Management Accounting:

an outline
Introduction:
Concepts and
techniques

Chapter 9

Marketing
decisions

Users and uses

Management Control Systems

and Responsibility Accounting

Cost behavior and

CVP analysis

Production
decisions

Measurement of
cost behavior
Cost management
system

Management
control system

Responsibility
center

Product
costing

Master
budget

Cost
allocation

Flexible
budgets

Job costing
systems

Management
control system
and responsibility
accounting
Management
control in
decentralized
organizations

9- 1

Lecture Outline

Planning
and
controlling

Decision
making

Process
costing
systems
Overhead
application
9-2

Management Control

Performance
measure

Cost
center
Segment
Statement

Profit
center
Investment
center

Nonfinancial
measure

Management controls include:

the plan of organization,

Controllability
Balanced
scorecard

methods and procedures

adopted by management

Quality
control

to ensure that its goals are met

9-3

Goals example

Management Control System

Luxury Suites: goals and performance measures

A system designed to influence

Organizational goals Performance measures

subordinates
to act in the organizations interest

1. Set Goals
and Execute

2. Monitor
and Report

9-4

3. Evaluate
and Reward
9-5

Exceed guest expectations

Satisfaction index
Number of repeat stays

Maximize revenue yield

Occupancy rate
Room rate
Income before fixed costs

Focus on innovation

New products/services
implemented per year
Number of employee
suggestions
9-6

Lecture Outline

Rewards example
Monetary rewards
money in a form of a bonus
trips paid for by the
company
gifts from a rewards
catalog
services such as cell
phone or paid cable
3 percent pay raise each
year
stock option

Nonmonetary rewards

movie tickets
restaurant coupons
thanks from the bosses
flexible schedules
a day off
recognition of birthdays
free lunches
parking space
outstanding employee plaque
corner office space
personalized items

Management
control system

Responsibility
center

Performance
measure

Cost
center
Profit
center
Investment
center

Segment
Statement

Nonfinancial
measure

Controllability
Balanced
scorecard

Quality
control

9-7

Responsibility Accounting

9-8

Responsibility Accounting

James O. McKinsey, founder of McKinsey & Co. :

In the modern business organization, control is
exercised through individuals who compose the
organization.
If control of expense is to be effected through
members of the organization, it is necessary that they
be classified so as to show responsibility for each class.
------ J McKinsey, Budgetary control, (New York: Ronald Press), p.281.

Reports revenues and costs at the level

within the organization having the related
responsibility.
Cost
center

Profit
center

Responsibility

Investment
center

9-9

Cost Center

9 - 10

Profit Center

A segment whose manager has control over costs, but not

over revenues or investment funds.

A segment whose manager

has control over both costs
and revenues,
but no control over
investment funds.

Revenues
Sales
Interest
Other

Costs
Mfg. costs
Commissions
Salaries
Other

9 - 11

9 - 12

Frequency of Profit Center Use

Investment Center
Corporate Headquarters

Industry

Percentage with Profit Centers

Commercial banks
Diversified financial
Diversified service
Hospitals
Life Insurance
Large manufacturing
Medium manufacturing
Retailers or wholesalers
Transportation
Utilities
Miscellaneous

A segment whose
manager has control
over costs, revenues,
and investments in
operating assets.

94%
71
95
27
77
97
95
97
76
61
92

S Umaphathy, Current Budgeting Practices in U.S. Industry

(New York: Quorum Books ), P. 20.
9 - 13

Summary of Responsibility Centers

The decision rights of a responsibility center should be
associated with its information advantage
Decision
1.Cost Center

Specific Knowledge
Information about
production

CostStandard cost

2.Profit Center The above+

Selling Price
product mix

The above+
Information about
product market

ProfitActual
results or actual
results compared
with budgets

The above+
The above +
Capital Investment Information about
Capital Expenditure investment
opportunities

Responsibility Centers example

Investment
Centers

Performance
Measure

Allocation of
Resources

3.Investment
Center

9 - 14

Operations
Vice President

Salty Snacks
Product Manger

Bottling Plant
Manager

Beverages
Product Manager

Warehouse
Manager

Superior Foods Corporation

Corporate Headquarters
President and CEO

Finance
Chief FInancial Officer

Legal
General Counsel

Personnel
Vice President

Confections
Product Manager

Distribution
Manager

Cost
Centers

An example of the various kinds of responsibility

centers that exist in an organization.

