RESPONSIBILITY ACCOUNTING, PERFORMANCE
EVALUATION, AND TRANSFER PRICING
QUESTIONS FOR WRITING AND DISCUSSION
Decentralization is the delegation of decision-
making authority to lower levels. In central-
ized decision making, decisions are made at
the very top level, and lower-level managers
are responsible for implementing these de-
cisions. For decentralized decision making,
decisions are made and implemented by
Reasons for decentralization include the fol-
lowing: access to local information, cognitive
limitations, more timely response, focusing
of central management, exposure of seg-
ments to market forces, enhanced competi-
tion, training, and motivation.
Knowledge of local conditions may be critic-
al for decisions; local managers are aware
of these conditions, whereas higher-level
managers may not be.
Margin = Net income/Sales, and Turnover =
Sales/Average operating assets. By break-
ing ROI into margin and turnover, more in-
sight into why ROI may change from one
period to the next is possible.
Three advantages of ROI include: (1) ROI
encourages managers to pay attention to
the relationships among sales, expenses,
and investment. (2) ROI encourages cost ef-
ficiency. (3) ROI discourages excessive in-
vestment in operating assets. Increased
profitability can be achieved (all other things
being equal) by increasing revenues, de-
creasing expenses, or lowering investment.
Two disadvantages of ROI are: (1) ROI may
discourage managers from investing in proj-
ects that would increase the profitability of
the firm but decrease the division’s ROI. (2)
It also may encourage managers to focus
on short-run profitability and to take actions
that may harm long-run profitability.
Residual income is the difference between
net income and the minimum dollar return
required on an investment. Residual income
encourages investment in all projects that
earn at least the minimum rate of return.
EVA is economic value added. It is the dif-
ference between after-tax income and the
cost of the capital employed. EVA is an ab-
solute dollar amount, not a percentage rate
of return like ROI. EVA differs from residual
income in EVA’s use of after-tax income and
the true cost of capital (rather than a hurdle
A stock option is the right to purchase a cer-
tain amount of stock at a fixed price. It can
encourage goal congruence by giving man-
agers an ownership stake in the firm, en-
couraging them to view operations from a
A transfer price is the price charged for
goods that are transferred from one division
to another division of the same company.
The transfer pricing problem is finding a
transfer price that simultaneously satisfies
three objectives: accurate performance eval-
uation, goal congruence, and preservation
of divisional autonomy.