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    Seung Hyun Bae
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    This document discusses internal control and decentralization within large organizations. It explains that firms establish multiple responsibility centers and put managers in charge of each to combat the fact that a single person cannot directly oversee the entire organization and people may pursue their own interests. Each responsibility center is controlled through incentives rather than direct commands. Common types of responsibility centers include standard cost centers, discretionary cost centers, revenue centers, profit centers, and investment centers which are evaluated based on accounting metrics like return on investment. The document also notes some potential problems with using return on investment and residual income to evaluate investment centers.

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    UCLA MGMT 122

    Original Title

    Mng Accounting Week 9

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    This document discusses internal control and decentralization within large organizations. It explains that firms establish multiple responsibility centers and put managers in charge of each to combat the fact that a single person cannot directly oversee the entire organization and people may pursue their own interests. Each responsibility center is controlled through incentives rather than direct commands. Common types of responsibility centers include standard cost centers, discretionary cost centers, revenue centers, profit centers, and investment centers which are evaluated based on accounting metrics like return on investment. The document also notes some potential problems with using return on investment and residual income to evaluate investment centers.

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    © All Rights Reserved
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    22 views7 pages

    Internal Control Management 122: Michael Williams

    Uploaded by

    Seung Hyun Bae
    This document discusses internal control and decentralization within large organizations. It explains that firms establish multiple responsibility centers and put managers in charge of each to combat the fact that a single person cannot directly oversee the entire organization and people may pursue their own interests. Each responsibility center is controlled through incentives rather than direct commands. Common types of responsibility centers include standard cost centers, discretionary cost centers, revenue centers, profit centers, and investment centers which are evaluated based on accounting metrics like return on investment. The document also notes some potential problems with using return on investment and residual income to evaluate investment centers.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
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    Download as pptx, pdf, or txt
    of 7

    Internal Control

    Management 122
    Michael Williams

    Decentralization
    Large organizations cannot be directly overseen
    by a single person.
    People are inherently selfish, so if not directly
    controlled, they will maximize their utility, not
    the organizations objectives.
    To combat this, firms establish numerous
    responsibility centers.
    Someone is put in charge of each center and held
    responsible for its achievements.

    Decentralization
    Each responsibility center is controlled by top
    management through incentivization, not direct
    command.
    The manager of the division is evaluated on
    certain accounting metrics.
    Incentives for the manager must be aligned with
    the best interests of the firm.
    Ideally, responsibility should match control.
    Penalizing a person for someone elses mistake is
    inefficient and bad for morale.

    Decentralization
    Pros

    Cons

    Reduces burden on top


    management

    Top management includes


    better decision makers

    People lower in the hierarchy


    will serve their own interests

    People lower in the hierarchy


    will serve their own interests

    Improve reaction time

    Responsibility centers
    Standard cost center

    Efficiency variances

    Discretionary cost center

    Non-financial output measures

    Revenue center

    Sales volume and price variances

    Profit center

    Actual - budgeted profit

    Investment center

    Return on investment (ROI)


    or residual income (RI)

    ROI = Profit / Investment


    RI = Profit Investment x cost of capital

    Problems with ROI and RI


    ROI can discourage positive NPV investments if ROI > cost of
    capital.
    The new ROI will be a weighted average of the old ROI and the
    new projects ROI.
    Even a good project could water down ROI in a highly profitable
    division.

    Both ROI and RI can discourage positive NPV investments if


    the manager has a short horizon.
    This is a problem when the manager expects to move to a new
    position in the near future.
    Investments are typically costly in the early years and pay off
    later. By then, the manager will be gone.

    Problems with ROI and RI


    Both ROI and RI can encourage negative NPV
    investments if the manager has a long horizon.
    This occurs when a new manager takes over.
    Early performance doesnt matter. You can blame
    bad results on your predecessor.

    Both ROI and RI are based on profit and


    investment measures that are potentially
    inaccurate and manipulable.

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