Bài giảng Fundamentals of cost accounting - Chapter 14: Business Unit Performance Measurement

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Not authorized for sale or distribution in any manner.  This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.  Business Unit PerformanceMeasurementChapter 14Learning ObjectivesLO 14-1 Evaluate divisional accounting income as a performance measure.LO 14-2 Interpret and use return on investment (ROI).LO 14-3 Interpret and use residual income (RI).LO 14-4 Interpret and use economic value added (EVA).LO 14-5 Explain how historical cost and net book value-based accounting measures can be misleading in evaluating performance.Divisional Performance Measurement As we develop performance measures, our discussion will be guided by three considerations.Is the performance measure consistent with the decision authority of the manager?Does the measure reflect the results of those actions that improve the performance of the organization?What actions might managers be taking that improve reported performance but are actually detrimental to organizational performance?Accounting IncomeLO 14-1 Evaluate divisional accounting income as a performance measure.Divisional Income Division revenues minus division costsInvestors use accounting income to assess a firm's performance.Firms use a division’s income to Assess divisional performance.LO 14-1 Divisional IncomeLO 14-1 Advantages and Disadvantagesof Divisional Income It is easy to understand. Decisions controlled by the manager are reflected. Results of decisions affecting revenues and costs are summarized. It makes comparison of divisions easy.LO 14-1 Advantages and Disadvantagesof Divisional Income Since the size of the division may have an impact, it may not reflect performance of divisional managers It does not determine if managers are making good decisions regarding the use of assetsLO 14-1Some Simple Financial RatiosMustang FashionsSelected Financial RatiosFor Year 1LO 14-1Return on InvestmentLO 14-2 Interpret and use return on investment (ROI). Return on Investment (ROI) Ratio of profits to investment in the asset that generates those profitsProvides a comparison of different size divisionsLO 14-2Return on InvestmentLO 14-2Return on InvestmentLO 14-2Return on InvestmentLO 14-2Limitations of ROI Short-term focus (myopia) from accounting information Conflicting incentives for managers (suboptimization)LO 14-2Limitations of ROIIncrease salesDecrease costsDecrease assetsLO 14-2Limitations of ROI Mustang Fashions requires a return on investments of 20%.Current division performanceWestern: 22%Eastern: 24%LO 14-2An Example: Mustang FashionsLimitations of ROIShould an investment be made if the following returns are expected?Company: ≥ 20%Western Division: ≥ 22%Eastern Division: ≥ 24%LO 14-2Limitations of ROIOrganization20%Western DivisionManager22%Eastern DivisionManager24%Conflicting IncentivesThe division managers’ goals differfrom the organization’s goals.LO 14-2Residual Income MeasuresLO 14-3 Interpret and use residual income (RI).Residual Income (RI)This is the excess of actual profit overthe cost of invested capital in the unit.LO 14-3Residual Income MeasuresCost of CapitalThis is the opportunity cost of the resources(equity and debt capital) invested in the business.LO 14-3Residual Income MeasuresAfter-tax incomeDivisional investmentCost of capitalCost of invested capital: Cost of capital × Divisional investmentResidual income$1,500.0 20%$336.0 300.0$ 36.0$214.2 180.0$ 34.2Western DivisionEastern Division$900.0 20%Mustang FashionsRI for Western and Eastern DivisionsFor Year 1 ($000) RI eliminates the dysfunctional behavior caused by evaluating performance based on ROI. Both managers will invest if return is ≥ 20%LO 14-3Economic 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 annualcost of (adjusted) capital.It makes adjustments to after-tax income andcapital to “eliminate accounting distortions.”LO 14-4EVA Example Advertising expenditures in Year 0: Western Division: $800,000 (50% charged to Year 1) Eastern Division: $300,000 (50% charged to Year 1) Mustang