Segmented Reporting Investment Center Evaluation and Transfer Pricing

3
Assalamualaikum wr.wb
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My name is Fariez Danial
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my name is ayu dian setyani
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my name is M. Haris azmi nur alam
SEGMENTED REPORTING , INVESTM

ENT CENTER EVALUATION, AND
TRANSFER PRICING
DECENTRALIZ
ATION AND
RESPONSIBILI
TY CENTERS
SEGMENTED
INCOME
STATEMENTS
USING
VARIABLE
COSTING
TRANSFE
R
PRICING
MEASURING
THE
PERFORMANCE
OF
INVESTMENT
CENTERS
USING ROI
MEASURING THE
PERFORMANCE OF
INVESTMENT
CENTERS USING
RESIDUAL INCOME
AND ECONOMIC
VALUE ADDED
DECENTRALIZATION AND RESPONS

IBILITY CENTERS
DECENTRALIZATION AND CENT

ER OF LIABILITY
In general, a company is organized along lines of responsibilit
y. The traditional organizational chart, with its pyramid shape,
illustrates the lines of responsibility flowing from the CEO dow
n
Reasons for Decentralization
Gathering and Using Local Information
Focusing Of central management
Training and motivating of managers
Enhanced Competition
Divisions in the Decentralized F

irm
Decentralization is usually achieved by creating units called di
visions. One way in which divisions are differentiated is by the
types of goods or services produced.
MEASURING THE PERFORMANCE OF

PROFIT CENTERS USING VARIABLE A
ND ABSORPTION INCOME STATEMEN
TS
Two methods of computing income h

ave been developed, one based on va
riable costing and the other based on
full or absorption costing.
Classification of Costs as Product or Period

Costs Under Absorption and Variable
Costing
Absorption Cost
Calculations
Variable Cost
Calculation
Product costs
Direct materials
Direct labor
overhead variable
fixed overhead
Direct materials
Direct labor
overhead variable
Cost Period
Selling expenses
administrative
expenses
fixed overhead
Selling expenses
administrative
expenses
Income Statements Using Vari

able and Absorption Costing
Because unit product costs are the basis for cost of goods sol
d, the variable- and absorption-costing methods can lead to di
fferent operating income figures.
The difference arises because of the amount of fixed overhea
d recognized as an expense under the two methods.
Production, Sales, and Income Relati

onships
The relationship between variable-costing income and absorp
tion-costing income changes as the relationship between prod
uction and sales changes
The change in fixed overhead in inventory is exactly equal to the difference

between the two incomes. This change can be computed by multiplying th
e fixed overhead rate times the change in total units in the beginning and e
nding inventories (which is the difference between production and sales). T
he difference between absorption-costing operating income and variable-c
osting operating income can be expressed as:
Absorptioncosting income
Variablecosting
income
Fixed
overhead
rates
( unit
production
units sold )
Evaluating Profit - Center Mana

gers
The evaluation of managers is often tied to the profitability of
the units they control.
if income performance is expected to reflect managerial perfo
rmance, then managers have the right to expect the following:
1.
As sales revenue increases from one period to the next, a

ll other things being equal, income should increase.
2.
As sales revenue decreases from one period to the next,

all other things being equal, income should decrease.
3.
As sales revenue remains unchanged from one period to

the next, all other things being equal, income should rem
ain unchanged.
Segmented Income Statement

s Using Variable Costing
Variable costing is useful in preparing segmented income stat
ements because it gives useful information on variable and fix
ed expenses.
A segment is a subunit of a company of sufficient importance
to warrant the production of performance reports.
Measuring the Performance of Invest

ment Centers Using ROI
Return on Investment
One way to relate operating profits to assets employed is to c
ompute the return on investment (ROI), which is the profit ear
ned per dollar of investment. ROI isb he most common measu
re of performance for an investment center. It can be defined
as follows:
ROI = Operating Income / Average Operating Assets
Average operating assets = ( Beginning Net book valuel + Endi
ng net book value) / 2
Margins and Turnover

