Responsibility Acctg

Chapter 10
Segment Reporting, Decentralization,

and the Balanced Scorecard
PowerPoint Authors:
Jon A. Booker, Ph.D., CPA, CIA
Charles W. Caldwell, D.B.A., CMA
Susan Coomer Galbreath, Ph.D., CPA
McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
10-2
Decentralization in Organizations
Advantages of
Top management
Decentralization freed to concentrate
on strategy.
Lower-level managers
gain experience in
decision-making. Decision-making
authority leads to
job satisfaction.
Lower-level decisions
often based on
better information.
Lower level managers
can respond quickly
to customers.
10-3
Decentralization in Organizations
May be a lack of
coordination among
autonomous
Lower-level managers managers.
may make decisions
without seeing the
“big picture.” Disadvantages of
Decentralization
Lower-level manager’s
objectives may not
be those of the May be difficult to
organization. spread innovative ideas
in the organization.
10-4
Responsibility Accounting
Cost Profit Investment

Center Center Center
Cost, profit,
and investment
centers are all
known as Responsibility
Center
responsibility
centers.
10-5
Cost Center
A segment whose manager has control
over costs, but not over revenues or
investment funds.
10-6
Profit Center
Revenues
A segment whose
Sales
manager has control Interest
over both costs and Other
revenues, Costs
but no control over Mfg. costs
investment funds. Commissions
Salaries
Other
10-7
Investment Center
Corporate Headquarters
A segment whose
manager has
control over costs,
revenues, and
investments in
operating assets.
10-8
Responsibility Centers
Investment
Centers Superior Foods Corporation
President and CEO
Operations Finance Legal Personnel

Vice President Chief FInancial Officer General Counsel Vice President
Salty Snacks Beverages Confections

Product Manger Product Manager Product Manager
Bottling Plant Warehouse Distribution

Cost
Manager Manager Manager
Centers
Superior Foods Corporation provides an example of the
various kinds of responsibility centers that exist in an
organization.
10-9
Superior Foods Corporation
President and CEO



Profit
Centers
organization.
10-10
President and CEO



Cost
Centers
organization.
10-11
Learning Objective 1
Prepare a segmented income

statement using the contribution
format, and explain the difference
between traceable fixed costs
and common fixed costs.
10-12
Decentralization and Segment Reporting

An Individual Store
Quick Mart
A segment is any part or A Sales Territory

activity of an organization
about which a manager
seeks cost, revenue, or
profit data.
A Service Center
10-13
Superior Foods: Segmented by

Geographic Regions
$500,000,000
East West Midwest South

$75,000,000 $300,000,000 $55,000,000 $70,000,000
Oregon Washington California Mountain States

$45,000,000 $50,000,000 $120,000,000 $85,000,000
Superior Foods Corporation could segment its business

by geographic region.
10-14
Superior Foods: Segmented by

Customer Channel
$500,000,000
Convenience Stores Supermarket Chains Wholesale Distributors Drugstores

$80,000,000 $280,000,000 $100,000,000 $40,000,000
Supermarket Chain A Supermarket Chain B Supermarket Chain C Supermarket Chain D

$85,000,000 $65,000,000 $90,000,000 $40,000,000
Superior Foods Corporation could segment its business

by customer channel.
10-15
Keys to Segmented Income

Statements
There are two keys to building
segmented income statements:
A contribution format should be used
because it separates fixed from variable
costs and it enables the calculation of a
contribution margin.
Traceable fixed costs should be separated

from common fixed costs to enable the
calculation of a segment margin.
10-16
Identifying Traceable Fixed Costs

Traceable costs arise because of the
existence of a particular segment and would
disappear over time if the segment itself
disappeared.
No computer No computer
division means . . . division manager.
10-17
Identifying Common Fixed Costs

Common costs arise because of the overall
operation of the company and would not
disappear if any particular segment were
eliminated.
No computer We still have a
division but . . . CEO.
10-18
Traceable Costs Can Become

