25-1 chapter 25 r esponsibility a ccounting segmental analysis

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CHAPTER 25CHAPTER 25

RESPONSIBILITY

ACCOUNTING

SEGMENTAL ANALYSIS

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Responsibility AccountingResponsibility Accounting Def. - An accounting system that

collects, summarizes and reports accounting data relating to responsibilities of individual managers.

It enables evaluation of managers by analyzing how well they manage those items under their control.

Therefore, responsibility reports should concentrate on controllablecontrollable items.

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Successful implementation of the system depends on properproper organizationorganization so that responsibility is assignable to individual managers. FormalFormal lines of authority and

responsibility should be fully defined. Organization charts such as the

following are used as a basis for responsibility reporting.

Responsibility AccountingResponsibility Accounting

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Vice Presidentof F inance

D epartm ent M anager

Store M anager

V ice Presidentof O perations

V ice Presidentof M arketing

President

B oard of D irectors

Organization ChartOrganization Chart

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Vice Presidentof F inance

D epartm ent M anager

Store M anager

V ice Presidentof O perations

V ice Presidentof M arketing

President

B oard of D irectors

Responsibility ReportsResponsibility Reports

Moredetail

Lessdetail

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Amount of detail varies according to level in organization. Department manager receives detailed report. Store manager receives summarized

information from each department. Vice president of operations receives

summarized information from each store. Management by exception (again)

A given level of management does not receive detail from lower levels unless needed.

e.g., VP could get store manager’s report

Responsibility ReportsResponsibility Reports889

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Responsibility ReportsResponsibility Reports

Be timely.Be simple andeasy to read.

Be issuedregularly.

Compare budgetedand actual amounts.

Responsibility reports should . . .

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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

SegmentsSegments

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Quick Mart

An Individual Store



can be . . .

SegmentsSegments

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A Department



can be . . .

SegmentsSegments

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A Product Line



can be . . .

SegmentsSegments

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A responsibility responsibility centercenter is a segment of an organization

for which a particular manager

is responsible.

Responsibility CentersResponsibility Centers

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Three Types of Centers

Expense (or Cost) Centers

Profit Centers

Investment Centers

Three Types of Centers

Expense (or Cost) Centers

Profit Centers

Investment Centers

Responsibility CentersResponsibility Centers

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Expense/Cost CentersExpense/Cost Centers

Incur expenses only Produce no direct revenue from sale of

goods or services Manager held responsible for long-run

minimization of expenses Primary means of evaluation

Standard costs Flexible budgets

e.g., accounting department

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Profit CentersProfit Centers

Incur expenses andand generate revenue Primary objective is profit maximization

Manager is held responsible for expense control and revenue growth

Primary means of evaluationContribution margin

Why are they so appealing?Management is often paid based on how well their profit center performs.

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Investment CentersInvestment Centers

What do they have besides expenses and revenues?

An appropriate investment base Objective is to maximize return on that

investment base Primary means of evaluation

Return on investment (ROI) A/K/A Rate of Return

Residual Income

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Transfer PricesTransfer Prices

The price used to record a transferof goods or services from onesegment to another segment

within the same company.

The price used to record a transferof goods or services from onesegment to another segment

within the same company.

BuyingSegment

SellingSegment

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What is the primary use for transfer pricing?

Allows turning a cost center into a profit center.

What is the primary use for transfer pricing?

Allows turning a cost center into a profit center.

BuyingSegment

SellingSegment

RevenueCost or expense

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Potentialconflict

BuyingSegment

SellingSegment

Revenue

Higher priceis desired.

Cost or expense

Lower priceis desired.


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BuyingSegment

SellingSegment

Revenue


Cost or expense


The transfer price can be . . . Market price if external market exists Cost to produce plus a profit margin Negotiated amount

The transfer price can be . . . Market price if external market exists Cost to produce plus a profit margin Negotiated amount


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BuyingSegment

SellingSegment

Revenue


Cost or expense



Setting prices is a big problem in practice. Management, marketing and finance courses

also cover transfer pricing. Each discipline thinks it “owns” the problem.

Setting prices is a big problem in practice. Management, marketing and finance courses

also cover transfer pricing. Each discipline thinks it “owns” the problem.

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Segmental AnalysisSegmental Analysis

Def. - Analyzing financial information by segment

Uses concepts previously studied Fixed and variable costs Contribution margin, net income, etc.

And new concepts Cost objective Direct cost Indirect cost

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Segmental Analysis ConceptsSegmental Analysis ConceptsCost ObjectiveCost Objective

Cost objectiveThe segment or product for which costs may be accumulated

i.e., a scheme for collecting costs

KEYKEY - Costs are either direct or indirect relative to a particular cost objective.

