BAB 15 SEGMENT REPORTING AND DECENTRALIZATION
Chapter
15
Segment Reporting, and
Decentralization
Decentralization in Organizations
Benefits of
Decentralization
Top
Top management
management
freed
freed to
to concentrate
concentrate
on
on strategy.
strategy.
Lower-level
Lower-level managers
managers
gain
gain experience
experience in
in
decision-making.
decision-making.
Decision-making
Decision-making
authority
authority leads
leads to
to
job
job satisfaction.
satisfaction.
Lower-level
decision
Lower-level decision
often
often based
based on
on
better
better information.
information.
Improves
Improves ability
ability to
to
evaluate
evaluate managers.
managers.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Decentralization in Organizations
Lower-level
Lower-level managers
managers
may
may make
make decisions
decisions
without
without seeing
seeing the
the
“big
“big picture.”
picture.”
Lower-level
Lower-level manager’s
manager’s
objectives
objectives may
may not
not
be
be those
those of
of the
the
organization.
organization.
Irwin/McGraw-Hill
May
May be
be aa lack
lack of
of
coordination
coordination among
among
autonomous
autonomous
managers.
managers.
Disadvantages of
Decentralization
May
May be
be difficult
difficult to
to
spread
spread innovative
innovative ideas
ideas
in
in the
the organization.
organization.
© The McGraw-Hill Companies, Inc., 2000
Decentralization and Segment Reporting
A segment is any
part or activity of an
organization about
which a manager
seeks cost,
revenue, or profit
data. A segment
can be . . .
Irwin/McGraw-Hill
An Individual Store
Quick Mart
A Sales Territory
A Service Center
© The McGraw-Hill Companies, Inc., 2000
Cost, Profit, and Investments Centers
C
o
st
Irwin/McGraw-Hill
t
st
but not over
revenues or
investment funds.
Co
s
Co
Cost Center
A segment whose
manager has
control over costs,
© The McGraw-Hill Companies, Inc., 2000
Cost, Profit, and Investments Centers
Profit Center
A segment whose
manager has
control over both
costs and
revenues,
but no control over
investment funds.
Irwin/McGraw-Hill
Revenues
Sales
Interest
Other
Costs
Mfg. costs
Commissions
Salaries
Other
© The McGraw-Hill Companies, Inc., 2000
Cost, Profit, and Investments Centers
Investment Center
A segment whose
manager has
control over costs,
revenues, and
investments in
operating assets.
Irwin/McGraw-Hill
Corporate Headquarters
© The McGraw-Hill Companies, Inc., 2000
Cost, Profit, and Investments Centers
Cost
Cost
Center
Center
Cost, profit,
and investment
centers are all
known as
responsibility
centers.
Irwin/McGraw-Hill
Profit
Profit
Center
Center
Investment
Investment
Center
Center
Responsibility
Responsibility
Center
Center
© The McGraw-Hill Companies, Inc., 2000
Traceable and Common Costs
Fixed
Costs
Traceable
Costs arise because
of the existence of
a particular segment
Irwin/McGraw-Hill
Common
Costs arise because
of overall operating
activities.
© The McGraw-Hill Companies, Inc., 2000
Traceable and Common Costs
Fixed
Costs
Traceable
Costs arise because
of the existence of
a particular segment
Irwin/McGraw-Hill
Don’t allocate
common costs.
Common
Costs arise because
of overall operating
activities.
© The McGraw-Hill Companies, Inc., 2000
Identifying Traceable Fixed Costs
Traceable costs would disappear over time
if the segment itself disappeared.
No computer
division means . . .
Irwin/McGraw-Hill
No computer
division manager.
© The McGraw-Hill Companies, Inc., 2000
Identifying Common Fixed Costs
Common costs arise because of overall
operation of the company and are not due to
the existence of a particular segment.
No computer
division but . . .
Irwin/McGraw-Hill
We still have a
company president.
© The McGraw-Hill Companies, Inc., 2000
Levels of Segmented Statements
Webber, Inc. has two divisions.
