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1、ADVANCED MANAGEMENT ACCOUNTING,Performance Evaluation,Learning Objectives,Compute and explain return on investment (ROI), residual income (RI), and economic value added (EVA) Discuss methods of evaluating and rewarding managerial performance,Measuring the Performance of Investment Centers,Return on
2、Investment (ROI) Residual Income (RI) Economic Value Added (EVA),Return On Investment (ROI),Compute return on investment (ROI) and show how changes in sales, expenses, and assets affect ROI.,10-5,Return on Investment (ROI) Formula,Cash, accounts receivable, inventory, plant and equipment, and other
3、productive assets.,Income before interest and taxes (EBIT),10-6,Net Book Value versus Gross Cost,Most companies use the net book value of depreciable assets to calculate average operating assets.,10-7,Components of ROI,Decomposition of the ROI formula: ROI = Operating income/Average operating assets
4、= (Operating income/Sales) x (Sales/Average operating assets)= Operating income margin x Operating asset turnover,Understanding ROI,10-9,An ROI Example,Year 1: Snack Foods Appliance Division Division Sales $30,000,000 $117,000,000 Operating income 1,800,000 3,510,000 Average operating assets 10,000,
5、000 19,500,000 Year 2: Sales $40,000,000 $117,000,000 Operating income 2,000,000 2,925,000 Average operating assets 10,000,000 19,500,000 Minimum return of 10%,Margin and Turnover Comparisons,Snack Food Appliance Year 1 Year 2 Year 1 Year 2 Margin 6.0% 5.0% 3.0% 2.5% Turnover x 3.0 x 4.0 x 6.0 x 6.0
6、 ROI 18.0% 20.0% 18.0% 15.0% = = = =,Increasing ROI,There are three ways to increase ROI . . .,Increase Sales,Reduce Expenses,Reduce Assets,10-12,Increasing ROI An Example,Regal Company reports the following:Net operating income $ 30,000Average operating assets $ 200,000Sales $ 500,000Operating expe
7、nses $ 470,000,What is Regal Companys ROI?,10-13,Increasing ROI An Example,10-14,Investing in Operating Assets to Increase Sales,Suppose that Regals manager invests in a $30,000 piece of equipment that increases sales by $35,000, while increasing operating expenses by $15,000.,Lets calculate the new
8、 ROI.,Regal Company reports the following:Net operating income $ 50,000 Average operating assets $ 230,000 Sales $ 535,000 Operating expenses $ 485,000,10-15,Investing in Operating Assets to Increase Sales,ROI increased from 15% to 21.8%.,10-16,Advantages of ROI,It encourages managers to pay careful
9、 attention to the relationships among sales, expenses, and investment, as should be the case for a manager of an investment center. It encourages cost efficiency. It discourages excessive investment in operating assets.,Disadvantages of the ROI Measure,It discourages managers from investing in proje
10、cts that would decrease the divisional ROI but would increase the profitability of the company as a whole. (Generally, projects with an ROI less than a divisions current ROI would be rejected.) It can encourage myopic behavior, in that managers may focus on the short run at the expense of the long r
11、un.,Criticisms of ROI,In the absence of the balanced scorecard, management may not know how to increase ROI.,Managers often inherit many committed costs over which they have no control.,Managers evaluated on ROI may reject profitable investment opportunities.,10-19,Residual Income,Compute residual i
12、ncome and understand its strengths and weaknesses.,10-20,Residual Income - Another Measure of Performance,Net operating income above some minimum required return on operating assets,10-21,Residual Income,Residual income is the difference between operating income and the minimum dollar return require
13、d on a companys operating assets:Residual income = Operating income - (Minimum rate of return x Operating assets),Calculating Residual Income,(,),ROI measures net operating income earned relative to the investment in average operating assets. Residual income measures net operating income earned less
14、 the minimum required return on average operating assets.,10-23,Residual Income Example,Project I Project II Investment $10,000,000 $4,000,000 Operating income 1,300,000 640,000 Targeted ROI 10% 10%,Residual Income Example,Project I Residual income = Operating income - (Minimum rate of return x Oper
15、ating assets) Residual income = $1,300,000 - (0.10 x $10,000,000)= $1,300,000 - $1,000,000= $300,000 Project II Residual income = $640,000 - (0.10 x $4,000,000)= $640,000 - $400,000= $240,000,Residual Income An Example,The Retail Division of Zephyr, Inc. has average operating assets of $100,000 and
16、is required to earn a return of 20% on these assets.In the current period, the division earns $30,000.,Lets calculate residual income.,10-26,Residual Income An Example,10-27,Motivation and Residual Income,Residual income encourages managers to make investments that are profitable for the entire company but would be rejected by managers who are evaluated using the ROI formula.,
