GROUP 4

CHAPTER 9: DECENTRALIZED OPERATIONS

AND SEGMENT REPORTING

Decentralization

- It is the process of delegating the decision-making authority throughout an organization.

Top Managers

- They determine when delegation of responsibility is desirable before designing strategic

performance.

Strategic Benefit of Centralized Approach

- The top management retains control over key business functions ensuring a desired level of
performance.
- The expertise of top management can be effectively coordinated.

Reasons why Decentralized Approach is preferred over Centralized Approach

- The top management cannot effectively manage the operations at a very detailed level that’s
why decisions at lower levels in the firm must be made on a timely basis using the information
at hand to make the firm more responsive to the customer.
- Managers are allowed at various operating levels the authority to make decisions relating to
their area of responsibilities.
- The informal relationships and channels of communication can develop outside the formal
reporting relationships on the organizational hart as a result of personal contact among
managers.

Advantages of Decentralization

 Creates greater responsiveness to local needs

- Sony Company reports that two advantages of decentralization are: 1) increase in the
company’s knowledge and; 2) improved service to customers.
 Leads to gains from quicker decision making
- It speeds decision making, creating a competitive advantage over centralized
organizations.
 Increases motivation of subunit managers
- J&J, a highly decentralized company, maintains: Decentralization = Creativity =
Productivity
 Aids management development and learning
- An electronics instruments company expressed this benefit as follows: “Decentralized
units provide a training ground for general managers, and a visible field of combat
where product champions fight for their ideas.”
  Sharpens the focus of subunit managers
- The manager of a small subunit has a concentrated focus. A small subunit is more
flexible and nimble than a larger subunit is better able to adopt itself quickly to a fast-
opening market opportunity.
 Decisions are best made at that level in an organization where problems and opportunities arise
 Management is relieved of much day-to-day problem solving and is left free to concentrate on
long-range planning and coordination of efforts
 Segment members obtain more job satisfaction and are encouraged to put forth their best
efforts by giving them added responsibility and decision making authority
 It provides excellent training to managers by giving them greater decision-making control over
their segments
 Better and faster performance evaluation
- Through decentralization, managers have more latitude for employing their skills and
efforts.

Limitations of Decentralization

 Dysfunctional decision making may result to suboptimal or incongruent decision making

- Suboptimal decision making may occur: 1) when there is a lack of harmony among the
overall organization goals, etc. and; 2) when no guidance is given to subunit managers
concerning the effects of their decision on other parts of the organization.
 Manager’s attention may be focused only on the subunit rather than the organization as a
whole
- Individual subunit managers may regard themselves as competing with managers of
other subunits in the same organization as if they were rivals.
 Cost to gather information is increased
- Managers may spend too much time obtaining information about different subunits of
the organization in order to coordinate their actions.
 Activities may be duplicated
- Several subunits of the organization may undertake the same activity separately.

Segment Reporting

- These are the statements of income designed to focus on various segments of the company.
- Its PURPOSE is to provide information needed by the manager to determine profitability of
product lines, divisions, sales territories, and other segments of a company. It emphasizes
performance of a profit or investment center rather than the performance of the company as a
whole.
Segment

- It is defined as any part or activity of an organization about which manager seeks costs,
revenue, or profit data. (E.g. sales territories, individual stores, service centers, manufacturing
plants, etc.)

(See Illustrative Problem 4-1 on page 242 regarding the preparation of segmental income statement)

Levels of Segmented Statement

- Segmented income statements can be prepared for activities at many levels in a company. To
provide more information to the company’s divisional manager, the report could further segment the
divisions according to their major product lines, and the product lines could be segmented as to how
they are sold – in retail computer stores or by catalog sales. One could look at the smaller pieces of the
company by going from one segmented statement to another. A manager is able to gain considerable
knowledge into the company’s operations viewed from many different angles by examining trends and
results in each segment.

(See Figure 9-1 on page 244 for an example of segmented income statement in the contribution
format)

Contribution Margin

- It is particularly useful in determining what happens to profit as volume changes, assuming that
the segment’s capacity and fixed costs are constant. Decisions concerning the most effective,
temporary, or short-run uses of existing capacity such as special orders can be made using the
contribution margin information.