W e b b e r , In c .
C o m p u te r D iv is io n
T e le v is io n D iv is io n
Let’s
Let’s look
look more
more closely
closely at
at the
the Television
Television
Division’s
Division’s income
income statement.
statement.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Levels of Segmented Statements
Our approach to segment reporting uses the
contribution format.
Income Statement
Contribution Margin Format
Television Division
Sales
$300,000
Variable COGS
120,000
Other variable costs
30,000
Total variable costs
150,000
Contribution margin
150,000
Traceable fixed costs
90,000
Segment margin
$ 60,000
Irwin/McGraw-Hill
Cost
Cost of
of goods
goods
sold
sold consists
consists of
of
variable
variable
manufacturing
manufacturing
costs.
costs.
Fixed
Fixed and
and
variable
variable costs
costs
are
are listed
listed in
in
separate
separate
sections.
sections.
© The McGraw-Hill Companies, Inc., 2000
Levels of Segmented Statements
Our approach to segment reporting uses the
contribution format.
Income Statement
Contribution Margin Format
Television Division
Sales
$300,000
Variable COGS
120,000
Other variable costs
30,000
Total variable costs
150,000
Contribution margin
150,000
Traceable fixed costs
90,000
Segment margin
$ 60,000
Irwin/McGraw-Hill
Segment
Segment margin
margin
is
is Television’s
Television’s
contribution
contribution
to
to overall
overall
operations.
operations.
© The McGraw-Hill Companies, Inc., 2000
Levels of Segmented Statements
Let’s see how the Television
Division fits into Webber, Inc.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Levels of Segmented Statements
Sales
Variable costs
CM
Traceable FC
Division margin
Common costs
Net income
Income Statement
Company
Television
$ 300,000
(150,000)
150,000
(90,000)
60,000
Computer
Segment
Segment margin
margin has
has now
now
become
become division
division margin.
margin.
Let’s add the Computer
Division’s numbers.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Levels of Segmented Statements
Sales
Variable costs
CM
Traceable FC
Division margin
Common costs
Net income
Irwin/McGraw-Hill
Income Statement
Company
Television
$ 500,000
$ 300,000
(230,000)
(150,000)
270,000
150,000
(170,000)
(90,000)
100,000
60,000
Computer
$ 200,000
(80,000)
120,000
(80,000)
40,000
© The McGraw-Hill Companies, Inc., 2000
Levels of Segmented Statements
Sales
Variable costs
CM
Traceable FC
Division margin
Common costs
Net income
Income Statement
Company
Television
$ 500,000
$ 300,000
(230,000)
(150,000)
270,000
150,000
(170,000)
(90,000)
100,000
60,000
(25,000)
$ 75,000
Computer
$ 200,000
(80,000)
120,000
(80,000)
40,000
Common
Common costs
costs arise
arise because
because of
of overall
overall
operating
operating activities.
activities. ABC
ABC may
may be
be helpful
helpful
in
in the
the analysis
analysis of
of common
common costs.
costs.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Traceable Costs Can Become Common Costs
Fixed costs that are traceable on one
segmented statement can become
common if the company is divided into
smaller segments.
Let’s see how this works!
