ACCT 2122 Chapter 11

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Manufacturing cycle efficiency (MCE) formula:

(Value-added time (aka Process time)) / (Throughput time (aka manufacturing cycle))

margin formula:

(net operating income) / (sales)

turnover formula:

(sales) / (average operating assets) > not a percentage

The major advantages of decentralization include:

1.) By delegating day-to-day problem solving to lower-level managers, top-level managers can concentrate on bigger issues, such as overall strategy. 2.) Empowering lower-level managers to make decisions puts the decision-making authority in the hands of those who tend to have the most detailed and up-to-date information about day-to-day operations. 3.)By eliminating layers of decision making and approvals, organizations can respond more quickly to customers and to changes in the operating environment. 4.) Granting decision-making authority helps train lower-level managers for higher-level positions. 5.) Empowering lower-level managers to make decisions can increase their motivation and job satisfaction.

Criticisms of ROI

1.) Just telling managers to increase ROI may not be enough. Managers may not know how to increase ROI; they may increase ROI in a way that is inconsistent with the company's strategy; or they may take actions that increase ROI in the short run but harm the company in the long run 2.) A manager who takes over a business segment typically inherits many committed costs over which the manager has no control. These committed costs may be relevant in assessing the performance of the business segment as an investment but they make it difficult to fairly assess the performance of the manager 3.) A manager who is evaluated based on ROI may reject investment opportunities that are profitable for the whole company but would have a negative impact on the manager's performance evaluation

The major disadvantages of decentralization include:

1.) Lower-level managers may make decisions without fully understanding the company's overall strategy. 2.) If lower-level managers make their own decisions independently of each other, coordination may be lacking.

non-value-added activities:

1.) Wait time 2.) Inspection time 3.) Move time 4.) Queue time

The three primary types of responsibility centers are:

1.) cost centers 2.) profit centers 3.) investment centers

Because it is in the best interests of the company as a whole to ___ managers who are evaluated based on ___ will tend to make better decisions concerning investment projects than managers who are evaluated based on ROI

> accept any project whose rate of return is above the minimum required rate of return > residual income

replacing old depreciated equipment with new equipment ___ and ___ Hence, using net book value in the calculation of average operating assets results in ___

> increases the book value of depreciable assets > decreases ROI > a predictable pattern of increasing ROI over time as accumulated depreciation grows and discourages replacing old equipment with new, updated equipment.

many organizations use a variety of ___ performance measures in addition to ___ measures

> nonfinancial > financial

Only one of these four activities adds value to the product ___. The other three activities, ___ add no value and should be eliminated as much as possible.

> process time > inspecting, moving, and queuing

profit center

A business segment whose manager has control over cost and revenue but has no control over investments in operating assets. Ex. (the manager in charge of a Six Flags amusement park would be responsible for both the revenues and costs, and hence the profits, of the amusement park, but may not have control over major investments in the park)

cost center

A business segment whose manager has control over cost but has no control over revenue or investments in operating assets. Ex. (Service departments such as accounting, finance, legal, ) Ex. (Manufacturing facilities)

investment center

A business segment whose manager has control over cost, revenue, and investments in operating assets. > Ex. General Motors' vice president of manufacturing in North America would have a great deal of discretion over investments in manufacturing—such as investing in equipment to produce more fuel-efficient engines. Once General Motors' top-level managers and board of directors approve the vice president's investment proposals, he is held responsible for making them pay off.

Economic Value Added (EVA)

A concept similar to residual income in which a variety of adjustments may be made to GAAP financial statements for performance evaluation purposes.

Responsibility center

Any business segment whose manager has control over costs, revenues, or investments in operating assets

The residual income approach has one major disadvantage:

It can't be used to compare the performance of divisions of different sizes > Larger divisions often have more residual income than smaller divisions, not necessarily because they are better managed but simply because they are bigger

Manufacturing cycle efficiency (MCE)

Process (value-added) time as a percentage of throughput time. > puts throughput time into better perspective

value-added activities:

Process time

ROI in terms of margin and turnover formula:

ROI = (margin) * (turnover) or ROI = ((net operating income) / (sales)) * ((sales) / (average operating assets))

delivery cycle time

The elapsed time from when a customer order is received until the finished goods are shipped

throughput time (manufacturing cycle time)

The elapsed time from when production is started until finished goods are shipped.

