Accounting 3020

Chapter 12 – Segment Reporting, Decentralization, and Balanced

Scorecard

Decentralization

• Decision making is spread throughout the organization, not all made by top management

• Advantages– Empowers managers to make decisions– Middle managers have more knowledge about day to day

activities

• Disadvantages– It gives a lot of responsibility to managers who may be

inexperienced– Divisions may not work toward the good of the overall

company – may promote only their own division

Segments

• Segment – part or division of a company

• Can be break the company into parts– By product– By function – sales, marketing, production,

accounting– By customer – industrial group, nonprofit

clients, schools, hospitals, etc.– By geographic region – U.S., Europe, Asia, etc.

Responsibility Accounting

• Organizational Structure and Responsibility

• Have segments account only for items they can control - controllability– Cost center (just costs)– Revenue center (just revenues)– Profit center (both revenues and costs)– Investment center (assets, revenues and costs)

Responsibility Accounting

• Evaluation– Cost center – variance analysis– Revenue center – variance analysis– Profit center – segmental profitability– Investment center – return on investment and

residual income

Segmental Reporting

• Segmental reporting for profit centers • Contribution margin format• Sales, variable costs, contribution margin• Fixed costs broken down into

– Traceable fixed costs– Common fixed costs– Traceable and common fixed costs vary by segments– Higher up the organization, the more traceable costs you have

• Segment margin is the final subtotal on which to be evaluated

Segmental Reporting

• Hindrances to Proper Cost Assignment– Improper allocation of common costs

• Based on sales, equally assigned, by activity based costing

• Method of assignment could cause behavioral problems

Investment Centers

• Performance Measures– Return on Investment

• Net operating income/Average operating assets

• ROI = Profit Margin x Asset turnover

• ROI = Net operating income/Sales x Sales/Average operating assets

• Is often used with the balanced scorecard

• Problems of manipulation

Investment Centers

• Performance Measures– Residual Income

• Net operating income - % minimum return on average operating assets

• Dollar figure developed to compare to other divisions and companies

• Allows firms to invest in projects that are below their ROI

Balanced Scorecard

• Information system for employees for all levels of the organization

• Translation of a business unit’s mission and strategy into tangible goals and measures.

• Balanced scorecards focus on continuous improvement• Four Different Perspectives

– Financial– Customer– Internal Business Process– Learning and growth

Performance Measures

• Critical Financial Performance Measures– Operating profit– Return on Investment– Return on Equity– Return on Capital Employed– Economic Value Added

• Critical Customer Performance Measures– Customer satisfaction– Customer retention– New customer acquisition– Customer profitability

Performance Measures

• Internal Business Process Performance Measures– Innovation Processes

– Quality measures

– Cycle time measures• Delivery cycle times

• Throughput time - time to manufacture

• Manufacturing Cycle Efficiency = Process time/Throughput time (Goal = 100%)

– Cost measures

– Post-Sale Service Processes

Performance Measures

• Learning and Growth Performance Measures– People– Systems– Organizational Procedures

• Balanced Scorecard measures should be measured in a timely fashion!!!!

Transfer Prices

• Definition – price charged between two divisions of the same company

• Theoretical price: Costs incurred + lost contribution margin

• Perfect market conditions– Market price charged if producing at full capacity– Variable costs charged if producing at less than full

capacity– Real world: Price somewhere between the two – Negotiated price

Transfer Prices

• Methods used in practice– Negotiated transfer prices

– Cost-based prices• At least variable costs charged (Variable cost)

• Often some portion of fixed costs is charged (Termed full cost)

• Sometimes a profit margin is added to the above costs

– Market-based prices

• Divisional autonomy and suboptimization

Transfer Pricing

• International Complications– Taxes– Competition– Import duties– National controls (currency rationing, limits on

amount of cash taken out of country)– Profitability of subsidiary