Atkinson, Solutions Manual t/a Management Accounting, 6E
Chapter 11
Financial
Control
QUESTIONS
Financial control is the formal evaluation of some financial facet of an organization
or a responsibility center to assess organization and management performance.
Financial control uses financial numbers, such as costs or expenses, as broad
indices of performance or measures of the resources used by a process or
organizational unit. Financial control may involve comparing actual financial
numbers with targets from a standard or budget to derive variances.
Internal financial control is the application of financial control tools to evaluate
organization units. The resulting information is used inside the organization and
is not provided to outsiders. External financial control is the application of
financial control tools by outside analysts to evaluate various aspects of
organization performance.
Decentralization is the delegation of decision-making authority from people at
higher levels in the organization to front line decision makers of the
organization.
Control refers to the systems and tools that an organization uses to motivate
decentralized decision makers to pursue the organization’s goals.
A responsibility center is an organizational unit for which a manager is held
accountable. The manager is asked to run the center to achieve the objectives of
the larger organization.
A cost center is a responsibility unit that is evaluated based on its ability to control
costs relative to some standard. Revenues or investment level are not
controlled.
– 178 –
,Atkinson, Solutions Manual t/a Management Accounting, 6E
A revenue center is assigned the responsibility to achieve, within its own operating
guidelines, a target level of revenues. Managers in a revenue center do not
control costs or the level of investment.
Organizations use profit centers when profit center employees have the ability and
responsibility to control significant levels of revenues and costs of the products
or services they deliver.
An investment center is a responsibility unit that is evaluated based on its return on
investment. The managers and other employees control revenues, costs, and the
level of investment.
The controllability principle requires that people should only be held accountable for
results that they can control. The manager of a responsibility center should be
assigned responsibility for the revenues, costs, or investments controlled by
responsibility center personnel.
Responsibility centers participate in developing the goods and services that the
organization supplies to its customers, sharing the use of many common
resources in this process. In most organizations, many revenues and costs are
jointly earned or incurred.
A segment margin is the difference between the revenues and costs that are deemed
to be directly controllable by a responsibility center. It is therefore an important
summary performance measure for each responsibility center.
A soft number is a number that is based on conventional accounting assumptions but
relies on subjective revenue and cost allocation assumptions over which there
can be legitimate disagreement. Because soft numbers result from subjective
interpretation, they are neither right nor wrong.
A transfer price is the price at which a good or service is deemed to have been
transferred between two responsibility centers within an organization. The
transfer price is treated as revenue in the supplying division and as a cost in the
receiving division. The transfer price is a fiction created for control purposes
and does not affect external reporting.
The four bases for setting transfer prices are market, cost, negotiated, and
administered.
– 179 –
, Chapter 12: Financial Control
Organizations earn revenues by selling goods and services to customers. When
organizations use control systems that require revenue numbers for
responsibility centers, the revenue earned from the sale to the final customer
must be divided among the contributing responsibility centers. This process is
necessary to prepare responsibility center income statements, and in turn,
evaluate the center’s performance.
Organizations use many types of resources to make goods and services. When
organizations use control systems that require cost numbers for responsibility
centers, the costs of the resources that are used by two or more responsibility
centers must be divided between or among those responsibility centers. This
process is necessary to prepare responsibility center income statements, and in
turn, evaluate the center’s performance.
Return on investment is a measure of accounting income (typically, operating
income) divided by a measure of the investment in the assets used to earn that
income.
All other things being equal, as efficiency (the ratio of income to sales)
increases (decreases), return on investment increases (decreases).
All other things being equal, as productivity (the ratio of sales to investment)
increases (decreases), return on investment increases (decreases).
Residual income is the difference between reported accounting income and the
required return on the investment (economic cost of investment) used to earn
that income.
Economic value added (EVA) is a refinement of the residual income idea. The
EVA computation adjusts reported accounting income and asset levels for what
many consider the biasing effects on current results of the financial accounting
doctrine of conservatism. For example, GAAP requires the immediate
expensing of research and development costs; yet, when shareholder value
analysis income is computed, research and development costs are capitalized
and expensed over a certain time period, such as five years.
Whole Foods states, ―We use EVA extensively for capital investment decisions,
including evaluating new store real estate decisions and store remodeling
proposals. We only invest in projects that we believe will add long-term value
to the Company. The EVA decision-making model also enhances operating
decisions in stores. Our emphasis is on EVA improvement …‖
– 180 –
Chapter 11
Financial
Control
QUESTIONS
Financial control is the formal evaluation of some financial facet of an organization
or a responsibility center to assess organization and management performance.
