= LEARNING OBJECTIVES Performance Measurement in Aer studying Decentralized Organizations Chapter 13, you should be able to: Ba Sony: Sle and Opera income by Semen frepare a segmented income statement using the contribution | format, and explain the difference between traceable fixed costs and. common fixed costs. Lo2 | Compute return on | intent ROD and show how changes in. sales, expenses, and assets affect ROL ‘Are Sony's Products Profitable? Sony is a well-known brand in the clectonies marker. In the 1980s sed. 1990s, its Walkman and ‘Trinitron TV delighted many custom- an In 2014, Apple and Samsung have become the biggest and domi- nate players in the portable music player and TV markets resepectively. Sony’ PlayStation is being strongly challenged by Microsofts Xbox. Sony’ fag: ging eleconics business, infact ave been slfering, Its TV busines alone Poo a total of $7.8 billion (787 bilion yen) over a decade In February 2014, Sony confirmed that it would sell its Vaio personal computer division and spin aif its TV operations into separate busines; TVs and PCs pitched Sony into a ‘et loss of $1.1 billion (110 billion yen inthe fiscal year ended March 31, 2014 ‘The restructuring, including a headcount reduction of 5,000 in the TV and Play- Station divisions, would save Sony 100 billion yen in annual fixed costs, Lo3 Compute residual income and sunderstand its strengths and weaknesses. Loa Compute delivery cycle tine throughput time, and manufacturing ‘le efficency (MCE) Pir sseacreeeyLos Understand how to construct and use a balanced scorecard. Los (Appendix 134) Determine the range, if any, within which a negotiated transfer price should fal Chapter 13 analysis onthe decentralized sgMENS sup Jccholders args music) vied chat Sony should just forse ton ‘One of the activist investg,. "te 2° bili, “The above segmental decision. In fact, some st me, pictues, and tainment (i. gm ae Daniel Loeb, was not BapPY YT ar yen though they had been COP the brands they had at their Cyrus, just co name fh the way the entertainment bus; sistently profitable. His a disposal, the Spiderman move ge a few, probably were more iad me many of Lady Gaga, and Miley than the Sony brand ise ve hoy Dens spent ns compacta ofthe Semlean ductors (eg re one ering medi and dt feznrding ems business, 2013 Online Annual Repor Sources: Sony re" (heep://worw.sony.nct/Sonylnfo/tRig, Spo Reuterscom. February 6, 2014 (hsp vneyes ry0140206); and Leonid Berhidsky, “Forge che on™ ssets/prin?aid-USBREAIS0AI tain,” Bloombergyiew-com, Febru Sony Shout Jus En 7 07 rgeethesvalkman-sony-should-justentercin). stice/ 20Performance e Measurement in Decentrazed Organizations some decisions, F ut oe izations, oF exam TONS Cop managers must dl xpd a Sere pana CED oft yan fea cre aot bhi wry Ele pw Fives nthe oaizaton, NYE ke is decision. Asin this exam- te some decisions to those who are at DECENTRALIZATION: CONCENTRATED OWNERSHIP IN ASIAN LARGE PS USNS | CORPORATIONS ion bay Ove Unde cage cs jomeies sch as Saniora), Korea te ur Oe eg nat Pec ny. oe aielared eo el be ita Get be Eee Gras ese Se Goss be Uppo oor a an aes Group (Singapore), and Ite-Yokado \apan) are controlled by ty ere ni to ofen marae mse ban eel cngay, Sr ing conglorates and he gb these compares reams ran seleerab aed mah sg 0 st polis and make eons, Dept sommtng cao ese ma sare talders cannot always be physically present at diferent locations to make decisions, hence there ae i erent detes of decenralestn on decsion main, sues fost runes ner respecte counties ey hea on xc eaderey scone se swe as odstarding execution by frontine, and supporting staf at al levels, and sibsdais, Decentralization in Organizations l In a decentralized organization, decision-making authority is spread throughout the crganization rather than being confined toa few tp executives. As noted above, out of necessity all large organizations are decentralized to some extent. Organizations do differ, however, inthe extent to which they are decentralized. In strongly centralized organiza- tions, decision-making authority is reluctantly delegated to lower-level managers who have little freedom to make decisions. In strongly decentralized organization, even the lonest-evel managers are empowered to make 2s many decisions a possible. Most orga- nization fall somewhere between these two extremes, Advantages and Disadvantages of Decentralization The major advantages of decentralization include: By delegating day-to-day problem solving to lower-level managers top management can concentrate on bigger issues such as overall strategy 2. Empowering lower-level managers to make decisions puts the decision-making authority in the hands of those who tend to have the most detailed and up-to-date information about day-to-day operation : 3. By eliminating layers of decision making and approvals, organizations can respond more quickly to customers snd to changes in the operating environment. 4. Granting decision-making authority helps train lower-level managers for higher-level Positions 5.. Empowering lower-level and job satisfaction. 1 managers to make decisions can increase their motivationChapter 13 ude 646 ratization i es of decental or disadvan pout uly understanding te ia iy, mt oeinaton maybe lack gh wth the objectives oft Taterestd in increasing th sprestg, than in increases Lower evel mame 2 at fowertevel man 3. Lowerlevel man crgaization.' FO fis or her depart eparent'efecve0eSS 4, Speodne mort a Sanat of ue organization ™4Y NE ion, but wihowt SCONE ofthe oxganizatio gen or oa adopied by; other pats of th OF power and cont Fading to rere akin a decentralized organization. Son 7 diffe in dea tat would benefit other nt ave ater ection the idea may not be get ral direction t be shi THREE PILLARS OF DECENTRALIZED OPERATIONS IN & JOHNSON sans btn ane pe ns 2013 Te ERS pe ele abo 28 or yee Devers ad Dagrosies Te ggg Seats Cone ol of cen. San erator omen ag cried nen he RS eg pans an 2/10) operas, Wh See cath sponse fo he ot totaal conan manoge By Cen Sor Josan oson hin tend operons and maregemet [atte Commitee, whichis responsible for the strategic operations and allocation o cave Commie, we ct Deconber 3, 2013 managed deer tig cs Tsou hse a tel corngs tse ard 5 coneche Yar Of Ge Seuce: Jenson oso’ yobs ty we vest convenmygany ven nage © Jorson & eho, Use wth puis | Responsibitity Accounting Decentralized organizations need responsibilit o onsibility accounting systems that link lowe level managers’ decision-making authority with Dility fr th = ccountability for the outcomes of hose decisions. The term responsibility ci i those decisions. The term esponsibility centri used fr any par ofan organi ger has control over and is accountable for cost, profit, or investmen!s The three primary types of responsibil fe Sc sponsibility centers are cost centers, profit centers td cra robe ex wih oe mage aswel. The shld ofthe company Set pte edie Tinchy et eas om en carey re’, comimus wo callngs pers. Tare erent Om eyo esa 4m. on investment and residual ince ae top mnazen sander be compas {fall—resulting in a loss of eae nals of rege tots selfing ay nd CEO nen ee ee conpaties clay basins igen # nines se, as rem coe a ype of cnr ea rs fw ibly «job, And, of course, particularly ouae=™* have demons = sponsible nly for generating eve 8 srl compares woul consi hb segment’ income statement, Fen, utlities) are usually deducted Fm Cost, Prof Cost Cente fue oF tHE general adm Foon, manuf tion. fost comers ervices de fmaniactut fhow much ard cost Vl ters, a oft Profit C que, but no Siam Park evens a trol over m comparing RESPON ‘with the inc ing, itis app indepth inte stateawned well as key cluded tat ing the pos purchasing rant stakeh cover the ye communal Source: Chu ina Chinese of Manchest Investm revenue, manufac ‘ments in engines. dent's in enter mPerformance Measurement in centralized Organizations 6a7 Cost, Profit, and Investment Cent ers Pk Co Contes Te mine: of seat ence a Rowling ys Sten ih cng ase ing ot 977 anufacturing fait oreo! re usually classined as cont cone, In fast centers are expected 10 mini ize costs while Neone parts of the organizat = Licata T Darts fanufacturingfaciity would be exatucs ee etzaton Fr example, the manager of aes paw ch ot shoul sve hen frie ata et en tl a Profit Center The manager ofa profit cem curator oe ofa an acs eh oe Sion Pat Cy amsenen ad wae Tan wed epee ee siness compa actual profit to targeted or budgeted profit, es are Ce RESPONSIBILITY ACCOUNTING: A CHINESE PERSPECTIVE oa inthe increasing emphasis on corporate social responsibilty and sustains practices and report- vel 2s key management staf of diferent nn-stateoumed compettors, Yang and Model (2012) con coed thatthe introduction of responsibilty accounting cd reconstitute economic behavior by remow ing the possiblities of creating “private treasuries" and unethical actvtes such as itresponsible purchasing and data manipulation. With the endorsement of socoeconomic objectives by the dom rant stakeholders, the performance indicators in the responsbity accountng framework evolved ner the years and it became clear to the fnance managers that there was 2 need ta conform to the cameunal ethos and socal wellare obligations that ensure soca stabi Seuce: Chun.’ Yang and Sven Model, "“The Economic Sociogy of esporsbity Accounting: A Feld Study ina rinece Site Ouned Enerpse’ Nay 28,2012, Nokng Paper, Manchester Business Schoo, Unversity af Manchester, England. yer es of : ation Investment Center The manager ofan investment center ha contol over cost, ent reread investments in operating assets. For example, Honda's vice president of and reeufacaing i Nowth America would have a great deal of disretion over invest dae rng -auch as imestng in equipment o produce more fel-fcient ns in mans ee dope eee Peano rem posal he is held responsible for making them pay of. Investment ae aninvestment (ROD or resioal income st center managers are often evaluated using return yon measures, as discussed later in the chapter ithe ance An Organizational View of Responsibility Centers tet pons / cures and distributes snack foods and mit Superior Foods Corporation, company tha maniacs 8 : zs ern oni i : ve Foi for Superior Foods that display its cost, profit, an Shows partial organization er cetera do tee sigfcat ve see investment ante Pe aided opt comers Tepe ave sn Spats Arh as eel ies by themselves ar Ad opeangunitssuc asthe botling plat warehouse, mance eal, and petsOnne ters generate revenue, and they inlude the and beverage distribution ¢Personnel ! egal | 1 | Finance eae | operations cotFrarelal \aeneralCouneel, | Vico Prosident Vice President officer 1 q 1 Botting Plant Warehouse Distribution | |. o———| Manaser, | Manager | t 1 salty snacks, beverages and confections product families. The vice president of operas oversees the allocation of investment funds across the product families and is response for the profits of those product families. And finally, corporate headquarters isan ives ‘ment center because it is responsible forall revenues, cos, and investments REPLACING HEADS OF UNDERPERFORMING BUSINESS UNITS: WIPRO AND CARREFOUR \Wino, lds nanber tee soar services experter, has been ageing behind its mn comb ‘ors, infosys and Tata Constancy, in terms of share price, proftabilty, as well as business grav {or fe tos consecuve quarters. Charman Aim Peri, 2ath richest bone te Weld according to Forbes, achnonedged te problem ata news conference on Janry 21, 201 #8 trounced that the two coche exetuieofcers of th TT units mau resign with fect fa vzy 31,2011. The surprise depart of two serio management staf demonstrates hem tance of sccunabily and esponsbilty among top managecent, [aia French retal giant, Carefour, announced that the head ofits French unt was si on May 5, 2011. Chief executive Lars Oofsson commented thatthe performance ot Cael? !ypematets in France since the second quatro the year had nat ed pois EE Henceforth he woul ike over the French uit to ensure efecive Implementation oft tal welled tote oprng of sme 90 Carefur Pant stores nfreee by 012 Sexes ara Nagar nd Saeet Cats a ree, * India’s Wipro tat ‘nal 2; sn Tono, "ar CO Pegs ope oa tne ae palo tS PER eaten sect mens a vem pe Pe fea $75,piffoctive decentralization re income statement, reports segment i8 a PAM or activity of na fevente, OF Profit data. Cost, prof fitores individual stores, service ¢ individval customers, and prod many ways. For example, could segment its business. The $500 million in revenue by geogr uires seg and iny Exhibit 13-2 ‘op half of the exhibit sh aphical region, and the botiom half shows Superior se menting its total revenue by custom svare, managers could easily drill the sales in California could be drill-down capability helps managers to ident financial performance. In this ch, tusiness segments. These segmented income s itability of Segments and in measuring the perfor Performance Measurement in Decentralized Organizations Decentralization and ented reporting. ded for individual ‘ te rele fegments of the organization. A ation about which managers would like cost "stment centers are segments as are sales ter ‘Panufacturing plants, marketing departments, A company's operations can be segmented in Shows several ways in which Superior Foods 1ows Superior segmenting its ner channel. With the appropriate database and soft- ven further down into the organization. For example, Segmented by product family, then by product line. This fy the sources of strong or weak overall 'pter, we lear how to construct income statements for latements are useful in analyzing the prof: mance of segment managers. 649 Segment Reporting || LEARNING OBJECTIVE 1 Prepare a segmented income statement using the contrition format, and explain the diference betwe traceable fred costs and ‘Common fixed costs EXHIBIT 13-2 ‘Superior Foods Corporation: Revenue Segmented by ‘Geographic Region and Customer ChannelMANAGERIAL [ACCOUNTING IN ‘ACTION. ‘The sue caper 13 WREAK HAVOC FOR AIRBUS ssive constCton JEL. Thy cap dble-decker et 15 eT anebulding 0025S BESS OU a ms chen De ten. a me assem sare atin Span Hands tal manuacurg, ‘cross-BORDER ‘SEGMENTS: The Abus A380 Towers te 5,000 emovovees ae Te pant in Germany petienced mi rok carey Apdlwaiiits four countries in the manufact 2s fear tment settee em ome ewan god we e395 en een + pushesseck ens pratt BEES MIDS Exava rafts over four yea" wi ctor 23, 2006, pp. 46-48 ees or aac “Wayward LS swece Building a Segmented Income Statement See neces ae usted in the folowing ex Ts Te ary ving orotate coe eta See ah ry ava general manager. They formed tec ere Stim ne ey ee pay a load a jb pd i vies, Ned eer Progen LHe WOH ye most ful No hotel wanted tobe the fst usw Ceo known company, Aer overcoming this bic wih pr nested ait dono cone service, and tery Hw into compar’ sls. ny a iy evel similar business solar for other specie mas oe eet aselp ar and computer games, Within fou eas os omy aa tad own tte pin hee Safer and Malsuo were no loge ae & on a atta he companys aii, Decetalization had become as aay ie company was splint wo dvsions-Businss Produc aC sama Pres By tual ensen Matsuo ook thee president and Salle wok el Vig president ofthe Busines Poets Division, Chris Worden, «programmer who ‘Petaded he dv ino te cpa and computer games markets, was designed ix Frese ofthe Consumer Prec Divison, ‘Alms media the issue arse of how best evaluate the performance divisions, Matsuo called a meeting to consider this issue and asked Saffer, Worden, ant ‘controller, Bill Carson, to attend, The following discussion took place at that meeting: Marjorie: We need to find a better way to measure th © e performance of our divisions. Chris: 1 agree. Consumer Products has been setting the pace in this company forthe st two years, and we shouldbe getting more recognition. dau Chris, we are delighted withthe success of the Consumer Products Division. 