Transcript Responsibility Accounting - University of Alaska | Home

Segment Reporting and
Decentralization
UAA – ACCT 202
Principles of Managerial Accounting
Dr. Fred Barbee
The Work of Management
Planning
Evaluating
Decision
Making
Controlling
Organizing &
Directing
Controlling Operations
• Management by exception
• Responsibility Accounting
• Delegation of authority
• Management by walking around
Responsibility Accounting
• . . . is a reporting system in which a
cost is charged to the lowest level of
management that has responsibility for
it.
President
and CEO
Vice President
Marketing
Vice President
Production
Vice President
Controller
Installing Responsibility
Accounting
• Create a set of financial
performance goals (budgets).
• Measure and report actual
performance.
• Evaluate based on comparison of
actual with budget.
Responsibility Accounting
• Evaluation of responsibility centers
depends on . . .
– The extent of delegation of authority; and
– A manager’s preference
Decentralization . . .
• . . . the delegation of authority to the
lowest level of management
responsibility that can make decisions.
Centralization . . .
• . . . A centralized organization is one in
which little authority is delegated to
lower level managers.
Decentralization
• The more decentralized the firm, the
greater the need for control.
– Monitor employees
– Motivate employees
Advantages of Decentralization
• Top level managers are relieved of
making routine decisions.
• Higher employee morale
• Training
• Decisions are made where the action is
taking place.
Disadvantages of Decentralization
• Upper level management loses some
control.
• Lack of goal congruence.
• Duplication of effort.
Decentralization and Segment
Reporting
An Individual Store
Quick Mart
A segment is any
part or activity of
an organization
about which a
manager seeks
cost, revenue, or
profit data. A
segment can be
A Sales Territory
A Service Center
Cost, Profit, and Investments
Centers
Responsibility
Centers
Cost
Center
Profit
Center
Investment
Center
Responsibility Centers: A Systems Perspective
Data
(Inputs)
Resources used . . .
DM
DL
MOH
Processing Steps
Within
Information Systems
Capital . . .
Working
Capital
Equipment
Etc.
Information
(Outputs)
Output . . .
Goods,
Services,
Ideas
Cost, Profit, and Investments
Centers
Cost Center
A segment whose
manager has
control over
costs,
but not over
revenues or
investment funds.
Responsibility Centers:
A Systems Perspective
Input
Process
Cost Center
Control only this
Output
Evaluation . . .
• A cost center is evaluated by means of
performance reports (i.e., comparison
of actual with standard).
Segments Classified as Cost, Profit and
Investment Centers
Responsibility Centers:
A Systems Perspective
Input
Process
Profit Center
Control these
Output
Cost, Profit, and Investments
Centers
Profit Center
A segment whose
manager has
control over both
costs and
revenues,
but no control over
investment funds.
Revenues
Sales
Interest
Other
Costs
Mfg. costs
Commissions
Salaries
Other
A Profit Center . . .
• A profit center is evaluated by
means of contribution margin
income statements.
Segments Classified as Cost, Profit and
Investment Centers
Cost, Profit, and Investments
Centers
Investment
Center
A segment whose
manager has
control over costs,
revenues, and
investments in
operating assets.
Corporate Headquarters
Responsibility Centers:
A Systems Perspective
Input
Process
Output
Investment Center
Control these
Investment Center
• An investment center is evaluated by
means of the Return on Investment
(ROI) or the Residual Income (RI) it is
able to generate.
Segments Classified as Cost, Profit and
Investment Centers
Responsibility Centers
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
the assets employed in earning
revenues.
Levels of Segmented
Statements
Levels of Segmented
Statements
Levels of Segmented
Statements
Webber, Inc. has two divisions.
Webber, Inc.
Computer Division
Television Division
Let’s look more closely at the Television
Division’s income statement.
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.
Fixed and
variable costs
are listed in
separate
sections.
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
Division Segment Margin
Segment margin
is Television’s
contribution
to profits.
Traceable and Common Costs
Fixed
Costs
Don’t allocate
common costs.
Traceable
Common
Costs arise because
of the existence of
a particular segment
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
division means . . .
No computer
division manager.
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
division but . . .
We still have a
company president.
Levels of Segmented
Statements
Sales
Variable costs
CM
Traceable FC
Division margin
Common costs
Net operating
income
Income Statement
Company
Television
$ 500,000
$ 300,000
230,000
150,000
270,000
150,000
170,000
90,000
100,000
$ 60,000
25,000
$
Computer
$ 200,000
80,000
120,000
80,000
$ 40,000
Common costs should not
be allocated to the
75,000
divisions. These costs
would remain even if one
of the divisions were
eliminated.
