Kế toán, kiểm toán - Chapter 12: Segment reporting, decentralization, and the balanced scorecard

Segment Reporting, Decentralization, and the Balanced ScorecardChapter 12Decentralization in OrganizationsBenefits ofDecentralizationTop managementfreed to concentrateon strategy.Lower-level managersgain experience indecision-making.Decision-makingauthority leads tojob satisfaction.Lower-level decisionsoften based onbetter information.Lower level managers can respond quickly to customers.Decentralization in OrganizationsDisadvantages ofDecentralizationLower-level managersmay make decisionswithout seeing the“big picture.”May be a lack ofcoordination amongautonomousmanagers.Lower-level manager’sobjectives may notbe those of theorganization.May be difficult tospread innovative ideasin the organization.Cost, Profit, and Investments CentersResponsibilityCenterCostCenterProfitCenterInvestmentCenterCost, profit,and investmentcenters are allknown asresponsibilitycenters.Cost CenterA segment whose manager has control over costs, but not over revenues or investment funds.Profit Center A segment whose manager has control over both costs and revenues, but no control over investment funds.RevenuesSalesInterestOtherCostsMfg. costsCommissionsSalariesOtherInvestment Center A segment whose manager has control over costs, revenues, and investments in operating assets. Corporate HeadquartersResponsibility CentersCost CentersInvestment CentersSuperior Foods Corporation provides an example of the various kinds of responsibility centers that exist in an organization.Responsibility CentersSuperior Foods Corporation provides an example of the various kinds of responsibility centers that exist in an organization.Profit CentersResponsibility CentersCost CentersSuperior Foods Corporation provides an example of the various kinds of responsibility centers that exist in an organization.Learning Objective 1Prepare a segmented income statement using the contribution format, and explain the difference between traceable fixed costs and common fixed costs.Decentralization and Segment Reporting A segment is any part or activity of an organization about which a manager seeks cost, revenue, or profit data. Quick MartAn Individual StoreA Sales TerritoryA Service CenterSuperior Foods: Geographic RegionsSuperior Foods Corporation could segment its business by geographic region.Superior Foods: Customer ChannelSuperior Foods Corporation could segment its business by customer channel.Keys to Segmented Income StatementsThere are two keys to building segmented income statements: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.Identifying Traceable Fixed Costs Traceable costs arise because of the existence of a particular segment and would disappear over time if the segment itself disappeared.No computer division means . . .No computerdivision manager.Identifying Common Fixed Costs Common costs arise because of the overall operation of the company and would not disappear if any particular segment were eliminated. No computer division but . . .We still have acompany president.Traceable Costs Can Become Common CostsIt is important to realize that the traceable fixed costs of one segment may be a common fixed cost of another segment.For example, the landing fee paid to land an airplane at an airport is traceable to the particular flight, but it is not traceable to first-class, business-class, and economy-class passengers.Segment MarginThe 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.TimeProfitsTraceable and Common CostsFixedCostsTraceableCommonDon’t allocatecommon costs to segments.Activity-Based CostingActivity-based costing can help identify how costs shared by more than one segment are traceable to individual segments. Assume that three products, 9-inch, 12-inch, and 18-inch pipe, share 10,000 square feet of warehousing space, which is leased at a price of $4 per square foot. If the 9-inch, 12-inch, and 18-inch pipes occupy 1,000, 4,000, and 5,000 square feet, respectively, then ABC can be used to trace the warehousing costs to the three products as shown.Levels of Segmented StatementsLet’s look more closely at the Television Division’s income statement.Webber, Inc. has two divisions.Levels of Segmented StatementsOur approach to segment reporting uses the contribution format.Cost of goodssold consists of variable manufacturingcosts.Fixed andvariable costsare listed inseparatesections.Levels of Segmented StatementsSegment marginis Television’s contributionto profits.Contribution marginis computed by taking sales minus variable costs.Our approach to segment reporting uses the contribution format.Levels of Segmented StatementsLevels of Segmented StatementsCommon costs should not be allocated to the divisions. These costs would remain even if one of the divisions were eliminated.Traceable Costs Can Become Common CostsAs previously mentioned, fixed costs that are traceable to one segment can become common if the company is divided into smaller segments.Let’s see how this works using the