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Chapter 11.docx

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Rotman Commerce
John Oesch

Chapter 11: Reporting for control Decentralization in organization  Decentralized organization: an organization in which decision making is spread throughout the organization rather than being confined to a few top executives  In one extreme, a strongly decentralized organization is one in which there are few, if any, constraint on the feed a quality that the lowest level managers and employees to make decisions  And the other extreme, in a strongly centralized organization, no level managers have little be done to make decision Decentralization and somewhat reporting  Affecting decentralization requires that meant reporting to permit an analysis if and evaluation of the decisions made by the segment manager  A segment is defined as a part or activity of an organization about which managers would like costs, revenue, or profit that has Segment reporting  To operate effectively, managers and decision makers must have a great deal more information available to them that the information provided by its single company wide income statement  Managers may want to analyze the results at a more detailed level to see if some salespeople are more effective than others or to see if some producing divisions are effectively or ineffectively using their capacity and resources.  To uncover in such problems the managers may need not one but several income statements that focus on the segments of a company The preparation of income statements of this type is known as segmented reporting  An operating segment for Financial Accounting purposes is a component of an enterprise 1. That engages in business activities from which each may earn revenues and incur expenses 2. Most operating results are regularly reviewed by the enterprise is chief operating officer to make decisions about resources to be allocated to the segment and assess its performance 3. For which discrete financial information is available Deferring levels of segmented statements  The divisions in fragmented income statement are segmented according to their major product lines  *** exhibit 11.1 and the example under this section***  By carefully examining trends and results in each segment, the manager can be considerable insight into the company as a whole and perhaps discover opportunities and courses of action that would otherwise be remained hidden from view.  The order of breakdown depends on what information is desired What management wants to learn and the type of comparison desired are factors used for deciding the order of breakdown The order of breakdown should not affect of the numbers, but it can alter what appears on a given report and the ease of review Assigning costs to segments  The segmented statements for internal use are typically prepared in the contribution format  In segmented statements, the fixed cost are divided into two parts on a segment that statement: 1. Traceable fixed cost: fixed cost labeled traceable are charged to the various segments 2. Common fixed cost: if fixed cost is not traceable directly to some segments than, it is treated as a common cost and kept separate from the segments themselves  Two items are followed in assigning cost to of various segments of a company under the contribution approach: 1. First, according to cost behavior pattern (variable or fixed) 2. Second, according to whether the cost are directly traceable to the segments involved Sales and contribution margin  To prepare segmented statements for management purposes, it is necessary to keep records of sales by individual segment, as well as in total for the organization.  After deducting related variable expenses, a contribution margin figures can be computed for each segment  If sales volume goes up or down, the effect on operating income can easily be computed by simply multiply the unit contribution margin by the change in the units sold or by multiplying the change its sales dollars by the contribution margin ratio  Segmented statements gives the manager the ability to make such computation on a product by product, division by division, or territory by territory basis, thereby, providing the information needed to show of areas for weaknesses or to capitalize on areas of strengths.  Like carefully monitoring segment contribution margin and segment contribution margin ratios, the manager is in a position to make those short-term decisions that maximized each segments contribution to the overall probability of the organization The importance of fixed cost  The breaking apart of variable and fixed cost also emphasizes to management that are costs are controlled differently and that these differences must be kept clearly in mind for both short run and long run planning  The group be a fixed costs under the contribution approach highlights the fact that, after the fixed costs have been covered, operating income increases to the extent of the contribution margin generated on each additional unit sold All of these concepts are useful to the manager internally for planning purposes Traceable and common fixed costs  Traceable fixed cost: fixed cost that can be identified with a particular segment and that arises because of the existence of the segment Only the traceable fixed costs are charged to particular segment  Common fixed cost: a fixed cost that supports the operations of more than one segment but it is not traceable in whole or in part to any one segmentcommon Fixed costs are not allocated two segments—the total amount is deducted to arrive at the income of the company as a whole Identifying traceable fixed cost  The general guideline to treat as traceable cost only those costs that would disappear over time as the segment itself does.  The important point is to resist the temptation to allocate cost such as depreciation that are clearly common and that will continue regardless of whether the segment exist are not Any allocation of common costs to segments reduces the value of the segment margin as a guide to long-run segment of ability and segment performance Breakdown of traceable fixed cost  A breakdown of the traceable fixed cost should be between discretionary fixed costs that are under the immediate control of the manager and committed fixed costs that are not under the immediate control of the manager  The discretionary fixed costs should be separated from the commuter fixed costs and deducted as a separate group from the segments contribution margin  The amount two remaining after deducting the discretionary fixed cost sometimes called a segment performance margin, should then be used as a basis for evaluating the segment manager’s performance because the margin under this segment represents the amount after deducting all costs controllable by the segment manager  Activity-based costing: - The method of assigning cost combines the strengths of activity-based costing read the power of the contribution approach and greatly enhances the managers ability to measure their profitability and performance of segments - However, managers must still ask themselves if the cost would in fact disappear over time if the segment itself disappeared - *** read the example under this section*** Traceable cost can become common  Fixed costs that are traceable in one segment made the comment cost for no other segments because there are limits to how finely a cost can be separated without resorting to arbitrary allocation The more finely segments are defined, the more cost there are that are common  *** see the example under this section and exhibit 11.2: reclassification of traceable fixed expenses from exhibit 11.1*** Segments margin  Segments margin: the segments margin is obtained by deducting the segments traceable fixed cost from the segments contribution margin Represents and the margin it available after a segment has covered all of its own expenses  The term long-run is added to probability because fixed cost could be altered if the segment was eliminated If a segment cannot cover its own cost, that segment probably could be dropped (unless it is essential to sales of other segments)  From in decision-making point of view, the segment margin is most useful in major decisions that affect capacity, such as dropping assignment  The contribution margin is most useful in decisions relating to short run changes, such as pricing of special orders that involve temporary use of existing capacity Summarize reporting for Financial Accounting  *** read from the PowerPoint*** Hindrances to improper cost assignment Omission of cost - The cost assigned to a segment should include all cost attributable to that segment from the company’s entire value chain. - To avoid having to maintain two costing system and provide consistency between internal and external reports, many companies also use absorption costing for the internal reports such as segmented income statements. As a result, such companies omit from their profitability analysis part or all of the upstream cost in the value chain, which consist of research and development and product design and the downstream cost which consist of marketing, distribution, and customer service Is either the upstream or downstream cost are omitted in probability analysis, and then the product is under cost eight and management may unwittingly double up and maintain products that result in losses in the long run In appropriate methods for assigning traceable cost among segments - Many companies may not trace fixed expenses to segments even when it is feasible to do so and they may use inappropriate to a location base is to allocate traceable fixed expenses to segments Failure to trace costs directly - Failure to trace costs directly to a specific company segment can result in this cost being placed in a company-wide overhead pool - While a portion of these cost would be allocated in the second generating these cost, the rest would be incorrectly allocated for other segments Inappropriate allocation base - Costs should be allocated two segments for internal decision-making purposes only when the allocation base actually drives the cost being allocated Arbitrarily dividing common cost among segments - If common cost is allocated among segments, the net effect will be to reduce the prophets of the company as a whole and make it even more difficult to cover the common cost Responsibility centers  Responsibility center: any business segment was manager has control over the cost or profits or the use of investment funds  Types of responsibility cen
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