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Chapter 10Segment Reporting, Decentralization,and the Balanced Scorecard

Solutions to Questions

10-1 In a decentralized organization,decision-making authority isnt confined toa few top executives, but rather is spreadthroughout the organization with lower-level managers and other employeesempowered to make decisions.

10-2 The benefits of decentralizationinclude !"# by delegating day-to-dayproblem solving to lower-level managers,top management can concentrate onbigger issues such as overall strategy$ !%#empowering lower-level managers tomake decisions puts decision-making

authority in the hands of those who tendto have the most detailed and up-to-dateinformation about day-to-day operations$! by eliminating layers of decision-making and approvals, organizations canrespond more 'uickly to customers and tochanges in the operating environment$ !(#granting decision-making authority helpstrain lower-level managers for higher-levelpositions$ and !)# empowering lower-levelmanagers to make decisions can increasetheir motivation and *ob satisfaction.

10-3 The manager of a cost center hascontrol over cost, but not revenue or theuse of investment funds. + profit centermanager has control over both cost andrevenue. +n investment center managerhas control over cost and revenue and theuse of investment funds.

10-4 + segment is any part or activity ofan organization about which a managerseeks cost, revenue, or profit data.xamples of segments includedepartments, operations, sales territories,divisions, and product lines.

10- nder the contribution approach,costs are assigned to a segment if andonly if the costs are traceable to thesegment !i.e., could be avoided if thesegment were eliminated#. ommon costsare not allocated to segments under thecontribution approach.

10-! + traceable cost of a segment is acost that arises specifically because of theexistence of that segment. If the segmentwere eliminated, the cost would disappear.+ common cost, by contrast, is a cost thatsupports more than one segment, but isnot traceable in whole or in part to anyone of the segments. If the departments ofa company are treated as segments, thenexamples of the traceable costs of adepartment would include the salary ofthe departments supervisor, depreciation

of machines used exclusively by thedepartment, and the costs of suppliesused by the department. xamples ofcommon costs would include the salary ofthe general counsel of the entirecompany, the lease cost of thehead'uarters building, corporate imageadvertising, and periodic depreciation ofmachines shared by several departments.

/ The 0c1raw-2ill ompanies, Inc., %3"3. +ll rights reserved.

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10-" The contribution margin is thedifference between sales revenue andvariable expenses. The segment margin isthe amount remaining after deductingtraceable fixed expenses from thecontribution margin. The contribution

margin is useful as a planning tool formany decisions, particularly those inwhich fixed costs dont change. Thesegment margin is useful in assessing theoverall profitability of a segment.

10-# If common costs were allocated tosegments, then the costs of segmentswould be overstated and their marginswould be understated. +s a conse'uence,some segments may appear to beunprofitable and managers may betempted to eliminate them. If a segment

were eliminated because of the existenceof arbitrarily allocated common costs, theoverall profit of the company woulddecline and the common cost that hadbeen allocated to the segment would bereallocated to the remaining segments5making them appear less profitable.

10-$ There are often limits to how fardown an organization a cost can betraced. Therefore, costs that are traceableto a segment may become common asthat segment is divided into smaller

segment units. 6or example, the costs ofnational T7 and print advertising might betraceable to a specific product line, but bea common cost of the geographic salesterritories in which that product line issold.

10-10 0argin refers to the ratio of netoperating income to total sales. Turnover

refers to the ratio of total sales to averageoperating assets. The product of the twonumbers is the 89I.

10-11 8esidual income is the netoperating income an investment center

earns above the companys minimumre'uired rate of return on operatingassets.

10-12 If 89I is used to evaluateperformance, a manager of an investmentcenter may re*ect a profitable investmentopportunity whose rate of return exceedsthe companys re'uired rate of return butwhose rate of return is less than theinvestment centers current 89I. Theresidual income approach overcomes thisproblem because any pro*ect whose rate

of return exceeds the companys minimumre'uired rate of return will result in anincrease in residual income.

10-13 + companys balanced scorecardshould be derived from and support itsstrategy. :ecause different companieshave different strategies, their balancedscorecards should be different.

