Accounting 3020 Chapter 12 – Segment Reporting, Decentralization, and Balanced Scorecard

Decentralization Decision making is spread throughout the organization, not all made by top management Advantages –Empowers managers to make decisions –Middle managers have more knowledge about day to day activities Disadvantages –It gives a lot of responsibility to managers who may be inexperienced –Divisions may not work toward the good of the overall company – may promote only their own division

Segments Segment – part or division of a company Can be break the company into parts –By product –By function – sales, marketing, production, accounting –By customer – industrial group, nonprofit clients, schools, hospitals, etc. –By geographic region – U.S., Europe, Asia, etc.

Responsibility Accounting Organizational Structure and Responsibility Have segments account only for items they can control - controllability –Cost center (just costs) –Revenue center (just revenues) –Profit center (both revenues and costs) –Investment center (assets, revenues and costs)

Responsibility Accounting Evaluation –Cost center – variance analysis –Revenue center – variance analysis –Profit center – segmental profitability –Investment center – return on investment and residual income

Segmental Reporting Segmental reporting for profit centers Contribution margin format Sales, variable costs, contribution margin Fixed costs broken down into –Traceable fixed costs –Common fixed costs –Traceable and common fixed costs vary by segments –Higher up the organization, the more traceable costs you have Segment margin is the final subtotal on which to be evaluated

Segmental Reporting Hindrances to Proper Cost Assignment –Improper allocation of common costs Based on sales, equally assigned, by activity based costing Method of assignment could cause behavioral problems

Investment Centers Performance Measures –Return on Investment Net operating income/Average operating assets ROI = Profit Margin x Asset turnover ROI = Net operating income/Sales x Sales/Average operating assets Is often used with the balanced scorecard Problems of manipulation

Investment Centers Performance Measures –Residual Income Net operating income - % minimum return on average operating assets Dollar figure developed to compare to other divisions and companies Allows firms to invest in projects that are below their ROI

Balanced Scorecard Information system for employees for all levels of the organization Translation of a business unit’s mission and strategy into tangible goals and measures. Balanced scorecards focus on continuous improvement Four Different Perspectives –Financial –Customer –Internal Business Process –Learning and growth

Performance Measures Critical Financial Performance Measures –Operating profit –Return on Investment –Return on Equity –Return on Capital Employed –Economic Value Added Critical Customer Performance Measures –Customer satisfaction –Customer retention –New customer acquisition –Customer profitability

Performance Measures Internal Business Process Performance Measures –Innovation Processes –Quality measures –Cycle time measures Delivery cycle times Throughput time - time to manufacture Manufacturing Cycle Efficiency = Process time/Throughput time (Goal = 100%) –Cost measures –Post-Sale Service Processes

Performance Measures Learning and Growth Performance Measures –People –Systems –Organizational Procedures Balanced Scorecard measures should be measured in a timely fashion!!!!

Transfer Prices Definition – price charged between two divisions of the same company Theoretical price: Costs incurred + lost contribution margin Perfect market conditions –Market price charged if producing at full capacity –Variable costs charged if producing at less than full capacity –Real world: Price somewhere between the two –Negotiated price

Transfer Prices Methods used in practice –Negotiated transfer prices –Cost-based prices At least variable costs charged (Variable cost) Often some portion of fixed costs is charged (Termed full cost) Sometimes a profit margin is added to the above costs –Market-based prices Divisional autonomy and suboptimization

Transfer Pricing International Complications –Taxes –Competition –Import duties –National controls (currency rationing, limits on amount of cash taken out of country) –Profitability of subsidiary