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11th Edition

Chapter 12

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Segment Reporting and
Decentralization

Chapter Twelve

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Decentralization in Organizations

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

May
May be
be aa lack
lack of
of
coordination
coordination among
among
autonomous
autonomous
Lower-level
Lower-level managers
managers managers.
managers.
may
may make
make decisions
decisions
without
without seeing
seeing the
the
“big
“big picture.”
picture.”
Disadvantages of
Lower-level
Decentralization
Lower-level manager’s
manager’s
objectives
objectives may
may not
not
be
be those
those of
of the
the
organization.
organization. May
May bebe difficult
difficult to
to
spread
spread innovative
innovative ideas
ideas
in
in the
the organization.
organization.
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Cost, Profit, and Investments Centers

Cost
Cost Profit
Profit Investment
Investment
Center
Center Center
Center Center
Center

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

Revenues
Profit Center
Sales
A segment whose Interest
manager has control Other
over both costs and Costs
revenues, Mfg. costs
but no control over Commissions
investment funds. 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 S u pe r i o r F o o d s
C o r p o r a t e
C o r p o r a t i o n
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

O p e r a t i o n s F i n a n c e L e g a l P e r s o n n
V i c e P r e s i Cd eh ni e t f F I n a n c i Ga l e On fe f ri ca el rC o u Vn is c e e l P r e s

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

B o t t l i n g WP l aa r n e t h o Du si s e t r i b u t i o n
Cost
Centers
M a n a g e Mr a n a g e Mr a n a g e r

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 u pe 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

O p e r a t i o n s F i n a n c e L e g a l P e r s o n n
V i c e P r e s i Cd eh ni e t f F I n a n c i Ga l e On fe f ri ca el rC o u Vn is c e e l P r e s

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

B o t t l i n g WP l aa r n e t h o Du si s e t r i b u t i o n
Profit
M a n a g e Mr a n a g e Mr a n a g e r
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 u pe 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

O p e r a t i o n s F i n a n c e L e g a l P e r s o n n
V i c e P r e s i Cd eh ni e t f F I n a n c i Ga l e On fe f ri ca el rC o u Vn is c e e l P r e s

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

B o t t l i n g WP l aa r n e t h o Du si s e t r i b u t i o n
Cost
Centers
M a n a g e Mr a n a g e Mr a n a g e r

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
A segment is any part Quick Mart

or activity of an
organization about A Sales Territory
which a manager
seeks cost, revenue,
or profit data. A
segment can be . . .
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 o r p o r a t i o n
$ 5 0 0 , 0 0 0 , 0 0 0

E 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$ 05 05 , 0 0 0 , 0 $0 70 0 , 0 0 0 ,

O r e g o n W a s h i n g t oC n a l i f o r n Mi a o u n t a i n 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$ 08 05 , 0 0 0 , 0 0 0

Superior Foods Corporation could segment its business


by geographic regions.
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Superior Foods: Customer Channel

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

C o n v e n i e n c eS uS p t oe rr em s a r k e W t Ch oh l a e i sn as l e 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

S u p e r m a r k eS t u C p h e a r mi n a A r k eS t u C p h e ar mi n a B r k eS t u C p h e ar mi n a C r k e t C h a i n
$ 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 No computer
division means . . . 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 We still have a


division but . . . 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,


margin which is computed by subtracting
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 Don’t allocate


Costs common costs to
segments.

Traceable Common

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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.

P ipe P roducts
9-inch 12-inch 18-inch Tota l
W a re house sq. ft. 1,000 4,000 5,000 10,000
Le a se price pe r sq. ft.
$ 4 $ 4 $ 4 $ 4
Tota l le a se cost $ 4,000 $ 16,000 $ 20,000 $ 40,000

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Levels of Segmented Statements

Webber, Inc. has two divisions.

W e b b e r , I n c .

C o m p u t e r DT ie v l ie s v i oi s n i o n

Let’s
Let’s look
look more
more closely
closely at
at the
the Television
Television
Division’s
Division’s income
income statement.
statement.

