Accounting: The Language of Business - Vol. 1 (Part 142)

The reaction of weak management to weak operations is often weak accounting.

Warren Buffett

 Performance Evaluation for Decentralized Operations (Part A)

by

Charles Lamson

Have you ever wondered if there is an economic reason why large retail stores are divided into departments? Typically, these stores include a Men's Department, Women's Department, Cosmetics Department, Gift Department, and Furnishings Department. Each department usually has a manager who is responsible for the financial performance of the department. The store may be the responsibility of a store manager, and a group of stores within a particular geographic area may be the responsibility of a division or district manager. If you were to be hired by a department store chain, you would probably begin your career in a department. Running a department would be a valuable experience before becoming responsible for a complete store. Likewise, responsibilities for a complete store provides excellent training for other management positions.

In the next several posts, we will focus on the role of accounting in assisting managers in planning and controlling organizational units, such as divisions, stores, and departments.

Centralized and Decentralized Operations

A centralized business is one in which all major planning and operating decisions are made by top management. For example, a one-person, owner/manager operated business is centralized because all plans and decisions are made by one person. In a small owner/manager operated business, centralization may be desirable. This is because the owner/manager's close supervision ensures that the business will be operated in the way the owner/manager wishes.

Separating a business into divisions or operating the units and delegating responsibility to unit managers is called decentralization. In a decentralized business, the unit managers are responsible for planning and controlling the operations of their units.

Divisions are often structured around common functions, products, customers, or regions. For example, Delta Airlines is organized around functions, such as the Flight Operations Division. The Procter & Gamble company is organized around common products, such as the Soap Division, which sells a wide array of cleaning products. The Norfolk Southern Corporation decentralizes its railroad operations into Eastern, Western, and Northern regional divisions.

There is no one best amount of decentralization for all businesses. In some companies, division managers have authority over all operations, including fixed asset acquisitions and retirements. At other companies, division managers have authority over profits but not fixed asset acquisitions and retirements. The proper amount of decentralization for a company depends on its advantages and disadvantages for the company's unique circumstances.

Advantages of Decentralization

As a business grows, it becomes more difficult for top management to maintain close daily contact with all operations. In such cases, delegating authority to managers closest to the operations usually results in better decisions. These managers often anticipate and react to operating data more quickly than could top management. In addition, as the company expands into a whole range of products and services, it becomes more difficult for top management to maintain operating expertise in all product lines and services. Decentralization allows managers to focus on acquiring expertise in their areas of responsibility. For example, in a company that maintains operations in insurance, banking, and healthcare, managers could become "experts" in their area of operation and responsibility.

Decentralized decision making also provides excellent training for managers. This may be a factor in helping a company retain quality managers. Since the art of management is best acquired through experience, delegating responsibility allows managers to acquire and develop managerial expertise early in their careers.

Businesses that work closely with customers, such as hotels, are often decentralized. This helps managers create good customer relations by responding quickly to customers needs. In addition, because managers of decentralized operations tend to identify with customers and with operations, they are often more creative in suggesting operating and product improvements.

Disadvantages of Decentralization

A primary disadvantage of decentralized operations is that decisions made by one manager may negatively affect the profitability of the entire company. For example, the Pizza Hut chain added chicken to its menu and ended up taking business away from KFC. Then KFC retaliated with a blistering ad campaign against Pizza Hut, this happened even though both chains are part of the same company, Yum Brands, Inc.

Another potential disadvantage of decentralized operations is duplicating assets and costs in operating divisions. For example, each manager of a product line might have a separate sales force and administrative office staff. Centralizing these personnel could save money. For example, McDonald's Corporation reduced the number of operating divisions in the United States from five to three in order to cut administrative expenses (Warren, Reeve, & Fess, 2005).

Responsibility Accounting

In a decentralized business, an important function of accounting is to assist unit managers in evaluating and controlling their areas of responsibility, called responsibility centers. Responsibility accounting is the process of measuring and reporting operating data by responsibility center. Three common types of responsibility centers are cost centers, profit centers, and investment centers. These three responsibility centers differ in their scope of responsibility, as shown below.

*WARREN, REEVE, & FESS, 2005, ACCOUNTING, 21ST ED., PP. 953-954*

end