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PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Business Unit Performance Measurement Chapter 14

14-3 Accounting Income LO 14-1 Evaluate divisional accounting income as a performance measure. Divisional Income Division revenues minus division costs Investors use accounting income to assess a firm's performance. Firms use a division’s income to Assess divisional performance. LO 14-1

14-4 Divisional Income LO 14-1

14-5 Some Simple Financial Ratios Mustang Fashions Selected Financial Ratios For Year 1 LO 14-1

14-6 Return on Investment LO 14-2 Interpret and use return on investment (ROI). Return on Investment (ROI) Ratio of profits to investment in the asset that generates those profits Provides a comparison of different size divisions LO 14-2

14-7 Return on Investment LO 14-2

14-8 Return on Investment LO 14-2

14-9 Return on Investment ROI After-tax income Divisional assets = After-tax income Sales Divisional assets =× Profit margin ratioAsset turnover=× LO 14-2

14-10 Residual Income Measures LO 14-3 Interpret and use residual income (RI). Residual Income (RI) This is the excess of actual profit over the cost of invested capital in the unit. LO 14-3

14-11 Residual Income Measures Cost of Capital This is the opportunity cost of the resources (equity and debt capital) invested in the business. LO 14-3

14-12 Economic Value Added (EVA) LO 14-4 Interpret and use economic value added (EVA). EVA is the annual after-tax (adjusted) divisional income minus the total annual cost of (adjusted) capital. It makes adjustments to after-tax income and capital to “eliminate accounting distortions.” LO 14-4

14-13 Measuring the Investment Base LO 14-5 Explain how historical cost and net book value-based accounting measures can be misleading in evaluating performance. Performance measures use divisional assets or investments in the calculation. Performance measures use divisional assets or investments in the calculation. How should divisional assets be measured? – Gross book value versus net book value – Historical cost versus current cost – Beginning, ending, or average balance How should divisional assets be measured? – Gross book value versus net book value – Historical cost versus current cost – Beginning, ending, or average balance LO 14-5

14-14 Other Issues in Divisional Performance Measurement LO 14-5 Divisional income, ROI, residual income, and EVA are financial performance measures that consider the activities of the business unit independently of other units in the firm. Measuring the manager only on the division’s results risks suboptimal decision making because the manager ignores the effect of the decisions on other business units.

14-15 End of Chapter 14