Chapter 10

Chapter 10
Segment Reporting, Decentralization,

and the Balanced Scorecard
PowerPoint Authors:
Jon A. Booker, Ph.D., CPA, CIA
Charles W. Caldwell, D.B.A., CMA
Susan Coomer Galbreath, Ph.D., CPA
McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
10-2
Decentralization in Organizations
Advantages of
Top management
Decentralization freed to concentrate
on strategy.
Lower-level managers
gain experience in
in
decision-making. Decision-making
authority leads to
job satisfaction.
satisfaction.
Lower-level decisions
often based on
better information.
Lower level
level managers
can respond quickly
quickly
to customers.
10-3
Decentralization in Organizations
May be a lack of
coordination among
autonomous
Lower-level managers managers.
may
may make decisions
without
without seeing
seeing the
“big picture.” Disadvantages of
Decentralization
Lower-level manager’s
objectives may not
be
be those of the May be
be difficult
difficult to
organization.
organization. spread innovative ideas
ideas
in the organization.
10-4
Responsibility Accounting
Cost
Cost Profit
Profit Investment
Investment
Center
Center Center
Center Center
Center
Cost, profit,
and investment
centers are all
known as Responsibility
Responsibility
Center
Center
responsibility
centers.
10-5
Cost Center
A segment whose manager has control
over costs, but not over revenues or
investment funds.
10-6
Profit Center
Revenues
A segment whose Sales
manager has control Interest
over both costs and Other
revenues, Costs
but no control over Mfg. costs
investment funds. Commissions
Salaries
Other
10-7
Investment Center
Corporate Headquarters
A segment whose
manager has
control over costs,
revenues, and
investments in
operating assets.
10-8
Responsibility Centers
Investment
Centers S u p e r io r F o o d s C o r p o r a tio n
C o rp o ra te H e a d q u a rte rs
P r e s id e n t a n d C E O
O p e r a tio n s F in a n c e Legal P e rs o n n e l
V ic e P r e s id e n t C h ie f F In a n c ia l O ffic e r G e n e ra l C o u n s e l V ic e P r e s id e n t
S a lty S n a c k s B e v e ra g e s C o n fe c tio n s
P ro d u c t M a n g e r P ro d u c t M a n a g e r P ro d u c t M a n a g e r
B o ttlin g P la n t W a re h o u s e D is tr ib u tio n
Cost
Centers
M anager M anager M anager
Superior Foods Corporation provides an example of the

various kinds of responsibility centers that exist in an
organization.
10-9
S u p e r io r F o o d s C o r p o r a tio n
Profit
Centers
organization.
10-10
Cost
Centers

organization.
10-11
Learning Objective 1
Prepare a segmented income

statement using the contribution
format, and explain the difference
between traceable fixed costs
and common fixed costs.
10-12
Decentralization and Segment Reporting

An Individual Store
Quick Mart
A segment is any part or A Sales Territory

activity of an organization
about which a manager
seeks cost, revenue, or
profit data.
A Service Center
10-13
Superior Foods: Segmented by

Geographic Regions
$ 5 0 0 , 0 0 0 ,0 0 0
E ast W est M id w e s t S o u th
$ 7 5 ,0 0 0 ,0 0 0 $ 3 0 0 ,0 0 0 ,0 0 0 $ 5 5 ,0 0 0 ,0 0 0 $ 7 0 ,0 0 0 ,0 0 0
O re g o n W a s h in g to n C a lif o r n ia M o u n t a in S t a t e s
$ 4 5 ,0 0 0 ,0 0 0 $ 5 0 ,0 0 0 ,0 0 0 $ 1 2 0 ,0 0 0 ,0 0 0 $ 8 5 ,0 0 0 ,0 0 0
Superior Foods Corporation could segment its business

by geographic region.
10-14
Superior Foods: Segmented by

Customer Channel
$ 5 0 0 ,0 0 0 ,0 0 0
C o n v e n ie n c e S to r e s S u p e r m a r k e t C h a in s W h o le s a l e D i s t r ib u t o r s D r u g s to r e s
$ 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 0
S u p e r m a r k e t C h a in A S u p e r m a r k e t C h a in B S u p e r m a r k e t C h a in C S u p e r m a r k e t C h a in D
$ 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.
10-15
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.
10-16
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.
10-17
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 . . . CEO.
10-18
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.
10-19
Segment Margin
The segment 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.
Segment Margin
Time
10-20
Traceable and Common Costs

