Performance measures. Managerial Accounting David Fender. What is a responsibility center?. A subunit in an organization whose manager is held accountable for specified financial results. What kind of responsibility centers?. Cost Center/ Revenue Center Profit center Investment center.
A subunit in an organization whose manager is held accountable for specified financial results.
Segment has control over both costs and revenues.
Segment has control over profits and invested capital.
Adivision of a
Company-owned restaurant in a fast-food chain.
What is the best way to evaluate performance of investment centers?
Residual income concepts?
(ROI intuitive compared to other measures)
Holly Flower Company reports :
Income $ 30,000
Invested Capital $ 200,000
What is the ROI?
Three ways to improve ROI
ROI can be a disincentive to taking on lucrative projects!!!
Money costs money!
Residual income measures net operating income earned less the minimum required return on average operating assets.
(ROI measures net operating income earned relative to the investment in average operating assets.)
Investment center profit
– Investment charge
= Residual income
×Imputed interest rate
= Investment charge
Investment center’sminimum requiredrate of return
What is the residual income?
The general idea behind CAPM is that investors need to be compensated in two ways: time value of money and risk. The time value of money is represented by the risk-free (rf) rate in the formula and compensates the investors for placing money in any investment over a period of time. The other half of the formula represents risk and calculates the amount of compensation the investor needs for taking on additional risk. This is calculated by taking a risk measure (beta) that compares the returns of the asset to the market over a period of time and to the market premium (Rm-rf).
Also referred to as “beta” – beta is an indicator of how much a stock changes in relative to changes in the overall market
Beta is calculated on historical data
For example: a stock has a beta of 0.5 – this means the stock is less risky than the market; when the market decreases by 10% the stock decreases by 5% - on the same token, when the market increases by 10% the stock increases by 5%CAPM
Economic Value Added
When both equity and debt are used (which is usually the case) then calculate a weighted cost of capital:
% of debt of total capital
Debt interest rate
Equity interest rate
% of equity of total capital
The Atlantic Division of Suncoast Food Centers reportedthe following results for the most recent period:
Compute Atlantic Division’s economic value added.
$40,000,000 + $60,000,000Economic Value Added
First, let’s compute theweighted-average cost of capital
$6,750,000 × (1 – 30%)
$4,725,000 After-tax operating income
= $ 409,320 Economic value added
($45,000,000 – $600,000) × 0.0972 = $4,315,680
(9% × (1 – 30%) × $40,000,000) + (.12 × $60,000,000)
$40,000,000 + $60,000,000