Chapter 23

Performance Evaluation for Decentralized Operations

Study Guide
Do You Know…?
Learning Objective 1: Describe the advantages and disadvantages of decentralized
operations.

□ The characteristics of decentralized operations? (See exercises 1–3)

□ The differences between the various types of responsibility accounting? (See exercises
4–6)

Learning Objective 2: Prepare a responsibility accounting report for a cost center.

□ How to prepare a responsibility accounting report for a cost center in order to

determine if costs were over or under budget? (See exercises 7–9)

Learning Objective 3: Prepare responsibility accounting reports for a profit center.

□ Which types of revenues and expenses a profit manager has authority over for making
decisions? (See exercises 10–12)

□ How to allocate service department charges to a division? (See exercises 13, 15, and 17)

□ How to prepare a responsibility accounting report for a profit center? (See exercises 14,
16, and 18)

Learning Objective 4: Compute and interpret the rate of return on investment, the
residual income, and the balanced scorecard for an investment center.

□ How to calculate the rate of return on investment for a company? (See exercises 19, 21,
and 23)

□ How to calculate the residual income for a company? (See exercises 20, 22, and 24)

□ The classifications of nonfinancial measures on the balanced scorecard? (See exercises

25–27)

1
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2 Chapter 23

Learning Objective 5: Describe and illustrate how the market price, negotiated price,
and cost price approaches to transfer pricing may be used by decentralized segments
of a business.

□ How the various methods used for transfer pricing can affect income of departments?
(See exercises 28–30)

Fill-in-the-Blank Equations
1. Service department charge rate = ____________/total service department usage

2. Rate of return on investment = __________/invested assets

3. Rate of return on investment = _________ × Investment turnover

4. Residual income = Income from operations – (_________ × Minimum rate of return)

5. Increase in supplying division’s income from operations = (Transfer price – __________)

× Units transferred

6. Increase in purchasing division’s income from operations = (Market price – __________)

× Units transferred

Exercises
1. Determine if each of the following is a characteristic of decentralized operations.

a. Many managers of a company making decisions for their division.

b. Managers are more able to focus on the needs of customers by division.

c. Managers report daily to top management regarding changes and decisions to

be made for each division.

2. A new company is trying to decide whether to use centralized or decentralized

operations. All branches will be fairly close together, and top management will have
access to each branch when needed and to supervise. To be aware of the operations,
management would like to make the most of the decisions. Would you suggest
centralized or decentralized operations?

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 Performance Evaluation for Decentralized Operations 3

3. Due to recent expansion, the management of a company is trying to decide if

centralized or decentralized operations would be best. Due to recent location openings,
many new managers were hired, but top management is unsure of the customer
demographics of the area. Would you suggest retaining centralized operations or
switching to decentralized operations?

4. The marketing manager of a company looks to find the best marketing opportunities
with the lowest cost for the company. Is this an example of a cost center, profit center,
or investment center manager?

5. A production manager identifies ways to increase profits by increasing revenue or

decreasing costs, which may include retiring out-of-date machinery and acquiring newer
models. Is this an example of a cost center, profit center, or investment center
manager?

6. The regional manager of a firm looks for ways to branch into new markets or cut costs
for the division in order to increase profits. Is this an example of a cost center, profit
center, or investment center manager?

7. For the month of May in 2015, the Mixing Department of the West Plant incurred the
following costs: factory wages, $27,500; materials, $10,600; utilities, $4,100;
depreciation, $1,200; and supervisor salaries, $9,750. Prepare the supervisor’s
responsibility accounting report if the department had the budgeted amounts shown
below.

Factory wages 2,500 hours at $10.00 per hour

Materials 6,000 units at $1.50 per unit
Utilities $4,150
Depreciation $1,200
Supervisor salaries $9,500

8. For the same month as in Exercise 7, the Bottling Department of the West Plant had the
same budget as the Mixing Department, but incurred the following costs: factory wages,
$22,750; supervisor salaries, $9,750; materials, $10,000; utilities, $3,950; and
depreciation, $1,200. Prepare the supervisor’s responsibility accounting report for the
department and identify the costs that are over budget.

9. Use the information in Exercises 7 and 8 to prepare the responsibility accounting report
for the manager of the West Plant if administration budgeted costs of $10,500 and was
over budget by $650.

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4 Chapter 23

10. Determine if a profit center manager of a division of a picture frame manufacturer has
control over each of the following costs and expenses.

a. Cost of materials used for the division’s production department

b. Sales goals the division’s top selling product

c. Cost of employees’ hourly wage in the department

11. A profit center manager of a company’s eastern sales division is looking at decreasing
the following costs: direct labor, utilities, and purchasing, which is allocated by the
number of requisitions. To do so, the manager plans to do the following: increase
efficiency in production to decrease the number of hours needed, thus decreasing the
direct labor and utilities and ordering larger quantities each purchase to decrease the
number of purchase orders. Are all of the costs the manager would like to decrease
controllable costs?

12. The profit manager of a company would like to decrease the following costs: legal,
purchasing, and direct labor. The company allocates legal by hours billed and purchasing
by number of purchase orders. The company requires that each division meet with the
lawyer for at least twenty hours but allows the manager to make purchase orders. Are
all costs the manager would like to decrease controllable costs?

13. Lazy Day Chairs has two divisions, South and North. The company’s service departments
include Purchasing, Advertising, and Research and Development, which allocate
expenses by number of purchase requisitions, number of advertising promotions, and
number of hours, respectively. The Purchasing Department incurred expenses of
$24,000, while Advertising incurred $14,000, and Research and Development incurred
$16,000. Using the information shown below, allocate the service department expenses
among the divisions.