Common Costs
It is important to realize that the traceable
fixed costs of one segment may be a
common fixed cost of another segment.
For example, the landing fee

paid to land an airplane at an
airport is traceable to the
particular flight, but it is not
traceable to first-class,
business-class, and
economy-class passengers.
10-19
Segment Margin
The segment margin, which is computed by
subtracting the traceable fixed costs of a segment
from its contribution margin, is the best gauge of
the long-run profitability of a segment.
Segment Margin
Time
10-20
Traceable and Common Costs

Fixed Don’t allocate
Costs common costs to
segments.
Traceable Common
10-21
Activity-Based Costing
Activity-based costing can help identify how costs
shared by more than one segment are traceable to
individual segments.
Assume that three products, 9-inch, 12-inch, and 18-inch pipe, share 10,000
square feet of warehousing space, which is leased at a price of $4 per square foot.
If the 9-inch, 12-inch, and 18-inch pipes occupy 1,000, 4,000, and 5,000 square
feet, respectively, then ABC can be used to trace the warehousing costs to the
three products as shown.
Pipe Products
9-inch 12-inch 18-inch Total
Warehouse sq. ft. 1,000 4,000 5,000 10,000
Lease price per sq. ft. $ 4 $ 4 $ 4 $ 4
Total lease cost $ 4,000 $ 16,000 $ 20,000 $ 40,000
10-22
Levels of Segmented Statements

Webber, Inc. has two divisions.
Webber, Inc.
Computer Television
Division Division
Let’s look more closely at the

Television Division’s income
statement.
10-23

Our approach to segment reporting uses the
contribution format.
Income Statement Cost of goods
Contribution Margin Format sold consists of
Television Division variable
Sales $ 300,000 manufacturing
Variable COGS 120,000 costs.
Other variable costs 30,000
Fixed and
Total variable costs 150,000
variable costs
Contribution margin 150,000
are listed in
Traceable fixed costs 90,000
separate
Segment margin $ 60,000
sections.
10-24

Our approach to segment reporting uses the
contribution format.
Income Statement
Contribution Margin Format Contribution margin
Television Division is computed by
Sales $ 300,000 taking sales minus
Variable COGS 120,000 variable costs.
Other variable costs 30,000
Total variable costs 150,000 Segment margin
Contribution margin 150,000 is Television’s
Traceable fixed costs 90,000 contribution
Segment margin $ 60,000 to profits.
10-25

Income Statement
Company Television Computer
Sales $ 500,000 $ 300,000 $ 200,000
Variable costs 230,000 150,000 80,000
CM 270,000 150,000 120,000
Traceable FC 170,000 90,000 80,000
Segment margin 100,000 $ 60,000 $ 40,000
Common costs
Net operating
income
10-26

Income Statement
Company Television Computer
Sales $ 500,000 $ 300,000 $ 200,000
Variable costs 230,000 150,000 80,000
CM 270,000 150,000 120,000
Traceable FC 170,000 90,000 80,000
Segment margin 100,000 $ 60,000 $ 40,000
Common costs 25,000
Common costs should not
Net operating be allocated to the
income $ 75,000 divisions. These costs
would remain even if one
of the divisions were
eliminated.
10-27

Common Costs
As previously mentioned, fixed costs that are
traceable to one segment can become common
if the company is divided into smaller
segments.
Let’s see how this works using

the Webber, Inc. example!
10-28

Common Costs
Webber’s Television Division
Television
Division
LCD Plasma
Product
Lines
10-29

