M_Acct - Chapter 9

net operating income is income before __ and ___

interest<br>taxes

Return on investment is a measure used to evaluate managers of ___ centers

investment

When a manager accepts a project because the net operating income from the investment exceeds the minimum required rate of return on average operating assets, the investment was evaluated base on __ __

residual income

Managers of cost centers are evaluated on:

their ability to control costs in their responsibility center

Comparing residual income versus return on investment

1. Residual income cannot be used to compare divisions of different sizes without some modification.2. A manager might reject a proposal using ROI that the manager would accept using residual income.

When evaluating divisions of different sizes?

Management should focus on the percentage change in residual income from year to year rather than on absolute amounts.

Profit center

Manager has control over both costs and revenue but not over the use of investment funds.

When a company uses the residual income approach to measure performance, ____

the objective is to Maximize the total residual income.

Investment venter

Has control over cost, revenue, and investments in operating assets

Operating assets

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

In ROI Computation, Operating assets are included, nonoperating assets are excluded.<br>What are examples of non-operating asssets?

Land held for future use, building rented to someone else, or marketable securities.

Lower level managers decision making authority can be linked to the outcomes of those decisions through ___ accounting systems

Responsibility

__ __ __ is an adaptation of residual income that modifies some accounting principles such as the handling of research and development costs.

economic value added

If residual income is adopted as the performance measure to replace ROI, performance evaluation should be based on the absolute amount of the residual income.

false

Managers who are evaluated using return on investment will pursue any project whose rate of return is above the minimum required rate of return.

false

Disadvantages of decentralization

1. Lower-level managers may make decisions without fully understanding the big picture.<br>2. If lower level managers make their own decisions independently of each other, coordination may be lacking.<br>3. Low managers may have objectives that clash with the objectives of the entire organization.<br>4.Hard to spread new ideas./Coordination among departments.

Residual income =

= Net operating income - (Average operating assets x Minimum required rate of return)

Net book value?

Acquisition costs - Accumulated Depreciation

Economic Value Added (EVA)

An adaptation of residual income that has een adopted by many companies.

Disadvantage to Residual income approach

Cannot be used to compare performances of divisions of different sizes

Cost center

Control over costs, but not over revenue or the use of investment funds.

An organization in which decision-making authority is spread throughout the organization is:

Decentralized.

The higher a business segment's return on investment, the greater the profit earned per ____ invested in the segment's average operating assets.

Dollar

Residual income approach

Encourages managers to make investments that are profitable for the entire company

Using the net book value to calculate average operating assets encourages new investment. True false

False

Profit Center

Has control over both costs and revenue but not over investment funds.

Net operating income

Income before interest and taxes (EBIT)

How can a company increase its return on investment?

Increase sales, Reduce operating expenses

The manager of an __ center has control over costs, revenue, and investments in operating assets.

Investment

investment center

Manager has the control over costs, revenues, and the investment in operating assets.

Margin formula

Margin = Net operating income / Sales

In order to fully evaluate ROI managers should compute both ___ and ___.

Margin<br>Turnover

Managers will be ___ (more/less) likely to pursue projects that will benefit the entire company when being evaluated on residual income, rather than on return on investment.

More

Return on Investment (ROI)

Net Operating Income (EBIT) / Average Operating Assets<br>Net Operating Income = Sales - Expenses (COGS,SellingExp,AdminExp) Operating Assets = Current assets + Noncurrent assets Average Operating Assets = [Beginning net book value of operating assets + Ending Net Book Value of Operating Assets] / 2

ROI alternative formula

ROI= Margin x Turnover

The net operating income that an investment center earns above the minimum required return on its average operating assets is its __ income

Residual

Residual Income

Residual income = Net operating income - (Average operating assets x Minimum required rate of return)

Residual income

The net operating income that an investment center earns above the minimum required return on its operating assets.

How does a manager who is evaluated based on residual income decide whether or not to invest in a new project?

To be accepted, net operating income for the investment should be above the minimum required return on average operating assets.

Turnover formula

Turnover = Sales / Average operating Assets

Profit center managers are often evaluated by comparing ___ profit to ____ profit

actual. budgeted.