99765186 responsibility accounting

7/30/2019 99765186 Responsibility Accounting

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Segment Reporting andDecentralization

UAA ACCT 202

Principles of Managerial AccountingDr. Fred Barbee


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Planning

Decision

Making

Organizing &Directing

Controlling

Evaluating

The Work of Management


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Controlling Operations

Management by exception

Responsibility Accounting Delegation of authority

Management by walking around


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Responsibility Accounting

. . . is a reporting system in which acost is charged to the lowest level of

management that has responsibility forit.

Vice PresidentMarketing

Vice PresidentProduction

Vice PresidentController

President

and CEO


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Installing ResponsibilityAccounting

Create a set of financialperformance goals (budgets).

Measure and report actualperformance.

Evaluate based on comparison ofactual with budget.


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Responsibility Accounting

Evaluation of responsibility centersdepends on . . .

The extent of delegation of authority; and

A managers preference


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Decentralization . . .

. . . the delegation of authority to thelowest level of management

responsibility that can make decisions.


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Centralization . . .

. . . A centralized organization is one inwhich little authority is delegated to

lower level managers.


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Decentralization

The more decentralized the firm, thegreater the need for control.

Monitor employees

Motivate employees


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Advantages of Decentralization

Top level managers are relieved ofmaking routine decisions.

Higher employee morale

Training

Decisions are made where the action istaking place.


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Disadvantages of Decentralization

Upper level management loses somecontrol.

Lack of goal congruence.

Duplication of effort.


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Decentralization and SegmentReporting

Quick MartAn Individual Store

A Sales Territory

A Service Center

Asegment is anypart or activity of

an organizationabout which amanager seekscost, revenue, or

profit data. Asegment can be


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Cost, Profit, and InvestmentsCenters

Responsibility

Centers

CostCenter

ProfitCenter

InvestmentCenter


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Responsibility Centers: A Systems Perspective

Processing StepsWithin

Information Systems

Data

(Inputs)

Information

(Outputs)

DM

DLMOH

Goods,

Services,Ideas

Working

CapitalEquipmentEtc.

Resources used . . . Capital . . . Output . . .


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Cost CenterA segment whose

manager hascontrol over

costs,

but not overrevenues orinvestment funds.


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Responsibility Centers:A Systems Perspective

Input OutputProcess

Control only this

Cost Center


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Evaluation . . .

A cost center is evaluated by means ofperformance reports (i.e., comparison

of actual with standard).


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Input OutputProcess

Control these

Profit Center


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Profit CenterA segment whose

manager hascontrol overboth

costs and

revenues,but no control overinvestment funds.

RevenuesSales

Interest

Other

CostsMfg. costs

CommissionsSalaries

Other


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A Profit Center . . .

A profit center is evaluated bymeans of contribution margin

income statements.


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InvestmentCenter

A segment whosemanager has

control over costs,

revenues, andinvestments inoperating assets. Corporate Headquarters


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Input OutputProcess

Control these

Investment Center


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Investment Center

An investment center is evaluated bymeans of the Return on Investment

(ROI) or the Residual Income (RI) it isable to generate.


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Respo

nsibilityCenters


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Profit Center Vs. InvestmentCenter

Aprofit center is focused on profits asmeasured by the difference between

revenues and expenses. An investment center is compared with

the assets employed in earning

revenues.


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Levels of SegmentedStatements


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Lets look more closely at the Television

Divisions income statement.

Webber, Inc. has two divisions.

Computer Division Television Division

Webber, Inc.


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Our approach to segment reporting uses thecontribution 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 150,000Traceable fixed costs 90,000

Division margin 60,000$

Cost of goodssold consists of

variable

manufacturingcosts.

Fixed andvariable costs

are listed inseparatesections.


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Segment marginis Televisionscontribution

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 90,000Division margin 60,000$

Our approach to segment reporting uses thecontribution format.

Division Segment Margin


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Traceable and Common Costs

FixedCosts

Traceable

Costs arise becauseof the existence of

a particular segment

Common

A cost that supports more than onesegment but that would not goaway if any particular segment

were eliminated.

Dont allocatecommon costs.


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Identifying Traceable FixedCosts

Traceable costswould disappear overtime if the segment itself disappeared.

No computerdivision means . . .

No computerdivision manager.


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Identifying Common FixedCostsCommon costsarise because of overalloperation of the company and are not due tothe existence of a particular segment.

No computerdivision but . . .

We still have acompany president.


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Income Statement

Company Television Computer

Sales 500,000$ 300,000$ 200,000$

Variable costs 230,000 150,000 80,000

CM 270,000 150,000 120,000Traceable FC 170,000 90,000 80,000

Division margin 100,000 60,000$ 40,000$

Common costs 25,000

Net operatingincome 75,000$

Common costs should not

be allocated to thedivisions. These costs

would remain even if oneof the divisions were

eliminated.