ROI
RI
EVA
9 - 15

9 - 16

Responsibility Centers example

Responsibility Centers example

Superior Foods Corporation

Corporate Headquarters
President and CEO

Superior Foods Corporation

Corporate Headquarters
President and CEO

Operations
Vice President

Salty Snacks
Product Manger

Bottling Plant
Manager

Beverages
Product Manager

Warehouse
Manager

Finance
Chief FInancial Officer

Legal
General Counsel

Personnel
Vice President

Confections
Product Manager

Distribution
Manager

Operations
Vice President

Salty Snacks
Product Manger

Profit
Centers

Bottling Plant
Manager

9 - 17

Beverages
Product Manager

Warehouse
Manager

Finance
Chief FInancial Officer

Legal
General Counsel

Personnel
Vice President

Confections
Product Manager

Distribution
Manager

Cost
Centers

9 - 18

Lecture Outline

Segments
An Individual Store

Management
control system

Quick Mart

Performance
measure

Responsibility
center
Cost
center

Segment
Statement

Profit
center
Investment
center

Nonfinancial
measure

segments are responsibility

centers for which a
company develops
separate measures of
revenues and costs

A Sales Territory

Controllability

A Service Center

Balanced
scorecard

Quality
control
9 - 19

Superior Foods: Geographic Regions

9 - 20

Superior Foods: Customer Channel

Superior Foods Corporation

$500,000,000

East
$75,000,000

Oregon
$45,000,000

West
$300,000,000

Washington
$50,000,000

Superior Foods Corporation

$500,000,000

Midwest
$55,000,000

California
$120,000,000

South
$70,000,000

Convenience Stores
$80,000,000

Supermarket Chain A
$85,000,000

Mountain States
$85,000,000

Supermarket Chains
$280,000,000

Supermarket Chain B
$65,000,000

Wholesale Distributors
$100,000,000

Supermarket Chain C
$90,000,000

Drugstores
$40,000,000

Supermarket Chain D
$40,000,000

Superior Foods Corporation could segment its business

by geographic region.

Superior Foods Corporation could segment its business

by customer channel.

9 - 21

9 - 22

Keys to Segmented Income Statements

Identifying Traceable Fixed Costs

Traceable costs arise because of the existence of a
particular segment and would disappear over time if
the segment itself disappeared.

Contribution Margin:

No computer
division means . . .

it separates fixed from variable costs.

No computer
division manager.

Segment margin:
It separates traceable fixed costs from
common fixed costs.
9 - 23

9 - 24

Identifying Common Fixed Costs

Common costs arise because of the overall
operation of the company and would not
disappear if any particular segment were
eliminated.
No computer
division but . . .

We still have a
company president.

Traceable Costs Can Become

Common Costs
The traceable fixed costs of one segment may
be a common fixed cost of another segment.
E.g., the landing fee paid to land
an airplane:
Traceable to the particular flight;
Not traceable to first-class,
business-class, and economyclass passengers.

9 - 25

Segment Margin

9 - 26

Traceable and Common Costs

Profits

Computed by subtracting the traceable fixed costs of a

segment from its contribution margin
The best gauge of the long-run profitability of a segment.

Fixed
Costs

Dont allocate
common costs to
segments.
Common

Traceable
Costs arise because
of the existence of
a particular segment

Time

A cost that supports more than one

segment but that would not go
away if any particular segment
were eliminated.

9 - 27

9 - 28

Activity-Based Costing

Levels of Segmented Statements

Help identify how costs shared by more than one

segment are traceable to individual segments.

Webber, Inc. has two divisions.

Assume that 3 products, 9-inch, 12-inch, and 18-inch pipe, share 10,000 square
feet of warehousing space, which is leased at a price of $4 per square foot.
If the 9-inch, 12-inch, and 18-inch pipes occupy 1,000, 4,000, and 5,000 square
feet, respectively, then ABC can be used to trace the warehousing costs to the 3
products as shown.

