Professional Documents
Culture Documents
BENEFITS OF DECENTRALIZATION
1. Better access to local information
2. Cognitive limitations
3. More timely response
4. Focusing of central management
5. Training and evaluation
6. Motivation
7. Enhanced competition.
COSTS OF DECENTRALIZATION
1. Some decisions made in one sub-unit may bring about negative effect to the other sub-
units or the organization as a whole.
2. Decentralization necessitates a more elaborate reporting system hence, the costs of
gathering and reporting of data increase.
3. Job duplication or overlapping of functions is usually encountered in a decentralized set-
up.
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Performance measures for investment centers usually attempt to assess how well managers are
utilizing invested assets of the division to produce profits by relating operating profits to assets.
Return on investment (ROI) is the most common measure of performance for investment
centers. ROI can be defined as follows:
Operating income refers to earnings before interest and taxes. Operating assets include all assets
acquired to generate operating income, including cash, receivables, inventories, land, buildings,
and equipment.
The ROI formula can also be broken down into the product of margin and turnover. Margin is
the ratio of operating income to sales. Turnover is defined as sales divided by average operating
assets.
or
Sales
Average Operating Assets
Residual income (RI) - the difference between operating income and the minimum peso return
required on a company’s operating assets. The equation for RI can be
expressed as follows:
ECONOMIC VALUE ADDED (EVA) – a more specific version of residual income. It represents
the segment’s true economic profit because it measures the benefit obtained by using
resources in a particular way.
After-tax operating income
(EBIT x[1 – Tax Rate]) xx
Less desired income
(After-tax WACC* x [Total assets – Current liabilities]) xx
Economic Value Added (EVA) xx
TRANSFER PRICING
TRANSFER PRICE – the monetary value or the price charged by one segment of a firm for the
goods and services it supplies to another segment of the same firm.
A good should be transferred internally whenever the minimum transfer price (set by
the selling division) is less than the maximum transfer price (set by the buying
division). By using this rule, total profits of the firm are not decreased by an internal
transfer.
The Balanced Scorecard translates an organization’s mission and strategy into operational
objectives and performance measures for four different perspectives: the financial
perspective, the customer perspective, the internal business process perspective, and the
learning and growth (infrastructure) perspective.
The financial perspective establishes the long- and short-term financial performance
objectives. The financial perspective is concerned with the global financial consequences
of the other three perspectives. Thus, the objectives and measures of the other
perspectives must be linked to the financial objectives. The financial perspective has three
strategic themes: revenue growth, cost reduction, and asset utilization.
Customer Perspective
The customer perspective is the source of the revenue component for the financial
objectives. This perspective defines and selects the customer and market segments in
which the company chooses to compete.
Process Perspective
To provide the framework needed for this perspective, a process value chain is defined.
The process value chain is made up of three processes: the innovation process, the
operations process, and the post sales process.
Velocity is the number of units that can be produced in a given period of time (e.g.,
units per hour).
The learning and growth perspective is the source of the capabilities that enable the
accomplishment of the other three perspectives’ objectives.
a. Delivery Cycle Time. This is the total elapsed time between when an order is placed by
a customer and when it is shipped to the customer. Part of this time is wait time that
occurs before the order is placed into production.
b. Throughput (Manufacturing Cycle) Time. This is the total elapsed time between
when an order is initiated into production and when it is shipped to the customer. It
consists of process time, inspection time, move time, and queue time. The only
element that adds value is processing time. Inspection time, move time, queue time,
and their associated activities do not add value and should be minimized.
c. Manufacturing Cycle Efficiency (MCE). MCE is the ratio of value-added time (i.e.,
process time) to total throughput time. It represents the percentage of time an order
is in production in which useful work is being done. The rest of the time represents
non-value-added time (i.e., inspection time, move time, and queue time).
Processing time
Processing time + Move Time + Inspection Time + Wait time
Quality-linked activities are those activities performed because poor quality may or does exist.
Costs of quality are costs that exist because poor quality may or does exist.
