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Responsibility Accounting

Topic Seven (7)

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Decentralization in Organizations
Benefits of Decentralization

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

Decentralization in Organizations
May be a lack of May be a lack of coordination among coordination among autonomous autonomous managers. managers.

Lower-level managers Lower-level managers may make decisions may make decisions without seeing the without seeing the big picture. big picture. Lower-level managers Lower-level managers objectives may not objectives may not be those of the be those of the organization. organization.

Disadvantages of Decentralization
May be difficult to May be difficult to spread innovative ideas spread innovative ideas in the organization. in the organization.
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Cost, Profit, and Investments Centers

Cost Cost Center Center

Profit Profit Center Center

Investment Investment Center Center

Cost, profit, and investment centers are all known as responsibility centers.
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Responsibility Responsibility Center Center


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Cost, Profit, and Investments Centers

Cost Center A segment whose manager has control over costs, but not over revenues or investment funds.

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Cost, Profit, and Investments Centers

Profit Center A segment whose manager has control over both costs and revenues, but no control over investment funds.

Revenues
Sales Interest Other

Costs
Mfg. costs Commissions Salaries Other

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Cost, Profit, and Investments Centers

Corporate Headquarters

Investment Center A segment whose manager has control over costs, revenues, and investments in operating assets.

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Responsibility Centers
Investment Centers
O V S P a l t y r o d u B o M p S e r i o r F o o d s C o r p o r a t i o n C o r p o r a t e H e a d q u a r t e r s P r e s i d e n t a n d C E O e r s o n n o u Vn is c e e l P r e s P u p

e r a t i o n s F i n a n c e L e g a l i c e P r e s i Cd e ni e t f F I n a n c i G l e On fe f ri c e rC h a a l

S n a c B k es v e r a g e Cs o n f e c t i o n s c t M P a r on dg u rc t M P a r no ad gu ec r t M a n a g e n

e r

t t l i n g WP l aa r n e t h o D si s e t r i b u t i o u a n a g e M a n a g e M a n a g e r r r

Cost Centers

Superior Foods Corporation provides an example of the various kinds of responsibility centers that exist in an organization.
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Responsibility Centers
S e r i o r F o o d s C o r p o r a t i o n C o r p o r a t e H e a d q u a r t e r s P r e s i d e n t a n d C E O e r s o n n o u Vn is c e e l P r e s P u p

O V S P a l t y r o d u B o M

e r a t i o n s F i n a n c e L e g a l i c e P r e s i Cd e ni e t f F I n a n c i G l e On fe f ri c e rC h a a l

S n a c B k es v e r a g e Cs o n f e c t i o n s c t M P a r on dg u rc t M P a r no ad gu ec r t M a n a g e n

e r

t t l i n g WP l aa r n e t h o D si s e t r i b u t i o u a n a g e M a n a g e M a n a g e r r r

Profit Centers

Superior Foods Corporation provides an example of the various kinds of responsibility centers that exist in an organization.
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Responsibility Centers
S e r i o r F o o d s C o r p o r a t i o n C o r p o r a t e H e a d q u a r t e r s P r e s i d e n t a n d C E O e r s o n n o u Vn is c e e l P r e s P u p

O V S P a l t y r o d u B o M

e r a t i o n s F i n a n c e L e g a l i c e P r e s i Cd e ni e t f F I n a n c i G l e On fe f ri c e rC h a a l

S n a c B k es v e r a g e Cs o n f e c t i o n s c t M P a r on dg u rc t M P a r no ad gu ec r t M a n a g e n

e r

t t l i n g WP l aa r n e t h o D si s e t r i b u t i o u a n a g e M a n a g e M a n a g e r r r

Cost Centers

Superior Foods Corporation provides an example of the various kinds of responsibility centers that exist in an organization.
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Decentralization and Segment Reporting


An Individual Store
Quick Mart

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 Sales Territory

A Service Center

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Superior Foods: Geographic Regions


S u p e r i o r F o o d s C $ 5 0 0 , 0 0 0 , 0 0 0 o r p o r a t i o n

a s t W e s t M i d w e s t S o u t h $ 7 5 , 0 0 0 , 0 $ 0 3 0 0 0 , 0 0 0 , 0 0 0 , 0 0 0 , 0 $0 70 0 , 0 0 0 , $ 5 5 O r e g o n W a s h i n g t o n a l i f o r n Mi a o u n t a i n C S t a t $ 4 5 , 0 0 0 , 0 $0 50 0 , 0 0 0 , 0 $ 0 1 0 2 0 , 0 0 0 , 0 0 0 , 0 0 0 , 0 0 0 $ 8 5

Superior Foods Corporation could segment its business by geographic regions.