Contribution Margin for the Segment

- It is yielded through deducting variable expenses from sales in the preparation of an income
statement for a particular segment.

Two Kinds of Fixed Costs

 Traceable/Direct fixed costs (the one charged to the segment report)

 Common cost

Traceable Costs of a Segment

- It is a fixed cost that is incurred as a consequence of the existence of the segment and could be
easily identified or traced to the particular segment. (E.g. Salary of the division manager,
Insurance and maintenance cost of the division building)

**Deducting traceable fixed costs from the segment contribution margin would yield the SEGMENT
MARGIN or contribution to indirect or common costs.
Segment Margin

- It represents the margin available after a segment has covered all of its own costs and the best
gauge of the long-run profitability of a segment.
- It is also most useful in major decisions that affect capacity such as dropping a segment.

** Deducting the allocated common fixed expenses not traceable to the individual segment from the
segment margin would result to the NET OPERATING INCOME or LOSS of the segment.

Problems Related to Proper Cost Assignment or practices that hinder proper cost assignment

 Omission of some costs in the assignment process

 The use of inappropriate methods for allocating costs among segments of a company
 The assignment of costs segments when they are really common costs

Omission of Costs

- For financial reporting purposes, ONLY manufacturing costs are included in product costs.
- The costs assigned to a segment should include all costs attributable to that segment from the
company’s entire VALUE CHAIN.
- If companies omit from their profitability analysis part/all of the UPSTREAM COSTS (i.e. research
and development, product design) and DOWNSTREAM COSTS (i.e. marketing, distribution,
customer services), then the product is undercosted and management may unintentionally
develop and maintain products that in the long run result in losses rather than profits from the
company.

Value Chain

- It consists of all the major business functions that add value to a company’s products and
services. These business functions include research and development, product design,
manufacturing, marketing, distribution, and customer services are required to bring a product or
service to the customer and generate revenues.

Cost Distortion or Cross-Subsidization

- It occurs when costs are improperly assigned among the company’s segments.
- It can occur in two (2) ways:
 When the company fails to track costs directly to segments in those situations where
it is feasible to do so.
 When the company uses inappropriate bases to allocate the costs.

Arbitrarily Dividing Common Costs among Segments

- The practice of assigning noticeable or common costs to segment is another business practice
that leads to distorted segment costs. For example, some companies allocate or divide the costs
of the corporate headquarters building equally to products on segment reports.
 - While it is true that common costs must be covered, arbitrarily allocating common costs to
segment may produce results that could be used in making erroneous decisions. For example,
adding a share of common costs to the real costs of a segment may make an otherwise
profitable segment appear to be unprofitable.
- If a manager erroneously eliminates the segment, the revenues will be lost, the real costs of the
segment will be avoided, but the common costs will still be there. This will result to a reduction
in the profits of the company as a whole and make it even more difficult to cover the common
costs.

Quiz

1.) It consists of all the major business functions that add value to a company’s products and
services. VALUE CHAIN.
2.) It is the process of delegating the decision-making authority throughout an organization.
DECENTRALIZATION
3.) It occurs when costs are improperly assigned among the company’s segments. COST
DISTORTION or CROSS-SUBSUDIZATION
4.) It represents the margin available after a segment has covered all of its own costs and the best
gauge of the long-run profitability of a segment. SEGMENT MARGIN
5.) It is particularly useful in determining what happens to profit as volume changes, assuming that
the segment’s capacity and fixed costs are constant. CONTRIBUTION MARGIN
6.) It is defined as any part or activity of an organization about which manager seeks costs, revenue,
or profit data. SEGMENT
7.) Its purpose is to provide information needed by the manager to determine profitability of
product lines, divisions, sales territories, and other segments of a company. SEGMENT
REPORTING
8.) Give two advantage of decentralization.
9.) Any two of the ten.
10.) Give one limitation of decentralization. Any of the four.