Chapter title - Islamic University of Gaza

Chapter title - Islamic University of Gaza

Segment Reporting and Decentralization Chapter Twelve McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-2 Decentralization in Organizations Benefits of Decentralization Top Top management management freed freed to to concentrate concentrate on on strategy. strategy. Lower-level Lower-level managers managers

gain gain experience experience in in decision-making. decision-making. Decision-making Decision-making authority authority leads leads to to job job satisfaction. satisfaction. Lower-level decisions Lower-level decisions often often based based on on better better information. information. Lower Lower level level managers managers

can can respond respond quickly quickly to to customers. customers. McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-3 Decentralization in Organizations Lower-level Lower-level managers managers may may make make decisions decisions without without seeing seeing the the big big picture. picture.

Lower-level Lower-level managers managers objectives objectives may may not not be be those those of of the the organization. organization. McGraw-Hill/Irwin May May be be aa lack lack of of coordination coordination among among autonomous autonomous managers. managers.

Disadvantages of Decentralization May May be be difficult difficult to to spread spread innovative innovative ideas ideas in in the the organization. organization. Copyright 2008, The McGraw-Hill Companies, Inc. 12-4 Cost, Profit, and Investments Centers Cost Cost Center Center Cost, profit, and investment

centers are all known as responsibility centers. McGraw-Hill/Irwin Profit Profit Center Center Investment Investment Center Center Responsibility Responsibility Center Center Copyright 2008, The McGraw-Hill Companies, Inc. 12-5 Cost Center A segment whose manager has control over costs,

but not over revenues or investment funds. McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-6 Profit Center A segment whose manager has control over both costs and revenues, but no control over investment funds. Revenues Sales Interest Other Costs Mfg. costs Commissions Salaries Other

McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-7 Investment Center Corporate Headquarters A segment whose manager has control over costs, revenues, and investments in operating assets. McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-8 Responsibility Centers Investment Centers O p e r a tio n s V ic e P r e s id e n t S a lty S n a c k s P ro d u c t M a n g e r B o ttlin g P la n t

M anager B e v e ra g e s P ro d u c t M a n a g e r W a re h o u s e M anager S u p e r io r F o o d s C o r p o r a tio n C o rp o ra te H e a d q u a rte rs P r e s id e n t a n d C E O F in a n c e C h ie f F In a n c ia l O ffic e r Legal G e n e ra l C o u n s e l P e rs o n n e l V ic e P r e s id e n t C o n fe c tio n s P ro d u c t M a n a g e r D is tr ib u tio n M anager Cost Centers Superior Foods Corporation provides an example of the various kinds of responsibility centers that exist in an

organization. McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-9 Responsibility Centers S u p e r io r F o o d s C o r p o r a tio n C o rp o ra te H e a d q u a rte rs P r e s id e n t a n d C E O O p e r a tio n s V ic e P r e s id e n t S a lty S n a c k s P ro d u c t M a n g e r B o ttlin g P la n t M anager B e v e ra g e s P ro d u c t M a n a g e r W a re h o u s e M anager F in a n c e C h ie f F In a n c ia l O ffic e r C o n fe c tio n s P ro d u c t M a n a g e r D is tr ib u tio n

M anager Legal G e n e ra l C o u n s e l P e rs o n n e l V ic e P r e s id e n t Profit Centers Superior Foods Corporation provides an example of the various kinds of responsibility centers that exist in an organization. McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-10 Responsibility Centers S u p e r io r F o o d s C o r p o r a tio n C o rp o ra te H e a d q u a rte rs P r e s id e n t a n d C E O O p e r a tio n s V ic e P r e s id e n t S a lty S n a c k s P ro d u c t M a n g e r

