Performance Evaluation of Business Units PERTEMUAN XIII Dr Rilla Gantino, SE., AK., MM MM-FEB

Teks penuh


Performance Evaluation of Business Units PERTEMUAN XIII






Proft centers and proft computationsTransfer pricing

National Youth Association

HCC Industries


Decentralization and

performance evaluation

Performance evaluation

becomes necessary when

decision rights are delegated.

Do owners evaluate


Decentralization: Why?


Information specialization

Timeliness of response

Conservation of central management


Computational complexity

Training of local managers


Responsibility centers:

Standard cost centers - production


Revenue centers - revenue variances

Discretionary expense centers

Proft centers - some measure of proft

Investment centers - some proftability


Problems associated with


Goal congruence



Responsibility accounting:

This refers to the various concepts

and tools used by managerial

accountants to measure the

performance of people and


Key concepts in responsibility



The controllability principle

Controllability problems


Designing an accounting-based

performance measure:

Representing fnancial (and other)


Choosing income and investment


Choosing measures for income and

investment numbers

Choosing a target


Proft centers:

Proft center: A proft center is a unit for

which the manager has the authority to make decisions on sources of supply and choices of markets.

Proft measurement:

Variable contribution margin Controllable contribution

Divisional contribution


John Daly

Suppose that a year or more ago, John Daly, who owned the rights to produce a nifty new product, believed the product, Nifty, would be quite proftable if economical production facilities could be located. After much

investigation, John located a small building on the edge of town that was reasonably cheap, even though it was actually


John Daly continued:

The building contained 150,000 square feet of usable space and cost $100,000 per year to rent. John’s manufacturing operation required about 75% of this space.

In his frst year of operation, the company

earned about $100,000 in operating income. John paid his manager a salary, but rewarded exceptional efort by sharing profts.


John Daly continued

A friend of John’s had an idea for using the excess space in the facility and he asked John to fnance the operation. Once the

friend had explained his idea, John agreed. New equipment was purchased, and the new product, New, was manufactured and sold, along with Nifty, during the second year of operation. There was no incremental


John Daly continued

Once the costs that could be directly associated with the new product were deducted, operating profts had increased by $25,000. Nifty’s

results were the same as in year one.


Investment centers: ROI and

Residual Income

Investment centers: The manager has been given maximum discretion for making short-run operating decisions on product mix, pricing and production

methods, as well as the level and type of assets to be used.


Simple example: ROI

The Division A manager earns $50,000 on his controllable investment of $350,000. His ROI is:


What income number?


Residual income

Residual income is as close as an accountant comes to computing economic profit. It is operating income after paying all providers of capital.

Residual income =

Operating income - the cost of capital


Simple example: Residual


Division A:

Operating income $50,000

Cost of capital (42,000)

Residual income $ 8,000

The cost of capital in dollars is just the per dollar opportunity cost of investors’ capital times the size of their investment.


Which performance

measure is better?

Simple example: The investors’ cost of capital remains 12% throughout.

Division A:Assets = $350,000 Income = $50,000

ROI = 14.3%

Suppose the division manager is considering investing $15,000 in an asset that will earn $2,000 in income.


Decision 1: Will she take the


Decision 2: Simple example

Suppose the division manager is considering disposing of an asset with a book value of $20,000 which earns $2,500 in income during any accounting period. Will he dispose of the asset?



Residual income: Decision


Suppose now that the division manager’s performance evaluation measure is residual income. Will the manager choose to invest in a new assets that makes $2,000 per year and costs $15,000?

What is the current residual income? $8,000


Residual income: Decision


Will the Division A manager who is evaluated using

residual income dispose of an asset with annual earnings of $2,500 and a book value of $20,000?

New residual income$47,500 controllable cont. (39,600) new cost of capital


Compare divisons: ROI and

residual income

Division A

Assets: $350,000 Contrib: $50,000 ROI: 14.3%

Division B

Assets: $250,000 Contrib: $37,500 ROI: 15%

Which division is more profitable?

What rate of return does the larger division make on its additional assets?


Proft centers: HCC


Participatory budgeting

Setting budget performance targets

Risk sharing and risk setting

Communicating using the budget

There are no actual calculations to

do for

HCC Industries


Proft centers and transfer




Objectives of transfer pricing schemes:

Encourage managers to make decisions

that are in the organization’s best


Provide information for evaluation of

business units and managers.

Minimize tax obligations (we will ignore)

Constraint: The scheme chosen should

require little intervention by top


The unifying principle is opportunity


The general transfer pricing rule: T = VC + OC






Transfer pricing: Crossville Company

At practical capacity, the Fabricating Division of Crossville Company has facilities to produce 8,000 units per month. Each unit requires five direct labor hours. The Assembly Division has forwarded a requisition for 8,000 units to the Fabricating Division. Since Crossville uses a market-based transfer pricing system,

contribution margin using a $50 market price would be $168,000.

Georges, Inc., a competitor, also sells the units for $50. The receipt of this requisition from Assembly upset the Fabricating manager as he had just been approached by an outside buyer with a rush order for 5,000 units at a $56 unit selling price.


Crossville Company

A. Does top management have a transfer pricing policy?

B. What is the minimum transfer price required by the selling division, Fabricating?

$53.75, the immediate average market price

C. What is the maximum transfer price required by the buying division?


Crossville Company

D. Will the two division managers agree to the transfer?


Division Selling Division


Crossvillle Company

Which of the following circumstances will lead

to goal congruence between the managers and the overall firm? Why?

1. The policy enforced is market price transfers.

Will the managers agree to transfer?

Is the transfer in the best interest of the company?


Crossville Company

Is the transfer in the best interest of the company? Minimize costs:

Internal transfer: Relevant cost of product = $53.75

External transfer: Fab: ($53.75) - 29 = ($24.75) Assy: $50.00

Relevant cost of product = $25.25 Note: $168,000 / 8,000 = $21 = CM/unit

Therefore, VC = $29 per unit


Crossville Company

2. Fabricating has adequate idle capacity.

This means that there is no meaningful market price for the items that would be transferred.

Internal transfer: Fab’s outlay cost = $29 Assy’s outlay cost = $0

External transfer Fab’s outlay cost = $0 Assy’s outlay cost = $50

What price will the Fabrication manager ask?


Crossville Company

3. Fabricating is forced to transfer product in lieu of selling 5,000 units outside.

Fabrication manager gets $50 Assembly manager pays $50

Internal transfer: $53.75 relevant cost

External transfer: $24.25 relevant cost


Negotiated market-based


Some form of outside market for the

intermediate product.

Sharing of all market information

among the negotiators.

Freedom to buy or sell outside. This

provides the necessary discipline to

the bargaining process.

Support and occasional involvement


Its limitations:

Time consuming

Leads to confict within frms

It makes the measurement of

divisional proftability sensitive to the

negotiating skills of managers.

It requires the time of top

management to oversee and mediate.

It may lead to a suboptimal level of



Transfer pricing.

Reward functions are as follows:

Total points = 300

Your fraction of the 300 points:

Your team’s margin/Overall corporate margin

These points will be used to award