Chapter 21-Decentralized Operations & Segment Reporting

Segment Reporting
• It is an income statement designed to focus on various segment of the company. A
segment is any part or activity of an organization about which manager seeks costs,
revenue or profit data)
>> Its purpose is to provide information needed by manager to determine profitability of product
lines, divisions, sales territories & other segments of the company.

Decentralization
-It is the process of delegating the decision-making authority throughout an organization.
 Top managers need to determine when delegation of responsibility is desirable.
 It maybe necessary as top management cannot effectively manage the operation at a very
detailed level, as it lacks necessary local knowledge. Decision at lower levels must be
made on timely basis using information at hand to make the firm more responsive to
customer.
 Managers are allowed at various operating levels the authority to make decisions relating
to their area of responsibilities.
Advantages of Decentralization
1. Creates greater responsiveness to local needs.
2. Leads to gain from quicker decision making.
3. Increases motivation of sub-unit managers.
4. Aid management development & learning
5. Sharpens the focus of sub-unit managers.
6. Decision are best made at that level in an organization where problems & opportunities
arise.
7. Management is relieved of much day to day problem solving and is left free to
concentrate on long range planning and on coordination of efforts.
8. Segment managers obtain more job satisfaction and are encouraged to put forth their best
efforts by giving them added responsibility & decision making authority.
9. It provides excellent training to managers by giving them greater decision-making
control over their segments.
10. Better and faster performance evaluation.
Limitations of Decentralization
1. Dysfunctional decision making may result to sub-optimal or incongruent decision
making.
2. Manager’s attention maybe focused on the sub-unit rather the organization as a whole.
3. Cost to gather information increased.
4. Activities maybe duplicated

Illustrative Problem 1

Illustrative Problem 1 solution

Illustrative Problem 1 Analysis

Levels of Segmented Statement

 Segmented income statement can be presented to as many levels as possible in a
company.
 To provide much detailed into to a manager, the division can be segmented according to
company’s major product lines, and the product lines can be segmented as to how they
are being sold.
 As one move from one statement to another level, the manager looks at a smaller &
smaller sections of the company
Illustrative Problem 2 (fm Level 1 to Level 2)
Illustrative Problem 2 (from level 2 to level 3)

Analysis of Segment Statements

• Sales & Contribution Margin
>>>For income statement respective variable cost per segment is deducted to segment sales to
derived at Contribution Margin (CM) for the segment.
>>>CM is particularly useful in determining what happens to profit as volume changes,
assuming that the segment’s capacity & fixed cost are constant.
• Traceable & Common Fixed cost
>>>Only traceable fixed cost (i.e. salary of segment manager) are charge to the segment column
report. These are cost incurred as a consequence of the existence of segment & could be easily
identified or traced to the particular segment.
>>>After deducting traceable fixed cost from Segment CM, the resulting amount is the segment
Margin or contribution to cover common cost.
• Segment Margin
>>> This represents the margin after the segment cover all its costs and can be a gauge of the
long-run profitability of the segment In case of deciding whether to drop or keep as segment it is
very useful
>>>Finally deducting the common cost (i.e. salary of president), not traceable to individual
segment will yield the company’s net operating income or loss of the firm.
Problems related to Proper cost assignment
Cost must be properly assigned to determine the profits being generated by a particular division
or segment, then all the costs attributable to that division/segment should be assigned it.
However, the following are certain practices that hinder proper cost assignment:
1. Omission of some costs in the assignment process
2. Use of inappropriate methods in allocating costs among segments of company.
3. The assignment of costs to segment when they are really common costs.
Omission of costs
 The costs assigned to a segment should include all costs attributable to that segment from
the company’s entire value chain, that is all major business function that add value to a
company’s products and services.
 These business function include research & development (R&D), product design,
manufacture, marketing, distribution & customer services, which are required to bring a
product or services to the customer. If these costs classified as “upstream costs” (i.e.
R&D & product design) & “downstream costs” (i.e. marketing, distribution & customer
service) are omitted, then the segment/division is under-costed which may lead
management to maintain products that in the long run result in losses rather than profits
for the company.
Inappropriate methods for allocating costs
Cost distortion or cross-subsidization – when costs are improperly
assigned among company segments. It occurs in (2) ways:
1. When the company fails to track cost directly to segment.
2. When company uses inappropriate bases for cost allocation
Arbitrarily Dividing costs among segment
 The practice of assignment non-traceable or common costs to segment leads to distorted
segment costs.
 Though it is true that all cost must be covered, arbitrary allocating common costs may
produce results that could be used in making erroneous decisions.
 A manager may erroneously eliminates the segment which will result in revenue loss, the
real costs of the segment may be avoided, but common cost will still be there, resulting
in reduction of profit of the company as a whole.