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Traceable Costs Can Become Common Costs
Webber’s Television Division
Product
Lines
T e le v is io n
D iv is io n
R e g u la r
U .S . S a le s
Irwin/McGraw-Hill
B ig S c r e e n
F o r e ig n S a le s
U .S . S a le s
F o r e ig n S a le s
Sales
Territories
© The McGraw-Hill Companies, Inc., 2000
Traceable Costs Can Become Common Costs
Income Statement
Television
Division
Regular
Sales
$ 200,000
Variable costs
(95,000)
CM
105,000
Traceable FC
(45,000)
Product line margin
60,000
Common costs
Divisional margin
Big Screen
$ 100,000
(55,000)
45,000
(35,000)
10,000
We obtained the following information from
the Regular and Big Screen segments.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Traceable Costs Can Become Common Costs
Income Statement
Television
Division
Regular
Sales
$ 300,000
$ 200,000
Variable costs
(150,000)
(95,000)
CM
150,000
105,000
Traceable FC
(80,000)
(45,000)
Product line margin
70,000
60,000
Common costs
10,000
Divisional margin
$ 60,000
Big Screen
$ 100,000
(55,000)
45,000
(35,000)
10,000
Fixed
Fixed costs
costs directly
directly traced
traced
to
to the
the Television
Television Division
Division
$80,000
$80,000 ++ $10,000
$10,000 == $90,000
$90,000
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Traceable Costs Can Become Common Costs
Income Statement
Television
Division
Regular
Sales
$ 300,000
$ 200,000
Variable costs
(150,000)
(95,000)
CM
150,000
105,000
Traceable FC
(80,000)
(45,000)
Product line margin
70,000
60,000
Common costs
10,000
Divisional margin
$ 60,000
Big Screen
$ 100,000
(55,000)
45,000
(35,000)
10,000
Of the $90,000 cost directly traced to
the Television Division, $45,000 is
traceable to Regular and $35,000
traceable to Big Screen product lines.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Traceable Costs Can Become Common Costs
Income Statement
Television
Division
Regular
Sales
$ 300,000
$ 200,000
Variable costs
(150,000)
(95,000)
CM
150,000
105,000
Traceable FC
(80,000)
(45,000)
Product line margin
70,000
60,000
Common costs
10,000
Divisional margin
$ 60,000
Big Screen
$ 100,000
(55,000)
45,000
(35,000)
10,000
The remaining $10,000 cannot be traced to
either the Regular or Big Screen product lines.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Segment Margin
Profits
The segment margin is the best gauge of
the long-run profitability of a segment.
Time
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Hindrances to Proper Cost Assignment
The Problems
Omission of some
costs in the
assignment process.
Assignment of costs
to segments that are
really common costs of
the entire organization.
The use of inappropriate
methods for allocating
costs among segments.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Omission of Costs
Costs assigned to a segment should include
all costs attributable to that segment from
the company’s entire value chain.
chain
Business Functions
Making Up The
Value Chain
R&D
Product
Design
Irwin/McGraw-Hill
Customer
Manufacturing Marketing Distribution Service
© The McGraw-Hill Companies, Inc., 2000
Inappropriate Methods of Allocating
Costs Among Segments
Arbitrarily dividing
common costs
among segments
Failure to trace
costs directly
Segment
1
Irwin/McGraw-Hill
Segment
2
Segment
3
Inappropriate
allocation base
Segment
4
© The McGraw-Hill Companies, Inc., 2000
Return on Investment (ROI) Formula
Income
Incomebefore
before interest
interest
and
andtaxes
taxes(EBIT)
(EBIT)
Net operating income
ROI =
Average operating assets
Cash,
Cash,accounts
accountsreceivable,
receivable,inventory,
inventory,
plant
plantand
andequipment,
equipment, and
andother
other
productive
productiveassets.
assets.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Return on Investment (ROI) Formula
Regal Company reports the following:
Net operating income
Average operating assets
Sales
$ 30,000
$ 200,000
$ 500,000
$30,000
= 15%
ROI =
$200,000
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Controlling the Rate of Return
Three ways to improve ROI . . .
Increase
Sales
Irwin/McGraw-Hill
Reduce
Expenses
Reduce
Assets
© The McGraw-Hill Companies, Inc., 2000
Controlling the Rate of Return
Regal’s manager was able to increase
sales to $600,000 which increased net
operating income to $42,000.
There was no change in the average
operating assets of the segment.
Let’s calculate the new ROI.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Return on Investment (ROI) Formula
We can modify our original formula slightly:
×
Margin
Turnover
ROI = Net operating income
Sales
Sales
×Average operating
assets
ROI = $42,000 × $600,000
$600,000
$200,000
ROI = 21%
We
We increased
increased ROI
ROI from
from 15%
15% to
to 21%
21%
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
ROI and the Balanced Scorecard
The balanced scorecard provides managers with
a roadmap that indicates how the company
intends to increase its ROI.
