Responsibitlity Centre,RI,ROI,EVA,Balance Score Card

18-1

CentralizedOrganizations

CentralizedOrganizations

DecentralizedOrganizations

DecentralizedOrganizations

Decisions are handed down form the top

echelon of management and

subordinates carry them out

Decisions are handed down form the top

echelon of management and

subordinates carry them out

Decisions are made at divisional and

departmental levels

Decisions are made at divisional and

departmental levels

Centralization Vs. Decentralization

18-2

CostsCosts

Benefits And Costs Of A Decentralized Organization

Benefits Managers = Specialists Decision Making Autonomy

= Managerial Training Decision Making Authority =

Greater Motivation Delegating = Time Relief Empowering Employees =

Knowledge & Expertise Delegating = Timely

Responses to Opportunities & Problems

Benefits Managers = Specialists Decision Making Autonomy

= Managerial Training Decision Making Authority =

Greater Motivation Delegating = Time Relief Empowering Employees =

Knowledge & Expertise Delegating = Timely

Responses to Opportunities & Problems

??Costs

Managers’ narrow focus is not consistent with organization’s overall goals

Narrow Focus = Tendency to ignore the consequences of actions on other units

Some tasks or services may be duplicated unnecessarily

Costs Managers’ narrow

focus is not consistent with organization’s overall goals

Narrow Focus = Tendency to ignore the consequences of actions on other units

Some tasks or services may be duplicated unnecessarily

18-3

Most organizations are divided into smaller units, divisions, segments, business units, work centers, or departments

Most organizations are divided into smaller units, divisions, segments, business units, work centers, or departments

Every on in an organization should work to achieve the goal of the

organization.

Every on in an organization should work to achieve the goal of the

organization.

BEHAVIORAL CONGRUENCEPerformance evaluation and incentivesystems are designed to encourage

employees to behave as if their goals are congruent with organizational goals

BEHAVIORAL CONGRUENCEPerformance evaluation and incentivesystems are designed to encourage

employees to behave as if their goals are congruent with organizational goals

Decentralized Organizations And Responsibility Accounting

She seems like a team player, but

I’m not sure.

18-4

Goal Congruenc

e

Goal Congruenc

e

Behavioral Congruenc

e

Behavioral Congruenc

e

Responsibility Accounting

Various concepts and tools used to measure the

performance of people and the departments in order to foster goal or behavioral congruence

Responsibility Accounting

Various concepts and tools used to measure the

performance of people and the departments in order to foster goal or behavioral congruence

Decentralized Organizations And Responsibility Accounting

18-5

Responsibility Accounting, control, and performance evaluation To create responsibility

accounting, i.e. evaluating performance, we have to:

assign responsibilities to each manager, so that we can evaluate him with respect to the boundaries of his responsibilities

…Responsibility centres

18-6

A RESPONSIBILITY CENTER is any part of an organization whose manager has control over cost, revenue, or investment funds.

A RESPONSIBILITY CENTER is any part of an organization whose manager has control over cost, revenue, or investment funds.

1- COST CENTRE2- REVENUE CENTRE3- PROFIT CENTRE4- INVESTMENT CENTRE

1- COST CENTRE2- REVENUE CENTRE3- PROFIT CENTRE4- INVESTMENT CENTRE

Responsibility Centres

18-7

Responsibility Centers

Cost Center Manager has

control over the incurrence

of costs.

Cost Center Manager has

control over the incurrence

of costs.

The Paint DepartmentThe Paint Departmentin an automobile plantin an automobile plant..

Revenue CenterRevenue Center ManagerManager

is responsibleis responsiblefor the revenue of for the revenue of

a unit.a unit.

Revenue CenterRevenue Center ManagerManager

is responsibleis responsiblefor the revenue of for the revenue of

a unit.a unit.

The ReservationsThe ReservationsDepartment of an airline.Department of an airline.

18-8

Responsibility Centers

Profit Center Manager has

control over both costs and

revenues.

Profit Center Manager has

control over both costs and

revenues.

Company-owned Company-owned restaurant in a fast-food restaurant in a fast-food

chain.chain.

Investment CenterInvestment Center

ManagerManager has has control over profits control over profits

and invested and invested capital.capital.

Investment CenterInvestment Center

ManagerManager has has control over profits control over profits

and invested and invested capital.capital.

A division of aA division of alarge corporation.large corporation.

