PRINCIPLES OF MANAGERIAL ACCOUNTING

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PRINCIPLES OF MANAGERIAL ACCOUNTING

• CHAPTER 12

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Responsibility Accounting

• Concerned with designing reports that would help
  motivate managers to make decisions and to take
  actions that are in the best interests of the
  overall organization.
• In a decentralized organization decision making
  is spread throughout the organization.

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• Flow of information
• Starts at the lower levels of the organizations
  structure and moves upward.
• Segment is any part or activity of an
  organization about which a manager seeks cost or
  revenue data.

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Benefits of decentralization

• Top management is relieved of much day-to-day
  problem solving.
• Greater decision making opportunity provides
  valuable training for managers as they rise in
  the organization.
• Increased job satisfaction and provide greater
  incentive for the manager.
• Decisions are made at the level where the problem
  occurs.
• Provides a more effective basis for measuring a
  managers performance.

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Disadvantages of decentralization

• Lower level managers may not understand the big
  picture
• May lead to a lack of coordination among the
  business segments.
• Lower level managers may pursue their own
  objectives rather than for the good of the
  overall organization.
• May lead to lack of communication and cooperation
  among the segments.

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Three types of responsibility centers

• Cost center the manager has control over cost
  and are evaluated based on how well costs are
  controlled at a given level of activity.
• Profit center the manager has control over both
  cost and revenue. Profit center managers are
  usually evaluated based upon performance relative
  to profit targets.
• Investment center the manager has control over
  cost and revenue as well as the use of investment
  funds. Usually evaluated based upon rate of
  return on investment.

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Traceable vs. Common Fixed Costs

• Traceable Fixed Costs are those costs that
  arise because of the existence of a particular
  segment. If a fixed cost is avoidable or if a
  segment were discontinued, then it is a traceable
  cost of that segment. Eg. If the particular
  segment is a product then salaries of the product
  manager and his or her staff, advertising costs
  are traceable.

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Common fixed costs

• Is a fixed cost that supports more than one
  business segment, but is NOT traceable in whole
  or in part to any one of the business segments.
  The cost would continue even if that particular
  segment were discontinued.

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Return on Investment (ROI)

• Investment centers are usually evaluated based
  upon some measure of the rate of return on
  investment (ROI)
• This measurement provides incentives to increase
  profits while controlling the amount of funds
  tied up in an organization.
• ROI Net operating income/Average operating
  assets

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ROI continued

• ROI Net operating income / Average operating
  assets
• Operating income is income before interest and
  taxes.
• Operating assets are cash, A/R, inventory, PPE
  (book value), and all other assets held for
  productive use in the organization.

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ROI Margin and Turnover

• ROI Margin Net operating income / Sales
• The measure of managements ability to control
  operating expenses in relation to salesthe same
  thing as profit margin except that it excludes
  interest and taxes)
• ROI Turnover Sales / Average operating assets
• A measure of the sales that are generated for
  each dollar invested in operating assets.

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How to improve ROI

• Increase sales
• Decrease expenses
• Reduce operating assets This is the focus of
  the JIT movement.

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Criticisms of ROI as a management evaluation

• Tends to emphasize short-run rather than
  long-term performance.
• Neglecting maintenance and training
• Skimping on quality control
• Purchasing lower quality inputs
• When a manager takes over an investment center,
  they typically inherit many committed costs over
  which this manager has little control.

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Residual Income or EVA (Economic Value Added)

• Another approach to measuring performance in an
  investment center.
• Definition Net income in an investment center
  minus the minimum required rate of return on its
  operating assets. The rate of return should be
  based on the firms cost of capital or
  opportunity cost of funds.

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Disadvantage of residual income theory

• Larger divisions naturally have more residual
  income than smaller divisions.
• This measure should be used for comparisons over
  a number of periods for the same divisionnot a
  comparison of divisions.