Decentralization in Organizations
Benefits of
Decentralization
Top management
freed to concentrate
on strategy.
Lower-level decisions
often based on
better information.
Lower level managers can respond quickly to customers.
Lower-level managers
gain experience in
decision-making.
Decision-making
authority leads to
job satisfaction.
Decentralization in Organizations
Disadvantages of
Decentralization
Lower-level managers
may make decisions
without seeing the
“big picture.”
May be a lack of
coordination among
autonomous
managers.
Lower-level manager’s
objectives may not
be those of the
organization.
May be difficult to
spread innovative ideas
in the organization.
Responsibility Accounting
Responsibility
Center
Cost
Center
Profit
Center
Investment
Center
Cost, profit,
and investment
centers are all
known as
responsibility
centers.
Cost Center
A segment whose manager has control over costs, but not over revenues or investment funds.
Profit Center
A segment whose manager has control over both costs and revenues,
but no control over investment funds.
Revenues
Sales
Interest
Other
Costs
Mfg. costs
Commissions
Salaries
Other
Investment Center
A segment whose manager has control over costs, revenues, and investments in operating assets.
Learning Objective 1
Compute return on investment (ROI) and show how changes in sales, expenses, and assets affect ROI.
Return on Investment (ROI) Formula
ROI =
Net operating income
Average operating assets
Cash, accounts receivable, inventory,
plant and equipment, and other
productive assets.
Income before interest
and taxes (EBIT)
Net Book Value versus Gross Cost
Most companies use the net book value of depreciable assets to calculate average operating assets.
Understanding ROI
Margin =
Net operating income
Sales
Turnover =
Sales
Average operating assets
ROI =
Margin × Turnover
Increasing ROI – An Example
Regal Company reports the following:
Net operating income $ 30,000
Average operating assets $ 200,000
Sales $ 500,000
Operating expenses $ 470,000
ROI =
Margin × Turnover
Net operating income
Sales
Sales
Average operating assets
×
ROI =
What is Regal Company’s ROI?
Increasing ROI – An Example
$30,000
$500,000
×
$500,000
$200,000
ROI =
6% × 2.5 = 15%
ROI =
ROI =
Margin × Turnover
Net operating income
Sales
Sales
Average operating assets
×
ROI =
Investing in Operating Assets to Increase Sales
Assume that Regal’s manager invests in a $30,000 piece of equipment that increases sales by $35,000, while increasing operating expenses by $15,000.
Let’s calculate the new ROI.
Regal Company reports the following:
Net operating income $ 50,000
Average operating assets $ 230,000
Sales $ 535,000
Operating expenses $ 485,000
Investing in Operating Assets to Increase Sales
$50,000
$535,000
×
$535,000
$230,000
ROI =
9.35% × 2.33 = 21.8%
ROI =
ROI increased from 15% to 21.8%.
ROI =
Margin × Turnover
Net operating income
Sales
Sales
Average operating assets
×
ROI =
Criticisms of ROI
In the absence of the balanced
scorecard, management may
not know how to increase ROI.
Managers often inherit many
committed costs over which
they have no control.
Managers evaluated on ROI
may reject profitable
investment opportunities.
Learning Objective 2
Compute residual income and understand its strengths and weaknesses.
Residual Income – Another Measure of Performance
Net operating income
above some minimum
return on operating
assets
Calculating Residual Income
(
)
This computation differs from ROI.
ROI measures net operating income earned relative to the investment in average operating assets.
Residual income measures net operating income earned less the minimum required return on average operating assets.
Residual Income – An Example
The Retail Division of Zephyr, Inc. has average operating assets of $100,000 and is required to earn a return of 20% on these assets.
In the current period, the division earns $30,000.
Let’s calculate residual income.
Residual Income – An Example
Motivation and Residual Income
Residual income encourages managers to
make profitable investments that would
be rejected by managers using ROI.
Quick Check ✓
Redmond Awnings, a division of Wrap-up Corp., has a net operating income of $60,000 and average operating assets of $300,000. The required rate of return for the company is 15%. What is the division’s ROI?
a. 25%
b. 5%
c. 15%
d. 20%
Quick Check ✓
Redmond Awnings, a division of Wrap-up Corp., has a net operating income of $60,000 and average operating assets of $300,000. The required rate of return for the company is 15%. What is the division’s ROI?
a. 25%
b. 5%
c. 15%
d. 20%
ROI = NOI/Average operating assets
= $60,000/$300,000 = 20%
Quick Check ✓
Redmond Awnings, a division of Wrap-up Corp., has a net operating income of $60,000 and average operating assets of $300,000. If the manager of the division is evaluated based on ROI, will she want to make an investment of $100,000 that would generate additional net operating income of $18,000 per year?
a. Yes
b. No
Quick Check ✓
Redmond Awnings, a division of Wrap-up Corp., has a net operating income of $60,000 and average operating assets of $300,000. If the manager of the division is evaluated based on ROI, will she want to make an investment of $100,000 that would generate additional net operating income of $18,000 per year?
a. Yes
b. No
ROI = $78,000/$400,000 = 19.5%
This lowers the division’s ROI from 20.0% down to 19.5%.