1 know. But i is hard to figure out just how successful we are with the pest ase See a Dy -are sales and cost of goods sold figures for the a with those figures? generally acoopel : oe eaes ‘They are prepared using ly accep Tris Te aes figues are fine. However, cost of gos sold includes some css iene of our division, and it excludes some costs that are. Le’ W*? Saag ante. Exeting we ein tbe Conner Products Divison ipa rane coding machine, which applies a unique bar code Yori: That's true for items from the Consumer Products Divi the Business Products Division as well as frites cris: Ta Merde tN eis toa ors ris NO sharore fet pit 1 ies io Marjo: Bill ments We sions. To are attrib costs Wo would al facturing Lar statemer the cont manuf contribe fixed cc discuss. of the ¢ ability. tion co Leve A por contri exhibi are tw Divisi‘ce Measurement in Decentrakzed Organizations oe rs: That's precisely the p Point. Whether an it sion ofthe Consumer Prodvets pir #€™ comes fom the Business Products Divi- Ompay machine after the software has heer MUS pass through the tay Se shah eps ea tin ha Marore: Because we have only one sugars SY CONSUME products? Plant in code the business product, Tyres Oat bar coder and we would need it anyway to ine pre. Chris: That's Fight. And because none of the ot WOuld be saved ma sumer Prodits Divison ro fH cst could be sted even ifthe entre Con | Airbye cost of the automatic J iminated, how can we logically e ie ic bar coe cally say that some ofthe Lys ts inte Cc on 8 be Coir ease charged with tena nse NY Buses Pods vison shoud Be Chris: No, that’s not what Iam saying, qe Marjorie: But Chris, I do not see hy ‘making someone responsible fo cur accounting expert, what do you think? Bit ibats some ideas for bindling-tssues ike the eutobase bi ede "The best approach would probably be forms teree Fetarine abet frm opt tgetea dt romance ear We can 1OW We can have sensible perf oe erformance reports without osts like the cost ofthe automatic bar coder. Bill, 5 aa everyone has something concrete o looks 18 Bill Carson, the controller of Sonsot n oftSolutions, realized that segmented income state who mets would be required to more appropriately evaluate the perfomance of the two divi Bes sions. To construct the segmented reports, he would have to carefully sepregte cass tha sper axe attributable to the segments from costs that are not. Because most of the disputes over rane «costs would be about fixed costs such as the automatic bar-coding machine, he knew he would also have to separate fied from variable cos. The conventional absorption costing income statement prepared forthe entre company commingles variable and fixed man- facturing costs in the cost of goods sold. Largely for these easons, Bill Carson decided wo use the contibuion forma income statement based on variable costing that was discussed in earlier chapters. Recall that when rkets the contribution format is used: (1) the cost of goods sold consists only of the variable iiag! manufacturing costs; (2) variable and fixed costs are listed in separate sections; and (3) a es contribution margin is computed, When such a statement is segmented as in this chapter, ie Se ee eran te ey eens a discussed later. This breakdown allows a segment margin to be computed foreach segment of the company. The segment margin isa valuable tool for assessing the long-run profit- sbilty ofa segment and is also'a much better too fr evaluating performance than absorp- tion costing income statements. Levels of Segmented Statements A portion of the segmented report Bill Carson prepared is shown in Exhibit 13-3. The ‘contribution forma income statement forthe enire company appears at the very top of the cahibit under the column labeled Total Company. Immediately to the right of this column are two columns_-one for each of the two divisions. We can see thatthe Business Products Division's segment margin is $60,000 and the Consumer Products Division's is $40,000. ‘These segment margins show the company’s se ‘managers how much each of their divisions is contributing to the company’s profits. 3 Homever segmented income statements can be prepared fo act ie ss ina company, To provide more information othe company’s divisional manager, Bil Carson has futher segmented the divisions according to their major product lines. Inthe cas ofthe Consumer roduc Division, he product fines ae clip at and computer gues. Going even further, Bll Carson hus segmented each ofthe produt ines according to ho thy are sold—in retail compute tres rove the Interne: In Exhibit 3-3 thi futher Segmentation is illustrated forthe computer games product line a eee ae ‘ne segmented statement to another, we 100k at smaller and smaller pieces os any, While chown in Bxhibit 13-3, Bll Carson also prepared sepmented income Statements for the major product lines in the Business Products Division.EXHIBIT 13-3 on Format Divi visions wes rents Defined 05 DIVE x Sogment Business Conan Total Products Progice company DWISICN ign 4 $300,000 $209 $500,000 $200.09) Variable expenses: 180,000 120,000 %, verati cot oF goods 8 ee vera ao oxense> es rot vl expose zo 06 cy ‘Contribution margin 20,000 80,069 comet exper oe Dynal eprent ma usin pau openssl : Sr ina vr Net opeting income —— al egmens Defined as Product Lines c Seamer gmer Products Dien Consumer Products Sagat Dien ClbAR Canes $200.000 $ 75.000 si25an9 Sales Variable expenses: Maa fatal gots ot 000 20,000 Sherveral orperaos ssc “S000 Tal wiadeoxerces ~e0.000 25.000 centiton nang 720,000 ‘aor ad oes F.000 precio segment rang £0,000 ramen ed reas Tmeonle oinivaulpewalnes.... 10000 t Divina segment narcn 20000 | ‘Segments Defined as Sales Channels for One Product Line, +I Sa Computer On-Line etal Games Sales Stores Sales fe! eee St 0 so awe hee 000 92,000 8,000 ‘Other variable expenses 15,000 5,000 10,000 Total variable expenses 55,000 37,000 iam, Contribution margin ~ 700 er 238 8 i ‘penses: “ 25,000 15,000 _ 10,000 scat ene! ‘segment margin....... 45, $ 48,000 se ‘ommon fixed expenses not ee Productine segment margin. sales and C ‘yo pre field the cont %ons to profits ant. The cont capacity st sind riscusse Traceable ae: 1, The sala of the M 2. The ma traceab) 3, The lah busines A comi -gment, bt were entire ‘example: 1, The sa 3. The e costo 4. The vvidua Tdentify mon fixe to segme todetem The; were sol salary. T of the di tinue to might ev salary is Wh costsPerform nce Mea Sales and Contribution Margi Margin To prepare 8 Seemented income il the contbution marin ny Yara pens to Profits as volume changers SS r ees holding ins especial costs and evEMUCS—the two come dacused in detain the next nape are deducted from sales tc The contribution m: hat hap. ch Sant. The contribution man of capacity Such as special Pes of decisions ten involve only arabe tribution margin, Such decisions will be Traceable and Common Fixed Cost sts ‘he most puzzling aspect of Exh y Exhibit 13-3 is prot spor lists two kinds of Sxed cons—iraceable nad ee Hid costs, The sts—iraccable and e Sas te charged to patciae eg EME A common Only the eae ed et cost isnot traceable to a segment, then its A traceable fixed cost of a se xine of he sen SEMEN reco that is imaed because of he *ement had never existed, the fixed cost would not have The maintenance cos forthe bling in whch Bosing 7 traceable ed costa the Tbe sepentokBob ‘The liability insurance at Disney We 1e¢ at Disney World isa traceable fixed cast ofthe Disney World business segment of the Disney Corporation. ee sembled is @ A common fixed cost is a fixed cost that supports the operations of more than one segment, but is not traceable in whole or in pat to any one segment, Even if a segment were entirely eliminated, there would be no change in a true common fixed cost. For example: 1. The salary of the CEO of Hyundai Motoris a common fixed cost ofthe various divi- sions of Hyundai Motor. 2. The cost of cooling a Giant or Carrefour hypermarket is a common fixed cost of the store's various departments—grocerics, produce, bakery, meat, et. 3. The cost of the automatic bar-coding machine at SoftSolutions is a common fixed cost of the Consumer Products Division and of the Business Produets Division, 4. ‘The cost of the receptionists salary at an office shared by a number of lawyers is @ common fixed cost of the lawyers. The cost is traceable to the office, but not to indi- vidual lawyers. Wdentifying Traceable Fixed Costs The distinction between traceable and com. thon fixed costs is cracial in segment reporting because traceable fixed costs are charged {0 segments and common fixed costs are not. Tn an actual situation, it is sometimes hard to detemine whether a cost should be classified as traceable or common, “The geno guideline isto teat astaceabl cons only thse css that would disappear overtime ifthe segment itself disappeared. For example, ifthe ‘Consumer Products Division Were sold or discontinued, it would no longer be necessary to pay the division manager's sary, Therefore the division manager's salary should be classified as a traceable fixed cost ‘of the division. On the other hand, the president of the company undoubtedly would con- Products Division were dropped. In fact, he or she sae if the Consumer oh micron oa oe if dropping the division was a good idea. Therefore, the president's ‘salary is common to both divisions ane ‘When assigning costs t segments. costs (uch as depreciation of corporate should not be carga ibe vision. ‘the key point