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29 Cards in this Set

  • Front
  • Back

reasons for decentralizing operations and decision making

-better decision making

-motivation for managers

-training of managers

-frees up time of central management to focus on strategic issues

types of decentralized units

-cost center

-revenue center

-profit center

-investment center

cost center

-is an organizational unit whose management is financially responsible only for its costs.

-sometimes broken down into standard cost centers and discretionary cost centers

standard cost center

a cost center that has clearly defined relationships between effort and accomplishment.


production departments in manufacturing organizations

-performance evaluated using variances and flexible budgets

discretionary cost center

a cost center that does not have clearly defined relationships between effort and accomplishment.

ex- research and development departments, maintenance departments, and administrative departments.

-performance is often evaluated using non financial measures

- one financial measure is to compare actual costs with budgeted costs, but does not help evaluate the effectiveness of the center

revenue center

a revenue center is an organizational unit whose management is financially responsible for the units revenues. these type of decentralized units are not very common.

ex might be a sales department, but if the department is also given any responsibility for costs, it should probably be evaluated as a profit center

profit center

a profit center is an organizational unit whose management is financially responsible for the difference between the units revenue and costs. marketing functions are often organized as profit centers because the manager has a responsibility for costs as well as for revenues.

a measure of profits is often used to evaluate the financial performance of a profit center

investment center

an investment center is an organizational unit whose management is financially responsible for the relationship between the units profits and total assets.

Divisions of companies are examples of investment centers.

two traditional measures of performance for investment centers are return on investment ROI and residual income RI.

recently economic value added (EVA) has been promoted as a metric for evaluating the performance of investment centers as well as companies

return on investment

ROI= income/investment

roi formula

ROI=(sales/investment) X (income/sales)

ROI= ( investment turnover X return on sales)

advantages to ROI

-encourage managers to consider the relationships bw income and investment

-encourage costs efficiency- reducing costs will increase ROI

-encourage efficient investments

disadvantages of roi

it may discourage managers from investing in projects that decrease the divisions ROI but might be acceptable to the company using discounted cash flow evaluation of capital investment proposals

- it may encourage managers to focus on the short term at the expense of the long term

residual income

RI= operating income- capital charge

(CC= minimum required return on capital X investment)

advantages of RI

encourages managers to accept investments that have a rate of return greater than the charge for capital

measures are expressed in dollars rather than a percentage which some managers seem to prefer

dis RI

residual income can be improved using short term actions that might harm the company in the long run

bc it is measured in dollars it makes it difficult to compare divisions of different sizes

transfer pricing

often decentralized units will buy and sell goods to each other. When this occurs, a price must be established for the transaction. The price determines the amount that is recorded as a sale for the selling unit and the amount that is recorded as the purchase costs for the buying unit. thus the amount that is used affects the profits and the performance measure of both decentralized units

what is a transfer price

the amount that is charged for goods and services that are sold by one segment of an organization and purchased by another segment

transfer pricing problem

occurs when the best transfer price for a decentralized unit is not the best transfer price from the companys viewpoint. the selling unit would like to have a high transfer price and the buying unit would like a low transfer price, and the optimal price form the firms viewpoint may not be the price managers agree on

methods for determining transfer price

market based transfer prices

-market price

-adjusted market price

negotiated transfer prices

-marginal or variable costs

-variable cost plus fixed fee

-full cost

-full cost plus markup

market price

the market price is the price the intermediate product sells for in the outside market. the market price should be used as the transfer price if there is a competitive market for the product. this price will encourage both departments to act in a manner that maximizes overall company profits. It is also the opportunity costs to the selling department

adjusted market price

an adjustment to the market price is sometimes made bc there are no selling costs or bad debts associated with intra company transfers.

negotiated price


-divisions managers with local information may take advantage of other manager

-negotiating skills may determine who receives the most benefit from the negotiation. the issue here is should negotiating skills affect performance evaluation

- negotiating can consume lots of time and effort

value chain

a value chain is a set of linked operations and processes that begins with obtaining resources and ends with providing products or services that customers value

life cycle concepts

three major types of activities in the production view point

research and development activities

production activities

logistical activities

purchases costs

costs incurred after the product has been sold and delivered to a customer

production life cycle

emphasizes cost management

four types of costs as life cycle costs

design and development costs

production costs

logistics and distribution costs

post purchase costs

target costing

is used at the design and development stage of a product bc during this stage when most of the products life cycle costs become committed

it requires

purchase high quality materials

maintain good relationship with suppliers

often redesign the manufacturing process into cells