Webber, Inc. example!Traceable Costs Can Become Common CostsProductLinesRegularBig ScreenTelevisionDivisionWebber’s Television DivisionTraceable Costs Can Become Common CostsWe obtained the following information fromthe Regular and Big Screen segments.Traceable Costs Can Become Common CostsFixed costs directly tracedto the Television Division $80,000 + $10,000 = $90,000External ReportsThe Financial Accounting Standards Board now requires that companies in the United States include segmented financial data in their annual reports.Companies must report segmented results to shareholders using the same methods that are used for internal segmented reports.Since the contribution approach to segment reporting does not comply with GAAP, it is likely that some managers will choose to construct their segmented financial statements using the absorption approach to comply with GAAP.Omission of CostsCosts assigned to a segment should include all costs attributable to that segment from the company’s entire value chain. Product Customer R&D Design Manufacturing Marketing Distribution ServiceBusiness FunctionsMaking Up TheValue ChainInappropriate Methods of Allocating Costs Among SegmentsSegment1Segment3Segment4Inappropriateallocation baseSegment2Failure to tracecosts directlyCommon Costs and Segments Segment1Segment3Segment4Segment2Common costs should not be arbitrarily allocated to segments based on the rationale that “someone has to cover the common costs” for two reasons:This practice may make a profitable business segment appear to be unprofitable.Allocating common fixed costs forces managers to be held accountable for costs they cannot control.Quick Check Assume that Hoagland's Lakeshore prepared its segmented income statement as shown.Quick Check  How much of the common fixed cost of $200,000 can be avoided by eliminating the bar?a. None of it.b. Some of it.c. All of it.Quick Check  How much of the common fixed cost of $200,000 can be avoided by eliminating the bar?a. None of it.b. Some of it.c. All of it.A common fixed cost cannot be eliminated by dropping one of the segments. Quick Check  Suppose square feet is used as the basis for allocating the common fixed cost of $200,000. How much would be allocated to the bar if the bar occupies 1,000 square feet and the restaurant 9,000 square feet?a. $20,000b. $30,000c. $40,000d. $50,000 Suppose square feet is used as the basis for allocating the common fixed cost of $200,000. How much would be allocated to the bar if the bar occupies 1,000 square feet and the restaurant 9,000 square feet?a. $20,000b. $30,000c. $40,000d. $50,000Quick Check The bar would be allocated 1/10 of the cost or $20,000.Quick Check If Hoagland's allocates its common costs to the bar and the restaurant, what would be the reported profit of each segment?Allocations of Common CostsHurray, now everything adds up!!!Quick Check  Should the bar be eliminated?a. Yesb. No Should the bar be eliminated?a. Yesb. NoQuick Check The profit was $44,000 before eliminating the bar. If we eliminate the bar, profit drops to $30,000!Learning Objective 2Compute return on investment (ROI) and show how changes in sales, expenses, and assets affect ROI.Return on Investment (ROI) FormulaROI = Net operating incomeAverage operating assets Cash, accounts receivable, inventory,plant and equipment, and otherproductive assets.Income before interestand taxes (EBIT)Net Book Value vs. Gross CostMost companies use the net book value of depreciable assets to calculate average operating assets.Understanding ROIROI = Net operating incomeAverage operating assets Margin = Net operating incomeSales Turnover = SalesAverage operating assets ROI = Margin  TurnoverIncreasing ROIThere are three ways to increase ROI . . .IncreaseSalesReduceExpensesReduceAssetsIncreasing ROI – An ExampleRegal Company reports the following: Net operating income $ 30,000 Average operating assets $ 200,000 Sales $ 500,000 Operating expenses $ 470,000ROI = Margin  Turnover Net operating income Sales Sales Average operating assets×ROI =What is Regal Company’s ROI?Increasing ROI – An Example $30,000 $500,000×$500,000$200,000ROI = 6%  2.5 = 15%ROI = ROI = Margin  Turnover Net operating income Sales Sales Average operating assets×ROI =Investing in Operating Assets to Increase SalesAssume 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. Let’s calculate the new ROI.Regal Company reports the following:Net operating income $ 50,000Average operating assets $ 230,000Sales $ 535,000Operating expenses $ 485,000Investing in Operating Assets to Increase Sales $50,000 $535,000×$535,000$230,000ROI = 9.35%  2.33 = 21.8%ROI = ROI increased from 15% to 21.8%.ROI = Margin  Turnover Net operating income Sales Sales Average operating assets×ROI =Criticisms of ROIIn the absence of the balancedscorecard, management maynot know how to increase ROI.Managers often inherit manycommitted costs over whichthey have no control.Managers evaluated on ROImay reject profitableinvestment opportunities. Learning Objective 3Compute residual