is o resist the temptation to allocate fangs) tat are clearly common and that654 location of comm sts or not Any 4 . ciherhe masa measure un meres fH Fagen ar Sane cont ps reduces the TO ¥ Yee snare easy testy 3 aCeABL CMS Fy Some costs sion is clearly traceable o ¢ _pased Costing casing Col z, machine, or ot os of Nt = oo en a building machine, o ter ge lhe ae al Se gape ase tal amalieeg cp i Padme iy eo oar EERIE Te ce ull range ofits produc, Would te eer space that is at ofthe products? Manages fanart be wed costing might a Ta traceable or a common nse cost is traceable and ve that the Tea ve that ach space the product Ue in he warn ae to the products according a inane es nce avd an aged? EMS t ation of selling and administrative Ce to the segments’ consump yany that manufactures co seen on prion, cone a Manis foc a ice Te company as three prosucs "SN Ce, T2inch pp eae geen a me senneea Oe ne ae pe aa (osu seg ane I ADE 100 See a Te re pene ee ve ee Pee aT cxsiany ase at mn et Resng epi ete Sn re processing cos ast yar, Mantgerent Deliv Wt Ord rsesig Sen resi ie apex bien aoe enenner sa 9H 2 900 ane, a cada which 1.20 were fr 9inch pipe 800 were fr neh pie nd ae ee tripe. Given these data, the following costs would be asigned exc provict using the ativity-based costing approach: Warehouse space cost: ‘Cinch pipe: $4 per square foot 1,000 square feet $ 4,000 {inch pipe: $4 per square foot x 4,000 square feet 16,000 ‘ernch pipe: $4 per square foot x 5,000 square feat ...... _ 20,000 Toial cost assigned... .- $40,000 | (Order processing costs {$150,000 ~ 2,500 orders = $60 per order .inch pipe: $60 per order x 1,200 orders ‘24inch pipe: $60 per order x 800 orders... Ss 48,000 ‘B-inch pipe: $60 per order x 500 orders... .. + 30,000 ‘otal cost assigned ¥ a etd of, Asining costs combines the strength of actvity-based costing with the power of he contbuon approach and really enhanes the manage’ bis et the oily and performance of segment, However, manages it silat tems fhe cons woul in at pear over ine if he same! itself dia per ea ‘orporation, itis clear that the $20,000 in warehousing Coss ‘athe inch ip unl be innate Binh pipes wee no lage being prose any woud simply rents warehouse space he following yen, Howe 5 Tight be slo cab ae peer the 18-inch pipes were discontinued, The comet aes he space, or use it for other products, but then again the SP ly be empiy while the warchousing costs continue tbe incued Traceable Costs Can Become Common Cost: Fined costs th = 5 al are traceable to one segment may be a common cost of another se3i ‘or example, Malaysia Airlines mij is lines might want a " ng rsp eee sna ones 0" the dU noe tothe ro Prec the Contribu Traceab Conti Tracea Produ Comm Divisic wi is divic sumer having the mi “ speci spentWith Id be costs, ding g Pipe and rental quare upies int first-class, business-clas, a sbstantial landing fee nomy-class segment margin: traceable cost of the fligh ae °Gaulle airport in Ps n COSt of th airline must pay aris. Ths fixed landing fee is a fconomy-cl48S Segments, Even fixed I 2 mnust be paid. So the I chet hand, paying Notice from the diagram that when seymeyee Products Division has $80,000 in traceable eft divisions, the Consumer cost ofthe two product ins ofthe Consumer Pen oo bese common Even ifthe anding fee isn 8 fee is nota be ass, business-class, or common cost ofthese three classes ‘Segment Business Consumer Total Products Products Company Division. Division ae 90,000 {80,000} Consumer Segment Products Clip Computer Division An Games Contribution margin ‘ $120,000 $50,000 $70,000 Traceable fixed expenses... 30,000 40,000 Productline segment margin. $20,000 ‘Common fixed expenses. Divisional segment margin ‘Why would $10,000 of traceable fixed cost hecome a commen cost when the division ised nea product ines? The $10.00 s the monly salary ofthe manage ofthe Con Sumer Products Division. This salary is a traceable cost ofthe division asa whol, but itis d onaron cont of the division's product lines. The managers salary ia necessary cost of bavi the two produ ines, bateven if oe ofthe product ines were iscontnied ently, the manager's salary would pastes be cut. Therefore, none ofthe managers salary can really be traced to the individual products. ra east ofthe prod ns cons of he costs of produt a un nba Product lines. Segment Margin haere om Exh 1-3 ate segment margins bine by deducing eae: alee eats of egment fom the septs onion MBS, ATT atin vallable aera segment has coved ao or ea antes oly hose Fa Tegan rfl of segment cute ini Oh oss at cannot the es gauge ofthe Une egret I segrent cant cove awn css thn tha aoe Pe dropped (unless it has important side eects on other Seg mn Na on ec oe ee covered in more depth in the next chapter. EXHIBIT 13-4 Reclassiicaton of SaftSoions’ Traceable Fred Expenses from sib 13-3656 my MANAGERIAL, ACCOUNTING IN ACTION The Wrapup Chapter 13 gin is mo: i of iw he semen TES MO Dl i suai w Seegment. BY CONS, we yon My ise ona in ive temporary use of existing ¢ IESS-CLASS FLIGHTS 55: ALL-BUSIN SEGMENTED BUSINESS our csses of seats a Combat oy Ful sence arines tical OF NI ty fnancial rss in 1997, 2nd 2008/2, many 1 és he use of busines ond frst class eng? Compares cut ost by Ini Jaf tothe economy 255 Et of tres gy! ther eyes Comes TIT a alhusessessSchedUled ats be oro hours were commerce 2 ines such asthe ansatanbic Malet and Shere, ands at preied U.S. continental serie? 4 bythe aes of albusiess casa Mw ran Aan Fs re te franc cris, Sngapore Anes SA ted ey, Inlay and August 2008, ust befor Be eae stop albusiness-ass fights between Singapore aod the ails of and Los Ang ‘to Amsterdam, and Munich to Riyadh, using smaller Boeing jets which carry between 45 ang 55 ‘lass flights could only have been made after performing careful segment analyses on the contribution ‘class facilties on board, and in terminal, as well as complementary normal schedule flights avaltle at various timings provide targeted business customers the needed flexibility and full packages Sources: George Hoi, natever Happened to sis Class Only Aries? Frommers.com, None 22,2010. Shonly after Bill Carson, the SoftSolutions, Inc. controller, completed the segmeatel income teen. he Sot copies othe ther managers an called a meeting in which "epot could be explained —Marore Matsuo, Lor Safer and Chris Worden wer ali Lori: think these segmented income statem. ny. Hower income statements ne ee ne staements ae fairly self-explanatory. How? Bill: What's that? $0 do I-my. wrist S Chose entice con marorie: Don't get Tine segment ma Zanvtlet the big reports, we all arin ve aris Vm willing 0 Gris: THe sen jorie: So bei Mar ail Stes ‘money. Chis, Yes. Ihave cnris: ¥ improved. “Marjorie: We look MANAGING PR Warissa Mayer, oo company fture 8 edges that caltre that embrec the company’ fut rents to identi mance of thriving Source: Ben Elgin,“ Segmented | For external re Accounting Pri 280 Segment Re the basic struc Operating Seg and are based These two star 1. Disclosure 2. Determin: less of the ‘mined bas way (ie, Both standard Decision Mal and for asses makers use 4 disclosures e Tequirement, ‘Users that are reasonable re International __-Fespectively,ring ness ton ness = Performanc ormance Meas asurement in Decent s: So do I—my division's cori Segment m forthe entire company. argin is higher than th jon’ get can cry ape sa arjrie: Dow wet carried away, yg The segment margins hay 0S not msn SegMeN MAINS have tobe bg wear BATE what his report means can't the big segment margin nao oe He COMMON costs ofthe company. We reports, we all have to margins overtime tori willing to give ita uy Gis: The reports make sense to me Marjorie: So be it, Then the Retail Stores channel for money. Chris, could you brief uson tht ch Ys have been spect a gerne en cee ime that our retail sales strategy could be ino a sense of complacency. If we use these agree that our ol bjective is to increase all rst item of business would appear selling computer eee ee games, where w : ere We appear to be losing Marjorie: We look forward to hearing your analy. MANAGING PRODUCT INNOVATION AT GOOGLE Matsa Mayer, Google's vice president for search products and user experience, elves that the conpany/s future success hinges on innovation. She encourages risktaking and readily acknowk edges that 60-80% ofthe compary’s new products wil fal. However, creating an organzational cute that embraces failure also helps produce the new product introductions