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Principles of Accounting, Volume 2: Managerial Accounting

9.2 Describe How Decision-Making Differs between Centralized and Decentralized Environments

Principles of Accounting, Volume 2: Managerial Accounting9.2 Describe How Decision-Making Differs between Centralized and Decentralized Environments
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  1. Preface
  2. 1 Accounting as a Tool for Managers
    1. Why It Matters
    2. 1.1 Define Managerial Accounting and Identify the Three Primary Responsibilities of Management
    3. 1.2 Distinguish between Financial and Managerial Accounting
    4. 1.3 Explain the Primary Roles and Skills Required of Managerial Accountants
    5. 1.4 Describe the Role of the Institute of Management Accountants and the Use of Ethical Standards
    6. 1.5 Describe Trends in Today’s Business Environment and Analyze Their Impact on Accounting
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Thought Provokers
  3. 2 Building Blocks of Managerial Accounting
    1. Why It Matters
    2. 2.1 Distinguish between Merchandising, Manufacturing, and Service Organizations
    3. 2.2 Identify and Apply Basic Cost Behavior Patterns
    4. 2.3 Estimate a Variable and Fixed Cost Equation and Predict Future Costs
    5. Key Terms
    6. Summary
    7. Multiple Choice
    8. Questions
    9. Exercise Set A
    10. Exercise Set B
    11. Problem Set A
    12. Problem Set B
    13. Thought Provokers
  4. 3 Cost-Volume-Profit Analysis
    1. Why It Matters
    2. 3.1 Explain Contribution Margin and Calculate Contribution Margin per Unit, Contribution Margin Ratio, and Total Contribution Margin
    3. 3.2 Calculate a Break-Even Point in Units and Dollars
    4. 3.3 Perform Break-Even Sensitivity Analysis for a Single Product Under Changing Business Situations
    5. 3.4 Perform Break-Even Sensitivity Analysis for a Multi-Product Environment Under Changing Business Situations
    6. 3.5 Calculate and Interpret a Company’s Margin of Safety and Operating Leverage
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  5. 4 Job Order Costing
    1. Why It Matters
    2. 4.1 Distinguish between Job Order Costing and Process Costing
    3. 4.2 Describe and Identify the Three Major Components of Product Costs under Job Order Costing
    4. 4.3 Use the Job Order Costing Method to Trace the Flow of Product Costs through the Inventory Accounts
    5. 4.4 Compute a Predetermined Overhead Rate and Apply Overhead to Production
    6. 4.5 Compute the Cost of a Job Using Job Order Costing
    7. 4.6 Determine and Dispose of Underapplied or Overapplied Overhead
    8. 4.7 Prepare Journal Entries for a Job Order Cost System
    9. 4.8 Explain How a Job Order Cost System Applies to a Nonmanufacturing Environment
    10. Key Terms
    11. Summary
    12. Multiple Choice
    13. Questions
    14. Exercise Set A
    15. Exercise Set B
    16. Problem Set A
    17. Problem Set B
    18. Thought Provokers
  6. 5 Process Costing
    1. Why It Matters
    2. 5.1 Compare and Contrast Job Order Costing and Process Costing
    3. 5.2 Explain and Identify Conversion Costs
    4. 5.3 Explain and Compute Equivalent Units and Total Cost of Production in an Initial Processing Stage
    5. 5.4 Explain and Compute Equivalent Units and Total Cost of Production in a Subsequent Processing Stage
    6. 5.5 Prepare Journal Entries for a Process Costing System
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  7. 6 Activity-Based, Variable, and Absorption Costing
    1. Why It Matters
    2. 6.1 Calculate Predetermined Overhead and Total Cost under the Traditional Allocation Method
    3. 6.2 Describe and Identify Cost Drivers
    4. 6.3 Calculate Activity-Based Product Costs
    5. 6.4 Compare and Contrast Traditional and Activity-Based Costing Systems
    6. 6.5 Compare and Contrast Variable and Absorption Costing
