NOTE. The following excerpts include the "Conclusion" section of chapter I and the whole of chapters II and III. Omitted portions of the book, preceding and following the excerpts, are indicated by the headings of chapters, sections and subsections, and the captions of figures and exhibits. Page references are to the paperback edition published by Richard D. Irwin, Inc., the title and copyright pages of which are reproduced, supra.-Committee editor. Chapter I. The Organization of Divisionalized Business_ Figure 1. Organization of a Mining and Manufacturing Company- Why do companies divisionalize?__ Prerequisites for success-- Divisionalization is not always the right answer.... Division of Responsibilities Between Head Office Staff and Operating Figure 3. Profits and the Pyramid of Power.. The chief executive officer and his lieutenants___ The Division of Authority Between Staff Departments and Divisions__ Figure 4. Organization of a Division of a Manufacturing Com- Divisions or Subsidiaries?____ Conclusion We have examined the organization of divisional companies at some length, and have noted numerous variations in the way responsibilities may be divided, as between the divisions and the corporate headquarters. We might have probed deeper still, and looked at the way in which, within a division, responsibilities are allocated between the operating units of the division-plants, sales offices, service installations and the like—and the staff departments at divisional headquarters. However, since our concern is primarily with the control of divisions, not with control within divisions, this discussion of organization will not be pursued further. That it has been taken as far as it has is due to the fact that, before we can consider methods of financial control of divisions, we have to know what their responsibilities are. For example, if a division has no power to determine its selling prices or its advertising appropriations, it is deprived of most of its ability to influence sales revenue. Elaborate methods of analyzing variances between budgeted and actual sales, while they might be of interest to the marketing department at the corporate level, would be of very little concern to anyone in the division. More generally, until a division's responsibilities are known, it is impossible to say whether it can be held truly accountable for its trading results, or how those results may best be measured so as to evaluate as effectively as possible the performance of the division and its management. This question of profit accountability will be taken up and examined in some detail in subsequent chapters. "This argument is adduced by Robert W. Murphy in "Corporate Divisions vs. Subsidiaries," loc. cit. 37 DIVISIONAL ACCOUNTING AND "GENERALLY ACCEPTED ACCOUNTING PRINCIPLES" CHAPTER II Recent pronouncements on the postulates and principles of accounting have, for the most part, been directed to the problems of reporting company results to stockholders. When accounting fundamentals are under discussion, little attention tends to be given to the question of whether accounting rules appropriate to the needs of stockholders are also appropriate to the needs of management. It is not just the methods of presenting financial information which are in question here, but the very bases of compiling this information as well. In this chapter we shall take a look at some of these issues, and especially at such of them as have special relevance to the needs of divisionalized firms. In what follows, the terms "internal" and "external" accounting will be used in preference to the more commonly used "management" and "financial" accounting. There are two reasons for this preference. All accounting in terms of a monetary unit might be called "financial accounting." Therefore, this term does not convey the kind of distinction within the field of monetary accounting which is intended. Moreover, what are usually called "financial accounts" are also used for certain managerial purposes (such as the determination of dividend policy) so that, again, the distinction is blurred. By referring to internal and external accounting, however, the true nature of the distinction can be more accurately conveyed. Before a judgment can be reached as to the extent to which the 38 principles of external accounting are applicable to internal accounting, there must be some consensus as to what these principles are. We shall take as our starting point for this discussion the Report of the 1961 Management Accounting Committee of the American Accounting Association1 though we shall depart considerably from the Committee's analysis and conclusions. In Part II of the Report, "the body of postulates, principles, and standards (herein referred to collectively as concepts) which underlie accounting as a general field" are listed as follows: It is not our aim to evaluate these concepts for the purposes of external accounting. But in assessing their value for internal accounting, which is what we shall try to do, it will probably be impossible to avoid all judgments on these concepts as they are used in other contexts. Entity concept The entity concept in accounting is a somewhat pompous way of saying that, before we can account intelligently, we had better identify the person or business unit for which we are accounting; or, at greater length, "The business entity concept provides a basis for identifying economic resources and activities with specific enterprises, and thus for defining the area of coverage appropriate to a given set of records or reports."2 For external accounting purposes, the ac 1 1 Accounting Review, XXXVII, No. 3, July 1962, pp. 523-537. The Committee's term "management accounting" and our term "internal accounting" are interchangeable in the present context. *"Accounting and Reporting Standards for Corporate Financial Statements," 1957 Revision, American Accounting Association, Accounting Review, Vol. XXXII, No. 4, October 1957, p. 537. counting entity is usually a legal person—a corporation, for example -though this is not always so. Consolidated accounts do not relate to a legal entity but, rather, to a group of legal entities (and not even that in any simple sense). In the case of a pooling of interests, it is really quite difficult to say what the accounting entity is. However, the normal case is straightforward enough. For internal accounting, legal entities have little significance. The accounting entity may be any sector or facet of a business which its management wishes to analyze. We can probably comprehend any such sector or facet of business activity about which it may be desired to collect or present accounting data by categorizing them in one or another of the following classes of entities: 1. Responsibility centers 2. Ventures or market entities a. Continuing ventures: focusing on product, market area, type of customer, etc. b. Transient ventures: identified as special projects, and either eventually terminating, or being transformed into, or merged with a continuing venture. The importance of the distinction between these two broad kinds of internal accounting entities is that they serve different purposes. When we are trying to evaluate the performance of a person or persons, it is the results of the appropriate responsibility center which call for attention. This kind of entity is defined by reference to the person bearing the responsibility for it. If, on the other hand, we want to evaluate an activity or a sector of the business (as distinct from the men running it) we must look at the results of the appropriate market entity. This includes the product or product group, the sales region, the market for original equipment as against replacement equipment (if we are in the automotive battery or the tire business) and so on. The project type of entity will generally have an ephemeral existence. It will be created for a special purpose such as the evaluation of a new line of business, or the contribution made to the business by a new plant, or the extension of an existing one. Usually, once suf 'The classes of entities listed by the AAA Management Accounting Committee (op. cit. p. 526) are responsibility entities, product entities and project entities. Numbers 1 and 2b in our list correspond to the first and third in the AAA Committee's list. Our 2a, however, is broader than theirs. "Product" is only one of the things that may identify a venture or a market. |