that should sustain the company’ future sales growth, Google's senior managers can use segmented income state= ments to identy the unprofitable products that shouldbe ciscontinued and to track the perfor nace of thriving new product innovatons Sauce: Ben Elgin, “So Much Fanfare, So Few His” BusinessWeek, iy 10, 2006, pp. 26-29. Segmented Financial Information in External Reports For external reporting purpose, companies following: the U.S. Generally Accepted Accounting Principles (GAAP) would apply Accounting Standards Codification, ASC 280 Segment Reporting (formerly FAS 131), while most Asian companies would follow the basic structure of the International Financial Report Standards (IFRS), IFRS 8 Operating Segments, Both standards apply to entities with publicreporting requirements and are based on a “management approach” in identifying the reportable segments These two standards largely converge except for the two requirements below: 1. Disclosure on segment liabilities is required by IFRS but not for GAAP. 2. Determination of segments for IFRS is based on the management approach regard- less ofthe form of an organization, whereas GAAP requites segments to be deter- mined based on products and services when entities are managed in more than one Way (ie, in a matrix form of organization) Both standards require the reported measure tobe the one used by the Chief Operating Decision to make decisions about allocating resources to the segment, ion Maker CODM) 0 formance, that is the exact same measures deision and for assessing segment perf i .s identified in the standards are mandatory makers use at work. Some basic pees by the CODM. This is a very unusual not ordinarily required to report the same data to external ily for decision-making purposes. This may seem like a “inancial Accounting Standards Board (FASB), and the ards Board (IASB), which set the ASC and IFRS serious drawbacks, First, segmented data are Users that are reported internal ‘easonable requirement for the F International Accounting Stand: Tespectively, to make, but it has some 657—_——sr oan rerelvetant 10 ease 02h 4180 e exsiive, and COMPANIES 1 then bave access 10 the data. Secon cents of a ore cpt heir COMPTON eo nonpublic COMPANIES i, eaiy analysis Seng egrets apy Tou that Fisted companies soop and mai ‘Therefore, some 1 cl s may weaken their panics). Ther, because these disclosures ae ther ha : isadvantazes segmented statements prepared in accor jnappropriat gaint, TPS, Ey vasa cos a8 BSD ar to among jt distinguish betwes ct statements illustrated ear) GAAP do net ve segmented income st fition to oF ommon east. Inde, rd GAAP for that reason. To avo te Bia = hope do oot conform We non-GAAP segment margins with IFRS Bie of reconciling non-TERS Ty that at least some managers will choose et al GF) consolidated earings. ements in a manner that conforms with IFRS o ailoe fed financial stateme! a jceurrences of the problems r discussed in the follow This will result in more ailure to T Fat pent shoul segment st ments. FOE Proper Cost Assignment SSerged direct | Hindrances to Ip Soot and the I ofthe costs attributable toa seg «mast be propery assigned to segments. A a aay those eres should be assigned tothe segment. Unfortunately, compe Inappropria ‘often make mistakes when assigning costs (0 segments ae omit pine nappy. Saas ss i cate common fixed costs ve expenses Griatlyasign traceable fixed costs, and arbitral allocate : Saat ‘expenses asit Omission of Costs Socom ‘The costs assigned to a segment should ‘include all costs attributable to that segment from ae ‘the company’s entire value chain, All of these functions, from research and development, ar Sat tresoshprednct design, manufacturing, marketing, distribution, and customer sev ete saree to bing a producto sevice tothe customer and generate revenues a However, only manufacturing costs are included in product costs under absorpin a ie costing, which is widely regarded as required for external financial reporting. To ac as faving io maintain two costing ystems and to provide consistency between intra nd Ene such as segmented income statements. As a result, such companies omit from ther poi ability analysis part or all ofthe “upstream” costs in the value chain, which consist o rescarch and development and product design, and the “downstream’” costs, which consi BUSINES of marketing, distribution, and customer service. Yet these nonmanufacturing cos == 3 just as essential in determining product profitability as are the manufacturing costs. Tse upstream and downstream costs, which are usually included in selfing and adminisaine ‘expenses on absorption costing income statements, can represent half or more ofthe tol extemal reports, many companies also use absorption costing for their internal repors IN BUSINESS Sates Postal Serces (USPS) oe d losing money. The Postal Reguatory Con rom ater produto serves tS ihgted hat he Standard ied be USS cSPe “oman: Nessuementinecetazed Organs re sof m organization. either ihe y nalysis, then the Mor downst : pity analysis, then the product ja? team costs ae omitted in profit Seren and mans roa TCs nd anos ae may unvitingly nthe ong ran rea Inappropriate Methods wit for Assignin, able aa Costs among Segments ining Traceable Tia this tion fo omitting costs, ications In ae Seasesacel ee, menities do not correctly handle traceable fixed Gaap 2 Sali dos, Sanr i NY eo ot wave fined expenes to ey ns ‘0. Second, 's¢ inappropriate allocation bases to Gang atest maceable Bred expenses o segment 4PPOpTtalocation base Section hillure to Trace Costs Directly cost sts that can be traced directly to a specific OS eS lpr le segments. For example, the rent fora branch Office of an insurance company should be charged diectly tothe branch office rather than included in a companywide overhead pool and then spread throughout the ‘company, nent : e ae peeepeo tart loca tibn Bate soni smpenleh gs waged ideale ce appro. Fr cnpered oa taen, For e2AMIe, ore companies alloeme selling and admfacte, eee ate ot tales revenues, Thus 4 eerien peaceiee 20% of tal Rear gid Be allocated 20% ofthe company's wlnrandacauasiae expenses a its “fai hare" This same basic procedure is followed if ost of goods sold or some other measure is used as the allocation base Gs Costs should be allocated to ‘segments for internal decision-making purposes only i 2 ‘when the allocation base actually drives the cost being allocated (or is very highly corre- administrative expenses only if 10% increase in sales will result in a 10% increase in seling and administrative expenses, To the extent that sling and administrative expenses xe not driven by sales volume, these expenses willbe improperly allocated —wvith a dis- soporionately high pereentage ofthe sling and administrative expenses assigned tthe segments with the largest sales.660 Chapter 13 ‘among Segments te hey no single product 8 likly to be responsi Eve it were eliminated entirely no signin se-and-effent relation (ae £08 ofthe com, Sane eb teen eo ac sats ofthe corporate headguarters Duldig 26 neseiyy Pcie ce gn The Pa fA oy of course to hays a Tihs is often justified on the Bom that “someone” has "While it is undeniably ‘cover the common costs.” While it is ee ebey acteurs te covered, arbitrarily allocating common costs 10 S°2 ts does not that this wi 6 Fea cost Of 2 seg ce Ginga share of common cost fo the Fe = ape Tn fot aig gent pea obs amproftable TC. manne ein rat anthers oi agente el aces csts of the Spm wg ba he PEE eos, And what happens f the common ied ny be saved, Bt reves gmc They dont disappear: they are reallosed de that were alloca par. That makes al ofthe remaining sepmens peg Cen iy ring in doping oer segment The ett i tobe ss Poa ie company and make it even more difScul ose the common costs” Foes pnnon xed costae not manageable by the manage to wom aaa teste ae he esponsibility of higher-level managers Alling eae cots responsi center is counterproductve in a responsi searing tem, When cominon iked cost ae allocated to managers, they a Teomsible for those costs even hough they cannot contro them. Take way many companies handle segment reporting resuls in cost ote ‘This istaon results fom thre practice—the failure trace costs relly tapes {ezment when tis feasted 0, he we of inappropriate bases fr alloeaig co thd the allocation of common costs to segments Tese practices are widespread. Om stody found that 60% ofthe companies surveyed made no attempt to