Common Costs
Income Statement
Television
Division LCD Plasma
Sales $ 200,000 $ 100,000
Variable costs 95,000 55,000
CM 105,000 45,000
Traceable FC 45,000 35,000
Product line margin $ 60,000 $ 10,000
Common costs
Divisional margin
We obtained the following information from

the LCD and Plasma segments.
10-30

Common Costs
Income Statement
Television
Division LCD Plasma
Sales $ 300,000 $ 200,000 $ 100,000
Variable costs 150,000 95,000 55,000
CM 150,000 105,000 45,000
Traceable 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 traced
to the Television Division
$80,000 + $10,000 = $90,000
10-31
External Reports
The Financial Accounting Standards Board now requires
that companies in the United States include segmented
financial data in their annual reports.
1. Companies must report segmented

results to shareholders using the same
methods that are used for internal
segmented reports.
2. Since the contribution approach to
segment reporting does not comply
with GAAP, it is likely that some
managers will choose to construct
their segmented financial statements
using the absorption approach to
comply with GAAP.
10-32
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
Product Customer
R&D Design Manufacturing Marketing Distribution Service
10-33
Inappropriate Methods of Allocating

Costs Among Segments
Failure to trace Inappropriate

costs directly allocation base
Segment Segment Segment Segment

1 2 3 4
10-34
Common Costs and Segments

Common costs should not be arbitrarily allocated to
segments based on the rationale that “someone has to
cover the common costs” for two reasons:
1. This practice may make a profitable business segment
appear to be unprofitable.
2. Allocating common fixed costs forces managers to be
held accountable for costs they cannot control.
Segment Segment Segment Segment

1 2 3 4
10-35
Quick Check ✓
Income Statement
Hoagland's
Lakeshore Bar Restaurant
Sales $ 800,000 $ 100,000 $ 700,000
Variable costs 310,000 60,000 250,000
CM 490,000 40,000 450,000
Traceable FC 246,000 26,000 220,000
Segment margin 244,000 $ 14,000 $ 230,000
Common costs 200,000
Profit $ 44,000
Assume that Hoagland's Lakeshore prepared its

segmented income statement as shown.
10-36
Quick Check ✓
How much of the common fixed cost of

$200,000 can be avoided by eliminating the
bar?
a. None of it.
b. Some of it.
c. All of it.
10-37
Quick Check ✓
How much of the common fixed cost of

$200,000 can be avoided by eliminating the
bar?
a. None of it.
b. Some of it.
c. All of it. A common fixed cost
cannot be eliminated by
dropping one of the
segments.
10-38
Quick Check ✓
Suppose square feet is used as the basis for
allocating the common fixed cost of $200,000.
How much would be allocated to the bar if the
bar occupies 1,000 square feet and the
restaurant 9,000 square feet?
a. $20,000
b. $30,000
c. $40,000
d. $50,000
10-39
Quick Check ✓
Suppose square feet is used as the basis for
allocating the common fixed cost of $200,000.
How much would be allocated to the bar if the
bar occupies 1,000 square feet and the
restaurant 9,000 square feet?
a. $20,000
b. $30,000 The bar would be
c. $40,000 allocated 1/10 of the cost
d. $50,000 or $20,000.
10-40
Quick Check ✓
If Hoagland's allocates its common
costs to the bar and the restaurant,
what would be the reported profit of
each segment?
10-41
Allocations of Common Costs

Income Statement
Hoagland's
Sales $ 800,000 $ 100,000 $ 700,000
Variable costs 310,000 60,000 250,000
CM 490,000 40,000 450,000
Traceable FC 246,000 26,000 220,000
Segment margin 244,000 14,000 230,000
Common costs 200,000 20,000 180,000
Profit $ 44,000 $ (6,000) $ 50,000
Hurray, now everything adds up!!!

