Segment Reporting and

Decentralization

UAA – ACCT 202

Principles of Managerial Accounting
Dr. Fred Barbee
The Work of Management
Planning

Decision Organizing &

Evaluating Directing
Making

Controlling
Controlling Operations
• Management by exception
• Responsibility Accounting
• Delegation of authority
• Management by walking around
Responsibility Accounting
• . . . is a reporting system in which a cost
is charged to the lowest level of
management that has responsibility for
it.
Installing Responsibility Accounting
• Create a set of financial
performance goals (budgets).
• Measure and report actual
performance.
• Evaluate based on comparison of
actual with budget.
Responsibility Accounting
• Evaluation of responsibility centers
depends on . . .
– The extent of delegation of authority; and
– A manager’s preference
Centralization Vs. Decentralization
Decentralization . . .
• . . . the delegation of authority to the
lowest level of management
responsibility that can make decisions.
Centralization . . .
• . . . A centralized organization is one in
which little authority is delegated to
lower level managers.
Decentralization
• The more decentralized the firm, the
greater the need for control.
– Monitor employees
– Motivate employees
Advantages of Decentralization

• Top level managers are relieved of

making routine decisions.
• Higher employee morale
• Training
• Decisions are made where the action is
taking place.
Disadvantages of Decentralization

• Upper level management loses some

control.
• Lack of goal congruence.
• Duplication of effort.
Decentralization and Segment
Reporting An Individual Store
Quick Mart

A segment is any
part or activity of A Sales Territory
an organization
about which a
manager seeks
cost, revenue, or
profit data. A
A Service Center

segment can be
Cost, Profit, and Investments Centers
Responsibility
Centers

Cost Profit Investment

Center Center Center
 Responsibility Centers: A Systems Perspective

Data Processing Steps Information

Within
(Inputs) Information Systems (Outputs)

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

Working
DM
Capital Goods,
DL
Equipment Services, Ideas
MOH
Etc.
Cost, Profit, and Investments Centers

Cost Center
A segment whose
manager has
control over
costs,
but not over
revenues or
investment funds.
 Responsibility Centers:
A Systems Perspective

Input Process Output

Cost Center
Control only this
Evaluation . . .
• A cost center is evaluated by means of
performance reports (i.e., comparison of
actual with standard).
Performance Reports
Show the budgeted and actual
amounts, and the variances
between these amounts, of key
financial results appropriate for
the type of responsibility center.

19
Segments Classified as Cost, Profit
and Investment Centers
 Responsibility Centers:
A Systems Perspective

Input Process Output

Profit Center
Control these
Cost, Profit, and Investments Centers

Profit Center Revenues

A segment whose Sales
manager has Interest
Other
control over both
costs and Costs
Mfg. costs
revenues, Commissions
but no control over Salaries

investment funds.
Other
A Profit Center . . .
• A profit center is evaluated by
means of contribution margin
income statements.
Segments Classified as Cost, Profit
and Investment Centers
Cost, Profit, and Investments Centers

Investment Center
A segment whose
manager has
control over costs,
revenues, and
investments in
operating assets.
Corporate Headquarters
 Responsibility Centers:
A Systems Perspective

Input Process Output

Investment Center
Control these
Investment Center
• An investment center is evaluated by
means of the Return on Investment
(ROI) or the Residual Income (RI) it is
able to generate.
Segments Classified as Cost, Profit
and Investment Centers
Responsibility Centers
Profit Center Vs. Investment Center

• A profit center is focused on profits as

measured by the difference between
revenues and expenses.
• An investment center is compared with
the assets employed in earning
revenues.
 Pro-Forma Statement
Total Segment A Segment B
Sales xx xx xx
Less: Variable Manufacturing Costs xx xx xx
Manufacturing Contribution Margin xx xx xx
Less: Variable non-manufacturing costs xx xx xx
Contribution Margin xx xx xx
Less: controllable fixed cost xx xx xx
Short-run performance margin xx xx xx
Less: direct, non-controllable fixed costs xx xx xx
Segment Margin xx xx xx
Less: Common costs allocated to segment xx xx xx
Operating Income xx xx xx
Levels of Segmented Statements
Webber, Inc. has two divisions.

