REPORTING FOR CONTROL

- Decentralized organization: decision making is spread throughout the organization rather than
being confined to a few top executives

- Requires segment reporting to permit analysis and evaluation of the decision made by the
segment managers
- The divisions are segmented according to their major product lines
- Fixed costs are divided into two parts on a segmented statement
- Traceable
- Only ones that are charged to the various segments
- Common
- Two guidelines are followed in assigning costs to the various segments of a company under the
contribution
- 1. According to the cost behaviour patterns
- 2.l According to whether the costs are directly traceable to the segments involved
- By carefully monitoring segment CM and segment CM ratios, the manager is in a position to
make those short-run decisions that maximize each segments contribution to the overall
profitability of the organization

- What the contribution approach does imply is that different costs are needed for different
purposes

- Common fixed costs are not allocated to segments

- Any allocation of common costs to segments reduces the value of the segment margin as a guide
to long-run segment profitability and segment performance

- In preparing segmented income statements, some managers like to separate the traceable fixed
costs into two classes- discretionary and committed
- Segment margin: is obtained by deducting a segments traceable fixed costs from the segments
CM
- The best gauge of the long-run profitability of a segment, because it includes only those
costs that are caused by the segment
- Most useful in decisions relating to short-run changes, such as pricing of special orders
that involve temporary use of existing capacity

- Segmented data are often highly sensitive

- Segmented statements prepared in accordance with GAAP do not distinguish between fixed and
variable costs and between traceable and common costs

- Upstream costs: research and development and product design

- Downstream costs: marketing, distribution, and customer service
- If either the upstream or downstream costs are omitted in profitability analysis, then the product is
undercosted and management may unwittingly develop and maintain products that result in losses
in the long run

- Failure to trace these costs directly results in the costs being placed in a company wide overhead
pool
- Some companies allocate costs to segments using arbitrary bases such as sales dollars or
COGS
- Costs should be allocated to segments for internal decision-making purposes only when
the allocation base actually drive the cost being allocated (or is very high correlated with
the real cost driver)

- The way many companies handle segment reporting results in cost distortion
- Failure to trace costs directly to a specific segment when it is feasible to do so
- The use of inappropriate bases for allocating costs
- The allocation of common costs to segments
- Fixed costs will disappear over time if the segment itself disappears

- Responsibility centre: broadly defined as any part of an organization whose manager has control
over and is accountable for cost, profit, o r investments
- Cost centres
- Profit centres
- Investment centres
- Cost centre: a business segment whose manager has control over costs but not revenue or
investment funds
- Accounting, finance, selling and administrative, legal, and personnel
- Profit centre: any business segment whose manager has control over both cost and revenue
- Does not have control over investment funds
- Investment centre: any segment of an organization whose manager has control over cost, revenue,
and investments in operating assets
- Return on investment: defined as operating income divided by average operating assets
- The higher the ROI of a business segment, the greater the profit generated per dollar
invested in the segments operating assets

- Operating income: is income before interest and taxes and is sometimes referred to as EBIT
- Operating assets: include cash, AR, inventory, P&E, and all other assets held for productive use in
the organization and/or the investment centre
- A major issue in ROI computations is the dollar amount of plant and equipment that should be
included in the operating assets base
- ROI = margin x turnover
- Margin = operating income sales
- Turnover = sales average operating assets

- Margin: is a measure of management's ability to control operating expenses in relation to sales

- Lower the operating expenses are per dollar of sales, the higher the margin earned
- Turnover: is a measure of the sales that are generated for each dollar invested in operating assets

- An increase in ROI must involve at least one of the following:

 - Increased sales
- Reduced operating expenses
- Reduced operating assets

- ROI = operating income sales x sales average operating assets

- Residual income: the operating income that an investment centre earns above the minimum
required return on its operating assets
- Economic value added: under the economic value-added concept, funds used for research and
development are treated as investments rather than as expenses
- The residual income approach has one major disadvantage
- It cannot be used to compare the performance of divisions of different sizes

- Balanced scorecard consists of an integrated set of performance measures that is derived from the
companies strategy and that supports the companies strategy throughout the organization
- Cost leadership: by maintaining low cost through efficiency relative to competitors, a
company can make superior profits at current industry prices
- differentiation: for producers or services that are perceived as unique, customers will
sometimes pay premium prices, given the company higher profit margins
- Focus or niche: by serving a narrow, strategic target market more effectively than rivals
who are competing more broadly, a firm may be able to achieve superior profitability
- In the most advanced companies, any defect is reported immediately, and its cause is tracked
down before any more defects occur
- Corporate social responsibility: is a concept whereby organization consider the needs of all
stakeholders when making decisions
- Opportunities and risks
- Global reporting initiative