Service Usage
Research and
Division Purchasing Advertising Development
South 1,200 Purchase requisitions 25 Promotions 3,200 Hours
North 1,800 75 800
Total 3,000 100 4,000

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 Performance Evaluation for Decentralized Operations 5

14. Prepare the divisional income statements for the year ending December 31, 2015, for
Lazy Day Chairs using the information in Exercise 13. The South Division earned
revenues of $152,600 while North earned revenues of $175,800. South incurred
operating expenses of $49,100 while North incurred expenses of $62,300.

15. Clean It Corp. has two sales divisions, CleanPro and Magic Clean. The service
departments of the company include Payroll Accounting, Research and Development,
and Legal, which all allocate expenses by number of payroll checks, hours, and hours
billed. Service departments incurred the following expenses: Payroll Accounting,
$12,000; Research and Development, $28,000; and Legal, $20,000. Use the information
below to allocate the service department expenses among the divisions.

Service Usage
Division Payroll Accounting Research and Development Legal
CleanPro 3,400 Payroll checks 480 Hours 350 Hours billed
Magic Clean 2,600 320 150
Total 6,000 800 500

16. Use the information in Exercise 15 to prepare the divisional income statement for Clean
It Corp. for the year ending September 30, 2015. The Clean Pro division earned revenues
of $125,200 and incurred operating expenses of $50,150. The Magic Clean division
earned revenues of $105,300 and incurred operating expenses of $47,300.

17. Shooz Manufacturing has two divisions, East and West. The service departments used
by the divisions include Advertising, Facilities Management, and Purchasing. Advertising
incurred total expenses of $22,000, while Facilities Management incurred $24,000 and
Purchasing incurred $52,000. Advertising allocates costs by number of advertising
promotions, while Facilities Management allocates costs by hours of assistance, and
Purchasing allocates costs by number of purchase requisitions. Determine the costs to
be allocated to each division using the information shown.

Service Usage
Division Advertising Facilities Management Purchasing
East 450 Promotions 330 Hrs. of assistance 2,200 Purchase requisitions
West 350 420 1,800
Total 800 750 4,000

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6 Chapter 23

18. Prepare Shooz Manufacturing’s divisional income statements for the year ending
December 31, 2015, using the information in Exercise 17. The East Division earned
$194,700 of revenues and incurred $57,200 of operating expenses while the West
Division earned $165,300 of revenue and incurred $41,500 of expenses.

19. Use the operating income determined in Exercise 14 for Lazy Day Chairs to calculate the
rate of return on investment for each division. The South Division owns $208,600 of
invested assets while the North Division owns $230,000. Round percentages to two
decimal places. Which division utilizes its assets more efficiently?

20. Use the information in Exercises 14 and 19 to calculate each division of Lazy Day Chairs’
residual income. The company requires a 25% return for invested assets.

21. Use the information shown below to calculate the profit margin, investment turnover,
and rate of return on investment using the DuPont formula for the company in 2015 and
2016. Determine if changes in the rate of return on investment are favorable or
unfavorable. Round answers to two decimal places.

2016 2015
Sales $ 456,000 $ 420,000
Income from operations 320,000 305,700
Invested assets 1,270,000 1,255,000

22. Using the information in Exercise 21 and a 15% required rate of return, calculate the
residual income.

23. Use the information in Exercise 18 to calculate the rate of return on investment for the
divisions of Shooz Manufacturing. The East Division holds $120,000 of invested assets
while the West Division holds $117,000. Round percentages to two decimal places.

24. Use the information in Exercises 18 and 23 for Shooz Manufacturing to determine the
residual income for each division. The company requires an 18% rate of return on
invested assets.

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 Performance Evaluation for Decentralized Operations 7

25. Determine if each of the following performance measures would be related to

innovation and learning, internal processes, customer service, or financial performance
on a balanced scorecard.

a. Cost variances from budgeted amounts

b. Number of finished goods produced in a day

c. Number of new product lines

26. Would each of the following be found in the innovation and learning, internal processes,
customer service, or financial performance section of a balanced scorecard?

a. Waste and scrap

b. Number of complaints

c. Operating costs

27. Determine if each of the following performance measures would be related to

innovation and learning, internal processes, customer service, or financial performance
on a balanced scorecard.

a. Developing a new market

b. Employee turnover

c. Number of sales returns

28. The South Department of a company has the option to purchase 15,000 units of
materials from outside suppliers for $20 per unit or from the company’s North
Department, which sells the products for $15 per unit to outsiders. The North
Department currently produces and sells 40,000 units but has capacity to produce
60,000 units. The department incurs variable costs of $5 per units and total fixed costs
of $25,000. Determine the change in income for each department using the following
methods:

a. Market price

b. Negotiated price of $17.50

c. Cost approach using the variable product cost per unit

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8 Chapter 23

29. The Red Department has the option to purchase 5,000 units of materials from outside
suppliers for $25 per unit or the Blue Department of the company, which sells to outside
buyers for $22 per unit. The Blue Department is currently at full capacity, producing and
selling 25,000 units and incurring fixed costs of $28,000 and variable costs of $15 per
unit. Determine the change in income for each department using the following
methods:

a. Market price

b. Negotiated price of $22.50

c. Cost approach using the total cost per unit

30. The Purchasing Department can either buy 2,000 units of materials from outside
suppliers for $15 per product or from the company’s Production Department. The
Production Department typically sells finished goods to outside buyers for $10 each. The
Production Department is currently at capacity, producing and selling 10,000 products
each period at a variable cost of $6 per product and incurring total fixed costs of
$22,000. Determine the change in income for each department using the following
methods:

a. Market approach

b. Negotiated price of $13.00

c. Cost approach using the variable cost per unit

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