MODUL PERKULIAHAN

Segment
Reporting &
Decentralization
Decentralization & Segment
Reporting

Fakultas Program Studi Tatap Muka Kode MK Disusun Oleh

08
Economic & Business Accountancy 8403 Alfiandri, MAcc

Abstract Kompetensi
Diisi dengan abstract 1. Understand the concept of
Decentralization in the company.
2. Understand type of responsibility
center in the company
3. Understand ROI approach in the
Investment center
4. Understand Residual Income in the
Investment Center
Pembahasan
1. Introduction

Every large organization implement decentralization model of management in order

to delegate some decision. Unlike, centralization model which only top managers who
could make decision and low manager just implement what decision already made,
implementing decentralization model in the organization involves low managers to make
decision. Low managers also play role in decision making as well as top management in
order to achieve the organization objectives. In addition to this, provide the information
more details and more valuable if it is compared with centralization role model.

2. Overview Decentralization in the Organization

Decentralization model states that the decision making authority is spread throughout the
entire of the organization rather than being confined by few top executives. As it noted
above, out of necessity all large organizations are decentralized to some extents.
Organizations do differ, however, in the extent to which they are centralized. In another
word, strong centralized organization, make decision authority is delegated reluctantly to
lower level of managers who have little freedom to make decision.
Decentralization on the other hand, lowest level managers are played roles to make as
many decisions as possible. Furthermore, most organization fall somewhere between
these two extreme model

According to James Hall, (2011) decentralization in the organization has advantages and
disadvantages.

 Advantages:

a. By delegating day-to-day problem solving to lower-level managers, top

management can concentrate on bigger issues, such as overall strategy.
b. Empowering lower-level managers to make decisions puts the decision-making
authority in the hands of those who tend to have the most detailed and up-to-date
information about day-to-day operations.

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 c. By eliminating layers of decision making and approvals, organizations can
respond more quickly to customers and to changes in the operating environment.
d. Granting decision-making authority helps train lower-level managers for higher-
level positions.
e. Empowering lower-level managers to make decisions can increase their
motivation and job satisfaction.

 Disadvantages:

a. Lower-level managers may make decisions without fully understanding the big
picture.
b. If lower-level managers make their own decisions independently of each other,
coordination may be lacking.
c. Lower-level managers may have objectives that clash with the objectives of the
entire organization. For example, a manager may be more interested in
increasing the size of his or her department, leading to more power and prestige,
than in increasing the department’s effectiveness
d. Spreading innovative ideas may be difficult in a decentralized organization.
Someone in one part of the organization may have a terrific idea that would
benefit other parts of the organization, but without strong central direction the
idea may not be shared with, and adopted by, other parts of the organization

Implementing decentralization in the organization need responsibility accounting system

that mingle to lower level managers’ decision making authority with accountability for the
outcomes of those decision. The term of responsibility is used for any parts in the
organization, particularly responsible on cost, profit and investment. According to James
Hall, (2011), three primary types of responsibility centers are cost centers, profit centers
and investment centers.

In order to understand three primary types of responsibility center, we are going to

discuss one by one

a. Cost Center.

The managers of cost center have control over cost, not over the revenue and
investment funds. Accounting, finance, general administration, legal and personnel

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 are name of few usually classify as cost center in the service department.
Manufacturing facilities are often considered as cost center as well in the
manufacture industry. The manager cost centers are expected to minimize the cost
while providing product and services demanded by other parts of the organization.
For example, the managers in the manufacture facilities would be evaluated actual
costs and comparing with the budget. How much cost should have been for actual
level of output during the periods. Comparing budget with actual cost is one of way to
measure cost center performance.

b. Profit Center

The manager of profit center has control over both cost and revenue, but not over the
use of investment funds. For example, the managers of Amusement Park Company
would be responsible on the costs, revenue and profit as well, but may not have
control over investment in the park. Profit center managers are often evaluated by
comparing actual profit to targeted or budgeted profit.

c. Investment Center

The manager of investment center has control over cost, revenue and investment in
operating asset. For example, vice president of the manufacture company would
have responsible and control over investment in manufacturing such as, investing in
equipment to produce more fuel efficient engines. Once top level managers and
board of directors approve the vice president’s investment proposal, he held
responsible for making them pay off. Investment center managers are often
evaluated using return on investment (ROI) or residual income measures

An investment center is responsible for earning an adequate return on investment. The

following two sections present two methods for evaluating this aspect of an investment
center’s performance. The first method, covered in this section, is called return on
investment (ROI). The second method, covered in the next section, is called residual income

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The Return of Investment (ROI) Formula

ROI defines as net operating income divided by average operating assets and can be
formula as:

Note: The higher a business segment’s return on investment (ROI), the greater the profit
earned per dollar invested in the segment’s operating assets

Net operating Income is income before interest and taxes and is sometimes referred to as
EBIT (earnings before interest and taxes). Net operating income is used in the formula
because the base (i.e., denominator) consists of operating assets.

