning expenses
Maintenance expenses

Common Allocation Bases

Number of employees
Number of employees
Number of employees
Sales
Number of Purchase Orders
Floor space occupied
Floor space occupied
9-15

C3

Service Department Costs

Question
ABCO
ABCO allocates
allocates its
its $300,000
$300,000 personnel
personnel cost
cost to
to
operating
operating departments
departments based
based on
on the
the number
number of
of
employees
employees in
in each
each department.
department. The
The assembly
assembly
department
department has
has 100
100 employees
employees and
and the
the packing
packing
department
department has
has 150
150 employees.
employees. What
What amount
amount of
of
cost
cost is
is allocated
allocated to
to assembly?
assembly?
a.
a. $100,000
$100,000
b.
b. $120,000
$120,000
c.
c. $150,000
$150,000
d.
d. $180,000
$180,000
9-16

C3

Service Department Costs

Question
ABCO
ABCO allocates
allocates its
its $300,000
$300,000 personnel
personnel cost
cost to
to
operating
operating departments
departments based
based on
on the
the number
number of
of
employees
employees in
in each
each department.
department. The
The assembly
assembly
department
department has
has 100
100 employees
employees and
and the
the packing
packing
department
department has
has 150
150 employees.
employees. What
What amount
amount of
of
cost
cost is
is allocated
allocated to
to assembly?
assembly?
a.
a. $100,000
$100,000
Assembly percentage
= 100 (100 + 150) = 40%
b.
b. $120,000
$120,000
c.
40% of $300,000 = $120,000
c. $150,000
$150,000
d.
d. $180,000
$180,000
9-17

P1

Preparing Departmental
Income Statements

Lets prepare departmental income statements

using the following steps:

Direct expense accumulation.

Indirect expense allocation.
Service department expense allocation.
9-18

P1

Departmental Expense
Allocation Spreadsheet

9-19

P1

Departmental Expense
Allocation Spreadsheet

Step 1: Direct expenses are traced to service

departments and sales departments without allocation.
9-20

P1

Departmental Expense
Allocation Spreadsheet

Of a total of 12,000 square feet, the service departments

occupy 1,500 square feet each, the hardware department
occupies 4,050 feet, housewares 2,700, and appliances
2250.

Step 2: Indirect expenses are allocated to both the service

and the sales departments based on floor space occupied.
9-21

P1

Departmental Expense
Allocation Spreadsheet

Step 3: The Service department total expenses (original

direct expenses + allocated indirect expenses) from the
two service departments are allocated to three remaining
operating or sales departments.
9-22

P1

Departmental Income Statements

Sales

Cost of goods sold

Gross profit on sales

Hardware

Housewares

Appliances

Dept.

Dept.

Dept.

119,500

73,800
$

45,700

71,700

43,800
$

27,900

47,800

Combined
$

30,200
$

17,600

239,000
147,800

91,200

Operating expenses
Salaries Expense

0
$

15,600

7,000

7,800

30,400

Depreciation Expense

400

100

200

700

Supplies Expense

300

200

100

600

4,860

3,240

2,700

10,800

Utilities Expense

810

540

450

1,800

Advertising Expense

500

300

200

1,000

Insurance Expense

900

600

400

1,900

Share of general office expense

7,650

4,590

3,060

15,300

Share of purchasing expenses

3,880

2,630

3,190

9,700

Rent Expense

Total operating expenses

34,900

19,200

18,100

72,200

Net income (loss)

10,800

8,700

(500)

19,000
9-23

P2

Departmental Income Statement

Sales

Cost of goods sold

Gross profit on sales

Hardware

Housewares

Appliances

Dept.

Dept.

Dept.

119,500

73,800
$

45,700

71,700

43,800
$

27,900

47,800

Combined
$

30,200
$

17,600

239,000
147,800

91,200

Operating expenses
Salaries Expense

0
$

15,600

7,000

7,800

30,400

Depreciation Expense

400

100

200

700

Supplies Expense

300

200

100

600

4,860

3,240

2,700

10,800

Utilities Expense

810

540

450

1,800

Advertising Expense

500

300

200

1,000

Insurance Expense

900

600

400

1,900

Share of general office expense

7,650

4,590

3,060

15,300

Share of purchasing expenses

3,880

2,630

3,190

9,700

Rent Expense

Total operating expenses

34,900

19,200

18,100

72,200

Net income

10,800

8,700

(500)

19,000
9-24

P2

Departmental Contribution to OH
Sales

Cost of goods sold

Gross profit on sales

Hardware

Housewares

Appliances

Dept.

