Segment Reporting and
Decentralization
UAA – ACCT 202 Principles of Managerial
Planning
Planning
Decision Making
Decision
Making Organizing & Directing Organizing
Controlling Operations
•
Management by exception
•Responsibility Accounting
•Delegation of authority
Responsibility Accounting
• . . . is a reporting system in which a
cost is charged to the lowest level of
Installing Responsibility
Accounting
•
Create a set of financial
performance goals (budgets).
•
Measure and report actual
performance.
•
Evaluate based on comparison of
Responsibility Accounting
• Evaluation of responsibility centers
depends on . . .
– The extent of delegation of authority; and
Decentralization . . .
• . . . the delegation of authority to the
lowest level of management
Centralization . . .
• . . . A centralized organization is one in
Decentralization
• The more decentralized the firm, the
greater the need for control.
– Monitor employees
Advantages of Decentralization
• Top level managers are relieved of
making routine decisions.
• Higher employee morale
• Training
• Decisions are made where the action is
Disadvantages of Decentralization
• Upper level management loses some
control.
• Lack of goal congruence.
Decentralization and Segment
Reporting
Quick Mart Quick Mart
An Individual Store
A Sales Territory
A Service Center
A segment is any part or activity of an organization about which a manager seeks cost, revenue, or profit data. A
Cost, Profit, and Investments
Center CenterProfit Profit
Center InvestmentCenter Investment
Responsibility Centers: A Systems Perspective
Responsibility Centers: A Systems Perspective
Cost, Profit, and Investments
Centers
Cost Center
A segment whose
manager has control over
costs, but not over
revenues or
Responsibility Centers:
A Systems Perspective
Responsibility Centers:
A Systems Perspective
Input
Input
Output
Output
Process
Process
Control only
this
Cost Center
Evaluation . . .
• A cost center is evaluated by means of
Responsibility Centers: A Systems Perspective
Responsibility Centers: A Systems Perspective
Input
Input
Process
Process
Output
Output
Control these
Profit Center
Cost, Profit, and Investments
Centers
Profit Center
A segment whose
manager has
control over both
A Profit Center . . .
•
A profit center is evaluated by
Cost, Profit, and Investments
Centers
Investment Center
A segment whose manager has
control over costs,
revenues, and
investments in
operating assets.
Responsibility Centers: A Systems Perspective
Responsibility Centers: A Systems Perspective
Input
Input
Output
Output
Process
Process
Control these
Investment Center
Investment Center
• An investment center is evaluated by
means of the Return on Investment
Segments Classified as Cost,
Profit and Investment Centers
R
es
po
n
sib
ilit
y C
en
te
Profit Center Vs. Investment
Center
• A profit center is focused on profits as
measured by the difference between revenues and expenses.
• An investment center is compared with
Let’s look more closely at the Television Division’s income statement.
Let’s look more closely at the Television Division’s income statement.
Webber, Inc. has two divisions.
Our approach to segment reporting uses the contribution format.
Income Statement
Contribution Margin Format Television Division
Sales $ 300,000
Variable COGS 120,000
Other variable costs 30,000 Total variable costs 150,000 Contribution margin 150,000 Traceable fixed costs 90,000 Division margin $ 60,000
Cost of goods sold consists of
variable
manufacturing costs.
Cost of goods sold consists of
variable
manufacturing costs.
Fixed and variable costs
are listed in separate sections.
Fixed and variable costs
Segment margin is Television’s
contribution to profits.
Segment margin is Television’s
contribution to profits.
Income Statement
Contribution Margin Format Television Division
Sales $ 300,000
Variable COGS 120,000
Other variable costs 30,000 Total variable costs 150,000 Contribution margin 150,000 Traceable fixed costs 90,000 Division margin $ 60,000
Our approach to segment reporting uses the contribution format.
Traceable and Common Costs
Fixed Costs
Traceable
Traceable
Costs arise because of the existence of a particular segment
Common
A cost that supports more than one segment but that would not go away if any particular segment
were eliminated.
Identifying Traceable Fixed
Costs
Traceable costs would disappear over time if the segment itself disappeared.
No computer
No computer
Identifying Common Fixed
Costs
Common costs arise because of overall
operation of the company and are not due to the existence of a particular segment.
No computer
No computer
division but . . .
division but . . .
We still have a
We still have a
company president.
Levels of Segmented
Statements
Income Statement
Company Television Computer
Sales $ 500,000 $ 300,000 $ 200,000
Common costs should not be allocated to the
divisions. These costs would remain even if one
of the divisions were eliminated.
Common costs should not be allocated to the
divisions. These costs would remain even if one
Traceable Costs Can Become
Common Costs
Fixed costs that are traceable on one segmented statement can become common if the company is divided into
smaller segments.
U . S . S a l e s F o r e i g n S a l e s
Traceable Costs Can Become
Common Costs
Income Statement Television
Division Regular Big Screen
Sales $ 300,000 $ 200,000 $ 100,000
Traceable Costs Can Become
Common Costs
Fixed costs directly traced to the Television Division
$80,000 + $10,000 = $90,000
Fixed costs directly traced to the Television Division
Traceable Costs Can Become
Common Costs
Of the $90,000 cost directly traced to the Television Division, $45,000 is traceable to Regular and $35,000
traceable to Big Screen product lines.
Income Statement Television
Division Regular Big Screen
Income Statement Television
Division Regular Big Screen
Sales $ 300,000 $ 200,000 $ 100,000
Traceable Costs Can Become
Common Costs
Segment Margin
The segment margin is the best gaugebest gauge of the long-run profitability of a segment.
Controllability is . . .
