25-1
CHAPTER 25
RESPONSIBILITY
ACCOUNTING
SEGMENTAL ANALYSIS
25-2
Responsibility Accounting
Def. - An accounting system that
collects, summarizes and reports
accounting data relating to
responsibilities of individual managers.
 It enables evaluation of managers
by analyzing how well they manage
those items under their control.

Therefore, responsibility
reports should concentrate
on controllable items.
25-3
Responsibility Accounting
Successful implementation of the
system depends on proper
organization so that responsibility is
assignable to individual managers.
Formal lines of authority and
responsibility should be fully defined.
 Organization charts such as the
following are used as a basis
for responsibility reporting.

25-4
Organization Chart
Board of Directors
President
Vice President
of Finance
Vice President
of Operations
Store Manager
Department Manager
Vice President
of Marketing
25-5
Responsibility Reports
Less
detail
Board of Directors
President
Vice President
of Finance
More
detail
Vice President
of Operations
Store Manager
Department Manager
Vice President
of Marketing
25-6
889

Responsibility Reports
Amount of detail varies according to
level in organization.
Department manager receives detailed report.
 Store manager receives summarized
information from each department.
 Vice president of operations receives
summarized information from each store.


Management by exception (again)
A given level of management does not receive
detail from lower levels unless needed.
e.g., VP could get store manager’s report
25-7
Responsibility Reports
Responsibility
reports should . . .
Be timely.
Be issued
regularly.
Be simple and
easy to read.
Compare budgeted
and actual amounts.
25-8
Segments
A segment is any
part or activity of an
organization about
which a manager
seeks cost,
revenue, or profit
data. A segment
can be . . .
A Sales Territory
25-9
Segments
A segment is any
part or activity of an
Quick Mart
organization about
which a manager
seeks cost,
revenue, or profit
An Individual Store
data. A segment
can be . . .
25-10
Segments
A segment is any
part or activity of an
organization about
which a manager
seeks cost,
revenue, or profit
data. A segment
can be . . .
A Department
25-11
Segments
A segment is any
part or activity of an
organization about
which a manager
seeks cost,
revenue, or profit
data. A segment
can be . . .
A Product Line
25-12
Responsibility Centers
A responsibility
center is a
segment of an
organization for
which a particular
manager is
responsible.
25-13
Responsibility Centers
Three Types of Centers

Expense (or Cost) Centers

Profit Centers

Investment Centers
25-14
Expense/Cost Centers
Incur expenses only
 Produce no direct revenue from sale of
goods or services
 Manager held responsible for long-run
minimization of expenses
 Primary means of evaluation

Standard costs
 Flexible budgets


e.g., accounting department
25-15
Profit Centers
Incur expenses and generate revenue
 Primary objective is profit maximization

Manager is held responsible for expense
control and revenue growth

Primary means of evaluation
Contribution margin

Why are they so appealing?
Management is often paid
based on how well their profit
center performs.
25-16
Investment Centers

What do they have besides expenses
and revenues?
An appropriate investment base
Objective is to maximize return on that
investment base
 Primary means of evaluation


Return on investment (ROI)
A/K/A Rate of Return

Residual Income
25-17
Transfer Prices
Buying
Segment
Selling
Segment
The price used to record a transfer
of goods or services from one
segment to another segment
within the same company.
25-18
Transfer Prices
Buying
Segment
Selling
Segment
Cost or expense
Revenue
What is the primary use for
transfer pricing?
Allows turning a cost center into
a profit center.
25-19
Transfer Prices
Buying
Segment
Selling
Segment
Cost or expense
Revenue
Lower price
is desired.
Higher price
is desired.
Potential
conflict
25-20
Transfer Prices
Buying
Segment
Selling
Segment
Cost or expense
Revenue
Lower price
is desired.
Higher price
is desired.
The transfer price can be . . .
 Market price if external market exists
 Cost to produce plus a profit margin
 Negotiated amount
25-21
Transfer Prices
Buying
Segment
Selling
Segment
Cost or expense
Revenue
Lower price
is desired.
Higher price
is desired.


Setting prices is a big problem in practice.
Management, marketing and finance
courses also cover transfer pricing. Each
discipline thinks it “owns” the problem.
25-22
Segmental Analysis
Def. - Analyzing financial information
by segment
 Uses concepts previously studied

Fixed and variable costs
 Contribution margin, net income, etc.


And new concepts
Cost objective
 Direct cost
 Indirect cost

25-23
Segmental Analysis Concepts
Cost Objective

Cost objective
The segment or product
for which costs may be
accumulated
i.e., a scheme for
collecting costs

KEY - Costs are either
direct or indirect
relative to a particular
cost objective.
25-24
Segmental Analysis Concepts
Direct Costs
Specifically traceable to a given cost
objective
 Likely to be eliminated if cost
objective eliminated
 Often controllable by segment manager
 Examples

Cost accountant’s salary at Little Rock plant
is a direct cost for that plant/cost objective
 Corp. accountant’s salary is direct cost to NY
accounting department/cost objective

25-25
Segmental Analysis Concepts
Indirect Costs
Allocated to a cost objective and not
specifically traceable to that objective
 Not likely to be eliminated if cost
objective eliminated
 Often not controllable
by segment manager
 Example

Corporate accountant’s salary and the rent
on NY home office are indirect relative to
the three plants/cost objectives
25-26
Segmental Analysis Concepts
Direct and Indirect Costs

Therefore, costs may be direct to one
cost objective and indirect to another.
Another example: Segment manager’s
salary is direct to the segment but indirect to
the units of product made in that segment.

