9 Decentralized Performance Evaluation
Learning Objectives LO
LO1 Describe the advantages and disadvantages of a decentralized organizational structure
LO2 Describe responsibility centers and their performance evaluation
LO3 Evaluate the performance of investment centers using profit margin ratio, asset turnover ratio, and return on investment ratio
LO4 Describe the advantages and disadvantages of return on investment (ROI)
LO5 Describe social return on investment (SROI)
LO6 Compute residual income and identify its strengths and weaknesses
Organizational structure LO1
Organizational structure is defined as the manner in which authority, responsibility, and lines of communication are arranged within an organization. Organizational structure is typically considered more centralized or decentralized.
In a centralized organization, authority and responsibility are concentrated in the highest levels of management. The rest of the organization is responsible for following orders. A small, family-owned business is more likely to have a centralized structure where the owners make most of the business decisions. Smaller organizations with fewer managerial employees usually have a more centralized organizational structure.
In a decentralized organization, lower levels of management have the authority to make decisions and also hold some degree of responsibility for their decisions. Examples of decentralized organizations are fast-food or retail store chains such as Chipotle or Walmart. In most chain stores, store managers have the authority to make decisions regarding the daily operations of their store or location. However, some decisions are made at the corporate level and pushed down to the store managers.
Very few organizations are considered entirely centralized or decentralized. Instead, most organizations fall somewhere on the centralized spectrum. Except in very small organizations, some authority and responsibility must be delegated to lower-level employees. For example, decision-making authority is more centralized in the military, but many decisions are delegated to military branches, commands, formations, and units.
The major advantages and disadvantages of decentralization are discussed in the next section. Then the types of responsibility centers found in a decentralized organization are defined. Performance evaluation is an essential component of the operational cycle when authority and responsibility are delegated to responsibility centers. The accounting tools used for performance evaluation depend on the type of responsibility center being evaluated. In the remaining sections of this chapter, tools used for the performance evaluation of investment centers are presented.
Advantages of decentralization
- Higher management can focus on more significant organizational issues if routine business decisions are delegated to lower-level management.
- Lower-level employees are more involved in day-to-day operations and usually have more informatio