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  8. 7 Budgeting
    1. Why It Matters
    2. 7.1 Describe How and Why Managers Use Budgets
    3. 7.2 Prepare Operating Budgets
    4. 7.3 Prepare Financial Budgets
    5. 7.4 Prepare Flexible Budgets
    6. 7.5 Explain How Budgets Are Used to Evaluate Goals
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  9. 8 Standard Costs and Variances
    1. Why It Matters
    2. 8.1 Explain How and Why a Standard Cost Is Developed
    3. 8.2 Compute and Evaluate Materials Variances
    4. 8.3 Compute and Evaluate Labor Variances
    5. 8.4 Compute and Evaluate Overhead Variances
    6. 8.5 Describe How Companies Use Variance Analysis
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  10. 9 Responsibility Accounting and Decentralization
    1. Why It Matters
    2. 9.1 Differentiate between Centralized and Decentralized Management
    3. 9.2 Describe How Decision-Making Differs between Centralized and Decentralized Environments
    4. 9.3 Describe the Types of Responsibility Centers
    5. 9.4 Describe the Effects of Various Decisions on Performance Evaluation of Responsibility Centers
    6. Key Terms
    7. Summary
    8. Multiple Choice
    9. Questions
    10. Exercise Set A
    11. Exercise Set B
    12. Problem Set A
    13. Problem Set B
    14. Thought Provokers
  11. 10 Short-Term Decision Making
    1. Why It Matters
    2. 10.1 Identify Relevant Information for Decision-Making
    3. 10.2 Evaluate and Determine Whether to Accept or Reject a Special Order
    4. 10.3 Evaluate and Determine Whether to Make or Buy a Component
    5. 10.4 Evaluate and Determine Whether to Keep or Discontinue a Segment or Product
    6. 10.5 Evaluate and Determine Whether to Sell or Process Further
    7. 10.6 Evaluate and Determine How to Make Decisions When Resources Are Constrained
    8. Key Terms
    9. Summary
    10. Multiple Choice
    11. Questions
    12. Exercise Set A
    13. Exercise Set B
    14. Problem Set A
    15. Problem Set B
    16. Thought Provokers
  12. 11 Capital Budgeting Decisions
    1. Why It Matters
    2. 11.1 Describe Capital Investment Decisions and How They Are Applied
    3. 11.2 Evaluate the Payback and Accounting Rate of Return in Capital Investment Decisions
    4. 11.3 Explain the Time Value of Money and Calculate Present and Future Values of Lump Sums and Annuities
    5. 11.4 Use Discounted Cash Flow Models to Make Capital Investment Decisions
    6. 11.5 Compare and Contrast Non-Time Value-Based Methods and Time Value-Based Methods in Capital Investment Decisions
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  13. 12 Balanced Scorecard and Other Performance Measures
    1. Why It Matters
    2. 12.1 Explain the Importance of Performance Measurement
    3. 12.2 Identify the Characteristics of an Effective Performance Measure
    4. 12.3 Evaluate an Operating Segment or a Project Using Return on Investment, Residual Income, and Economic Value Added
    5. 12.4 Describe the Balanced Scorecard and Explain How It Is Used
    6. Key Terms
    7. Summary
    8. Multiple Choice
    9. Questions
    10. Exercise Set A
    11. Exercise Set B
    12. Problem Set A
    13. Problem Set B
    14. Thought Provokers
  14. 13 Sustainability Reporting
    1. Why It Matters
    2. 13.1 Describe Sustainability and the Way It Creates Business Value
    3. 13.2 Identify User Needs for Information
    4. 13.3 Discuss Examples of Major Sustainability Initiatives
    5. 13.4 Future Issues in Sustainability
    6. Key Terms
    7. Summary
    8. Multiple Choice
    9. Questions
    10. Thought Provokers
  15. Financial Statement Analysis
  16. Time Value of Money
  17. Suggested Resources
  18. Answer Key
    1. Chapter 1
    2. Chapter 2
    3. Chapter 3
    4. Chapter 4
    5. Chapter 5
    6. Chapter 6
    7. Chapter 7
    8. Chapter 8
    9. Chapter 9
    10. Chapter 10
    11. Chapter 11
    12. Chapter 12
    13. Chapter 13
  19. Index

