CONCEPTUAL
Direct expenses are traced to a specific
department and are incurred for the sole benefit of that
department. Indirect expenses benefit more than one department.
Indirect expenses are allocated to departments when computing
departmental net income. Ideally, we allocate indirect
expenses by using a causeeffect relation for the allocation base. When a
cause-effect relation is not identifiable, each indirect
expense is allocated on a basis reflecting the relative benefit received
by each department.
Transfer prices are used to
record transfers of items between divisions of the same company.
Transfer prices can be based on costs or market prices, or can be
negotiated by division managers.
A joint cost refers
to costs incurred to produce or purchase two or more products at the
same time. When income statements are prepared, joint costs are
usually allocated to the resulting joint products using either a physical or
value basis.
ANALYTICAL
A financial measure often used to evaluate
an investment center manager is the return on investment, also called return
on assets. This measure is computed as the center’s income divided
by the center’s average total assets. Residual income, computed as
investment center income minus a target income is an alternative financial measure of investment center
performance.
Return on investment can also
be computed as profit margin times investment turnover. Profit margin
(equal to income/sales) measures the income earned per dollar of sales,
and investment turnover (equal to sales/assets) measures how
efficiently a division uses its assets.
A balanced scorecard uses a
combination of financial and nonfinancial measures to evaluate performance. Customer,
internal process, and innovation and learning are the three primary perspectives
of nonfinancial measures used in balanced scorecards.
It is important for
companies to reduce the time to produce their products and to
improve manufacturing efficiency. One measure of that time is cycle
time (CT), defined as Process time + Inspection time + Move time + Wait time.
Process time is value-added time; the others are non-value-added time. Cycle efficiency
(CE) is the ratio of value-added time to total cycle time. If CE is low,
management should evaluate its production process to see if it can
reduce non-value-added activities.
PROCEDURAL
Responsibility accounting systems provide
information for evaluating the performance of department managers.
A responsibility accounting system’s performance reports for evaluating
department managers should include only the expenses (and revenues)
that each manager controls.
Indirect expenses include
items like depreciation, rent, advertising, and other expenses
that cannot be assigned directly to departments. Indirect expenses are
recorded in company accounts, an allocation base is identified for each expense, and costs are allocated
to departments. Departmental expense allocation spreadsheets are
often used in allocating indirect expenses to departments.
Each profit center
(department) is assigned its expenses to yield its own income statement. These costs
include its direct expenses and its share of indirect expenses. The
departmental income statement lists its revenues and costs of goods
sold to determine gross profit. Its operating expenses
(direct expenses and its indirect expenses allocated to the department) are
deducted from gross profit to yield departmental net income. The departmental contribution
report is similar to the departmental income statement in terms of computing the gross
profit for each department. Then the direct operating expenses for each
department are deducted from gross profit to determine the contribution
generated by each department. Indirect operating expenses are deducted in total from the company’s
combined contribution.
Guidance Answers to Decision
Maker
Division Manager
Your division’s ROI without further action is 10.5% (equal
to 7% × 1.5).
In a highly competitive industry,
it is difficult to increase profit margins by raising prices. Your division might be better able to control its costs to
increase its profit
margin. In addition, you might engage in a marketing program to increase sales
without increasing your division’s invested assets. Investment turnover and thus ROI
will increase if the
marketing campaign attracts customers.
We must first realize that the two investment opportunities are not comparable
on the basis of absolute dollars of income or on assets. For instance, the
second investment provides a higher
income in absolute dollars but requires a higher investment. Accordingly, we need to compute return on investment for each
alternative: (1) $50,000 ÷ $250,000 = 20%, and (2) $175,000 ÷ $1 million = 17.5%. Alternative 1 has
the higher return and is preferred over alternative 2. Do you pursue one, both, or
neither? Because
alternative 1’s return is higher than the center’s usual return of 19%, it should
be pursued, assuming its risks are acceptable. Also, since alternative 1 requires a small
investment, top management is likely to be more agreeable to pursuing it. Alternative 2’s return is lower than the usual
19% and is not likely to be acceptable.
Comments
Post a Comment