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CHAPTER 25 PowerPoint Presentation

CHAPTER 25

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CHAPTER 25

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  1. CHAPTER 25 RESPONSIBILITY ACCOUNTING SEGMENTAL ANALYSIS

  2. Responsibility Accounting • Def. - An accounting system that collects, summarizes and reports accounting data relating to responsibilities of individual managers. • It enables evaluation of managers by analyzing how well they manage those items under their control. Therefore, responsibility reports should concentrate on controllable items.

  3. Responsibility Accounting Successful implementation of the system depends on properorganization so that responsibility is assignable to individual managers. • Formal lines of authority and responsibility should be fully defined. • Organization charts such as the following are used as a basis for responsibility reporting.

  4. Organization Chart

  5. Less detail More detail Responsibility Reports

  6. 889 Responsibility Reports • Amount of detail varies according to level in organization. • Department manager receives detailed report. • Store manager receives summarized information from each department. • Vice president of operations receives summarized information from each store. • Management by exception (again) A given level of management does not receive detail from lower levels unless needed. • e.g., VP could get store manager’s report

  7. Be timely. Be simple andeasy to read. Be issuedregularly. Compare budgetedand actual amounts. Responsibility Reports Responsibility reports should . . .

  8. A Sales Territory Segments A segment is any part or activity of an organization about which a manager seeks cost, revenue, or profit data. A segment can be . . .

  9. Segments A segment is any part or activity of an organization about which a manager seeks cost, revenue, or profit data. A segment can be . . . Quick Mart An Individual Store

  10. Segments A segment is any part or activity of an organization about which a manager seeks cost, revenue, or profit data. A segment can be . . . A Department

  11. Segments A segment is any part or activity of an organization about which a manager seeks cost, revenue, or profit data. A segment can be . . . A Product Line

  12. Responsibility Centers A responsibility center is a segment of an organization for which a particular manager is responsible.

  13. Responsibility Centers Three Types of Centers • Expense (or Cost) Centers • Profit Centers • Investment Centers

  14. Expense/Cost Centers • Incur expenses only • Produce no direct revenue from sale of goods or services • Manager held responsible for long-run minimizationofexpenses • Primary means of evaluation • Standard costs • Flexible budgets • e.g., accounting department

  15. Profit Centers • Incur expenses and generate revenue • Primary objective is profit maximization Manager is held responsible for expense control and revenue growth • Primary means of evaluation Contributionmargin • Why are they so appealing? Management is often paid based on how well their profit center performs.

  16. Investment Centers • What do they have besides expenses and revenues? An appropriate investment base • Objective is to maximize return on that investment base • Primary means of evaluation • Return on investment (ROI) • A/K/A Rate of Return • Residual Income

  17. BuyingSegment SellingSegment Transfer Prices The price used to record a transferof goods or services from onesegment to another segmentwithin the same company.

  18. Transfer Prices What is the primary use for transfer pricing? Allows turning a cost center into a profit center. BuyingSegment SellingSegment Cost or expense Revenue

  19. Transfer Prices BuyingSegment SellingSegment Cost or expense Lower priceis desired. Revenue Higher priceis desired. Potentialconflict

  20. Transfer Prices The transfer price can be . . . • Market price if external market exists • Cost to produce plus a profit margin • Negotiated amount BuyingSegment SellingSegment Cost or expense Lower priceis desired. Revenue Higher priceis desired.

  21. Transfer Prices BuyingSegment SellingSegment Cost or expense Lower priceis desired. Revenue Higher priceis desired. • Setting prices is a big problem in practice. • Management, marketing and finance courses also cover transfer pricing. Each discipline thinks it “owns” the problem.

  22. Segmental Analysis • Def. - Analyzing financial information by segment • Uses concepts previously studied • Fixed and variable costs • Contribution margin, net income, etc. • And new concepts • Cost objective • Direct cost • Indirect cost

  23. Segmental Analysis ConceptsCost Objective • Cost objective The segment or product for which costs may be accumulated • i.e., a scheme for collecting costs • KEY - Costs are either direct or indirect relativetoaparticularcostobjective.

  24. Segmental Analysis ConceptsDirect Costs • Specifically traceable to a given cost objective • Likely to be eliminated if cost objective eliminated • Often controllable by segment manager • Examples • Cost accountant’s salary at Little Rock plant is a direct cost for that plant/cost objective • Corp. accountant’s salary is direct cost to NY accounting department/cost objective

  25. Segmental Analysis ConceptsIndirect Costs • Allocated to a cost objective and not specifically traceable to that objective • Not likely to be eliminated if cost objective eliminated • Often not controllable by segment manager • Example Corporate accountant’s salary and the rent on NY home office are indirect relative to the three plants/cost objectives

  26. Segmental Analysis ConceptsDirect and Indirect Costs • Therefore, costs may be direct to one cost objective and indirect to another. Another example: Segment manager’s salary is direct to the segment but indirect to the units of product made in that segment. • Caveat - Some direct costs may not be controllable by the segment manager. Example: Segment manager’s salary is direct to segment but not controlled by the segment manager.

