accounting ch.12

Increase ROI

1) increase sales 2) reduce expenses 3) reduce assets

criticism of ROI

1) management may not know how to increase ROI 2) inherit many committed costs they have no control over 3) managers evaluated on ROI may reject profitable investment opportunities

Increase in ROI includes...

1. Increased sales 2. reduced operating expenses 3. reduced operating assets

Segmented Income Statement

Sales- Variable expenses=contribution margin - traceable fixed expenses= product line segment margin - common fixed expenses= divisional segment margin.

contribution margin

Variable expenses deducted from sales to yield contribution margin. (tells us what happens to the profit as volume changes- holding segment's capacity and fixed costs constant.

turnover

turnover= sales / average operating assets

disadvantages of decentralization

1. lower level managers may make decisions with out understanding big picture 2. lack of coordination 3. lower level managers have objectives that clash with objectives of entire organization 5. difficult to spread innovative ideas

Criticisms of ROI

1. managers may not know how to increase ROI consistently with company's strategy. 2. difficult to assess the performance of a new manager 3. managers assessed based on ROI way reject investment opportunities profitable for whole company but not individually for manager

advantages of decentralization:

1. top managers can focus on bigger issues 2. lower level managers tend to have most detailed and up to day info 3. faster response time 4. trains lower level managers for higher level positions 5. Increase motivation and job satisfaction

responsibility center

any part of an organization whose manager has control over and is accountable for cost, profit, or investments. (cost centers, profit centers, investment centers)

decentralized organization

decision making authority is spread throughout the organization rather than being confined to a few top executives.

traceable fixed cost

fixed cost that is incurred because of the existence of the segment- if the segment had never existed, the fixed cost would not have been incurred. If the segment were eliminated, the fixed cost would disappear.

common fixed cost

fixed cost that supports the operations of more than one segment, but is not traceable in whole or in part to any one segment. If the segment were to be entirely eliminated, there would be no change in true common fixed cost

operating assets

include cash, accounts receivable, inventory, plant, and equipment, and all other assets held for operating purposes.

Net operating income (NOI)

income before interest and taxes and is sometimes referred to as EBIT (earnings before interest and taxes).

RI disadvantage

it cannot be used to compare the performance of divisions of different sizes

investment center

manager has control over cost, revenue, and investments in operating assets.

cost center

manager of a cost center has control over costs but not over revenue or the use of investment funds. usually includes accounting, finance, general admin, legal, and personnel service departments.

profit center

manager of profit center has control over both costs and revenue but not investment funds.

margin

margin=net operating income / sales margin improved by increasing sales or reducing operating expenses

residual income motivation

motivates managers to make profitable investments that would be rejected my ROI managers

residual income

net operating income above minimum return on operating assets NOI - (AOA x min ROR)

Return on Investment

net operating income divided by operating assets ROI= net operating income / operating assets the higher a business segment's ROI, the greater the profit earned per dollar invested in the segments operating assets ROI= margin x turnover

Residual Income

net operating income that an investment center earns above the minimum required return on its operating assets. Residual Income=Net operating income - (average operating assets x minimum required rate of return) *encourages managers to make investments that are profitable for the entire company but that would be rejected by managers evaluated using ROI

segment margin

obtained by deducting the traceable fixed costs of a segment from the segments contribution margin. best gauge of long run profitability of a segment because it only includes those costs incurred by a segment. If a segment cant cover its own costs then the segment should be dropped

Segment

part or activity of an organization about which managers would like cost, revenue, or profit data. Cost, profit, and investment centers are segments as well as sales territories individual stores, service centers, manufacturing plants, marketing departments, individual customers, and product lines