Mark Krilanovich
May 5, 2010
ACCT 240
Chapter 12: Reporting on Segments of our Company
Overview
Financial Accounting reports on our company as a whole. Managerial Accounting
reports on small pieces of our company to help our managers make decisions affecting
the company's future.
In this chapter we subdivide our company into segments. Some useful ways to
separate our company into segments are:
1. By manager’s responsibility. One segment includes all business functions one
manager has control over, and thus responsibility for. The manager can be
anywhere on the company’s organizational chart [p. 511], which is its command
structure for delegating responsibility. (A report on such a segment represents
the performance of that manager.)
2. By product line. One segment includes all the business functions for producing
one of the company’s products. For a soup-making company, one segment could
be "all business functions engaged in making and selling chicken soup," while
another segment could be for vegetable soup. (A report would compare the
profitability of chicken soup to vegetable soup.)
3. By geographical region. A company that sells products to many states of the
country might benefit from a report that defines each state as a unique segment
of the company.
Cost Centers, Profit Centers, and Investment Centers
When we segment our company by manager's responsibility, each manager has 1 of
3 kinds of responsibility:
1. A Cost-Center Manager has responsibility for controlling only expenses incurred
by his piece of the company.
2. A Profit-Center Manager has responsibility for both expenses incurred and
revenues earned by his piece of the company.
3. An Investment-Center Manager has responsibilities of a Profit-Center Manager,
plus the return earned on his investment in operating assets (more on this in
Chapter 14).
To compare the performance of different profit centers in our company, we prepare
a Segmented Income Statement for those segments. For our managers we use the
"contribution approach" income statement from Chapter 6, and the Variable Costing
concepts of Chapter 7. The segmented income statement has two new features that will
be fundamental to Chapter 13:
1. Traceable fixed costs versus common fixed costs Throughout this course,
we try to trace every dollar of cost to what caused it and/or what benefits from
it. A segment's traceable fixed cost is one that the segment causes by its mere
existence. A common fixed cost is incurred jointly by several segments, and
cannot be traced to just one segment. (All variable costs are traceable.)
©2010 Mark Krilanovich
This and other material are available at www.silcom.com/~mkrilano
Chapter 12, page 2
2. Segment margin. A contribution margin is "sales revenue minus variable
expenses" (which also equals the portion of profit that's variable with respect to
the number of units sold). The segment margin is a segment’s contribution
margin minus that segment’s traceable fixed costs. The segment margin is the
best indicator of the segment's long-term profitability.
The Segmented Income Statement
A Segmented Income Statement details the revenues and expenses of two or more
segments, and totals them for their "parent" segment of which they are subdivisions
(which may be the whole company).
It computes these values in the following order (see p. 514 for example):
Sales Revenue
- Variable Expenses
= Contribution Margin
Contribution Margin
- Traceable Fixed Expenses
=
(traceable to this one segment)
Segment Margin
Segment Margin
- Common Fixed Expenses
= Margin of parent segment
(common to all segments on the statement)
or Company's Net Operating Income
See the next page for a full example of segmented income statements.
It's crucial to learn the skill of distinguishing between "Traceable Fixed Expenses" and
"Common Fixed Expenses" (p. 516-518, 520-522). This will carry into Chapter 13.
Measures of an Investment Center's Performance
Three ways to evaluate the short-term performance of an investment center are the
Return On Investment (p. 522), Residual Income, and EVA® (p. 526-528).
ROI
Net Operating Income
= -----------------------------------Sales
x
Sales
----------------------------------------Average Operating Assets
Residual Income = Income earned above the minimum-required income
= Average Operating Assets x (ROI
EVA® = After-Tax Operating Profit
©2010 Mark Krilanovich
– Minimum Required Return)
- Total Annual Cost of Capital
This and other material are available at www.silcom.com/~mkrilano