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Chapter 22. Decentralization and Performance Evaluation. Conceptual Learning Objectives. C1: Explain departmentalization and the role of departmental accounting C2: Distinguish between direct and indirect expenses C3: Identify bases for allocating indirect expenses to departments
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Chapter 22 Decentralization and Performance Evaluation
Conceptual Learning Objectives C1: Explain departmentalization and the role of departmental accounting C2: Distinguish between direct and indirect expenses C3: Identify bases for allocating indirect expenses to departments C4: Explain controllable costs and responsibility accounting C5:Appendix 22A: Describe allocation of joint costs across products
Analytical Learning Objectives A1: Analyze investment centers using return on total assets
Procedural Learning Objectives P1: Prepare departmental income statements P2: Prepare departmental contribution reports
Provide informationfor managers to usein performanceevaluation. Assign costs tomanagers who areresponsible forcontrolling the costs. Departmental Accounting C1 Primarygoals
Departmental Accounting C1 Large complex businesses are divided into departments enabling managers to have a smaller effective span of control.
Production Sales Service Departmental Accounting C1 Departments areestablished forspecialized functions.
Information forDepartmental Evaluation C1 The accounting system provides information about resources used and outputs achieved. Managers use this information to: • Control operations. • Appraise performance. • Allocate resources. • Plan strategy
Costcenter Profitcenter Evaluated on ability tocontrol costs. Evaluated on abilityto generate revenuesin excess of expenses. Information forDepartmental Evaluation C1 The type of accounting information provided depends on whether the department is a . . .
CustomerSatisfaction Quality CostEffectiveness Profitability Information forDepartmental Evaluation C1 Information must support these four pillars of any successful business
Departmental Expense Allocation C2 Direct expensesare incurred for the sole benefit of a specific department. Indirect expensesbenefit more than one department and are allocated among departments benefited.
Illustration of IndirectExpense Allocation C2 Exh. 21-7 Classic Jewelry pays its janitorial service $300 per month to clean its store. Management allocates this cost to its three departments according to the floor space each occupies.
Illustration of IndirectExpense Allocation C2 Exh. 21-7 Classic Jewelry pays its janitorial service $300 per month to clean its store. Management allocates this cost to its three departments according to the floor space each occupies.
Illustration of IndirectExpense Allocation C2 Exh. 21-7 Classic Jewelry pays its janitorial service $300 per month to clean its store. Management allocates this cost to its three departments according to the floor space each occupies.
Bases for AllocatingService Department Costs C3 Exh. 21-8 Service department costs are shared, indirect expenses that support the activities of two or more production departments.
Service Department CostsQuestion C3 ABCO allocates its $300,000 personnel cost to operating departments based on the number of employees in each department. The assembly department has 100 employees and the packing department has 150 employees. What amount of cost is allocated to assembly? a. $100,000 b. $120,000 c. $150,000 d. $180,000
Service Department CostsQuestion C3 ABCO allocates its $300,000 personnel cost to operating departments based on the number of employees in each department. The assembly department has 100 employees and the packing department has 150 employees. What amount of cost is allocated to assembly? a. $100,000 b. $120,000 c. $150,000 d. $180,000 Assembly percentage= 100 ÷ (100 + 150) = 40% 40% of $300,000 = $120,000
Let’s prepare departmental income statements using the following steps: • Direct expense accumulation. • Indirect expense allocation. • Service department expense allocation. Preparing DepartmentalIncome Statements P1
Step 1: Direct Expense Accumulation P1 Direct expensesaretracedto eachdepartment without allocation. Service Dept. One Service Dept. Two Operating Dept. One Operating Dept. Two
Step 2: Indirect Expense Allocation P1 Indirect expensesareallocatedto all departmentsusing appropriate allocation bases. Allocation Allocation Allocation Allocation Service Dept. One Service Dept. Two Operating Dept. One Operating Dept. Two
Step 3: Service Department Expense Allocation P1 Service departmenttotal expenses(original direct expenses + allocated indirect expenses) areallocatedto operating departments. Service Dept. One Service Dept. Two Allocation Allocation Operating Dept. One Operating Dept. Two
Let’s examine this three-step allocation procedure forOwl Company. Departmental ExpenseAllocation Spreadsheet P1
Departmental ExpenseAllocation Spreadsheet P1 Step 1:Direct expensesaretracedto service departments and sales departments without allocation.
