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Decentralization

12. Chapter. Segment Reporting and Decentralization. Decentralization. Autonomy. Authority to make decisions. Responsibility. Example of Decentralization. Proctor & Gamble. Baby Care. Fabric and Home Care. Food and Beverage. Production. Advantages? Disadvantages?

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Decentralization

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  1. 12 Chapter Segment Reporting and Decentralization Decentralization Autonomy Authority to make decisions Responsibility

  2. Example of Decentralization Proctor & Gamble Baby Care Fabric and Home Care Food and Beverage Production Advantages? Disadvantages? What management control system? Marketing Finance

  3. Responsibility Centers • Cost Center • Profit center • Investment center

  4. Segment Reporting • Possible segments: • divisions w/in a company • product lines w/in a division • Report by segment: • revenues • variable expenses • traceable fixed expenses • Do not allocate common fixed expenses to segments. • segment managers cannot control these Segment margin

  5. Issues in Responsibility Accounting • Responsibility for which expenses? • Gain or loss on sale of equipment? • Depreciation? • Taxes? • Does responsibility require complete control? • Are comparisons meaningful across operating units? • Should common costs ever be allocated?

  6. Evaluating Investment Center Performance Compagnie du Froid Required rate of return 18% Weighted-average cost of capital 15% Tax rate 30%

  7. Fr 3,600 Fr 2,400 Fr 3,800 Fr 10,000 Fr 16,000 Fr 18,000 France Italy Spain Revenue Fr 75,400 Fr 42,500 Fr 59,900 Operating exp 71,600 40,100 56,300 Net income Assets Current assets Fr 2,400 Fr 1,500 Fr 1,200 Plant & equip 22,900 18,700 20,100 Accum deprec. (7,300) (10,200) (5,300) Total assets Current liabilities Fr 4,200 Fr 1,100 Fr 800

  8. Income Investment France Italy Spain Oper. Income Fr 3,800 Fr 2,400 Fr 3,600 Fr 18,000 Fr 25,300 Fr 13,800 Fr 10,000 Fr 20,200 Fr 8,900 Fr 21,300 Fr 15,200 Fr 16,000 Return on Investment (ROI) = Total assets Total assets - current liab. Alternative Investment measures Gross book value

  9. France Italy Spain Oper. Income Fr 3,800 Fr 2,400 Fr 3,600 Fr 18,000 Fr 10,000 Fr 16,000 Residual Income = Income - (Required rate of return x Investment) Total assets ROI Residual income

  10. After tax Total Current Income Assets Liabilities = - [ WACC x ( - )] France Italy Spain Oper. Income Fr 3,800 Fr 2,400 Fr 3,600 Total assets Total assets - current liab. Residual income Fr 560 Fr 600 Fr 720 3 2 1 Fr 13,800 Fr 18,000 Fr 8,900 Fr 10,000 Fr 15,200 Fr 16,000 ROI (assts-c_liab) 27.5% 27.0% 23.7% 1 2 3 Economic Value Added (EVA) EVA

  11. Transfer Prices The price one division charges to another for goods or services. Component Division Cellular Phone Division Micro-transmitter Pocket Cellular

  12. Objectives of transfer pricing system: • Autonomy of the division managers. • Decisions are in the best interest of the firm. • Transfer price fairly represents each manager’s contribution to the firm. • Ease of implementation.

  13. Micro T Pocket C Other Compnts Other Phones Price $ 10.00 $ 60.00 $ 50.00 $ 8.00 DM / unit 2.00 22.00 26.00 1.50 10.00 DL / unit 4.00 13.00 8.00 3.00 CM / unit $ 4.00 $ 15.00 $ 16.00 $ 3.50 $ 2,000 $ 7,500 Units 500 500 3,000 4,500 $48,000 $15,750 Total CM Transfer Pricing Example Component Division Cell Phone Division A transfer price of $10.00. Other phones are higher margin for Cell Phone Division.

  14. Micro T Other Compnts Price $ 10.00 $ 8.00 DM / unit 2.00 1.50 DL / unit 4.00 3.00 CM / unit $ 4.00 $ 3.50 $ 2,000 Units 500 4,500 $15,750 Total CM If Cell Phone Division wants to renegotiate… Component Division 1. Component Division has idle capacity. 2. Component Division is at full capacity. a. $10 mkt for Micro T b. No mkt for Micro T

  15. Pocket C Other Phones Price $ 60.00 $ 50.00 DM / unit 22.00 26.00 10.00 DL / unit 13.00 8.00 CM / unit $ 15.00 $ 16.00 $ 7,500 Units 500 3,000 $48,000 Total CM If Component Division wants to renegotiate… Cell Phone Division 1. Cell Phone Division has idle capacity. a. $10 mkt for Micro T b. No mkt for Micro T 2. Cell Phone Division is at full capacity.

  16. When is a transfer in the best interest of the firm? • Answer: When a price can be found that will satisfy both managers. • If the transfer helps both divisions, it helps the firm as a whole. • Notice that a transfer is not always in the firm’s best interest. 2. Component Division is at full capacity. 2. Cell Phone Division is at full capacity. b. No mkt for Micro T Maximum price = $9 Minimum price = $9.50

  17. Possible Transfer Prices Options Variable cost + opportunity cost Market price Cost + mark-up Negotiated by managers Advantages ensures optimal decisions for the firm a good price if a market exists easy to implement manager autonomy generally good decisions Disadvantages difficult to measure markets often don’t exist or are imperfect too high if supplying division has idle capacity no incentives to control costs; OH allocation games time-consuming

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