assign sling un tdhminsralve eso Segments ona cause and-ect basis Dost ly Dividing Comme” Costs ie that Arbitraril ‘petit sins mat con ‘of the corporat ouigprotit om Manon of hi leads 10 Is However, i a any significant ‘would usually be S mu building to the produc | Evaluating Investment Center Performance—Return on Investment LEARNING OBJECTIVE 2 Compute return on investment (8) and show how changes in sales, expenses, and assets affect RO, Tsar th cope has Foes on owt propel asin cots to respnsily ee ao struct segmented income statements. These are vital steps when evalua Gotan ro ceres Hove rating sn investment cent’ pronase = ost and segment margin reporting. In addition, an investment DE, ee eae soeere, Teturn on investment. The following two s* or evaluating this aspect of an investment center's performi, rtd ced nt ot sn Sea amen ines (RD Ti > James R, Emore and Joseph A. Ness, es, The Slow i our of Cs Managements 8,939, RE Of Messing Change in Cot STE qhe Retur turn on im Fperati a5 sqhe higher al per dalla in Net Oper ote that net ‘operating i pr (ear pecause the use net oper Operat sent, and 3 included for future “These asset ating asset average of Most ciation) of drawbacks tion increa ROL. Con depreciate assets and ating asse seprecati ment. An accumula ignored: depreciat Neve age oper recordin as an op value apPeromance Meas "asurement in Decentralized Organizations oes The Return on Investme tea att ROD Formula er Aefined as ne ad et operating income divided by average Return oF operating Ror = _Net operating income Average operating ass ‘The higher a business segment’s pedal invested inthe segments NESIMER ROD, he greater the profit earned W'S operating assets, Net Operating Income and Operating ssets Defined E neces alloca Nate that net operating income, rather han net beating Merling incomes reo Eee net Beom is sda the ROI oma Net sts must «2 BIT (earings before interest and taxes), Net opantg ort ered 10 as Sein because the base (L.., denominator) consists of operanny ance Te boo en a: se pening means le) Umi of pera at Te een, We : Operating assets include cash ney = 4h, accounts receivable, iver ee set andl oterasets held fr operating purpxes Reaping en nen ct ment with aaa a ena sts Beli for operating purses, Examples of ass hat arena Bred coal ig acts (ie, examples of nonoperating asets) include land held for future use, an investment in another cede company, or building rented to someone else These assets are not held for operating purreee ots ae nee a eating purposes and therefor are excluded from opet- as ating assets. The operating assets base used inthe formula srypically computed ase effect average ofthe operating assets between the Begining and the rod of th Soa ; sinning andthe end of the year. ost companies use he netbook vale. agin cos ss acura epe- ciation) of depreciable assets to calculate vero fn b fae operating assets. This approach has hom they drawbacks, An asset's net book value dereases overtime s the accumulated deprecia. cating ton increases. This decreases the denominator inthe ROI calculation, ths increasing ponsibility ROI. Consequently, ROI mechanically increases overtime. Moreover, replacing old Y are held depreciated equipment with new equipment increases the book value of depreciable assets and decreases ROI. Hence, using net book vale in te calculation of average ope listortion aing assets results in a predictable pattem of inreasng ROI overtime as accumulated a specific depreciation grows and discourages replacing old equipment with new, updated equip- ing costs, nent An altemative to using netbook value isthe gross cost ofthe ase, which ignores ead. One accumulated depreciation. Gross cost says constant over time because depreciation is ling and ignored; therefore, ROT does not grow automatically overtime, and replacing a fully depreciated asset with @ comparably priced new asset will ot adversely affect ROT. Nevertheless, most companies use the net book value approach to Computing aver- age operating assets because it is consistent with their financial reporting practices of recording the net book value of assets on the balance sheet and including depreciation 4 an operating expense on the income statement, In this text, we will use the net book ‘alue approach unless a specific exercise or problem directs otherwise, Understanding ROI i at does not ‘The equation for ROI, net operating incor by average operating assets, offers two levers for improving performance—net operating income and average opera- ing assets, Fortunately, ROI can also be expressed as follows: ROI = Margin X Turnover: WhereEXHIBIT 13-5 Chanter 13 and Tumover Fie eae i cesets, So either formula for ROL will give py Belinea es eye Pees pericerns tre ‘Note that te sales ferms in the margin multiplied togeter. mtome and average operating paesyer However, the margin and tumove roma manager's perspective, marl sin s ordinarily improved by increasing eds sd and eling and adiinstieexpenses-The lowes Vs perigee ao teste higher te marin eared. Some manage end fc og ican ignore tumor Hoveve, tumor incorporals crucial ea of oma a the ivesment in operating assets. Excesive funds ted up in ge! sepia, accounts receivable, inventories, plant and equipment, and othr thre tumover and lower ROL. In act, infin! use of operating asses can ey aes a day on profablty as excessive operating expenses, which depress magn A jaPent de Nemours and Company (better known as DuPont) pionered he, ROL ani eeepivad ie mporance of ¥oking at both margin and tumover in esa ronager’s performance. ROI is now widely used asthe Key measure of inestne ce ratsande ROI refs ina single Aigure many aspects ofthe manager's responsi aes art tne returns of her investment centers in the organization, tema Grothe companies ne industry, andto the pst returns ofthe investment cetera Ta Elements of Retumn on investment ROD = Net ‘operating income Sales,NM Ee sized Organizations 6 DuPont also developed the anagers understand h : iit manag HOW they cats it 13-5. This exhibit helps Teast one of the following. ROL must involve at 1. Increased sales 2, Reduced operating expense 3, Reduced operating asseis Many actions involve combin, For example, a manager may mat, nd operating assets reduce operating expenses or increase si i ating assets to judged in terms of its overall impact on ROL rable oF not is et EXTREME RETURN ON INVESTMENT FoR ZaRA : spainbasedckting gin Zara Peed the tse of Tre Spabased hing gent aa, funded 1975, nas rum none othe wrt est Fin assessing ftfston etal. Zar’ stateny nv Isle eating colton oe. Ts eaoees aoroech encourages customer to visit the stores more sien ond lo era arte spate ad ca Bee te scones nd to purchase en he soto a esponsibili usl tracks customer preferences and can cestock or modify existing products ion, the. ae wihin two weeks. For new products, it can originate @ new desig n and have it in the stores within four ae to five weeks. node to ensire good reins forts mesmo, Zs pacton takes lace el small batches. Products are shipped directly fromm its twc al distribution centers to 1,500 stores. worldwide twice 2 week with the help of ts T system uitichs embedded wth sophisticated operation research models to determine allocation details for each invertor shipment. Duen the plot runs the system helped Zara to increase sales by 3% 10 4% ‘The short cycle time and ow inventory approach reduce working capital intensity 2s wel asthe teed for warehouses and facitate continuous manufacture of new products. Furtermore, Zara spent only 0.3% ofits revenue on resia advertising, compared with 3% to 4% for most specialty retalers. To speed up product Ife cycle, Zara's poly also includes removal ofan article from the ‘splay whenever one ofthe key sizes is out of stock. Zara used to employ a manual and informal decisionmaking process for determining rice markdowns for stockouts or endofseason prod cs. A formal forecasting system feeding a orice optimization model was introduced in 2008 to help improve the clearance processes and revenue. The new processes improved ‘clearance revenue” by 6% during its pilot runs. . Sawoes Pankaj Ghemawat and José Lis Nuno, ‘ARA: Fst Fastion’ Hanaré Busness Schoo Deceiber 21, 2006; and Jean Francis Puget, Ho Zra Realy Grew othe Wor’ Largest Fashion Rta BN, tam, November 15,2012 ttf. con/Gevetopenworks/comnunty/togs/fo/enty/zaratang For example, suppose that the Montvale Burger Grill expects the following