Businesses are organized with the intention of creating efficiency and effectiveness in achieving organizational goals. To aid in this, larger businesses use segments, uniquely identifiable components of the business. A company often creates them because of the specific activities undertaken within a particular portion of the business.4 Segments are often categorized within the organization based on the services provided (i.e., departments), products produced, or even by geographic region. The purpose of identifying distinguishable segments within an organization is to provide efficiency in decision-making and effectiveness in operational performance.

Organizational Charts

Many organizations use an organizational chart to graphically represent the authority for decision-making and oversight. Organizational charts are similar in appearance to flowcharts. An organizational chart for a centralized organization is shown in Figure 9.2. The middle tier represents position held by individuals or departments within the company. The lowest tier represents geographic locations in which the company operates. The lines connecting the boxes indicate the relationship among the segments and branch from the ultimate and decision-making authority. Organizational charts are typically arranged with the highest-ranking person (or group) listed at the top.

A centralized organizational chart showing four departments reporting to the President: Sales and Marketing, Operations, Manufacturing, and Finance. Three locations report to the President: Northeast Region, Southwest Region, and Midwest Region.
Figure 9.2 An Organizational Chart for a Centralized Organization. Centralized organizations have units that report directly to one person. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-SA 4.0 license)

Notice the organization depicted in Figure 9.2 has segments based on departments as well as geographic regions. In addition, all lines connect directly to the president of the organization. This indicates that the president is responsible for the oversight and decision-making for the production and sales departments as well as the district (Northeast, Southwest, and Midwest) managers; essentially, the president has seven direct reports. In this centralized organizational structure, all decision-making responsibility resides with the president.

Figure 9.3 shows the same organization structured as a decentralized organization.

A decentralized organizational chart showing five divisions reporting to the President: Operations, Northeast Region, Southwest Region, Midwest Region, and Finance. Each of the regions have two divisions that report to them: Sales and Marketing, and Manufacturing.
Figure 9.3 An Organizational Chart for a Decentralized Organization. Decentralized organizations have units that report through intermediate management layers. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-SA 4.0 license)

Notice that the organization depicted in Figure 9.3 has the same segments, which represent departments and geographic regions. There are, however, noticeable differences between the centralized and decentralized structure. Instead of seven direct reports, the president now oversees five direct reports, three of which are based on geography—the Western, Southern, and Eastern regional managers. Notice, too, each regional district manager is responsible for their respective production and sales departments. In this decentralized organization, all decision-making responsibility does not reside with the president; regional decisions are delegated to the three regional managers. Understand, however, that responsibility for achieving the organization’s goals still ultimately resides with the company president.

In a centralized environment, the major decisions are made at the top by the CEO and then are carried out by everyone below the CEO. In a decentralized environment, the CEO sets the tone for the running of the organization and provides some decision-making guidelines, but the actual decisions for the day-to-day operations are made by the managers at the various levels of the organization. In other words, the essential difference between centralized and decentralized organizations involves decision-making. While no organization can be 100% centralized or 100% decentralized, organizations generally have a well-established structure that outlines the decision-making authority within the organization.

Continuing Application

Centralized vs. Decentralized Management

Gearhead Outfitters was founded by Ted Herget in 1997 in a friend’s living room in Jonesboro, AR. By 2003, the business moved to its downtown location. In 2006, a second Jonesboro location was opened. Over the next several years, the company’s growth allowed for expansion to several different cities, miles and hours away. Eventually Little Rock, AR, Fayetteville, AR, Shreveport, LA, Springfield, MO, and Tulsa, OK became home to Gearhead branches.

With such growth, the company faced many management challenges. Would it be best for management to remain centralized with decision-making coming from a single location, or should the process be decentralized, allowing local management the flexibility and autonomy to run individual locations? If local management is given autonomy to make their own decisions, will those decisions be in line with company, or perhaps, individual goals? How will management be evaluated? Will inventory management be a uniform process, or will people and the process have to adapt to accommodate differences in demand at each location?

These are just some of the hurdles that Gearhead needed to address. What are some other issues which Gearhead might have considered? Think in terms of inventory management, personnel, efficiencies, and leadership development. How could Gearhead have use decentralized management to grow and thrive? Conversely, what would the benefits of keeping all or some of the company’s management decisions more centralized be?

How Does Decision-Making Differ in a Centralized versus a Decentralized Environment?

The CEO of a centralized organization will determine the direction of the company and determine how to get the company to its goals. The steps necessary to reach these goals are then passed along to the lower-level managers who carry out these steps and report back to the CEO. The CEO would then evaluate the results and incorporate any necessary operational changes. On the other hand, the CEO of a decentralized organization will determine the goals of the company and either pass along the goals to the divisional managers for them to determine how to reach these goals or work with the managers to determine the strategic plans and how to meet the goals laid out by those plans. The divisional managers will then meet with the managers below them to determine the best way to reach these goals. The lower-level managers are responsible for carrying out the plan and reporting their results to the manager above them. The higher-level managers will combine the results of several managers and evaluate those results before sending them to the divisional manager.

Think It Through

Determining the Best Structure

Here are some examples of decisions that every business must make:

  • Facility and equipment purchases and upgrades
  • Personnel decisions such as hiring and compensation
  • Products and services to offer, prices to charge customers, markets in which to operate

For each decision listed, identify and explain the best structure (centralized, decentralized, or both) for each of the following types of businesses:

  • Auto manufacturer with multiple production departments
  • Florist shop (with three part-time employees) owned by a local couple
  • Law firm with four attorneys

Footnotes

  • 4 In Building Blocks of Managerial Accounting, you learned that generally accepted accounting principles (GAAP)—also called accounting standards—provide official guidance to the accounting profession. Under the oversight of the Securities and Exchange Commission (SEC), GAAP are created by the Financial Accounting Standards Board (FASB). The official definition of segments as provided by FASB can be reviewed in ASC 280-10-50.
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