net book value

acquisition cost less accumulated depreciation

Profit center managers are often evaluated by comparing ___

actual profit to targeted or budgeted profit

a given percentage increase in unit sales usually leads to ___

an even larger percentage increase in net operating income

ROI is best used as part of a ___

balanced scorecard > A balanced scorecard can provide concrete guidance to managers, making it more likely that their actions are consistent with the company's strategy and reducing the likelihood that they will boost short-run performance at the expense of long-term performance.

strongly centralized organizations

decision-making authority is reluctantly delegated to lower-level managers who have little freedom to make decisions > In strongly decentralized organizations, even the lowest-level managers are empowered to make as many decisions as possible

decentralized organization

decision-making authority is spread throughout the organization rather than being confined to a few top executives > all large organizations are decentralized to some extent by necessity

An asset's net book value ___ over time as the accumulated depreciation increases.

decreases > This decreases the denominator in the ROI calculation, thus increasing ROI.

delivery cycle time formula:

delivery cycle time = (wait time) + (throughput time)

An investment center is responsible for ___

earning an adequate return on investment.

Standard cost variances and flexible budget variances are often used to ___

evaluate cost center performance

ROI and ROI in terms of margin and turnover both ___

give the same answer, but ROI in terms of margin and turnover gives better insights into how to improve ROI

The higher a business segment's return on investment (ROI), the ___

greater the profit earned per dollar invested in the segment's operating assets

in a decentralized organization, managers should be ___

held accountable for the outcomes of their actions

Operating assets

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

Net operating income

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

When companies succeed in drastically reducing or eliminating wait time plus the non-value-added components of throughput time it often enables them to ___

increase customer satisfaction and profits

margin is ordinarily improved by ___

increasing selling prices, reducing operating expenses, or increasing unit sales, decrease average operating assets > Increasing selling prices and reducing operating expenses both increase net operating income and therefore margin > Increasing unit sales also ordinarily increases the margin because of operating leverage

a greater amount of residual income ___ an indication of better management

isn't

responsibility accounting systems

link lower-level managers' decision-making authority with accountability for the outcomes of those decisions

When residual income or EVA is used to measure performance, the objective is to ___

maximize the total amount of residual income or EVA, not to maximize ROI > This is an important distinction since if the objective were to maximize ROI, then every company should divest all of its products except the single product with the highest ROI

The managers of cost centers are expected to ___

minimize costs while providing the level of products and services needed by other parts of the organization Ex. (the manager of a manufacturing facility would be evaluated at least in part by comparing actual costs to how much costs should have been for the actual level of output during the period)

Most companies use the ___ of depreciable assets to calculate average operating assets

net book value

residual income equation

net operating income - (average operating assets * minimum required rate of return)

Return on Investment (ROI)

net operating income / average operating assets > a percentage

non-value-added throughput time formula:

percentage of throughput time spent in non-value-added activities

managers who are evaluated using residual income will pursue any project whose ___

rate of return is above the minimum required rate of return because it will increase their residual income

generally, a manager who is evaluated based on ROI will reject any project whose ___

rate of return is below the division's current ROI even if the rate of return on the project is above the company's minimum required rate of return.

investment center managers are often evaluated using ___

return on investment (ROI) or residual income measures.

queue time

the amount of time a product spends waiting to be worked on, to be moved, to be inspected, or to be shipped

inspection time

the amount of time spent ensuring that the product is not defective

process time

the amount of time work is actually done on the product

The operating assets base used in the ROI formula is typically computed as ___

the average of the operating assets between the beginning and the end of the year

Net operating income is used in the ROI formula because ___

the base (i.e., denominator) consists of operating assets

Wait time

the elapsed time from when a customer order is received until production of the order is started > non-value-added activity that should be reduced or eliminated

turnover incorporates a crucial area of a manager's responsibility, ___

the investment in operating assets > Excessive funds tied up in operating assets depress turnover and lower ROI, which can be just as much of a drag on ROI as the excessive operating expenses that depress margin

residual income

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

move time

the time required to move materials or partially completed products from workstation to workstation

throughput time formula:

throughput time = (process time) + (inspection time) + (move time) + (queue time)

throughput time, delivery cycle time, and manufacturing cycle efficiency all display ___ trends

unfavorable

While financial measures reflect the results of what people in the organization do, they do not measure ___

what drives organizational performance > Ex. For activity and revenue variances summarize the results of efforts aimed at increasing sales, but they do not measure the actions that actually drive sales such as improving quality, exposing more potential customers to the product, filling customer orders on time, and so on


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