B o ttlin g P la n t M anager B e v e ra g e s P ro d u c t M a n a g e r W a re h o u s e M anager F in a n c e C h ie f F In a n c ia l O ffic e r Legal G e n e ra l C o u n s e l P e rs o n n e l V ic e P r e s id e n t C o n fe c tio n s P ro d u c t M a n a g e r D is tr ib u tio n M anager Cost Centers Superior Foods Corporation provides an example of the various kinds of responsibility centers that exist in an organization. McGraw-Hill/Irwin

Copyright 2008, The McGraw-Hill Companies, Inc. Decentralization and Segment Reporting 12-11 An Individual Store A segment is any part or activity of an organization about which a manager seeks cost, revenue, or profit data. A segment can be . . . McGraw-Hill/Irwin Quick Mart A Sales Territory A Service Center Copyright 2008, The McGraw-Hill Companies, Inc. 12-12

Superior Foods: Geographic Regions S u p e r io r F o o d s C o r p o r a tio n $ 5 0 0 , 0 0 0 ,0 0 0 E ast $ 7 5 ,0 0 0 ,0 0 0 O re g o n $ 4 5 ,0 0 0 ,0 0 0 W est $ 3 0 0 ,0 0 0 ,0 0 0 W a s h in g to n $ 5 0 ,0 0 0 ,0 0 0 M id w e s t $ 5 5 ,0 0 0 ,0 0 0 C a lif o r n ia $ 1 2 0 ,0 0 0 ,0 0 0 S o u th $ 7 0 ,0 0 0 ,0 0 0 M o u n t a in S t a t e s $ 8 5 ,0 0 0 ,0 0 0 Superior Foods Corporation could segment its business by geographic regions.

McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-13 Superior Foods: Customer Channel S u p e r io r F o o d s C o r p o r a tio n $ 5 0 0 ,0 0 0 ,0 0 0 C o n v e n ie n c e S to r e s $ 8 0 ,0 0 0 ,0 0 0 S u p e r m a r k e t C h a in A $ 8 5 ,0 0 0 ,0 0 0 S u p e r m a r k e t C h a in s $ 2 8 0 , 0 0 0 ,0 0 0 S u p e r m a r k e t C h a in B $ 6 5 ,0 0 0 ,0 0 0 W h o le s a l e D i s t r ib u t o r s $ 1 0 0 , 0 0 0 ,0 0 0 S u p e r m a r k e t C h a in C $ 9 0 ,0 0 0 ,0 0 0 D r u g s to r e s $ 4 0 ,0 0 0 ,0 0 0

S u p e r m a r k e t C h a in D $ 4 0 ,0 0 0 ,0 0 0 Superior Foods Corporation could segment its business by customer channel. McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-14 Keys to Segmented Income Statements There are two keys to building segmented income statements: A contribution format should be used because it separates fixed from variable costs and it enables the calculation of a contribution margin. Traceable fixed costs should be separated from common fixed costs to enable the calculation of a segment margin. McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-15 Identifying Traceable Fixed Costs

Traceable costs arise because of the existence of a particular segment and would disappear over time if the segment itself disappeared. No computer division means . . . McGraw-Hill/Irwin No computer division manager. Copyright 2008, The McGraw-Hill Companies, Inc. 12-16 Identifying Common Fixed Costs Common costs arise because of the overall operation of the company and would not disappear if any particular segment were eliminated. No computer division but . . . McGraw-Hill/Irwin We still have a company president.

Copyright 2008, The McGraw-Hill Companies, Inc. Traceable Costs Can Become Common Costs 12-17 It is important to realize that the traceable fixed costs of one segment may be a common fixed cost of another segment. For example, the landing fee paid to land an airplane at an airport is traceable to the particular flight, but it is not traceable to first-class, business-class, and economy-class passengers. McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-18 Segment Margin Profits The segment margin, which is computed by subtracting the traceable fixed costs of a segment from its

contribution margin, is the best gauge of the long-run profitability of a segment. McGraw-Hill/Irwin Time Copyright 2008, The McGraw-Hill Companies, Inc. 12-19 Traceable and Common Costs Fixed Costs Traceable McGraw-Hill/Irwin Dont allocate common costs to segments. Common Copyright 2008, The McGraw-Hill Companies, Inc. 12-20