10-14The balanced scorecard isconstructed to support the companysstrategy, which is a theory about what

actions will further the companys goals.+ssuming that the company has financialgoals, measures of financial performancemust be included in the balancedscorecard as a check on the reality of thetheory. If the internal business processesimprove, but the financial outcomes donot improve, the theory may be flawedand the strategy should be changed.


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Brie% &'ercise 10-1 !") minutes#

Total Weedban Greengrow

4ales;................................&,333 &?,333 "(@,333ontribution margin.......... ""@,333 )(,333 ?&,333

Traceable fixed expenses. . ??,333 (),333 %",333Aroduct line segment

margin............................ )",333 < =,333 < (%,333ommon fixed expenses

not traceable to products &&,333

Cet operating income........G E H%,>33,333........................ )3(,3338esidual income.............................. H =?,333


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Brie% &'ercise 10-4!() minutes#

". 0As previous manufacturing strategy was focused on high-volume production of a limited range of paper grades. The goalof this strategy was to keep the machines running constantly to

maximize the number of tons produced. hangeovers wereavoided because they lowered e'uipment utilization.0aximizing tons produced and minimizing changeovers helpedspread the high fixed costs of paper manufacturing acrossmore units of output. The new manufacturing strategy isfocused on low-volume production of a wide range of products.

The goals of this strategy are to increase the number of papergrades manufactured, decrease changeover times, andincrease yields across non-standard grades. Dhile 0A realizes

that its new strategy will decrease its e'uipment utilization, itwill still strive to optimize the utilization of its high fixed costresources within the confines of flexible production. In aneconomists terms the old strategy focused on economies ofscale while the new strategy focuses on economies of scope.

%. mployees focus on improving those measures that are used toevaluate their performance. Therefore, strategically-alignedperformance measures will channel employee effort towardsimproving those aspects of performance that are most

important to obtaining strategic ob*ectives. If a companychanges its strategy but continues to evaluate employeeperformance using measures that do not support the newstrategy, it will be motivating its employees to make decisionsthat promote the old strategy, not the new strategy. +nd ifemployees make decisions that promote the new strategy,their performance measures will suffer.

4ome performance measures that would be appropriate for0As old strategy include e'uipment utilization percentage,

number of tons of paper produced, and cost per ton produced.These performance measures would not support 0As newstrategy because they would discourage increasing the rangeof paper grades produced, increasing the number ofchangeovers performed, and decreasing the batch sizeproduced per run.


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Brie% &'ercise 10-4!continued#

&. 4tudents answers may differ in some details from this solution.


4olutions 0anual hapter "3 %(@

4ales ontributionmargin per

(inancial

Time to fillan order

ustomer satisfaction withbreadth of product offerings

Cumber of newcustomers ac'uired

Customer

+verage change-over time

Cumber of differentpaper grades

+veragemanufacturing

)nternalBusiness*rocess

Cumber ofemployees trained

to support the

+earningand roth

J

J

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Brie% &'ercise 10-4!continued#

(. The hypotheses underlying the balanced scorecard areindicated by the arrows in the diagram. 8eading from thebottom of the balanced scorecard, the hypotheses are

K If the number of employees trained to support the flexibilitystrategy increases, then the average changeover time willdecrease and the number of different paper grades producedand the average manufacturing yield will increase.

K If the average changeover time decreases, then the time tofill an order will decrease.

K If the number of different paper grades produced increases,then the customer satisfaction with breadth of product

offerings will increase.K If the average manufacturing yield increases, then the

contribution margin per ton will increase.

K If the time to fill an order decreases, then the number of newcustomers ac'uired, sales, and the contribution margin perton will increase.

K If the customer satisfaction with breadth of product offeringsincreases, then the number of new customers ac'uired,sales, and the contribution margin per ton will increase.