10-42
Quick Check ✓
Should the bar be eliminated?
a. Yes
b. No
10-43
Quick Check ✓
Should the bar be eliminated?
a. Yes The profit was $44,000 before
b. No eliminating the bar. If we eliminate
the bar,
Income profit drops
Statement to $30,000!
Hoagland's
Sales $ 700,000 $ 700,000
Variable costs 250,000 250,000
CM 450,000 450,000
Traceable FC 220,000 220,000
Segment margin 230,000 230,000
Common costs 200,000 200,000
Profit $ 30,000 $ 30,000
10-44
Compute return on investment

(ROI) and show how changes in
sales, expenses, and assets
affect ROI.
10-45
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.
10-46
Net Book Value versus Gross Cost

Most companies use the net book value of
depreciable assets to calculate average
operating assets.
Acquisition cost
Less: Accumulated depreciation
Net book value
10-47
Understanding ROI
ROI =
Margin =
Sales
Turnover = Sales
ROI = Margin  Turnover

10-48
Increasing ROI
There are three ways to increase ROI . . .
Reduce
Increase Expenses Reduce
Sales Assets
10-49
Increasing ROI – An Example

Regal Company reports the following:
Net operating income $ 30,000
Average operating assets $ 200,000
Sales $ 500,000
Operating expenses $ 470,000
What is Regal Company’s ROI?

Net operating income Sales
ROI =
Sales
× Average operating assets
10-50
Increasing ROI – An Example

ROI =
Sales
ROI = $30,000 $500,000

×
$500,000 $200,000
ROI = 6%  2.5 = 15%

10-51
Investing in Operating Assets to

Increase Sales
Suppose that Regal's manager invests in a
$30,000 piece of equipment that increases sales
by $35,000, while increasing operating
expenses by $15,000.
Regal Company reports the following:
Net operating income $ 50,000

Average operating assets $ 230,000
Sales $ 535,000
Operating expenses $ 485,000
Let’s calculate the new ROI.

10-52
Investing in Operating Assets to

Increase Sales
ROI =
Sales
ROI = $50,000 ×
$535,000
$535,000 $230,000
ROI = 9.35%  2.33 = 21.8%
ROI increased from 15% to 21.8%.

10-53
Criticisms of ROI
In the absence of the balanced
scorecard, management may
not know how to increase ROI.
Managers often inherit many

committed costs over which
they have no control.
Managers evaluated on ROI

may reject profitable
investment opportunities.
10-54
Compute residual income

and understand its
strengths and weaknesses.
10-55
Residual Income - Another

Measure of Performance

above some minimum
required return on
operating assets
10-56
Calculating Residual Income

Residual
income
=
Net
operating -
income
(
Average
operating
assets

Minimum
)
required rate of
return
ROI measures net operating income earned relative

to the investment in average operating assets.
Residual income measures net operating income
earned less the minimum required return on average
operating assets.
10-57
Residual Income – An Example

• The Retail Division of Zephyr, Inc. has
average operating assets of $100,000 and is
required to earn a return of 20% on these
assets.
• In the current period, the division earns
$30,000.
Let’s calculate residual income.

10-58
Residual Income – An Example

Operating assets $ 100,000
Required rate of return × 20%
Minimum required return $ 20,000
Actual income $ 30,000

Minimum required return (20,000)
Residual income $ 10,000
10-59
Motivation and Residual Income

