Chapter 10

Segment Reporting, Decentralization, and the Balanced Scorecard

Solutions to Questions

10-1 In a decentralized organization, decision-making authority isnt confined to a few top executives, but rather is spread throughout the organization with lowerlevel managers and other employees empowered to make decisions. 10-2 The benefits of decentralization include !"# by delegating day-to-day problem solving to lower-level managers, top management can concentrate on bigger issues such as overall strategy$ !%# empowering lower-level managers to make decisions puts decision-making authority in the hands of those who tend to have the most detailed and up-to-date information about day-to-day operations$ !&# by eliminating layers of decisionmaking and approvals, organizations can respond more 'uickly to customers and to changes in the operating environment$ !(# granting decision-making authority helps train lower-level managers for higher-level positions$ and !)# empowering lower-level managers to make decisions can increase their motivation and *ob satisfaction. 10-3 The manager of a cost center has control over cost, but not revenue or the use of investment funds. + profit center manager has control over both cost and revenue. +n investment center manager has control over cost and revenue and the use of investment funds.

10-4 + segment is any part or activity of an organization about which a manager seeks cost, revenue, or profit data. ,xamples of segments include departments, operations, sales territories, divisions, and product lines. 10-nder the contribution approach, costs are assigned to a segment if and only if the costs are traceable to the segment !i.e., could be avoided if the segment were eliminated#. .ommon costs are not allocated to segments under the contribution approach. 10-! + traceable cost of a segment is a cost that arises specifically because of the existence of that segment. If the segment were eliminated, the cost would disappear. + common cost, by contrast, is a cost that supports more than one segment, but is not traceable in whole or in part to any one of the segments. If the departments of a company are treated as segments, then examples of the traceable costs of a department would include the salary of the departments supervisor, depreciation of machines used exclusively by the department, and the costs of supplies used by the department. ,xamples of common costs would include the salary of the general counsel of the entire company, the lease cost of the head'uarters building, corporate image advertising, and periodic depreciation of machines shared by several departments.

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10-" The contribution margin is the difference between sales revenue and variable expenses. The segment margin is the amount remaining after deducting traceable fixed expenses from the contribution margin. The contribution margin is useful as a planning tool for many decisions, particularly those in which fixed costs dont change. The segment margin is useful in assessing the overall profitability of a segment. 10-# If common costs were allocated to segments, then the costs of segments would be overstated and their margins would be understated. +s a conse'uence, some segments may appear to be unprofitable and managers may be tempted to eliminate them. If a segment were eliminated because of the existence of arbitrarily allocated common costs, the overall profit of the company would decline and the common cost that had been allocated to the segment would be reallocated to the remaining segments5 making them appear less profitable. 10-$ There are often limits to how far down an organization a cost can be traced. Therefore, costs that are traceable to a segment may become common as that segment is divided into smaller segment units. 6or example, the costs of national T7 and print advertising might be traceable to a specific product line, but be a common cost of the geographic sales territories in which that product line is sold. 10-10 0argin refers to the ratio of net operating income to total sales. Turnover

refers to the ratio of total sales to average operating assets. The product of the two numbers is the 89I. 10-11 8esidual income is the net operating income an investment center earns above the companys minimum re'uired rate of return on operating assets. 10-12 If 89I is used to evaluate performance, a manager of an investment center may re*ect a profitable investment opportunity whose rate of return exceeds the companys re'uired rate of return but whose rate of return is less than the investment centers current 89I. The residual income approach overcomes this problem because any pro*ect whose rate of return exceeds the companys minimum re'uired rate of return will result in an increase in residual income. 10-13 + companys balanced scorecard should be derived from and support its strategy. :ecause different companies have different strategies, their balanced scorecards should be different. 10-14 The balanced scorecard is constructed to support the companys strategy, which is a theory about what actions will further the companys goals. +ssuming that the company has financial goals, measures of financial performance must be included in the balanced scorecard as a check on the reality of the theory. If the internal business processes improve, but the financial outcomes do not improve, the theory may be flawed and the strategy should be changed.

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Brie% &'ercise 10-1 !") minutes# Total Weedban Greengrow <&33,33 3 <=3,333 <%"3,333 ">&,333 &?,333 "(@,333 ""@,333 )(,333 ?&,333 ??,333 (),333 %",333 )",333 &&,333 <B ">,333 <B=,333 <B(%,333

4ales;................................ 7ariable expenses;;.......... .ontribution margin.......... Traceable fixed expenses. . Aroduct line segment margin............................ .ommon fixed expenses not traceable to products Cet operating income........ ;

Deedban "),333 units E <?.33 per unit F <=3,333. 1reengrow %>,333 units E <@.)3 per unit F <%"3,333. ;; Deedban "),333 units E <%.(3 per unit F <&?,333. 1reengrow %>,333 units E <).%) per unit F <"(@,333.

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Brie% &'ercise 10-2 !"3 minutes# ". 0argin F F %. Cet operating income 4ales <?33,333 F >G <@,)33,333 4ales +verage operating assets <@,)33,333 F ".) <),333,333

Turnover F F

&.

89I F 0argin E Turnover F >G E ".) F "%G

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Brie% &'ercise 10-3 !"3 minutes# +verage operating assets................ Cet operating income...................... 0inimum re'uired return ">G E H%,>33,333........................ 8esidual income.............................. H%,>33,333 H ?33,333 )3(,333 H =?,333

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Brie% &'ercise 10-4 !() minutes# ". 0A.s previous manufacturing strategy was focused on highvolume production of a limited range of paper grades. The goal of this strategy was to keep the machines running constantly to maximize the number of tons produced. .hangeovers were avoided because they lowered e'uipment utilization. 0aximizing tons produced and minimizing changeovers helped spread the high fixed costs of paper manufacturing across more units of output. The new manufacturing strategy is focused on low-volume production of a wide range of products. The goals of this strategy are to increase the number of paper grades manufactured, decrease changeover times, and increase yields across non-standard grades. Dhile 0A. realizes that its new strategy will decrease its e'uipment utilization, it will still strive to optimize the utilization of its high fixed cost resources within the confines of flexible production. In an economists terms the old strategy focused on economies of scale while the new strategy focuses on economies of scope. %. ,mployees focus on improving those measures that are used to evaluate their performance. Therefore, strategically-aligned performance measures will channel employee effort towards improving those aspects of performance that are most important to obtaining strategic ob*ectives. If a company changes its strategy but continues to evaluate employee performance using measures that do not support the new strategy, it will be motivating its employees to make decisions that promote the old strategy, not the new strategy. +nd if employees make decisions that promote the new strategy, their performance measures will suffer. 4ome performance measures that would be appropriate for 0A.s old strategy include e'uipment utilization percentage, number of tons of paper produced, and cost per ton produced. These performance measures would not support 0A.s new strategy because they would discourage increasing the range of paper grades produced, increasing the number of changeovers performed, and decreasing the batch size produced per run.
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Brie% &'ercise 10-4 !continued# &. 4tudents answers may differ in some details from this solution. (inancial 4ales I .ontribution margin per ton I

