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!