Control activities are performed by an organization to prevent or detect poor quality. Control
costs are the costs of performing control activities. There are two broad categories of
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control costs: prevention costs and appraisal costs. Prevention costs are incurred to
prevent poor quality in the products or services being produced. Appraisal costs are
incurred to determine whether products and services are conforming to their requirements
or customer needs.
Failure activities are performed by an organization or its customers in response to poor quality.
Failure costs are the costs incurred by an organization because failure activities are
performed. There are two broad categories of failure costs: internal failure costs and
external failure costs. Internal failure costs are incurred because products and services do
not conform to specifications or customer needs and the nonconformance is detected prior
to being delivered to outside parties. External failure costs are incurred because products
or services fail to conform to requirements or satisfy customer needs and the
nonconformance is detected after being delivered to outside parties.
PRODUCTIVITY MEASUREMENT
Productivity – measures the relationship between actual inputs used (both quantities and costs)
and actual outputs produced.
Partial productivity – compares the quantity of output produced with the quantity of an individual
input used.
Total Factor Productivity – the ratio of quantity of output produced to the costs of all inputs used
based on current period prices.
EXERCISES:
Dekuryente Motor Company makes electric cars and has only two products, the
Theena and the Xander. To produce the Theena, Dekuryente Motor employed assets
of P13,500,000 at the beginning of the period, and P13,400,000 of assets at the end
of the period. Other costs to manufacture the Theena include the following:
General administration and selling costs total P7,340,000 for the period. In the
current period, Dekuryente Motor produced 10,000 Theena cars using 6,000 setup-
hours and 175,200 machine-hours. Dekuryente Motor sold these cars for P12,000
each.
REQUIRED:
1. Assuming that Dekuryente Motor defines investment as average assets during the
period, what is the Return on Investment for the Theena division?
2. Calculate the residual income for the Theena if Dekuryente Motor has a required
rate of return of 12% on investments.
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2. The Sporty Company produces a wide variety of sports equipment. Its newest
division, Golf Pro, manufactures and sells a single product— AccuClub, a golf club that
uses global positioning satellite technology to improve the accuracy of golfers’ shots.
The demand for AccuClub is relatively insensitive to price changes. The following data
are available for Golf Pro, which is an investment center for Sporty:
REQUIRED:
1. Compute Golf Pro’s ROI if the selling price of AccuClubs is P720 per club. 6.25%
2. If management requires an ROI of at least 25% from the division, what is the minimum
selling price that the Golf Pro Division should charge per AccuClub? P780
3. Assume that Sporty judges the performance of its investment centers on the basis of RI
rather than ROI. What is the minimum selling price that Golf Pro should charge per
AccuClub if the company’s required rate of return is 20%? P764
3. Selected sales and operating data for three divisions of different structural
engineering firms are given as follows:
REQUIRED:
4. Montante, Inc., has decided to use EVA to evaluate its performance. Last year, Montante
had operating income before tax of P500,000. Two sources of financing were used by the
company: P3 million of mortgage bonds paying 6 percent interest and P9 million in
common stock, which was considered to be relatively more risky than other stocks, and
had a risk premium of 10 percent. The rate on long-term treasury bonds is 4 percent.
Montante, Inc., has P4,500,000 in total assets and P500,000 in current liabilities. It pays a
marginal tax rate of 30 percent.
REQUIRED:
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TRANSFER PRICING
The Handles Division’s normal capacity for Model ABC is 500,000 units. At present, it
produces and sells 300,000 units to the outside market for P5 each. It incurs variable
cost per unit of P3 for Model ABC.
REQUIRED:
a. What is the maximum transfer price that the Kitchen Cabinets Division would be
willing to pay the Handles Division for the Model ABC Handles?
b. What is the minimum price that the Handles Division would consider to produce the
Model ABC handles for the Kitchen Cabinets Division?
d. If the Handles Division is currently operating at 85% of capacity, so that it would have
to reduce its sales to the outside customers should it decide to sell the handles being
ordered by the Kitchen Cabinets Division, what should the minimum price be?
e. Refer to the original data. What transfer price should be set so that the benefits may
be divided equally between the Kitchen Cabinets Division and the Handles Division?