Activity-Based Costing Activity-based costing can help identify how costs shared by more than one segment are traceable to individual segments. Assume that three products, 9-inch, 12-inch, and 18-inch pipe, share 10,000 square feet of warehousing space, which is leased at a price of $4 per square foot. If the 9-inch, 12-inch, and 18-inch pipes occupy 1,000, 4,000, and 5,000 square feet, respectively, then ABC can be used to trace the warehousing costs to the three products as shown. Pipe Products 9-inch 12-inch 18-inch Total Warehouse sq. ft. 1,000 4,000 5,000 10,000 Lease price per sq. ft. $ 4 $ 4 $ 4 $ 4 Total lease cost $ 4,000 $ 16,000 $

20,000 $ 40,000 McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-21 Levels of Segmented Statements Webber, Inc. has two divisions. W e b b e r , In c . C o m p u te r D iv is io n T e le v is io n D iv is io n Lets Lets look look more more closely closely at at the the Television Television Divisions Divisions income income statement. statement.

McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-22 Levels of Segmented Statements Our approach to segment reporting uses the contribution format. Income Statement Contribution Margin Format Television Division Sales $ 300,000 Variable COGS 120,000 Other variable costs 30,000 Total variable costs 150,000 Contribution margin 150,000 Traceable fixed costs 90,000 Division margin $ 60,000 McGraw-Hill/Irwin Cost

Cost of of goods goods sold sold consists consists of of variable variable manufacturing manufacturing costs. costs. Fixed Fixed and and variable variable costs costs are are listed listed in in separate separate sections. sections. Copyright 2008, The McGraw-Hill Companies, Inc.

12-23 Levels of Segmented Statements Our approach to segment reporting uses the contribution format. Income Statement Contribution Margin Format Television Division Sales $ 300,000 Variable COGS 120,000 Other variable costs 30,000 Total variable costs 150,000 Contribution margin 150,000 Traceable fixed costs 90,000 Division margin $ 60,000 McGraw-Hill/Irwin Contribution Contribution margin margin is is computed

computed by by taking taking sales sales minus minus variable variable costs. costs. Segment Segment margin margin is is Televisions Televisions contribution contribution to to profits. profits. Copyright 2008, The McGraw-Hill Companies, Inc. 12-24 Levels of Segmented Statements Sales Variable costs CM

Traceable FC Division margin Common costs Net operating income McGraw-Hill/Irwin Income Statement Company Television $ 500,000 $ 300,000 230,000 150,000 270,000 150,000 170,000 90,000 100,000 $ 60,000 Computer $ 200,000 80,000 120,000 80,000 $ 40,000

Copyright 2008, The McGraw-Hill Companies, Inc. 12-25 Levels of Segmented Statements Sales Variable costs CM Traceable FC Division margin Common costs Net operating income McGraw-Hill/Irwin Income Statement Company Television $ 500,000 $ 300,000 230,000 150,000 270,000 150,000 170,000 90,000 100,000

$ 60,000 25,000 $ 75,000 Computer $ 200,000 80,000 120,000 80,000 $ 40,000 Common Common costs costs should should not not be be allocated allocated to to the the divisions. divisions. These These costs costs would would remain

remain even even ifif one one of of the the divisions divisions were were eliminated. eliminated. Copyright 2008, The McGraw-Hill Companies, Inc. 12-26 Traceable Costs Can Become Common Costs As previously mentioned, fixed costs that are traceable to one segment can become common if the company is divided into smaller segments. Lets see how this works using the Webber, Inc. example! McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc.

