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Summary LU8: Divisional performance evaluation
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Luthando Zulu: 17599770Finance 2B – FINM6212
LU8: Divisional performance evaluation
Responsibility accounting (divisional performance evaluation):
Refers to a method of preparing financial information used in evaluating the efficiency and effectiveness
of management over the financial performance within their control. Large diversified organizations are
difficult to manage as a single operation, so they need to be decentralized into manageable parts. These
parts are called responsibility centers or divisions. They include:
Revenue centers (manager responsible for generating sales e.g. sales department)
Cost centers (manager responsible for costs. e.g. purchasing department)
Profit centers (manager responsible for both revenues and costs)
Investment centers (manager responsible for investments e.g. acquisition and utilization of
assets)
Each responsibility centre is assigned a manager who is responsible for:
The aspects of performance within their control;
The difference between actual and budgeted performance;
The planning and controlling of resources within their responsibility centre.
Potential problems with inter-divisional performance measurement:
Inter-divisional performance measurement may be risky as no two divisions are identical. Performance
measurement will be ineffective where:
Divisions are comparatively different in size;
Divisions apply different interest rates;
The assets being compared have different useful lives and are of a different age;
Divisions use different financing methods (debt or equity);
The extent of head office involvement differs;
One division is labour-intensive and the other is capital-intensive;
One division owns production facilities and the other rents;
Products are sold in different markets, have different pricing strategies and face different
competitive pressures;
Different asset valuation methods are used.
Head office allocations should be excluded from the divisional performance evaluation.
Organizational structures:
Describes the manner in which an organization determines how roles, power and responsibilities are
delegated, controlled and coordinated, and how information flows between management levels.
1. Functional organizational structure:
Describes a typical hierarchical organizational structure where employees are managed through
clear lines of authority. Information and reporting flows upwards through the hierarchy. Decision-
making is determined by top (central) management, with strict control being exercised over
departments and divisions. The entire organization is viewed as an investment center, with a
functional structure operating below it. Activities of a similar type are placed under the control of
an appropriate department head.
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