Chapter 16
Management Control In
Decentralized
Learning Objective 1
Define decentralization and
identify its expected
Decentralization
The delegation of freedom to make decisions is called decentralization.
Centralization versus
Decentralization
Maximum Constraints
Centralization Decentralization
Costs and Benefits
Benefits of decentralization:
Lower-level managers have the best
information concerning local conditions. It promotes management skills which,
Costs and Benefits
Costs of decentralization:
Managers may make decisions that are not in the organization’s best interests.
Costs and Benefits
Middle Ground
Cost-benefit considerations usually require
that some management decisions be highly decentralized and others centralized.
Decentralization is most successful when an
Segment Autonomy
If management has decided in favor of heavy
Learning Objective 2
Distinguish between profit
Profit Centers and
Decentralization
Profit centers Accountability forrevenue and expenses
Decentralization Freedom to make
decisions
Profit Centers and
Decentralization
All control systems are imperfect.
Judgments about their merits should concentrate on which alternative
Learning Objective 3
Transfer Prices
Transfer prices are the amounts charged by
one segment of an organization for a
Purpose of Transfer Pricing
Why do transfer-pricing systems exist?
– to communicate data that will lead to goal-congruent decisions
– to evaluate segment performance and thus motivate managers toward
Purpose of Transfer Pricing
Learning Objective 4
Identify the relative advantages
and disadvantages of basing
transfer prices on total
costs, variable costs,
Transfers at Cost
About half of the major companies in the
Transfers at Cost
Variable costs
Full cost
Full cost plus a profit markup
Standard costs Actual costs
Market-Based Transfer Prices
If there is a competitive market for the product or service being transferred internally, using
the market price as a transfer price will generally lead to the desired goal
Market-Based Transfer Prices
The major drawback to market-based prices
is that market prices are not always
Variable-Cost Pricing
When market prices cannot be used,
Variable-Cost Pricing
In situations where idle capacity exists, variable cost would generally be the
Negotiated Transfer Prices
Companies heavily
Dysfunctional Behavior
The Need for Many Transfer
Prices
The “correct” transfer price depends on the
economic and legal circumstances and the decision at hand.
Organizations may have to make trade-offs
Learning Objective 5
Multinational Transfer Pricing
Example
An item is produced by Division A in a
country with a 25% income tax rate.
It is transferred to Division B in a country
with a 50% income tax rate.
An import duty equal to 20% of the price of
the item is assessed.
Multinational Transfer Pricing
Example
Which transfer price should be chosen?
Multinational Transfer Pricing
Example
Income of A is $40 higher:
25% × $40 = ($10) higher taxes Income of B is $40 lower:
50% × $40 = $20 lower taxes Import duty paid by B:
Learning Objective 6
Explain how the linking of
rewards to responsibility
center results affects
Link Rewards to Results
Choices of Responsibility Motivational Criteria Centers and Incentives
Choices of Responsibility Motivational Criteria Centers and Incentives
Goal
Congruence
Goal
Congruence ManagerialEffort Managerial
Effort PerformanceMeasures Performance
Measures RewardsRewards
Link Rewards to Results
Research shows that the more objective the
measures of performance, the more likely the manager will provide effort.
Thus accounting measures, which provide
Agency Theory
Economists describe the formal choices of performance measures and rewards as agency theory.
Employment contracts will trade off three factors:
Learning Objective 7
Compute ROI, residual income,
and economic value added
(EVA)
and contrast them as criteria for
judging the performance of
Measures of Profitability
Segment managers in decentralized
organizations are often evaluated based on their segment’s profitability.
Is it net income?
Income before taxes?
Net income percentage based on revenue?
Return on Investment
ROI = Income ÷ Investment
Return on Investment
Project A: Operating income ÷ Investment required $200,000 ÷ $500,000 = 40%
Residual Income
RI = Net operating income – Imputed interest
Imputed interest refers to the cost of capital. RI tells you how much your company’s
Economic Value Added
Economic value added = Income
– After-tax cost of capital
Learning Objective 8
Compare the advantages and
disadvantages of various bases
for measuring the invested
ROI or Residual Income?
Why do some companies prefer residual income (or EVA) to ROI?
Under ROI, the message is go forth and
maximize your rate of return, a percentage.
Invested Capital
To apply either ROI or residual income, both income and invested capital must be measured and defined.
Total assets Total assets employed Total assets less current liabilities
Asset Allocation to Divisions
Commonly used bases for allocation, when
assets are not directly identifiable with a specific division, include:
Asset Class
Corporate cash Receivables
Inventories
Possible Allocation Base
Budgeted cash needs
Valuation of Assets
Should values be based on historical cost or some version of current value?
Practice is overwhelmingly in favor of using net book value based on historical cost.
Learning Objective 9
Understand the role of
Keys to Successful
Management Control Systems
Successful management control systems have several key factors in addition to appropriate measures of profitability.
Focus on Controllability
A distinction should be made between the
performance of the division manager and the performance of the division as an
investment by the corporation.
Managers should be evaluated on the basis
Management by Objectives
MBO describes the joint formulation by a manager and his or her superior of a set of goals and plans for achieving the goals for a forthcoming period.
The manager’s performance is then evaluated in relation to these
Tailoring Budgets for Managers
Many of the troublesome motivational
effects of performance evaluation systems can be minimized by the astute use of
budgets.
The desirability of tailoring a budget to