income and understand its strengths and weaknesses.Residual Income - Another Measure of PerformanceNet operating incomeabove some minimumreturn on operatingassetsCalculating Residual Income()This computation differs from ROI. ROI measures net operating income earned relative to the investment in average operating assets. Residual income measures net operating income earned less the minimum required return on average operating assets.Residual Income – An ExampleThe Retail Division of Zephyr, Inc. has average operating assets of $100,000 and is required to earn a return of 20% on these assets.In the current period, the division earns $30,000.Let’s calculate residual income.Residual Income – An ExampleMotivation and Residual IncomeResidual income encourages managers to make profitable investments that wouldbe rejected by managers using ROI.Quick Check  Redmond Awnings, a division of Wrap-up 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  Redmond Awnings, a division of Wrap-up 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%ROI = NOI/Average operating assets = $60,000/$300,000 = 20%Quick Check  Redmond Awnings, a division of Wrap-up 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. Yesb. NoQuick Check  Redmond Awnings, a division of Wrap-up 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. Yesb. NoROI = $78,000/$400,000 = 19.5%This lowers the division’s ROI from 20.0% down to 19.5%.Quick Check  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. Yesb. NoQuick Check  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. Yesb. NoROI = $18,000/$100,000 = 18%The return on the investment exceeds the minimum required rate of return.Quick Check  Redmond Awnings, a division of Wrap-up 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. $240,000b. $ 45,000c. $ 15,000d. $ 51,000Quick Check  Redmond Awnings, a division of Wrap-up 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. $240,000b. $ 45,000c. $ 15,000d. $ 51,000Net operating income $60,000Required return (15% of $300,000) (45,000)Residual income $15,000Quick Check  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. Yesb. NoQuick Check  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. Yesb. NoNet operating income $78,000Required return (15% of $400,000) (60,000)Residual income $18,000 Yields an increase of $3,000 in the residual income.Divisional Comparisons and Residual IncomeThe residual income approach has one major disadvantage. It cannot be used to compare the performance of divisions of different sizes.Zephyr, Inc. - ContinuedRecall the following information for the Retail Division of Zephyr, Inc. Assume the following information for the Wholesale Division of Zephyr, Inc. Zephyr, Inc. - ContinuedThe residual income numbers suggest that the Wholesale Division outperformed the Retail Division because its residual income is $10,000 higher. However, the Retail Division earned an ROI of 30% compared to an ROI of 22% for the Wholesale Division. The Wholesale Division’s residual income is larger than the Retail Division simply because it is a bigger division.Learning Objective 4Understand how to construct and use a balanced scorecard.The Balanced ScorecardManagement translates its strategy into performance measures that employees understand and influence.PerformancemeasuresCustomersLearningand growthInternalbusinessprocessesFinancialThe Balanced Scorecard: FromStrategy to Performance MeasuresFinancialHas our financialperformance improved?CustomerDo customers recognize thatwe are delivering more value?Internal Business ProcessesHave we improved key business processes so that we can deliver more value to customers?Learning and GrowthAre we maintaining our abilityto change and improve?Performance MeasuresWhat are ourfinancial goals?What customers dowe want to serve andhow are we going towin and retain them?What internal busi-ness processes arecritical to providingvalue to customers?Vision and StrategyThe Balanced Scorecard: Non-financial MeasuresThe balanced scorecard relies on non-financial measures in addition to financial measures for two reasons: Financial measures are lag indicators that summarize the results of past actions. Non-financial measures are leading indicators of future financial performance. Top managers are ordinarily responsible for financial performance measures – not lower level managers.  