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.
Let’s see how this works!
Traceable Costs Can Become
Common Costs
Webber’s Television Division
Product
Lines
Television
Division
Regular
U.S. Sales
Big Screen
Foreign Sales
U.S. Sales
Sales
Territories
Foreign Sales
Traceable Costs Can Become
Common Costs
Income Statement
Television
Division
Regular
Sales
$ 300,000
$ 200,000
Variable costs
150,000
95,000
CM
150,000
105,000
Traceable FC
80,000
45,000
Product line margin
70,000
$ 60,000
Common costs
10,000
Divisional margin
$ 60,000
Big Screen
$ 100,000
55,000
45,000
35,000
$ 10,000
Fixed costs directly traced
to the Television Division
$80,000 + $10,000 = $90,000
Traceable Costs Can Become
Common Costs
Income Statement
Television
Division
Regular
Sales
$ 300,000
$ 200,000
Variable costs
150,000
95,000
CM
150,000
105,000
Traceable FC
80,000
45,000
Product line margin
70,000
$ 60,000
Common costs
10,000
Divisional margin
$ 60,000
Big Screen
$ 100,000
55,000
45,000
35,000
$ 10,000
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.
Traceable Costs Can Become
Common Costs
Income Statement
Television
Division
Regular
Sales
$ 300,000
$ 200,000
Variable costs
150,000
95,000
CM
150,000
105,000
Traceable FC
80,000
45,000
Product line margin
70,000
$ 60,000
Common costs
10,000
Divisional margin
$ 60,000
Big Screen
$ 100,000
55,000
45,000
35,000
$ 10,000
The remaining $10,000 cannot be traced to
either the Regular or Big Screen product lines.
Segment Margin
Profits
The segment margin is the best gauge of
the long-run profitability of a segment.
Time
Responsibility and Controllability
Controllability is . . .
• The degree of influence that a specific
manager has over costs, revenues, or
other items in question.
Controllability
• Few costs are
clearly under the
sole influence of
one manager.
Controllability
• With a long
enough time
span, all costs
will come under
someone’s
control.
The Controllability Principle
Management
Actions
Costs
Uncontrollable
Environmental
Effects
Managers only
partially control
costs.
The Controllability Principle
. . . lead to more predictable
rewards for managers.
Management
Actions
Costs
Uncontrollable
Environmental
Effects
Performance
Measures
Rewards
Performance measurement
systems that are based on
controllable costs . . .
The Controllability Principle
The performance measures and rewards
will influence management to focus on the
controllable costs.
Management
Actions
Costs
Performance
Measures
Rewards
The Controllability Principle
Management
Actions
Costs
Uncontrollable
Environmental
Effects
Performance
Measures
Rewards
When performance measures
are affected by uncontrollable
environmental effects . . .
The Controllability Principle
Management
Actions
Costs
Uncontrollable
Environmental
Effects
Performance
Measures
Rewards
. . . management may try to control
the performance measure rather than
the underlying cost.
Hindrances to Proper Cost
Assignment
The Problems
Omission of some
costs in the
assignment process.
Assignment of costs
to segments that are
really common costs of
the entire organization.
The use of inappropriate
methods for allocating
costs among segments.
Omission of Costs
Costs assigned to a segment should include
all costs attributable to that segment from
the company’s entire value chain.
Business Functions
Making Up The
Value Chain
R&D
Product
Design
Customer
Manufacturing Marketing Distribution Service
Inappropriate Methods of Allocating
Costs Among Segments
Arbitrarily dividing
common costs
among segments
Inappropriate
allocation base
Failure to trace
costs directly
Segment
1
Segment
2
Segment
3
Segment
4
Return on Investment
• The ROI formula is expressed as:
Return on Investment
• Where . . .
Income
Margin = -------------------Sales
Return on Investment
• Where . . .
Sales
Turnover = -----------------------------Invested Capital
Return on Investment
Income
------------------------------
Sales
The ratio of
operating
income to sales
x
Sales
------------------------------
Invested Capital
The efficiency
of asset
utilization.
Return on Investment
Income
-----------------------------Sales
The ratio of
operating
income to sales
x
Sales
-----------------------------Invested Capital
The efficiency
of asset
utilization.
Return on Investment
Income
-----------------------------Invested Capital
=
ROI
Sales
Cost of
Goods Sold
Sales - OE
Selling
Expense
Operating
Expenses
Admin.
Expense
Net Oper.
Income
NOI / Sales
Margin
Sales
Margin is a measure of management’s
ability to control operating expenses in
relation to sales.
Turnover is a measure of the amount of
sales that can be generated in an
investment center for each dollar invested
in operating assets.