Reduce
Expenses
Increase
Reduce
Sales
Assets
Irwin/McGraw-Hill
I’m glad we used the
balanced scorecard
to tell which approach
is best.
© The McGraw-Hill Companies, Inc., 2000
Criticisms of ROI
In the absence of the balanced
scorecard, management may
not know how to increase ROI.
Managers often inherit many
committed costs over which
they have no control.
Managers evaluated on ROI
may reject profitable
investment opportunities.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Criticisms of ROI
As division manager at Winston, Inc., your
compensation package includes a salary plus bonus
based on your division’s ROI -- the higher your ROI,
the bigger your bonus.
The company requires an ROI of 15% on all new
investments -- your division has been producing an
ROI of 30%.
You have an opportunity to invest in a new project
that will produce an ROI of 25%.
As division manager would you
invest in this project?
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Criticisms of ROI
As division manager,
I wouldn’t invest in
that project because
it would lower my pay!
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Criticisms of ROI
Gee . . .
I thought we were
supposed to do what
was best for the
company!
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Residual Income - Another Measure of
Performance
Net operating income
above some minimum
return on operating
assets
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Residual Income
A division of Zepher, 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.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Residual Income
Operating
$$100,000
Operating assets
assets
100,000
Required
20%
Requiredrate
rateof
ofreturn
return ××
20%
Required
$$ 20,000
Requiredreturn
return
20,000
Actual
Actualreturn
return
Required
Required return
return
Residual
Residualincome
income
Irwin/McGraw-Hill
$$ 30,000
30,000
(20,000)
(20,000)
$$ 10,000
10,000
© The McGraw-Hill Companies, Inc., 2000
Motivation and Residual Income
Residual income encourages managers to
make profitable investments that would
be rejected by managers using ROI.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
End of Chapter 12
Let’s get to work
on my ROI . . .
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
15
Segment Reporting, and
Decentralization
Decentralization in Organizations
Benefits of
Decentralization
Top
Top management
management
freed
freed to
to concentrate
concentrate
on
on strategy.
strategy.
Lower-level
Lower-level managers
managers
gain
gain experience
experience in
in
decision-making.
decision-making.
Decision-making
Decision-making
authority
authority leads
leads to
to
job
job satisfaction.
satisfaction.
Lower-level
decision
Lower-level decision
often
often based
based on
on
better
better information.
information.
Improves
Improves ability
ability to
to
evaluate
evaluate managers.
managers.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Decentralization in Organizations
Lower-level
Lower-level managers
managers
may
may make
make decisions
decisions
without
without seeing
seeing the
the
“big
“big picture.”
picture.”
Lower-level
Lower-level manager’s
manager’s
objectives
objectives may
may not
not
be
be those
those of
of the
the
organization.
organization.
Irwin/McGraw-Hill
May
May be
be aa lack
lack of
of
coordination
coordination among
among
autonomous
autonomous
managers.
managers.
Disadvantages of
Decentralization
May
May be
be difficult
difficult to
to
spread
spread innovative
innovative ideas
ideas
in
in the
the organization.
organization.
© The McGraw-Hill Companies, Inc., 2000
Decentralization and Segment Reporting
A segment is any
part or activity of an
organization about
which a manager
seeks cost,
revenue, or profit
data. A segment
can be . . .
Irwin/McGraw-Hill
An Individual Store
Quick Mart
A Sales Territory
A Service Center
© The McGraw-Hill Companies, Inc., 2000
Cost, Profit, and Investments Centers
C
o
st
Irwin/McGraw-Hill
t
st
but not over
revenues or
investment funds.
Co
s
Co
Cost Center
A segment whose
manager has
control over costs,
© The McGraw-Hill Companies, Inc., 2000
Cost, Profit, and Investments Centers
Profit Center
A segment whose
manager has
control over both
costs and
revenues,
but no control over
investment funds.
Irwin/McGraw-Hill
Revenues
Sales
Interest
Other
Costs
Mfg. costs
Commissions
Salaries
Other
© The McGraw-Hill Companies, Inc., 2000
Cost, Profit, and Investments Centers
Investment Center
A segment whose
manager has
control over costs,
revenues, and
investments in
operating assets.
Irwin/McGraw-Hill
Corporate Headquarters
© The McGraw-Hill Companies, Inc., 2000
Cost, Profit, and Investments Centers
Cost
Cost
Center
Center
Cost, profit,
and investment
centers are all
known as
responsibility
centers.
Irwin/McGraw-Hill
Profit
Profit
Center
Center
Investment
Investment
Center
Center
Responsibility
Responsibility
Center
Center
© The McGraw-Hill Companies, Inc., 2000
Traceable and Common Costs
Fixed
Costs
Traceable
Costs arise because
of the existence of
a particular segment
Irwin/McGraw-Hill
Common
Costs arise because
of overall operating
activities.
© The McGraw-Hill Companies, Inc., 2000
Traceable and Common Costs
Fixed
Costs
Traceable
Costs arise because
of the existence of
a particular segment
Irwin/McGraw-Hill
Don’t allocate
common costs.
Common
Costs arise because
of overall operating
activities.
© The McGraw-Hill Companies, Inc., 2000
Identifying Traceable Fixed Costs
Traceable costs would disappear over time
if the segment itself disappeared.
No computer
division means . . .
Irwin/McGraw-Hill
No computer
division manager.
© The McGraw-Hill Companies, Inc., 2000
Identifying Common Fixed Costs
Common costs arise because of overall
operation of the company and are not due to
the existence of a particular segment.
No computer
division but . . .
Irwin/McGraw-Hill
We still have a
company president.
© The McGraw-Hill Companies, Inc., 2000
Levels of Segmented Statements
Webber, Inc. has two divisions.
W e b b e r , In c .
C o m p u te r D iv is io n
T e le v is io n D iv is io n
Let’s
Let’s look
look more
more closely
closely at
at the
the Television
Television
Division’s
Division’s income
income statement.
statement.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Levels of Segmented Statements
Our approach to segment reporting uses the
contribution format.
Income Statement
Contribution Margin Format
Television Division
Sales
$300,000
Variable COGS
120,000
Other variable costs
30,000
Total variable costs
150,000
Contribution margin
150,000
Traceable fixed costs
90,000
Segment margin
$ 60,000
Irwin/McGraw-Hill
Cost
Cost of
of goods
goods
sold
sold consists
consists of
of
variable
variable
manufacturing
manufacturing
costs.
costs.
Fixed
Fixed and
and
variable
variable costs
costs
are
are listed
listed in
in
separate
separate
sections.
sections.
© The McGraw-Hill Companies, Inc., 2000
Levels of Segmented Statements
Our approach to segment reporting uses the
contribution format.
Income Statement
Contribution Margin Format
Television Division
Sales
$300,000
Variable COGS
120,000
Other variable costs
30,000
Total variable costs
150,000
Contribution margin
150,000
Traceable fixed costs
90,000
Segment margin
$ 60,000
Irwin/McGraw-Hill
Segment
Segment margin
margin
is
is Television’s
Television’s
contribution
contribution
to
to overall
overall
operations.
operations.
© The McGraw-Hill Companies, Inc., 2000
Levels of Segmented Statements
Let’s see how the Television
Division fits into Webber, Inc.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Levels of Segmented Statements
Sales
Variable costs
CM
Traceable FC
Division margin
Common costs
Net income
Income Statement
Company
Television
$ 300,000
(150,000)
150,000
(90,000)
60,000
Computer
Segment
Segment margin
margin has
has now
now
become
become division
division margin.
margin.
