Page 69 - DMGT514_MANAGEMENT_CONTROL_SYSTEMS

Management Control Systems

Notes the divisional manager but should be considered in overall segment performance by
comparison with the budget and with the division’s results for the prior period.
7. Segment profit contribution: This is the difference between controllable segment margin
and the attributable segment costs. Variance analysis, percentage analysis of individual
costs and revenues, and trend and time period analysis can be used to evaluate the various
components of segment profit contribution. Comparison can be made with industry
standards.

8. Common firm wide costs: These costs are incurred for the firm as a whole and do not relate
specifically to any segment. These costs are to be allocated to the segments on some
appropriate basis, so as to reflect the correct profitability of the segment. The basis of
allocation reflects the relative amount of expenses that is incurred for each segment or the
amount of benefit received by each unit.

Notes There are two arguments against such allocations. First, the costs incurred by
corporate staff departments such as CEO’s office, finance, accounting and human resources
are not controllable by profit centre managers. Second, it is difficult to find a proper
acceptable basis for allocating the costs that would properly reflect the relative amount of
corporate costs caused by each profit centre.
There are, however, arguments for and against allocating corporate overheads to profit
centres:

(i) Profit centre performance can be comparable to competitors.
(ii) Corporate service units have a tendency to “empire build” to increase their power
base and make their departments excellent, without regard for their values to the
company. If such costs are allocated to profit centres, the profit centre managers will
raise questions about the amount of corporate overhead, this helps to keep a check
on spending at the corporate office.
(iii) The profit centre manager is given the message that the profit centre has not earned
a profit it recovers all costs, including a share of allocated corporate overhead. Thus,
profit centre managers would be motivated to make optimum long-term marketing
decisions (pricing, product mix and so on) because they must keep in mind that they
must recover their share of corporate overhead.
9. Segment net income: This is equal to the difference between the segment profit contributions
minus the allocated common firm wide costs. The performance of profit centre is appraised
by comparison of actual results with budgeted amounts. In addition, data on competitors
and industry provide a good cross check on the appropriateness of the budget.
Illustration of Profit Centre Evaluation: ABC Ltd. employs a budgetary control system which
measures performance based on its product divisions A and B. The budgeted and actual sales for
a particular month are as follows:

Sales Quantity Sales Revenue `
Division Budget Actual Budget Actual
A 40000 48000 400,000 480,000
B 80000 80000 400,000 480,000

The standard unit controllable variable costs are ` 4 and ` 2 for A and B respectively.
The budgeted controllable fixed costs for the month are ` 40,000 each for products A and B.
The attributable segment costs budgeted are ` 80,000 and ` 120,000 for products A and B.

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