ACCOUNTING; Chapter 11

Negatives of decentralization?

•Lower-level managers may make decisions without fully understanding the "big picture." • There may be a lack of coordination among autonomous managers. The balanced scorecard can help reduce this problem by communicating a company's strategy throughout the organization. • Lower-level managers may have objectives that differ from those of the entire organization. This problem can be reduced by designing performance evaluation systems that motivate managers to make decisions which are in the best interests of the company. • It may be difficult to effectively spread innovative ideas in a strongly decentralized organization. This problem can be reduced through the effective use of intranet systems, which enable globally dispersed employees to electronically share ideas.

Cost Center

A business segment whose manager has control over cost but has no control over revenue or investments in operating assets.

Investment Center

A business segment whose manager has control over cost, revenue, and investments in operating assets.

Profit Center

A business segment whose manager has control over revenue but no control over costs or investments in operating assets.

Decentralized Organization

An organization in which decision-making authority is not confined to a few top executives, but rather is spread throughout the organization.

Responsibility Center

Any business segment whose manager has control over revenue, costs or investments in operating assets.

Operating Assets

Cash, Accounts receivable, inventory, plants and equipment, and all other assets held for operating purposes.

What is meant by the term decentralization?

Decentralization spreads decision-making authority across an entire organization, rather than being confined to a few top executives.

Net Operating Income

Income before interest and income taxes have been deducted. (Earnings before interest and taxes)

Distinguish between a cost center, a profit center, and an investment center.

Managers at cost centers have control over costs alone, not profits or investments in operating assets. Service departments such as accounting and finance are generally considered cost centers. Managers at profit centers have control over costs and profits, but not over investments-- similar to the likes of a manager at an amusement park. Investment center managers have control over costs, profits and investments in operating assets, such as the vice president of general motors in North America.

What is meant by the terms margin and turnover in ROI calculations?

Margin is net operating income divided by sales, and is ordinarily improved by increasing selling price, reducing operating expenses, or increasing unit sales. Turnover is sales divided by average operating assets. If excess funds are tied up in operating asset investments, it will depress turnover, and result in a lower ROI.

Margin

Net Operating Income divided by sales

Return on Investment (ROI)

Net operating income divided by average operating assets. It also equals margin multiplied by turnover.

What is meant by residual income?

Residual income is the net operating income that an investment center earns above the minimum required rate of return on operating assets. It measures the net operating income earned less the minimum required rate of return on average operating assets, where as ROI measures income relative to investment in operating assets.

Turnover

Sales divided by average operating assets.

Residual Income

The income that an investment center earns above the minimum required return on its operating assets.

What benefits result from decentralization?

• It enables top management to concentrate on strategy, higher-level decision-making, and coordinating activities. • It acknowledges that lower-level managers have more detailed information about local conditions that enable them to make better operational decisions. • It enables lower-level managers to quickly respond to customers. • It provides lower-level managers with the decision-making experience they will need when promoted to higher level positions. • It often increases motivation, resulting in increased job satisfaction and retention, as well as improved performance.