Strategic Cost Management: Module 4

DECENTRALIZATION OF OPERATION AND SEGMENT REPORTING

Organizational Structure

● The outline of a company’s framework and guidelines for managing business operations

● It consists of activities such as the task allocation, coordination and supervision, which is directed towards the achievement of the
organizational goals

● It will determine the modes in which how an organization will operate and perform

Type of Organizational Structure

● Centralized- only one person (usually the business owner) or a group is being relied upon by the organization to make decisions and
provide direction for the entity

● Decentralized- the decision-making authority is spread throughout the organization to the lowest managerial level possible

Centralized VS Decentralized

Centralized Decentralized

Advantages ● Reduced Cost ● It enables top management to concentrate on

strategy, higher-level decision making and
● Uniformity in action coordinating activities
● Personal leadership ● It acknowledges that lower-level managers:
● Flexibility - Have more detailed information about local conditions
● Improved quality of - Can quickly respond to customers
work
● It provides lower-level managers with the decision-
● Better coordination making experience they will need when promoted to
higher level positions

● It often increase motivation

Disadvantages ● Delay in work ● Lower level managers may make decisions without
fully understanding the “big picture”
● Remote control
● Lower level managers may have objectives that differ
● No loyalty from those of the entire organization
● No secrecy ● It may difficult to effectively spread innovative ideas in
● No special attention a strongly decentralized organization

Responsibility Accounting

● It provides a method of encouraging goal congruence by setting and communicating the performance measures by which managers
will be evaluated

● It links decision-making authority with accountability for the outcomes of those decisions.

● Main Concepts:

○ Management by Objectives
 ■ The managers participate in the goal setting activities of the company that, in turn, they will strive to achieve

■ This encourages goal congruence while being autonomous

○ Goal Congruence

■ This is wherein the subunits of an entity set goals in line with the overall goals

■ Different managers aligned their personal goals with the overall objectives of the entity

○ Autonomous

■ Acting independently or having the freedom to do so

○ Motivation

■ It is the reasoning behind a focus effort to achieve a particular goal

● Advantages

○ It aids in the assignment of accountabilities

○ It facilitates the establishment of performance measurement and evaluation techniques

○ It assists in the implementation of management by objectives (see above)

○ It allows effective usage of the concept of management by exception (standard costing and variance analysis)

Responsibility Centers

● It is any part of an organization whose manager has control over, and is accountable for cost, profit, and/or investments

● Segment- is a part or activity of an organization about which managers would like cost, revenue, or profit data.

○ Methods of Segmentation in an organization

■ Geographical Location (continent, regional, district, town, etc.)

■ Product Line

■ Functional Areas (Marketing, Human Resource, etc)

○ A performance report shows the budgeted and actual amounts, and key financial results appropriate for the type of center
involved

Type of Responsibility Centers

Responsibility Cost Center Profit Center Investment Center

Center

Responsibility Costs, but not over revenue or Both costs and revenue Cost, Revenue, and investments in operating
investment funds assets

Examples Service departments such as A company’s cafeteria. Corporate headquarters. Subsidiary

accounting, general Product line managers
administrations, legal and
personnel
 Performance Standard Cost and Flexible Comparing actual profit to Return on investment or residual income or
Evaluation Budget variances targeted or budgeted Economic Value added
profit

Cost Center

● Usage of Standard Costing Systems and Variance analysis

● Preparation of flexible budget

● Projects budget data for various level of activity

● Projects budget data for various levels of activity

● Essentially a series of static budgets at a different activity level

○ Budgetary process more useful if it is adaptable to changes in operating conditions

○ Can be prepared for each of budget in the master budget

● Variance analysis using flexible budget

○ Identify variance costs and determine the rate per unit

○ Multiply the rate per unit to the actual activity level serving as the budgeted amount

○ Determine variances by comparing the newly computed budgeted amount and th actual amount

Cost Center

VARIANCE ANALYSIS

Costs Budgeted Actual Variance Remarks

Direct Costs:

Controllable

Non-controllable

Indirect Cost

TREND ANALYSIS

Costs Period 1 Period 2 Period 3

Direct Costs:

Controllable

Non-controllable

Indirect Costs
Profit Centers

● Segmented Income Statement

○ Usage of the contribution margin approach income statement

○ Segregation of fixed cost into Traceable and Common Cost

Traceable fixed Cost Common Fixed Costs

● It is a fixed cost that is incurred because of the ● It is a fixed cost that supports the operations of more than
existence of the segment one segment, but is not traceable in whole or in part to
any one segment
● If the segment were eliminated, the fixed cost would
disappear

