1 PowerPointPresentation by PowerPoint Presentation by Gail B. Wright Professor Emeritus of Accounting Bryant University MANAGERIAL ACCOUNTING 10 TH EDITION BY MAHER, STICKNEY & WEIL INVESTMENT CENTER PERFORMANCE EVALUATION STUDENT CHAPTER 11 © Copyright 2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star Logo, and South- Western are trademarks used herein under license.

Managerial Planning, Control, & Performance Evaluation 2 1.Identify benefits & disadvantages of decentralization. 2.Identify issues that must be addressed when using return on investment (ROI) as a divisional performance measure. 3.Identify examples of differential analysis to make- or-buy decisions with different transfer prices. 4.Discuss transfer pricing issues & methods. LEARNING OBJECTIVES Continued

Managerial Planning, Control, & Performance Evaluation 3 5.Identify types of costs to be considered in measuring divisional operating costs. 6.Explain the contribution approach alternative to ROI for division performance measurement. 7.Identify issues in measuring the investment base for calculating ROI. 8.Describe purpose of ROI calculation, & identify its shortcomings. LEARNING OBJECTIVES Continued

Managerial Planning, Control, & Performance Evaluation 4 9.Explain how to calculate economic value added, & identify its use. LEARNING OBJECTIVES

Managerial Planning, Control, & Performance Evaluation 5 CHAPTER GOAL Chapter 11 discusses concepts & methods for measuring performance & controlling activities in multidivisional companies that have both manufacturing & non-manufacturing divisions. ☼☼

Managerial Planning, Control, & Performance Evaluation 6 ADVANTAGES OF DECENTRALIZATION Major advantages of decentralization (authority & responsibility are delegated from top management) include:  Enabling local personnel to respond quickly to a changing environment.  Freeing top management from detailed operating decisions.  Dividing large, complex problems into manageable pieces.  Training managers & providing a basis for evaluating their decision-making performance.  Motivating ambitious managers. LO 1

Managerial Planning, Control, & Performance Evaluation 7 DISADVANTAGES OF DECENTRALIZATION Major disadvantages of decentralization include:  Local managers do not act to achieve the overall goals of the organization.  Possible conflicts between goals of a division & those of the organization. LO 1

Managerial Planning, Control, & Performance Evaluation 8 PERFORMANCE EVALUATIONS Top management should distinguish between an organizational division & the division manager. Many measures used to evaluate divisions can/should be adjusted to account for revenues, costs, & investments that are controllable by its manager. LO 1

Managerial Planning, Control, & Performance Evaluation 9 RETURN ON INVESTMENT (ROI): Definition Is a method of evaluating performance based on assets invested. LO 2

Managerial Planning, Control, & Performance Evaluation 10 CALCULATING ROI LO 2 Return on investment (ROI) = Division operating profit Division Investment

Managerial Planning, Control, & Performance Evaluation 11 TRANSFER PRICE: Definition Is the value assigned to goods or services transferred from one unit to another within the organization. LO 3

Managerial Planning, Control, & Performance Evaluation 12 EXAMPLE: E-Z Computing E-Z Computing (E-Z) manufactures & sells various computer products through 2 decentralized divisions, Production & Marketing. Production is considering raising its price from $50 to $60 per unit. Marketing sells each mouse for $100 externally. Assume the following information for each division: LO 3 Continued E- Z

Managerial Planning, Control, & Performance Evaluation 13 EXAMPLE: E-Z Computing Marketing Monthly FC$5,000 LO 3 Continued E- Z Production VC per unit$50 Monthly FC$10,000 Consider 2 cases: Case #1: Production is below capacity Case #2: Production is at capacity

Managerial Planning, Control, & Performance Evaluation 14 EXHIBIT 11.2 When there is idle capacity, E- Z will profit most if Production continues to sell to Marketing. LO 3 E- Z