Financial control uses financial numbers, such as costs or expenses, as broad
indices of performance or measures of the resources used by a process or
organizational unit. Financial control may involve comparing actual financial
numbers with targets from a standard or budget to derive variances.
Internal financial control is the application of financial control tools to evaluate
organization units. The resulting information is used inside the organization and
is not provided to outsiders. External financial control is the application of
financial control tools by outside analysts to evaluate various aspects of
organization performance.
Decentralization is the delegation of decision-making authority from people at
higher levels in the organization to front line decision makers of the
organization.
Control refers to the systems and tools that an organization uses to motivate
decentralized decision makers to pursue the organization’s goals.
A responsibility center is an organizational unit for which a manager is held
accountable. The manager is asked to run the center to achieve the objectives of
the larger organization.
A cost center is a responsibility unit that is evaluated based on its ability to control
costs relative to some standard. Revenues or investment level are not
controlled.
– 178 –
,Atkinson, Solutions Manual t/a Management Accounting, 6E
A revenue center is assigned the responsibility to achieve, within its own operating
guidelines, a target level of revenues. Managers in a revenue center do not
control costs or the level of investment.
Organizations use profit centers when profit center employees have the ability and
responsibility to control significant levels of revenues and costs of the products
or services they deliver.
An investment center is a responsibility unit that is evaluated based on its return on
investment. The managers and other employees control revenues, costs, and the
level of investment.
The controllability principle requires that people should only be held accountable for
results that they can control. The manager of a responsibility center should be
assigned responsibility for the revenues, costs, or investments controlled by
responsibility center personnel.
Responsibility centers participate in developing the goods and services that the
organization supplies to its customers, sharing the use of many common
resources in this process. In most organizations, many revenues and costs are
jointly earned or incurred.
A segment margin is the difference between the revenues and costs that are deemed
to be directly controllable by a responsibility center. It is therefore an important
summary performance measure for each responsibility center.
A soft number is a number that is based on conventional accounting assumptions but
relies on subjective revenue and cost allocation assumptions over which there
can be legitimate disagreement. Because soft numbers result from subjective
interpretation, they are neither right nor wrong.
A transfer price is the price at which a good or service is deemed to have been
transferred between two responsibility centers within an organization. The
transfer price is treated as revenue in the supplying division and as a cost in the
receiving division. The transfer price is a fiction created for control purposes
and does not affect external reporting.
The four bases for setting transfer prices are market, cost, negotiated, and
administered.
– 179 –
, Chapter 12: Financial Control
Organizations earn revenues by selling goods and services to customers. When
organizations use control systems that require revenue numbers for
responsibility centers, the revenue earned from the sale to the final customer
must be divided among the contributing responsibility centers. This process is
necessary to prepare responsibility center income statements, and in turn,
evaluate the center’s performance.
Organizations use many types of resources to make goods and services. When
organizations use control systems that require cost numbers for responsibility
centers, the costs of the resources that are used by two or more responsibility
centers must be divided between or among those responsibility centers. This
process is necessary to prepare responsibility center income statements, and in
turn, evaluate the center’s performance.
Return on investment is a measure of accounting income (typically, operating
income) divided by a measure of the investment in the assets used to earn that
income.
All other things being equal, as efficiency (the ratio of income to sales)
increases (decreases), return on investment increases (decreases).
All other things being equal, as productivity (the ratio of sales to investment)
increases (decreases), return on investment increases (decreases).
Residual income is the difference between reported accounting income and the
required return on the investment (economic cost of investment) used to earn
that income.
Economic value added (EVA) is a refinement of the residual income idea. The
EVA computation adjusts reported accounting income and asset levels for what
many consider the biasing effects on current results of the financial accounting
doctrine of conservatism. For example, GAAP requires the immediate
expensing of research and development costs; yet, when shareholder value
analysis income is computed, research and development costs are capitalized
and expensed over a certain time period, such as five years.
Whole Foods states, ―We use EVA extensively for capital investment decisions,
including evaluating new store real estate decisions and store remodeling
proposals. We only invest in projects that we believe will add long-term value
to the Company. The EVA decision-making model also enhances operating
decisions in stores. Our emphasis is on EVA improvement …‖
– 180 –
