segment reporting, decentralization, and the balanced scorecard chapter 11 powerpoint authors: susan...
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SEGMENT REPORTING,
DECENTRALIZATION, AND THE
BALANCED SCORECARD
Chapter 11
PowerPoint Authors:Susan Coomer Galbreath, Ph.D.,
CPACharles W. Caldwell, D.B.A., CMAJon A. Booker, Ph.D., CPA, CIA
Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
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Decentralization in OrganizationsDecentralization in Organizations
Benefits ofDecentralization
Top managementfreed to concentrate
on strategy.
Top managementfreed to concentrate
on strategy.Lower-level managers
gain experience indecision-making.
Lower-level managersgain experience indecision-making. Decision-making
authority leads tojob satisfaction.
Decision-makingauthority leads tojob satisfaction.
Lower-level decisionsoften based on
better information.
Lower-level decisionsoften based on
better information.Lower level managers can respond quickly
to customers.
Lower level managers can respond quickly
to customers.
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Decentralization in OrganizationsDecentralization in Organizations
Disadvantages ofDecentralization
Disadvantages ofDecentralization
Lower-level managersmay make decisionswithout seeing the
“big picture.”
Lower-level managersmay make decisionswithout seeing the
“big picture.”
May be a lack ofcoordination among
autonomousmanagers.
May be a lack ofcoordination among
autonomousmanagers.
Lower-level manager’sobjectives may not
be those of theorganization.
Lower-level manager’sobjectives may not
be those of theorganization.
May be difficult tospread innovative ideas
in the organization.
May be difficult tospread innovative ideas
in the organization.
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Cost, Profit, and Investments CentersCost, Profit, and Investments Centers
ResponsibilityCenter
ResponsibilityCenter
CostCenterCost
CenterProfit
CenterProfit
CenterInvestment
CenterInvestment
Center
Cost, profit,and investmentcenters are allknown asresponsibilitycenters.
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Keys to Segmented Income Keys to Segmented Income StatementsStatements
There 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.
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Identifying Traceable Fixed CostsIdentifying 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.
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Identifying Common Fixed CostsIdentifying 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.
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Segment MarginSegment Margin
The 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.
TimeTime
Pro
fits
Pro
fits
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Common Costs and Segments Common Costs and Segments
Segment1
Segment3
Segment4
Segment2
Common costs should not be arbitrarily allocated to segments based on the rationale that “someone has to cover the
common costs” for two reasons:
1. This practice may make a profitable business segment appear to be unprofitable.
2. Allocating common fixed costs forces managers to be held accountable for costs they cannot control.
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Return on Investment (ROI) Return on Investment (ROI) FormulaFormula
ROI = ROI = Net operating incomeNet operating incomeAverage operating assets Average operating assets
Cash, accounts receivable, inventory,plant and equipment, and other
productive assets.
Cash, accounts receivable, inventory,plant and equipment, and other
productive assets.
Income before interestand taxes (EBIT)
Income before interestand taxes (EBIT)
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Understanding ROIUnderstanding ROI
ROI = Net operating income
Average operating assets
Margin = Net operating income
Sales
Turnover = SalesAverage operating
assets
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Increasing ROIIncreasing ROI
There are three ways to increase ROI . . .
IncreaseSales
ReduceExpenses
ReduceAssets
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Calculating Residual IncomeCalculating Residual Income
Residual income
=Net
operating income
-Average
operating assets
Minimum
required rate of return
( )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.
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Internalbusiness
processes
Customers
Learningand growth
The Balanced ScorecardThe Balanced Scorecard
Management translates its strategy into performance measures that employees
understand and influence.
Management translates its strategy into performance measures that employees
understand and influence.
Performancemeasures
Financial
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The Balanced Scorecard: FromThe Balanced Scorecard: FromStrategy to Performance MeasuresStrategy to Performance Measures
FinancialHas our financial
performance improved?
CustomerDo customers recognize that
we 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 ability
to change and improve?
Performance Measures
What are ourfinancial goals?
What customers dowe want to serve andhow are we going towin and retain them?
What internal busi-ness processes arecritical to providing
value to customers?
Vision and
Strategy
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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 performance
measure . . .
Another desiredperformance measure
will improve.
The Balanced ScorecardThe Balanced Scorecard
Then
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Key Concepts/DefinitionsKey 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.
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Three Primary ApproachesThree Primary Approaches
There are three primary approaches to setting
transfer prices:
1. Negotiated transfer prices;
2. Transfers at the cost to the selling division; and
3. Transfers at market price.
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Service Department ChargesService Department Charges
Operating Departments
Carry out central purposes of organization.
Service Departments
Do not directly engage in operating activities.
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Reasons for Charging Service Reasons for Charging Service Department CostsDepartment Costs
To encourage operating departments to wisely use service
department resources.
To encourage operating departments to wisely use service
department resources.
To provide operating departments with
more complete cost data for making
decisions.
To provide operating departments with
more complete cost data for making
decisions.
To help measure the profitability of
operating departments.
To help measure the profitability of
operating departments.
To create an incentive for service
departments to operate efficiently.
To create an incentive for service
departments to operate efficiently.
Service department costs are charged to operating departments for a variety of reasons including:
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$
Transfer PricesTransfer Prices
OperatingDepartments
ServiceDepartments
The 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.
The 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.
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Charging Costs by BehaviorCharging Costs by Behavior
Whenever possible,variable and fixed
service department costsshould be charged
separately.
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End of Chapter 11