Residual income encourages managers to
make investments that are profitable
for the entire company but would be
rejected by managers who are evaluated
using the ROI formula.
10-60
Quick Check ✓
Redmond Awnings, a division of Wrap-up Corp.,
has a net operating income of $60,000 and
average operating assets of $300,000. The
required rate of return for the company is 15%.
What is the division’s ROI?
a. 25%
b. 5%
c. 15%
d. 20%
10-61
Quick Check ✓
What is the division’s ROI?
a. 25%
b. 5%
ROI = NOI/Average operating assets
c. 15%
d. 20% = $60,000/$300,000 = 20%
10-62
Quick Check ✓
average operating assets of $300,000. If the
manager of the division is evaluated based on
ROI, will she want to make an investment of
$100,000 that would generate additional net
operating income of $18,000 per year?
a. Yes
b. No
10-63
Quick Check ✓
average operating assets of $300,000. If the
manager of the division is evaluated based on
ROI, will she want to make an investment of
$100,000 that would generate additional net
operating income of $18,000 per year?
a. Yes ROI = $78,000/$400,000 = 19.5%
b. No
This lowers the division’s ROI from
20.0% down to 19.5%.
10-64
Quick Check ✓
The company’s required rate of return is 15%.
Would the company want the manager of the
Redmond Awnings division to make an
investment of $100,000 that would generate
additional net operating income of $18,000 per
year?
a. Yes
b. No
10-65
Quick Check ✓
The company’s required rate of return is 15%.
Would the company want the manager of the
Redmond Awnings division to make an
investment of $100,000 that would generate
additional net operating income of $18,000 per
year?
ROI = $18,000/$100,000 = 18%
a. Yes
b. No The return on the investment
exceeds the minimum required rate
of return.
10-66
Quick Check ✓
What is the division’s residual income?
a. $240,000
b. $ 45,000
c. $ 15,000
d. $ 51,000
10-67
Quick Check ✓
What is the division’s residual income?
a. $240,000
b. $ 45,000 Net operting income $ 60,000
c. $ 15,000 Required return (15% × $300,000) (45,000)
d. $ 51,000
10-68
Quick Check ✓
If the manager of the Redmond Awnings
division is evaluated based on residual
income, will she want to make an investment
of $100,000 that would generate additional
net operating income of $18,000 per year?
a. Yes
b. No
10-69
Quick Check ✓
If the manager of the Redmond Awnings
division is evaluated based on residual
income, will she want to make an investment
of $100,000 that would generate additional
net operating income of $18,000 per year?
a. Yes
Net operting income $ 78,000
b. No
Required return (15% × $400,000) (60,000)
Yields an increase of $3,000 in residual income
10-70
Divisional Comparisons and

Residual Income
The residual
income approach
has one major
disadvantage.
It cannot be used
to compare the
performance of
divisions of
different sizes.
10-71
Zephyr, Inc. - Continued

Recall the following Assume the following
information for the Retail information for the Wholesale
Division of Zephyr, Inc. Division of Zephyr, Inc.
Retail Wholesale
Operating assets $ 100,000 $ 1,000,000
Required rate of return × 20% 20%
Minimum required return $ 20,000 $ 200,000
Retail Wholesale
Actual income $ 30,000 $ 220,000
Minimum required return (20,000) (200,000)
Residual income $ 10,000 $ 20,000
10-72
Zephyr, Inc. - Continued

The residual income numbers suggest that the Wholesale
Division outperformed the Retail Division because its
residual income is $10,000 higher. However, the Retail
Division earned an ROI of 30% compared to an ROI of 22% for
the Wholesale Division. The Wholesale Division’s residual
income is larger than the Retail Division simply because it is
a bigger division.
Retail Wholesale
Operating assets $ 100,000 $ 1,000,000
Required rate of return × 20% 20%
Minimum required return $ 20,000 $ 200,000
Retail Wholesale
Actual income $ 30,000 $ 220,000
Minimum required return (20,000) (200,000)
Residual income $ 10,000 $ 20,000
10-73
Understand how to
construct and use a
balanced scorecard.
10-74
The Balanced Scorecard

Consists of an integrated set of performance
measures that are derived from and support a
company’s strategy.
Financial Customers
Performance
measures
Internal Learning
business and growth
processes
10-75

Performance Measures
Financial What are our
Has our financial financial goals?
performance improved?
Customer What customers do Vision

we want to serve and
Do customers recognize that how are we going to and
we are delivering more value? win and retain them? Strategy
Internal Business Processes What internal busi-

Have we improved key business ness processes are
processes so that we can deliver critical to providing
more value to customers? value to customers?
Learning and Growth

Are we maintaining our ability
to change and improve?
10-76

The balanced scorecard relies on non-financial measures
in addition to financial measures for two reasons:
 Financial measures are lag indicators that summarize

the results of past actions. Non-financial measures are
leading indicators of future financial performance.
 Top managers are ordinarily responsible for financial

performance measures – not lower level managers.
Non-financial measures are more likely to be
understood and controlled by lower level managers.
10-77
The Balanced Scorecard for

