Responsibility Accounting – Segmental Analysis
This chapter explains responsibility accounting and its use in a business, and how to prepare responsibility accounting reports for the managers held accountable for each responsibility center. It covers preparing a segmental income statement using the contribution margin format, calculating return on investment, margin, and turnover for a segment, and calculating a segment’s residual income.
Responsibility centers and reports
As a business grows, authority for its activities is delegated to lower-level managers who are then held responsible for the revenues, costs, or investments under their control, and the business is organized into responsibility centers accordingly. Responsibility reports measure each manager’s performance against a budget for only the items that manager can actually control, with unfavorable and favorable variances highlighted so results flow up through the organization from first-level supervisors to top management.
The segmental income statement
A segmental income statement uses the contribution margin format, separating variable from fixed costs and further dividing fixed costs into those directly traceable to a segment and those that are common to the company as a whole, so a segment’s contribution to overall profit can be judged without being distorted by arbitrary allocations of unrelated costs.
Return on investment and residual income
Return on investment relates a segment’s income to the assets invested in it, and can be broken into margin, income divided by sales, and turnover, sales divided by invested assets, so a change in return on investment can be traced to a change in profitability or in asset efficiency. Residual income instead measures the income a segment earns above a minimum required return on its invested assets, which can avoid return on investment’s tendency to discourage a manager from accepting a profitable project that would lower an already-high average return.