Non-financial measures are more likely to be understood and controlled by lower level managers.The Balanced Scorecard for IndividualsA personal scorecard should contain measures that can beinfluenced by the individual being evaluated and thatsupport the measures in the overall balanced scorecard.The entire organization should have an overall balanced scorecard.Each individual should have a personal balanced scorecard.The balanced scorecard lays out concrete actions to attain desired outcomes.A balanced scorecard should have measuresthat are linked together on a cause-and-effect basis.If we improveone performancemeasure . . .Another desiredperformance measurewill improve.The Balanced ScorecardThenThe Balanced Scorecard and Compensation Incentive compensation should be linked to balanced scorecard performance measures. Employee skills in installing optionsNumber ofoptions availableTime toinstall optionCustomer satisfactionwith optionsNumber of cars soldContribution per carProfitLearningand GrowthInternal Business ProcessesCustomerFinancialThe Balanced Scorecard ─ Jaguar Example Employee skills in installing optionsNumber ofoptions availableTime toinstall optionCustomer satisfactionwith optionsNumber of cars soldContribution per carProfitIncrease OptionsTimeDecreasesStrategiesSatisfaction IncreasesIncrease SkillsResultsThe Balanced Scorecard ─ Jaguar Example Employee skills in installing optionsNumber ofoptions availableTime toinstall optionCustomer satisfactionwith optionsNumber of cars soldContribution per carProfitSatisfaction IncreasesResultsCars sold IncreaseThe Balanced Scorecard ─ Jaguar Example Employee skills in installing optionsNumber ofoptions availableTime toinstall optionCustomer satisfactionwith optionsNumber of cars soldContribution per carProfitResultsTimeDecreasesContributionIncreasesSatisfaction IncreasesThe Balanced Scorecard ─ Jaguar Example The Balanced Scorecard ─ Jaguar Example Employee skills in installing optionsNumber ofoptions availableTime toinstall optionCustomer satisfactionwith optionsNumber of cars soldContribution per carProfitResultsContributionIncreasesProfitsIncreaseIf numberof cars soldand contributionper car increase,profits increase.Cars Sold IncreasesTransfer PricingAppendix 12AKey Concepts/DefinitionsA transfer price is the price charged when one segment of a company provides goods or services to another segment of the company.The fundamental objective in setting transfer prices is to motivate managers to act in the best interests of the overall company.Three Primary ApproachesThere are three primary approaches to setting transfer prices: Negotiated transfer prices;Transfers at the cost to the selling division; andTransfers at market price.Learning Objective 5Determine the range, if any, within which a negotiated transfer price should fall.Negotiated Transfer PricesA negotiated transfer price results from discussions between the selling and buying divisions.Advantages of negotiated transfer prices:They preserve the autonomy of the divisions, which is consistent with the spirit of decentralization.The managers negotiating the transfer price are likely to have much better information about the potential costs and benefits of the transfer than others in the company.Upper limit is determined by the buying division.Lower limit is determined by the selling division.Range of Acceptable Transfer PricesGrocery Storehouse – An ExampleAssume the information as shown with respect to West Coast Plantations and Grocery Mart (both companies are owned by Grocery Storehouse).Grocery Storehouse – An ExampleThe selling division’s (West Coast Plantations) lowest acceptable transfer price is calculated as:The buying division’s (Grocery Mart) highest acceptable transfer price is calculated as:Let’s calculate the lowest and highest acceptable transfer prices under three scenarios.If an outside supplier does not exist, the highest acceptable transfer price is calculated as:Grocery Storehouse – An ExampleIf West Coast Plantations has sufficient idle capacity (3,000 crates) to satisfy Grocery Mart’s demands (1,000 crates), without sacrificing sales to other customers, then the lowest and highest possible transfer prices are computed as follows:Selling division’s lowest possible transfer price:Buying division’s highest possible transfer price:Therefore, the range of acceptable transfer prices is $10 – $20.Grocery Storehouse – An ExampleIf West Coast Plantations has no idle capacity (0 crates) and must sacrifice other customer orders (1,000 crates) to meet Grocery Mart’s demands (1,000 crates), then the lowest and highest possible transfer prices are computed as follows:Selling division’s lowest possible transfer price:Buying division’s highest possible transfer price:Therefore, there is no range of acceptable transfer prices.Grocery Storehouse – An ExampleIf West Coast Plantations has some idle capacity (500 crates) and must sacrifice other customer orders (500 crates) to meet Grocery Mart’s demands (1,000 crates), then the lowest and highest possible transfer prices are computed as follows:Buying division’s highest possible transfer price:Therefore, the range of acceptable transfer prices is $17.50 – $20.00.Selling division’s lowest possible transfer price:Evaluation of Negotiated Transfer PricesIf a transfer within a company would result in higher overall profits for the company, there is always a range of transfer prices within which both the selling and buying divisions would have higher profits if they agree to the transfer.If managers are pitted against each other rather than against their past performance or reasonable benchmarks, a noncooperative atmosphere is almost guaranteed.Given