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Superior Foods: Customer Channel

e r i o r F o o d s C $ 5 0 0 , 0 0 0 , 0 0 0

r p

r a t i o n

v e n i e n c eS uS p t oe rr em s a r k e W t C oh l a e i sn as l e h D i s t D r i rb u u g t so tr os r e $ 8 0 , 0 0 0 , 0 0 0 $ 2 8 0 , 0 0 0 , 0 0 0$ 1 0 0 , 0 0 0 , 0 0 0 $ 4 0 , 0 0 0 , 0 0 h a i n

e r m a r k e S t u C p h e a r m n a A r k e S t u C p h e ar m n a B r k e S t u C p h e a r m n a C r k e t C i i i $ 8 5 , 0 0 0 , 0 0 0 $ 6 5 , 0 0 0 , 0 0 0 $ 9 0 , 0 0 0 , 0 0 0 $ 4 0 , 0 0 0 , 0 0 0

Superior Foods Corporation could segment its business by customer channel.


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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.

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Identifying Traceable Fixed Costs


Traceable costs arise because of the existence of a particular segment and would disappear over time if the segment itself disappeared.

No computer division means . . .

No computer division manager.

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Identifying Common Fixed Costs


Common costs arise because of the overall operation of the company and would not disappear if any particular segment were eliminated. No computer division but . . . We still have a company president.

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

Profits

Time
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Traceable and Common Costs


Fixed Costs

Dont allocate common costs to segments. Common

Traceable

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Levels of Segmented Statements Webber, Inc. has two divisions.


W e b b e r , I n c .

o m

p u t e r

DT

ie v l ie s v i oi s n i o n

Lets look more closely at the Television Lets look more closely at the Television Divisions income statement. Divisions income statement.
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Levels of Segmented Statements


Our approach to segment reporting uses the contribution format.
Income Statement Contribution Margin Format Television Division Sales $ 300,000 Variable COGS 120,000 Other variable costs 30,000 Total variable costs 150,000 Contribution margin 150,000 Traceable fixed costs 90,000 Division margin $ 60,000
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Cost of goods Cost of goods sold consists of sold consists of variable variable manufacturing manufacturing costs. costs. Fixed and Fixed and variable costs variable costs are listed in are listed in separate separate sections. sections.
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Levels of Segmented Statements


Our approach to segment reporting uses the contribution format.
Income Statement Contribution Margin Format Television Division Sales $ 300,000 Variable COGS 120,000 Other variable costs 30,000 Total variable costs 150,000 Contribution margin 150,000 Traceable fixed costs 90,000 Division margin $ 60,000
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Contribution margin Contribution margin is computed by is computed by taking sales minus taking sales minus variable costs. variable costs. Segment margin Segment margin is Televisions is Televisions contribution contribution to profits. to profits.
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Levels of Segmented Statements


Income Statement Company Television $ 500,000 $ 300,000 230,000 150,000 270,000 150,000 170,000 90,000 100,000 $ 60,000 25,000 $

Sales Variable costs CM Traceable FC Division margin Common costs Net operating income

Computer $ 200,000 80,000 120,000 80,000 $ 40,000

Common costs should not Common costs should not be allocated to the be allocated to the 75,000 divisions. These costs divisions. These costs would remain even if one would remain even if one of the divisions were of the divisions were eliminated. eliminated.
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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 into smaller segments.

Lets see how this works using the Webber Inc. example!
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Traceable Costs Can Become Common Costs

Webbers Television Division


Television Division

Regular

Big Screen

Product Lines
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Traceable Costs Can Become Common Costs

Sales Variable costs CM Traceable FC Product line margin Common costs Divisional margin

Income Statement Television Division Regular $ 300,000 $ 200,000 150,000 95,000 150,000 105,000 80,000 45,000 70,000 $ 60,000 10,000 $ 60,000

Big Screen $ 100,000 55,000 45,000 35,000 $ 10,000

Fixed costs directly traced Fixed costs directly traced to the Television Division to the Television Division
$80,000 + $10,000 = $90,000 $80,000 + $10,000 = $90,000

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

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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: 1. This practice may make a profitable business segment appear to be unprofitable. 2. Allocating common fixed costs forces managers to be held accountable for costs they cannot control.

Segment 1

Segment 2

Segment 3

Segment 4

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Allocations of Common Costs

Sales Variable costs CM Traceable FC Segment margin Common costs Profit

Income Statement Haglund's Lakeshore Bar $ 800,000 $ 100,000 310,000 60,000 490,000 40,000 246,000 26,000 244,000 $ 14,000 200,000 $ 44,000

Restaurant $ 700,000 250,000 450,000 220,000 $ 230,000

Assume that Haglunds Lakeshore prepared the segmented income statement as shown. Common Cost: 10% to Bar & 90% to Restaurant
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Allocations of Common Costs

Sales Variable costs CM Traceable FC Segment margin Common costs Profit

Income Statement Haglund's Lakeshore Bar $ 800,000 $ 100,000 310,000 60,000 490,000 40,000 246,000 26,000 244,000 14,000 200,000 20,000 $ 44,000 $ (6,000)

Restaurant $ 700,000 250,000 450,000 220,000 230,000 180,000 $ 50,000

Hurray, now everything adds up!!!


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