12-27 Traceable Costs Can Become Common Costs Webbers Television Division Television Division Regular Big Screen Product Lines McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-28 Traceable Costs Can Become Common Costs Income Statement Television Division Regular Sales $ 200,000

Variable costs 95,000 CM 105,000 Traceable FC 45,000 Product line margin $ 60,000 Common costs Divisional margin Big Screen $ 100,000 55,000 45,000 35,000 $ 10,000 We obtained the following information from the Regular and Big Screen segments. McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-29 Traceable Costs Can Become Common Costs

Income Statement Television Division Regular Sales $ 300,000 $ 200,000 Variable costs 150,000 95,000 CM 150,000 105,000 Traceable FC 80,000 45,000 Product line margin 70,000 $ 60,000 Common costs 10,000 Divisional margin $ 60,000 Big Screen $ 100,000 55,000 45,000 35,000

$ 10,000 Fixed Fixed costs costs directly directly traced traced to to the the Television Television Division Division $80,000 $80,000 ++ $10,000 $10,000 == $90,000 $90,000 McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-30 External Reports The Financial Accounting Standards Board now requires that companies in the United States include segmented financial data in their annual reports. 1.

Companies must report segmented results to shareholders using the same methods that are used for internal segmented reports. 2. Since the contribution approach to segment reporting does not comply with GAAP, it is likely that some managers will choose to construct their segmented financial statements using the absorption approach to comply with GAAP. McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-31 Omission of Costs Costs assigned to a segment should include all costs attributable to that segment from the companys entire value chain. chain Business Functions Making Up The Value Chain

R&D McGraw-Hill/Irwin Product Design Customer Manufacturing Marketing Distribution Service Copyright 2008, The McGraw-Hill Companies, Inc. Inappropriate Methods of Allocating Costs Among Segments 12-32 Failure to trace costs directly Segment 1 McGraw-Hill/Irwin Segment 2 Inappropriate

allocation base Segment 3 Segment 4 Copyright 2008, The McGraw-Hill Companies, Inc. 12-33 Common Costs and Segments Common costs should not be arbitrarily allocated to segments based on the rationale that someone has to cover the common costs for two reasons: 1. This practice may make a profitable business segment appear to be unprofitable. 2. Allocating common fixed costs forces managers to be held accountable for costs they cannot control. Segment 1 McGraw-Hill/Irwin Segment 2

Segment 3 Segment 4 Copyright 2008, The McGraw-Hill Companies, Inc. 12-34 Quick Check Sales Variable costs CM Traceable FC Segment margin Common costs Profit Income Statement Haglund's Lakeshore Bar $ 800,000 $ 100,000 310,000 60,000 490,000

40,000 246,000 26,000 244,000 $ 14,000 200,000 $ 44,000 Restaurant $ 700,000 250,000 450,000 220,000 $ 230,000 Assume that Hoagland's Lakeshore prepared its segmented income statement as shown. McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-35 Quick Check How much of the common fixed cost of $200,000 can be avoided by eliminating the bar? a. None of it. b. Some of it. c. All of it.

McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-36 Quick Check How much of the common fixed cost of $200,000 can be avoided by eliminating the bar? a. None of it. b. Some of it. c. All of it. A common fixed cost cannot be eliminated by dropping one of the segments. McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-37 Quick Check Suppose square feet is used as the basis for allocating the common fixed cost of $200,000. How much would be allocated to the bar if the bar occupies 1,000 square feet and the restaurant

9,000 square feet? a. $20,000 b. $30,000 c. $40,000 d. $50,000 McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-38 Quick Check Suppose square feet is used as the basis for allocating the common fixed cost of $200,000. How much would be allocated to the bar if the bar occupies 1,000 square feet and the restaurant 9,000 square feet? a. $20,000 The bar would be b. $30,000 allocated 1/10 of the cost c. $40,000 or $20,000. d. $50,000 McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc.