Fixed Don’t allocate
Costs common costs to
segments.
Traceable Common
10-21
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.
Pipe Products
9-inch 12-inch 18-inch Total
Warehouse sq. ft. 1,000 4,000 5,000 10,000
Lease price per sq. ft. $ 4 $ 4 $ 4 $ 4
Total lease cost $ 4,000 $ 16,000 $ 20,000 $ 40,000
10-22
Levels of Segmented Statements

Webber, Inc. has two divisions.
Webber, Inc.
Computer Television
Division Division
Let’s look more closely at the

Television Division’s income
statement.
10-23

Our approach to segment reporting uses the
contribution format.
Cost
Cost of
of goods
goods
sold
sold consists
consists of
of
variable
variable
manufacturing
manufacturing
costs.
costs.
Fixed
Fixed and
and
variable
variable costs
costs
are
are listed
listed in
in
separate
separate
sections.
sections.
10-24

Our approach to segment reporting uses the
contribution format.
Contribution
Contribution margin
margin
is
is computed
computed byby
taking
taking sales
sales minus
minus
variable
variable costs.
costs.
Segment
Segment margin
margin
is
is Television’s
Television’s
contribution
contribution
to
to profits.
profits.
10-25

10-26
Common
Common costs
costs should
should notnot
be
be allocated
allocated to
to the
the
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.
10-27

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!
10-28

Common Costs
Webber’s Television Division
Television
Division
LCD Plasma
Product
Lines
10-29

Common Costs
We obtained the following information from

the LCD and Plasma segments.
10-30

Common Costs
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
10-31
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.
10-32
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
10-33
Inappropriate Methods of Allocating

Costs Among Segments
Failure to trace Inappropriate

costs directly allocation base
Segment Segment Segment Segment

1 2 3 4
10-34
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
10-35
Quick Check 
Assume that Hoagland's Lakeshore prepared its

segmented income statement as shown.
10-36
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.
10-37
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.
10-38
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
10-39
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 The bar would be
c. $40,000 allocated 1/10 of the cost
d. $50,000 or $20,000.
10-40
Quick Check 
If Hoagland's allocates its common
costs to the bar and the restaurant,
what would be the reported profit of
each segment?
10-41
Allocations of Common Costs
Hurray, now everything adds up!!!

10-42
Quick Check 
Should the bar be eliminated?
a. Yes
b. No
10-43
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, profit drops to $30,000!
10-44
Compute return on investment

(ROI) and show how changes in
sales, expenses, and assets
affect ROI.
10-45
Return on Investment (ROI) Formula

Income before interest
and taxes (EBIT)
Net operating income

ROI =
Average operating assets
Cash, accounts receivable, inventory,

plant and equipment, and other
productive assets.
10-46
Net Book Value versus Gross Cost

Most companies use the net book value of
depreciable assets to calculate average
operating assets.
Acquisition cost
Less: Accumulated depreciation
Net book value
10-47
Understanding ROI
ROI =
Average operating assets
Margin =
Sales
Sales
Turnover =
Average operating
assets
ROI =Margin  Turnover
10-48
Increasing ROI
There are three ways to increase ROI . . .
Reduce
Increase Expenses Reduce
Sales Assets
10-49
Increasing ROI – An Example

Regal Company reports the following:
Net operating income $ 30,000
Average operating assets $ 200,000
Sales $ 500,000
Operating expenses $ 470,000
What is Regal Company’s ROI?

