22208 Chap.10 Performance Measurement in Decentralised Firms
Performance Measurement in Decentralised Firms
Week 10 looks at how accounting information is used to drive performance and evaluate managers. Decentralised organisations use responsibility accounting, measuring each manager on what he or she controls through cost, revenue, profit and investment centres. Segment margin shows what each division contributes before common costs, while return on investment and residual income judge investment centres.
The topic ends with the balanced scorecard and incentives.
Typical questions supply a segmented income statement and ask for contribution margin ratios, segment margins and company profit, or give a division’s operating income, assets and required rate and ask for return on investment and residual income. Classification items ask which kind of responsibility centre a manager runs.
Written parts ask why managers of different centres should be judged differently and how incentives affect behaviour.
What this chapter covers
- 01
Decentralisation and its benefits and drawbacks
- 02
Responsibility accounting and the four centres
- 03
Contribution margin and segment margin
- 04
Return on investment
- 05
Residual income and goal congruence
- 06
Balanced scorecard and management incentives
Worked example · free
ROI and residual income for one division
- 1ROI: 96,000 ÷ 640,000 = 15%.
- 1Required return in dollars: 640,000 × 10% = $64,000.
- 1Residual income: 96,000 − 64,000 = $32,000.
- 1The division earns five percentage points above the minimum, which adds $32,000 of value beyond the required return.
Key terms
- Responsibility accounting
- A system that evaluates each manager only on the costs, revenues or assets he or she controls.
- Investment centre
- A unit whose manager is responsible for revenue, costs and the assets invested.
- Segment margin
- Contribution margin less the fixed costs traceable to a segment, before common fixed costs.
- Residual income
- Net operating income minus the minimum required return on average operating assets.
- Goal congruence
- Alignment of managers’ goals with those of the shareholders.
- Contribution margin ratio
- Contribution margin divided by sales, the share of each sales dollar left after variable costs.
- Cost centre
- A unit whose manager is responsible for costs but does not generate external revenue.
Performance Measurement in Decentralised Firms FAQ
Why are common fixed costs left out of segment margin?
Common fixed costs support the whole company and would remain if any one segment closed. Charging them to segments would make a division that covers its own costs look unprofitable and could lead to a closure that lowers total profit.
When can ROI and residual income disagree?
When a project earns more than the minimum required rate but less than the division’s current ROI. Accepting it lowers the average ROI, so a manager judged on ROI may reject it, yet its residual income is positive and it adds value.
Does goal congruence remove all conflict between managers and shareholders?
No. The pre-quiz treats that claim as false: incentives can align goals more closely, through mixed and non-cash rewards, but they cannot eliminate every conflict of interest.
Why should cost centre managers not be judged on profit?
A cost centre manager controls costs but not revenue, so profit would hold them responsible for results they cannot influence. Responsibility accounting measures each manager only on what they control, such as spending against budget for a cost centre.
What is a segment margin used for?
It shows what a division contributes after its own variable and traceable fixed costs but before common costs it does not control. That makes it a fair basis for judging a segment manager and a sound starting point for deciding whether to keep, grow or drop a segment.
Exam move
Practise building a segmented income statement from raw data and computing both ratios. Then work ROI and residual income side by side for a proposed project, and be ready to explain in two sentences why the two measures can point in different directions. Set out every investment-centre answer with both measures side by side, and add a sentence saying which decision each would encourage.
Also prepare a few sentences on the balanced scorecard and on incentives, since the module lists both as outcomes, and be ready to explain why goal congruence reduces but never eliminates conflict between managers and shareholders.
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