Warehouse sq. ft.

Lease price per sq. ft. $
Total lease cost
$

Pipe Products
9-inch
12-inch
18-inch
Total
1,000
4,000
5,000
10,000
4 $
4 $
4 $
4
4,000 $
16,000 $
20,000 $
40,000

9 - 29

Webber, Inc.

Computer Division

Television Division

Lets look more closely at the Television

Divisions income statement.
9 - 30

Levels of Segmented Statements

Levels of Segmented Statements

Our approach to segment reporting uses the

contribution format.

Our approach to segment reporting uses the

contribution format.

Income Statement
Contribution Margin Format
Television Division
Sales
$ 300,000
Variable COGS
120,000
Other variable costs
30,000
Total variable costs
150,000
Contribution margin
150,000
Traceable fixed costs
90,000
Division margin
$ 60,000

Cost of goods
sold consists of
variable
manufacturing
costs.
Fixed and
variable costs
are listed in
separate
sections.

Income Statement
Contribution Margin Format
Television Division
Sales
$ 300,000
Variable COGS
120,000
Other variable costs
30,000
Total variable costs
150,000
Contribution margin
150,000
Traceable fixed costs
90,000
Division margin
$ 60,000

Contribution margin
is computed by
taking sales minus
variable costs.
Segment margin
is Televisions
contribution
to profits.

9 - 31

Levels of Segmented Statements

Sales
Variable costs
CM
Traceable FC
Division margin
Common costs
Net operating
income

Income Statement
Company
Television
$ 500,000
$ 300,000
230,000
150,000
270,000
150,000
170,000
90,000
100,000
$ 60,000

Computer
$ 200,000
80,000
120,000
80,000
$ 40,000

9 - 32

Levels of Segmented Statements

Sales
Variable costs
CM
Traceable FC
Division margin
Common costs
Net operating
income

Income Statement
Company
Television
$ 500,000
$ 300,000
230,000
150,000
270,000
150,000
170,000
90,000
100,000
$ 60,000
25,000
$

75,000

Computer
$ 200,000
80,000
120,000
80,000
$ 40,000

Common costs should not

be allocated to the
divisions. These costs
would remain even if one
of the divisions were
eliminated.

9 - 33

Traceable Costs Can Become

Common Costs

9 - 34

Traceable Costs Can Become Common Costs

As previously mentioned, fixed costs that are

traceable to one segment can become
common if the company is divided into
smaller segments.

Lets see how this works

using the Webber, Inc.
example!

Webbers Television Division

Product
Lines

Television
Division

Regular

U.S. Sales

Big Screen

Foreign Sales

U.S. Sales

Foreign Sales

Sales
Territories
9 - 35

9- 36

Traceable Costs Can Become

Common Costs
Income Statement
Television
Division
Regular
Sales
$ 200,000
Variable costs
95,000
CM
105,000
Traceable FC
45,000
Product line margin
$ 60,000
Common costs
Divisional margin

Traceable Costs Can Become

Common Costs

Big Screen
$ 100,000
55,000
45,000
35,000
$ 10,000

We obtained the following information from

the Regular and Big Screen segments.
9 - 37

Income Statement
Television
Division
Regular
Sales
$ 300,000
$ 200,000
Variable costs
150,000
95,000
CM
150,000
105,000
Traceable FC
80,000
45,000
Product line margin
70,000
$ 60,000
Common costs
10,000
Divisional margin
$ 60,000

The remaining $10,000

cannot be traced to
either the Regular or Big
Screen product lines.

The Financial Accounting Standards Board now requires

that companies in the United States include segmented
financial data in their annual reports.
Companies must report segmented
results to shareholders using the same
methods that are used for internal
segmented reports.

2.

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.

Fixed costs directly traced

to the Television Division
$80,000 + $10,000 = $90,000
9 - 38

Hindrances to Proper Cost

Assignment

External Reports

1.