Cash
Accounts
Receivable
Sales
Current
Assets
Sales / AOA
Inventory
CA + NCA
PP&E
Other
Assets
Noncurr.
Assets
Ave Oper
Assets
Turnover
Sales
Cost of
Goods Sold
Sales - OE
Selling
Expense
Operating
Expenses
Admin.
Expense
Net Oper.
Income
NOI / Sales
Margin
Sales
MxT
Cash
Accounts
Receivable
Sales
Current
Assets
Sales / AOA
Inventory
CA + NCA
PP&E
Other
Assets
Noncurr.
Assets
Ave Oper
Assets
Turnover
ROI
Measuring Income and
Invested Capital
Income
-----------------------------Sales
x
Sales
-----------------------------Invested Capital
Measuring Income
• Variety of possibilities
• Text uses EBIT (Net Operating Income)
– Earnings Before Interest and Taxes
Measuring Invested Capital
• Variety of possibilities
• Text uses Net Book Value
– Consistent with how PP&E is listed on the
Balance Sheet.
– Consistent with the computation of
operating income.
Return on Investment (ROI)
Formula
Income before interest
and taxes (EBIT)
Net operating income
ROI =
Average operating assets
Cash, accounts receivable, inventory,
plant and equipment, and other
productive assets.
Improving the ROI
Increase
Sales
Reduce
Expenses
Reduce
Assets
XYZ Company
Income (EBIT)
$30,000
Sales
$500,000
Invested Capital
$200,000
Return on Investment
$30,000
-------------$500,000
x
$500,000
-------------$200,000
6%
x
2.5
=
15%
Approach #1:
Increase Sales
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.
• What is the impact on ROI?
Return on Investment
$42,000
-------------$600,000
x
$600,000
-------------$200,000
7%
x
3.0
=
21%
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.
• What is the impact on ROI?
Return on Investment
$40,000
-------------$500,000
x
$500,000
-------------$200,000
8%
x
2.5
=
20%
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.
• What is the impact on ROI?
Return on Investment
$30,000
-------------$500,000
x
$500,000
-------------$125,000
6%
x
2.4
=
24%
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
operating asset efficiency.
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
short run at the expense of the long
run.
Overinvestment
• Evaluation in terms of profit can lead
to overinvestment.
Overinvestment
• Increases in
Assets
Company
Manager
• Increases in
Profits
Underinvestment
• Evaluation in terms of ROI can lead to
underinvestment.
Overinvestment
• Decreases in
Assets
Company
Manager
• Increases in
ROI
Criticisms of ROI . . .
• ROI tends to emphasize short-run
performance over long-run profitability.
• ROI may not be completely controllable
by the division manager due to
committed costs.
Multiple Criteria . . .
• Growth in market share
• Increases in productivity
• Dollar profits
• Receivables turnover
• Inventory turnover
• Product innovation
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
= EBIT – Cost of Capital x Investment
Residual Income Example
Division A
Division B
$1,000,000
$3,000,000
EBIT Last Year
200,000
450,000
*Min. Required R of R
120,000
360,000
Residual Income
$80,000
$90,000
Invested Capital
*Minimum Required Rate of Return = 12%
Problem with RI . . .
• RI cannot be used to compare
performance of divisions of different
sizes.
Advantage of RI . . .
• RI encourages managers to make
profitable investments that would be
rejected under the ROI approach.
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%.
Should the investment be made?
Marsh Company
Return on Investment
Present
New
$1,000,000
$250,000
$1,250,000
NOPAT (2)
200,000
*40,000
240,000
ROI (1)/(2)
20%
16%
19.2%
Invested Capital (1)
*$250,000 x 16% = $40,000
Overall
Marsh Company
Return on Investment
Reject - Reduces overall ROI!!!
Present
New
$1,000,000
$250,000
$1,250,000
NOPAT (2)
200,000
*40,000
240,000
ROI (1)/(2)
20%
16%
19.2%
Invested Capital (1)
*$250,000 x 16% = $40,000
Overall
Marsh Company
Residual Income
Accept - Positive Residual Income!!!
Present
New
$1,000,000
$250,000
$1,250,000
200,000
40,000
240,000
Minimum RofR*
$120,000
$30,000
$150,000
Residual Income
$80,000
$10,000
$90,000
Invested Capital (1)
NOPAT (2)
Overall
*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.
– If EVA is negative, the company is
destroying capital.
Calculating EVA . . .
• EVA = After-tax operating income
minus (the weighted-average cost of
capital times total capital employed)
– Determine weighted average cost of capital
– Determine total dollar amount of capital
employed