the disputes that often accompany the negotiation process, most companies rely on some other means of setting transfer prices.Transfers at the Cost to the Selling DivisionMany companies set transfer prices at either the variable cost or full (absorption) cost incurred by the selling division.Drawbacks of this approach include:Using full cost as a transfer price can lead to suboptimization.The selling division will never show a profit on any internal transfer. Cost-based transfer prices do not provide incentives to control costs.Transfers at Market PriceA market price (i.e., the price charged for an item on the open market) is often regarded as the best approach to the transfer pricing problem.A market price approach works best when the product or service is sold in its present form to outside customers and the selling division has no idle capacity.A market price approach does not work well when the selling division has idle capacity.Divisional Autonomy and SuboptimizationThe principles of decentralization suggest that companies should grant managers autonomy to set transfer prices and to decide whether to sell internally or externally, even if this may occasionally result in suboptimal decisions. This way top management allows subordinates to control their own destiny.Service Department ChargesAppendix 12BLearning Objective 6Charge operating departments for services provided by service departments.Service Department ChargesOperating DepartmentsCarry out central purposes of organization.Service DepartmentsDo not directly engage in operating activities. Reasons for Charging Service Department CostsTo encourage operating departments to wisely use service department resources.To provide operating departments with more complete cost data for making decisions.To help measure the profitability of operating departments.To create an incentive for service departments to operate efficiently.Service department costs are charged to operating departments for a variety of reasons including:$Transfer PricesOperatingDepartmentsServiceDepartmentsThe service department charges considered in this appendix can be viewed as a transfer price that is charged for services provided by service departments to operating departments. Charging Costs by BehaviorWhenever possible,variable and fixedservice department costsshould be chargedseparately.Variable servicedepartment costs should becharged to consuming departmentsaccording to whatever activitycauses the incurrence of the cost.Charging Costs by BehaviorCharge fixed service department costs to consuming departments in predetermined lump-sum amounts that are based on the consuming department’s peak-period or long-run average servicing needs. Are based on amounts ofcapacity each consumingdepartment requires.Should not vary fromperiod to period.Charging Costs by BehaviorShould Actual or Budgeted Costs Be Charged?Budgeted variableand fixed service departmentcosts should be charged tooperating departments.Sipco has a maintenance department and two operatingdepartments: Cutting and Assembly. Variable maintenancecosts are budgeted at $0.60 per machine hour. Fixedmaintenance costs are budgeted at $200,000 per year.Data relating to the current year are: Allocate maintenance costs to the two operating departments.Sipco: An ExampleActual hoursSipco: End of the YearPercent of peak-period capacity.Sipco: End of the YearActual hoursQuick Check Foster City has an ambulance service that is used by the two public hospitals in the city. Variable ambulance costs are budgeted at $4.20 per mile. Fixed ambulance costs are budgeted at $120,000 per year. Data relating to the current year are:Quick Check  How much ambulance service cost will be allocated to Mercy Hospital at the end of the year?a. $121,200b. $254,400c. $139,500d. $117,000 How much ambulance service cost will be allocated to Mercy Hospital at the end of the year?a. $121,200b. $254,400c. $139,500d. $117,000Quick Check Allocating fixed costs using a variableallocation base.Pitfalls in Allocating Fixed CostsUsing salesdollars as anallocation base.Pitfalls in Allocating Fixed CostsResultSales of one departmentinfluence the servicedepartment costsallocated to otherdepartments.Autos R Us – An ExampleAutos R Us has one service department and three sales departments, New Cars, Used Cars, and Car Parts. The service department costs total $80,000 for both years in the example. Contrary to good practice, Autos R Us allocates theservice department costs based on sales.Autos R Us – First-year Allocation$1,500,000 ÷ $3,000,00050% of $80,000In the next year, the manager of the New Cars departmentincreases sales by $500,000. Sales in the other departmentsare unchanged. Let’s allocate the $80,000 service departmentcost for the second year given the sales increase.Autos R Us – Second-year Allocation$2,000,000 ÷ $3,500,00057% of $80,000If you were the manager of the New Cars department, wouldyou be happy with the increased service departmentcosts allocated to your department?End of Chapter 12