ROI = Margin  Turnover
Net operating income Sales
ROI = ×
Sales Average operating assets
10-50
Increasing ROI – An Example

ROI = ×
ROI = $30,000 $500,000

×
$500,000 $200,000
ROI =6%  2.5 = 15%

10-51
Investing in Operating Assets to

Increase Sales
Suppose 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.

10-52
Investing in Operating Assets to

Increase Sales
ROI = ×
ROI = $50,000 × $535,000

$535,000 $230,000
9.35%  2.33 = 21.8%

ROI =
ROI increased from 15% to 21.8%.

10-53
Criticisms of ROI
In the absence of the balanced
scorecard, management may
not know how to increase ROI.
Managers often inherit many

committed costs over which
they have no control.
Managers evaluated on ROI

may reject profitable
investment opportunities.
10-54
Compute residual income

and understand its
strengths and weaknesses.
10-55
Residual Income - Another

Measure of Performance

above some minimum
required return on
operating assets
10-56
Calculating Residual Income
( )
Net Average Minimum
Residual
= operating - operating  required rate of
income
income assets return
ROI measures net operating income earned relative

to the investment in average operating assets.
Residual income measures net operating income
earned less the minimum required return on average
operating assets.
10-57
Residual Income – An Example

••The
The Retail
Retail Division
Division of
of Zephyr,
Zephyr, Inc.
Inc. has
has
average
average operating
operating assets
assets ofof $100,000
$100,000 and
and is
is
required
required to to earn
earn aa return
return of
of 20%
20% onon these
these
assets.
assets.
••InIn the
the current
current period,
period, the
the division
division earns
earns
$30,000.
$30,000.
Let’s calculate residual income.

10-58
Residual Income – An Example

Operating
Operating assets
assets $$100,000
100,000
Required
Required rate
rate of
of return
return ×× 20%
20%
Minimum
Minimum required
required return
return $$ 20,000
20,000
Actual
Actual income
income $$ 30,000
30,000
Minimum
Minimum required
requiredreturn
return (20,000)
(20,000)
Residual
Residual income
income $$ 10,000
10,000
10-59
Motivation and Residual Income

Residual income encourages managers to
make investments that are profitable
for the entire company but would be
rejected by managers who are evaluated
using the ROI formula.
10-60
Quick Check 
Redmond Awnings, a division of Wrap-up Corp.,
has a net operating income of $60,000 and
average operating assets of $300,000. The
required rate of return for the company is 15%.
What is the division’s ROI?
a. 25%
b. 5%
c. 15%
d. 20%
10-61
Quick Check 
What is the division’s ROI?
a. 25%
b. 5%
ROI = NOI/Average operating assets
c. 15%
d. 20% = $60,000/$300,000 = 20%
10-62
Quick Check 
average operating assets of $300,000. If the
manager of the division is evaluated based on
ROI, will she want to make an investment of
$100,000 that would generate additional net
operating income of $18,000 per year?
a. Yes
b. No
10-63
Quick Check 
average operating assets of $300,000. If the
manager of the division is evaluated based on
ROI, will she want to make an investment of
$100,000 that would generate additional net
operating income of $18,000 per year?
a. Yes ROI = $78,000/$400,000 = 19.5%
b. No
This lowers the division’s ROI from
20.0% down to 19.5%.
10-64
Quick Check 
The company’s required rate of return is 15%.
Would the company want the manager of the
Redmond Awnings division to make an
investment of $100,000 that would generate
additional net operating income of $18,000 per
year?
a. Yes
b. No
10-65
Quick Check 
The company’s required rate of return is 15%.
Would the company want the manager of the
Redmond Awnings division to make an
investment of $100,000 that would generate
additional net operating income of $18,000 per
year?
ROI = $18,000/$100,000 = 18%
a. Yes
b. No The return on the investment
exceeds the minimum required rate
of return.
10-66
Quick Check 
What is the division’s residual income?
a. $240,000
b. $ 45,000
c. $ 15,000
d. $ 51,000
10-67
Quick Check 
What is the division’s residual income?
a. $240,000
b. $ 45,000
c. $ 15,000
d. $ 51,000
10-68
Quick Check 
If the manager of the Redmond Awnings
division is evaluated based on residual
income, will she want to make an investment
of $100,000 that would generate additional
net operating income of $18,000 per year?
a. Yes
b. No
10-69
Quick Check 
If the manager of the Redmond Awnings
division is evaluated based on residual
income, will she want to make an investment
of $100,000 that would generate additional
net operating income of $18,000 per year?
a. Yes
b. No
10-70
Divisional Comparisons and

