Segment Reporting Segment Reporting and Decentralization and Decentralization ACC 2203 Review Workshop Professor Huang Responsibility Accounting, Performance Measurement Responsibility Accounting, Performance Measurement Segment Reporting, and Transfer Pricing 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 Responsibility Accounting, Performance Measurement Segment Reposting, and Transfer Pricing 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 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 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 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 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 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 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 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 assets operating Average income operatingNet investment on Return = 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... 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... 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 ROI = Net operating income Sales ROI = ?? × Sales Average operating assets Decreasing Operating .  Investment centers – segments whose managers are held responsible for the capital invested as well as the profits made in the segment Segment Reporting Segment Reporting Obviously, in each segment category. to run all of them? Segment Reporting Segment Reporting Segment reports provide information about each segment s financial performance and are important for assessing a segment s success in. Performance Measurement Segment Reporting, and Transfer Pricing Segment Reporting, and Transfer Pricing Large companies are comprised of many business units or segments. A segment may be a division,