Customer Cumber of new customers ac'uired Time to fill an order J I

.ustomer satisfaction with I breadth of product offerings

)nternal Business *rocess

Cumber of different I paper grades produced +verage I manufacturing yield

+verage changeJ over time

+earning and ,ro-th

Cumber of employees trained I to support the flexibility strategy

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Brie% &'ercise 10-4 !continued# (. The hypotheses underlying the balanced scorecard are indicated by the arrows in the diagram. 8eading from the bottom of the balanced scorecard, the hypotheses are K If the number of employees trained to support the flexibility strategy increases, then the average changeover time will decrease and the number of different paper grades produced and the average manufacturing yield will increase. K If the average changeover time decreases, then the time to fill an order will decrease. K If the number of different paper grades produced increases, then the customer satisfaction with breadth of product offerings will increase. K If the average manufacturing yield increases, then the contribution margin per ton will increase. K If the time to fill an order decreases, then the number of new customers ac'uired, sales, and the contribution margin per ton will increase. K If the customer satisfaction with breadth of product offerings increases, then the number of new customers ac'uired, sales, and the contribution margin per ton will increase. K If the number of new customers ac'uired increases, then sales will increase. ,ach of these hypotheses can be 'uestioned. 6or example, the time to fill an order is a function of additional factors above and beyond changeover times. Thus, 0A.s average changeover time could decrease while its time to fill an order increases if, for example, the shipping department proves to be incapable of efficiently handling greater product diversity, smaller batch sizes, and more fre'uent shipments. The fact that each of the hypotheses mentioned above can be 'uestioned does not invalidate the balanced scorecard. If the scorecard is used correctly, management will be able to identify which, if any, of the hypotheses are invalid and modify the balanced scorecard accordingly.
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&'ercise 10- !%3 minutes# ". 89I computations 89I F 0argin E Turnover F Cet operating income 4ales E 4ales +verage operating assets M%"3,333 M&,333,333 E M&,333,333 M",333,333

9saka Livision 89I F

F @G E & F %"G Nokohama Livision 89I F M@%3,333 M=,333,333 E M=,333,333 M(,333,333

F >G E %.%) F ">G %. +verage operating assets !a#............... Cet operating income.......................... 0inimum re'uired return on average operating assets ")G E !a#............. Osaka Yokohama M",333,33 M(,333,33 3 3 MB %"3,33 MB @%3,33 3 3 ")3,333

?33,333 MB "%3,33 8esidual income.................................. MB ?3,333 3 &. Co, the Nokohama Livision is simply larger than the 9saka Livision and for this reason one would expect that it would have a greater amount of residual income. 8esidual income cant be used to compare the performance of divisions of different sizes. Oarger divisions will almost always look better. In fact, in the case above, the Nokohama Livision does not appear to be as well managed as the 9saka Livision. Cote from Aart !"# that Nokohama has only an ">G 89I as compared to %"G for 9saka.
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&'ercise 10-! !") minutes# ". 89I computations 89I F 0argin E Turnover F Cet operating income 4ales E 4ales +verage operating assets <&?3,333 <(,333,333 E <(,333,333 <%,333,333

Pueensland Livision 89I F

F =G E % F ">G Cew 4outh Dales Livision 89I F <(%3,333 <@,333,333 E <@,333,333 <%,333,333

F ?G E &.) F %"G %. The manager of the Cew 4outh Dales Livision seems to be doing the better *ob. +lthough her margin is three percentage points lower than the margin of the Pueensland Livision, her turnover is higher !a turnover of &.), as compared to a turnover of two for the Pueensland Livision#. The greater turnover more than offsets the lower margin, resulting in a %"G 89I, as compared to an ">G 89I for the other division. Cotice that if you look at margin alone, then the Pueensland Livision appears to be the stronger division. This fact underscores the importance of looking at turnover as well as at margin in evaluating performance in an investment center.

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&'ercise 10-" !") minutes# Alpha <(,333,33 4ales............................... 3 Cet operating income..... <"?3,333 +verage operating assets........................... <>33,333 ; <(,?33,333 0argin............................ (G; >G Turnover......................... ); %.) 8eturn on investment !89I#............................ %3G %3G; Division Bravo <"",)33,33 3; <=%3,333 ; Charlie <&,333,33 3 <%"3,333 ; <",)33,33 3 @G; % "(G;

Cote that Livisions +lpha and :ravo apparently have different strategies to obtain the same %3G return. Livision +lpha has a low margin and a high turnover, whereas Livision :ravo has *ust the opposite. ;1iven.

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&'ercise 10-# !&3 minutes# ". 89I computations 89I F 0argin E Turnover F Cet operating income 4ales E 4ales +verage operating assets <?33,333 <"%,333,333 E <"%,333,333 <&,333,333

Livision + 89I F

F )G E ( F %3G Livision : 89I F <)?3,333 <"(,333,333 E <"(,333,333 <@,333,333

F (G E % F >G Livision . 89I F <>33,333 <%),333,333 E <%),333,333 <),333,333

F &.%G E ) F "?G %. Division Division A Division B C <&,333,33 <@,333,33 <),333,33 +verage operating assets.... 3 3 3 8e'uired rate of return........ E B"(G E BB"3G EBBB"?G <B < >33,33 0inimum re'uired return..... (%3,333 < @33,333 3 <B ?33,33 <B )?3,33 < >33,33 +ctual net operating income 3 3 3 0inimum re'uired return !above#............................. (%3,333 @33,333 >33,333 < ">3,33 8esidual income.................. 3 <!"(3,333# < 3
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&'ercise 10-# !continued# &. a. and b. 8eturn on investment !89I#..... Therefore, if the division is presented with an investment opportunity yielding ")G, it probably would.................................... 0inimum re'uired return for computing residual income... Therefore, if the division is presented with an investment opportunity yielding ")G, it probably would.................................... Division A %3G Division B >G Division C "?G

8e*ect "(G

+ccept "3G

8e*ect "?G

+ccept

+ccept

8e*ect

If performance is being measured by 89I, both Livision + and Livision . probably would re*ect the ")G investment opportunity. These divisions 89Is currently exceed ")G$ accepting a new investment with a ")G rate of return would reduce their overall 89Is. Livision : probably would accept the ")G investment opportunity because accepting it would increase the divisions overall rate of return. If performance is measured by residual income, both Livision + and Livision : probably would accept the ")G investment opportunity. The ")G rate of return promised by the new investment is greater than their re'uired rates of return of "(G and "3G, respectively, and would therefore add to the total amount of their residual income. Livision . would re*ect the opportunity because the ")G return on the new investment is less than its "?G re'uired rate of return.

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&'ercise 10-$ !&3 minutes# ". 0argin F F Turnover F F Cet operating income 4ales <@3,333 F )G <",(33,333 4ales +verage operating assets <",(33,333 F( <&)3,333

89I F 0argin E Turnover F )G E ( F %3G %. 0argin F F F Turnover F F F Cet operating income 4ales <@3,333 I <">,%33 <",(33,333 I <@3,333 <>>,%33 F ?G <",(@3,333 4ales +verage operating assets <",(33,333 I <@3,333 <&)3,333 <",(@3,333 F (.% <&)3,333

89I F 0argin E Turnover F ?G E (.% F %).%G

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&'ercise 10-$ !continued# &. 0argin F F F Turnover F F Cet operating income 4ales <@3,333 I <"(,333 <",(33,333 <>(,333 F ?G <",(33,333 4ales +verage operating assets <",(33,333 F( <&)3,333

89I F 0argin E Turnover F ?G E ( F %(G (. 0argin F F Turnover F F F Cet operating income 4ales <@3,333 F )G <",(33,333 4ales +verage operating assets <",(33,333 <&)3,333 - <@3,333 <",(33,333 F) <%>3,333

89I F 0argin E Turnover F )G E ) F %)G

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&'ercise 10-10 !") minutes# ". 0argin F F Turnover F F Cet operating income 4ales <")3,333 F )G <&,333,333 4ales +verage operating assets <&,333,333 F( <@)3,333

89I F 0argin E Turnover F )G E ( F %3G %. 0argin F F F Turnover F F F Cet operating income 4ales <")3,333!".33 I %.33# <&,333,333!".33 I 3.)3# <()3,333 F "3G <(,)33,333 4ales +verage operating assets <&,333,333!".33 I 3.)3# <@)3,333 <(,)33,333 F? <@)3,333

89I F 0argin E Turnover F "3G E ? F ?3G

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&'ercise 10-10 !continued# &. 0argin F F F Turnover F F F Cet operating income 4ales <")3,333 I <%33,333 <&,333,333 I <",333,333 <&)3,333 F >.@)G <(,333,333 4ales +verage operating assets <&,333,333 I <",333,333 <@)3,333 I <%)3,333 <(,333,333 F( <",333,333

89I F 0argin E Turnover F >.@)G E ( F &)G

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&'ercise 10-11 !() minutes# ". 4tudents answers may differ in some details from this solution. (inancial Arofit margin I 4ales I

8evenue per employee I Customer

Cumber of new customers ac'uired .ustomer satisfaction with efficiency

I .ustomer satisfaction I with service 'uality

.ustomer satisfaction I with effectiveness )nternal Business *rocesses

+verage number of J errors per tax return +verage time needed J to prepare a return

8atio of billable I hours to total hours +earning .nd ,ro-th Aercentage of *ob I offers accepted

,mployee morale

+mount of compensation paid above industry average

+verage number of J years to be promoted

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&'ercise 10-11 !continued# %. The hypotheses underlying the balanced scorecard are indicated by the arrows in the diagram. 8eading from the bottom of the balanced scorecard, the hypotheses are K If the amount of compensation paid above the industry average increases, then the percentage of *ob offers accepted and the level of employee morale will increase. K If the average number of years to be promoted decreases, then the percentage of *ob offers accepted and the level of employee morale will increase. K If the percentage of *ob offers accepted increases, then the ratio of billable hours to total hours should increase while the average number of errors per tax return and the average time needed to prepare a return should decrease. K If employee morale increases, then the ratio of billable hours to total hours should increase while the average number of errors per tax return and the average time needed to prepare a return should decrease. K If employee morale increases, then the customer satisfaction with service 'uality should increase. K If the ratio of billable hours to total hours increases, then the revenue per employee should increase. K If the average number of errors per tax return decreases, then the customer satisfaction with effectiveness should increase. K If the average time needed to prepare a return decreases, then the customer satisfaction with efficiency should increase. K If the customer satisfaction with effectiveness, efficiency and service 'uality increases, then the number of new customers ac'uired should increase. K If the number of new customers ac'uired increases, then sales should increase. K If revenue per employee and sales increase, then the profit margin should increase.
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&'ercise 10-11 !continued# ,ach of these hypotheses can be 'uestioned. 6or example, +riels customers may define effectiveness as minimizing their tax liability which is not necessarily the same as minimizing the number of errors in a tax return. If some of +riels customers became aware that +riel overlooked legal tax minimizing opportunities, it is likely that the Qcustomer satisfaction with effectivenessR measure would decline. This decline would probably puzzle +riel because, although the firm prepared what it believed to be error-free returns, it overlooked opportunities to minimize customers taxes. In this example, +riels internal business process measure of the average number of errors per tax return does not fully capture the factors that drive the customer satisfaction. The fact that each of the hypotheses mentioned above can be 'uestioned does not invalidate the balanced scorecard. If the scorecard is used correctly, management will be able to identify which, if any, of the hypotheses are invalid and then modify the balanced scorecard accordingly. &. The performance measure Qtotal dollar amount of tax refunds generatedR would motivate +riels employees to aggressively search for tax minimization opportunities for its clients. 2owever, employees may be too aggressive and recommend 'uestionable or illegal tax practices to clients. This undesirable behavior could generate unfavorable publicity and lead to ma*or problems for the company as well as its customers. 9verall, it would probably be unwise to use this performance measure in +riels scorecard. 2owever, if +riel wanted to create a scorecard measure to capture this aspect of its client service responsibilities, it may make sense to focus the performance measure on its training process. Aroperly trained employees are more likely to recognize viable tax minimization opportunities.

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&'ercise 10-11 !continued# (. ,ach offices individual performance should be based on the scorecard measures only if the measures are controllable by those employed at the branch offices. In other words, it would not make sense to attempt to hold branch office managers responsible for measures such as the percent of *ob offers accepted or the amount of compensation paid above industry average. 8ecruiting and compensation decisions are not typically made at the branch offices. 9n the other hand, it would make sense to measure the branch offices with respect to internal business process, customer, and financial performance. 1athering this type of data would be useful for evaluating the performance of employees at each office.

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&'ercise 10-12 !") minutes# Company A B C <=,333,33 ; <@,333,33 ; <(,)33,33 ; 3 3 3 <)(3,333 <%>3,333 ; <&?3,333 <&,333,33 ; <%,333,33 <",>33,33 ; 3 3 3 ">G; "(G; %3G "?G; <(>3,333 <?3,333 "?G ")G; <&%3,333 ; <%@3,333 <!(3,333# <=3,333 ;

4ales................................... Cet operating income.......... +verage operating assets.... 8eturn on investment !89I#. 0inimum re'uired rate of return Aercentage........................ Lollar amount................... 8esidual income.................. ;1iven.

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&'ercise 10-13 !%3 minutes# ". <@),333 E (3G .0 ratio F <&3,333 increased contribution margin in 0inneapolis. :ecause the fixed costs in the office and in the company as a whole will not change, the entire <&3,333 would result in increased net operating income for the company. It is not correct to multiply the <@),333 increase in sales by 0inneapolis %(G segment margin ratio. This approach assumes that the segments traceable fixed expenses increase in proportion to sales, but if they did, they would not be fixed. %. a. The segmented income statement follows Segments Total Company Chicago inneapolis Amo!nt " Amo!nt " Amo!nt " <)33,33 <%33,33 <&33,33 3 "33.3 3 "33 3 "33 %(3,333 (>.3 ?3,333 &3 ">3,333 ?3 %?3,333 )%.3 "(3,333 @3 "%3,333 (3 "%?,333 %).% "&(,333 %?.> @>,333 &= <B ?%,333 &" (>,333 "? < @%,333 %(

4ales....................... 7ariable expenses... .ontribution margin Traceable fixed expenses.............. 9ffice segment margin................. .ommon fixed expenses not traceable to segments............. Cet operating income.................

?&,333 "%.? <B @",333 "(.%

b. The segment margin ratio rises and falls as sales rise and fall due to the presence of fixed costs. The fixed costs are spread over a larger base as sales increase. In contrast to the segment ratio, the contribution margin ratio is stable so long as there is no change in either the variable expenses or the selling price per unit of service.
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&'ercise 10-14 !") minutes# ". The company should focus its campaign on the Lental market. The computations are Increased sales....................................... 0arket .0 ratio...................................... Incremental contribution margin............ Oess cost of the campaign...................... Increased segment margin and net operating income for the company as a whole................................................ edical <(3,333 E &?G <"(,(33 ),333 Dental <&),333 EB(>G <"?,>33 ),333

< =,(33 <"",>33

%. The <(>,333 in traceable fixed expenses in the previous exercise is now partly traceable and partly common. Dhen we segment 0inneapolis by market, only <&&,333 remains a traceable fixed expense. This amount represents costs such as advertising and salaries of individuals that arise because of the existence of the 0edical and Lental markets. The remaining <"),333 !<(>,333 J <&&,333# is a common cost when 0inneapolis is segmented by market. This amount would include costs such as the salary of the manager of the 0inneapolis office that could not be avoided by eliminating either of the two market segments.

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&'ercise 10-1 ".

!%3 minutes# Division Total Company Central West <(33,33 <&)3,33 <%)3,333 3 3 "(3,33 "&3,333 "%3,333 3 "%3,333 %>3,333 %"3,333 "@),33 "?3,333 %33,333 3 <B < <!(3,333# >3,333 &),333 #ast

4ales........................... <",333,333 7ariable expenses....... .ontribution margin.... Traceable fixed expenses.................. Livisional segment margin...................... .ommon fixed expenses not traceable to divisions;.................. Cet operating income !loss#......................... &=3,333 ?"3,333 )&),333 @),333

=3,333 <B!"),333#

;<?%),333 J <)&),333 F <=3,333. %. Incremental sales !<&)3,333 E %3G#. .ontribution margin ratio !<%"3,333 S <&)3,333#................... Incremental contribution margin........ Oess incremental advertising expense Incremental net operating income..... <@3,333 EB?3G <(%,333 "),333 <%@,333

Nes, the advertising program should be initiated.

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&'ercise 10-1! !%3 minutes# ". $a% Sales <%,)33,33 3 <%,?33,33 3 <%,@33,33 3 <%,>33,33 3 <%,=33,33 3 <&,333,33 3 $b% $c% &et Average Operatin Operatin g g 'O( (ncome) Assets $b% * $c% <",333,33 <(@),333 3 (@.)G <",333,33 <)33,333 3 )3.3G <",333,33 <)%),333 3 )%.)G <",333,33 <))3,333 3 )).3G <",333,33 <)@),333 3 )@.)G <",333,33 <?33,333 3 ?3.3G

;4ales E .ontribution 0argin 8atio J 6ixed ,xpenses %. The 89I increases by %.)G for each <"33,333 increase in sales. This happens because each <"33,333 increase in sales brings in an additional profit of <%),333. Dhen this additional profit is divided by the average operating assets of <",333,333, the result is an increase in the companys 89I of %.)G. Increase in sales............................................. .ontribution margin ratio............................... Increase in contribution margin and net operating income !a# E !b#.......................... <"33,333 !a# %)G !b#

<%),333 !c# <",333,33 +verage operating assets............................... 3 !d# Increase in return on investment !c# S !d#..... %.)G

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*ro/lem 10-1". !&3 minutes# ". +resent !"# 4ales..................... <"3,333,333 Cet operating !%# income................ <>33,333 !&# 9perating assets. . . !(# 0argin !%# S !"#..... !)# Turnover !"# S !&#.. !?# 89I !(# E !)#.......... ; <(,333,333 >G %.) %3.3G &ew ,ine <%,333,33 3 Total <"%,333,33 3

<"?3,333 ; <=?3,333 <",333,33 3 <),333,333 >G >G %.3 %.( "?.3G "=.%G <%,333,33 3 ",%33,33 3 >33,333 ?(3,333 < "?3,33 3

4ales..................................................... 7ariable expenses !?3G E <%,333,333# .ontribution margin.............................. 6ixed expenses..................................... Cet operating income...........................

%. Lell 2avasi will be inclined to re*ect the new product line because accepting it would reduce his divisions overall rate of return. &. The new product line promises an 89I of "?G, whereas the companys overall 89I last year was only ")G. Thus, adding the new line would increase the companys overall 89I. (. a. 9perating assets............... 0inimum return re'uired... 0inimum net operating income............................ +ctual net operating income............................ 0inimum net operating income !above#............... 8esidual income................
4olutions 0anual .hapter "3

+resent <(,333,33 3 EBBB"%G < (>3,33 3 < >33,33 3

&ew ,ine Total <",333,33 <),333,33 3 3 EBBB"%G EBBB"%G < ?33,33 < "%3,333 3 < =?3,33 < "?3,333 3

(>3,333 "%3,333 ?33,333 < &%3,33 <B (3,333 < &?3,33

%?@

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b. -nder the residual income approach, Lell 2avasi would be inclined to accept the new product line because adding the product line would increase the total amount of his divisions residual income, as shown above.

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*ro/lem 10-1#. !&3 minutes# ". :reaking the 89I computation into two separate elements helps the manager to see important relationships that might remain hidden. 6irst, the importance of turnover of assets as a key element to overall profitability is emphasized. Arior to use of the 89I formula, managers tended to allow operating assets to swell to excessive levels. 4econd, the importance of sales volume in profit computations is stressed and explicitly recognized. Third, breaking the 89I computation into margin and turnover elements stresses the possibility of trading one off for the other in attempts to improve the overall profit picture. That is, a company may shave its margins slightly hoping for a large enough increase in turnover to increase the overall rate of return. 6ourth, ratios make it easier to make comparisons between segments of the organization. %. 4ales................................. Cet operating income........ +verage operating assets.. 0argin............................... Turnover............................ 8eturn on investment !89I#............................... ;1iven. &AA 'eport &o- ./ states !p. &)# QIntroducing sales to measure level of operations helps to disclose specific areas for more intensive investigation. .ompany : does as well as .ompany + in terms of profit margin, for both companies earn "(G on sales. :ut .ompany : has a much lower turnover of capital than does .ompany +. Dhereas a dollar of investment in .ompany + supports two dollars in sales each period, a dollar investment in .ompany : supports only fifty cents in sales each period. This suggests that the analyst should look carefully at .ompany :s
/ The 0c1raw-2ill .ompanies, Inc., %3"3. +ll rights reserved. 4olutions 0anual .hapter "3 %?=

Companies in the Same (nd!stry A B C <?33,33 ; ; <%,333,3 3 <)33,333 33 <>(,333 ; <@3,333 ; <@3,333 <&33,33 ; <",333,3 <",333,3 ; 3 33 33 "(G "(G &.)G ; %.3 3.) %.3 ; ; %>G @G @G

investment. Is the company keeping an inventory larger than necessary for its sales volumeT +re receivables being collected promptlyT 9r did .ompany + ac'uire its fixed assets at a price level which was much lower than that at which .ompany : purchased its plantTR

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*ro/lem 10-1#. !continued# Thus, by including sales specifically in 89I computations the manager is able to discover possible problems, as well as reasons underlying a strong or a weak performance. Oooking at .ompany + compared to .ompany ., notice that .s turnover is the same as +s, but .s margin on sales is much lower. Dhy would . have such a low marginT Is it due to inefficiency, is it due to geographical location !re'uiring higher salaries or transportation charges#, is it due to excessive materials costs, or is it due to other factorsT 89I computations raise 'uestions such as these, which form the basis for managerial action. To summarize, in order to bring :s 89I into line with +s, it seems obvious that :s management will have to concentrate its efforts on increasing turnover, either by increasing sales or by reducing assets. It seems unlikely that : can appreciably increase its 89I by improving its margin on sales. 9n the other hand, .s management should concentrate its efforts on the margin element by trying to pare down its operating expenses.

/ The 0c1raw-2ill .ompanies, Inc., %3"3. +ll rights reserved. 4olutions 0anual .hapter "3 %@"

*ro/lem 10-1$. !() minutes# The answers below are not the only possible answers. Ingenious people can figure out many different ways of making performance look better even though it really isnt. This is one of the reasons for a balanced scorecard. :y having a number of different measures that ultimately are linked to overall financial goals, QgamingR the system is more difficult. ". 4peed-to-market can be improved by taking on less ambitious pro*ects. Instead of working on ma*or product innovations that re'uire a great deal of time and effort, 8UL may choose to work on small, incremental improvements in existing products. There is also a danger that in the rush to push products out the door, the products will be inade'uately tested and developed. %. Aerformance measures that are ratios or percentages present special dangers. + ratio can be increased either by increasing the numerator or by decreasing the denominator. -sually, the intention is to increase the numerator in the ratio, but a manager may react by decreasing the denominator instead. In this case !which actually happened#, the managers pulled telephones out of the high-crime areas. This eliminated the problem for the managers, but was not what the .,9 or the city officials had intended. They wanted the phones fixed, not eliminated. &. In real life, the production manager simply added several weeks to the delivery cycle time. In other words, instead of promising to deliver an order in four weeks, the manager promised to deliver in six weeks. This increase in delivery cycle time did not, of course, please customers and drove some business away, but it dramatically improved the percentage of orders delivered on time.

