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ACCT 2302 Fundamentals of Accounting II Spring 2011 Lecture 15 Professor Jeff Yu

ACCT 2302 Fundamentals of Accounting II Spring 2011 Lecture 15 Professor Jeff Yu. Review: Performance Evaluation. Evaluation Tool. Cost Center ( controls costs only ). Spending Variance; Standard Cost Variances. Profit Center (controls costs & revenues ). Segmented Income Statement

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ACCT 2302 Fundamentals of Accounting II Spring 2011 Lecture 15 Professor Jeff Yu

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  1. ACCT 2302 Fundamentals of Accounting II Spring 2011 Lecture 15 Professor Jeff Yu

  2. Review: Performance Evaluation Evaluation Tool Cost Center (controlscosts only) Spending Variance; Standard Cost Variances Profit Center (controls costs & revenues) Segmented Income Statement (Segment Margin) Investment Center (controls costs & revenues & Investments) Return on Investment (ROI); Residual Income

  3. Materials Price Variance AQ(AP - SP) Labor/VOH Rate Variance AH(AR – SR) Materials Quantity Variance SP(AQ - SQ) Labor/VOH Efficiency Variance SR(AH – SH) Review: Standard Cost Variances AP (AR)= Actual Price (Actual Rate): the amount actually paid for each unit of the materials (labor or VOH). SP (SR)= Standard Price (Standard Rate): the amount that should Have been paid for each unit of the materials (labor or VOH). AQ (AH)= Actual Quantity (Actual Hour): the amount of materials (labor or VOH activity) actually used in the production. SQ (SH)= Standard Quantity (Stan. Hour) allowed for the actual output = actualproductionin units * standard quantity (hours) per unit

  4. Review: Segmented Income Statement Sales - Variable Expenses Contribution Margin - Traceable Fixed costs Segment Margin • NOI for the company = the sum of segment margins minus Common fixed costs. • Important: CVP analyses using the segmented income statement!

  5. Return on Investment (ROI) ROI = NOI ÷ AOA Turnover Margin AOA=Average Operating Assets =(Beginning + Ending Operating Assets)/2 Thought Question: how will changes in sales, operating expenses and average operating assets affect ROI?

  6. Example Holly Company reports the following information in 2009: Net Operating Income $ 30,000 Sales Revenue $ 500,000 Average Operating Assets $ 200,000 Q: • Holly’s 2009 ROI? Margin? Turnover? Operating Expenses? (2) How will Holly’s ROI change if sales increases to $600,000 and both AOA and operating expenses do not change in 2010? (3) How will Holly’s ROI change if there is no change in sales and AOA but operating expenses decrease to $458,000 in 2010? (4) How will Holly’s ROI change if there is no change in sales and operating expenses, but AOA decreases to $100,000 in 2010?

  7. Summary: Improving ROI Decrease Operating Expenses DuPont Analysis: ROI = Margin * Turnover Increase Sales generate the same NOI with Less Operating Assets

  8. Residual Income (RI) RI = NOI - Required rate of return× AOA NOI- Net operating income (profits)AOA- Average operating assets Required rate of return × AOA = Required return Decision Rule: Invest if RI>0.

  9. Practice Problem At Pitts Co. the required rate of return on operating assets is 8%. The 2010 sales revenue for division A is $10 million, NOI is $2 million, AOA is $2.5 million. Q: Division A’s 2010 ROI? Margin? Turnover? Residual Income?

  10. Practice Problem Given the following information for Division C:NOI $560,000Margin 35%Turnover 1.6Minimum required rate of return 12%What is the division’s residual income?

  11. Example: ROI vs. RI • Flower Co. Division C has an opportunity to invest $100,000 (AOA) in a project that will yield NOI of $25,000 for the year. • Flower Co. has a 20% required rate of return and Division C has a 30% ROI on its existing business. Q: (1) As a manager at Division C, will you invest in that project if you are evaluated based on division ROI (the higher the ROI, the bigger the bonus)? (2) Is this investment project good for the company? (3) Will your decision be different if you are evaluated using residual income?

  12. ROI – A Drawback As division manager, I wouldn’t invest in that project because it would lower my pay! Gee . . . I thought we were supposed to do what was best for the company!

  13. Residual Income VS. ROI Under ROI, the basic message is: Maximize rate of return, a percentage. Under the residual income approach, the basic message is: Maximize residual income, an absolute amount. • Residual income may encourage managers to make profitable investments that would be rejected by managers using ROI to evaluate that same investment. • However, residual income cannot be used to compare the performance of divisions with different sizes (i.e. different AOA).

  14. Customers Financial Learningand growth Internalbusinessprocesses The Balanced Scorecard Management translates its strategy into performance measures that employees understand and accept. Performancemeasures

  15. The Balanced Scorecard: FromStrategy to Performance Measures Performance Measures Financial Has our financialperformance improved? What are ourfinancial goals? What customers dowe want to serve andhow are we going towin and retain them? Vision and Strategy Customer Do customers recognize thatwe are delivering more value? What internal busi-ness processes arecritical to providingvalue to customers? Internal Business Processes Have we improved key business processes so that we can deliver more value to customers? Learning and Growth Are we maintaining our abilityto change and improve?

  16. Financial measures are lagging indicators that summarize the results of past actions. Non-financial measures are leading indicators of future financial performance. • Top managers are ordinarily responsible for financial performance measures – not lower level managers. Non-financial measures are more likely to be understood and controlled by lower level managers. The Balanced Scorecard: Non-financial Measures The balanced scorecard relies on non-financial measures in addition to financial measures for two reasons:

  17. Financial Customer Internal Business Processes Learningand Growth Example: The Balanced Scorecard Profit CM per car Number of cars sold Customer satisfactionwith options Number ofoptions available Time toinstall option Employee skills in installing options

  18. ROI and the Balanced Scorecard It may not be obvious to managers how to increase sales, decrease costs, and decrease investments in a way that is consistent with the company’s strategy. A well constructed balanced scorecard can provide managers with a road map that indicates how the company intends toincrease ROI. Which internal business process should be improved? Which customers should be targeted and how will they be attracted and retained at a profit?

  19. For Next Class • Review for Midterm Exam II

  20. Homework Problem 1 At Davis Co. the required rate of return on operating assets is 8%. The 2010 residual income of division B is $120,000, Margin is 25%, ROI is 20%. Q: (1) What is Division B’s 2010 Turnover? (2) What is Division B’s NOI? (3) What is Division B’s AOA? (4) What is Division B’s Sales?

  21. Homework Problem 2 DFW Inc.’s required rate of return is 10%. In 2009, its Division A reported the following performance data: Residual Income = $18,000, Margin = 20%, Turnover = 1.5. Q: (1) What is Division A’s ROI in 2009? (2) What is Division A’s NOI in 2009? (3) What is Division A’s AOA in 2009? (4) What is Division A’s sales revenue in 2009?

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