ACCT 2122 Chapter 11
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