6. GreenThumb, Inc., is a nursery products firm. It has three divisions that grow and sell
plants: the Western Division, the Southern Division, and the Central Division.
The Western Division had bought its plastic pots in lots of 100 from a variety of vendors.
The average price paid was P75 per box of 100 pots. However, the acquisition made Nay
Sy, manager of the Western Division, wonder whether a more favorable price could be
arranged. She decided to approach Flint, manager of the Southern Division, to see if he
wanted to offer a better price for an internal transfer. She suggested a transfer of 3,500
boxes at P70 per box.
Flint gathered the following information regarding the cost of a box of 100 pots:
Direct materials P35
Direct labor 8
Variable overhead 10
Fixed overhead* 10
Total unit cost P63
REQUIRED:
1. Suppose that the plastics factory is producing at capacity and can sell all that it
produces to outside customers. How should Flint respond to Nay’s request for a
lower transfer price?
2. Now assume that the plastics factory is currently selling 16,000 boxes. What are the
minimum and maximum transfer prices? Should Flint consider the transfer at P70
per box?
3. Suppose that GreenWorld’s policy is that all transfer prices be set at full cost plus 20
percent. Would the transfer take place? Why or why not?
1. Flint should not reduce the price charged to Nay if he can sell all he produces. It does not matter whether the
two divisions trade internally or not.
2. The minimum price is P53, and the maximum is P75. Yes, Flint should consider the transfer, since his income
will increase by P59,500 [3,500(P70 – P53)].
3. The transfer price would be P75.60 (P63 × 1.2). No, the transfer would not occur, since the transfer price is
higher than the outside price that Nay could get.
7. The Balanced Scorecard translates an organization’s mission and strategy into operational
objectives and performance measures for four different perspectives: the financial
perspective, the customer perspective, the internal business process perspective, and the
learning and growth (infrastructure) perspective.
Consider the following factors (operational objectives) that follow. Determine the proper
balanced scorecard perspective (financial, customer, learning and growth, or internal
operations) for each of the factors listed. Then, give the appropriate performance
measure(s) for each factor. The first factor is used as an example:
8. Data Screen Corporation is a highly automated manufacturing firm. The vice president of
finance has decided that traditional standards are inappropriate for performance measures
in an automated environment. Labor is insignificant in terms of the total cost of
production and tends to be fixed, material quality is considered more important than
minimizing material cost, and customer satisfaction is the number one priority. As a result,
production and delivery performance measures have been chosen to evaluate
performance.
The following information is considered typical of the time involved to complete and ship
orders.
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Waiting time:
From order being placed to start of production 2 days
From start of production to completion 1 week
Inspection time 3 days
Processing time 14 days
Move time 4 days
REQUIRED:
a. Calculate the delivery cycle time and delivery cycle efficiency.
b. Calculate the manufacturing time and manufacturing cycle efficiency.
c. As judged by the cycle efficiency, what percentage of the overall production time
was spent on (1) value-adding activities and (2) non-value adding activities?
9. Pinto Company manufactures high-quality wooden doors used in home construction. Pinto
produces doors in batches of 70 units. The following information pertains to operations
during February.
Processing time (average per batch) 20 hours
Inspection time (average per batch) 4 hour
Waiting time (average per batch) 5 hours
Move time (average per batch) 6 hours
REQUIRED:
Compute the following operational measures:
1. average value-added time per batch
2. average nonvalue- added time per batch
3. manufacturing cycle efficiency
4. manufacturing cycle time
5. velocity.
10. Box Co. manufactures hand-made pine storage boxes for a variety of clients. As
production manager, you have developed the following value chart:
REQUIRED:
a. Determine the value-added activities and their total time.
b. Determine the non-value-added activities and their total time.
c. Calculate the manufacturing cycle efficiency.
ANSWER:
11. Laudencio, Inc. automated its plant at the start of the current year and installed a
flexible manufacturing system. The company is also evaluating its suppliers and moving
toward Lean Production. Many adjustment problems have been encountered, including
problems relating to performance measurement. After much study, the company has
decided to use the performance measures below, and it has gathered data relating to
these measures for the first four months of operations.
