Question

A long-established, highly centralized company has grown to the extent that its Chief

Executive Officer, despite having a good supporting team, is finding it difficulty

keeping up with the many decisions of importance in the company.

Consideration is therefore being given to re-organizing the company into segments.

These segments will be headed by a managing director, who will be responsible for

all the segment’s activities relating to its products.  

You are required to:

a) Critically discuss the decision areas that should be transferred to the new

managing directors if such a reorganization is to achieve its objectives;

b) Critically discuss the decision areas that might reasonably be retained at the

company head office;

c) Provide a detailed account of management accounting problems that might be

expected to arise in introducing effective segment control

d) Differentiate between traceable and common costs, and demonstrate the different

ways of allocating common costs to segments

Answer 1

a) When the company has been re-organised by forming into segments the efficient personnel should be appointed as a segment managing director and he should be given a free hand regarding few decisions in order to take effective decision. The following are the decision that should be transferred to new managing director:

1.Decision relating acquisition of efficient supporting personnel.

2.Decisions relating to selection of stratagies suitable to the organisation.

3.Decisions relating to cost considerations.

4.Decisions relating to appointment of process managers.

5.Decisions relating to disbursement of duties of each process managers under his control.

6.Decision relating to distribution of responsibilities of each employee under his control.

7. Decision relating to selection of buyers of each segment products.

8. Decision relating to price fixing and marketing issues.

b) Area to be retained by the head office.

1. Decisions relating to appointment of segment managers.

2. Strategy formation decisions for a company as a whole.

3. Investment decisions

4. Dividend distribution decisions

5. Treasury decisions

6. Hirarchy decisions

7. Long borrowing, loans and advances decisions.

c) Detailed account of management accounting problems that might be expected to arise in introducing effective segment control.

1. People may show resistance to the new segments.

2. Employee may resist to the introduction of new controls.

3. problem may occur in top down and bottom up communication.

4. problem in implementation of changed process.

5. Problems of lack of expertise in implementing new strategic plans and their implementation.

6. Problem in lack of working expertise of new controls

7. Lack of coordination among employees and managers

8. Lack of proper training for personnel

d)  Differentiate between traceable and common costs, and demonstrate the different ways of allocating common costs to segments.

1. A traceable cost arises because of the existence of the particular segment, and would disappear if the segment itself disappeared. Examples of traceable costs can be found in chapter 6, and I have attached a link for your future use. A few of the traceable costs mentioned are:

• product manager's salaries
• maintenance cost of the building
• liability insurance

2. A common fixed cost supports the operation of more than one business segment, but is not traceable, in whole or in part, to any one segment. Examples as stated in the book include:

• cost of receptionist's salary to the doctors
• cost of heating a grocery store to the individual departments
• salary of the CEO to various divisions

Allocation of common costs to segments:

Proportional Allocation;

Proportional indirect cost allocation assigns a percentage of an indirect cost to all or several departments within the business. Percentages can be determined each month for each indirect cost but most often are assigned and reviewed annually. The amount each department is charged depends on the type of cost. For example, a heating bill might be allocated according to the number of square feet each department occupies, while a telephone bill -- minus long distance charges that can be traced to a specific department -- might be allocated evenly between every department.

Activity-Based Cost Allocation:

Activity-based indirect cost allocation is more time-consuming but is also a more accurate method for allocating indirect costs. It first requires managers to identify and record each business activity a department performs. Activities then are categorized as incurring direct or indirect costs. At the end of reporting period, such as at month's end, records are reviewed, indirect cost rates are calculated and the appropriate indirect costs are allocated.

Cost Rate Calculations:

Indirect cost rate calculations can be determined by dividing an indirect cost by a cost object, such as sales revenues or square footage. Indirect cost rates for proportional allocation also can be calculated using an overhead cost calculation. An overall overhead cost rate can be calculated by dividing individual or total indirect costs by the direct costs each department incurs.

Assume, for example, that total indirect costs are $3,000. The printing department has direct costs totaling $4,000, and the mail room has direct costs totaling $2,000 for a combined total of 6,000. Divide $3,000 by $6,000 to get an overhead rate of 50 percent. Then, multiply direct costs for each department to get the total indirect costs to be allocated to each department. In this case, $2,000 of indirect costs are be allocated to the print shop, and $1,000 is allocated to the mail room.