Let’s add the Computer
Division’s numbers.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Levels of Segmented Statements
Sales
Variable costs
CM
Traceable FC
Division margin
Common costs
Net income
Irwin/McGraw-Hill
Income Statement
Company
Television
$ 500,000
$ 300,000
(230,000)
(150,000)
270,000
150,000
(170,000)
(90,000)
100,000
60,000
Computer
$ 200,000
(80,000)
120,000
(80,000)
40,000
© The McGraw-Hill Companies, Inc., 2000
Levels of Segmented Statements
Sales
Variable costs
CM
Traceable FC
Division margin
Common costs
Net income
Income Statement
Company
Television
$ 500,000
$ 300,000
(230,000)
(150,000)
270,000
150,000
(170,000)
(90,000)
100,000
60,000
(25,000)
$ 75,000
Computer
$ 200,000
(80,000)
120,000
(80,000)
40,000
Common
Common costs
costs arise
arise because
because of
of overall
overall
operating
operating activities.
activities. ABC
ABC may
may be
be helpful
helpful
in
in the
the analysis
analysis of
of common
common costs.
costs.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Traceable Costs Can Become Common Costs
Fixed costs that are traceable on one
segmented statement can become
common if the company is divided into
smaller segments.
Let’s see how this works!
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Traceable Costs Can Become Common Costs
Webber’s Television Division
Product
Lines
T e le v is io n
D iv is io n
R e g u la r
U .S . S a le s
Irwin/McGraw-Hill
B ig S c r e e n
F o r e ig n S a le s
U .S . S a le s
F o r e ig n S a le s
Sales
Territories
© The McGraw-Hill Companies, Inc., 2000
Traceable Costs Can Become Common Costs
Income Statement
Television
Division
Regular
Sales
$ 200,000
Variable costs
(95,000)
CM
105,000
Traceable FC
(45,000)
Product line margin
60,000
Common costs
Divisional margin
Big Screen
$ 100,000
(55,000)
45,000
(35,000)
10,000
We obtained the following information from
the Regular and Big Screen segments.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Traceable Costs Can Become Common Costs
Income Statement
Television
Division
Regular
Sales
$ 300,000
$ 200,000
Variable costs
(150,000)
(95,000)
CM
150,000
105,000
Traceable FC
(80,000)
(45,000)
Product line margin
70,000
60,000
Common costs
10,000
Divisional margin
$ 60,000
Big Screen
$ 100,000
(55,000)
45,000
(35,000)
10,000
Fixed
Fixed costs
costs directly
directly traced
traced
to
to the
the Television
Television Division
Division
$80,000
$80,000 ++ $10,000
$10,000 == $90,000
$90,000
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Traceable Costs Can Become Common Costs
Income Statement
Television
Division
Regular
Sales
$ 300,000
$ 200,000
Variable costs
(150,000)
(95,000)
CM
150,000
105,000
Traceable FC
(80,000)
(45,000)
Product line margin
70,000
60,000
Common costs
10,000
Divisional margin
$ 60,000
Big Screen
$ 100,000
(55,000)
45,000
(35,000)
10,000
Of the $90,000 cost directly traced to
the Television Division, $45,000 is
traceable to Regular and $35,000
traceable to Big Screen product lines.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Traceable Costs Can Become Common Costs
Income Statement
Television
Division
Regular
Sales
$ 300,000
$ 200,000
Variable costs
(150,000)
(95,000)
CM
150,000
105,000
Traceable FC
(80,000)
(45,000)
Product line margin
70,000
60,000
Common costs
10,000
Divisional margin
$ 60,000
Big Screen
$ 100,000
(55,000)
45,000
(35,000)
10,000
The remaining $10,000 cannot be traced to
either the Regular or Big Screen product lines.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Segment Margin
Profits
The segment margin is the best gauge of
the long-run profitability of a segment.
Time
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Hindrances to Proper Cost Assignment
The Problems
Omission of some
costs in the
assignment process.
Assignment of costs
to segments that are
really common costs of
the entire organization.