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Segmental Analysis ConceptsSegmental Analysis Concepts Direct CostsDirect Costs

Specifically traceable to a given cost objective

Likely to be eliminated if cost objective eliminated

Often controllable by segment manager Examples

Cost accountant’s salary at Little Rock plant is a direct cost for that plant/cost objective

Corp. accountant’s salary is direct cost to NY accounting department/cost objective

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Allocated to a cost objective and not specifically traceable to that objective

Not likely to be eliminated if cost objective eliminated

Often not controllable by segment manager

ExampleCorporate accountant’s salary and the rent on NY home office are indirect relative to the three plants/cost objectives

Segmental Analysis ConceptsSegmental Analysis Concepts Indirect CostsIndirect Costs

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Therefore, costs may be direct to one cost objective and indirect to another.

Another example: Segment manager’s salary is direct to the segment but indirect to the units of product made in that segment.

Caveat - Some direct costs may not be controllable by the segment manager.

Example: Segment manager’s salary is direct to segment but not controlled by the segment manager.

Segmental Analysis ConceptsSegmental Analysis Concepts Direct and Indirect CostsDirect and Indirect Costs

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Radio Division Television Division

Total Company

Segmental AnalysisSegmental AnalysisExampleExample

Total Company has two divisions.

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Total TV RadioCompany Division Division

Sales 700,000$Less: Variable expenses 300,000 Contribution margin 400,000 Less: Direct fixed expenses 190,000 Contribution to indirect expenses 210,000

Less: Indirect fixed expenses 60,000 Income 150,000$

Contribution Margin Format Income StatementBefore Segmenting into Divisions


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Contribution Margin Format Income StatementAfter Segmenting into Divisions

Total TV RadioCompany Division Division

Sales 700,000$ 500,000$ 200,000$Less: Variable expenses 300,000 200,000 100,000 Contribution margin 400,000 300,000 100,000 Less: Direct fixed expenses 190,000 170,000 20,000 Contribution to indirect expenses 210,000 130,000$ 80,000$


Indirect expenses are not attributable toeither the TV or Radio Divisions.


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Contribution Margin Format Contribution Margin Format Income StatementIncome Statement

Emphasizes a segment’s contribution to indirect expenses contribution to indirect expenses as appropriate figure for evaluating earnings of the segment.

Expenses are classified as either . . . Variable or fixed Direct or indirect

Companies may choose to allocate or not to allocate indirect fixed expenses.

Authors’ preference?

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Fixed costs that are direct on one segmented statement can become

indirect if the segment is divided into smaller segments.

Direct and Indirect CostsDirect and Indirect Costs

Let’s see how this works!

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O rganiza tiona l Segm ents

U. S. Sales Foreign Sales

Black & White

U. S. Sales Foreign Sales

Color

TelevisionDivision


Organizational Segments

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TV Black andDivision Color White



TV Division’s $170,000 direct fixed expenses becomes $140,000 with additional segmentation. $30,000 is indirect to product lines.


Contribution Margin Format Income StatementBefore Segmenting TV Division into Product Lines

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Contribution Margin Format Income StatementBefore Segmenting TV Division into Product Lines




Direct to products 140,000$ Indirect to products 30,000 Total 170,000$

$170,000 is directto TV Division.


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Contribution Margin Format Income StatementAfter Segmenting TV Division into Product Lines


Sales 500,000$ 350,000$ 150,000$Less: Variable expenses 200,000 120,000 80,000 Contribution margin 300,000 230,000 70,000 Less: Direct fixed expenses 140,000 90,000 50,000 Contribution to indirect expenses 160,000 140,000$ 20,000$



Direct to products 140,000$ Indirect to products 30,000 Total 170,000$

$170,000 is directto TV Division.

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Are you readyfor investment

center analysis?

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Investment Center AnalysisInvestment Center AnalysisReturn on InvestmentReturn on Investment

Return on investment (ROIROI) provides a relative measure of effectiveness of segments.

ROI calculates the return (income) as a percentage of assets employed (investment).

Income Investment

ROI =

Skipped in Chapter 17 - Must know now!

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ROI may be used to evaluate different levels of investment centers in a company. (ILL. 25.7, p. 896) Evaluation of earnings of an

entireentire companycompany Evaluation of the income contribution of a

segmentsegment Evaluation of income performance of a

segment managersegment manager Therefore, “Income” and “Investment”

can be defined any of three ways.

Investment Center AnalysisInvestment Center AnalysisReturn on InvestmentReturn on Investment

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Evaluation of EarningsEvaluation of Earningsof Entire Companyof Entire Company

When evaluating an entire company . . . “Income” in ROI formula is net income of

company. “Investment” in ROI formula is total assets

of entire company.

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Evaluation of Income Evaluation of Income Contribution of SegmentContribution of Segment

When evaluating a segment . . . “Income” in ROI formula is contribution to contribution to

indirect expenses.indirect expenses. “Investment” in ROI formula is assets

directly used by and identified with the segment.