Caveat - Some direct costs may not be
controllable by the segment manager.
Example: Segment
manager’s salary is direct
to segment but not controlled
by the segment manager.
25-27
Segmental Analysis
Example
Total Company has two divisions.
Total Company
Radio Division
Television Division
25-28
Segmental Analysis
Example
Contribution Margin Format Income Statement
Before Segmenting into Divisions
Total
Company
Sales
$ 700,000
Less: Variable expenses
300,000
Contribution margin
400,000
Less: Direct fixed expenses
190,000
Contribution to indirect expenses
210,000
Less: Indirect fixed expenses
Income
60,000
$ 150,000
TV
Division
Radio
Division
25-29
Segmental Analysis
Example
Contribution Margin Format Income Statement
After Segmenting into Divisions
Total
Company
Sales
$ 700,000
Less: Variable expenses
300,000
Contribution margin
400,000
Less: Direct fixed expenses
190,000
Contribution to indirect expenses
210,000
Less: Indirect fixed expenses
Income
TV
Division
$ 500,000
200,000
300,000
170,000
$ 130,000
60,000
$ 150,000
Indirect expenses are not attributable to
either the TV or Radio Divisions.
Radio
Division
$ 200,000
100,000
100,000
20,000
$ 80,000
Contribution Margin Format
Income Statement
Emphasizes a segment’s
contribution to indirect expenses as
appropriate figure for evaluating
earnings of the segment.
 Expenses are classified as either . . .

Variable or fixed
 Direct or indirect


Companies may choose to
allocate or not to allocate
indirect fixed expenses.
Authors’ preference?
25-30
25-31
Direct and Indirect Costs
Fixed costs that are direct on one
segmented statement can become
indirect if the segment is divided into
smaller segments.
Let’s see how this works!
25-32
Segmental Analysis
Example
Organizational Segments
Organizational
Segments
Television
Division
Black & White
U. S. Sales
Foreign Sales
Color
U. S. Sales
Foreign Sales
25-33
Segmental Analysis
Example
Contribution Margin Format Income Statement
Before Segmenting TV Division into Product Lines
TV
Division
Sales
$ 500,000
Less: Variable expenses
200,000
Contribution margin
300,000
Less: Direct fixed expenses
140,000
Contribution to indirect expenses
160,000
Less: Indirect fixed expenses
30,000
Income
$ 130,000
Color
Black and
White
TV Division’s $170,000 direct fixed expenses becomes $140,000
with additional segmentation. $30,000 is indirect to product lines.
25-34
Segmental Analysis
Example
Contribution Margin Format Income Statement
Before Segmenting TV Division into Product Lines
TV
Division
Sales
$ 500,000
Less: Variable expenses
200,000
Contribution margin
300,000
Less: Direct fixed expenses
140,000
Contribution to indirect expenses
160,000
Less: Indirect fixed expenses
30,000
Income
$ 130,000
Direct to products
Indirect to products
Total
$ 140,000
30,000
$ 170,000
Color
Black and
White
$170,000 is direct
to TV Division.
25-35
Segmental Analysis
Example
Contribution Margin Format Income Statement
After Segmenting TV Division into Product Lines
TV
Division
Sales
$ 500,000
Less: Variable expenses
200,000
Contribution margin
300,000
Less: Direct fixed expenses
140,000
Contribution to indirect expenses
160,000
Less: Indirect fixed expenses
30,000
Income
$ 130,000
Direct to products
Indirect to products
Total
$ 140,000
30,000
$ 170,000
Color
$ 350,000
120,000
230,000
90,000
$ 140,000
Black and
White
$ 150,000
80,000
70,000
50,000
$ 20,000
$170,000 is direct
to TV Division.
25-36
Are you ready
for investment
center analysis?
25-37
Investment Center Analysis
Return on Investment
ROI =
Income
Investment

Return on investment (ROI) provides a
relative measure of effectiveness of
segments.

ROI calculates the return (income) as a
percentage of assets employed
(investment).
Skipped in Chapter 17 - Must know now!
25-38
Investment Center Analysis
Return on Investment

ROI may be used to evaluate different
levels of investment centers in a
company. (ILL. 25.7, p. 896)
Evaluation of earnings of an
entire company
 Evaluation of the income contribution of a
segment
 Evaluation of income performance of a
segment manager


Therefore, “Income” and “Investment”
can be defined any of three ways.
Evaluation of Earnings
of Entire Company
When evaluating an entire company . . .
“Income” in ROI formula is net income of
company.
 “Investment” in ROI formula is total assets
of entire company.