The use of inappropriate
methods for allocating
costs among segments.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Omission of Costs
Costs assigned to a segment should include
all costs attributable to that segment from
the company’s entire value chain.
chain
Business Functions
Making Up The
Value Chain
R&D
Product
Design
Irwin/McGraw-Hill
Customer
Manufacturing Marketing Distribution Service
© The McGraw-Hill Companies, Inc., 2000
Inappropriate Methods of Allocating
Costs Among Segments
Arbitrarily dividing
common costs
among segments
Failure to trace
costs directly
Segment
1
Irwin/McGraw-Hill
Segment
2
Segment
3
Inappropriate
allocation base
Segment
4
© The McGraw-Hill Companies, Inc., 2000
Return on Investment (ROI) Formula
Income
Incomebefore
before interest
interest
and
andtaxes
taxes(EBIT)
(EBIT)
Net operating income
ROI =
Average operating assets
Cash,
Cash,accounts
accountsreceivable,
receivable,inventory,
inventory,
plant
plantand
andequipment,
equipment, and
andother
other
productive
productiveassets.
assets.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Return on Investment (ROI) Formula
Regal Company reports the following:
Net operating income
Average operating assets
Sales
$ 30,000
$ 200,000
$ 500,000
$30,000
= 15%
ROI =
$200,000
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Controlling the Rate of Return
Three ways to improve ROI . . .
Increase
Sales
Irwin/McGraw-Hill
Reduce
Expenses
Reduce
Assets
© The McGraw-Hill Companies, Inc., 2000
Controlling the Rate of Return
Regal’s manager was able to increase
sales to $600,000 which increased net
operating income to $42,000.
There was no change in the average
operating assets of the segment.
Let’s calculate the new ROI.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Return on Investment (ROI) Formula
We can modify our original formula slightly:
×
Margin
Turnover
ROI = Net operating income
Sales
Sales
×Average operating
assets
ROI = $42,000 × $600,000
$600,000
$200,000
ROI = 21%
We
We increased
increased ROI
ROI from
from 15%
15% to
to 21%
21%
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
ROI and the Balanced Scorecard
The balanced scorecard provides managers with
a roadmap that indicates how the company
intends to increase its ROI.
Reduce
Expenses
Increase
Reduce
Sales
Assets
Irwin/McGraw-Hill
I’m glad we used the
balanced scorecard
to tell which approach
is best.
© The McGraw-Hill Companies, Inc., 2000
Criticisms of ROI
In the absence of the balanced
scorecard, management may
not know how to increase ROI.
Managers often inherit many
committed costs over which
they have no control.
Managers evaluated on ROI
may reject profitable
investment opportunities.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Criticisms of ROI
As division manager at Winston, Inc., your
compensation package includes a salary plus bonus
based on your division’s ROI -- the higher your ROI,
the bigger your bonus.
The company requires an ROI of 15% on all new
investments -- your division has been producing an
ROI of 30%.
You have an opportunity to invest in a new project
that will produce an ROI of 25%.
As division manager would you
invest in this project?
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Criticisms of ROI
As division manager,
I wouldn’t invest in
that project because
it would lower my pay!
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Criticisms of ROI
Gee . . .
I thought we were
supposed to do what
was best for the
company!
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Residual Income - Another Measure of
Performance
Net operating income
above some minimum
return on operating
assets
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Residual Income
A division of Zepher, 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.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
Residual Income
Operating
$$100,000
Operating assets
assets
100,000
Required
20%
Requiredrate
rateof
ofreturn
return ××
20%
Required
$$ 20,000
Requiredreturn
return
20,000
Actual
Actualreturn
return
Required
Required return
return
Residual
Residualincome
income
Irwin/McGraw-Hill
$$ 30,000
30,000
(20,000)
(20,000)
$$ 10,000
10,000
© The McGraw-Hill Companies, Inc., 2000
Motivation and Residual Income
Residual income encourages managers to
make profitable investments that would
be rejected by managers using ROI.
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000
End of Chapter 12
Let’s get to work
on my ROI . . .
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 2000