CHAPTER 12 Decentralization and Performance Evaluation Slide 12-2 Decentralized Organizations  As firms increase in size and complexity, business segments or subunits are organized  The managers of the segments are granted decision making authority so that the firm will function efficiently and effectively  Firms that grant substantial decision making authority to the managers of subunits are referred to as decentralized organizations Slide 12-3 Learning objective 1: Explain the advantages and disadvantages of decentralization, explain why companies evaluate the performance of subunits and subunit managers, and identify cost centers, profit centers, and investment centers Decentralized Organizations  Most firms are neither totally centralized nor totally decentralized  Typically, decentralization is a matter of degree  A firm is more decentralized if more decision making authority is delegated to sub-unit managers  Performance evaluation can be used to ensure that managers make decisions that are in the best interest of the entire firm Slide 12-4 Learning objective 1: Explain the advantages and disadvantages of decentralization, explain why companies evaluate the performance of subunits and subunit managers, and identify cost centers, profit centers, and investment centers Decentralized Organizations Slide 12-5 Learning objective 1: Explain the advantages and disadvantages of decentralization, explain why companies evaluate the performance of subunits and subunit managers, and identify cost centers, profit centers, and investment centers Advantages of Decentralization  A primary reason is that subunit managers have better information than top management and can respond quicker to changing circumstances  Other reasons include  Some firms decentralize because they believe that managers are more motivated and work harder  Decentralized organizations provide excellent training for future top-level executives Slide 12-6 Learning objective 1: Explain the advantages and disadvantages of decentralization, explain why companies evaluate the performance of subunits and subunit managers, and identify cost centers, profit centers, and investment centers Disadvantages of Decentralization  Decentralization can cause problems  It may result in a costly duplication of activities  Managers may pursue personal goals that are incompatible with the goals of the company as a whole  This problem is called goal congruence  To control goal congruence, companies evaluate the performance of subunit managers Slide 12-7 Learning objective 1: Explain the advantages and disadvantages of decentralization, explain why companies evaluate the performance of subunits and subunit managers, and identify cost centers, profit centers, and investment centers Test Your Knowledge All of the following are advantages of decentralization except: a b c d Faster response to changing circumstances Costly duplication of activities Increased motivation of managers Better information, leading to superior decisions Answer: b Costly duplication of activities Slide 12-8 Learning objective 1: Explain the advantages and disadvantages of decentralization, explain why companies evaluate the performance of subunits and subunit managers, and identify cost centers, profit centers, and investment centers Evaluating Subunits Evaluation of subunits is undertaken to identify successful operations and areas needing improvement Top management may perform incremental analysis to determine: Whether a successful operation should be expanded Whether an unsuccessful operation should be eliminated or improved Slide 12-9 Learning objective 1: Explain the advantages and disadvantages of decentralization, explain why companies evaluate the performance of subunits and subunit managers, and identify cost centers, profit centers, and investment centers Evaluating Subunit Managers  A company evaluates subunit managers in order to motivate them to take actions that maximize the value of the firm  Reasons for evaluating subunit managers:  Identifies successful operations and areas needing improvement  Influences the behavior of managers Slide 12-10 Learning objective 1: Explain the advantages and disadvantages of decentralization, explain why companies evaluate the performance of subunits and subunit managers, and identify cost centers, profit centers, and investment centers Slide 12-51 Learning objective 3: Explain the potential benefits of using a balanced scorecard to assess performance, and discuss how a strategy map can be used to communicate the linkages among the measures in a balanced scorecard Slide 12-52 Learning objective 3: Explain the potential benefits of using a balanced scorecard to assess performance, and discuss how a strategy map can be used to communicate the linkages among the measures in a balanced scorecard You Get What You Measure Slide 12-53 Learning objective 3: Explain the potential benefits of using a balanced scorecard to assess performance, and discuss how a strategy map can be used to communicate the linkages among the measures in a balanced scorecard Developing a Strategy Map for a Balanced Scorecard  A strategy map is a diagram of the relationships of the strategic objectives across the four dimensions of the balanced scorecard  It is useful to test the soundness of the strategy and how the strategy is linked to measures on the scorecard  It is useful to communicates strategic objectives to employees Slide 12-54 Learning objective 3: Explain the potential benefits of using a balanced scorecard to assess performance, and discuss how a strategy map can be used to communicate the linkages among the measures in a balanced scorecard Strategy Map Example Slide 12-55 Learning objective 3: Explain the potential benefits of using a balanced scorecard to assess performance, and discuss how a strategy map can be used to communicate the linkages among the measures in a balanced scorecard Keys to a Successful Balanced Scorecard  Targets  For each measure, there should be a target so managers know what they are expected to achieve  Initiatives  For each measure, the company must identify actions that will be taken to achieve the target Slide 12-56 Learning objective 3: Explain the potential benefits of using a balanced scorecard to assess performance, and discuss how a strategy map can be used to communicate the linkages among the measures in a balanced scorecard Keys to a Successful Balanced Scorecard  Responsibility  A specific employee must be given responsibility/accountability for the implementation of each initiative  Funding  Initiatives must be funded appropriately  Top Management Support  It is crucial to have the full support of top management Slide 12-57 Learning objective 3: Explain the potential benefits of using a balanced scorecard to assess performance, and discuss how a strategy map can be used to communicate the linkages among the measures in a balanced scorecard Slide 12-58 Learning objective 3: Explain the potential benefits of using a balanced scorecard to assess performance, and discuss how a strategy map can be used to communicate the linkages among the measures in a balanced scorecard Evaluation Slide 12-59 Learning objective 3: Explain the potential benefits of using a balanced scorecard to assess performance, and discuss how a strategy map can be used to communicate the linkages among the measures in a balanced scorecard Appendix - Transfer Pricing  The transfer price is the price that is used to value internal transfers of goods or services  For external financial reporting purposes, a company cannot recognize revenue on the sale of goods between responsibility centers within the firm  The revenue has not been realized Slide 12-60 Learning objective A1: Discuss the use of market price, variable cost, full cost plus profit, and negotiation in setting transfer prices Methods of Setting the Transfer Price  In practice, a number of different approaches are taken to setting transfer prices     Slide 12-61 Market price Variable costs Full cost plus profit Negotiated prices Learning objective A1: Discuss the use of market price, variable cost, full cost plus profit, and negotiation in setting transfer prices Methods of Setting the Transfer Price  The most appropriate transfer price depends on the circumstances  Should lead subunit managers to make decisions that maximize firm value  Since there is no arm’s length transaction, revenue is not recognized for financial reporting purposes  Motivation of best decision is measured by opportunity cost of producing an item and transferring it inside the company Slide 12-62 Learning objective A1: Discuss the use of market price, variable cost, full cost plus profit, and negotiation in setting transfer prices Lowering Transfer Price Below the Market Price Slide 12-63 Learning objective A1: Discuss the use of market price, variable cost, full cost plus profit, and negotiation in setting transfer prices Slide 12-64 Learning objective A1: Discuss the use of market price, variable cost, full cost plus profit, and negotiation in setting transfer prices Copyright © 2016 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein Slide 12-65 .. .CHAPTER 12 Decentralization and Performance Evaluation Slide 12- 2 Decentralized Organizations  As firms increase in size and... cost centers, profit centers, and investment centers Responsibility Accounting and Performance Evaluation  Responsibility accounting is a technique that holds managers responsible only for costs... prominent role in the design of accounting systems used to evaluate managers  Costs and revenues are traced to the organizational level where they can be controlled Slide 12- 11 Learning objective 1: