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ACC 2203 Review Workshop
Professor Huang
Responsibility Accounting, Performance Measurement
Segment Reporting, and Transfer Pricing
Cost centers – segments whose managers are held responsible only for
costs but not for revenue or investments
Profit centers – segments whose managers are held responsible for both
costs and revenues but not for investments
The salary of the president of GE’s Appliances business unit which comprises
multiple divisions such as Refrigerators & Freezers; Washers & Dryers;
Dishwashers & Disposers
The maintenance and depreciation cost on the cameras used by NBC’s sports
division
The cost of heating, lighting, and air conditioning the NBC offices in Burbank,
California and in New York
Concept check
1. Managers in which of the following responsibility centers are held
responsible for profits? (You may select more than one answer.)
a. Revenue centers
b. Cost centers
c. Profit centers
d. Investment centers
2. Which of the following statements is false? (You may select more than one
answer.)
a. The same cost can be traceable or common depending on how the
segment is defined.
b. In general, common fixed costs should be assigned to segments.
c. If a company eliminates a segment of its business, the costs that were
traceable to that segment should disappear.
d. If four segments share $1 million in common fixed costs and one
segment is eliminated, the common fixed costs will decrease by
$250,000.
Segment Reporting - Example
The Coldex Company has two divisions: Refrigerators
Division and Deep-Freezers Division. The following
financial information pertains to the operations of the
divisions:
(in thousands) Refrigerators Deep-Freezers
Sales revenue $600,000 $330,000
Var. Man. $180,000 $120,000
Variable S&A $100,000 $80,000
Traceable FC $140,000 $100,000
The common fixed costs in the company totaled $93,000
Segment Reporting - Example
Prepare an income statement for the
Coldex company segmented by the
divisions.
(in thousands) Company Refrigerators Deep-
Freezers
Sales revenue $
Variable costs $
Cont. margin $
Traceable FC $
Division margin $
Common FC $
Net Op income $
Measuring Segment Performance
A major purpose of segment reporting is to determine how well segments have performed
and how well they are being run by the segment managers. In many companies, segment
performance directly affects managerial compensation, managerial promotion, and
amount of investment funds allocated to each segment by the headquarters. We will
study two popular metrics that are primarily used in profit and investment centers for
judging segment performance: Return on investment (ROI) and Residual income.
Return on investment (ROI) measures the net operating income generated per dollar
of investment in operating assets
Net
ope
in
on
Return
invest
Aver
ope
as
Net operating income – income before interest and taxes (or earnings before
interest and taxes – EBIT)
Operating assets – include accounts receivable, inventory, plant and equipment
and other productive assets; excludes land held for future use, investments in other
companies
Average operating assets – average value of the operating assets between the
beginning and end of a period
ROI - Definition
The ROI formula can also be expressed as follows:
Net operating income Sales
ROI = x
Sales Average operating assets
ROI = ??
Decreasing Operating Expenses with no
Change in Sales or Operating Assets
Assume that Regal’s manager was able to reduce
operating expenses by $10,000 without affecting
sales or operating assets. This would increase
net operating income to $40,000.
Regal Company reports the following:
Net operating income $ 40,000
Average operating assets $ 200,000
Sales $ 500,000
Operating expenses $ 460,000
Decreasing Operating Assets with no
Change in Sales or Operating Expenses
Assume that Regal’s manager was able to reduce
inventories by $20,000 using just-in-time
techniques without affecting sales or operating
expenses.
Regal Company reports the following:
Net operating income $ 30,000
Average operating assets $ 180,000
Sales $ 500,000
Operating expenses $ 470,000
Let’s calculate the new ROI.
Investing in Operating Assets to Increase
Sales
Assume that Regal’s manager invests in a
$30,000 piece of equipment that increases sales
by $35,000 while increasing operating expenses
by $15,000.
Regal Company reports the following:
Net operating income $ 50,000
Average operating assets $ 230,000
Sales $ 535,000
Operating expenses $ 485,000
Let’s calculate the new ROI.
Residual Income - Definition
Residual Income (RI) measures the net operating income earned
in excess of a required return on operating assets.
RI =
ROI Vs. Residual Income
The residual income approach emphasizes maximizing the overall firm value by
encouraging managers to invest in projects that earn more than the firm’s
cost of capital. The ROI approach, on the other hand, emphasizes
maximizing the segment ROI, leading managers to sometimes forego
projects that would otherwise improve overall firm value but reduce
segment ROI.
Problem: Sussex Magnet, a division of Sussex International Corp., has a net
operating income of $150,000 and average operating assets of $500,000.
The required annual rate of return for the company is 20%. Sussex Magnet
identified a new project that would require an investment of $180,000 and
earn an additional net operating income of $40,000 per year.
1. What is the division’s current ROI?