Managerial Planning, Control, & Performance Evaluation 15 EXHIBIT 11.3 When there is no excess capacity, Production will sell at its market price, $60. E-Z will earn the same profit whether Marketing buys from Production or another supplier. LO 3 E- Z

Managerial Planning, Control, & Performance Evaluation 16 SETTING TRANSFER PRICES Management must consider congruence with organizational goals when setting transfer prices. Methods of setting transfer prices include: 1.Top management intervenes to set prices 2.Top management establishes policies for setting transfer prices 3.Division managers negotiate their own transfer prices LO 4

Managerial Planning, Control, & Performance Evaluation 17 TRANSFER PRICING POLICIES 1 Management has several choices for transfer pricing policies  Market-price based  Best in competitive market  Only if market prices are readily available LO 4

Managerial Planning, Control, & Performance Evaluation 18 TRANSFER PRICING POLICIES 2 Management has several choices for transfer pricing policies  Transfer prices based on cost  Full-absorption costs  Only if differential or variable costs are available  Activity-based costing  Cost-plus pricing  Standard costs or actual costs LO 4

Managerial Planning, Control, & Performance Evaluation 19 TRANSFER PRICING POLICIES 3 Management has several choices for transfer pricing policies  Other motivational aspects  Dual pricing  Provides selling division with profit but charges buying division with costs only  Other incentives  Balanced scorecard  Basing part of supplying manager’s bonus on purchasing center’s profits LO 4

Managerial Planning, Control, & Performance Evaluation 20 PROFIT MARGIN LO 8 ROI = Profit Margin Divisional Revenues * Divisional Investment

Managerial Planning, Control, & Performance Evaluation 21 PROFIT MARGIN PERCENTAGE: Definition Indicates the portion of each dollar of revenue that is profit. LO 8

Managerial Planning, Control, & Performance Evaluation 22 INVESTMENT TURNOVER RATIO: Definition Is the ratio of divisional sales to investment in divisional assets; a measure of the effective use of invested funds. LO 8

Managerial Planning, Control, & Performance Evaluation 23 ECONOMIC VALUE ADDED (EVA): Definition Is the amount of earnings generated above the cost of funds invested to generate those earnings. LO 9

Managerial Planning, Control, & Performance Evaluation 24 EVA LO 9 EVA = Net operating profit after tax - (Weighted-average cost of capital * Investment)

Managerial Planning, Control, & Performance Evaluation 25 EVA: Calculation LO 9 In our example, the tax rate is 20%, & WACC is 15%, same as minimum acceptable return EVA = Net operating profit after tax - (Weighted-average cost of capital * Investment) EVA (before investment) = [$1,000,000 * (1-.20)] – [0.15 * ($4,000,000)] = $800,000 - $600,000 = $200,000 EVA (for investment) = [$400,000 * (1-.20)] – [0.15 * $2,000,000)] = ?

Managerial Planning, Control, & Performance Evaluation 26 MODIFYING ACCOUNTING NUMBERS 1 Adjustments can be made to GAAP accounting numbers for performance evaluation purposes  Capitalize R&D expenditures, then amortize  Capitalize customer development, advertising, promotion expenditures if future benefits & amortize  Capitalize employee training expenditures & amortize LO 9

Managerial Planning, Control, & Performance Evaluation 27 MODIFYING ACCOUNTING NUMBERS 2 Adjustments can be made to GAAP accounting numbers for performance evaluation  Make price-level adjustments so that assets, revenues, expenses are stated in current year currency values  Use market values of assets at beginning & end of fiscal periods to reflect actual decline in economic value LO 9

Managerial Planning, Control, & Performance Evaluation 28 MODIFYING ACCOUNTING NUMBERS 3 Adjustments can be made to GAAP accounting numbers for performance evaluation  Restate inventories to reflect replacement cost  Do not amortize goodwill (amortization no longer allowed) LO 9

Managerial Planning, Control, & Performance Evaluation 29 CHAPTER 11 THE END