Departmental ExpenseAllocation Spreadsheet P1 Of a total of 2,000 square feet, the service departments occupy 200 square feet each, sales department one occupies 600 square feet, and sales department two occupies 1,000 square feet. Step 2:Indirect expensesare allocatedto both the service and the sales departments based on floor space occupied.
Departmental ExpenseAllocation Spreadsheet P1 Step 3: Service departmenttotal expenses(original direct expenses + allocated indirect expenses) areallocatedto sales departments. Sales department one has $40,000 in sales and sales department two has $48,000 in sales.
Departmental ExpenseAllocation Spreadsheet P1 Step 3: Service departmenttotal expenses(original direct expenses + allocated indirect expenses) areallocatedto sales departments. Sales department one has 28 employees and sales department two has 40 employees.
DepartmentalIncome Statements P1 Now that we have the costs, let’s do an income statement.
Departmental Contributionto Overhead P1 Departmental revenue– Direct expenses = Departmental contribution Departmental contribution . . . • Is used to evaluate departmental performance. • Is not a function of arbitrary allocations of indirect expenses. A department may be eliminated when its departmental contribution is negative.
Eliminating anUnprofitable Department P1 As a general rule, a department canbe considered a candidate forelimination if its revenues are lessthan its escapable expenses. • Direct expenses are usually escapable. • Indirectexpenses are usually inescapable.
Departmental Contributionto Overhead P2 Let’s recast Owl Company’s income statement using the departmental contribution approach where indirect expenses are not allocated.
Departmental Contributionto Overhead P2 Net income for the company is still $17,500.
Departmental Contributionto Overhead P2 Departmental contributions to indirect expenses (overhead) are emphasized.
Departmental Contributionto Overhead P2 Departmental contributions are positive so neither department is a candidate for elimination.
Controllable Costs C4 I’m in control Costs are controllableif the managerhas the power to determine, or strongly influence, the amounts incurred. A manager’s performance evaluation should be based on controllable costs.
Distinguishing Controllableand Direct Costs C4 Direct costs are traced to departments, but may not be controllable by the department manager. • Example: Department managers usuallyhave no control over their own salaries. Controllable costs are identified with a particular manager and a definite time period. • All costs are controllable at some level of management if the time period is long enough.
Relating to theresponsibilities ofindividual managers. To evaluatemanagers oncontrollable items. Responsibility Accounting C4 An accounting system thatprovides information . . .
Responsibility Accounting C4 Successful implementation ofresponsibility accountingmay use organization charts with clear lines of authority and clearly defined levels of responsibility.
Responsibility AccountingPerformance Reports C4 Amount of detail varies according to level in organization. A store manager receives summarized information from each department. A department manager receives detailed reports.
Responsibility AccountingPerformance Reports C4 Amount of detail varies according to level in organization. Management by exception: Upper-level management does not receive operating detail unless problems arise. The vice president of operations receives summarized information from each store.
Responsibility AccountingPerformance Reports C4 To be of maximum benefit, responsibility reports should . . . • Be timely. • Be issued regularly. • Beunderstandable. • Comparebudgetedand actual amounts.
Joint Costs C5 A single cost incurred in producing or purchasing two or more different products. • Similar to an indirect expensesince it is shared among morethan one cost object. • Example: The cost of crudeoil is a joint cost for manypetrochemical products.
Jointcosts Allocation Allocation Joint Costs and Their Allocation C5 If we allocate the joint costs of raising the animal to the two productsbased on weight, which product would receive the largest cost allocation? Hamburger, because there is more of it.
Jointcosts Allocation Allocation Joint Costs and Their Allocation C5 If we allocate the joint costs of raising the animal to the two products based on sales value, would the steak receive a greater portion of the cost allocation? Yes, steak has a higher sales value than hamburger.
$200,000Joint Cost Value Basis Allocation of Joint Costs C5 Product OneSales value = $80,000 Product TwoSales value = $200,000 Product ThreeSales value = $120,000 Allocate the $200,000 joint cost based on sales value.
