Accounting 225-Chapter 6 and 11

cost center managers are evaluated on.

how well they minimize costs while providing the level of products and services demanded by other parts of the organization

Operating assets

include cash, accounts receivable, inventory, plant and equipment, and all other assets held for operating purposes doesn't include land, investment inn another company, or building rented to someone else

Net operating income

income before interest and taxes and is sometimes referred to as EBIT (earnings before interest and taxes)

all other things the same the margin is ordinarily improved by...

increasing selling prices reducing operating expenses increasing unit sales

Traceable fixed costs are charged to ___ and common fixed costs ____

segments are not

cost center

has control over costs but not over revenue or the use of investment funds

criticism of ROI

1. Just telling managers to increase ROI may not be enough 2. managers may inherit committed costs 3. manager who is evaluated based on ROI may reject investment opportunities that areprofitable for the hole company but may have a negative impact on the manager's performance eval

Traceable fixed cost

a fixed cost that is incurred because of the existence of the segment, if the segment had never existed, the fixed cost would not have been incurred and if the segment were eliminated the fixed cost would disappear

operating assets used in the turnover ratio is typically...

computed as an average of the operating assets between the beginning and the end of the year. for depreciable assets nbv (acquisition cost less accum dep) to calc avg op assets or use the gross cost <--stays constant

General guideline is to treat costs as traceable costs only those....

cost that would disappear over time if the segment itself disappeared

Segment Margin

obtained by deducting the traceable fixed costs from the segment's contribution margin margin available after a segment has covered all of its own costs the segment margin is the best gauge of the long run profitability of a segment because it includes only costs caused by the segment

business practices that lead to distorted segment costs

omission of costs inappropriate methods for assigning traceable costs among segments arbitrarily dividing common costs among segments

profit center managers evaluated on...

on how well they compare actual profit to targeted or budgeted profit

Fixed costs that are ____ to one segment may be ____ to another segment

traceable to one segment may be the common cost of another segment

investment center managers are evaluated on

using return on investment (ROI) or residual income measures

decentralized organization

decision making authority is spread throughout the organization rather than being confined to a few top executives

common fixed cost

fixed cost that supports the operations of more than one segment, but is not traceable in whole or in part to any one segment even if a segment were entirely eliminated there would be no change in a true common fixed cost

Return on Investment (ROI)

defined as net operating income divided by average operating assets net operating income/ average operating assets the higher a business segment's return on investment (ROI) the greater the profit earned per dollar invested in the segment's operating assets

Do not allocate costs such as _____

depreciation, clearly common and will continue regardless of whether the segment exists or not

Advantages of Decentralization

1. allow top management to concentrate on bigger issues 2. puts power in the hands of those who tend to have most detailed and up to date info 3. eliminate layers of decision making and approvals organizations can respond more quickly to customers and changes in op environment 4. help train lower level managers for higher level positions 5. possible increase lower level managers motivation and job satisfaction

Disadvantages of decentralization

1. lower level managers may make decisions without fully understanding big pic 2. lower level managers make decisions independently of each other coordination may be lacking 3. may have goals that clash with the objectives of the entire organization 4. difficult to spread innovative ideas

Profit center

has control over both costs and revenues, but not over investment funds

Investment center

has control over cost, revenue, and investment in operating assets

Economic Value added

an adaptation of residual income that has been adopted by many companies

Responsibility center

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

ROI equation expressed in terms of margin and turnover

margin x turn over where margin=net operating income/ sales and turnover= sales/ average operating assets

Residual income

net operating income that an investment center earns above the minimum required return on its operating assets Net operating income -(Average operating assets x Minimum required rate of return)

The contribution margin tells us what happens to

profits as volume changes- holding a segment's capacity and fixed costs constant