Reporting for Control

1. Reporting for Control Chapter Twelve

2. Learning Objectives After studying this chapter, you should be able to: 1. Differentiate among responsibility centres such as cost centres, profit centres, and investment centres, and explain how performance is measured in each. 2. Prepare a segmented income statement using the contribution format, and explain the difference between traceable fixed costs and common fixed costs. 3. Analyze variances from sales targets.

3. Learning Objectives After studying this chapter, you should be able to: 4. Analyze marketing expenses using cost drivers. 5. Analyze the return on investment (ROI). • Compute residual income, and describe the strengths and weaknesses of this method of measuring performance. • Explain the use of Balanced Scorecards to assess performance. 8. (Appendix 12A) Determine the range, if any, within which a negotiated transfer price should fall.

4. Decentralization in Organizations Benefits of Decentralization Top management freed to concentrate on strategy. Lower-level managers gain experience in decision-making. Decision-making authority leads to job satisfaction. Lower-level decision often based on better information. Lower level managers can respond quickly to customers.

5. Decentralization in Organizations May be a lack of coordination among autonomous managers. Lower-level managers may make decisions without seeing the “big picture.” Disadvantages of Decentralization Lower-level manager’s objectives may not be those of the organization. May be difficult to spread innovative ideas in the organization.

6. Cost, Profit, and Investments Centres Cost Centre Profit Centre Investment Centre Cost, profit, and investment centres areall known as responsibility centres. Responsibility Centre

7. Cost, Profit, and Investments Centres Cost Centre A segment whose manager has control over costs, but not over revenues or investment funds.

8. Revenues Sales Interest Other Costs Mfg. costs Commissions Salaries Other Cost, Profit, and Investments Centres Profit Centre A segment whose manager has control overbothcosts and revenues, but no control over investment funds.

9. Cost, Profit, and Investments Centres Investment Centre A segment whose manager has control over costs, revenues, and investments in operating assets. Corporate Headquarters

10. Investment Centres Cost Centres Responsibility Centres Superior Foods Corporation provides an example of the various kinds of responsibility centres that exist in an organization.

11. Responsibility Centres Profit Centres Superior Foods Corporation provides an example of the various kinds of responsibility centres that exist in an organization.

12. Cost Centres Responsibility Centres Superior Foods Corporation provides an example of the various kinds of responsibility centres that exist in an organization.

13. An Individual Store Quick Mart A Service Centre Decentralization and Segment Reporting Asegmentis any part or activity of an organization about which a manager seeks cost, revenue, or profit data. A segment can be . . . A Sales Territory

14. Superior Foods: Geographic Regions Superior Foods Corporation could segment its business by geographic regions.

15. Superior Foods: Customer Channel Superior Foods Corporation could segment its business by customer channel.

16. Keys to Segmented Income Statements 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.

17. No computer division means . . . No computer division manager. Identifying Traceable Fixed Costs Traceable costsarise because of the existence of a particular segment and would disappear over time if the segment itself disappeared.

18. No computer division but . . . We still have a company president. Identifying Common Fixed Costs Common costsarise because of the overall operation of the company and would not disappear if any particular segment were eliminated.

19. Traceable Costs Can Become Common Costs It 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.

20. Segment Margin The segment margin, which is computed by subtracting the traceable fixed costs of a segment from its contribution margin, is the best gaugeof the long-run profitability of a segment. Profits Time

21. Don’t allocate common costs to segments. Traceable Common Traceable and Common Costs Fixed Costs

22. Activity-Based Costing Activity-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.

23. Let’s look more closely at the Television Division’s income statement. Levels of Segmented Statements Webber, Inc. has two divisions.

24. Cost of goods sold consists of variable manufacturing costs. Fixed and variable costs are listed in separate sections. Levels of Segmented Statements Our approach to segment reporting uses the contribution format.

25. Levels of Segmented Statements Our approach to segment reporting uses the contribution format. Contribution margin is computed by taking sales minus variable costs. Segment margin is Television’s contribution to profits.

26. Levels of Segmented Statements

27. Levels of Segmented Statements Common costs should not be allocated to the divisions. These costs would remain even if one of the divisions were eliminated.

28. Traceable Costs Can Become Common Costs As previously mentioned, fixed costs that are traceable to one segment can become common if the company is divided intosmaller segments. Let’s see how this works using the Webber Inc. example!

29. Television Division Regular Big Screen Traceable Costs Can Become Common Costs Webber’s Television Division Product Lines

30. Traceable Costs Can Become Common Costs We obtained the following information from the Regular and Big Screen segments.

31. Traceable Costs Can Become Common Costs Fixed costs directly traced to the Television Division $80,000 + $10,000 = $90,000

32. External Reports The CICA Handbook now requires that public enterprises that have publicly traded debt or equity 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. • Though the contribution approach to segment reporting does comply with GAAP, most companies choose to construct their segmented financial statements using the more commonly used absorption approach.

33. Hindrances to Proper Cost Assignment Three Problems Omission of some costs in the assignment process. Assignment to segments of costs that are really common costs of the entire organization. Use of inappropriate methods for allocating costs among segments.

34. Product Customer R&D Design Manufacturing Marketing Distribution Service Omission of Costs Costs assigned to a segment should include all costs attributable to that segment from the company’s entirevalue chain. Business Functions Making Up The Value Chain

35. Inappropriate allocation base Failure to trace costs directly Segment 1 Inappropriate Methods of Allocating Costs Among Segments Segment 2 Segment 3 Segment 4

36. Segment 1 Common Costs and Segments • Common 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. Segment 2 Segment 3 Segment 4

37. Allocations of Common Costs Assume that Haglund’s Lakeshore prepared the segmented income statement as shown.

38. 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.

39. 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.

40. 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. $20,000 b. $30,000 c. $40,000 d. $50,000

41. 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. $20,000 b. $30,000 c. $40,000 d. $50,000 The bar would be allocated 1/10 of the cost or $20,000.

42. Quick Check  If Haglund’s allocates its common costs to the bar and the restaurant, what would be the reported profit of each segment?

43. Hurray, now everything adds up!!! Allocations of Common Costs

44. Quick Check  Should the bar be eliminated? a. Yes b. No

45. The profit was $44,000 before eliminating the bar. If we eliminate the bar, profit drops to $30,000! Quick Check  Should the bar be eliminated? a. Yes b. No

46. Sales Variance Analysis Consider the following example for CardCo: BudgetActual Sales in units Deluxe cards 14,000 17,000 Standard cards 6,000 5,000 Price per unit Deluxe cards $18 $16 Standard cards $ 9 $10 Market volume Deluxe cards 75,000 85,000 Standard cards 95,000 90,000 Variable cost per unit Deluxe cards $ 8 $ 8 Standard cards $ 3 $ 3

47. CardCo Actual and Budgeted Results Sales Variance Analysis Actual results are based on the actual quantity sold multiplied by the actual selling price or variable cost

48. CardCo Actual and Budgeted Results Sales Variance Analysis Flexible budget results are based on the actual quantity sold multiplied by the budgetedselling price or variable cost

49. CardCo Actual and Budgeted Results Sales Variance Analysis Master budget results are based on the budgeted quantity sold multiplied by the budgetedselling price or variable cost

50. CardCo Actual and Budgeted Results Sales Variance Analysis Sales Price Variance $29,000 U