18-9

Measuring Management Performance

CostCoststandardsstandardsCostCoststandardsstandards

Contributionincomestatement

Contributionincomestatement

- Rate of return- Rate of returnon investmenton investment- Residual incomeResidual income- EVAEVA

- Rate of return- Rate of returnon investmenton investment- Residual incomeResidual income- EVAEVA

Evaluation ToolEvaluation ToolCostCost

CenterCenterCostCost

CenterCenter

InvestmentInvestmentCenterCenter

InvestmentInvestmentCenterCenter

ProfitCenterProfit

Center

18-10

Mail Order Division

Koala Camp Gear Division Retail Division

Sales revenue $350,000,000 $405,000,000 $960,000,000Income 14,000,000 45,000,000 48,000,000Invested capital 70,000,000 300,000,000 480,000,000

Mail Order Division

Koala Camp Gear Division Retail Division

Sales revenue $350,000,000 $405,000,000 $960,000,000Income 14,000,000 45,000,000 48,000,000Invested capital 70,000,000 300,000,000 480,000,000

Return on investment (ROI) = Return on investment (ROI) = IncomeInvested capital

IncomeInvested capital

Return On Investment As A Performance Measure

18-11

Capital TurnoverFocuses on the number of sales dollars generated by

each dollar of invested capital

Capital TurnoverFocuses on the number of sales dollars generated by

each dollar of invested capital

Sales MarginMeasures the percentage of each sales dollar that remains as profit

after all expenses are covered

Sales MarginMeasures the percentage of each sales dollar that remains as profit

after all expenses are covered

Factors Underlying ROI

Return on investment Income

Invested CapitalIncome

Sales revenueSales revenue

Invested capital= = X

18-12





Focuses on the number of salesdollars generated by each dollar of

invested capital


invested capital

Measures the percentage of each sales dollar that remains as

profit after all expenses are covered



Mail-order division

$14,000,000 $350,000,000

$350,000,000 $70,000,000

Koala Camp Gear division

$45,000,000 $405,000,000

$405,000,000 $300,000,000

Retail division$48,000,000

$960,000,000$960,000,000 $480,000,000

Mail-order division

$14,000,000 $350,000,000

$350,000,000 $70,000,000


$45,000,000 $405,000,000

$405,000,000 $300,000,000


$960,000,000$960,000,000 $480,000,000

SalesMargin

CapitalTurnoverX

XX

XX

XX


18-13






invested capital


invested capital





Mail-order division 5% 4%Koala Camp Gear division 11.11% 1.35%

Retail division 5% 2%

Mail-order division 5% 4%Koala Camp Gear division 11.11% 1.35%

Retail division 5% 2%

SalesMargin

CapitalTurnoverX

XX

XX

XX


18-14






invested capital


invested capital





Mail-order division

$14,000,000 $350,000,000

$350,000,000 $70,000,000 = 20%


$45,000,000 $405,000,000

$405,000,000 $300,000,000 = 15%


$960,000,000$960,000,000 $480,000,000 = 10%

Mail-order division

$14,000,000 $350,000,000

$350,000,000 $70,000,000 = 20%


$45,000,000 $405,000,000

$405,000,000 $300,000,000 = 15%


$960,000,000$960,000,000 $480,000,000 = 10%

SalesMargin

CapitalTurnoverX

XX

XX

XX


18-15

10% 5% 2Current retaildivision ROI

Improving A Division’s ROI

Retail division’sROI

Sales margin

Capital turnover

X=

18-16


Improved retail

division ROI

One way to increase the ROI is to increase the SALES MARGIN.

For example we can increase the sales price, or cut expenses.

One way to increase the ROI is to increase the SALES MARGIN.

For example we can increase the sales price, or cut expenses.


14% 27%7%


Sales margin

Capital turnover

X=

18-17


Improved retail

division ROI

Another way to increase the ROI is to increase the CAPITAL TURNOVER.

For example we can increase the sales price, or decrease our total investment.

Another way to increase the ROI is to increase the CAPITAL TURNOVER.

For example we can increase the sales price, or decrease our total investment.