Big Screen
$ 100,000
55,000
45,000
35,000
$ 10,000

The Problems
Omission of some
costs in the
assignment process.

Assignment of costs
to segments that are
really common costs of
the entire organization.

The use of inappropriate

methods for allocating
costs among segments.
9 - 39

9 - 40

Inappropriate Methods of
Allocating Costs Among Segments

Omission of Costs
Costs assigned to a segment should include all
costs attributable to that segment from the
companys entire value chain.
chain

Failure to trace
costs directly

Inappropriate
allocation base

Business Functions
Making Up The
Value Chain
R&D

Product
Design

Customer
Manufacturing Marketing Distribution Service

9 - 41

Segment
1

Segment
2

Segment
3

Segment
4

9 - 42

Common Costs and Segments

Quick Check

Common costs should not be arbitrarily allocated to segments

based on the rationale that someone has to cover the
common costs for two reasons:

Income Statement

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.

Segment
2

Segment
1

Segment
3

Segment
4

Sales
Variable costs
CM
Traceable FC
Segment margin
Common costs
Profit

Hoagland's
Lakeshore
$ 800,000
310,000
490,000
246,000
244,000
200,000
$ 44,000

Bar
$ 100,000
60,000
40,000
26,000
$ 14,000

Restaurant
$ 700,000
250,000
450,000
220,000
$ 230,000

Assume that Hoagland's Lakeshore prepared its

segmented income statement as shown.

9 - 43

9 - 44

Quick Check

Quick Check

How much of the common fixed cost of

$200,000 can be avoided by eliminating the
bar?
a. None of it.
b. Some of it.
c. All of it.

Suppose square feet is used as the basis for

allocating the common fixed cost of $200,000. How
much would be allocated to the bar if the bar
occupies 1,000 square feet and the restaurant 9,000
square feet?
a. $20,000
b. $30,000
c. $40,000
d. $50,000

A common fixed cost

cannot be eliminated by
dropping one of the
segments.

The bar would be

allocated 1/10 of the cost
or $20,000.

9 - 45

Quick Check

9 - 46

Allocations of Common Costs

If Hoagland's allocates its common

costs to the bar and the restaurant,
what would be the reported profit of
each segment?

Income Statement

Sales
Variable costs
CM
Traceable FC
Segment margin
Common costs
Profit

9 - 47

Hoagland's
Lakeshore
$ 800,000
310,000
490,000
246,000
244,000
200,000
$ 44,000

Bar
$ 100,000
60,000
40,000
26,000
14,000
20,000
$
(6,000)

Restaurant
$ 700,000
250,000
450,000
220,000
230,000
180,000
$ 50,000

Hurray, now everything adds up!!!

9 - 48

Lecture Outline

Quick Check
Should the bar be eliminated?
a. Yes
b. No

The profit was $44,000 before

eliminating the bar. If we eliminate
the bar,
profit drops to $30,000!
Income
Statement

Sales
Variable costs
CM
Traceable FC
Segment margin
Common costs
Profit

Hoagland's
Lakeshore
$ 700,000
250,000
450,000
220,000
230,000
200,000
$ 30,000

Bar

Management
control system

Responsibility
center

Performance
measure

Cost
center
Segment
Statement

Profit
center

Restaurant
$ 700,000
250,000
450,000
220,000
230,000
200,000
$ 30,000

Investment
center

Nonfinancial
measure

Controllability
Balanced
scorecard

Quality
control

9 - 49

9 - 50

Controllability is . . .

Controllability

The degree of influence that

a specific manager has over
costs, revenues, or other
items in question.

Few costs are clearly under

the sole influence of one
manager.
With a long enough time
span, all costs will come
under someones control.
9- 51

The Controllability Principle

The Controllability Principle

. . . lead to more predictable
rewards for managers.

Management
Actions

Management
Actions

Costs
Uncontrollable
Environmental
Effects

9 - 52

Managers only
partially control
costs.

9 - 53

Costs
Uncontrollable
Environmental
Effects

Performance
Measures

Rewards

Performance measurement
systems that are based on
controllable costs . . .
9 - 54

The Controllability Principle

The Controllability Principle

The performance measures and rewards
will influence management to focus on the
controllable costs.