operating 6 results next month: Sauipe es Operating expenses Net operating income ‘Average operating assels The expected return on avestment (ROD forthe month is ‘computed as follows: ‘Net operafing income Safes ROL Sales ‘Average operating assetseee emeeerram Chapter 13, 1,000, $100,000 i 0,00 * $50,000 $100.000 = 10% + Gril is considering investing 59 2. ti jonvale Burge! he Monlvichine that can dispense a number of by $4,000, but would require ting income would increase by §3 x youl Boost Suppose that the ma the-art somtser _ evy machine 7 flavors, This new hus, net opera : mses of $1,000. Tht : operating expenses of $1,000 7 ‘ $13,000, The new ROL oe i er opeting noe, —_Stles_ ROLE Saw Sales: ‘Average operating assets 313,000 _ $104,000 = $104,000 * $52,000 cx 2 = 25% (as compared to 20% originally) the investment increases ROI, but that wil not always happy Inthis particular example, NISSIN INVESTMENT IN CHINA—EXPECTED RETURN OF INVESTMENT OF 8% The goal nstart ode marl wa estate tobe abot USS25 bon i 2010 and he ges player in Japan is Nissin Foods Holdings Co.,Ltd. (Nissin Foods) with revenue of nearly USS4 iy in 2010, However itis notte gest player in China despite entering the China martin 1, Instead, Chins market is dominated by Kong shit (or Master Kong in English, aTavanones brand. Anther Taiwan instant noodles maker, UniPresident Enterprise is also one of the top or ‘brands in China, the remaining two consisting of local brands, Baixiang, which focuses on the lover pice range products, and Huson, th local partner of Nissin Foods. Despite Kanes capturing aver 50% ofthe market share in value), Nissin Foods has pas to invest ¥20 billion (US$215 million) in the China market in 2011 and 2012, as China's inst noodle markets groving at exponetal rates. Chief executive of Nissin Foods, Kok Ani, cos ‘mente, “Our statgy is to focus on the mide to highend make. We ae thinking ht an 60, {Retur on kvestment woud be a passing gu” Nissin Foods! 2010 annual report so ice that for the financial year 2013 the expected Return on Equity (ROE) would be 8%. Mi Nissin Foods'2010 segment report showed that 86% ofits revenue came from Japa, 59% was generated from cuptype instant noodles. New products and geographical expats a important for Nissin Foods' future growth as noted ints 2010 annual report, which tated is aS {0 expand furter into China and to have large-scale investments in research and develomestl 2019 withthe am of intodcing nen novation ever ten years Sources: sin Foods Holdings 2010 Amul Report: ang ‘ "geo Tack Ca Eee ed, ato, + nN Pee a Nik Kowa Nesta Criticisms of ROI Although ROI is wide Ay used in evalu oo aiepae » use in evaluating performance, i is subject tote fall 1 Just telling managers to i how to increase ROI; they may company’s strategy or they may harm the company i tment). This is why ROL is best in this chapter. A balanced sco ' not be enough, Managers may nt yeheS® ROL in a way that is inconsistent Wl 'y take actions that increase ROI in the short {ut (Such as cutting back on research and de ae cts part ofa balanced scorecard, as discus "ecard can provide concrete guidance 10 male making and re of long 2, Amati costs ¢ vant i they 1 3, As di reject woulk Residual Residual calculate R Econom adopted | principle often tre dealt wit between Whe isto max isan imp should d street, E Foods, | Quaker States P Technol Corpora Technol Termin: and con use EY, ments i © The by 10 year sulting f 2 Over labile nd the Ken Pea lal Manitiona, Perfomance Messurementin Decentralized Orrizaions making it more likely that and reducing the likelihoog of long-term performance, 2, A manager who takes over costs over Which the m: their ac tions are consist ; dave tent with the company’s strategy 9 wllboos shorerun perormane at iecnene Gata »Seement typically inherits many committed van in a8esing the perfomance mt Fa Tse ‘committed costs may be rele- eae ae ED ice ne seeereaa epee 3. As discussed in the next s, erformance of the manager. RietiatenmeN eet A tanugér ba Guitiel oo Rol xp Mould have a newaeeertunities that are profitable forthe whole ‘company but that ate impact onthe managers pevtorane sae Residual income is another a Residual income is the net ninimum required return 0} calculated as follows ;PProach to measuring an investment center’s performance. erating income that an investment center earns above the m its operating assets. In equation form, residual income is, Residual _ Net operating Aver ing. Mini i eee gg end Minima ei) assels rate of return Economic Value Added (EVA®) is an adaptation of residual income that has been adopted by many companies.* Under EVA, companies often modify their accounting Principles in various ways. For example, funds used for research and development are ofien treated as investments rather than as expenses.* These complications are best dealt with in a more advanced course; in this text we will not draw any distinction between residual income and EVA, When residual income or BVA is used to measure performance, the objective is to maximize the total amount of residual income or EVA, not to maximize ROI. This is an important distinction. Ifthe objective were to maximize ROI, then every company should divest all of its products except the single product with the highest ROI. ‘A wide variety of organizations have embraced some version of residual income or EVA, including Bausch & Lomb, Best Buy, Boise Cascade, Coca-Cola, Dun and Brad- street, Eli Lilly, Federated Mogul, Georgia-Pacific, Guidant Corporation, Hershey Foods, Husky Injection Molding, J.C, Penney, Kansas City Power & Light, Olin, Quaker Oats, Silicon Valley Bank, Sprint, Toys R Us, Tupperware, and the United States Postal Service. In Singapore, Temasek-linked companies such as Singapore Technologies Telemedia, STATS ChipPAC, Singapore Telecommunications, Keppel Corporation, Neptune Orient Lines, PSA International, Sembcorp Industries, Singapore Technologies Engineering, Singapore Airlines, SMRT, Capital-and, Singapore Airport Terminal Services and Singapore Power all employ EVA for performance evaluation ‘nd control. In addition, financial institutions such as Credit Suisse First Boston now se EVA—-and its allied concept, market value added—to evaluate potential invest- ‘ents in other companies. ‘economic valve added tas been around for over popularized and trademarked by the con- Sulting firm Stern, Stewart & Co- Te ene emeeans ae 5 2} ‘deferred taxes, iaerues, pecresons re 10 ert sen me geo changin unig es ein es acquisitions, For further details, see John O'Hanlon and ‘Accounting: the Stem Stewart EVA® Finan- 66 Residual Income LEARNING OBJECTIVE 3 ‘Compute residual income and understand its strengths and Weaknesses,—_— ~~ ye canter 13. side he following dts fOr an ivesimey E 566 ‘of illustration, &¢ ea services Corporation. fo ill 6 or purposes Of i axkan Marine S tis po ; rchikan Division Divisi tne Ket Preing mat ate add ss Marine Senices Corporation company. aka Merikan DBM on ($4500 asic Data for Performance Evaluat et ‘ an $100,000 If the . ‘Average operating Ee s TILL $20,000 would be * operating income « 15% | wrod oT , has long had a policy of using ROL to ey . ‘Alaskan Marine Serves COUPEE. sidering switching 0 residual ay me | its investment center Manse” © favor of the change to residual income, has prov controller of the company, Who ma formance of the divi woul | customer Satistaction Innovative Products Profitable Growth [ Focus on deivery of quality products to [ valued customers [ Responsibities to Society [Quality i Response Time [ ost Management Prine Factors Sales Growth * I8e2 percentage gon lured sales iroerpovrtage fom ky asters G1 employe peducety eee G2 = employee satisfaction index Itis essential to clearly identify the definition of measures, targets, frequency of review and the objectives of such measures on the balanced scorecard because it serves as an official communication from the top management, and acceptance of the commitmest {rom the division responsible for such activites and operations. A Balanced Scorecard Example for a Business Division of Media Products Manufacturer ue paced scorecard has been embraced by a wide variety: ‘of organizations inclui- Hage: indonesian government, Toyota, Nissan, Keppel Corporation, Keppe! Land, He DBS Bank, Tata Group, Reliance Industries, Infosys Technologies, Chin 1 Pewee Misoelectonics, Datacraft Asia, Korea Custom Sereey 8 gapore Minis) o a Thai Carbon