Management has asked for your help in computing throughput time, delivery cycle time,
and MCE. The following average times have been gathered:
REQUIRED:
1. For each month, compute the following:
a. The throughput time 7.4; 8.0; 8.8; 9.5
b. The manufacturing cycle efficiency (MCE) 28.4%; 25.0%; 21.6%; 18.9%
c. The delivery cycle time 23.4; 25.5; 27.8; 30.0
2. Evaluate the company’s performance over the given four months (January to
April).
All of the performance measures display unfavorable trends. Throughput time per unit is
increasing—largely because of an increase in queue time. Manufacturing cycle efficiency is
declining and delivery cycle time is increasing. In addition, the percentage of on-time deliveries
has dropped.
3. Refer to the move time, process time, and so forth given for the month of
April.
a. Assume that in May, the move time, process time, and so forth are the same
as in April, except that through the use of Lean Production, the company is
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able to completely eliminate the queue time during production. Compute the
new throughput time and MCE. 2.8; 64.3%
b. Assume that in June, the move time, process time, and so forth, are again the
same as in April, except that the company is able to completely eliminate both
the queue time during production and the inspection time. Compute the new
throughput time and MCE. 2.2; 81.8%
12. Kalidad Enterprises has identified the following as having an impact on the company's
quality costs:
a. Product design
b. Rework labor and overhead costs
c. Returns and allowances arising from poor quality
d. Cost of scrap
e. Technical support to suppliers
f. Product testing
g. Depreciation of test equipment
h. Warranty replacements
i. Rework of defective goods before transfer to finished goods
j. Cost of servicing a unit under a warranty agreement
k. Supervision of testing and inspection activities
l. Inspection of goods while in process
m. Evaluation of suppliers
n. Maintenance of test equipment
o. Systems development
REQUIRED:
Classify the eleven costs as prevention, appraisal, internal failure, or external failure.
13. Xandel Company's quality cost report is to be based on the following data:
Liability arising from defective products P82,000
Final product testing and inspection 40,000
Returns arising from quality problems 24,000
Technical support provided to suppliers 52,000
Disposal of defective products 98,000
Maintenance of test equipment 53,000
Systems development 67,000
Depreciation of test equipment 11,000
Debugging software errors 87,000
REQUIRED:
Compute the total amount of (a) prevention costs, P119,000 (b) appraisal costs, P104,000 (c)
internal failure costs, P185,000 and (d) external failure costs. P106,000
Prevention costs
Technical support provided to suppliers P 52,000
Systems development 67,000
Total P119,000
Appraisal costs
Depreciation of test equipment P 11,000
Maintenance of test equipment 53,000
Final product testing and inspection 40,000
Total P104,000
Total P185,000
1. Belle, Inc. uses an accounting system that charges costs to the manager who has been
delegated the authority to make decisions incurring the costs. For example, if the sales
manager accepts a rush order that will result in higher-than-normal manufacturing
costs, these additional costs are charged to the sales manager because the authority to
accept or decline the rush order was given to the sales manager. This type of
accounting system is known as
a. responsibility accounting. c. reciprocal allocation.
b. functional accounting. d. transfer price accounting.
6. Which one of the following statements pertaining to the return on investment (ROI) as a
performance measurement is incorrect?
a. When the average age of assets differs substantially across segments of a
business, the use of ROI may not be appropriate.
b. ROI relies on financial measures that are capable of being independently verified,
while other forms of performance measures are subject to manipulation.
c. The use of ROI may lead managers to reject capital investment projects that can
be justified by using discounted cash flow models.
d. The use of ROI can make it undesirable for a skillful manager to take on trouble-
shooting assignments such as those involving turning around unprofitable
divisions.
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7. Yuri’s Service Co. is a service center. For the month of June, Yuri had the following
operating statistics:
Sales P750,000
Operating income 25,000
Net profit after taxes 8,000
Total assets available 500,000
Shareholders’ equity 200,000
Cost of capital 6%
Yuri has a
a. return on investment of 3.33%. c. return on investment of 6%.
b. residual income of P(5,000). d. residual income of P(20,000).