Let’s look more closely at the Television

Division’s income statement.
Our approach to segment reporting uses the
contribution format.

Cost of goods
sold consists of
variable
manufacturing
costs.

Fixed and
variable costs
are listed in
separate
sections.
Our approach to segment reporting uses the
contribution format.

Segment margin
is Television’s
contribution
to profits.

Division Segment Margin

Traceable and Common Costs
Fixed
Costs
Don’t allocate
common costs.

Traceable Common

Costs arise because A cost that supports more than one

of the existence of segment but that would not go
a particular segment away if any particular segment
were eliminated.
Identifying Traceable Fixed Costs

Traceable costs would disappear over

time if the segment itself disappeared.
No computer No computer
division means . . . division manager.
Identifying Common Fixed Costs
Common costs arise because of overall
operation of the company and are not due to
the existence of a particular segment.
No computer We still have a
division but . . . company president.
Levels of Segmented Statements

Common costs should not

be allocated to the
divisions. These costs
would remain even if one
of the divisions were
eliminated.
Segment Margin
The segment margin is the best gauge of
the long-run profitability of a segment.
Profits

Time
Inappropriate Methods of Allocating
Costs Among Segments

Arbitrarily dividing
common costs
among segments
Inappropriate
Failure to trace allocation base
costs directly

Segment Segment Segment Segment

1 2 3 4
Return on Investment
• The ROI formula is expressed as:
Return on Investment
• Where . . .

Income
Margin = --------------------
Sales
Return on Investment
• Where . . .

Sales
Turnover = ------------------------------
Invested Capital
 Return on Investment

Income Sales
------------------------------ x ------------------------------
Sales Invested Capital

The ratio of The efficiency

operating income of asset
to sales utilization.
 Return on Investment

Income Sales
------------------------------
Sales
x ------------------------------
Invested Capital

The ratio of The efficiency

operating income of asset
to sales utilization.
 Return on Investment

Income
------------------------------
Invested Capital
= ROI
 Measuring Income and Invested
Capital

Income Sales
------------------------------
Sales
x ------------------------------
Invested Capital
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.
Improving the ROI
❷Reduce
❶Increase Expenses ❸Reduce
Sales Assets
 XYZ Company

Income (EBIT) $30,000

Sales $500,000

Invested Capital $200,000

 Return on Investment

$30,000 $500,000
-------------- --------------
$500,000
x $200,000

6% 2.5
x
= 15%
Disadvantages of ROI
• It can produce a narrow focus on
divisional 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.
Criticisms of ROI . . .
• ROI tends to emphasize short-run
performance over long-run profitability.
• ROI may not be completely controllable
by the division manager due to
committed costs.
Residual Income . . .
• . . . is the net operating income that
an investment center is able to earn
above some minimum rate of return
on its operating assets.
Residual Income = EBIT – Required Profit

= EBIT – Cost of Capital x Investment

 Residual Income Example

Division A Division B

Invested Capital $1,000,000 $3,000,000

EBIT Last Year 200,000 450,000

*Min. Required R of R 120,000 360,000

Residual Income $80,000 $90,000

*Minimum Required Rate of Return = 12%

Problem with RI . . .
• RI cannot be used to compare
performance of divisions of different
sizes.
Transfer Price
• … the amount charged by one segment
of the organization for goods/ services
transferred/ provided to another
segment of the same organization
Factors Considered in Selecting A
Transfer Pricing

• Goal Congruence
• Segmental Performance
• Negotiation
• Capacity
• Cost Structure
• Taxes
Ways of Determining Transfer Prices

• Market price if a market for the goods or

services exists
• Incremental Costs plus opportunity costs
to the seller
• Full absorption costs
• Cost plus markup
Ways of Determining Transfer Prices

• Negotiated transfer price

– Minimum price
– Maximum price

• Dual transfer price

TP= Incremental Cost + Opportunity Cost- Savings