● Segment Margin

○ Segment Contribution Margin less Traceable Fixed Costs

○ It is a valuable tool for assessing the long-run profitability of segment

● Problems related to proper cost assignment

○ Omission of costs

○ Inappropriate methods for allocating costs among segments

○ Arbitrarily dividing common costs among segments

Profit Center

● Sample Format

Company Division A Division B

Sales 1,000,000 600,000 400,000

Variable Costs (Manufacturing and Operating) 500,000 300,000 200,000

Contribution MArgin 500,000 300,000 200,000

Less: Traceable-Controllable Fixed Costs 120,000 80,000 40,000

Controllable Margin 380,000 220,000 160,000

Less: Traceable- Noncontrollable fixed costs 200,000 150,000 50,000

Division Margin 180,000 70,000 110,000

 Common Fixed Costs 100,000

Net Operating Income 80,000

Investment Centers

● Return on Investment

○ Objective: To express the income as a proportion of the invested capital

○ ROI= Net Operating Income / Average Operating Assets

○ ROI= Sales Margin x Turnover

○ Sales Margin= Net Operating Income / Sales

○ Turnover= Sales / Net Operating Assets

○ Increasing ROI- Increase sales; Reduce Expenses; and Reduce Assets

○ Drawbacks of ROI- Ignores the firm’s cost of raising investment capital hence managers may forego significant
investments

● Residual Income

○ Objective: The amount that remains after subtracting the required rate of return

○ RI= Segment income - (invested capital x imputed interest)

○ Increasing RI: Increase profit; Decrease Capital Investment; Decrease Imputed Interest (Less Risk)

○ Drawbacks: Cannot be used in comparing different sized investment centers and intra-period comparison

● Economic Value Added

○ Objective: Indicates how much shareholder wealth is being created

○ EVA = NIAT-((Total Assets-Current Liabilities)x WACC)

○ Increasing EVA: Increase Profit; Decrease Financing; Decrease WACC

Sample Problem: Segment Reporting

Kawit Inc. operates a chain of 80 retail stores throughout the Region 4A that specializes in the sale of sports equipment. The following costs
related to store no. 19 in Naic, Cavite.

Sales 3,200,000

Salary of Store Manager 58,000

Allocated Corporate Overhead 55,000

Cost of Goods Sold 1,560,000

Landscaping and grounds costs (yearly contract) 6,800

Hourly wages of sales clerks 343,000

Local Advertising (negotiated by store manager) 76,000

Property Taxes 25,800

Sales Commission 221,000

Required: Construct the store’s segmented income statement being sure to disclose the segment contribution margin, the segment controllable
profit margin, and segment profit margin.

Sorsogon Company produces and sells two packaged products, Product W and Product Z. Revenue and cost data relating to the two products
is as follows:

● Last year the company produced and sold 18,000 units of Product W and 30,000 units of Product Z. The selling price of W is P8 per
unit and the selling price of Z is P12 per unit

● Variable Expenses of W are P5 per unit and Z P9 per unit.

● Each product line has respective managers which receive annual salary of P10,000 each

● The product managers are in-charge of hiring sales associates which receives an annual salary of P5,000 each. Product W has 3
associates while Product Z has 2 associates.

● Also, the managers negotiate the advertising costs of each product, Product W and Product Z’s total advertising expense for the year
amounted to P12,000 and P15,000, respectively

● Other traceable fixed expenses per year are P5,000 for W and P6,000 of Z.

● Common fixed expenses not traceable in the company’s products total P44,000 per year and may be allocated based on total sales

Prepare a contribution format income statement segmented by product lines.

Sample Problem: ROI and Residual Income

Meycauayan Company’s Electronics Division provided the following annual data for 2015.

Sales 8,000,000

Net operating income 1,000,000

Average operating assets 4,000,000

Minimum Required Rate of Return 15%

1. Compute the return on investment (ROI), turnover, and sales margin

2. Compute the division’s residual income

Sample Problem: EVA

The following information pertains to Cyclops Corp.

Sales 11,400

Cost of Sales 6,000

Gross Profit 5,400

Operating Expenses 4,000

Operating Income 1,400

Interest Expense 400

Income before Tax 1,000

Tax Expense(35%) 350

Net Income 650

The company’s total assets as of the end of the current year were determined to be P9700 while current liabilities totaled P1700. The
company’s computed weighted average cost of capital is at 10%

Required: Compute the company’s economic value added