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Traceable Costs Can BecomeCommon Costs

Fixed costs that are traceable on onesegmented statement can become

common if the company is divided intosmaller segments.

Lets see how this works!


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U.S. Sales Foreign Sales

Regular

U.S. Sales Foreign Sales

Big Screen

Television

Division


ProductLines

SalesTerritories

Webbers Television Division


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Income StatementTelevision

Division Regular Big Screen

Sales 300,000$ 200,000$ 100,000$

Variable costs 150,000 95,000 55,000

CM 150,000 105,000 45,000Traceable FC 80,000 45,000 35,000

Product line margin 70,000 60,000$ 10,000$

Common costs 10,000

Divisional margin 60,000$


Fixed costs directly tracedto the Television Division

$80,000 + $10,000 = $90,000


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Of the $90,000 cost directly traced to the TelevisionDivision, $45,000 is traceable to Regular and $35,000

traceable to Big Screen product lines.



Sales 300,000$ 200,000$ 100,000$

Variable costs 150,000 95,000 55,000

CM 150,000 105,000 45,000Traceable FC 80,000 45,000 35,000


Common costs 10,000



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Sales 300,000$ 200,000$ 100,000$

Variable costs 150,000 95,000 55,000

CM 150,000 105,000 45,000Traceable FC 80,000 45,000 35,000


Common costs 10,000



The remaining $10,000 cannot be traced toeither the Regular or Big Screen product lines.


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Segment Margin

The segment margin is the best gauge ofthe long-run profitability of a segment.

Time

P

rofits


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Responsibility and Controllability


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Controllability is . . .

The degree of influence that a specificmanager has over costs, revenues, or

other items in question.


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Controllability

Few costs are

clearly under thesole influence ofone manager.


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Controllability

With a longenough time

span, all costswill come undersomeones

control.


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The Controllability Principle

ManagementActions

UncontrollableEnvironmental

Effects

CostsManagers onlypartially control

costs.


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Rewards

. . . lead to more predictablerewards for managers.Management

Actions

Uncontrollable

EnvironmentalEffects

PerformanceMeasures

Costs


Performance measurementsystems that are based on

controllable costs . . .


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The performance measures and rewardswill influence management to focus on the

controllable costs.

ManagementActions

Performance

MeasuresCosts Rewards


Performance

Measures


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When performance measuresare affected by uncontrollable

environmental effects . . .

ManagementActions

Uncontrollable


PerformanceMeasures

Costs Rewards



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. . . management may try to controlthe performance measure rather than

the underlying cost.

ManagementActions

Uncontrollable


PerformanceMeasures

Costs Rewards



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Hi d t P C t


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Hindrances to Proper CostAssignment

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.


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Omission of Costs

Costs assigned to a segment should includeall costs attributable to that segment from

the companys entirevalue chain.

Product CustomerR&D Design Manufacturing Marketing Distribution Service

Business FunctionsMaking Up The

Value Chain

I i t M th d f All ti


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Inappropriate Methods of AllocatingCosts Among Segments

Segment1

Segment3

Segment4

Failure to tracecosts directly

Arbitrarily dividingcommon costs

among segments

Inappropriateallocation base

Segment2


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Return on Investment

The ROI formula is expressed as:


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Where . . .

IncomeMargin = --------------------

Sales


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Where . . .

SalesTurnover = ------------------------------

Invested Capital


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Income------------------------------

Sales

Sales------------------------------

Invested Capital

x


The ratio of

operating

income to sales

The efficiencyof asset

utilization.


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Income

------------------------------

Sales

Sales

------------------------------

Invested Capital

x


The ratio ofoperating

income to sales

The efficiencyof asset

utilization.


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Income

------------------------------

Invested Capital= ROI



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SellingExpense

Admin.

Expense

Cost of

Goods Sold

Sales

OperatingExpenses

Net Oper.

Income

Sales

Margin

Sales - OE

NOI / Sales

Margin is a measure of managements

ability to control operating expenses in

relation to sales.

T i f th t f


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Accounts

Receivable

Inventory

PP&E

Other

Assets

Cash

Current

Assets

Noncurr.

Assets

Ave Oper

Assets

Sales

Turnover

CA + NCA

Sales / AOA

Turnover is a measure of the amount of

sales that can be generated in an

investment center for each dollar investedin operating assets.

Sales


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Selling

ExpenseAdmin.

Expense

Accounts

Receivable

Inventory

PP&E

Other

Assets

Cost of

Goods Sold

Cash

Sales

Operating

Expenses

Net Oper.

Income

Sales

Margin

ROI

Current

Assets

Noncurr.