Residual Income
The residual
income approach
has one major
disadvantage.
It cannot be used
to compare the
performance of
divisions of
different sizes.
10-71
Zephyr, Inc. - Continued

Recall the following Assume the following
information for the Retail information for the Wholesale
Division of Zephyr, Inc. Division of Zephyr, Inc.
Retail
Retail Wholesale
Wholesale
Operating
Operating assets
assets $$ 100,000
100,000 $$ 1,000,000
1,000,000
Required
Required rate
rate of
ofreturn
return ×× 20%
20% 20%
20%
Minimum
Minimum required
required return
return $$ 20,000
20,000 $$ 200,000
200,000
Retail
Retail Wholesale
Wholesale
Actual
Actual income
income $$ 30,000
30,000 $$ 220,000
220,000
Minimum
Minimum required
required return
return (20,000)
(20,000) (200,000)
(200,000)
Residual
Residual income
income $$ 10,000
10,000 $$ 20,000
20,000
10-72
Zephyr, Inc. - Continued

The residual income numbers suggest that the Wholesale
Division outperformed the Retail Division because its
residual income is $10,000 higher. However, the Retail
Division earned an ROI of 30% compared to an ROI of 22% for
the Wholesale Division. The Wholesale Division’s residual
income is larger than the Retail Division simply because it is
a bigger division.
Retail
Retail Wholesale
Wholesale
Operating
Operatingassets
assets $$ 100,000
100,000 $ 1,000,000
$ 1,000,000
Required
Required rateof
rate ofreturn
return ×× 20%
20% 20%
20%
Minimum
Minimumrequired
requiredreturn
return $$ 20,000 $
20,000 $ 200,000
200,000
Retail
Retail Wholesale
Wholesale
Actual income
Actual income $$ 30,000
30,000 $$ 220,000
220,000
Minimum required return
Minimum required return (20,000)
(20,000) (200,000)
(200,000)
Residual
Residualincome
income $$ 10,000
10,000 $$ 20,000
20,000
10-73
Understand how to
construct and use a
balanced scorecard.
10-74
The Balanced Scorecard

Consists of an integrated set of performance
measures that are derived from and support a
company’s strategy.
Financial Customers
Performance
measures
Internal Learning
business and growth
processes
10-75

Performance Measures
Financial
Has our financial What are our
performance improved? financial goals?
Customer What customers do Vision

Do customers recognize that we want to serve and and
we are delivering more value? how are we going to
win and retain them? Strategy
Internal Business Processes What internal busi-

Have we improved key business ness processes are
processes so that we can deliver critical to providing
more value to customers? value to customers?
Learning and Growth

Are we maintaining our ability
to change and improve?
10-76

The balanced scorecard relies on non-financial measures
in addition to financial measures for two reasons:

 Financial
Financial measures
measures are are lag
lag indicators
indicators that
that summarize
summarize
the
the results
results of
of past
past actions.
actions. Non-financial
Non-financial measures
measures are
are
leading
leading indicators
indicators of
of future
future financial
financial performance.
performance.