Quick Check ✓
The company’s required rate of return is 15%. Would the company want the manager of the Redmond Awnings division to make an investment of $100,000 that would generate additional net operating income of $18,000 per year?
a. Yes
b. No
Quick Check ✓
The company’s required rate of return is 15%. Would the company want the manager of the Redmond Awnings division to make an investment of $100,000 that would generate additional net operating income of $18,000 per year?
a. Yes
b. No
ROI = $18,000/$100,000 = 18%
The return on the investment exceeds the minimum required rate of return.
Quick Check ✓
Redmond Awnings, a division of Wrap-up Corp., has a net operating income of $60,000 and average operating assets of $300,000. The required rate of return for the company is 15%. What is the division’s residual income?
a. $240,000
b. $ 45,000
c. $ 15,000
d. $ 51,000
Quick Check ✓
Redmond Awnings, a division of Wrap-up Corp., has a net operating income of $60,000 and average operating assets of $300,000. The required rate of return for the company is 15%. What is the division’s residual income?
a. $240,000
b. $ 45,000
c. $ 15,000
d. $ 51,000
Net operating income $60,000
Required return (15% of $300,000) (45,000)
Residual income $15,000
Quick Check ✓
If the manager of the Redmond Awnings division is evaluated based on residual income, will she want to make an investment of $100,000 that would generate additional net operating income of $18,000 per year?
a. Yes
b. No
Quick Check ✓
If the manager of the Redmond Awnings division is evaluated based on residual income, will she want to make an investment of $100,000 that would generate additional net operating income of $18,000 per year?
a. Yes
b. No
Net operating income $78,000
Required return (15% of $400,000) (60,000)
Residual income $18,000
Yields an increase of $3,000 in the residual income.
Divisional Comparisons and Residual Income
The residual income approach has one major disadvantage.
It cannot be used to compare the performance of divisions of different sizes.
Zephyr, Inc. – Continued
Recall the following information for the Retail Division of Zephyr, Inc.
Assume the following information for the Wholesale Division of Zephyr, Inc.
Zephyr, Inc. – Continued
The residual income numbers suggest that the Wholesale Division outperformed the Retail Division because its residual income is $10,000 higher. However, the Retail Division earned an ROI of 30% compared to an ROI of 22% for the Wholesale Division. The Wholesale Division’s residual income is larger than the Retail Division simply because it is a bigger division.
Learning Objective 3
Compute delivery cycle time, throughput time, and manufacturing cycle efficiency (MCE).
Process time is the only value-added time.
Delivery Performance Measures
Wait Time
Process Time + Inspection Time + Move Time + Queue Time
Delivery Cycle Time
Order Received
Production Started
Goods Shipped
Throughput Time
Manufacturing
Cycle
Efficiency
Value-added time Manufacturing cycle time
=
Delivery Performance Measures
Wait Time
Process Time + Inspection Time + Move Time + Queue Time
Delivery Cycle Time
Order Received
Production Started
Goods Shipped
Throughput Time
Quick Check ✓
A TQM team at Narton Corp has recorded the following average times for production:
Wait 3.0 days Move 0.5 days
Inspection 0.4 days Queue 9.3 days
Process 0.2 days
What is the throughput time?
a. 10.4 days.
b. 0.2 days.
c. 4.1 days.
d. 13.4 days.
A TQM team at Narton Corp has recorded the following average times for production:
Wait 3.0 days Move 0.5 days
Inspection 0.4 days Queue 9.3 days
Process 0.2 days
What is the throughput time?
a. 10.4 days.
b. 0.2 days.
c. 4.1 days.
d. 13.4 days.
Quick Check ✓
Throughput time = Process + Inspection + Move + Queue
= 0.2 days + 0.4 days + 0.5 days + 9.3 days
= 10.4 days
Quick Check ✓
A TQM team at Narton Corp has recorded the following average times for production:
Wait 3.0 days Move 0.5 days
Inspection 0.4 days Queue 9.3 days
Process 0.2 days
What is the Manufacturing Cycle Efficiency (MCE)?
a. 50.0%.
b. 1.9%.
c. 52.0%.
d. 5.1%.
