Segmentation Slides v1

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SEGMENT
REPORTING
GROUP 4
RESPONSIBILITY CENTERS
RESPONSIBILITY ACCOUNTING
Responsibility accounting is a system that involves identifying
responsibility centers and their objectives, developing performance
measurement schemes, and preparing and analyzing performance
reports of the responsibility centers.
Responsibility accounting systems link lower-level managers’ decisionmaking authority with accountability for the outcomes of those decisions.
RESPONSIBILITY CENTERS
A part of an organization for which a particular
executive/manager is responsible.
Cost, profit,and investment centers are the three known
primary types of responsibility centers.
RESPONSIBILITY CENTERS
Cost Center
A cost center is a part of the organization whose managers
have control over its costs but are not responsible for
revenues or investment decisions.
RESPONSIBILITY CENTERS
Informatio
n
Technology
Accountin
g
Human Resources
RESPONSIBILITY CENTERS
Profit Center
A profit center is a part of the organization whose
managers have control over both costs and revenue, but
not over the use of investment funds.
RESPONSIBILITY CENTERS
Store/Branch
Managers
Sales
Department
RESPONSIBILITY CENTERS
Investment Center
An investment center is a part of the organization whose
managers have control over both costs and revenue, and
the use of investment funds.
RESPONSIBILITY CENTERS
Division
Head/Executives
Corporate HQ
DECENTRALIZED
ORGANIZATIONS &
SEGMENT REPORTING
DECENTRALIZATION IN ORGANIZATIONS
Decision-making authority is spread
throughout the organization rather than
being confined to a few top executives.
DECENTRALIZATION IN ORGANIZATIONS
Top management
freed to concentrate
on strategy.
Lower-level decisions
often based on
better information.
Lower-level
managers
gain experience in
decision-making.
Decision-making
authority leads to
job satisfaction.
Lower level
managers can
respond quickly to
customers.
ADVANTAGES
DECENTRALIZATION IN ORGANIZATIONS
May be a lack of
coordination among
autonomous
managers.
DISADVANTAG
ES
Lower-level
manager’s
objectives may not
be those of the
organization.
Lower-level
managers
may make decisions
without seeing the
“big picture.”
May be difficult to
spread innovative
ideas
in the organization.
SEGMENTED INCOME STATEMENT
Segment reporting breaks out
a company's financial data by
company divisions,
subsidiaries or other segments.
A segment is any part or
activity of an organization
about which a manager seeks
cost, revenue, or profit data.
SUPERIOR FOOD CORP:
SEGMENTED BY GEOGRAPHIC REGIONS
SUPERIOR FOODS CORP:
SEGMENTED BY CUSTOMER CHANNELS
SEGMENTED INCOME STATEMENT
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.
TRACEABLE FIXED COSTS AND COMMON
COSTS
NO Computer Division means...
Traceable costs arise
because of the existence
of a particular segment
and would disappear
over time if the segment
itself disappeared.
NO Computer Division Manager.
TRACEABLE FIXED COSTS AND COMMON
COSTS
NO Computer Division but...
Common costs arise
because of the overall operation
of the company and would not
disappear if any particular
segment were eliminated.
we STILL HAVE a CEO.
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.
CONTRIBUTION APPROACH
Let’s look more closely at the Television
Division’s income statement.
CONTRIBUTION APPROACH
Cost of goods
sold consists of
variable
manufacturing
costs.
Fixed and
variable costs
are listed in
separate
sections.
CONTRIBUTION APPROACH
Contribution margin
is computed by taking sales
minus variable costs.
Segment margin is
Television’s contribution to
profits.
CONTRIBUTION APPROACH
CONTRIBUTION APPROACH
Common costs should not be
allocated to the divisions.
These costs would remain
even if one of the divisions
were eliminated.
COMMON MISTAKES
❖ Omission of costs - costs assigned to a segment should include ALL
costs attributable to all business functions that add value to a
company’s products & services
❖ Inappropriate methods of allocating costs among segments
➢ Failure to trace costs directly
➢ Allocate costs to segments using arbitrary bases
SEGMENTED IS –
AN EXAMPLE
Segmented Income Statement An Example
Company
Division
Product
Lines
Sales
Channels
ProphetMax, Inc. Variable Costing Income Statement
ProphetMax, Inc.
Consumer
Products
Clip Art
Business
Products
Computer
Games
Online
Sales
ProphetMax, Inc. Business Segment
Retail
Stores
Segmented Income Statement An Example
A separate column is present to
break down the income statement
according to level of segmentation.
In this case, segmentation is in the
division level.
Segmented Income Statement An Example
Lower levels of segmentation can be
further break down to determine the
costing of each product line.
The computation for Consumer Products
Division should be the basis of the Product
Line breakdown
Traceable and common untraceable fixed
expenses should add up to the fixed
expenses of the division
Divisional Segment Amount should be the
same as of previous computation at
division level
Segmented Income Statement An Example
Lower levels of segmentation can be
further break down to to determine the
costing of each sales channel
The computation for Product Line should
be the basis of the Sales Channel
breakdown
It appears that margins for Retail Stores
channel has dipped to -3000! This loss
enables management to pinpoint which
segment experiences loss to able to plot
further steps to avoid incurring more losses
Traceable and common untraceable fixed
expenses should add up to the fixed
expenses of the division
Segmented Income Statement An Example
■ Segmenting Income Statements to its lowest level allows
management to make better decisions based on which
product line or division is gaining/losing.
■ Through segment margins, management can determine a
scenario whether losing/adding a segment is profitable for
the business.
Calculating ROI
ROI
Net Operating Income*
Average Operating Assets**
Margin
Net Operating Income
Sales
Turnover
Sales
Average Operating Assets
ROI = Margin x Turnover
* Earnings before interest and taxes (EBIT)
** Typically includes cash, account receivables, PPE, other assets held for operating purposes
Relationship and Impact of ROI as to:
Directly related
Inversely related
Three ways to Increase ROI
Criticisms of ROI (1/2)
❖ In the absence of balanced scorecard,
management may not know how to increase
ROI
❖ Managers evaluated on ROI may reject profitable
investment opportunities
Criticisms of ROI (1/2)
RESIDUAL INCOME
Calculating Residual Income
RI Advantage and Disadvantage
Encourages managers
to make investments
that are profitable for
the entire company
It cannot be used to
compare the performance
of division of different
sizes
RI Advantage and Disadvantage
Transfer Pricing
A transfer price is the price charged when one segment
of a company provides goods or services to another
segment of the same company.
A negotiated transfer price results from discussions
between the selling and buying
divisions.
Seller & Buyer’s Perspectives
● For the selling division the transfer price must cover
both the variable costs of producing the transferred units
and any opportunity costs from lost sales.
● For the buying division, buy from the inside supplier if
the price is less than the price offered by the outside
supplier
Sample Problem
THANK YOU!
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