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Levels of Segmented Statements

Our approach to segment reporting uses the


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

Our approach to segment reporting uses the


contribution format.
Income Statement
Contribution Margin Format Contribution
Contribution margin
margin
Television Division is
is computed
computed byby
Sales $ 300,000 taking
taking sales
sales minus
minus
Variable COGS 120,000 variable
variable costs.
costs.
Other variable costs 30,000
Total variable costs 150,000
Segment
Segment margin
margin
Contribution margin 150,000
is
is Television’s
Television’s
Traceable fixed costs 90,000
contribution
contribution
Division margin $ 60,000
to
to profits.
profits.
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Levels of Segmented Statements

Income Statement
Company Television Computer
Sales $ 500,000 $ 300,000 $ 200,000
Variable costs 230,000 150,000 80,000
CM 270,000 150,000 120,000
Traceable FC 170,000 90,000 80,000
Division margin 100,000 $ 60,000 $ 40,000
Common costs
Net operating
income

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Levels of Segmented Statements

Income Statement
Company Television Computer
Sales $ 500,000 $ 300,000 $ 200,000
Variable costs 230,000 150,000 80,000
CM 270,000 150,000 120,000
Traceable FC 170,000 90,000 80,000
Division margin 100,000 $ 60,000 $ 40,000
Common costs 25,000
Common
Common costs
costs should
should notnot
Net operating
be
be allocated
allocated to
to the
the
income $ 75,000 divisions.
divisions. These
These costs
costs
would
would remain
remain even
even ifif one
one
of
of the
the divisions
divisions were
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.

Let’s see how this works


using the Webber Inc.
example!

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Traceable Costs Can Become Common Costs

Webber’s Television Division


Television
Division

Regular Big Screen

Product
Lines
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Traceable Costs Can Become Common Costs

Income Statement
Television
Division Regular Big Screen
Sales $ 200,000 $ 100,000
Variable costs 95,000 55,000
CM 105,000 45,000
Traceable FC 45,000 35,000
Product line margin $ 60,000 $ 10,000
Common costs
Divisional margin

We obtained the following information from


the Regular and Big Screen segments.
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Traceable Costs Can Become Common Costs

Income Statement
Television
Division Regular Big Screen
Sales $ 300,000 $ 200,000 $ 100,000
Variable costs 150,000 95,000 55,000
CM 150,000 105,000 45,000
Traceable FC 80,000 45,000 35,000
Product line margin 70,000 $ 60,000 $ 10,000
Common costs 10,000
Divisional margin $ 60,000

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

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External Reports

The Financial Accounting Standards Board now requires


that companies in the United States include segmented
financial data in their annual reports.

1. Companies must report segmented


results to shareholders using the same
methods that are used for internal
segmented reports.
2. Since the contribution approach to
segment reporting does not comply
with GAAP, it is likely that some
managers will choose to construct
their segmented financial statements
using the absorption approach to
comply with GAAP.

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Omission of Costs

Costs assigned to a segment should include all


costs attributable to that segment from the
company’s entire value chain.
chain

Business Functions
Making Up The
Value Chain
Product Customer
R&D Design Manufacturing Marketing Distribution Service

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Inappropriate Methods of Allocating Costs Among
Segments

Failure to trace
costs directly Inappropriate
allocation base

Segment Segment Segment Segment


1 2 3 4

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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 Segment Segment Segment


1 2 3 4

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Allocations of Common Costs

Income Statement
Haglund's
Lakeshore Bar Restaurant
Sales $ 800,000 $ 100,000 $ 700,000
Variable costs 310,000 60,000 250,000
CM 490,000 40,000 450,000
Traceable FC 246,000 26,000 220,000
Segment margin 244,000 $ 14,000 $ 230,000
Common costs 200,000
Profit $ 44,000

Assume that Haglund’s Lakeshore prepared the


segmented income statement as shown.
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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.

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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.

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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

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.


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

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.


Quick Check 

If Haglund’s allocates its common


costs to the bar and the restaurant,
what would be the reported profit of
each segment?

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Allocations of Common Costs

Income Statement
Haglund's
Lakeshore Bar Restaurant
Sales $ 800,000 $ 100,000 $ 700,000
Variable costs 310,000 60,000 250,000
CM 490,000 40,000 450,000
Traceable FC 246,000 26,000 220,000
Segment margin 244,000 14,000 230,000
Common costs 200,000 20,000 180,000
Profit $ 44,000 $ (6,000) $ 50,000

Hurray, now everything adds up!!!


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Quick Check 

Should the bar be eliminated?


a. Yes
b. No

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Quick Check 

Should the bar be eliminated?


a. Yes The profit was $44,000 before
b. No eliminating the bar. If we eliminate
the bar,
Income profit drops to $30,000!
Statement
Haglund's
Lakeshore Bar Restaurant
Sales $ 700,000 $ 700,000
Variable costs 250,000 250,000
CM 450,000 450,000
Traceable FC 220,000 220,000
Segment margin 230,000 230,000
Common costs 200,000 200,000
Profit $ 30,000 $ 30,000
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End of Chapter 12

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.

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