K If the number of new customers ac'uired increases, thensales will increase.

ach of these hypotheses can be 'uestioned. 6or example, thetime to fill an order is a function of additional factors above andbeyond changeover times. Thus, 0As average changeovertime could decrease while its time to fill an order increases if,for example, the shipping department proves to be incapable ofefficiently handling greater product diversity, smaller batch

sizes, and more fre'uent shipments. The fact that each of thehypotheses mentioned above can be 'uestioned does notinvalidate the balanced scorecard. If the scorecard is usedcorrectly, management will be able to identify which, if any, ofthe hypotheses are invalid and modify the balanced scorecardaccordingly.


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&'ercise 10-!%3 minutes#

". 89I computations

89I F 0argin E Turnover

Cet operating income 4alesF E

4ales +verage operating assets

9saka Livision

M%"3,333 M&,333,33389I F E

M&,333,333 M",333,333

F @G E & F %"G

Nokohama Livision

M@%3,333 M=,333,33389I F E

M=,333,333 M(,333,333

F >G E %.%) F ">G

%. Osaka Yokohama

+verage operating assets !a#...............M",333,33

3M(,333,33

3

Cet operating income..........................M %"3,33

3M @%3,33

30inimum re'uired return on average

operating assets ")G E !a#............. ")3,333 ?33,333

8esidual income.................................. M ?3,333M "%3,33

3

&. Co, the Nokohama Livision is simply larger than the 9sakaLivision and for this reason one would expect that it wouldhave a greater amount of residual income. 8esidual incomecant be used to compare the performance of divisions ofdifferent sizes. Oarger divisions will almost always look better.In fact, in the case above, the Nokohama Livision does notappear to be as well managed as the 9saka Livision. Cote fromAart !"# that Nokohama has only an ">G 89I as compared to%"G for 9saka.


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&'ercise 10-!!") minutes#

". 89I computations




Pueensland Livision

G 89I for the other division.

Cotice that if you look at margin alone, then the PueenslandLivision appears to be the stronger division. This factunderscores the importance of looking at turnover as well as atmargin in evaluating performance in an investment center.


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&'ercise 10-"!") minutes#

DivisionAlpha Bravo Charlie

4ales...............................

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&'ercise 10-#!&3 minutes#

". 89I computations




Livision +

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&'ercise 10-#!continued#

&. a. and b.Division

ADivision

BDivision

C

8eturn on investment !89I#..... %3G >G "?GTherefore, if the division is

presented with aninvestment opportunityyielding ")G, it probablywould.................................... 8e*ect +ccept 8e*ect

0inimum re'uired return forcomputing residual income... "(G "3G "?G

Therefore, if the division is

presented with aninvestment opportunityyielding ")G, it probablywould.................................... +ccept +ccept 8e*ect

If performance is being measured by 89I, both Livision + andLivision probably would re*ect the ")G investmentopportunity. These divisions 89Is currently exceed ")G$accepting a new investment with a ")G rate of return wouldreduce their overall 89Is. Livision : probably would accept the

")G investment opportunity because accepting it wouldincrease the divisions overall rate of return.

If performance is measured by residual income, both Livision +and Livision : probably would accept the ")G investmentopportunity. The ")G rate of return promised by the newinvestment is greater than their re'uired rates of return of "(Gand "3G, respectively, and would therefore add to the totalamount of their residual income. Livision would re*ect theopportunity because the ")G return on the new investment is

less than its "?G re'uired rate of return.


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&'ercise 10-$!&3 minutes#

". Cet operating income0argin F

4ales

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&'ercise 10-$ !continued#

&. Cet operating income0argin F

4ales

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&'ercise 10-10!") minutes#

". Cet operating income0argin F

4ales

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&'ercise 10-10 !continued#

&. Cet operating income0argin F

4ales

.@)G E ( F &)G


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&'ercise 10-11 !() minutes#

". 4tudents answers may differ in some details from this solution.


%)> Introduction to 0anagerial +ccounting, )th dition

8evenue per employee 4ales

Arofit margin

(inancial

8atio of billablehours to total hours

+verage number oferrors per tax

+verage time neededto prepare a return

Aercentage of *oboffers accepted

mployeemorale

+mount of compensationpaid above industry

+verage number ofyears to be promoted

Customer

)nternal Business*rocesses

+earning.nd roth

J

J

ustomersatisfaction

with

ustomersatisfaction

with

ustomer

satisfactionwith

service

Cumber of newcustomers

J

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%. The hypotheses underlying the balanced scorecard areindicated by the arrows in the diagram. 8eading from thebottom of the balanced scorecard, the hypotheses are

K If the amount of compensation paid above the industryaverage increases, then the percentage of *ob offersaccepted and the level of employee morale will increase.

K If the average number of years to be promoted decreases,then the percentage of *ob offers accepted and the level ofemployee morale will increase.

K If the percentage of *ob offers accepted increases, then theratio of billable hours to total hours should increase while the

average number of errors per tax return and the averagetime needed to prepare a return should decrease.

K If employee morale increases, then the ratio of billable hoursto total hours should increase while the average number oferrors per tax return and the average time needed toprepare a return should decrease.

K If employee morale increases, then the customer satisfactionwith service 'uality should increase.

K If the ratio of billable hours to total hours increases, then therevenue per employee should increase.

K If the average number of errors per tax return decreases,then the customer satisfaction with effectiveness shouldincrease.

K If the average time needed to prepare a return decreases,then the customer satisfaction with efficiency shouldincrease.

K If the customer satisfaction with effectiveness, efficiency and

service 'uality increases, then the number of new customersac'uired should increase.

K If the number of new customers ac'uired increases, thensales should increase.

K If revenue per employee and sales increase, then the profitmargin should increase.


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ach of these hypotheses can be 'uestioned. 6or example,+riels customers may define effectiveness as minimizing theirtax liability which is not necessarily the same as minimizing the

number of errors in a tax return. If some of +riels customersbecame aware that +riel overlooked legal tax minimizingopportunities, it is likely that the Qcustomer satisfaction witheffectivenessR measure would decline. This decline wouldprobably puzzle +riel because, although the firm prepared whatit believed to be error-free returns, it overlooked opportunitiesto minimize customers taxes. In this example, +riels internalbusiness process measure of the average number of errors pertax return does not fully capture the factors that drive the

customer satisfaction. The fact that each of the hypothesesmentioned above can be 'uestioned does not invalidate thebalanced scorecard. If the scorecard is used correctly,management will be able to identify which, if any, of thehypotheses are invalid and then modify the balanced scorecardaccordingly.

&. The performance measure Qtotal dollar amount of tax refundsgeneratedR would motivate +riels employees to aggressivelysearch for tax minimization opportunities for its clients.

2owever, employees may be too aggressive and recommend'uestionable or illegal tax practices to clients. This undesirablebehavior could generate unfavorable publicity and lead toma*or problems for the company as well as its customers.9verall, it would probably be unwise to use this performancemeasure in +riels scorecard.

2owever, if +riel wanted to create a scorecard measure tocapture this aspect of its client service responsibilities, it maymake sense to focus the performance measure on its training

process. Aroperly trained employees are more likely torecognize viable tax minimization opportunities.


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(. ach offices individual performance should be based on thescorecard measures only if the measures are controllable bythose employed at the branch offices. In other words, it would

not make sense to attempt to hold branch office managersresponsible for measures such as the percent of *ob offersaccepted or the amount of compensation paid above industryaverage. 8ecruiting and compensation decisions are nottypically made at the branch offices. 9n the other hand, itwould make sense to measure the branch offices with respectto internal business process, customer, and financialperformance. 1athering this type of data would be useful forevaluating the performance of employees at each office.


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&'ercise 10-12!") minutes#

CompanyA B C

4ales...................................

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&'ercise 10-13!%3 minutes#

". .3 ?3,333 &3 ">3,333 ?3ontribution margin %?3,333 )%.3 "(3,333 @3 "%3,333 (3

Traceable fixedexpenses.............. "%?,333 %).% @>,333 &= (>,333 "?

9ffice segmentmargin................. "&(,333 %?.>

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