DECENTRALIZATION AND RESPONSIBILITY CENTERS

In general, a company is organized along lines of responsibility. Firms with multiple

responsibility centers usually choose one of two decision-making approaches to manage their
diverse and complex activities: centralized and decentralized. Reasons for Decentralization :
ease of gathering and using local information, focusing of central management, training and
motivating of segment managers, and enhanced competition, exposing segments to market
forces
The benefit of decentralization is that decisions are more likely to be made by managers
who possess the specific local knowledge—not possessed by high level managers—to use the
firm’s resources in the best way possible to maximize firm value.

MEASURING THE PERFORMANCE OF INVESTMENT CENTERS BY USING

RETURN ON INVESTMENT

• Return on Investment
ROI = Operating Income/Average Operating Assets
Average Operating Assets = (Beginning Assets + Ending Assets)/2

• Margin and Turnover

Margin = Operating Income/Sales
Turnover = Sales/Average Operating Assets
ROI = Margin x Turnover

• Advantages of Return on Investment

It encourages managers to focus on the relationship among sales, expenses, and investment,
as should be the case for a manager of an investment center, focus on cost efficiency, and
focus on operating asset efficiency.

• Disadvantages of the Return on Investment Measure

a. It can produce a narrow focus on divisional profitability at the expense of profitability for
the overall firm.
b. It encourages managers to focus on the short run at the expense of the long run.

MEASURING THE PERFORMANCE OF INVESTMENT CENTERS BY USING

RESIDUAL INCOME AND ECONOMIC VALUE ADDED

EVA is an alternate way to calculate residual income that is being used in a number of
companies

• Residual Income
Residual Income = Operating Income – (Minimum Rate of Return x Average Operating
Assets)

• Economic Value Added (EVA)

EVA = After-Tax Operating Income - (Actual Percentage Cost of Capital x Total Capital
Employed)
TRANSFER PRICING

Transfer price is the price charged for a component by the selling division to the buying
division of the same company. The price charged for the transferred good affects both : the
costs of the buying division and the revenues of the selling division. Transfer Pricing Policies
: market price, cost-based transfer prices, and negotiated transfer prices

THE BALANCED SCORECARD—BASIC CONCEPTS

The Balanced Scorecard is a strategic management system that defines a strategic based
responsibility accounting system. Strategy specifies management’s desired relationships
among the four perspectives. Strategy translation, on the other hand, means specifying
objectives, measures, targets, and initiatives for each perspective. The four perspectives :
Financial Perspective (Revenue Growth, Cost Reduction, Asset Utilization), Customer
Perspective (Core Objectives and Measures, Customer Value), Internal (Process) Perspective
(Innovation Process, Operations Process, Post sales Service Process), and Learning and Growth
Perspective (increase employee capabilities, increase motivation, empowerment, and
alignment, and increase information systems capabilities).