A second way to calculate ROI is to separate the formula (Ope
rating income/Average operating assets) into margin and turn
over.
ROI = Margin x turnover
= Operating profit x
Sales
Sales
Average operating assets
Advantages of ROI
At least three positive results stem from the use of ROI:
1.
It encourages managers to focus on the relationship am

ong sales, expenses, and investment, as should be the ca
se for a manager of an investment center.
2.
It encourages managers to focus on cost efficiency.
3.
It encourages managers to focus on operating asset effici

ency.
Disadvantages of the ROI Meas

ure
1.
It can produce a narrow focus on divisional profitability a

t the expense of profitability for the overall firm.
2.
It encourages managers to focus on the short run at the

expense of the long run.
Measuring the Performance of Inves

ment Centers Using
Residual Income and Economic Value
Added
To compensate for the tendency of ROI to discourage investm

ents that are profitable for the company but that lower a divisi
ons ROI, some companies have adopted alternative performa
nce measures such as residual income.
Residual Income
Residual income is the difference between operating income a
nd the minimum dollar return required on a companys opera
ting assets:
Profit = Profit Income - (Minimum rate of return X averag
e
operating assets )
Economic Value Added (EVA)
Economic value added (EVA) is net income (operating income

minus taxes) minus the total annual cost of capital. Basically,
EVA is residual income with the cost of capital equal to the act
ual cost of capital for the firm (as opposed to some minimum
rate of return
desired by the company for other reasons).
Calculating EVA
EVA is net income, or after-tax operating income, minus the d
ollar cost of capital employed
EVA = After-tax operating income - (Actual percentage
cost of capital X Total capital employed)
Behavioral Aspects of EVA

A number of companies have discovered that EVA helps to enc
ourage the right kind of behavior from their divisions in a way
that emphasis on operating income alone cannot.
TRANSFER PRICING
the value of the transferred good is revenue to the selling divi

sion and cost to the buying division. This value, or internal pri
ce, is called the transfer price. In other words, a transfer price
is the price charged for a component by the selling division to
the buying division of the same company.
Impact of the Transfer Pricing on Div

isions and the Firm as a Whole
When one division of a company sells to another division, bot

h divisions as well as the company as a whole are affected. Th
e price charged for the transferred good affects the costs of th
e buying division and the revenues of the selling division.
Transfer Pricing Policies

They are defined for each division as follows:
1. The minimum transfer price is the transfer price that woul
d leave the selling division no worse off if the good were so
ld to an internal division than if the good were sold to an e
xternal party. This is sometimes referred to as the floor o
f the bargaining range.
2. The maximum transfer price is the transfer price that woul
d leave the buying division no worse off if an input were p
urchased from an internal division than if the same good
were purchased externally. This is sometimes referred to a
s the ceiling of the bargaining range.
Market price
the best approach to transfer pricing. Since the selling division
can sell all that it produces at the market price, transferring in
ternally at a lower price would make the division worse off.
Cost-Based Transfer Prices

Frequently, there is no good outside market price. This may oc
cur because the transferred product uses patented designs o
wned by the parent company.
Negotiated Transfer price

This approach is particularly useful in cases with market
imperfections, such as the ability of an in-house division to av
oid selling and distribution
costs
TERIMA KASIH
WASSALAMUALAIKUM WR.WB

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3

SEGMENTED REPORTING , INVESTM

DECENTRALIZATION AND RESPONS

DECENTRALIZATION AND CENT

Reasons for Decentralization

Gathering and Using Local Information

Focusing Of central management

Training and motivating of managers

Divisions in the Decentralized F

MEASURING THE PERFORMANCE OF

Two methods of computing income h

Classification of Costs as Product or Period

Income Statements Using Vari

Production, Sales, and Income Relati

The change in fixed overhead in inventory is exactly equal to the difference

Evaluating Profit - Center Mana

As sales revenue increases from one period to the next, a

As sales revenue decreases from one period to the next,

As sales revenue remains unchanged from one period to

Segmented Income Statement

Measuring the Performance of Invest

Margins and Turnover

It encourages managers to focus on the relationship am

It encourages managers to focus on cost efficiency.

It encourages managers to focus on operating asset effici

Disadvantages of the ROI Meas

It can produce a narrow focus on divisional profitability a

It encourages managers to focus on the short run at the

Measuring the Performance of Inves

To compensate for the tendency of ROI to discourage investm

Economic Value Added (EVA)

Economic value added (EVA) is net income (operating income

Behavioral Aspects of EVA

the value of the transferred good is revenue to the selling divi

Impact of the Transfer Pricing on Div

When one division of a company sells to another division, bot

Transfer Pricing Policies

Cost-Based Transfer Prices

Negotiated Transfer price

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