8. Listed below is selected financial information for the Northern Division of Hanziel Company
for last year:
Account Amount (in thousands)
Average working capital P 625
General and administrative expenses 75
Net sales 4,000
Average plant and equipment 1,775
Cost of goods sold 3,525
9. Apple is the general manager of the Industrial Product Division, and his performance is
measured using the residual income method. Apple is reviewing the following
forecasted information for his division for next year:
Category Amount (in thousands)
Working capital P 1,800
Revenue 30,000
Plant and equipment 17,200
If the imputed interest charge is 15% and Apple wants to achieve a residual income
target of P2,000,000, what will costs have to be in order to achieve the target?
a. P 9,000,000 c. P25,150,000
b. P10,800,000 d. P25,690,000
10. Vicky Co. is a computer service center. For the month of May, Vicky had the following
operating statistics:
Sales P450,000
Operating income 25,000
Net profit after taxes 8,000
Total assets 500,000
Shareholders’ equity 200,000
Cost of capital 6%
Based on the above information, which one of the following statements is correct?
Vicky
has a
a. return on investment of 4%. c. return on investment of 1.6%.
b. residual income of P(5,000). d. residual income of P(22,000).
11. The price that one division of a company charges another division for goods or services
provided is called the
a. market price. c. outlay price.
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12. The most fundamental responsibility center affected by the use of market-based transfer
prices is a(n)
a. production center. c. cost center.
b. investment center. d. profit center.
13. Transfer price should encourage goal congruence and managerial effort. In a
decentralized organization, it should also encourage autonomous decision-making.
Managerial effort is
a. the desire and the commitment to achieve a specific goal.
b. the sharing of goals by supervisors and subordinates.
c. the extent to which individuals have the authority to make decisions.
d. the extent of the attempt to accomplish a specific goal.
15. Motivation is
a. the desire and the commitment to achieve a specific goal.
b. the sharing of goals by supervisors and subordinates.
c. the extent to which individuals have the authority to make decisions.
d. the extent of the attempt to accomplish a specific goal.
17. An appropriate transfer price between two divisions of GMA Company can be
determined from the following data:
Fabricating Division
Market price of sub-assembly P50
Variable cost of sub-assembly P20
Excess capacity (in units) 1,000
Assembling Division
Number of units needed 900
The actual costs per unit used by the Entertainment Division are presented below:
Plastic Components Video Cards
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The Plastics Division sells its commercial products at full cost plus a 25% markup and
believes the proprietary plastic component made for the Entertainment Division would
sell for P6.25 per unit on the open market. The market price of the video card used by
the Entertainment Division is P10.98 per unit.
18. A per-unit transfer price from the Video Cards Division to the Entertainment Division at
full cost, P9.15, would
a. allow evaluation of both divisions on a competitive basis.
b. satisfy the Video Cards Division’s profit desire by allowing recovery of opportunity
costs.
c. provide no profit incentive for the Video Cards Division to control or reduce costs.
d. encourage the Entertainment Division to purchase video cards from an outside
source.
19. Assume that the Entertainment Division is able to purchase a large quantity of video
cards from an outside source at P8.70 per unit. The Video Cards Division, having excess
capacity, agrees to lower its transfer price to P8.70 per unit. This action would
a. optimize the profit goals of the Entertainment Division while subverting the profit
goals of River Park, Inc.
b. allow evaluation of both divisions on the same basis.
c. subvert the profit goals of the Video Cards Division while optimizing the profit
goals of the Entertainment Division.
d. optimize the overall profit goals of River Park, Inc.
20. Assume that the Plastics Division has excess capacity and it has negotiated a transfer
price of P5.60 per plastic component with the Entertainment Division. This price will
a. cause the Plastics Division to reduce the number of commercial plastic
components it manufactures.
b. motivate both divisions as estimated profits are shared.
c. encourage the Entertainment Division to seek an outside source for plastic
components.
d. demotivate the Plastics Division causing mediocre performance.
1. A 11. B
2. B 12. D
3. D 13. D
4. B 14. B
5. C 15. A
6. B 16. D
7. B 17. A
8. D 18. C
9. C 19. D
10. B 20. B
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