Management
Actions

Management
Actions

Costs

Costs

Performance
Measures

Rewards

Uncontrollable
Environmental
Effects

Performance
Measures

Rewards

When performance measures

are affected by uncontrollable
environmental effects . . .

9 - 55

The Controllability Principle

Controllable cost
Based on our textbook, we use controllable
cost and traceable cost interchangeably

Management
Actions

Costs
Uncontrollable
Environmental
Effects

9 - 56

Performance
Measures

Rewards

. . . management may try to control

the performance measure rather than
the underlying cost.
9 - 57

Lecture Outline
Management
control system

Responsibility
center

The Balanced Scorecard

Performance
measure

Cost
center
Profit
center
Investment
center

Segment
Statement

9 - 58

Nonfinancial
measure

It links performance to rewards.

Controllability
Balanced
scorecard

a performance measurement and

reporting system that strikes a balance
between financial and operating measures.

Quality
control
9 - 59

It gives explicit recognition to the

diversity of organizational goals.
9 - 60

The Balanced Scorecard: From

Strategy to Performance Measures
Performance Measures

The Balanced Scorecard

Management translates its strategy into
performance measures that employees
understand and influence.

Financial
Has our financial
performance improved?

Customer

Customers

Financial

Internal Business Processes

Performance
measures
Internal
business
processes

Do customers recognize that

we are delivering more value?

Have we improved key business

processes so that we can deliver
more value to customers?

Learning
and growth
9 - 61

The Balanced Scorecard:

Non-financial Measures

What are our

financial goals?
What customers do
we want to serve and
how are we going to
win and retain them?

Vision
and
Strategy

What internal business processes are

critical to providing
value to customers?

Learning and Growth

Are we maintaining our ability
to change and improve?

Example of Nonfinancial Measures

The balanced scorecard relies on non-financial measures

in addition to financial measures for two reasons:

Financial measures are lag indicators that summarize

the results of past actions. Non-financial measures are
leading indicators of future financial performance.

Top managers are ordinarily responsible for financial

performance measures not lower level managers.
Non-financial measures are more likely to be
understood and controlled by lower level managers.

AT&T Universal Card Services uses 18 performance

measures for its customer inquiries process.
These measures include average speed of answer,
abandon rate, and application processing time.

Often the effects of poor nonfinancial

Performance do not show up in the
financial measures until
considerable ground has been lost.

9 - 63

The Balanced Scorecard for

Individuals
The entire organization
should have an overall
balanced scorecard.

9 - 62

9 - 64

The Balanced Scorecard and

Compensation

Each individual should

have a personal
balanced scorecard.

Incentive compensation should be linked to

balanced scorecard performance measures.

A personal scorecard should contain measures that can be

influenced by the individual being evaluated and that
support the measures in the overall balanced scorecard.
9 - 65

9 - 66

The Balanced Scorecard Jaguar

Example

The Balanced Scorecard Jaguar

Example

Profit

Profit

Contribution per car

Contribution per car

Number of cars sold

Number of cars sold

Customer satisfaction
with options

Customer satisfaction
with options

Financial

Customer

Internal
Business
Processes

Results
Satisfaction
Increases

Strategies
Number of
options available

Learning
and Growth

Increase
Options

Time to
install option

Increase
Skills

Employee skills in
installing options

Number of
options available

Time to
install option

Time
Decreases

Employee skills in
installing options

9 - 67

The Balanced Scorecard Jaguar

Example

9 - 68

The Balanced Scorecard Jaguar

Example

Profit

Profit

Contribution per car

Contribution per car

Results
Contribution
Increases

Results
Number of cars sold
Customer satisfaction
with options

Number of
options available

Cars sold
Increase
Satisfaction
Increases

Time to
install option

Number of cars sold

Customer satisfaction
with options

Number of
options available

Employee skills in
installing options

Satisfaction
Increases

Time to
install option

Time
Decreases

Employee skills in
installing options
9 - 69

The Balanced Scorecard Jaguar

Example
Results
If number
of cars sold
and contribution
per car increase,
profits
increase.

Profit

Profits
Increase

Contribution per car

Contribution
Increases

Number of cars sold

Cars Sold
Increases

Customer satisfaction
with options

Number of
options available

Time to
install option

9 - 70

Balanced scorecard_Luxury Suites

Hotels example
Component and measures

target

Financial strength
Revenue ( $mill) per new service
Revenue per arrival
Customer satisfaction
Customer satisfaction index
Brand loyalty index
Business process improvement
Number of improvements
Average cycle time (minutes) for check-in and check-out
Organizational learning
Percent of staff retrained
Training hours per employee

result

$50
$75

$58
$81

95
60

88
40

8
15

8
12

80
30

85
25

Employee skills in
installing options
9 - 71

9 - 72

Balanced scorecard_Composite Example

Questions
Financial

Objectives

Measures

Actions

Reform cost
structure

How do
customers look
on us

Gain
recognition
and
reputation

Brand image
and
reputation

Achieve 10% Innovative

within one
advertising
year

Internal
Process

What do we
must excel at

Shorten
innovation
cycle

Innovation
cycle

Shorten from Cross1 year to 3

department
months
R&D team

Learning
&
Growth

Can we create
value
continuously

Change to
consulting
selling
method

Ratio of
employees
mastering
that method

80% within
half of one
year

Customer

Unit cost

Targets

How do
shareholders
look on us

Reduce 5%
within one
year

Use of Balanced Scorecard and

Weights
A survey of 100 large US companies
60% use some forms of balanced scorecard

Internal
training
program

Relative weights to the four perspectives:

Financial
Customer
Internal process
Learning & growing

55%
19%
12%
14%

9- 73

Quality Control

9 - 74

Cost of Quality Report

In a cost of quality report, the financial
impact of quality is displayed.

Quality control is the

effort to ensure that
products and services
perform to customer
satisfaction.

Prevention()

Internal failure
()

Appraisal()

External failure
()

9 - 75

Cost of Quality Report

9 - 76

Cost of Quality Report

Internal failure costs are the costs of defective
components and final products or services
that are scrapped or reworked.

Prevention costs are the costs incurred to

prevent the production of defective products
or delivery of substandard services.

External failure costs are the costs caused by

delivery of defective products or services
to customers, such as field repairs,
returns, and warranty expenses.

Appraisal costs are the costs incurred to

identify defective products or services.

9 - 77

9 - 78

Quality-Control Chart

Quality-Control Chart

The quality-control chart is a statistical plot

of measures of various product dimensions
or attributes.
This plot helps detect process deviations
before the process generates defects.

Quality-Control Chart
Actual

Goal .6%

Percentage of
Defects

2
1.5
1
0.5
0
3/12 3/19 3/26

4/2

4/9 4/16 4/23 4/30

Week of

5/7

9 - 79

9 - 80

Total Quality Management

Total Quality Management

Quality throughout
the production process.

The application of
quality principles
to all of the
organizations
endeavors
to satisfy customers.

5/14

Customer
Orientation
in a Global
Economy

Rewards for employees

who find defects.

on

Employees encouraged
to try new methods
to improve quality.

Company emphasizes
value of quality through
quality awards.
9 - 82

9 - 81

Control of Cycle Time

Cycle Time
Cycle time, or throughput time, is the time
taken to complete a product or service, or
any of the components of a product or service.

Lowering cycle time requires smooth-running

processes and high quality, and also creates
increased flexibility and quicker reactions to
customer needs.

One key to improving quality is to reduce

cycle time.

9 - 83

9 - 84

Summary

1. How to define an organizational subunit as a cost center,

a profit center, or an investment center.
2. Prepare segment income statements for evaluating profit
and investment centers using the contribution margin
and traceable-cost concepts.
3. Understand traceable-cost and controllable-cost.
4. Use a balanced scorecard to recognize both financial and
nonfinancial measures of performance.
5. Measure performance against quality, cycle time, and
other nonfinancial objectives.

TQM in Mettler Toledo

HW8
P393. 9-34; P397. 9-45; P400. 9-52
9- 85

9- 86