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*ro/lem 10-1$. !continued# (. +s stated above, ratios can be improved by changing either the numerator or the denominator. 0anagers who are under pressure to increase the revenue per employee may find it easier to eliminate employees than to increase revenues. 9f course, eliminating employees may reduce total revenues and total profits, but the revenue per employee will increase as long as the percentage decline in revenues is less than the percentage cut in number of employees. 4uppose, for example, that a manager is responsible for business units with a total of ",333 employees, <"%3 million in revenues, and profits of <% million. 6urther suppose that a manager can eliminate one of these business units that has %33 employees, revenues of <"3 million, and profits of <".% million. Be0ore A0ter eliminating the eliminating the b!siness !nit b!siness !nit Total revenue............ <"%3,333,333 <""3,333,333 Total employees....... ",333 >33 8evenue per employee............... <"%3,333 <"&@,)33 Total profits.............. <%,333,333 <>33,333 +s these examples illustrate, performance measures should be selected with a great deal of care and managers should avoid placing too much emphasis on any one performance measure.

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*ro/lem 10-20. !%3 minutes# ". 9perating assets do not include investments in other companies or in undeveloped land. #nding Beginning Balances Balances < "%3,333 < "(3,333 )&3,333 ()3,333 &>3,333 &%3,333 ?%3,333 ?>3,333 <",?)3,33 3 <",)=3,333

.ash............................................... +ccounts receivable........................ Inventory........................................ Alant and e'uipment !net#.............. Total operating assets..................... +verage operating assets F 0argin F F TurnoverF F

<",?)3,333 I <",)=3,333 F <",?%3,333 % Cet operating income 4ales <(3),333 F "3G <(,3)3,333 4ales +verage operating assets <(,3)3,333 F %.) <",?%3,333

89I F 0argin E Turnover F "3G E %.) F %)G %. Cet operating income................................... 0inimum re'uired return !")G E <",?%3,333#................................................ 8esidual income............................................ <(3),333 %(&,333 <"?%,333

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*ro/lem 10-21. !&3 minutes# ". 89I F 0argin E Turnover F F Cet operating income 4ales E 4ales +verage operating assets <&?3,333 <(,333,333 E <(,333,333 <%,333,333

F =G E % F ">G %. 89I F <&?3,333 <(,333,333 E <(,333,333 <",?33,333

F =G E %.) F %%.)G !-nchanged# !Increase# !Increase# &. 89I F F <&=%,333 <(,333,333 E <(,333,333 <%,333,333 =.>G E % F !Increase# !-nchanged# "=.?G !Increase#

(. Interest is a financing expense and thus it is not used to compute net operating income. 89I F F <&>3,333 <(,333,333 E <(,333,333 <%,)33,333 =.)G E ".? F ").%G !Increase# !Lecrease# !Lecrease#

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*ro/lem 10-21. !continued# ). The company has a contribution margin ratio of &3G !<%( .0 per unit, divided by the <>3 selling price per unit#. Therefore, a %3G increase in sales would result in a new net operating income of 4ales !".%3 E <(,333,333#. 7ariable expenses............. .ontribution margin.......... 6ixed expenses.................. Cet operating income........ 89I F F <?33,333 <(,>33,333 E <(,>33,333 <%,333,333 "%.)G E %.( F &3G !Increase# !Increase# !Increase# <&%3,333 <(,333,333 E <(,333,333 <",=?3,333 >G E %.3( F "?.&G !Lecrease# !Increase# !Lecrease# <&?3,333 <(,333,333 E <(,333,333 <",>33,333 <(,>33,333 &,&?3,333 ",((3,333 >(3,333 <B ?33,333 "33 G @3 &3 G

?.

89I F F

@.

89I F

F =G E %.%% F %3G !-nchanged# !Increase# !Increase#

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*ro/lem 10-22. !() minutes# ". 4tudents answers may differ in some details from this solution. (inancial Deekly profit

I I

Deekly sales Customer .ustomer satisfaction with service )nternal Business Lining area *rocesses cleanliness

.ustomer satisfaction with menu choices

+verage time to prepare an J order +verage time Cumber of J to take an menu items order

+earning and Aercentag ,ro-th e of dining room staff completing hospitality course

Aercentag e of kitchen staff completin g cooking course

/ The 0c1raw-2ill .ompanies, Inc., %3"3. +ll rights reserved. 4olutions 0anual .hapter "3 %@@

*ro/lem 10-22. !continued# %. The hypotheses underlying the balanced scorecard are indicated by the arrows in the diagram. 8eading from the bottom of the balanced scorecard, the hypotheses are o If the percentage of dining room staff that complete the basic hospitality course increases, then the average time to take an order will decrease. o If the percentage of dining room staff that complete the basic hospitality course increases, then dining room cleanliness will improve. o If the percentage of kitchen staff that complete the basic cooking course increases, then the average time to prepare an order will decrease. o If the percentage of kitchen staff that complete the basic cooking course increases, then the number of menu items will increase. o If the dining room cleanliness improves, then customer satisfaction with service will increase. o If the average time to take an order decreases, then customer satisfaction with service will increase. o If the average time to prepare an order decreases, then customer satisfaction with service will increase. o If the number of menu items increases, then customer satisfaction with menu choices will increase. o If customer satisfaction with service increases, weekly sales will increase. o If customer satisfaction with menu choices increases, weekly sales will increase. o If sales increase, weekly profits for the Oodge will increase. ,ach of these hypotheses can be 'uestioned. 6or example, the items added to the menu may not appeal to customers. 4o even if the number of menu items increases, customer satisfaction with the menu choices may not increase. The fact that each of the hypotheses can be 'uestioned does not, however, invalidate the balanced scorecard. If the scorecard is used correctly, management will be able to identify which, if any, of the hypotheses are incorrect. V4ee below.W

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*ro/lem 10-22. !continued# &. 0anagement will be able to tell if a hypothesis is false if an improvement in a performance measure at the bottom of an arrow does not, in fact, lead to improvement in the performance measure at the tip of the arrow. 6or example, if the number of menu items is increased, but customer satisfaction with the menu choices does not increase, management will immediately know that something was wrong with that particular hypothesis.

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*ro/lem 10-23. !?3 minutes# ". Total Sales Territory Compan &orther So!ther y n n <@)3,33 <&33,33 4ales............................................. 3 3 <()3,333 ")?,33 7ariable expenses......................... &&?,333 3 ">3,333 .ontribution margin...................... ("(,333 "((,333 %@3,333 "%3,33 Traceable fixed expenses.............. %%>,333 3 "3>,333 <B 4ales territory segment margin..... ">?,333 %(,333 <"?%,333 .ommon fixed expenses not traceable to sales territories !<&@>,333 J <%%>,333 F <")3,333#................................... ")3,333 <B Cet operating income.................... &?,333 &orthern Territory 4ales............................................ <&33,333 7ariable expenses........................ .ontribution margin..................... Traceable fixed expenses............. ")?,333 "((,333 @3,333 +rod!ct ,ine +aks Tibs <%)3,33 <)3,333 3 "(),33 "",333 3 &=,333 "3),333 (3,33 &3,333 3 <B <B=,333 ?),333

Aroduct line segment margin....... @(,333 .ommon fixed expenses not traceable to product lines !<"%3,333 J <@3,333 F <)3,333#.................................... )3,333 4ales territory segment margin.... <B%(,333

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*ro/lem 10-23. !continued# Total Sales Territory Compan &orther So!ther y n n "33.3G "33G "33G ((.>G )%G (3G )).%G (>G ?3G &3.(G (3G %(G %(.>G >G &?G

4ales............................................. 7ariable expenses......................... .ontribution margin...................... Traceable fixed expenses.............. 4ales territory segment margin..... .ommon fixed expenses not traceable to sales territories !<&@>,333 J <%%>,333 F <")3,333#................................... Cet operating income....................

%3.3G (.>G +rod!ct ,ine +aks Tibs "33G "33G %%G )>G @>G (%G ?3G "?G ">G %?G

&orthern Territory 4ales............................................ "33.3G 7ariable expenses........................ )%.3G .ontribution margin..................... (>.3G Traceable fixed expenses............. %&.&G Aroduct line segment margin....... %(.@G .ommon fixed expenses not traceable to product lines !<"%3,333 J <@3,333 F <)3,333#.................................... "?.@G 4ales territory segment margin.... >.3G

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*ro/lem 10-23. !continued# %. Two insights should be brought to the attention of management. 6irst, compared to the 4outhern territory, the Corthern territory has a low contribution margin ratio. 4econd, the Corthern territory has high traceable fixed expenses. 9verall, compared to the 4outhern territory, the Corthern territory is very weak. &. +gain, two insights should be brought to the attention of management. 6irst, the Corthern territory has a poor sales mix. Cote that the territory sells very little of the Aaks product, which has a high contribution margin ratio. This poor sales mix accounts for the low overall contribution margin ratio in the Corthern territory mentioned in part !%# above. 4econd, the traceable fixed expenses of the Aaks product seem very high in relation to sales. These high fixed expenses may simply mean that the Aaks product is highly leveraged$ if so, then an increase in sales of this product line would greatly enhance profits in the Corthern territory and in the company as a whole.

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*ro/lem 10-24. !?3 minutes# ". Total Compa Cook1 Travel 2andy ny book G!ide Speller <&33,33 3 <=3,333 <")3,333 <?3,333 "3%,333 %@,333 &3,333 =,333 "&%,333 &?,333 "?>,333 )(,333 &?,333 "&,)33 &&,333 ">,333 =,333 %,@33 "%,333 ",>33 =3,333 &?,333 ?&,333 "%,333 "),333 ?,333 @>,333 ">,333 @%,333 (%,333 "=,)33 =,333 (,)33 ?,333 &,333 ?,333 ",>33 (,%33

4ales................................. 7ariable expenses Arinting cost.................... 4ales commissions.......... Total variable expenses..... .ontribution margin.......... Traceable fixed expenses +dvertising...................... 4alaries........................... ,'uipment depreciation; Darehouse rent;;............ Total traceable fixed expenses......................... Aroduct line segment margin............................ .ommon fixed expenses 1eneral sales.................. 1eneral administration. . . Lepreciation5office facilities........................ Total common fixed expenses......................... Cet operating income........

&=,333 "),333

@>,333 <">,333 <B&&,333 <%@,333 ">,333 (%,333 &,333 ?&,333 <B "),333

; <=,333 E &3G, )3G, and %3G, respectively. ;; <(>,333 s'uare feet E <& per s'uare foot F <"((,333$ <"((,333 S "% months F <"%,333 per month. <"%,333 S (>,333 s'uare feet F <3.%) per s'uare foot per month. <3.%) per s'uare foot E @,%33 s'uare feet F <",>33$ <3.%) per s'uare foot E %(,333 s'uare feet F <?,333$ and <3.%) per s'uare foot E "?,>33 s'uare feet F <(,%33.

/ The 0c1raw-2ill .ompanies, Inc., %3"3. +ll rights reserved. 4olutions 0anual .hapter "3 %>&

*ro/lem 10-24. !continued# %. a. Co, the cookbook line should not be eliminated. The cookbook is covering all of its own costs and is generating an <">,333 segment margin toward covering the companys common costs and toward profits. !Cote Aroblems relating to the elimination of a product line are covered in more depth in the next chapter.# b. .ontribution margin !a#........... 4ales !b#.................................. .ontribution margin ratio !a# S !b#..................................... Cook1 Travel book G!ide <)(,333 <@%,333 <")3,33 <=3,333 3 ?3G (>G 2andy Speller <(%,333 <?3,333 @3G

It is probably unwise to focus all available resources on promoting the travel guide. The company is already spending more on the promotion of this product than on the other two products combined. 6urthermore, the travel guide has the lowest contribution margin ratio of the three products. Therefore, a dollar of sales of the travel guide generates less profit than a dollar of sales of either of the two other products. Cevertheless, we cannot say for sure which product should be emphasized in this situation without more information. The problem states that there is ample demand for all three products, which suggests that there is no idle capacity. If the e'uipment is being fully utilized, increasing the production of any one product would re'uire cutting back production of the other products. In the next chapter we will discuss how to choose the most profitable product when a production constraint forces such a trade-off among products.

/ The 0c1raw-2ill .ompanies, Inc., %3"3. +ll rights reserved. %>( Introduction to 0anagerial +ccounting, )th ,dition

*ro/lem 10-2 . !=3 minutes# ". :oth companies view training as important$ both companies need to leverage technology to succeed in the marketplace$ and both companies are concerned with minimizing defects. There are numerous differences between the two companies. 6or example, +pplied Aharmaceuticals is a product-focused company and Lestination 8esorts International !L8I# is a service-focused company. +pplied Aharmaceuticals training resources are focused on their engineers because they hold the key to the success of the organization. L8Is training resources are focused on their front-line employees because they hold the key to the success of their organization. +pplied Aharmaceuticals technology investments are focused on supporting the innovation that is inherent in the product development side of the business. L8Is technology investments are focused on supporting the day-to-day execution that is inherent in the customer interface side of the business. +pplied Aharmaceuticals defines a defect from an internal manufacturing standpoint, while L8I defines a defect from an external customer interaction standpoint.

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*ro/lem 10-2 . !continued# %. 4tudents answers may differ in some details from this solution. .pplied *harmaceuticals (inancial 8eturn on 4tockholders ,'uity I

Customer .ustomer perception of first-to-market capability )nternal Business *rocess +earning and ,ro-th I .ustomer perception I of product 'uality

8UL Nield

Lefect rates

Aercentage of *ob I offers accepted I Lollars invested in engineering training per engineer I

Lollars invested in engineering technology

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*ro/lem 10-2 . !continued# Destination Resorts )nternational (inancial 4ales I

Customer Cumber of repeat customers

)nternal Business *rocess

8oom cleanliness

Aercentage of I error-free repeat customer check-ins

+verage time to resolve customer J complaint

+earning and ,ro-th

,mployee turnover

4urvey of employee morale

Cumber of employees receiving database I training

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*ro/lem 10-2 . !continued# &. The hypotheses underlying the balanced scorecards are indicated by the arrows in each diagram. 8eading from the bottom of each balanced scorecard, the hypotheses are o o o o o o o .pplied *harmaceuticals If the dollars invested in engineering technology increase, then the 8UL yield will increase. If the percentage of *ob offers accepted increases, then the 8UL yield will increase. If the dollars invested in engineering training per engineer increase, then the 8UL yield will increase. If the 8UL yield increases, then customer perception of firstto-market capability will increase. If the defects per million opportunities decrease, then the customer perception of product 'uality will increase. If the customer perception of first-to-market capability increases, then the return on stockholders e'uity will increase. If the customer perception of product 'uality increases, then the return on stockholders e'uity will increase. Destination Resort )nternational If the employee turnover decreases, then the percentage of error-free repeat customer check-ins and room cleanliness will increase and the average time to resolve customer complaints will decrease. If the number of employees receiving database training increases, then the percentage of error-free repeat customer check-ins will increase. If employee morale increases, then the percentage of errorfree repeat customer check-ins and room cleanliness will increase and the average time to resolve customer complaints will decrease. If the percentage of error-free repeat customer check-ins increases, then the number of repeat customers will increase. If the room cleanliness increases, then the number of repeat customers will increase.
Introduction to 0anagerial +ccounting, )th ,dition

o o

o o

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o If the average time to resolve customer complaints decreases, then the number of repeat customers will increase. o If the number of repeat customers increases, then sales will increase.

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*ro/lem 10-2 . !continued# ,ach of these hypotheses is 'uestionable to some degree. 6or example, in the case of +pplied Aharmaceuticals, 8UL yield is not the sole driver of the customers perception of first-tomarket capability. 0ore specifically, if +pplied Aharmaceuticals experimented with nine possible drug compounds in year one and three of those compounds proved to be successful in the marketplace it would result in an 8UL yield of &&G. If in year two, it experimented with four possible drug compounds and two of those compounds proved to be successful in the marketplace it would result in an 8UL yield of )3G. Dhile the 8UL yield has increased from year one to year two, it is 'uite possible that the customers perception of first-to-market capability would decrease. The fact that each of the hypotheses mentioned above can be 'uestioned does not invalidate the balanced scorecard. If the scorecard is used correctly, management will be able to identify which, if any, of the hypotheses are invalid and the balanced scorecard can then be appropriately modified.

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*ro/lem 10-2!. !?3 minutes# ". The disadvantages or weaknesses of the companys version of a segmented income statement are as follows a. The company should include a column showing the combined results of the three regions taken together. b. The regional expenses should be segregated into variable and fixed categories to permit the computation of both a contribution margin and a regional segment margin. c. The corporate expenses are probably common to the regions and should not be arbitrarily allocated. %. .orporate advertising expenses have been allocated on the basis of sales dollars$ the general administrative expenses have been allocated evenly among the three regions. 4uch allocations can be misleading to management because they seem to imply that these expenses are caused by the segments to which they have been allocated. The segment margin5which only includes costs that are actually caused by the segments5should be used to measure the performance of a segment. The Qnet operating incomeR or Qnet lossR after allocating common expenses should not be used to *udge the performance of a segment.

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*ro/lem 10-2!. !continued# &. 4ales................................ 7ariable expenses .ost of goods sold.......... 4hipping expense........... Total variable expenses.... .ontribution margin......... Traceable fixed expenses +dvertising..................... 4alaries.......................... -tilities........................... Lepreciation.................. Total traceable fixed expenses........................ 8egional segment margin. .ommon fixed expenses not traceable to the regions +dvertising !general# 1eneral administrative expenses..................... Total common fixed expenses........................ Cet loss............................ Total West Central #ast <%,333,3 <>33,33 <@)3,33 33 <()3,333 3 3 >"=,(33 @@,?3 3 >=@,33 3 ","3&,33 3 )">,333 &"&,333 (3,)33 >),33 3 =)?,)3 3 "(?,)3 3 "?%,=33 %>3,333 &@?,)33 &%,33 %>,)3 "@,"33 3 3 &"%,33 (3),33 ">3,333 3 3 (>>,33 &(),33 %@3,333 3 3 "3>,333 %33,333 %"3,333 =3,333 >>,333 "&),333 "&,)33 "%,333 "),333 %>,33 &3,33 %@,333 3 3 &%>,33 &=3,33 %&>,)33 3 3 <"?3,33 <!(),333 <&",)33 3 #

>3,333 ")3,33 3 %&3,33 3 < !>&,)3 3#

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*ro/lem 10-2!. !continued# 4ales................................. 7ariable expenses .ost of goods sold.......... 4hipping expense........... Total variable expenses..... .ontribution margin.......... Traceable fixed expenses +dvertising..................... 4alaries........................... -tilities........................... Lepreciation................... Total traceable fixed expenses........................ 8egional segment margin. .ommon fixed expenses not traceable to the regions +dvertising !general# 1eneral administrative expenses...................... Total common fixed expenses........................ Cet loss............................. Total West Central #ast "33.3G "33.3G "33.3G "33.3G (".3G &.=G ((.=G ))."G %).=G ").?G %.3G (.&G (@.>G @.&G &?.%G &.>G (3.3G ?3.3G %(.3G %3.3G &.3G ?.3G )&.3G @.3G &).3G (.3G &=.3G ?".3G %).3G "".3G ".)G &.)G (".3G %3.3G )3.%G &.>G )(.3G (?.3G %>.3G ">.3G %.3G (.3G )%.3G !?.3G#

(.3G @.)G "".)G !(.%G#

Cote Aercentage figures may not total down due to rounding.

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*ro/lem 10-2!. !continued# (. The following points should be brought to the attention of management a. 4ales in the Dest are much lower than in the other two regions. This is not due to lack of salespeople5salaries in the Dest are about the same as in the .entral 8egion, which has the highest sales of the three regions. b. The Dest is spending about half as much for advertising as the .entral 8egion. Aerhaps this is the reason for the Dests lower sales. c. The ,ast apparently is selling a large amount of low-margin items. Cote that it has a contribution margin ratio of only (?G, compared to ?3G or more for the other two regions. d. The ,ast appears to be overstaffed. Its salaries are about )3G greater than in either of the other two regions. e. The ,ast is not covering its own traceable costs. +ttention should be given to improving the sales mix and reducing expenses in this region. f. +pparently, the salespeople in all three regions are on a salary basis. Aerhaps a change to a commission basis would encourage the sales staff to be more aggressive and improve sales throughout the company.

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Communicating in *ractice Late To 6rom 4ub*ect .urrent date Instructor 4tudents Came Talk with a store manager

The students memorandum should address the following The name, title and *ob affiliation of the individual interviewed. !Cote These data are not specifically re'uired in problem but are essential background. This could provide a good basis for class discussion of what should be included in a memorandum.# + brief description of the corporations goals !that is, the broad, long-range plans of the company#. + summary of the performance measures that are used to help motivate the managers and monitor progress toward achieving the corporations goals, and an indication as to whether the performance measures include return on investment andXor residual income. + synopsis of the managers opinion as to whether the performance measures are consistent with the managers compensation plan.

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Case !?3 minutes# ". 4tudent answers may differ concerning which category5 learning and growth, internal business processes, customers, or financial5a particular performance measure belongs to. (inancial

Total profit +verage age of accounts receivable

Customer

.ustomer satisfaction with accuracy of charge account )nternal bills Aercentage of Business *rocesses charge account bills containing errors

Dritten-off accounts receivable as a percentage of sales

I
-nsold inventory at end of season as a percentage of total cost of sales Aercentage of suppliers making *ust-in-time deliveries

+earning and ,ro-th

Aercentage of sales clerks trained to correctly enter data on charge account slips

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Case !continued# + number of the performance measures suggested by managers have not been included in the above balanced scorecard. The excluded performance measures may have an impact on total profit, but they are not linked in any obvious way with the two key problems that have been identified by management5accounts receivables and unsold inventory. If every performance measure that potentially impacts profit is included in a companys balanced scorecard, it would become unwieldy and focus would be lost. %. The results of operations can be exploited for information about the companys strategy. ,ach link in the balanced scorecard should be regarded as a hypothesis of the form QIf ..., then ...R. 6or example, the balanced scorecard on the previous page contains the hypothesis QIf customers express greater satisfaction with the accuracy of their charge account bills, then the average age of accounts receivable will improve.R If customers in fact do express greater satisfaction with the accuracy of their charge account bills, but the average age of accounts receivable does not improve, this would have to be considered evidence that is inconsistent with the hypothesis. 0anagement should try to figure out why the average age of receivables has not improved. !4ee the answer below for possible explanations.# The answer may suggest a shift in strategy. In general, the most important results are those that provide evidence inconsistent with the hypotheses embedded in the balanced scorecard. 4uch evidence suggests that the companys strategy needs to be reexamined.

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Case !continued# &. a. This evidence is inconsistent with two of the hypotheses underlying the balanced scorecard. The first of these hypotheses is QIf customers express greater satisfaction with the accuracy of their charge account bills, then the average age of accounts receivable will improve.R The second of these hypotheses is QIf customers express greater satisfaction with the accuracy of their charge account bills, then there will be improvement in bad debts.R There are a number of possible explanations. Two possibilities are that the companys collection efforts are ineffective and that the companys credit reviews are not working properly. In other words, the problem may not be incorrect charge account bills at all. The problem may be that the procedures for collecting overdue accounts are not working properly. 9r, the problem may be that the procedures for reviewing credit card applications let through too many poor credit risks. If so, this would suggest that efforts should be shifted from reducing charge account billing errors to improving the internal business processes dealing with collections and credit screening. +nd in that case, the balanced scorecard should be modified. b. This evidence is inconsistent with three hypotheses. The first of these is QIf the average age of receivables declines, then profits will increase.R The second hypothesis is QIf the written-off accounts receivable decrease as a percentage of sales, then profits will increase.R The third hypothesis is QIf unsold inventory at the end of the season as a percentage of cost of sales declines, then profits will increase.R +gain, there are a number of possible explanations for the lack of results consistent with the hypotheses. 0anagers may have decreased the average age of receivables by simply writing off old accounts earlier than was done previously. This would actually decrease reported profits in the short term. :ad debts as a percentage of sales could be decreased by drastically cutting back on extensions of credit to customers5perhaps even canceling some charge accounts. !:ad debts would be zero if there were no credit
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sales.# This would have the effect of reducing bad debts, but might irritate otherwise loyal credit customers and reduce sales and profits.

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Case !continued# The reduction in unsold inventories at the end of the season as a percentage of cost of sales could have occurred for a number of reasons that are not necessarily good for profits. 6or example, managers may have been too cautious about ordering goods to restock low inventories5creating stockouts and lost sales. 9r, managers may have cut prices drastically on excess inventories in order to eliminate them before the end of the season. This may have reduced the willingness of customers to pay the stores normal prices. 9r, managers may have gotten rid of excess inventories by selling them to discounters be0ore the end of the season.

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Research and .pplication ". 6ed,x succeeds because of its operational excellence customer value proposition. Aage = of the "3-Y describes the companys largest business segment, 6ed,x ,xpress, by saying Q6ed,x ,xpress invented express distribution in "=@& and remains the industry leader, providing rapid, reliable, time-definite delivery of packages, documents and freight to more than %%3 countries and territories. 6ed,x ,xpress offers time-certain delivery within one to three business days, serving markets that generate more than =3G of the worlds gross domestic product through door-to-door, customs-cleared service with a moneyback guarantee. 6ed,x ,xpresss unmatched air route authorities and extensive transportation infrastructure, combined with leading-edge information technologies, make it worlds largest express transportation company.R The combination of global scale coupled with one to three day delivery capability testifies to the companys extraordinary operational excellence. Aage ( of the "3-Y describes 6ed,xs efforts to integrate its business segments so that customers have a single point of contact with the company for all of their air, ground, or freight transportation needs. This is undoubtedly an important aspect of 6ed,xs strategy. %. 6ed,xs four main business segments are, 6ed,x ,xpress, 6ed,x 1round, 6ed,x 6reight, and 6ed,x Yinkos. ,xamples of traceable fixed costs for the 6ed,x ,xpress segment include the costs of operating the primary sorting facility in 0emphis, Tennessee, the costs of operating regional hubs in Cewark, 9akland, and 6ort Dorth, and the costs of owning ))@ airplanes !see page %% of the "3-Y#. ,xamples of traceable fixed costs for the 6ed,x 1round segment include the costs of owning "=,@33 trailers !see page "( of the "3-Y#, the costs of operating )") facilities and %> hubs throughout the -.4. and .anada !see page "( of the "3-Y#, and the compensation paid to the Aresident and .hief ,xecutive 9fficer of 6ed,x 1round, Laniel Z. 4ullivan !see page %= of the "3-Y#.

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Research and .pplication !continued# ,xamples of traceable fixed costs for the 6ed,x 6reight segment include the costs of operating &%" service centers, the costs of owning &=,)33 vehicles, and the service center manager salaries. ,xamples of traceable fixed costs for the 6ed,x Yinkos segment include the utility costs to operate the ",%=3 6ed,x Yinkos 9ffice and Arint .enters, the salaries paid to the 9ffice and Arint .enter managers, and the rental costs incurred to operate the 9ffice and Arint .enters. ,xamples of common costs include all of the 6ed,x sponsorships mentioned on page "= of the "3-Y. 6or example, the cost of hosting college footballs 6ed,x 9range :owl is common to the four business segments. 9ther common costs include the salary paid to the companys .,9 6rederick D. 4mith, and the fee paid to the companys auditor, ,rnst U Noung. &. Aage %( of the "3-Y lists all of the sorting facilities for the 6ed,x ,xpress segment. These sorting facilities are examples of cost centers. ,ach of the retail 6ed,x Yinkos 9ffice and Arint .enters is a profit center. The four main business segments5 6ed,x ,xpress, 6ed,x 1round, 6ed,x 6reight, and 6ed,x Yinkos5are examples of investment centers. (. The salary paid to 1ary 0. Yusin, the Aresident and .hief ,xecutive 9fficer for 6ed,x Yinkos is traceable to the 6ed,x Yinkos business segment, but it is common to each of the 6ed,x Yinkos retail locations. The cost of operating a 6ed,x ,xpress regional hub in Cewark is traceable to that hub, but the costs are common to the flights that arrive and depart from Cewark. The cost of maintaining the companys website !www.fedex.com# is traceable to the companys Information Technology Lepartment but it is common to the four business segments.

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Research and .pplication !continued# ). The margin, turnover, and 89I for all four segments are summarized in the below table !dollar figures are in millions# 3ed#4 3ed#4 #4pres Gro!n s d <"=,(> <(,?> ) 3 <",("( <?3( <"&,"& <%,@@ 3 ? <"%,(( <%,%( & > <"%,@> @ 3ed#4 3reigh t <&,%"@ <&)( <%,3(@ <",=%( 3ed#4 5inko6s <%,3?? <"33 <%,=>@ <%,=3& <%,=() (.>G 3.@3 &.(G

4ales................................. 9perating income.............. 4egment assets %33)....... 4egment assets %33(....... +verage operating assets V4egment assets %33) I 4egment assets %33(WX% 0argin V9perating income S 4alesW.......................... Turnover V4ales S +verage operating assetsW............ 89I V0argin E TurnoverW. . .

<%,)" % <",=>? "".3G ".?% "@.>G

@.&G "%.=G ".)% ".>? ""."G %(.3G

?. +ssuming a ")G re'uired rate of return, the residual income for all four segments would be computed as follows !dollar figures are in millions# 3ed#4 #4pres s <"%,@> @ <",("( ",="> < !)3(# 3ed#4 Gro!n d <%,)" % <?3( &@@ <%%@ 3ed#4 3reigh t <",=> ? <&)( %=> < )? 3ed#4 5inko6s <%,=( ) < "33 ((% <!&(%#

+verage operating assets.. 9perating income.............. 0inimum re'uired return V")G E +verage operating assetsW............ 8esidual income................

@. + <%3,333,333 investment that increases operating income by <(,333,333 provides an 89I of %3G. :ecause the 6ed,x
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,xpress segment is currently earning an 89I of ""."G !as calculated above#, its managers would pursue the investment opportunity because it would increase their overall 89I. The 6ed,x 1round segment is currently earning an 89I of %(G !as calculated above#$ therefore, its managers would pass on the investment opportunity because it would lower their overall 89I.

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Research and .pplication !continued# If the managers are evaluated using residual income, the managers of both segments would pursue the investment opportunity because it would increase their overall residual incomes. -sing residual income instead of 89I aligns the incentives of segment managers with the overall goals of the company. The increase in residual income for both segments is shown below !dollar figures are in millions# 3ed#4 #4pres s <!)3(# < ( & < " 3ed#4 Gro!n d <%%@ < ( & < " <%%>

8esidual income before investment !from re'uirement ?#........................................ 9perating income from the investment..... 8e'uired return on investment in operating assets !<%3,333,333 E ")G F <&,333,333#............................................ 8esidual income provided by investment opportunity............................................. 8esidual income after the investment.......

<!)3&#

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