Assets

Ave Oper

Assets

Sales

Turnover

Sales - OE

CA + NCA

M x T

NOI / Sales

Sales / AOA


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Measuring Income andInvested Capital

Income

------------------------------

Sales

Sales

------------------------------

Invested Capitalx


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Measuring Income

Variety of possibilities

Text uses EBIT (Net Operating Income)

Earnings Before Interestand Taxes


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Measuring Invested Capital

Variety of possibilities

Text uses Net Book Value

Consistent with how PP&E is listed on theBalance Sheet.

Consistent with the computation ofoperating income.

Return on Investment (ROI)


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Return on Investment (ROI)Formula

ROI = Net operating incomeAverage operating assets

Cash, accounts receivable, inventory,plant and equipment, and other

productive assets.

Income before interestand taxes (EBIT)


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Improving the ROI

IncreaseSales

ReduceExpenses Reduce

Assets


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XYZ Company

Income (EBIT)

Sales

Invested Capital

$30,000

$500,000

$200,000


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$30,000--------------

$500,000

$500,000--------------

$200,000

x


6% 2.5

x15%=


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Approach #1:Increase Sales


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Increase Sales . . .

Assume that XYZ is able to increasesales to $600,000.

Net Operating Income increases to$42,000.

Average Operating Assets remain

unchanged.

What is the impact on ROI?


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$42,000--------------

$600,000

$600,000--------------

$200,000

x


7% 3.0x

21%=


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Reduce Expenses . . .

Assume that XYZ is able to reduceexpenses by $10,000

Net Operating Income increases to$40,000.

Average Operating Assets and sales

remain unchanged.


R I


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$40,000--------------

$500,000

$500,000--------------

$200,000

x


8% 2.5x

20%=


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Reduce Assets . . .

Assume that XYZ is able to reduceits operating assets from $200,000

to $125,000. Sales and Net Operating Income

remain unchanged.


R t I t t


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$30,000--------------

$500,000

$500,000--------------

$125,000

x


6% 2.4x

24%=


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Advantages of ROI . . .

It encourages managers to focus on therelationship among sales, expenses,

and investment. It encourages managers to focus on

cost efficiency.

It encourages managers to focus onoperating asset efficiency.


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Disadvantages of ROI

It can produce a narrow focus ondivisional 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.


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Overinvestment

Evaluation in terms ofprofit can leadto overinvestment.


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Overinvestment

Increases inAssets

Increases inProfits

Manager

Company


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Underinvestment

Evaluation in terms ofROI can lead tounderinvestment.


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Overinvestment

Decreases inAssets

Increases inROI

Manager

Company


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Criticisms of ROI . . .

ROI tends to emphasize short-runperformance over long-run profitability.

ROI may not be completely controllableby the division manager due tocommitted costs.


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Multiple Criteria . . .

Growth in market share

Increases in productivity

Dollar profits

Receivables turnover

Inventory turnover Product innovation


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Residual Income . . .

. . . is the net operating incomethat an investment center is able to

earn above some minimum rate ofreturn on its operating assets.

Residual Income = EBIT Required Profit

= EBIT Cost of Capital x Investment

Residual Income Example


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Residual Income Example

Division BDivision A

Invested Capital

EBIT Last Year

*Min. Required R of R

Residual Income

$1,000,000

200,000

120,000

$80,000

$3,000,000

450,000

360,000

$90,000

*Minimum Required Rate of Return = 12%


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Problem with RI . . .

RI cannot be used to compareperformance of divisions of different

sizes.


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Advantage of RI . . .

RI encourages managers to makeprofitable investments that would be

rejected under the ROI approach.


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Example . . .

Assume that ABC Companys Division Ahas an opportunity to make an

investment of $250,000 that wouldgenerate a 16% return.

The Divisions current ROI is 20%.

Should the investment be made?

Marsh Company


96/100


OverallNew

Invested Capital (1)

NOPAT (2)

ROI (1)/(2)

*$250,000 x 16% = $40,000

$250,000

*40,000

16%

$1,250,000

240,000

19.2%20%

200,000

$1,000,000

Present

Marsh Company


97/100


OverallNew


NOPAT (2)

ROI (1)/(2)

*$250,000 x 16% = $40,000

$250,000

*40,000

16%

$1,250,000

240,000

19.2%20%

200,000

$1,000,000

Present

Reject - Reduces overall ROI!!!

Marsh Company


98/100

Residual Income

OverallNew


NOPAT (2)

Minimum RofR*

Residual Income

$250,000

40,000

$30,000

$1,250,000

240,000

$150,000$120,000

200,000

$1,000,000

Present

$80,000 $10,000 $90,000

*Minimum Required Rate of Return = 12% x Invested Capital

Accept - Positive Residual Income!!!


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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 isdestroying capital.


100/100

Calculating EVA . . .

EVA = After-tax operating incomeminus (the weighted-average cost of

capital times total capital employed) Determine weighted average cost of capital

Determine total dollar amount of capital

employed

99765186 responsibility accounting

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