ACCT CH 11

*Any allocation of common costs to segments reduces the value of the segment margin

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When a company uses residual income or EVA to measure performance, the objective is to maximize residual income or EVA, NOT ROI

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performance measures used in the balanced scorecard approach tend to fall into four groups:

1. financial 2. customer 3. internal business processes 4. learning and growth

Any increase in ROI must involve one of the following:

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

Criticisms of ROI

1. managers may not know how to increase ROI (ROI is best used as part of a balanced scorecard) 2. a manager who takes over a business segment typically inherits many committed costs over which the manager has no control 3. a manager who is evaluated on ROI may reject investment opportunities that are profitable for the whole company but that would have a negative impact on the manager's performance evaluation

segment margin

CM margin - traceable fixed costs of the segment *best gauge of the long-run profitability of a segment because it includes only those costs that are caused by the segment

*treat traceable costs: only those that would disappear over time if the segment itself disappeared

Ex: if the consumer products division was discontinued it would no longer be necessary to pay the division's managers salary

ROI = Margin x Turnover

Margin = Net Op. Income/Sales Turnover = Sales/Avg. Operating assets

Residual income =

Net Op. Income - (avg. op. assets x minimum required rate of return)

ROI =

Net operating income --------------------------- average operating assets

Traceable fixed cost

a fixed cost that is incurred because of the existence of the segment; if the segment never existed the cost would not have been incurred; and if the segment were eliminated the cost would disappear EX: -salary of Fritos product manager at PepsiCO is traceable to the Fritos business segment of PepsiCo -liability insurance at Disney World is traceable fixed cost of the Disney World business segment of the Disney Coorporation

Economic Value Added (EVA)

an adaptation of residual income that has been adopted by many companies. (*dont worry about the distinction) under EVA, companies can modify their accounting principles in various ways. EX: funds used for research and development are often treated as investments instead of expenses

responsibility center (3 types)

any part of an organization whose manager has control over and is accountable for cost, profit, or investments 1. cost centers 2. profit centers 3. investment centers

the various measures on a balanced scorecard should

be linked on a probable cause-and-effect basis

current assets

cash, accounts receivable, inventories

operating assets

cash, accounts receivable, inventory, plant and equipment, and all other assets held for operating purposes (*NOT land held for future use, investments in another company, or building rented to someone else)

Balanced scorecard

consists of an integrated set of performance measures that are derived from and support the company's strategy under the balanced scorecard approach, top management translates its strategy into performance measures that employees can understand and influence EX: the amt of time passengers have to wait in line to have their baggage checked might be a performance measure for the supervisor in charge of the airlines check-in counter

Operating expenses

cost of goods sold, selling expense, administrative expense

decentralized organization

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

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. Even if a segment were entirely eliminated, there would be no change in a true common fixed cost EX: -salary of the CEO of of General Motors is a common fixed cost of the various divisions of GE -cost of heating a Kroger store is a common fixed cost of the store's various departments (meant, bakery etc) -cost of receptionists salary at an office shared by a number of doctors

margin

improved by increasing sales or reducing operating expenses *lower operating expenses - higher margin

Net operating income

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

turnover

investment in operating assets (excessive funds tied up in operating assets depress turnover and lower ROI)

in essence, the balanced scorecard:

lays out a theory of how the company can take concrete actions to attain its desired outcomes *an integrated system of performance measures designed to support an organizations strategy

responsibility accounting systems

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

Investment center

manager has control over costs, revenue and investments

Residual income

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

noncurrent assets

plant and equipment, other assets

Residual income vs ROI

residual income encourages managers to make investments that are profitable for the entire company but that would be rejected by managers who are evaluated using ROI

Divisional segment margins

show company's divisional managers how much their division is contributing to company's profits

Cost center

the manager of a cost center has control over costs but not over revenue or the use of investment funds Ex: accounting, finance, legal, general administration managers are expected to minimize costs while providing the level of products and services demanded by other parts of the organization

Profit Center

the manager of a profit center has control over both costs and revenues, but not over the use of investment funds

segment margin

valuable tool for assessing the long-run profitability of a segment of the company & is a much better tool for evaluating performance than absorption costing income statements