ACCT 2200 - Chapter 10

Chapter 10
Decentralized Performance
Evaluation
ACCT 2200
PROFESSOR THOMAS BOURVEAU
Learning Objective 10-1
List and explain the advantages and

disadvantages of decentralization.
Decentralization of Responsibility
Decentralization pushes
decision making down
to lower-level managers.
Decentralization often occurs as organizations continue to grow.

Decentralization of Responsibility
Describe the different types of

responsibility centers and explain
how managers in each type are
evaluated.
Responsibility Centers
Responsibility accounting gives managers authority
and responsibility for a particular part of the
organization and then evaluates them based on the
results of that area of responsibility.
Managers of responsibility
centers should be held
responsible only for that
which they can control.
Describe the four dimensions of the

balanced scorecard and
explain how they are used to evaluate
managerial performance.
The Balanced Scorecard
Management
Managementtranslates
translatesits
itsstrategy
strategyinto
into
performance
performancemeasures
measuresthat
thatemployees
employeesunderstand
understand
and
andaccept.
accept.
Financial Customers
Performance
measures
Internal Learning
business and growth
processes
https://www.youtube.com/watch?v=Z5KZhm19EO0
Again, the Ted Talk by Alex Edmans

Compute and interpret return on

investment, investment turnover, and
profit margin.
Return on Investment (ROI)
Compute and interpret residual

income.
Residual Income
The hurdle rate is the required return on

invested assets, sometimes called the
cost of capital.
Residual income is the organization’s extra

profit, over and above that needed to cover
the required return on invested assets.
Residual Income
ROI versus Residual Income
 As
As the
the store
store manager
manager at atApple’s
Apple’s Online
Online Store,
Store, you
you have
have the
the opportunity
opportunity toto
invest
invest $1,000,000
$1,000,000 in
in aa project
project promising
promising aa return
return of
of $150,000
$150,000 (15(15
percent).
percent).
 The
The company
company requires
requires aa minimum
minimum return
return of
of 10
10 percent
percent on
on all
all projects,
projects, so
so
the
the project
project would
would be
be acceptable
acceptable from
from the
the company’s
company’s perspective.
perspective.
Would you invest in this project?

ROI versus Residual Income
Limitations of Financial
Performance Measures
Both ROI and residual income are lagging indicators of
financial performance. These measures tell how well a
company or a division has done in the past but not
necessarily how well it will do in the future.
To improve short-run financial

results, managers may make harmful
decisions to cut costs in areas such
as research and development,
employee training, or quality of
manufacturing materials.
Annual financial data for Hotels Desfleurs for 2011
Let’s assume that the group’s required rate of investments is 12%.
Compute the Return on investment and the residual income for each
hotel of the group.
Assume that the group has an expansion opportunity of Vaison Hotel

that will increase operating profit by €160,000 and increase total assets
by €800,000. Should they do it?
Vaison Perpignan La Rochelle
Total
Hotel Hotel hotel
Hotel revenues (sales) €1,200,000 €1,400,000 €3,185,000 €5,785,000
Hotel variable costs 310,000 375,000 995,000 1,680,000
Hotel fixed costs 650,000 725,000 1,680,000 3,055,000
Hotel operating profit €240,000 €300,000 €510,000 €1,050,000
Interest costs on long-term debt at 10% - - - 450,000

Profit before income taxes - - - 600,000
Income taxes at 30% - - - 180,000
Net profit - - - €420,000
Average book values for 2011

Current assets €400,000 €500,000 €600,000 €1,500,000
Long-term assets 600,000 1,500,000 2,400,000 4,500,000
Total assets €1,000,000 €2,000,000 €3,000,000 €6,000,000
Current Liabilities €50,000 €150,000 €300,000 €500,000

Long-term debt - - - 4,500,000
Stockholders' equity - - - 1,000,000
Total liabilities and shareholder equity €6,000,000
23
Desfleurs: ROI
Hotel Operating profit ÷ Total assets = ROI

Vaison €240 000 ÷ €1 000 000 = 24%
Perpignan €300 000 ÷ €2 000 000 = 15%
La Rochelle €510 000 ÷ €3 000 000 = 17%
24
Desfleurs: Residual income

Let’s assume Desfleurs’ required rate of investments is 12%
Required rate of return X Residual
Hotel Operating Profit - =
investment income
Vaison €240,000 - €120,000 (= 12% x €1,000,000) = €120,000
Perpignan €300,000 - €240,000 (= 12% x €2,000,000) = €60,000
La Rochelle €510,000 - €360,000 (= 12% x €3,000,000) = €150,000
25
Assume
◦ Desfleurs requires a rate of return on investment of 12%
◦ Expansion of Vaison Hotel will increase operating profit by €160,000 and
increase total assets by €800,000
For Desfleurs, expansion makes sense:

◦ ROI of expansion is 20% (€160,000 ÷ € 800,000) Problem of
suboptimization
For Vaison Hotel?
◦ Pre-expansion ROI: €240,000 ÷ € 1,000,000 = 24%
€240,000 + €160,0000 €400,000
◦ Post-expansion ROI: = = 22.2%
€1,000,000 + €800,000 €1,800,000
Oh oh! Vaison’s ROI will decrease and

maybe also the managers’ bonus!
Manager is not too happy.
26
Exercise
Your firm is composed of two divisions, the Business Division and the
Engineering Division. Operating results for the two divisions are as
follows:
Business Engineering
Net Operating Income $10,000 $6,000
Assets $50,000 $42,000
The firm has a cost of capital of 10%. An investment available to both

divisions with a return of $20,000 on an investment of $130,000 exists.
1/ If the divisions are evaluated based on return on investment, which
division(s) would like to accept the project?
2/ If the division are evaluated based on residual income, which

1/ If the divisions are evaluated based on return on investment, which

ROI Business = 10,000 / 50,000 = 20%
ROI Engineering = 6,000 / 42,000 = 14.2%
New project ROI = 20,000 / 130,000 = 15.3%

Only Engineering accept
2/ If the division are evaluated based on residual income, which

Residual income of the new project:

20,000 – 130,000 X 0.10 = 7,000
Both will accept

ACCT 2200 - Chapter 10

Uploaded by

Copyright:

Available Formats

ACCT 2200 - Chapter 10

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

ACCT 2200 - Chapter 10

Uploaded by

Copyright:

Available Formats

Chapter 10

List and explain the advantages and

Decentralization often occurs as organizations continue to grow.

Describe the different types of

Describe the four dimensions of the

Again, the Ted Talk by Alex Edmans

Compute and interpret return on

Compute and interpret residual

The hurdle rate is the required return on

Residual income is the organization’s extra

Would you invest in this project?

To improve short-run financial

Let’s assume that the group’s required rate of investments is 12%.

Assume that the group has an expansion opportunity of Vaison Hotel

Interest costs on long-term debt at 10% - - - 450,000

Average book values for 2011

Current Liabilities €50,000 €150,000 €300,000 €500,000

Hotel Operating profit ÷ Total assets = ROI

For Desfleurs, expansion makes sense:

Oh oh! Vaison’s ROI will decrease and

The firm has a cost of capital of 10%. An investment available to both

You might also like

Pfad - The Proxy pFad of © 2024 Garber Painting. All rights reserved.