Segment Performance Measurements

Chapter 10 Segment Performance Measurements

LEARNING OBJECTIVES

1.      Understand what a segment report is and its purpose.
2.      Identify traceable fixed costs, segment margin and common fixed costs.
3.      Know how to prepare a segment report showing performance or different segments.
4.      Allocate common fixed costs that affect the performance of different segments.

Organigramma

1. Allocation of Costs and Segment Report
(Jun 11, Dec 14)

1.1

Definitions

(a)       A segment can be an activity or a part of a company that involves revenue, costs and profit. For example, divisions of a company, individual stores, different geographical sales locations, different product lines, production plant, marketing departments and individual customers can give different segment.
(b)       Segment report shows the segment results of analyzing the profitability of each segment and in measuring the performance of those segment managers. Managers can focus more on improving the weaker segment or consider dropping that while maintaining the strengths of the stronger segment. Therefore, the segment results are relevant for responsibility accounting as it is related to the performance of individual segments.
(c)       A traceable fixed cost of a segment is defined as a fixed cost incurred because of the existence of the segment but not incurred without the segment.
(d)       Segment margin is calculated by deducting the traceable fixed costs of a segment from the segment’s contribution margin. It represents the margin available after a segment has covered all of its own costs.
(e)       Common fixed costs, as different from the traceable fixed costs, are costs that support the operations of more than one segment but are not traceable in whole or in part to any one segment. For examples, the salaries of the top executives of the company, general electricity fees for daily operation and building insurance costs for the company’s main premises.

1.2

Example 1

To illustrate how it works, here is an example:

Segments	Total	Division A	Division B
	$	$	$
Revenue	500	300	200
Less: Variable expenses
Variable cost of goods sold	(180)	(120)	(60)
Other variable expenses	(50)	(30)	(20)
Total variable expenses	(230)	(150)	(80)
Contribution margin	270	150	120
Less: Traceable fixed costs	(170)	(90)	(80)
Divisional segment margin	100	60	40
Less: Common fixed expenses not traceable to individual divisions	(85)
Net operating income	15

1.3       In order to utilize segment reporting for achieving its purposes, costs must be properly allocated to segments properly. If the purpose is to determine the profits being generated by a particular division, all costs should be attributable to that division.
1.4       However, in daily operation, companies make mistakes easily when allocating costs to responsibility centres. Such problems generally include:
(a)        Omit some costs through the value chain
(b)       Allocate traceable fixed costs inappropriately as a result of failure to trace costs directly and with inappropriate allocation base
(c)        Allocate common fixed costs arbitrarily (任意地) among segments.
1.5       All of the above problems may seriously affect the segments’ profitability and so may even result in dropping of some segments. The net effect would be reducing the overall profit of the company and make it even more difficult to cover those common costs.

2. General Aspects in Performance Measurements

2.1 In considering the segmental reporting, there are a large number of business performance measures which may be used.

2.2	Financial and non-financial measures
	(a) Financial performance measures include turnover, profit and return on capital employed. (b) Non-financial performance measures include market share, capacity utilization, labour turnover, etc.

2.3 The areas of performance criteria will vary. Some of the criteria, and control and measurement used, are as follows:

Financial performance	Cost Profitability Liquidity Budget variance analysis Capital structure Market ratios Level of bad debts Return on capital employed
Competitiveness	Sales growth by product or service Measures of customer base Relative market share and position
Activity	Sales units Labour / machine hours No. of passengers carried No. of material requisitions serviced
Productivity	Efficiency measurements of resources planned against consumed Measurements of resources available against those used Productivity measurements such as production per person or per hour or per shift

Quality of service	Quality measures in every unit Number of customer complaints received Number of new accounts lost or gained
Customer satisfaction	Speed of response to customer needs Informal listening by calling a certain number of customers each week Number of customers visit to the factory or workplace
Quality of working life	Days absence Labour turnover Overtime Measures of job satisfaction
Innovation	Proportion of new products and services to old ones New product or service sales levels

Examination Style Questions

Question 1

(HKIAAT PBE Paper II Management Accounting June 2006 Q6)

Question 2 – Segment reporting, responsibility accounting and decentalised structure
Agape Company manufactures and sells two types of mobile phone: 3G and 4G. The manufacturing information for the first quarter is as follows:

	3G	4G
Sales in units	5,000	3,000
Sales price per unit	$3,000	$6,000
Variable production costs per unit	$600	$1,200
Traceable fixed production costs	$6,000,000	$9,000,000
Variable selling expenses per unit	$300	$360
Traceable fixed selling expenses	$300,000	$450,000
Allocated portion of corporate expenses	$3,480,000	$3,600,000

Required:

(a)     Prepare a segmented income statement for the first quarter, showing columns for the company as a whole and for each product.                                                                             (8 marks)
(b)    Explain why segment reporting is an extension of responsibility accounting. Use the data from part (a), point out the item(s) which is/are relevant for responsibility accounting. (3 marks)
(c)     The director of the 3G product is responsible for its production and marketing. What are the advantages of such decentalised structure?                                                    (4 marks)
(d) What are the THREE levels of responsibility to which decentalised companies divide their segments? Describe briefly and indicate which level the 3G business belongs to.         (5 marks)
                  (HKIAAT PBE Paper II Management Accounting and Finance June 2011 Q4)

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Segment Performance Measurements

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