A TQM team at Narton Corp has recorded the following average times for production:
Wait 3.0 days Move 0.5 days
Inspection 0.4 days Queue 9.3 days
Process 0.2 days
What is the Manufacturing Cycle Efficiency (MCE)?
a. 50.0%.
b. 1.9%.
c. 52.0%.
d. 5.1%.
Quick Check ✓
MCE = Value-added time ÷ Throughput time
= Process time ÷ Throughput time
= 0.2 days ÷ 10.4 days
= 1.9%
Quick Check ✓
A TQM team at Narton Corp has recorded the following average times for production:
Wait 3.0 days Move 0.5 days
Inspection 0.4 days Queue 9.3 days
Process 0.2 days
What is the delivery cycle time (DCT)?
a. 0.5 days.
b. 0.7 days.
c. 13.4 days.
d. 10.4 days.
A TQM team at Narton Corp has recorded the following average times for production:
Wait 3.0 days Move 0.5 days
Inspection 0.4 days Queue 9.3 days
Process 0.2 days
What is the delivery cycle time (DCT)?
a. 0.5 days.
b. 0.7 days.
c. 13.4 days.
d. 10.4 days.
Quick Check ✓
DCT = Wait time + Throughput time
= 3.0 days + 10.4 days
= 13.4 days
Learning Objective 4
Understand how to construct and use a balanced scorecard.
The Balanced Scorecard
Management translates its strategy into performance measures that employees understand and influence.
Customer
Learning and growth
Internal business processes
Financial
Performance measures
The Balanced Scorecard: From Strategy to Performance Measures
Financial
Has our financial performance improved?
Customer
Do customers recognize that we are delivering more value?
Internal Business Processes
Have we improved key business processes so that we can deliver more value to customers?
Learning and Growth
Are we maintaining our ability to change and improve?
Performance Measures
What are our financial goals?
What customers do we want to serve and how are we going to win and retain them?
What internal busi- ness processes are critical to providing value to customers?
Vision and Strategy
The Balanced Scorecard: Non-financial Measures
The balanced scorecard relies on non-financial measures in addition to financial measures for two reasons:
Financial measures are lag indicators that summarize the results of past actions. Non-financial measures are leading indicators of future financial performance.
Top managers are ordinarily responsible for financial performance measures – not lower level managers. Non-financial measures are more likely to be understood and controlled by lower level managers.
The Balanced Scorecard for Individuals
A personal scorecard should contain measures that can be influenced by the individual being evaluated and that support the measures in the overall balanced scorecard.
The entire organization should have an overall balanced scorecard.
Each individual should have a personal balanced scorecard.
The balanced scorecard lays out concrete actions to attain desired outcomes.
A balanced scorecard should have measures that are linked together on a cause-and-effect basis.
If we improve one performance measure . . .
Another desired performance measure will improve.
The Balanced Scorecard
Then
The Balanced Scorecard and Compensation
Incentive compensation should be linked to balanced scorecard performance measures.
Employee skills in installing options
Number of options available
Time to install option
Customer satisfaction with options
Number of cars sold
Contribution per car
Profit
Learning and Growth
Internal Business Processes
Customer
Financial
The Balanced Scorecard ─ Jaguar Example
Increase Options
Time Decreases
Strategies
Increase Skills
Results
The Balanced Scorecard ─ Jaguar Example
Employee skills in installing options
Number of options available
Time to install option
Customer satisfaction with options
Number of cars sold
Contribution per car
Profit
Satisfaction Increases
Employee skills in installing options
Number of options available
Time to install option
Customer satisfaction with options
Number of cars sold
Contribution per car
Profit
Results
Cars sold Increase
The Balanced Scorecard ─ Jaguar Example
Satisfaction Increases
Employee skills in installing options
Number of options available
Time to install option
Customer satisfaction with options
Number of cars sold
Contribution per car
Profit
Results
Time Decreases
Contribution Increases
The Balanced Scorecard ─ Jaguar Example
Satisfaction Increases
Employee skills in installing options
Number of options available
Time to install option
Customer satisfaction with options
Number of cars sold
Contribution per car
Profit
The Balanced Scorecard ─ Jaguar Example
Results
Contribution Increases
Profits Increase
If number of cars sold and contribution per car increase, profit should increase.
Cars Sold Increases
Questions
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