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Managerial Accounting Chapter 12

How do you enable calculation of the segment margin?
Traceable fixed costs should be separated from common fixed costs to enable the calculation of a segment margin
What is a segment?
A segment is any part or activity of an organization about which a manager seeks cost, revenue, or profit data: such as geographic location or different customers (retail or wholesale customer)
What is a cost center?
A segment whose manager has control over costs, but not over revenues or investment funds such as the accounting department
What is a profit center?
A segment whose manager has control over both costs and revenues, but no control over investment funds.
What is an investment center?
A segment whose manager has control over costs, revenues, and investments in operating assets. They figure out how to deploy their limited resources
What are traceable fixed costs?
Traceable costs arise because of the existence of a particular segment and would disappear over time if the segment itself disappeared. Such as without a football team there is not football coach!
What are common fixed costs?
Common costs arise because of the overall operation of the company and would not disappear if any particular segment were eliminated.
How can traceable costs become common costs?
It is important to realize that the traceable fixed costs of one segment may be a common fixed cost of another segment. For example, a landing fee for a plane is traceable to the plane itself but not the first-class or economy passengers on the plane for whom are common costs
What is a segment margin? Formula?
The segment margin, which is computed by subtracting the traceable fixed costs of a segment from its contribution margin, is the best gauge of the long-run profitability of a segment, Segment margin
is Television’s contribution to profits.
What you shouldn’t do with common costs
Do not allocate common costs to segments (because they remain even after the segment is gone), but you can with traceable costs.
The FASB now requires that companies in the United States include segmented financial data in their annual reports
Since the contribution approach to segment reporting does not comply with GAAP, it is likely that some managers will choose to construct their segmented financial statements using the absorption approach to comply with GAAP
R&D Design Manufacturing Marketing Distribution Service
Costs assigned to a segment should include all costs attributable to that segment from the company’s entire value chain.
Why shouldn’t common costs be allocated?
1. This practice may make a profitable business segment appear to be unprofitable.
2. Allocating common fixed costs forces managers to be held accountable for costs they cannot control.
Criticisms of ROI
Managers evaluated on ROI may reject profitable investment opportunities
Residual income
Net operating income – ( average operating assets * WACC)
What’s the difference between residual income and ROI?
ROI measures net operating income earned relative to the investment in average operating assets. Residual income measures net operating income earned less the minimum required return on average operating assets.

Residual income encourages managers to
make profitable investments that would
be rejected by managers using ROI.

What is one major disadvantage of using the residual income?
It cannot be used to compare the performance of divisions of different sizes.
Many companies set transfer prices at either the variable cost or full (absorption) cost incurred by the selling division.
Drawbacks of this approach include:
Using full cost as a transfer price can lead to suboptimization (not acting the full interest of the co.)
The selling division will never show a profit on any internal transfer.
Cost-based transfer prices do not provide incentives to control costs.
When does the market price work best?
when there’s no idle capacity
Should Actual or Budgeted Costs Be Charged?
Budgeted variable and fixed service department costs should be charged to operating departments.

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