Operating assets include cash, accounts receivable, inventory, plant and equipment, and
all other assets held for operating purposes. Examples of assets that are not included in
operating assets (i.e., examples of non-operating assets) include land held for future use, an
investment in another company, or a building rented to someone else. These assets are not
held for operating purposes and therefore are excluded from operating assets. The operating
assets base used in the formula is typically computed as the average of the operating assets
between the beginning and the end of the year

Understanding of ROI

ROI actually can be expressed in terms of Margin and Turnover too. This is because the
general formula of ROI which is net operating income divided by average operating assets
does not provide much help to managers in taking action improve the ROI. The formula of
ROI in terms of Margin and Turnover as follows:

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Margin and turnover are important concepts in understanding how a manager can affect
ROI. There are three ways increase the ROI. Firstly, increase sell, secondly, reducing
operating expenses and finally reduce the assets.

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Criticism of ROI

Even though ROI uses to evaluate the company performance, but it subjects to have the
criticisms such as,

1. Just telling managers to increase ROI may not be enough. Managers may not know how
to increase ROI; they may increase ROI in a way that is inconsistent with the company’s
strategy; or they may take actions that increase ROI in the short run but harm the
company in the long run (such as cutting back on research and development). This is
why ROI is best used as part of a balanced scorecard, as discussed later in this chapter.
A balanced scorecard can provide concrete guidance to managers, making it more likely
that their actions are consistent with the company’s strategy and reducing the likelihood
that they will boost short-run performance at the expense of long-term performance.

2. Manager who takes over a business segment typically inherits many committed costs
over which the manager has no control. These committed costs may be relevant in
assessing the performance of the business segment as an investment but they make it
difficult to fairly assess the performance of the manager.

3. As discussed in the next section, a manager who is evaluated based on ROI may reject
investment opportunities that are profitable for the whole company but would have a
negative impact on the manager’s performance evaluation

Residual Income

Residual income is the net operating income that an investment center earns above the
minimum required return on its operating assets and its formula:

In adaption Residual Income, many companies adopt EVA (Economic Value Added). Under
EVA (Economic Value Added) companies often modify their accounting principles in various

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ways. For example, funds used for research and development are often treated as
investments rather than as expenses.

The objective of adoption Residual Income or EVA is maximizes the total amount of residual
income or EVA, not to maximize ROI. This is an important distinction. If the objective were to
maximize ROI, then every company should divest all of its products except the single
product with the highest ROI (Garrison & Noreen 2006).

For example, A Ketchikan Division of Alaskan Marine Services Corporation, this company is
financial service company. This company has long had policy of using ROI to evaluate its
investment center managers but, it is considering switch to residual income. Therefore, the
company has follow information

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The reasoning underlying the residual income calculation is straightforward. The company is
able to earn a rate of return of at least 15% on its investments. Because the company has
invested $100,000 in the Ketchikan Division in the form of operating assets, the company
should be able to earn at least $15,000 (15%×$100,000) on this investment. Because the
Ketchikan Division’s net operating income is $20,000, the residual income above and
beyond the minimum required return is $5,000. If residual income is adopted as the
performance measure to replace ROI, the manager of the Ketchikan Division would be
evaluated based on the growth in residual income from year to year.

Motivation use Residual Income approach.

The residual income approach encourages managers to make investments that are
profitable for the entire company but that would be rejected by managers who are evaluated
using the ROI formula.

To illustrate this problem with ROI, suppose that the manager of the Ketchikan Division is
considering purchasing a computerized diagnostic machine to aid in servicing marine diesel
engines. The machine would cost $25,000 and is expected to generate additional operating
income of $4,500 a year. From the standpoint of the company, this would be a good
investment because it promises a rate of return of 18% ($4,500 ÷ $25,000), which exceeds
the company’s minimum required rate of return of 15%.
If the Manager of the company evaluate based on Residual income then the calculation as
follows:

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Because the project would increase the residual income of the Ketchikan Division by $750,
the manager would choose to invest in the new diagnostic machine.

If the Manager of the company evaluate based on ROI then the calculation as follows:

The new project reduces the division’s ROI from 20% to 19.6%. This happens because the
18% rate of return on the new diagnostic machine, while above the company’s 15%
minimum required rate of return, is below the division’s current ROI of 20%. Therefore, the
new diagnostic machine would decrease the division’s ROI even though it would be a good
investment from the standpoint of the company as a whole. If the manager of the division is
evaluated based on ROI, she will be reluctant to even propose such an investment.

Generally, a manager who is evaluated based on ROI will reject any project whose rate of
return is below the division’s current ROI even if the rate of return on the project is above the
company’s minimum required rate of return. In contrast, managers who are evaluated using
residual income will pursue any project whose rate of return is above the minimum required
rate of return because it will increase their residual income. Because it is in the best interests
of the company as a whole to accept any project whose rate of return is above the minimum
required rate of return, managers who are evaluated based on residual income will tend to
make better decisions concerning investment projects than managers who are evaluated
based on ROI.

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Daftar Pustaka

Garrison, R.H. 2006. Managerial Accounting. Edisi 11. Penerbit Salemba Empat. Jakarta

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