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Decentralization within an organization is when decision making authority is spread throughout the organization. A one extreme, a strongly decentralized organization empowers even the lowest level managers and employees to make decisions. At the other extreme, a strongly centralized organization provides lower level managers with little freedom to make decisions. Advantages of decentralization: top management can use their time to concentrate on big picture, middle management has most detailed and up-to-date information, quicker response to changes in operating environment and customers, increases motivation in employees. Disadvantages include: decisions that conflict with bigger picture goals, a lack in co-ordination, and problems concerning the dissemination of new ideas throughout the organization.
Responsibility accounting is where managers are divided by responsibilities. There are three general types of responsibility accounting; cost center, profit center, and investment center. Cost center managers are responsible for the costs of their segment but not the revenue or investments made with the revenue concerning that segment. Profit center mangers are concerned with both the cost and the revenue of that center, and must make sure that both the cost and revenue are meeting the master budget. Still he is not a decision maker when it comes to making investments with that revenue even to better the future of that particular segment. Investment center managers are almost fully autonomous; they are concerned with all three costs, profit, and investment. It is their responsibility to make decisions concerning the future of their segments by investing their revenue properly.
In investment centers the manager is like the owner of the company and is responsible for the every outcome. One way for owners or upper level management to judge the manager by us called ROI (Return on investment). The ROI is calculated taking the net operating income and dividing it by the average operating assets. Net operating income includes all income pre-tax and before interest. Average operating assets include all assets directly related to the operation of that segment, including things like: cash, accounts receivable, inventory, plant and equipment. Another way to calculate ROI is by multiplying the margin and the turnover. The margin is: net operating income divided by net sales. The turnover is: net sales divided by average operating assets. In most cases a managers goal is to increase ROI to bring profit to the company. This can be done in a number of ways: A) Increased sales without any increase in operating assets B) Decreased operating expenses with no change in sales or operating assets C) Decreased operating assets with any change in sales or operating expenses D) invest in operating assets to increase sales. The use a balanced score card is still paramount because this system has its flaws. Just increasing ROI is not enough, for it may work well in the short term but not for long term gain, for example; cutting the budget (average operating assets) for R&D.
Another way to gauge the success of an investment center is through residual income. To calculate residual income you take the net operating income and subtract the sum of the average operating assets times the required rate of return. Residual income = Net operating income (average operating assets x required rate of return). The advantage of using residual income as an indicator is that it is more motivational for the manager and more in line with company goals.
Transfer price is the price charged when one segment of an organization provides goods or service to another segment of the same organization. This helps companies avoid problems that arise while evaluating segments of a company when one segment provides a good or service to another segment. The question of what transfer price to charge is one of the most difficult questions in managerial accounting. In practice, most companies adopt a simplified transfer pricing policy based on variable cost, absorption cost, or market prices.
Chapter 11 Managers must decide what products to sell, whether to make or buy component parts, what price to charge, what channels of distribution to use, whether to accept special orders at special prices etc. Every decision involves choosing from among at least two alternatives. Costs that differ between alternatives are called relevant costs, distinguishing between relevant and irrelevant costs are crucial to managerial success.
Avoidable costs is an example of a relevant cost, if you were not sure whether to buy a movie ticket or rent a movie the cost of either the ticket or the rental is an avoidable cost because each alternative negates the cost of the other. If you were going to by pizza later that cost is irrelevant because it has no bearing on whether or not you want the movie ticket or the video rental.
The two broad cost categories are: sunk costs and future costs, both of these costs are costs that do not differ between the two present alternatives. Differential costs and incremental costs are also examples of relevant costs.
A fundamental idea in decision making while using costs is that managers need different costs for different purposes. For one purpose, a particular group of costs may be relevant; for another purpose, an entirely different group of costs may be relevant rendering the previous one irrelevant.
In order to identify the relevant costs follow the steps below: A) Eliminate costs and benefits that do not differ between the two alternatives. These irrelevant costs consist of sunk costs and future costs that do not differ between alternatives. B) Use the remaining costs and benefits that do differ between alternatives in making the decision. The costs that remain are the differential, or avoidable, costs.
Although many times you may arrive at the same conclusion using only relevant costs as you would calculate the total costs, using relevant costs can usually save you a tremendous amount of time and energy due to data processing. Especially where giant corporations are concerned, to be able to sift through all the data of each and every segment of the company is not usually possible. Utilizing this system and only using the relevant cost data greatly enhances the speed at which crucial business decisions can be made. Another reason why it is advisable to use this system is because very rarely is there enough information provided to properly asses all your alternatives. Under those circumstances it would be virtually impossible to an income statement of any type.
Decisions relating to whether product lines or other segments of the company should be dropped or not is one of the hardest decisions a manger will ever make. In such decisions many qualitative and quantitative calculations must be made. Ultimately, however, any final decisions is based primarily on whether or not the company will make more money or not. What a manager must do is compare the relevant costs in each alternative carefully measuring only the information and data that is relevant to that alternative. If there is an overhead costs, or a sunk cost that has been allocated to unit level or batch level production or sales the manager must be careful not to include that if is a sunk cost or irrelevant cost.
Opportunity costs for the most part are not put down on the bottom line but for many organizations it is a big part of the decision making. For example, a department store has only a limited amount of space and must decide what space they can use to sell which products. They cannot just sell anything because their opportunity cost would be too high. Special orders are calculated very much in the same manner. A manager must calculate the relevant costs of making a special order and the opportunity of utilizing that time, money, space, machinery etc.
Chapter 13 Classifying Transactions
This explains how to classify transactions: operating, investing and financing. A statement of cash flow is used to answer questions like: is the cashflow enough to sustain ongoing operations, can the company pay back its laons, can it pay its dividends, where to get the money to invest etc.
Cash flow includes cash equivalent, liquid investments and cash. T-bills short terms assets, stocks all count as cash. The cash flow is akin to blood running through the body, it is the life force of the company. The cash flow statement highlight the activities that directly and indirectly impact the cash flows and hence impact the overall balance.
To make it easier to compare statements of cash flow from different companies, the Financial Accounting Standards Board (FASB) requires that companies follow prescribed rules for preparing the statement of cash flows.
In a cash flow statement the beginning cash balance is reconciled in the ending cash balance. So for example a increase in liability would be decreased from net income. All items on the cash flow statement should be presented in gross amounts. For example, if Macys sold $20,000 in merchandise and purchased $20,000 both activities must be documented fully in their gross amounts. It cannot just give the final number.
Each source and use of cash is classified by one of these three activities: operating, investing and financing. Operating activities with regard to cash flow statements are activities that effect current assets, current liability or net income. Investing activities with regard to cash-flow statements: acquiring or disposing of noncurrent assets. Current assets are assets that cannot be converted to cash within the year. Financing activities include: transactions involving creditors or owners of the company as well as taxes and dividends.
The general process of statement of cash flow is as follows: the manager would start with the net income of that period for the company, adjustment are then made to convert the net income to a cash basis by removing the gains and losses from net income of that period. Then all the investment and financing activities are taken into account the sum of this number is then subtracted from the net income. This is a snapshot of the statement of cash flow.
There are a number of pitfalls when reading a statement of cash flows. Perhaps the most common pitfall is to misinterpret the nature of the depreciation charges on the statement of cash flows. Since depreciation is added back to net income, you might think that you can increase net cash flow by increasing depreciation charges. This is false. Depreciation, depletion, amortization charges are added back to net income on the statement of cash flows because they are a decrease in the asset not because they generate cash.