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Decentralization and Performance Evaluation

Presentation Outline
I. The Concept of Decentralization II. Types of Responsibility Centers III. Evaluating Investment Centers with Return on Investment (ROI) IV. The Balanced Scorecard

I. The Concept of Decentralization


A. Decentralization Defined B. Advantages/Disadvantages of Decentralization C. Two Reasons for Evaluating Subunit Performance D. Responsibility Accounting

A. Decentralization Defined
Firms that grant substantial decision making authority to the managers of subunits are referred to as decentralized organizations. Most firms are neither totally centralized nor totally decentralized.

B. Advantages/Disadvantages of Decentralization
Advantages Better information, leading to superior decisions. Faster response to changing circumstances. Increased motivation of managers Excellent training for future top level executives. Disadvantages Costly duplication of activities. Lack of goal congruence.

C. Two Reasons for Evaluating Subunit Performance


Identification of successful areas of operation and areas in need of improvement. Influence over the behavior of managers. Note that it is quite possible to have a good manager and a bad subunit.
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D. Responsibility Accounting
Managers should only be held responsible for costs and revenues that they control. In a decentralized organization, costs and revenues are traced to the organizational level where they can be controlled.

II. Types of Responsibility Centers


A. Cost Centers B. Profit Centers C. Investment Centers

A. Cost Centers
A cost center is a subunit that has responsibility for controlling costs but not for generating revenues. Most service departments (i.e., maintenance, computer) are classified as cost centers. Production departments may be cost centers when they simply provide components for another department. Cost centers are often controlled by comparing actual with budgeted or standard costs.

B. Profit Centers
A profit center is a subunit that has responsibility of generating revenue and controlling costs. Profit center evaluation techniques include:
Comparison of current year income with a target or budget. Relative performance evaluation compares the center with other similar profit centers.

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C. Investment Centers

An investment center is a subunit that is responsible for generating revenue, controlling costs, and investing in assets. An investment center is charged with earning income consistent with the amount of assets invested in the segment. Most divisions of a company can be treated as either profit centers or investment centers.

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III. Evaluating Investment Centers with Return on Investment (ROI)

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A. The Components of ROI


ROI has a distinct advantage over income as a measure of performance since it considers both income (the numerator) and investment (the denominator). ROI = Income Invested capital
Investment Turnover

Profit Margin

ROI =

Income Sales

Sales Invested capital

The breakdown of the formula shows that managers can increase return by more profit and/or generating more sales for each 13 investment dollar.

B. Measuring ROI Income and Invested Capital


ROI Income Investment center income will be measured using net operating profit after taxes (NOPAT). NOPAT should exclude nonoperating items such as interest expense and nonoperating gains and losses, net of the tax effect. ROI Invested Capital Invested capital is measured as total assets less noninterest bearing current liabilities. Noninterest bearing current liabilities are deducted from total assets because they are a free source of funds and reduce the cost of the investment in assets.
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IV. The Balanced Scorecard

A. The Balanced Scorecard Approach B. The Balanced Scorecard Dimensions C. How Balance is Achieved
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A. The Balance Scorecard Approach


It is tried & tested management system for implementing corporate strategies It is the extension of key concept like TQM,KAIZEN,employee empowerment etc. BSC is a management framework for determining key organizational goals, how to achieve them, monitoring progress & driving results

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B. The Balanced Scorecard Dimensions


Financial Perspective Financial Perspective Is company achieving Is company achieving financial goals? financial goals?

Customer Perspective Customer Perspective Is company meeting Is company meeting customer expectations? customer expectations?

Strategy

Internal Process Internal Process Is company improving Is company improving critical internal processes? critical internal processes?

Learning and Growth Learning and Growth Is company improving Is company improving its ability to innovate? its ability to innovate?

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C. How Balance is Achieved


Performance is assessed across a balanced set of dimensions Quantitative measures (e.g., number of defects) are balanced with qualitative measures (e.g., rate of customer satisfaction). There is a balance of backward-looking and forward-looking measures.

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Summary
Decentralization and Responsibility Accounting Cost, Profit, and Investment Centers ROI Balanced Scorecard

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Thank You

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