  27. Segmental AnalysisExample Total Company has two divisions.

  28. Segmental AnalysisExample Contribution Margin Format Income StatementBefore Segmenting into Divisions

  29. Indirect expenses are not attributable toeither the TV or Radio Divisions. Segmental AnalysisExample Contribution Margin Format Income StatementAfter Segmenting into Divisions

  30. Contribution Margin Format Income Statement • Emphasizes a segment’s contribution to indirect expenses as appropriate figure for evaluating earnings of the segment. • Expenses are classified as either . . . • Variable or fixed • Direct or indirect • Companies may choose to allocate or not to allocate indirect fixed expenses. Authors’ preference?

  31. Direct and Indirect Costs Fixed costs that are direct on one segmented statement can become indirect if the segment is divided into smallersegments. Let’s see how this works!

  32. Segmental AnalysisExample Organizational Segments

  33. Segmental AnalysisExample Contribution Margin Format Income StatementBefore Segmenting TV Division into Product Lines TV Division’s $170,000 direct fixed expenses becomes $140,000 with additional segmentation. $30,000 is indirect to product lines.

  34. $170,000 is directto TV Division. Segmental AnalysisExample Contribution Margin Format Income StatementBefore Segmenting TV Division into Product Lines

  35. Segmental AnalysisExample Contribution Margin Format Income StatementAfter Segmenting TV Division into Product Lines $170,000 is directto TV Division.

  36. Are you readyfor investmentcenter analysis?

  37. Income Investment ROI = Investment Center AnalysisReturn on Investment • Return on investment (ROI)provides a relative measure of effectiveness of segments. • ROI calculates the return (income) as a percentage of assets employed (investment). Skipped in Chapter 17 - Must know now!

  38. Investment Center AnalysisReturn on Investment • ROI may be used to evaluate different levels of investment centers in a company. (ILL. 25.7, p. 896) • Evaluation of earnings of an entirecompany • Evaluation of the income contribution of a segment • Evaluation of income performance of a segment manager • Therefore, “Income” and “Investment” can be defined any of three ways.

  39. Evaluation of Earningsof Entire Company When evaluating an entire company . . . • “Income” in ROI formula is net income of company. • “Investment” in ROI formula is total assets of entire company.

  40. Evaluation of Income Contribution of Segment When evaluating a segment . . . • “Income” in ROI formula is contribution to indirect expenses. • “Investment” in ROI formula is assets directly used by and identified with the segment.

  41. Evaluation of Performanceof Segment Manager When evaluating a segment manager . . . • “Income” in ROI formula is income that is controllable by segment manager. • Begin with contribution to indirect expenses and eliminate any revenues and expenses not under the direct control of segment manager. • “Investment” is assets under the control of the segment manager.

  42. Income Sales Sales Investment × ROI = Marginor Return on Sales Turnover Expanded Form of ROI Calculation The ROI formula is expanded into two ratios to more easily demonstrate actions that might be taken to increase ROI.

  43. ROI Question Regal Company has sales of $500,000, income of $30,000 and investment in assets of $200,000. What is Regal’s margin (return on sales)? a. 6% b. 10% c. 12% d. 15%

  44. ROI Question Regal Company has sales of $500,000, income of $30,000 and investment in assets of $200,000. What is Regal’s margin (return on sales)? a. 6% b. 10% c. 12% d. 15% Margin = $30,000 ÷ $500,000 = 6%

  45. ROI Question Regal Company has sales of $500,000, income of $30,000 and investment in assets of $200,000. What is Regal’s turnover? a. 2.0 times b. 2.5 times c. 3.0 times d. 3.5 times

  46. ROI Question Regal Company has sales of $500,000, income of $30,000 and investment in assets of $200,000. What is Regal’s turnover? a. 2.0 times b. 2.5 times c. 3.0 times d. 3.5 times Turnover = $500,000 ÷ $200,000 = 2.5 times

  47. ROI Question Regal Company has sales of $500,000, income of $30,000 and investment in assets of $200,000. What is Regal’s ROI? a. 6% b. 10% c. 12% d. 15%

  48. ROI Question Regal Company has sales of $500,000, income of $30,000 and investment in assets of $200,000. What is Regal’s ROI? a. 6% b. 10% c. 12% d. 15% ROI = Margin × TurnoverROI = 6% × 2.5 = 15%

  49. Problems With ROIMeasuring Investment in Assets Three Ways To Measure Investment • Original cost • Original cost less accumulated depreciation (i.e., book value) • Current replacement cost

  50. Problems With ROISuboptimization • Def. - Segment manager takes action in segment’s best interest, but not in best interest of company as a whole. • To deal with suboptimization, companies sometimes use Residual Income (RI). • Residual income is the amount of income a segment has in excess of a desired minimum ROI.