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Evaluation of PerformanceEvaluation of Performanceof Segment Managerof Segment Manager

When evaluating a segment manager . . . “Income” in ROI formula is

income that is controllable by segment manager.

Begin with contribution to indirect expenses and eliminate any revenues and expenses not under the direct control of segment manager.

“Investment” is assets under the control of the segment manager.

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Expanded Form of Expanded Form of ROI CalculationROI Calculation

Income Sales Sales Investment

Income Sales Sales InvestmentROI = ×

The ROI formula is expanded into two ratios to more easily demonstrate actions

that might be taken to increase ROI.

Margin or

Return on Sales

Turnover

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Regal Company has sales of $500,000, income of $30,000 and investment in assets of $200,000. What is Regal’s

margin (return on sales)?

a. 6%

b. 10%

c. 12%

d. 15%



a. 6%

b. 10%

c. 12%

d. 15%

ROI QuestionROI Question

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a. 6%

b. 10%

c. 12%

d. 15%



a. 6%

b. 10%

c. 12%

d. 15%

Margin = $30,000 ÷ $500,000 = 6%


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turnover?

a. 2.0 times

b. 2.5 times

c. 3.0 times

d. 3.5 times


turnover?

a. 2.0 times

b. 2.5 times

c. 3.0 times

d. 3.5 times


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turnover?

a. 2.0 times

b. 2.5 times

c. 3.0 times

d. 3.5 times


turnover?

a. 2.0 times

b. 2.5 times

c. 3.0 times

d. 3.5 times

Turnover = $500,000 ÷ $200,000 = 2.5 times


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Regal Company has sales of $500,000, income of $30,000 and investment in

assets of $200,000. What is Regal’s ROI?

a. 6%

b. 10%

c. 12%

d. 15%



a. 6%

b. 10%

c. 12%

d. 15%


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a. 6%

b. 10%

c. 12%

d. 15%



a. 6%

b. 10%

c. 12%

d. 15%

ROI = Margin × TurnoverROI = 6% × 2.5 = 15%


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Problems With ROIProblems With ROIMeasuring Investment in AssetsMeasuring Investment in Assets

Three Ways To Measure InvestmentThree Ways To Measure Investment

Original cost

Original cost less accumulated depreciation (i.e., book value)

Current replacement cost

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Def. - Segment manager takes action in segment’s best interest, but not in best interest of company as a whole.

To deal with suboptimization, companies sometimes use Residual Income (Residual Income (RI).

Residual income is the amount of income a segment has in excess of a desired minimum ROI.

Problems With ROIProblems With ROISuboptimizationSuboptimization

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You are a division manager with an annual salary of $50,000 plus a bonus of $10,000 for

each one percent that your division ROI exceeds company ROI. Your division ROI is

30 percent while the company ROI is 15 percent.

What is your current total annual pay?

Problems With ROIProblems With ROISuboptimization ExampleSuboptimization Example

Salary 50,000$ Bonus = $10,000 × (30 - 15) = 150,000 Total annual pay 200,000$

Salary 50,000$ Bonus = $10,000 × (30 - 15) = 150,000 Total annual pay 200,000$

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You are a division manager with an annual salary of $50,000 plus a bonus of $10,000 for

each one percent that your division ROI exceeds company ROI. Your division ROI is

30 percent while the company ROI is 15 percent.

A new project is available with an ROI of 24 percent. Based on your compensation plan,

would you accept the project?


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As division manager,I wouldn’t invest in

that project becauseit would lower my pay!


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Hmm . . . I thought we were supposedto do what was best

for the company!


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Residual IncomeResidual Income

To deal with suboptimization of this type, let’s use residual income (RI).

To deal with suboptimization of this type, let’s use residual income (RI).

RI = Income – (Investment × Minimum ROI)

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A division has a $100,000 investment in assets and a company minimum ROI of 20 percent. If income for the division is

$30,000, what is residual income?

a. $30,000

b. $20,000

c. $10,000

d. $0



a. $30,000

b. $20,000

c. $10,000

d. $0

Residual Income QuestionResidual Income Question

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a. $30,000

b. $20,000

c. $10,000

d. $0



a. $30,000

b. $20,000

c. $10,000

d. $0

Income 30,000$ Minimum Required Return ($100,000 × 20%) 20,000 Residual Income 10,000$

Residual Income QuestionResidual Income Question

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Motivation and Residual IncomeMotivation and Residual IncomeUsing residual income to

evaluate managers encourages them to make profitable

investments that would be rejected by managers evaluated

using ROI only.

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My residual incomeis rising even though

average ROI is declining!

Motivation and Residual IncomeMotivation and Residual Income

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THE ENDTHE ENDI’ll teach you a thing or two

about responsibility and authority in my organization!

25-1 chapter 25 r esponsibility a ccounting segmental analysis

Documents

profit centers

responsibility reports

organization chart slide

accounting department

responsibility reporting

types of centers

u store manager

u department manager