Chapter 12 RESPONSIBILITY ACCOUNTING, SEGMENT

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Chapter 12 RESPONSIBILITY ACCOUNTING, SEGMENT Powered By Docstoc
					        Segment Reporting
       and Decentralization
ACC 2203 Review Workshop
Professor Huang
Responsibility Accounting, Performance Measurement
Segment Reporting, and Transfer Pricing

   Large companies are comprised of many business units or
   segments. A segment may be a division, department, product
   line, sales territory, or a service center. Effective management of
   large companies requires delegating much of the decision
   making authority from corporate top management to segment
   managers. Segment managers are, in turn, held responsible for
   improving the segment performance as it relates to the overall
   corporate performance.
Responsibility Accounting, Performance Measurement
Segment Reposting, and Transfer Pricing
 Responsibility Accounting is a management system that aims to develop
   performance measures by which segment managers are evaluated. Under
   responsibility accounting segments are broadly categorized as:


    Cost centers – segments whose managers are held responsible only for
     costs but not for revenue or investments


    Profit centers – segments whose managers are held responsible for both
     costs and revenues but not for investments


    Investment centers – segments whose managers are held responsible for
     the capital invested as well as the profits made in the segment
       Segment Reporting
Obviously, in each segment category managerial responsibilities are
 different. The performance measures for evaluating managers
 should also be different so as to be consistent with the
 responsibilities. For example, assigning revenue or sales targets to
 a cost center manager would not be sensible.
What are the advantages and disadvantages of decentralization –
 that is dividing the company into cost, profit, and investment
 centers and hiring managers to run each center rather than
 requiring the corporate top management to run all of them?
       Segment Reporting
Segment reports provide information about each segment’s financial
  performance and are important for assessing a segment’s success in attaining
  its goals as set mainly by upper level management.
Segmented income statements reveal the profits earned by individual
  segments and hence the contribution of each segment to the overall
  corporate profitability. Income statements of segments are usually prepared
  in the contribution format which requires identifying the fixed costs
  attributable to segments.
Traceable fixed costs – are caused by a particular segment and would go
  away if the segment is discontinued
Common fixed costs – costs that are incurred to support more than one
  segment and hence are not directly identified with a particular segment.
  Common fixed costs would not go away if any particular segment is
  discontinued.
Only traceable fixed costs are included in the income statements of segments;
  common fixed costs are excluded.
         Traceable and Common Costs
Classify the following fixed costs as traceable or common (Note: NBC is a subsidiary
   of GE):
 The salary of GE’s CEO


   The salary of the president of GE’s Appliances business unit which comprises
    multiple divisions such as Refrigerators & Freezers; Washers & Dryers;
    Dishwashers & Disposers

   The maintenance cost for the broadcasting studios of NBC

   The depreciation cost on the GE headquarters building

   The maintenance and depreciation cost on the cameras used by NBC’s sports
    division

   The salaries paid to the news anchors at NBC

   The cost of heating, lighting, and air conditioning the NBC offices in Burbank,
    California and in New York
     Concept check
1. Managers in which of the following responsibility centers are held
     responsible for profits? (You may select more than one answer.)
    a. Revenue centers
    b. Cost centers
    c. Profit centers
    d. Investment centers

2. Which of the following statements is false? (You may select more than
     one answer.)
    a. The same cost can be traceable or common depending on how the
           segment is defined.
    b. In general, common fixed costs should be assigned to segments.
    c. If a company eliminates a segment of its business, the costs that were
           traceable to that segment should disappear.
    d. If four segments share $1 million in common fixed costs and one
           segment is eliminated, the common fixed costs will decrease by
           $250,000.
    Segment Reporting - Example
  The Coldex Company has two divisions: Refrigerators
   Division and Deep-Freezers Division. The following
   financial information pertains to the operations of the
   divisions:
(in thousands) Refrigerators Deep-Freezers
Sales revenue          $600,000              $330,000
Var. Man.              $180,000              $120,000
Variable S&A           $100,000                $80,000
Traceable FC           $140,000              $100,000
 The common fixed costs in the company totaled $93,000
Segment Reporting - Example
   Prepare an income statement for the
    Coldex company segmented by the
    divisions.
(in thousands)    Company   Refrigerators Deep-
   Freezers
Sales revenue $
Variable costs$
Cont. margin $
Traceable FC $
Division margin   $
Common FC         $
Net Op income     $
         Measuring Segment Performance
A major purpose of segment reporting is to determine how well segments have
  performed and how well they are being run by the segment managers. In many
  companies, segment performance directly affects managerial compensation, managerial
  promotion, and amount of investment funds allocated to each segment by the
  headquarters. We will study two popular metrics that are primarily used in profit and
  investment centers for judging segment performance: Return on investment (ROI) and
  Residual income.
Return on investment (ROI) measures the net operating income generated per dollar
  of investment in operating assets




Net operating income – income before interest and taxes (or earnings before
interest and taxes – EBIT)
Operating assets – include accounts receivable, inventory, plant and equipment
and other productive assets; excludes land held for future use, investments in other
companies
Average operating assets – average value of the operating assets between the
beginning and end of a period
  ROI - Definition
The ROI formula can also be expressed as follows:




 Sales margin – measures a segment’s ability to control its operating
 costs and to make money on its sales
 Capital turnover – measures a segment’s ability to generate revenue
 for each dollar invested in operating assets
 Sales margin and capital turnover constitute the components of ROI and
 point attention to areas that present improvement opportunities such as
 increasing sales without increasing operating assets (increases capital
 turnover) and reducing costs without impairing sales (increases sales
 margin).
        Increasing ROI – An Example

  Regal Company reports the following:
   Net operating income         $ 30,000
   Average operating assets $ 200,000
   Sales                         $ 500,000
   Operating expenses           $ 470,000

