1. What is meant by the term decentralization? What benefits result from decentr
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Question
1. What is meant by the term decentralization? What benefits result from decentralization? 2. Distinguish between a cost center, a profit center, and an investment center. 3. In what way can the use of ROl as a performance measure for investment centers lead to bad decisions? How does the residual income approach overcome this proble? 4. What is the difference between delivery cycle time and throughput time? What four elements make up throughput time? What elements of throughput time are value-added and what elements are non-value-added? 5. What does a manufacturing cycle efficiency (MCE) of less than 1 mean? How would you interpret an MCE of 0.40? 6. Why do the measures used in a balanced scorecard differ from company to companyExplanation / Answer
1. Decentralisation: It is systematic process through which authority is distributed by the top management down the managerial hierarchy to create autonomous units. According to Louis A. Allen, “Decentralisation refers to tire systematic effort to delegate to the lowest levels all authority except that which can only be exercised at central points.” Advantages of decentralisation are:
a) Reduce the burden of Top Management: decisions of routine nature can be taken at lower level of management.
b) Top Management focuses on strategic planning: by delegating routine decisions to lower level top management have more time to focus on planning and implementation of strategies.
c) Quick Decision Making: no need to get prior approvals from higher level executives.
d) Boost morale of Employees: delegation of authority to subordinate enhance their morale and motivation.
e) Executive development through Opportunity to grow: decentralisation give opportunity to subordinates to take initiatives that helps to develop their talent for managerial positions.
2. A Cost center, a profit center and an investment center are created under the responsibility accounting. Responsibility accounting is the system of control where responsibility is established for the control of costs by delegating authority.
a) Cost Center: A cost center is a unit of an organisation whose manger is responsible for the cost incurred in that unit. Like in manufacturing organisation production department is classified as cost center.
b) Profit center: A profit center is that segment of the organisation whose manager is responsible for both revenues and costs. The main purpose of profit center is to earn profit.
c) Investment Center: An investment center is manger is responsible for both investments and returns on that investments. The investment center’s manager has the control over the amount invested in the assets of the center, expenses and incomes.
3. Return on Investment is measure of performance which evaluate the performance in terms of return earned on amount invested:
= Net Opearting Profit after Taxes (NOPAT) / Invested Capital
The two main limitations of ROI which leads to bad decisions are Overinvestment and Underinvestment.
a) Overinvestment: When manger are evaluated only in terms of profit, they are motivated to overinvest because their goal is to increase profit. Profit can be increased by investing in new projects that carry any rate of return, including a rate that is less than the minimum required rate specified by the management.
b) Underinvestment: Manger may not like to invest in that projects that don’t increase their ROI even if the ROI of that project is greater than minimum required rate of return.
Both the problem posed while using ROI as performance can be overcome by using residual income approach.
Residual Income= Net Operating Profit after Taxes (NOPAT) – Require Profit ( Cost of Capital * Invested Capital)
A positive residual incomes indicates that investment will add value to shareholders wealth thus the decision to invest will be wise.
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