Decentralization

AutonomyAuthority

to make decisions

Responsibility

12 Segment Reporting andDecentralization

Chapter

Baby Care

Food and BeverageFabric and Home Care

Production

Marketing

Finance

Advantages?

Disadvantages?

What management

control system?

Example of Decentralization

Proctor & Gamble

Cost Center

Responsibility Centers

Profit center

Investment center

Segment Reporting

Possible segments:

divisions w/in a company

product lines w/in a division

Report by segment:

revenues

variable expenses

traceable fixed expenses

Do not allocate common fixed expenses to segments.

segment managers cannot control these

Segment margin

Issues in Responsibility Accounting

Responsibility for which expenses?

Gain or loss on sale of equipment?

Depreciation?

Taxes?

Does responsibility require complete control?

Are comparisons meaningful across operating units?

Should common costs ever be allocated?

Evaluating Investment Center Performance

Required rate of return 18%

Weighted-average cost of capital

15%

Tax rate 30%

Compagniedu Froid

France Italy Spain

Fr 75,400

71,600

Fr 2,400

22,900

(7,300)

Fr 3,800

Fr 18,000

Fr 4,200

Fr 42,500

40,100

Fr 1,500

18,700

(10,200)

Fr 2,400

Fr 10,000

Fr 1,100

Fr 59,900

56,300

Fr 1,200

20,100

(5,300)

Fr 3,600

Fr 16,000

Fr 800

Revenue

Operating exp

Net income

Assets

Current assets

Plant & equip

Accum deprec.

Total assets

Current liabilities

Return on Investment (ROI) Income

Investment=

Fr 18,000 Fr 10,000 Fr 16,000

France Italy Spain

Fr 3,800 Fr 2,400 Fr 3,600Oper. Income

Alt

ern

ati

ve

Invest

men

t m

easu

res

Total assets

Fr 13,800 Fr 8,900 Fr 15,200Total assets - current liab.

Fr 25,300 Fr 20,200 Fr 21,300Gross book value

Residual Income

= Income - (Required rate of return x Investment)

Fr 18,000 Fr 10,000 Fr 16,000

France Italy Spain

Fr 3,800 Fr 2,400 Fr 3,600Oper. Income

Total assets

Residual income

ROI

Economic Value Added (EVA)

27.5% 27.0% 23.7%ROI (assts-c_liab)1 2 3

Fr 560 Fr 600 Fr 720Residual income 123

Fr 18,000 Fr 10,000 Fr 16,000

France Italy Spain

Fr 3,800 Fr 2,400 Fr 3,600Oper. Income

Total assets

Fr 13,800 Fr 8,900 Fr 15,200Total assets - current liab.

EVA

After tax Total CurrentIncome Assets Liabilities

= - [ WACCx ( - )]

The price one division charges to anotherfor goods or services.

Micro-transmitter Pocket Cellular

Component Division Cellular Phone Division

Transfer Prices

Objectives of transfer pricing system:

Autonomy of the division managers.

Decisions are in the best interest of the firm.

Transfer price fairly represents each manager’s

contribution to the firm.

Ease of implementation.

Component Division Cell Phone Division

Micro T

$ 10.00

2.00

4.00

500

$ 4.00

$ 2,000

OtherCompnts

$ 8.00

1.50

3.00

4,500

$ 3.50

$15,750

Price

DL / unit

CM / unit

Total CM

DM / unit

Units

Pocket C

$ 60.00

22.00

13.00

500

$ 15.00

$ 7,500

10.00

OtherPhones

$ 50.00

26.00

8.00

3,000

$ 16.00

$48,000

A transfer price of $10.00.

Other phones are higher margin for Cell Phone Division.

Transfer Pricing Example

Component Division

If Cell Phone Division wants to renegotiate…

Micro T

$ 10.00

2.00

4.00

500

$ 4.00

$ 2,000

OtherCompnts

$ 8.00

1.50

3.00

4,500

$ 3.50

$15,750

Price

DL / unit

CM / unit

Total CM

DM / unit

Units

1. Component Division has idle capacity.

2. Component Division is at full capacity.

a. $10 mkt for Micro T

b. No mkt for Micro T

If Component Division wants to renegotiate…

Cell Phone Division

Price

DL / unit

CM / unit

Total CM

DM / unit

Units

Pocket C

$ 60.00

22.00

13.00

500

$ 15.00

$ 7,500

10.00

OtherPhones

$ 50.00

26.00

8.00

3,000

$ 16.00

$48,000

1. Cell Phone Division has idle capacity.

a. $10 mkt for Micro T

2. Cell Phone Division is at full capacity.

b. No mkt for Micro T

When is a transferin the best interest of the firm?

Answer: When a price can be found that will satisfy both managers.

If the transfer helps both divisions, it helps the firm as a whole.

Notice that a transfer is not always in the firm’s best interest.

2. Component Division is at full capacity.

b. No mkt for Micro T

Minimum price = $9.50

2. Cell Phone Division is at full capacity.

Maximum price = $9

Options

Variable cost + opportunity cost

Market price

Cost + mark-up

Negotiated by managers

Advantages

ensures optimal decisions for the firm

a good price if a market exists

easy to implement

manager autonomy

generally good decisions

Disadvantages

difficult to measure

markets often don’t exist or are imperfect

too high if supplying division has idle capacity

no incentives to control costs; OH allocation games

time-consuming

Possible Transfer Prices