Individuals
The entire organization Each individual should
should have an overall have a personal
balanced scorecard. balanced scorecard.
A personal scorecard should contain measures that can be

influenced by the individual being evaluated and that
support the measures in the overall balanced scorecard.
10-78

A balanced scorecard should have measures
that are linked together on a cause-and-effect basis.
If we improve Then Another desired

one performance performance measure
measure . . . will improve.
The balanced scorecard lays out concrete

actions to attain desired outcomes.
10-79
The Balanced Scorecard and

Compensation
Incentive compensation should be linked to
balanced scorecard performance
measures.
10-80
The Balanced Scorecard ─ An

Example
Profit
Financial
Contribution per car
Number of cars sold

Customer
Customer satisfaction
with options
Internal
Business Number of Time to
options available install option
Processes
Learning Employee skills in

and Growth installing options
10-81

Example
Profit
Number of cars sold
Customer satisfaction Results

with options Satisfaction
Increases
Strategies
Increase Number of Time to
Options options available install option Time
Decreases
Increase Employee skills in

Skills installing options
10-82

Example
Profit

Results
Cars sold
Number of cars sold Increase
Customer satisfaction Satisfaction

with options Increases
Number of Time to
Employee skills in
installing options
10-83

Example
Profit Results
Contribution
Contribution per car Increases
Number of cars sold
Customer satisfaction Satisfaction

with options Increases
Number of Time to Time

options available install option Decreases
Employee skills in
installing options
10-84

Example
Profit Profits
If number Increase
of cars sold Contribution per car Contribution
Increases
and contribution
per car increase, Cars Sold
Number of cars sold Increases
profits
increase. Results
Customer satisfaction
with options
Number of Time to
Employee skills in
installing options
10-85
End of Chapter 10

Responsibility Acctg

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Chapter 10

Segment Reporting, Decentralization,

Cost Profit Investment

Operations Finance Legal Personnel

Salty Snacks Beverages Confections

Bottling Plant Warehouse Distribution

Operations Finance Legal Personnel

Salty Snacks Beverages Confections

Bottling Plant Warehouse Distribution

Operations Finance Legal Personnel

Salty Snacks Beverages Confections

Bottling Plant Warehouse Distribution

Prepare a segmented income

Decentralization and Segment Reporting

A segment is any part or A Sales Territory

Superior Foods: Segmented by

East West Midwest South

Oregon Washington California Mountain States

Superior Foods Corporation could segment its business

Superior Foods: Segmented by

Convenience Stores Supermarket Chains Wholesale Distributors Drugstores

Supermarket Chain A Supermarket Chain B Supermarket Chain C Supermarket Chain D

Superior Foods Corporation could segment its business

Keys to Segmented Income

Traceable fixed costs should be separated

Identifying Traceable Fixed Costs

Identifying Common Fixed Costs

Traceable Costs Can Become

For example, the landing fee

Traceable and Common Costs

Levels of Segmented Statements

Let’s look more closely at the

Levels of Segmented Statements

Levels of Segmented Statements

Levels of Segmented Statements

Levels of Segmented Statements

Traceable Costs Can Become

Let’s see how this works using

Traceable Costs Can Become

Traceable Costs Can Become

We obtained the following information from

Traceable Costs Can Become

1. Companies must report segmented

Inappropriate Methods of Allocating

Failure to trace Inappropriate

Segment Segment Segment Segment

Common Costs and Segments

Segment Segment Segment Segment

Assume that Hoagland's Lakeshore prepared its

How much of the common fixed cost of

How much of the common fixed cost of

Allocations of Common Costs

Hurray, now everything adds up!!!

Compute return on investment

Return on Investment (ROI) Formula

Net operating income

Cash, accounts receivable, inventory,

Net Book Value versus Gross Cost

ROI = Margin  Turnover

Increasing ROI – An Example

What is Regal Company’s ROI?

Increasing ROI – An Example

ROI = $30,000 $500,000