Chapter 18

1. Chapter 18 Organizational Design, Responsibility Accounting, and Evaluation of Divisional Performance

2. Decentralized Organizations And Responsibility Accounting Most organizations are divided into smaller units, divisions, segments, business units, work centers, or departments Goal Congruence, between units, occurs when the managers of subunits throughout the organization have incentives to perform in the common interest of the organization She seems like a team player, but I’m not sure. BEHAVIORAL CONGRUENCE Performance evaluation and incentive systems are designed to encourage employees to behave as if their goals are congruent with organizational goals

3. Decentralized Organizations And Responsibility Accounting Responsibility Accounting Various concepts and tools used to measure the performance of people and the departments in order to foster goal or behavioral congruence Goal Congruence Behavioral Congruence

4. Centralization Vs. Decentralization Centralized Organizations Decentralized Organizations Decisions are handed down from the top echelon of management and subordinates carry them out Decisions are made at divisional and departmental levels

5. 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 (suboptimal decision making) Narrow Focus = Tendency to ignore the consequences of actions on other units Some tasks or services may be duplicated unnecessarily Benefits And Costs Of A Decentralized Organization Costs ?

6. Cost Center Investment Center Profit Center Discretionary Cost Center Revenue Center Responsibility Accounting A RESPONSIBILITY CENTER is a subunit in an organization whose manager is held accountable for specified financial and nonfinancial results of the subunit’s activities RESPONSIBILITY CENTERS

7. Responsibility Accounting • well-defined input-output relationships • the manager is responsible for the cost of activities Cost Center • input-output relationships are not well specified • the manager is responsible for the cost of activities Discretionary Cost Center • the manager is responsible for the revenue of the • subunit Revenue Center Profit Center • the manager is responsible for the subunit’s profit • the manager is responsible for the profit and the • invested capital used to generate the profit Investment Center

8. Responsibility Accounting

9. Performance Report A performance report shows the budgeted and actual amounts of key financial results appropriate for the type of responsibility involved. BUDGETED amounts of key financial results ACTUAL amounts of key financial results VARIANCE

10. Activity-Based ResponsibilityAccounting ABC Traditional Responsibility Accounting Systems Focus on the financial performance measures of cost, revenues, and profit for the subunits of the organization Activity-based responsibility systems focus not only on the cost of performing activities but on the activities themselves

11. Return on investment (ROI) = Income Invested capital Return On Investment As A Performance Measure

12. Return on investment Income Invested Capital Income Sales revenue Sales revenue Invested capital = = X Factors Underlying ROI Sales Margin Measures the percentage of each sales dollar that remains as profit after all expenses are covered Capital Turnover Focuses on the number of sales dollars generated by each dollar of invested capital

13. Return on investment Income Invested Capital Income Sales revenue Sales revenue Invested capital = = X Sales Margin Capital Turnover X Factors Underlying ROI Focuses on the number of sales dollars generated by each dollar of invested capital Measures the percentage of each sales dollar that remains as profit after all expenses are covered X X X

14. Retail division’s ROI Sales margin Capital turnover = X 10% 5% 2 Improving A Division’s ROI Current retail division ROI

15. Retail division’s ROI Sales margin Capital turnover = X 10% 5% 2 7% Improving A Division’s ROI Current retail division ROI Improved retail division ROI 14% 7% 2 One way to increase the ROI is to increase the SALES MARGIN. For example we can increase the sales price, or cut expenses.

16. Retail division’s ROI Sales margin Capital turnover = X 10% 5% 2 3 Improving A Division’s ROI Current retail division ROI Improved retail division ROI 15% 5% 3 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.

17. Residual Income As A Performance Measure Residual Income=Profit- (Invested Capital x Imputed Interest Rate) Investment in new equipment raises residual income by $500,000

18. Advantages of RI Goal Congruence It includesan important piece of data: the firm’s minimum required rate of return. Return On Investment V.S. Residual Income Disadvantages of RI • Distort comparisons between investment centers between different sizes.

19. Economic Value Added (EVA) As A Performance Measure EVA analysis tells us how much shareholder wealth is being created EVA EVA = After-tax income profit - [ (TA-CL) x W-A Cost of Capital ]

20. After-tax cost of debt capital Market value of debt Cost of equity capital Market value of equity + Weighted average cost of capital Market value of debt Market value of equity = + .063 $400,000,000 .12 $600,000,000 + .0972 = $400,000,000 $600,000,000 + Weighted Average Cost Of Capital

21. Economic value added Investment center’s after- tax operating profit Investment center’s total assets Investment center’s current liabilities Weighted- average cost of capital = - - X Economic Value Added For Outback Outback Outfitters has $20 million in current liabilities

22. What Is The Division’s Invested Capital? Appropriate if the division manager has considerable authority in making decisions about all of the division’s assets, including nonproductive assets Total assets Appropriate if the division manager has been directed by top level management to keep nonproductive assets in progress, making it appropriate to exclude nonproductive assets from the measure of invested capital Total productive assets Total assets less current liabilities Appropriate if the division manager has authority to secure short-term bank loans and other short-term credit

23. 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 Net Book Value Versus Gross Book Value Advantages of net book value; disadvantages of gross book value Advantages of gross book value; disadvantages of net book value

24. Example-18.27 • R Company manufactures clothing in Buenos Aires, Argentina. The company’s outer wear division is considering the acquisition of a new asset that will cost 360,000 and have a cash flow of 140,000 per year for each of the five years of its life. Depreciation is computed on a straight-line method with no salvage value. Required: • What is the ROI for each year of the asset’s life if the division uses beginning-of-year asset balances and net book value for the computation? • What is the residual income each year if the imputed interest rate is 25%?

25. Example- 18.33 • ABC Corporation, has two sources of long-term capital: debt and equity. ABC’s cost of issuing debt is the after-tax cost of the interest payment on the debt, considering the fact that interest payments are tax deductible. ABC’s cost of equity capital is the investment opportunity rate of ABC’s investors, that is, the rate they could earn on investment of similar risk to that of investing in ABC. The interest rate on ABC’s $60 million of long-term debt is 10 percent, and the company’s tax rate is 40 percent. ABC’s cost of equity capital is 15 percent. Moreover, its market value (and book value) of equity is $90 million. Required: Calculate ABC’s weighted-average cost of capital.

26. Conclusion • 在 ROI 法下，若管理人員減少其流動或固定資產之投資，即可提升 ROI 。 • 剩餘利益法可促使管理人員追求絕對數額(剩餘利益金額)最大化，而非盡量提高某一百分比 (ROI) ，只要某方案所賺得之報酬率超過投資之必要報酬率 (而非現有ROI)，該方案即應被採行。 • EVA 之下，當稅後利益超過投資資金之成本時，才會創造出股東價值。為改善 EVA，管理人員應在相同或較少資本下賺取更高之營業利益，或投資其資本於更高報酬率之計畫。 • ROI 衡量產生決策次佳化的問題，可藉由EVA 及RI 克服；另外，許多管理人員喜歡使用 EVA，因其考慮了稅的影響。