1. Responsibility accounting is a management control system that assigns responsibility for costs and revenues to various individuals or departments within an organization. The aim is to evaluate the performance of these units based on their assigned responsibilities. The four types of responsibility centers are:
- Cost centers: These are departments or individuals responsible for controlling costs within a given area. They do not generate revenues directly. Examples include the maintenance department or the IT department.
- Revenue centers: These units are responsible for generating revenues but not for controlling costs. They focus on maximizing sales or revenue generation. Examples include the sales department or the marketing department.
- Profit centers: These centers are accountable for both generating revenues and controlling costs. They are evaluated based on their ability to generate profits. Examples include business units or divisions within a company.
- Investment centers: These units have the highest level of responsibility as they are accountable for generating revenues, controlling costs, and managing invested capital. They are evaluated based on their return on investment (ROI) or other financial performance measures. Examples include subsidiaries or divisions that operate as separate profit-generating entities.
2. Firms choose to decentralize for several reasons:
- Improved decision-making: Decentralization allows decision-making authority to be distributed to lower levels of management. This can lead to faster and more informed decision-making, as those closest to the operations can respond quickly to changing situations.
- Better resource allocation: Decentralization enables resources to be allocated more efficiently, as managers at lower levels have a better understanding of local needs and conditions. This can result in higher productivity and cost savings.
- Motivation and accountability: Decentralization provides managers with greater authority and responsibility, which can increase their motivation and commitment to achieving organizational goals. It also promotes accountability, as managers are held responsible for the outcomes of their decisions.
- Flexibility and adaptability: Decentralized organizations can respond more effectively to local market conditions and customer needs. They are better equipped to adapt to changes in the business environment and can quickly seize new opportunities.
3. - Return on Investment (ROI): ROI is a financial performance measure that evaluates the profitability of an investment. It is calculated by dividing the net income (or operating income) by the invested capital. ROI provides an indication of how effectively an investment is generating profits relative to its cost.
- Residual Income (RI): RI is a measure of profitability that evaluates the excess of a division's operating income over the minimum required return on its invested capital. It is calculated by subtracting the division's required return on investment from its operating income. RI helps assess whether a division is creating value above and beyond the minimum required by the organization.
- Economic Value Added (EVA): EVA is a financial performance measure that calculates the value created by a business unit or division. It takes into account the cost of capital and calculates the excess of net operating profit after taxes (NOPAT) over the cost of capital. EVA reflects the value added by a division in excess of the capital invested and is used to assess the overall financial performance of the unit.
4. Methods of evaluating and rewarding managerial performance include:
- Financial measures: These include measures such as return on investment (ROI), profit margins, revenue growth, and cost control. Financial measures focus on the overall financial performance of the manager's responsibility center.
- Non-financial measures: These measures assess non-financial aspects of performance, such as customer satisfaction, employee engagement, product quality, and innovation. Non-financial measures provide a more comprehensive evaluation of a manager's performance beyond just financial results.
- Balanced scorecard: The balanced scorecard approach combines both financial and non-financial measures to evaluate managerial performance. It looks at various perspectives, including financial, customer, internal processes, and learning and growth.
- Peer evaluation: In some organizations, managers may evaluate and provide feedback on the performance of their peers. This can provide a broader perspective and help identify areas for improvement.
- Incentive compensation: Managers may be rewarded through incentive compensation such as bonuses, profit-sharing, or stock options. These incentives are tied to achieving specific performance targets and can motivate managers to strive for better results.
5. Transfer pricing is the pricing of goods or services transferred between units or divisions within the same organization. In a decentralized firm, transfer pricing plays a crucial role in determining how costs and revenues are allocated among different divisions or units. It affects the profitability of each division and can influence their decision-making and performance evaluation.
Transfer pricing is important for several reasons:
- Profitability measurement: Transfer pricing allows the allocation of costs and revenues among divisions, enabling the calculation of divisional profits. It ensures that each division's performance can be accurately assessed.
- Decision-making: Transfer pricing affects the costs and profitability of divisions. Managers need to consider these costs when making decisions about production, sourcing, or pricing. The transfer price can influence the profitability of a division and the overall organization.
- Motivation and behavior: Transfer pricing can impact the behavior and motivation of managers. If a division is penalized for high transfer prices, it may be discouraged from purchasing goods or services internally and instead seek external alternatives.
- Tax implications: Transfer pricing can also have tax implications, as it affects the allocation of profits across different tax jurisdictions. Governments closely monitor transfer pricing to prevent profit shifting and ensure fair taxation.
6. There are various methods of setting transfer prices in decentralized firms. The common methods include:
- Market-based prices: Transfer prices are set based on the prevailing market prices for similar goods or services. This ensures that divisions are treated as independent entities and encourages efficiency and competitiveness.
- Cost-based prices: Transfer prices are set based on the cost of production plus a markup. This approach ensures that the selling division covers its costs and generates a reasonable profit margin.
- Negotiated prices: Divisions negotiate transfer prices based on their mutual agreement. This approach allows for flexibility and considers the specific circumstances of the divisions involved.
- Dual pricing: Different transfer prices are used for different purposes, such as internal performance evaluation and external reporting. This approach separates internal and external considerations.
The choice of transfer pricing method depends on various factors, including the nature of the goods or services, market conditions, divisional autonomy, and the objectives of the organization. It is essential to strike a balance between divisional autonomy and overall organizational goals.