• The degree of influence that a specific
Controllability
•
Few costs are
Controllability
•
With a long
enough time
span, all costs
will come under
someone’s
The Controllability Principle
Managers only
partially control
costs.
Managers only
partially control
Rewards
Rewards
. . . lead to more predictable rewards for managers.
. . . lead to more predictable rewards for managers.
Management
The Controllability Principle
Performance measurement systems that are based on
controllable costs . . .
Performance measurement systems that are based on
The performance measures and rewards will influence management to focus on the
controllable costs.
The performance measures and rewards will influence management to focus on the
controllable costs.
Costs RewardsRewards
The Controllability Principle
Performance Measures
When performance measures are affected by uncontrollable
environmental effects . . .
When performance measures are affected by uncontrollable
environmental effects . . . Management
Costs RewardsRewards
. . . management may try to control the performance measure rather than
the underlying cost.
. . . management may try to control the performance measure rather than
the underlying cost.
Management
Costs RewardsRewards
Hindrances to Proper Cost
Assignment
The Problems
The Problems
Omission of some costs in the
assignment process.
Assignment of costs to segments that are really common costs of
the entire organization.
Omission of Costs
Costs assigned to a segment should include all costs attributable to that segment from
the company’s entire value chainvalue chain.
Product Customer R&D Design Manufacturing Marketing Distribution Service
Business Functions
Business Functions
Making Up The
Making Up The
Value Chain
Inappropriate Methods of Allocating
Costs Among Segments
Segment Failure to trace
costs directly
Return on Investment
Return on Investment
• Where . . .
Income
Return on Investment
• Where . . .
Sales
Income
Return on Investment
The ratio of operating income to sales
The efficiency of asset
Income
Return on Investment
The ratio of operating income to sales
The efficiency of asset
Income
Selling
Accounts
Turnover is a measure of the amount of
sales that can be generated in an
Measuring Income and
Invested Capital
Income
---Sales
Sales
---Invested Capital
Measuring Income
• Variety of possibilities
• Text uses EBIT (Net Operating Income)
Measuring Invested Capital
• Variety of possibilities
• Text uses Net Book Value
– Consistent with how PP&E is listed on the Balance Sheet.
Return on Investment (ROI)
Formula
ROI =
ROI =
Net operating income
Net operating income
Average operating assets
Average operating assets
Cash, accounts receivable, inventory, plant and equipment, and other
productive assets.
Cash, accounts receivable, inventory, plant and equipment, and other
productive assets. Income before interest
and taxes (EBIT) Income before interest
Improving the ROI
IncreaseIncrease Sales Sales
ReduceReduce Expenses
XYZ Company
Income (EBIT)
Sales
Invested Capital
$30,000
$500,000
$30,000
---$500,000
$500,000
---$200,000
x
Return on Investment
6%
x
2.515%
Increase Sales . . .
• Assume that XYZ is able to increase sales
to $600,000.
• Net Operating Income increases to
$42,000.
• Average Operating Assets remain
unchanged.
$42,000
---$600,000
$600,000
---$200,000
x
Return on Investment
7%
x
3.021%
Reduce Expenses . . .
• Assume that XYZ is able to reduce
expenses by $10,000
• Net Operating Income increases to
$40,000.
• Average Operating Assets and sales
remain unchanged.
$40,000
---$500,000
$500,000
---$200,000
x
Return on Investment
8%
x
2.520%
Reduce Assets . . .
•
Assume that XYZ is able to reduce
its operating assets from $200,000
to $125,000.
•
Sales and Net Operating Income
remain unchanged.
$30,000
---$500,000
$500,000
---$125,000
x
Return on Investment
6%
x
2.424%
Advantages of ROI . . .
• It encourages managers to focus on the
relationship among sales, expenses, and investment.
• It encourages managers to focus on
cost efficiency.
• It encourages managers to focus on
Disadvantages of ROI
• It can produce a narrow focus on
divisional profitability at the expense of profitability for the overall firm.
• It encourages managers to focus on the
Overinvestment
• Evaluation in terms of profit can lead
Overinvestment
•
Increases in
Assets
•
Increases in
Profits
ManagerUnderinvestment
• Evaluation in terms of ROI can lead to
Overinvestment
•
Decreases in
Assets
•
Increases in
ROI
ManagerCriticisms of ROI . . .
• ROI tends to emphasize short-run
performance over long-run profitability.
• ROI may not be completely controllable
Multiple Criteria . . .
• Growth in market share • Increases in productivity • Dollar profits
Residual Income . . .
•
. . . is the net operating income
that an investment center is able to
earn above some minimum rate of
return on its operating assets.
Residual Income = EBIT – Required Profit
Residual Income Example
Division B Division A
Invested Capital
EBIT Last Year
*Min. Required R of R
Residual Income
Problem with RI . . .
• RI cannot be used to compare
Advantage of RI . . .
• RI encourages managers to make
Example . . .
• Assume that ABC Company’s Division A
has an opportunity to make an
investment of $250,000 that would generate a 16% return.
• The Division’s current ROI is 20%.
Marsh Company
Return on Investment
Overall New
Invested Capital (1)
Marsh Company
Return on Investment
Overall New
Invested Capital (1)
NOPAT (2)
Marsh Company Residual Income
Overall New
Invested Capital (1)
NOPAT (2)
$80,000 $10,000 $90,000
*Minimum Required Rate of Return = 12% x Invested Capital
Economic Value Added
• Economic Value Added (EVA) is
after-tax operating profit minus the total annual cost of capital
– If EVA is positive, the company is creating wealth.
Calculating EVA . . .
• EVA = After-tax operating income
minus (the weighted-average cost of capital times total capital employed)
– Determine weighted average cost of capital