15% 35%


Sales margin

Capital turnover

X=

3

18-18

In Summary

ROI can be improved by: increasing Sales reducing expenses reducing assets

18-19

Outback’s koala Camp Gear division manager is considering a major investment in computer-

integrated manufacturing (CIM) equipment. The CIM will cost $50 million, but there will be an

annual operating savings, and thus an increase in divisional income of $5.5 million. Return on this

new investment is:


integrated manufacturing (CIM) equipment. The CIM will cost $50 million, but there will be an

annual operating savings, and thus an increase in divisional income of $5.5 million. Return on this

new investment is:

Problem with ROI-Example

18-20


integrated manufacturing (CIM) equipment


integrated manufacturing (CIM) equipment

Problem with ROI

Return on new investment = increase in divisional profit ($5,500,000)increase in invested capital ($50,000,000)

But if manager is going to be evaluated based on devsional performance

$45,000,000 $45,000,000+$5,500,000$300,000,000 $300,000,000 + $50,000,000 < 15%

With CIM investmentWithout CIM investment

11%=

= 15%

18-21

Divisional profit $45,000,000 $50,500,000

Less imputed interest charge: Invested capital $300,000,000 $350,000,000X imputed interest rate x .10 x .10

Imputed interest charge 30,000,000 35,000,000

RI $15,000,000

Without Investment in New CIM Equipment

With Investment in New CIM Equipment

$15,500,000




RI $15,000,000

Without Investment in New CIM Equipment

With Investment in New CIM Equipment

$15,500,000

Koala Camp Gear Division’s Residual Income Without/With New CIM Equipment

Koala Camp Gear Division’s Residual Income Without/With New CIM Equipment

Investment in new equipment raises residual income by $500,000

Residual Income As A Performance Measure

18-22




RI $7,000,000

Mail-Order Division Koala Camp Gear Division

$15,000,000




RI $7,000,000

Mail-Order Division Koala Camp Gear Division

$15,000,000

Should not be used to compare performance of different sized investment

centers

Should not be used to compare performance of different sized investment

centers

The Koala Division’s RI is much higher simply because it is larger

than the mail-order division

Problem with Residual Income

18-23

EVA analysis tells us how much shareholder wealth is being

created

EVA analysis tells us how much shareholder wealth is being

created

Economic Value Added (EVA) As A Performance Measure

Economicvalueadded

Investmentcenter’s after-tax operating

profit

Investmentcenter’s

total assets

Investmentcenter’s current

liabilities

Weighted-averagecost ofcapital

= -- X( )[ ]Outback outfitter:

Interest rate on $400 million debt = 9%Tax rate = 30%; after-tax cost of debt =6.3% [9%x (1-30%)

Cost of equity capital = 12%Market value of equity = $600 million. What is the AWCC and EVA?

Outback outfitter:Interest rate on $400 million debt = 9%

Tax rate = 30%; after-tax cost of debt =6.3% [9%x (1-30%)Cost of equity capital = 12%

Market value of equity = $600 million. What is the AWCC and EVA?

18-24

Weightedaveragecost of capital Market

valueof debt

Market value ofequity

+

After-taxcost of

debtcapital

Market value

of debt

Cost ofequitycapital

Market value ofequity

+

=

.0972

.063 $400,000,000 .12 $600,000,000+

=

$400,000,000 $600,000,000+

Weighted Average Cost Of Capital

18-25

Division Current LiabilitiesMail-Order $6,000,000Koala Camp Gear 5,000,000Retail 9,000,000

Outback Outfittershas $20 million incurrent liabilities

Outback Outfittershas $20 million incurrent liabilities

Economic Value Added For Outback

Economicvalueadded

Investmentcenter’s after-tax operating

profit

Investmentcenter’s

total assets

Investmentcenter’s current

liabilities

Weighted-averagecost ofcapital

= -- X( )[ ]Mail-order $14 X (1 - .30) - [($ 70 - $6) X .0972] = $3,579,200Koala Camp Gear $45 X (1 - .30) - [($300 - $5) X .0972] = $2,826,000Retail $48 X (1 - .30) - [($480 - $9) X .0972] =$(12,181,200)

In millions

Mail-order $14 X (1 - .30) - [($ 70 - $6) X .0972] = $3,579,200Koala Camp Gear $45 X (1 - .30) - [($300 - $5) X .0972] = $2,826,000Retail $48 X (1 - .30) - [($480 - $9) X .0972] =$(12,181,200)

In millions

18-26

Advantages of net book value; disadvantages

of gross book value

Advantages of net book value; disadvantages

of gross book value

Advantages of gross book value; disadvantages

of net book value

Advantages of gross book value; disadvantages

of net book value

Net Book Value Versus Gross Book Value

The usual methods of computing depreciation are arbitrary and should not be allowed to affect ROI, residual income, or EVA calculations

When long lived assets are depreciated, their net book value declines over time resulting in a misleading increase in ROI, residual income, and EVA across time

The usual methods of computing depreciation are arbitrary and should not be allowed to affect ROI, residual income, or EVA calculations

When long lived assets are depreciated, their net book value declines over time resulting in a misleading increase in ROI, residual income, and EVA across time

Using net book value maintains consistency with the balance sheet prepared for external reporting purposes

Using net book value to measure invested capital is also more consistent with the definition of income, which is the numerator in ROI calculations

Using net book value maintains consistency with the balance sheet prepared for external reporting purposes

Using net book value to measure invested capital is also more consistent with the definition of income, which is the numerator in ROI calculations

18-27

ROIResidual Income

EVA

ROIResidual Income

EVA

Ignore: defective product, quality,

Customer satisfaction, and others

Ignore: defective product, quality,

Customer satisfaction, and others

Non-financial measure:Non-financial measure:

The Balanced Scorecard

The Balanced Scorecard

Alternatives To ROI, Residual Income And EVA

18-28

Business and productionprocess perspective

Learning and growthperspective

Financial perspective

Customer perspective

How should we sustainour ability to change

and improve

How should we appear toour shareholders?

At what businesspractices must we excel?

How should we appear toour customers?

Visionand

strategy

Four Basic Balanced Scorecard Perspectives

Exh.20-3

18-29

What is Balance Scorecard

What is a Balanced Scorecard?

Balanced Scorecard is a measurement tool:

It allows the organization to assess progress in implementing strategy

It allows the organization to benchmark its progress against great practices outside and

inside the organization, and over time

It provides a diagnostic framework for tracking relationships and impact among strategies BSC is a measurement tool

18-30

Balance Scorecard

Balanced Scorecard is a communication tool:

It allows an organization to articulate its chain of value creation within the organization and to the world at large

It provides a platform for planning and communication of planning BSC is a communication tool

18-31

Organizational Learning & Growth

Employee capabilitiesKnowledge & skills that are indicators of the

organization’s ability to meet future customer needs & generate new sales.

Employee capabilitiesKnowledge & skills that are indicators of the

organization’s ability to meet future customer needs & generate new sales.

Areas of Performance Employee training and education

Employee satisfaction Employee turnover

Innovativeness Opportunities for improvement

Areas of Performance Employee training and education

Employee satisfaction Employee turnover

Innovativeness Opportunities for improvement

18-32

Business & Production Process Efficiency

Logically, a cause-and-effect relationship exists between Logically, a cause-and-effect relationship exists between improvements in organizational learning and growth improvements in organizational learning and growth

and improvements in internal business and and improvements in internal business and production processes.production processes.

Logically, a cause-and-effect relationship exists between Logically, a cause-and-effect relationship exists between improvements in organizational learning and growth improvements in organizational learning and growth

and improvements in internal business and and improvements in internal business and production processes.production processes.

Areas of Performance New service development.

Employee productivity and error rates. Service costs.

Process improvements. Supplier relations.

Areas of Performance New service development.

Employee productivity and error rates. Service costs.

Process improvements. Supplier relations.

18-33

Customer Value

Customer ValueCustomer Value reflects the degree to which products reflects the degree to which products and services satisfy customers’ expectations about and services satisfy customers’ expectations about

price, function, and quality.price, function, and quality.

Customer ValueCustomer Value reflects the degree to which products reflects the degree to which products and services satisfy customers’ expectations about and services satisfy customers’ expectations about

price, function, and quality.price, function, and quality.

Areas of Performance Customer satisfaction.

Customer retention and loyalty. Sales growth. Market share.

Customer risk.

Areas of Performance Customer satisfaction.

Customer retention and loyalty. Sales growth. Market share.

Customer risk.

18-34

Financial Performance

The relations among the other three areas of the The relations among the other three areas of the Balanced Scorecard logically result in Balanced Scorecard logically result in

financial outcomes.financial outcomes.

The relations among the other three areas of the The relations among the other three areas of the Balanced Scorecard logically result in Balanced Scorecard logically result in

financial outcomes.financial outcomes.

Areas of Performance Net interest growth.

Revenue growth. Customer profitability.

Overall return on assets.

Areas of Performance Net interest growth.

Revenue growth. Customer profitability.

Overall return on assets.

18-35

Costs of the Balanced Scorecard

Costs:•Measurement

costs•Education

costs•Use costs

18-36

End of Week 11

I always balance my scorecards before

anyone else sees them!

At least my division did well. I wonder how the whole

company did?

Documents

Responsibitlity Centre,RI,ROI,EVA,Balance Score Card