Dept.

Dept.

119,500

73,800

71,700

43,800

Combined

47,800

30,200

239,000
147,800

45,700

27,900

17,600

91,200

15,600

7,000

7,800

30,400

Operating expenses
Direct Expenses
Salaries Expense
Depreciation Expense

400

100

200

700

Supplies Expense

300

200

100

600

16,300

7,300

8,100

31,700

29,400

20,600

9,500

59,500

Total Direct Expenses

Departmental Contributions
To Overhead
Indirect Expenses:
Rent Expense

10,800

Utilities Expense

1,800

Advertising Expense

1,000

Insurance Expense

1,900

Share of general office expense

15,300

Share of purchasing expenses

9,700

Total operating expenses

40,500

Net income

19,000

Contribution as percent of sales

24.6%

28.7%

19.9%

24.9%

9-25

Financial Performance
Evaluation Measures

A1

One of the ways to evaluate

investment center managers is to use
a measure called return on investment
(or return on assets.)
The formula for ROI is as follows:

ROI =

Investment center net income

Investment center average invested assets

9-26

Financial Performance
Evaluation Measures

A1

Another measure of evaluating

financial performance is by computing
the investment centers residual
income.

Residual
Income =

Investment Center - Target investment

net income
center net income

9-27

A1

Balanced Scorecard

The Balanced Scorecard is a system of

performance measures, including nonfinancial measures.
It Is used to assess company and division
performance based on four perspectives:
1. Customer
2. Internal processes
3. Innovation and Learning
4. Financial
9-28

C4

Responsibility Accounting
An accounting system that
provides information . . .
Relating to the
responsibilities of
individual managers.

To evaluate
managers on
controllable items.

9-29

C4

Controllable Costs
Costs are controllable
if the manager
has the power to
determine, or strongly
influence, the amounts
incurred.

Im in
control

A managers
performance
evaluation should be
based on controllable
costs.
9-30

Distinguishing Controllable
and Direct Costs

C4

Direct costs are traced to departments, but

may not be controllable by the department
manager.

Example: Department managers usually

have no control over their own salaries.

Controllable costs are identified with a

particular manager and a definite time
period.

All costs are controllable at some level of

management if the time period is long enough.
9-31

C4

Successful
implementation
of
responsibility
Successful
implementation
of
responsibility
Responsibility
Accounting
accounting
accounting may
may use
use organization
organization charts
charts with
with
clear
clear lines
lines of
of authority
authority and
and clearly
clearly defined
defined
levels
levels of
of responsibility.
responsibility.
B o a r d o f D ir e c to r s
P r e s id e n t
V ic e P r e s id e n t
o f F in a n c e

V ic e P r e s id e n t
o f O p e r a tio n s

V ic e P r e s id e n t
o f M a r k e tin g

S to re M a n a g e r
D e p a rtm e n t M a n a g e r

9-32

C4

Responsibility Accounting
Performance Reports
Amount of detail varies according
to level in organization.

A department manager
receives detailed reports.

A store manager receives

summarized information
from each department.
9-33

C4

Responsibility Accounting
Performance Reports
Amount of detail varies according
to level in organization.
Management by exception:
Upper-level management
does not receive operating
detail unless problems arise.

The vice president of operations

receives summarized information
from each store.
9-34

C4

Responsibility Accounting
Performance Reports
To be of maximum benefit, responsibility
reports should . . .

Be timely.
Be issued regularly.
Be understandable.
Compare budgeted
and actual amounts.

9-35

A2

Investment Center Analysis

We can further examine investment

center performance by splitting down
return on investment into profit margin
and investment turnover:

ROI = Profit Margin X Investment Turnover

This will provide further information on the performance of the unit.

9-36

A2

Profit Margin

The profit margin is the first

component in the expanded equation
and measures the income earned per
dollar of sales.

Profit margin = Investment Center Net Income

Investment Center Sales

9-37

A2

Investment Turnover

The investment turnover measures

how efficiently the company generates
sales from its invested assets.
It is used in the second half of the
expanded ROI formula.

Investment = Investment Center Sales

Turnover Investment Center Average Assets
9-38

End of Chapter 9

9-39