25-39
Evaluation of Income
Contribution of Segment
When evaluating a segment . . .
“Income” in ROI formula is contribution to
indirect expenses.
 “Investment” in ROI formula is assets
directly used by and identified with the
segment.

25-40
Evaluation of Performance
of Segment Manager
When evaluating a segment
manager . . .

“Income” in ROI formula is
income that is controllable by
segment manager.
Begin with contribution to indirect
expenses and eliminate any
revenues and expenses not under
the direct control of segment
manager.

“Investment” is assets under the
control of the segment manager.
25-41
25-42
Expanded Form of
ROI Calculation
ROI
=
Income
Sales
×
Margin
or
Return on Sales
Sales
Investment
Turnover
The ROI formula is expanded into two
ratios to more easily demonstrate actions
that might be taken to increase ROI.
25-43
ROI Question
Regal Company has sales of $500,000,
income of $30,000 and investment in
assets of $200,000. What is Regal’s
margin (return on sales)?
a. 6%
b. 10%
c. 12%
d. 15%
25-44
ROI Question
Regal Company has sales of $500,000,
income of $30,000 and investment in
assets of $200,000. What is Regal’s
margin (return on sales)?
a. 6%
Margin = $30,000 ÷ $500,000 = 6%
b. 10%
c. 12%
d. 15%
25-45
ROI Question
Regal Company has sales of $500,000,
income of $30,000 and investment in
assets of $200,000. What is Regal’s
turnover?
a.
b.
c.
d.
2.0 times
2.5 times
3.0 times
3.5 times
25-46
ROI Question
Regal Company has sales of $500,000,
income of $30,000 and investment in
assets of $200,000. What is Regal’s
turnover?
a.
b.
c.
d.
Turnover =
2.0 times
2.5 times
3.0 times
3.5 times
$500,000 ÷ $200,000 = 2.5 times
25-47
ROI Question
Regal Company has sales of $500,000,
income of $30,000 and investment in
assets of $200,000. What is Regal’s ROI?
a. 6%
b. 10%
c. 12%
d. 15%
25-48
ROI Question
Regal Company has sales of $500,000,
income of $30,000 and investment in
assets of $200,000. What is Regal’s ROI?
a. 6%
b. 10%
c. 12%
d. 15%
ROI = Margin × Turnover
ROI = 6% × 2.5 = 15%
25-49
Problems With ROI
Measuring Investment in Assets
Three Ways To Measure Investment

Original cost

Original cost less accumulated
depreciation (i.e., book value)

Current replacement cost
25-50
Problems With ROI
Suboptimization
Def. - Segment manager takes action
in segment’s best interest, but not in
best interest of company as a whole.
 To deal with suboptimization,
companies sometimes use
Residual Income (RI).
 Residual income is the amount of
income a segment has in excess of
a desired minimum ROI.

25-51
Problems With ROI
Suboptimization Example
You are a division manager with an annual
salary of $50,000 plus a bonus of $10,000 for
each one percent that your division ROI
exceeds company ROI. Your division ROI is
30 percent while the company ROI is 15
percent.
What is your current total annual pay?
Salary
Bonus = $10,000 × (30 - 15) =
Total annual pay
$ 50,000
150,000
$ 200,000
25-52
Problems With ROI
Suboptimization Example
You are a division manager with an annual
salary of $50,000 plus a bonus of $10,000 for
each one percent that your division ROI
exceeds company ROI. Your division ROI is
30 percent while the company ROI is 15
percent.
A new project is available with an ROI of 24
percent. Based on your compensation plan,
would you accept the project?
25-53
Problems With ROI
Suboptimization Example
As division manager,
I wouldn’t invest in
that project because
it would lower my pay!
25-54
Problems With ROI
Suboptimization Example
Hmm . . . I thought
we were supposed
to do what was best
for the company!
25-55
Residual Income
To deal with suboptimization of this
type, let’s use residual income (RI).
RI = Income – (Investment × Minimum ROI)
25-56
Residual Income Question
A division has a $100,000 investment in
assets and a company minimum ROI of
20 percent. If income for the division is
$30,000, what is residual income?
a.
b.
c.
d.
$30,000
$20,000
$10,000
$0
25-57
Residual Income Question
A division has a $100,000 investment in
assets and a company minimum ROI of
20 percent. If income for the division is
$30,000, what is residual income?
a.
b.
c.
d.
$30,000
$20,000
$10,000
$0
Income
$ 30,000
Minimum Required Return
($100,000 × 20%)
20,000
Residual Income
$ 10,000
25-58
Motivation and Residual Income
Using residual income to evaluate
managers encourages them to make
profitable investments that would be
rejected by managers evaluated using
ROI only.
25-59
Motivation and Residual Income
My residual income
is rising even though
average ROI is
declining!
25-60
THE END
I’ll teach you a thing or two
about responsibility and
authority in my organization!