# ACCT 2302 Fundamentals of Accounting II Spring 2011 Lecture 15 Professor Jeff Yu - PowerPoint PPT Presentation

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ACCT 2302 Fundamentals of Accounting II Spring 2011 Lecture 15 Professor Jeff Yu. Review: Performance Evaluation. Evaluation Tool. Cost Center ( controls costs only ). Spending Variance; Standard Cost Variances. Profit Center (controls costs & revenues ). Segmented Income Statement

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ACCT 2302 Fundamentals of Accounting II Spring 2011 Lecture 15 Professor Jeff Yu

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ACCT 2302

Fundamentals of Accounting II

Spring 2011

Lecture 15

Professor Jeff Yu

Review: Performance Evaluation

Evaluation Tool

Cost Center

(controlscosts only)

Spending Variance;

Standard Cost Variances

Profit Center

(controls costs & revenues)

Segmented

Income Statement

(Segment Margin)

Investment Center

(controls costs & revenues

& Investments)

Return on Investment (ROI);

Residual Income

Materials Price Variance

AQ(AP - SP)

Labor/VOH Rate Variance

AH(AR – SR)

Materials Quantity Variance

SP(AQ - SQ)

Labor/VOH Efficiency Variance

SR(AH – SH)

### Review: Standard Cost Variances

AP (AR)= Actual Price (Actual Rate): the amount actually paid for

each unit of the materials (labor or VOH).

SP (SR)= Standard Price (Standard Rate): the amount that should

Have been paid for each unit of the materials (labor or VOH).

AQ (AH)= Actual Quantity (Actual Hour): the amount of materials

(labor or VOH activity) actually used in the production.

SQ (SH)= Standard Quantity (Stan. Hour) allowed for the actual output

= actualproductionin units * standard quantity (hours) per unit

Review: Segmented Income Statement

Sales

- Variable Expenses

Contribution Margin

- Traceable Fixed costs

Segment Margin

• NOI for the company = the sum of segment margins minus Common fixed costs.

• Important: CVP analyses using the segmented income statement!

### Return on Investment (ROI)

ROI = NOI ÷ AOA

Turnover

Margin

AOA=Average Operating Assets

=(Beginning + Ending Operating Assets)/2

Thought Question: how will changes in sales, operating expenses and average operating assets affect ROI?

### Example

Holly Company reports the following information in 2009:

Net Operating Income \$ 30,000

Sales Revenue\$ 500,000

Average Operating Assets\$ 200,000

Q:

• Holly’s 2009 ROI? Margin? Turnover? Operating Expenses?

(2) How will Holly’s ROI change if sales increases to \$600,000 and both AOA and operating expenses do not change in 2010?

(3) How will Holly’s ROI change if there is no change in sales and AOA but operating expenses decrease to \$458,000 in 2010?

(4) How will Holly’s ROI change if there is no change in sales and operating expenses, but AOA decreases to \$100,000 in 2010?

### Summary: Improving ROI

Decrease

Operating

Expenses

DuPont Analysis: ROI = Margin * Turnover

Increase

Sales

generate the same NOI with Less

Operating Assets

### Residual Income (RI)

RI = NOI - Required rate of return× AOA

NOI- Net operating income (profits)AOA- Average operating assets

Required rate of return × AOA = Required return

Decision Rule: Invest if RI>0.

### Practice Problem

At Pitts Co. the required rate of return on operating assets is 8%. The 2010 sales revenue for division A is \$10 million, NOI is \$2 million, AOA is \$2.5 million.

Q: Division A’s 2010 ROI? Margin? Turnover? Residual Income?

Practice Problem

Given the following information for Division C:NOI\$560,000Margin35%Turnover1.6Minimum required rate of return12%What is the division’s residual income?

### Example: ROI vs. RI

• Flower Co. Division C has an opportunity to invest \$100,000 (AOA) in a project that will yield NOI of \$25,000 for the year.

• Flower Co. has a 20% required rate of return and Division C has a 30% ROI on its existing business.

Q: (1) As a manager at Division C, will you invest in that project if you are evaluated based on division ROI (the higher the ROI, the bigger the bonus)?

(2) Is this investment project good for the company?

(3) Will your decision be different if you are evaluated using residual income?

ROI – A Drawback

As division manager,

I wouldn’t invest in

that project because

it would lower my pay!

Gee . . .

I thought we were

supposed to do what

was best for the

company!

### Residual Income VS. ROI

Under ROI, the basic message is:

Maximize rate of return, a percentage.

Under the residual income approach, the basic message is:

Maximize residual income, an absolute amount.

• Residual income may encourage managers to make profitable investments that would be rejected by managers using ROI to evaluate that same investment.

• However, residual income cannot be used to compare the performance of divisions with different sizes (i.e. different AOA).

Customers

Financial

Learningand growth

### The Balanced Scorecard

Management translates its strategy into performance measures that employees understand and accept.

Performancemeasures

### The Balanced Scorecard: FromStrategy to Performance Measures

Performance Measures

Financial

Has our financialperformance improved?

What are ourfinancial goals?

What customers dowe want to serve andhow are we going towin and retain them?

Vision and Strategy

Customer

Do customers recognize thatwe are delivering more value?

What internal busi-ness processes arecritical to providingvalue to customers?

Have we improved key business processes so that we can deliver more value to customers?

Learning and Growth

Are we maintaining our abilityto change and improve?

• Financial measures are lagging indicators that summarize the results of past actions. Non-financial measures are leading indicators of future financial performance.

• Top managers are ordinarily responsible for financial performance measures – not lower level managers. Non-financial measures are more likely to be understood and controlled by lower level managers.

### The Balanced Scorecard: Non-financial Measures

The balanced scorecard relies on non-financial measures in addition to financial measures for two reasons:

Financial

Customer

Learningand Growth

### Example: The Balanced Scorecard

Profit

CM per car

Number of cars sold

Customer satisfactionwith options

Number ofoptions available

Time toinstall option

Employee skills in installing options

### ROI and the Balanced Scorecard

It may not be obvious to managers how to increase sales, decrease costs, and decrease investments in a way that is consistent with the company’s strategy. A well constructed balanced scorecard can provide managers with a road map that indicates how the company intends toincrease ROI.

Which internal business process should be improved?

Which customers should be targeted and how will they be attracted and retained at a profit?

### For Next Class

• Review for Midterm Exam II

### Homework Problem 1

At Davis Co. the required rate of return on operating assets is 8%.

The 2010 residual income of division B is \$120,000, Margin is 25%, ROI is 20%.

Q: (1) What is Division B’s 2010 Turnover?

(2) What is Division B’s NOI?

(3) What is Division B’s AOA?

(4) What is Division B’s Sales?

### Homework Problem 2

DFW Inc.’s required rate of return is 10%. In 2009, its Division A reported the following performance data: Residual Income = \$18,000, Margin = 20%, Turnover = 1.5.

Q: (1) What is Division A’s ROI in 2009?

(2) What is Division A’s NOI in 2009?

(3) What is Division A’s AOA in 2009?

(4) What is Division A’s sales revenue in 2009?