Fundamentals of Cost Accounting 3rd Edition by William N. Lanen, Shannon W. Anderson, Michael Maher

Exercise 23

Analyze Performance Report for Decentralized Organization

Hall O’ Fame Products is a nationwide sporting goods manufacturer. The company operates with a widely based manufacturing and distribution system that has led to a highly decentralized management structure. Each division manager is responsible for producing and distributing corporate products in one of eight geographical areas of the country.

Division managers are evaluated using a performance measure that is calculated as the division’s contribution to corporate profits before taxes less a 20 percent investment charge on the division’s investment base. The investment base of each division is the sum of its year-end balances of accounts receivable, inventories, and net plant fixed assets (cost less accumulated depreciation). Corporate policies dictate that divisions minimize their investments in receivables and inventories. Investments in fixed plant assets are decisions jointly made by the division and corporate based on proposals made by division plant managers, available corporate funds, and general corporate policy.

James Davenport, division manager for the California sector, prepared the year 2 and preliminary year 3 budgets for his division late in year 1. Final approval of the year 3 budget took place in late year 2 after adjustments for trends and other information developed during year 2. Preliminary work on the year 4 budget also took place at that time. In early October of year 3, Davenport asked the division controller to prepare a report that presents performance for the first nine months of year 3. The report follows:

	HALL O’ FAME PRODUCTS California Sector
	Year 3			Year 2
	Annual Budget	Nine-Month Budget a	Nine-Month Actual	Annual Budget	Actual Results
Sales	$19,600	$14,700	$15,400	$17,500	$17,010
Divisional costs and expenses
Direct materials and labor	$7,448	$ 5,586	$ 6,965	$ 6,300	$ 6,230
Supplies	308	231	245	245	301
Maintenance and repairs	1,400	1,050	420	1,225	1,120
Plant depreciation	840	630	630	770	770
Administration	840	630	630	630	700
Total divisional costs and expenses	$10,836	$ 8,127	$ 8,890	$ 9,170	$ 9,121
Divisional margin	$ 8,764	$ 6,573	$ 6,510	$ 8,330	$ 7,889
Allocated corporate fixed costs	2,520	1,890	1,680	2,380	2,240
Divisional profits	$ 6,244	$ 4,683	$ 4,830	$ 5,950	$ 5,649
	Budgeted Balance 12/31/Year 3	Budgeted Balance 9/30/Year 3	Actual Balance 9/30/Year 3	Budgeted Balance 12/31/Year 2	Actual Balance 12/31/Year 2
Divisional investment
Accounts receivable	$ 1,960	$ 2,030	$ 1,750	$ 1,750	$ 1,750
Inventories	3,500	3,500	4,550	3,150	3,325
Plant fixed assets (net)	9,240	9,450	7,700	8,050	7,700
Total	$14,700	$14,980	$14,000	$12,950	$12,775

a Hall O’ Fame’s sales occur uniformly throughout the year.

Required

a. Evaluate the performance of James Davenport for the nine months ending September 30, Year 3. Support your evaluation with pertinent facts from the problem.

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b. Identify the features of Hall O’ Fame’s division performance measurement reporting and evaluation system that need to be revised if it is to effectively reflect the responsibilities of the divisional managers.

(CMA adapted)

Step 1 of 2

a.?An evaluation of the performance of James Davenport for the nine months ending September Year 3 would appear favorable if only the divisional performance measure figure were considered. The actual performance measure is well above the nine-month budgeted figure. However, closer examination of the report reveals that overall performance cannot be considered satisfactory for the following reasons:

?•?Variable cost of sales (direct materials and labor) has increased significantly as a percentage of sales.

?•?The maintenance and repair costs included in the budget and probably needed have not been incurred.

?•?Allocated corporate fixed costs are below budget. While these costs should have no effect on the performance of this division, its inclusion in the report does affect the residual income figure.

?Corporate policy dictates that division managers minimize their investment in inventories and maintain control over plant fixed assets. In this respect, James Davenport has not performed as well as expected for reasons described as follows:

?•?Inventories have increased significantly relative to sales volume and to divisional investment.

?•?Budgeted additions to plant fixed assets have not been made. The decision to postpone obtaining these fixed assets at the division level could have been made for the purpose of reducing the investment base and the imputed interest charge, or to reduce the investment base.