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Decentralization: Responsibility Accounting, Performance Evaluation, and Transfer Pricing

. 1.Define responsibility accounting and describe the four types of responsibility centers.2.Explain why firms chose to decentralize.3.Compute and explain return on investment (ROI), residual income (RI), and economic value added (EVA).4.Discuss the methods of evaluating and rewarding manager

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Decentralization: Responsibility Accounting, Performance Evaluation, and Transfer Pricing

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    4. Responsibility Accounting Responsibility accounting is a system that measures the results of each responsibility center and compares those results with some measure of expected or budgeted outcome. There are four major types of responsibility centers: Cost center Revenue center Profit center Investment center

    5. Reasons for Decentralization 1. Better access to local information 2. Cognitive limitations 3. More timely response 4. Focusing of central management 5. Training and evaluation 6. Motivation 7. Enhanced competition

    6. Measuring the Performance of Investment Centers Return on Investment (ROI) Residual Income (RI) Economic Value Added (EVA)

    7. Components of ROI

    10. Year 1: Sales $30,000,000 $117,000,000 Operating income 1,800,000 3,510,000 Average operating assets 10,000,000 19,500,000 ROI 18 % 18 % Year 2: Sales $40,000,000 $117,000,000 Operating income 2,000,000 2,925,000 Average operating assets 10,000,000 19,500,000 ROI 20 % 15 %

    13. Residual Income Residual income is the difference between operating income and the minimum dollar return required on a company’s operating assets:

    17. Economic Value Added Economic value added (EVA) is after-tax operating profit minus the total annual cost of capital.

    24. Multiple Performance Measurements

    25. Incentive Pay for Managers Why would managers not provide good service? There are three reasons: They may have low ability. They may prefer not to work hard. They may prefer to spend company resources on perquisites.

    26. Managerial Rewards

    30. Impact on divisional performance measures Impact on firm wide profits Impact on divisional autonomy

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