 Top
Top managers
managers are
are ordinarily
ordinarily responsible
responsible for
for financial
financial
performance
performance measures
measures –– not
not lower
lower level
level managers.
managers.
Non-financial
Non-financial measures
measures are
are more
more likely
likely to
to be
be
understood
understood and
and controlled
controlled by
by lower
lower level
level managers.
managers.
10-77
The Balanced Scorecard for

Individuals
The entire organization Each individual should
should have an overall have a personal
balanced scorecard. balanced scorecard.
AApersonal
personal scorecard
scorecard should
should contain
contain measures
measures that
that can
can be
be
influenced
influenced by
by the
the individual
individual being
being evaluated
evaluated and
and that
that
support
support the
the measures
measures in in the
the overall
overall balanced
balanced scorecard.
scorecard.
10-78

A balanced scorecard should have measures
that are linked together on a cause-and-effect basis.
If we improve Then Another desired

one performance performance measure
measure . . . will improve.
The balanced scorecard lays out concrete

actions to attain desired outcomes.
10-79
The Balanced Scorecard and

Compensation
Incentive compensation should be linked to
balanced scorecard performance

measures.
10-80
The Balanced Scorecard ─ An

Example
Profit
Financial
Contribution per car
Number of cars sold

Customer
Customer satisfaction
with options
Internal
Number of Time to
Business options available install option
Processes
Learning Employee skills in

and Growth installing options
10-81

Example
Profit
Number of cars sold
Results
with options Satisfaction
Increases
Strategies
Increase Number of Time to
Options options available install option Time
Decreases
Increase Employee skills in

Skills installing options
10-82

Example
Profit

Results
Number of cars sold Cars sold

Increase
Customer satisfaction Satisfaction

with options Increases
Number of Time to
options available install option
Employee skills in
installing options
10-83

Example
Profit Results
Contribution
Contribution per car Increases
Number of cars sold
Customer satisfaction Satisfaction

with options Increases
Number of Time to Time

options available install option Decreases
Employee skills in
installing options
10-84

Example
Profit Profits
If number Increase
of cars sold Contribution per car Contribution
and contribution Increases
per car increase, Cars Sold
Number of cars sold
profits Increases
increase. Results
with options
Number of Time to
options available install option
Employee skills in
installing options
10-85
End of Chapter 10

Chapter 10

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Chapter 10

Segment Reporting, Decentralization,

Superior Foods Corporation provides an example of the

Superior Foods Corporation provides an example of the

Prepare a segmented income

Decentralization and Segment Reporting

A segment is any part or A Sales Territory

Superior Foods: Segmented by

Superior Foods Corporation could segment its business

Superior Foods: Segmented by

Superior Foods Corporation could segment its business

Keys to Segmented Income

Traceable fixed costs should be separated

Identifying Traceable Fixed Costs

Identifying Common Fixed Costs

Traceable Costs Can Become

For example, the landing fee

Traceable and Common Costs

Levels of Segmented Statements

Let’s look more closely at the

Levels of Segmented Statements

Levels of Segmented Statements

Levels of Segmented Statements

Levels of Segmented Statements

Traceable Costs Can Become

Let’s see how this works using

Traceable Costs Can Become

Traceable Costs Can Become

We obtained the following information from

Traceable Costs Can Become

1. Companies must report segmented

Inappropriate Methods of Allocating

Failure to trace Inappropriate

Segment Segment Segment Segment

Common Costs and Segments

Segment Segment Segment Segment

Assume that Hoagland's Lakeshore prepared its

How much of the common fixed cost of

How much of the common fixed cost of

Allocations of Common Costs

Hurray, now everything adds up!!!

Compute return on investment

Return on Investment (ROI) Formula

Net operating income

Cash, accounts receivable, inventory,

Net Book Value versus Gross Cost

Increasing ROI – An Example

What is Regal Company’s ROI?

Increasing ROI – An Example

ROI = $30,000 $500,000

ROI =6%  2.5 = 15%

Investing in Operating Assets to

Net operating income $ 50,000

Let’s calculate the new ROI.

Investing in Operating Assets to

ROI = $50,000 × $535,000

9.35%  2.33 = 21.8%

ROI increased from 15% to 21.8%.

Managers often inherit many

Managers evaluated on ROI

Compute residual income

Residual Income - Another

Net operating income