Black, Korea Telecom, Ansteel Group Corporation, Korea East fest Power, Bak of Toko Mitsubishi UEI, Brigham & Women's Hospital, KeyComs ental of Kansas, in ‘ar, Hilton Hotels, half of all FortPerformance Me ee Mal surement vex_| Review Pe ee Frequoney| __Objectves improvement |~ vious y re ous years ous yas EVA 15% Annually [Proftabitty ana | fective use of funds 15% [Annually [Sales growth las namie a percentage fares Mabe Sion wih amnalioarae ty |» Quality of products | from ke Beas (Minimum | and services + [Quate |s Customer satstacton | ~ |" ee MN + Sales and marketing 2 |etvery _|Onsime dotvery pares ———— | Cane 1 || LL Jacouracy | der 100% |Frequent + Customor a 5% (Minimum | satisfaction — a ; auataty J coodnaingston_| | | — — internal Business Process z iBP1 [Defects per [Detects per mi t r fies bar Pet milion units ] 8 [Monty ously 1 || fee iouuniis Cost | 1BP2 [Percentage [Actual sales value : aces Fe goods returns Ontime deivery || | (products missing the shipment date are | ejected 100% inthis j= | businass) | Learning and Growth | UGi [Employee [Sales dolar per man-hour $200 [Annually [+ Employee traning productivity er and productivity man- | Empioyee a hour satisaction | satisfaction score |months — |satstaction = index as | > Strategic linkage between measures and perspectives Tying Compensation to the Balanced Scorecard such as bonuses, can, and probably should, be i fee _ However, this should be done only anes wee silly ‘managed with the scorecard for some time— 28, Incentive compensation for employes ice measures ster the organization has been succes! the performance measures are ‘must be confident that the ps n Paap a eae eee who ae eing sve, nd nt a mani Telable, sensible, undersion’ vid Norton the originators of the balanect! ore lated. As Robert Kaplan a such a powertl lever th YOu Nave e Oe pate Nee int measures and have god dl for he meas dent that you ‘making the link." ebrvary 2001, pp. 73-78. nce: A CFO Inierview” CFO. Lori Calabro, “On BalChapter 13 ep SCORECARD doped management 005 ath ster aomance cars Wee je directions 25 Well 25 2 perform BALANC! pen use ofthe most widely aye reed variants: Te tant for strates EXTEN! : ‘re alanced score Fppesr under aerent cares ahi the baanced scorece’ a e impor one ofits strategic objectives: otoving 25 te BOT's strategies under the by te i nee the execution of the in South East Ai, and BP mie emer moe. Aero aa eet pox based on 2 laced Crea py rere SAE ey ga tg customer product Sutabiity and agrt a ets te ne nen eto ar USS11 3 mani 2010, wasted ard dere alee snes Nr Kenn ances, an promarces inne ard SF, ETON acy aa eeeuch specifi Asin rani eres evaluates the strenths of 170 banks andy arcane acoss the Asi Paci, the Middle East, Central Asia, and Afi by using a bara, mnecard model coupled vith a comprehensive methodology that invohed experienced stacy, Goctingiterdews and extensive research. n 2011, RH Bank from Malaysia was picked as te wer of "Excelence in Best Busmess Model i Asia.” Sources: Bak of Talon, The Bork of Thaland’s Strategic Plan 2007-2011. May 1, 2011; DBS Ba itr. 08S Determined to hold Standards; Refined Sales Process n Place," iy 8, 2009; Yum Ras, "B/E Head Mopers Gets Po kes Tat Tol to USS 1.3 Mion Fiscal 2010,” Iernatonal uses Times Sepember 22,201 ard The Asian Barker Press Release, HB Bank Malaysia Wns Excelars Best Business Melina,’ March 2, 2011. NT EL TE Advantages of Timely and Graphic Feedback Whatever performance measures are used, they should be reported on a frequent an timely basis. For example, data about defects should be reported to the responsible ma agers at least once a day so that action can be quickly taken if an unusual number of defects occurs. In the most advanced companies, any defect is reported immediately, 208 cae tracked down before any more defects occur. Another common characterise ete performance measures under the balanced scorecard approach is that manages focus on trends in the performance measures over time, The emphasis is on progres aa {improvement rather than on meeting any specific standard. nize business process to el scorecard” see path DBS Bank Lt scp estes Oe eres an sass ts ta rene tat aes he pertorance of 2 3B), one ofthe la ss and mining 8 CORPORAT SCORECARDS NANCE OR SUSTAINABILITY REPORT AND The Dyeflols decade saw corporate governance gain in importance, Since 2006, he fms mmo rove fom 1 Tagine the practces in corporate govemance to creating Corarte and Sata inability Reporting. The Sustainability Reporting Gudelte® ne tate (GI has become the backbones often rts Kay sekeholets, including shareholders, cle i tes, enh, Nom organizations fae in the areas of ext Such as Society, human rights, labor practices, and ptPerformance Measurement a Decent olzedOrgarzaons ity. Most importa een en ah eden Fequre companies to spell out explity the ents Kenta the rape ME Meats to ache Be eee, From the inal 11 su 6, and 3,718 in 2012, ty prod ten The aon TY vn ng table fampanies it 2012 by continents SUM ‘eetstered in 1999 in the GRI database to 547 in W2ty bractice has been gaining popuanty and much artes the 3,718 sustainabilty reports resisted by ‘ica [Asia [ Europe 21 1,368 atin America 444 North America | Oceania | Total Reports 537 161 3718 Dear pany Pte Hom hint edicary ra has Gos nw! aidan Sos Kore, 92 fom Snaapre, Jo rt 2 ce om Chg, 182 fom Ja, land, 50 from India, 35 from Turkey, 27 from Indo sesia, 20 from Hone Kong, 19 from Malaysia, 19 fom, ‘srael, 18 from the United Arab Emirates, lastom the Pines, and 72 rom otter sian oes den, The Nether Sands Norway and Chia hae issued poles reqirng eagerness tanabilty reporting es requiring state-owned companies to produce sus- Hey areas folow the GR format and provide te stoege direction 25 wea corporate | Sass Hach Gow, “Corporate Susaebity Repu 20 Gal Reg ve, egereg ‘Satis for 2012" trom the Gt database as at Mach 19,2014, IN GOVERNMENTHowes ears at digcussed in it Cr f eet divisions, product lines 1°" variable costs and fixed costs are ae aan approach covered io IIS CNPC igaceable toa Segment are asp, . oniibution appro iat iat Fixed common costs are not allocated 1 yee et a minating the segment. Fixe ens ss fs Tess variable expenses, les ble fined expen i See residual income and its cousin EVA ae Widely use, uate the performance of invese that would deerease their ROT but whose retuns ear, sage i ee cro Pea at in od me a eet ere onto rgantzation’'sstaegy. The various measures in a balanced seorecard shouldbe linked oni, hie cause-and-effect basis from the very lowest leve] up through the organization’ ukinag ‘hjectives. Th balanced scorecard i essentially a theory about how specific actions taken by yg Jos people inthe organization will further the organization’s objectives. The theory sould ere a ameter Be ae ee eo ee ech iemt aee the balanced scorecard should also change. The balanced scorecard is a dynamic measuremea, system that evolves as an organization learns more about what works and what doesn't work mi refines its strategy accordingly. Review Problem 1: Segmented Statements ‘The basiness staff ofthe law firm Frampton, Davis & Smythe has constructed the following rqat Which breaks down the firm’s overall results for last month into two main business segment— family law and commercial law: Revenues from clients . Variable expenses 220,000 100,000 120,000 Contbuton margin. 70,000 ; 300,000 00 Traceable fixed expenses 670000 _2e0000 anand ‘Segment margin Conon had erase fmnito, aio een Net operating income $50,000 $ (4,000) $54,000Performance Measurement in Decenralzed Organizations owere. this Fp isnot Gute correct fers cals. general adn The common ft : tntive expenses ietwo seenents based on revenues Soe expenses such a the managing pat- and general im advertising hve been alloted to the segment report, I rribs bee of fxs Ce ano of commen acd expenses. Would the rv cliey ah ily law Segment were dropped? (Note: Many of the drawing up wills) Also use the fm fr tei amily tw egurements such 8 firm's advertising agen Bee tre cee rnctnt tn wd canine bong ne ein his tha wold ier DEN woul co $209 an aoe = Frampton, Davis & Smyth ly Jaw revenues by $100,000, The managing partner of were this increase in batnes could be acommodted witout any ierease in fixed expenses, Exams = a i caramiatn firm's commercial ta Ne theft his a campaign woul fav on th fay Et CT won ets te Solution to Review Problem 1 | fe Tie comected sezmente income satemen ppeas below: