Chapter 11 - Performance Measurement in Decentralized Organizations Flashcards
What 3 centers are known as responsibility centers?
- Cost Centers
- Profit Centers
- Investment Centers
What do cost center managers have control over?
Costs
What do profit center managers have control over?
Costs and Revenues
What do investment center managers have control over?
Costs, Revenues, and Investments in operating assets
What are the 2 formulas to find the return on investment?
- Net operating income / Average operating assets
2. Margin x Turnover
List 4 average operating assets
- Cash
- Accounts receivable
- Inventory
- Plant and equipment
What is the formula to find the margin?
Net operating income / Sales
What is the formula to find the turnover?
Sales / Average operating assets
What is the formula to find net operating income?
Sales - Operating expenses
Regal Company reports the following: Net operating income = $30,000 Average operating assets = $200,000 Sales = $500,000 Operating expenses = $470,000
What is the Regal Company’s ROI?
ROI = (NOI / AOA) x 100 ROI = (30,000 / 200,000) x 100 ROI = 15%
Assume that Regal’s manager invests in a $30,000 piece of equipment that increases sales by $35,000, while increasing operating expenses by $15,000.
Regal Company reports the following: Net operating income = $50,000 Average operating assets = $230,000 Sales = $535,000 Operating expenses = $485,000
What is the Regal Company’s ROI?
ROI = (NOI / AOA) x 100 ROI = (50,000 / 230,000) x 100 ROI = 21.8%
What measures net operating income above some minimum return on operating assets?
The residual income
What is the formula to find the residual income?
NOI - (Average operating assets x Min. required rate of return)
The Retail Division of Zephyr, Inc. has average operating assets of $100,000 and is required to earn a return of 20% on these assets.
In the current period, the division earns $30,000.
Calculate the residual income
RI = NOI - (AOA X Min. req RoR) RI = 30,000 - (100,000 x 20%) RI = 30,000 - 20,000 RI = $10,000
What encourages managers to make profitable investments that would be rejected by managers using ROI?
Residual income
Redmond Awnings, a division of Wrap-up Corp., has a net operating income of $60,000 and average operating assets of $300,000. The required rate of return for the company is 15%. What is the division’s ROI?
A. 25%
B. 5%
C. 15%
D. 20%
D. 20%
ROI = (NOI / AOA) x 100 ROI = (60,000 / 300,000) x 100 ROI = 20%
Redmond Awnings, a division of Wrap-up Corp., has a net operating income of $60,000 and average operating assets of $300,000. If the manager of the division is evaluated based on ROI, will she want to make an investment of $100,000 that would generate additional net operating income of $18,000 per year?
A. Yes
B. No
B. No
ROI = (NOI / AOA) x 100 ROI = (60,000 / 300,000) x 100 ROI = 20%
ROI = (NOI / AOA) x 100 ROI = (78,000 / 400,000) x 100 ROI = 19.5%
19.5% < 20%
No
The company’s required rate of return is 15%. Would the company want the manager of the Redmond Awnings division to make an investment of $100,000 that would generate additional net operating income of $18,000 per year?
A. Yes
B. No
ROI = (NOI / AOA) x 100 ROI = (18,000 / 100,000) x 100 ROI = 18%
18% > 15% (Req. RoR)
Yes
Redmond Awnings, a division of Wrap-up Corp., has a net operating income of $60,000 and average operating assets of $300,000. The required rate of return for the company is 15%. What is the division’s residual income?
A. $240,000
B. $45,000
C. $15,000
D. $51,000
C. $15,000
RI = NOI - (OAO x Min. Req. RoR) RI = 60,000 - (300,000 x 15%) RI = 60,000 - 45,000 RI = 15,000
Will an increase in net operating income increase or decrease residual income?
Increase
Redmond Awnings has a net operating income of $60,000 and average operating assets of $300,000. The required rate of return for the company is 15%. If the manager of the Redmond Awnings division is evaluated based on residual income, will she want to make an investment of $100,000 that would generate additional net operating income of $18,000 per year?
A. Yes
B. No
A. Yes
RI = NOI - (OAO x Min. Req. RoR) RI = 60,000 - (300,000 x 15%) RI = 60,000 - 45,000 RI = 15,000
RI = NOI - (OAO x Min. Req. RoR) RI = 78,000 - (400,000 x 15%) RI = 78,000 - 60,000 RI = 18,000
18,000 > 15,000
Yes
What is the major disadvantage of the residual income approach?
It cannot be used to compare the performance of divisions of different sizes
Why can’t the residual income approach be used to compare the performance of divisions of different sizes?
It says that the larger division has the larger residual income
What are 2 ways that are used to evaluate performance?
- Return on Investment (ROI)
2. Residual Income
What links decision-making authority with accountability?
Responsibility Accounting
Is a larger or smaller residual income an indication of better management?
A smaller residual income
Is margin a percentage?
Yes
Is asset turnover a percentage?
No
List the 2 formulas used to find average operating assets
- Net operating income / Return on investments
2. (Beg total assets + End total assets) / 2
What is the amount that we exceed the minimum required return?
Residual income
Is residual income a percentage?
Yes
List 5 advantages of decentralization in organizations
- Lower-level decisions are based on better information
- Lower-level managers gain experience in decision-making
- Top management is freed to concentrate on strategy
- Lower-level managers can respond quickly to customers
- Job satisfaction
List 3 disadvantages of decentralization in organizations
- Lack of coordination
- Lower-level manager’s objectives may not “line up” with business objectives
- Lower-level managers may make decisions without seeing the “big picture”
What are the 3 criticisms of return on investments?
- In the absence of the balanced scorecard, management may not know how to increase ROI
- Managers often inherit many committed costs that they have no control over
- Managers evaluated on ROI may reject profitable investment opportunities