          ROI = Margin ´ Turnover
         Net operating income                Sales
ROI =
                Sales
                                ×   Average operating assets
        Increasing ROI – An Example

  Regal Company reports the following:
   Net operating income         $ 30,000
   Average operating assets $ 200,000
   Sales                         $ 500,000
   Operating expenses           $ 470,000
    What is Regal Company’s ROI?
             Margin ´ Turnover
          ROI = Margin ´ Turnover
         Net operating income                Sales
ROI =
                Sales
                                ×   Average operating assets
        Increasing ROI – An Example
          ROI = Margin ´ Turnover
         Net operating income                Sales
ROI =
                Sales
                                ×   Average operating assets
     Increasing Sales Without an
     Increase in Operating Assets
   Regal’s manager was able to increase sales to $600,000
    while operating expenses increased to $558,000.
   Regal’s net operating income increased to $42,000.
   There was no change in the average operating assets of
    the segment.




    What is the new ROI?
        Increasing Sales Without an
        Increase in Operating Assets
          ROI = Margin ´ Turnover
         Net operating income                Sales
ROI =
                Sales
                                ×   Average operating assets




    ROI = ??
 Decreasing Operating Expenses with no
 Change in Sales or Operating Assets
Assume that Regal’s manager was able to reduce
       operating expenses by $10,000 without
  affecting sales or operating assets. This would
     increase net operating income to $40,000.
 Regal Company reports the following:
   Net operating income        $ 40,000
   Average operating assets    $ 200,000
   Sales                       $ 500,000
   Operating expenses          $ 460,000
 Decreasing Operating Assets with no
 Change in Sales or Operating Expenses
Assume that Regal’s manager was able to reduce
     inventories by $20,000 using just-in-time
  techniques without affecting sales or operating
                    expenses.
Regal Company reports the following:
  Net operating income        $ 30,000
  Average operating assets    $ 180,000
  Sales                       $ 500,000
  Operating expenses          $ 470,000
    Let’s calculate the new ROI.
 Investing in Operating Assets to Increase
 Sales
 Assume that Regal’s manager invests in a
  $30,000 piece of equipment that increases
 sales by $35,000 while increasing operating
            expenses by $15,000.
Regal Company reports the following:
 Net operating income       $ 50,000
 Average operating assets   $ 230,000
 Sales                      $ 535,000
 Operating expenses         $ 485,000
   Let’s calculate the new ROI.
     Residual Income - Definition
Residual Income (RI) measures the net operating income earned
  in excess of a required return on operating assets.

RI = Net operating income – Required return on
                              operating assets

Decision rule: Accept a project if its residual income >0

Residual income recognizes that funds invested in operating assets
  impose a cost on the firm. For example, if a firm borrowed
  bank loans to acquire the operating assets, it has to pay
  interest. To improve the value of the firm, those assets must
  generate an income greater than the interest payments.
  Otherwise, value will be destroyed.
     Residual Income - Example
A division of Epsilon Corp. has average operating assets of
  $200,000. The required rate of return for the division is
  20%. The division recently reported a net operating
  income of $50,000. Calculate the division’s residual
  income and indicate whether Epsilon should keep or
  discontinue the division.

   Required return on assets =

   RI =
       ROI Vs. Residual Income
The residual income approach emphasizes maximizing the overall firm value by
     encouraging managers to invest in projects that earn more than the firm’s
     cost of capital. The ROI approach, on the other hand, emphasizes
     maximizing the segment ROI, leading managers to sometimes forego
     projects that would otherwise improve overall firm value but reduce
     segment ROI.
Problem: Sussex Magnet, a division of Sussex International Corp., has a net
     operating income of $150,000 and average operating assets of $500,000.
     The required annual rate of return for the company is 20%. Sussex Magnet
     identified a new project that would require an investment of $180,000 and
     earn an additional net operating income of $40,000 per year.
1.   What is the division’s current ROI?

2.   If the manager of Sussex Magnet is compensated based on the division’s
     ROI, would the manager undertake the new project? Why or why not?
     ROI Vs. Residual Income
3. Would the Sussex International Corp. want the
   Sussex Magnet division to undertake the new
   project? Why or why not?
4. What is Sussex Magnet’s current residual
   income?
5. If the manager of Sussex Magnet is
   compensated based on the division’s residual
   income, would the manager undertake the new
   project? Why or why not?
Quick Check ü
  Redmond Awnings, a division of Wrapup Corp., has a
  net operating income of $60,000 and average
  operating assets of $300,000. The required rate of
  return for the company is 15%. What is the division’s
  ROI?
  a. 25%
  b. 5%
  c. 15%
  d. 20%
Quick Check ü
 Redmond Awnings, a division of Wrapup Corp., has a
 net operating income of $60,000 and average
 operating assets of $300,000. If the manager of the
 division is evaluated based on ROI, will she want to
 make an investment of $100,000 that would generate
 additional net operating income of $18,000 per year?
 a. Yes
 b. No
Quick Check ü
 The company’s required rate of return is 15%.
 Would the company want the manager of the
 Redmond Awnings division to make an investment of
 $100,000 that would generate additional net
 operating income of $18,000 per year?
 a. Yes
 b. No
Quick Check ü
Redmond Awnings, a division of Wrapup Corp., has a
net operating income of $60,000 and average
operating assets of $300,000. The required rate of
return for the company is 15%. What is the division’s
residual income?
a. $240,000
b. $ 45,000
c. $ 15,000
d. $ 51,000
Quick Check ü
If the manager of the Redmond Awnings division is
evaluated based on residual income, will she want to
make an investment of $100,000 that would generate
additional net operating income of $18,000 per year?
a. Yes
b. No

				
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posted:7/12/2013
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Jun Wang Jun Wang Dr
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