Fashion believes an advertising campaign has a two-year life. GAAP requires advertising be expensed when incurred. Advertising expenditures charged to Year 1: Western Division: ($800,000 × 50%) + $1,200 × 25%) Eastern Division: ($300,000 × 50%) + $ 500 × 25%) LO 14-4EVA ExampleWestern DivisionEastern DivisionAfter-tax incomeAdd: Back advertising expenseLess: Amortization of advertisingAdvertising expenditure in Year 0Advertising expenditure in Year 1Adjusted incomeDivision investmentLess: Current liabilitiesNet investmentUnamortized advertising (800 – 200), (300 – 75)Adjusted divisional investmentCalculation of EVA:Adjusted income (from above)Cost of adjusted divisional investment (@ 20%)EVA$400.0 300.0$ 336.0 1,200.0$1,536.0 700.0$ 836.0$1,500.0 352.0$1,148.0 600.0$1,748.0$ 836.0 349.6$ 486.4$214.2 500.0$714.2 275.0$439.2$900.0 375.0$525.0 225.0$750.0$439.2 150.0$289.2$150.0 125.0Mustang FashionsEVA for Western and Eastern DivisionsFor Year 1 ($000)LO 14-4Limitations of EVAWho determines the "accounting distortions"?EVA is based on accounting income, notpresent value of cash flowsLO 14-4Measuring the Investment BaseLO 14-5 Explain how historical cost and net book value-based accounting measures can be misleading in evaluating performance.Performance measures use divisional assetsor 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 LO 14-5Gross Book Value versusNet Book Value Example Profits before depreciation (all in cash flows at end of year): $100 each year for 3 years Asset cost at beginning of year 1, $500 Depreciation: Ten year life, straight-line, no salvage value Amounts are in thousand of dollars.LO 14-5Gross Book Value versusNet Book Value ExampleROI= $50c $500=10%Year===ROI= $50c $500=10%ROI= $50c $500=10%Net Book ValueGross Book Value$100a – (0.1 × $500)b$500d – (0.1 × $500)e11.1%ROI=12$100a – (0.1 × $500)b$450d – (0.1 × $500)e12.5%ROI=3$100a – (0.1 × $500)b$400d – (0.1 × $500)e14.3%ROI=a The first term in the numerator is the annual cash profit.b The second term in the numerator is depreciation for the year.c Net income = $50 = $100 – ($500 × 0.1)d The first term in the denominator is the beginning-of-the-year asset value.e The second term in the denominator reduces the beginning-of-the-year value of the asset by the amount of current year's depreciationLO 14-5Historical Cost versus Current CostCurrent CostCost to replace or rebuildan existing assetHistorical CostOriginal cost to purchaseor build an assetLO 14-5Historical Cost versus Current Cost Operating profits before depreciation (all in cash flows at end of year): Year 1, $100; Year 2, $120; Year 3, $144 Annual rate of price changes is 20 percent. Asset cost at beginning of year 1 is $500. Amounts are in thousand of dollars. Straight-line depreciation is used; the straight-line rate is 10% per yearLO 14-5Historical Cost versus Current CostYear=Historical Cost$100a – (0.1 × $500)b$500c – (0.1 × $500)11.1%ROI=1=2$120a – (0.1 × $500)b$500c – (0.2 × $500)17.5%ROI==3$144a – (0.1 × $500)b$500c – (0.3 × $500)26.9%ROI=Year=Current Cost$100a – (0.1 × $600)b$600d – (0.1 × $600)e7.4%ROI=1=2$120a – (0.1 × $720)b$720f – (0.2 × $720)e8.3%ROI==3$144a – (0.1 × $864)b$864g – (0.3 × $864)e9.5%ROI=Year=Historical Cost$100a – $50b$500c10.0%ROI=1=2$120a – $50b$500c14.0%ROI==3$144a – $50b$500c18.8%ROI=Year=Current Cost$100a – $60b$600d6.7%ROI=1=2$120a – $72b$720f6.7%ROI==3$144a – $86.4b$864g6.7%ROI=Net Book ValueGross Book Valuea Annual operating profit before depreciation. b Depreciation for the year.c Beginning-of-the-first-year value of the assets used in the investment base. d Current cost of asset ($500 × 120%)e Accumulated depreciation at the end of the year. f Current cost of asset ($600 × 120%)g Current cost of asset ($720 × 120%)LO 14-5Beginning, Ending,or Average Balance?Should beginning, ending, or average balance be used for the investment base?LO 14-5Managers can manipulate purchases anddisposition based on which balance isbeing used in evaluations.Other Issues in Divisional Performance MeasurementLO 14-5Divisional 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.End of Chapter 14