12-39 Quick Check If Hoagland's allocates its common costs to the bar and the restaurant, what would be the reported profit of each segment? McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-40 Allocations of Common Costs Sales Variable costs CM Traceable FC Segment margin Common costs Profit Income Statement Haglund's Lakeshore Bar

$ 800,000 $ 100,000 310,000 60,000 490,000 40,000 246,000 26,000 244,000 14,000 200,000 20,000 $ 44,000 $ (6,000) Restaurant $ 700,000 250,000 450,000 220,000 230,000 180,000 $ 50,000 Hurray, now everything adds up!!! McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc.

12-41 Quick Check Should the bar be eliminated? a. Yes b. No McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-42 Quick Check Should the bar be eliminated? a. Yes The profit was $44,000 before b. No eliminating the bar. If we eliminate the bar, profit drops to $30,000! Income Statement Sales Variable costs CM

Traceable FC Segment margin Common costs Profit McGraw-Hill/Irwin Haglund's Lakeshore $ 700,000 250,000 450,000 220,000 230,000 200,000 $ 30,000 Bar Restaurant $ 700,000 250,000 450,000 220,000 230,000 200,000 $ 30,000 Copyright 2008, The McGraw-Hill Companies, Inc. 12-43

Return on Investment (ROI) Formula Income Incomebefore before interest interest and andtaxes taxes(EBIT) (EBIT) Net operating income ROI = Average operating assets Cash, Cash, accounts accountsreceivable, receivable,inventory, inventory, plant plantand andequipment, equipment, and andother other productive productiveassets. assets.

McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-44 Net Book Value vs. Gross Cost Most companies use the net book value of depreciable assets to calculate average operating assets. Acquisition cost Less: Accumulated depreciation Net book value McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-45 Understanding ROI Net operating income ROI = Average operating assets Net operating income Margin = Sales

Sales Turnover = Average operating assets Margin Turnover ROI = McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-46 Increasing ROI There are three ways to increase ROI . . . Increase Sales McGraw-Hill/Irwin Reduce Expenses Reduce Assets Copyright 2008, The McGraw-Hill Companies, Inc. 12-47

Increasing ROI An Example Regal Company reports the following: Net operating income Average operating assets Sales Operating expenses $ 30,000 $ 200,000 $ 500,000 $ 470,000 What is Regal Companys ROI? Margin Turnover ROI = Sales ROI = Net operating income Sales Average operating assets McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-48 Increasing ROI An Example

Margin Turnover ROI = Sales ROI = Net operating income Sales Average operating assets ROI = $30,000 $500,000 $500,000 $200,000 ROI =6% 2.5 = 15% McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-49 Increasing Sales Without an Increase in Operating Assets Regale's manager was able to increase sales to $600,000, while operating expenses increased to $558,000. Regale's net operating income increased to $42,000. There was no change in the average operating assets of the segment. Lets calculate the new ROI.

McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-50 Increasing Sales Without an Increase in Operating Assets Margin Turnover ROI = Sales ROI = Net operating income Sales Average operating assets ROI = $42,000 $600,000 $600,000 $200,000 ROI =7% 3.0 = 21% ROI ROI increased increased from from 15% 15% to to 21%. 21%. McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc.

12-51 Decreasing Operating Expenses with no Change in Sales or Operating Assets Assume that Regale's manager was able to reduce operating expenses by $10,000, without affecting sales or operating assets. This would increase net operating income to $40,000. Regal Company reports the following: Net operating income Average operating assets Sales Operating expenses $ 40,000 $ 200,000 $ 500,000 $ 460,000 Lets calculate the new ROI. McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-52

Decreasing Operating Expenses with no Change in Sales or Operating Assets Margin Turnover ROI = Sales ROI = Net operating income Sales Average operating assets ROI = $40,000 $500,000 $500,000 $200,000 ROI =8% 2.5 = 20% ROI ROI increased increased from from 15% 15% to to 20%. 20%. McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. Decreasing Operating Assets with no Change in Sales or Operating Expenses 12-53

Assume that Regale's manager was able to reduce inventories by $20,000 using just-in-time techniques, without affecting sales or operating expenses. Regal Company reports the following: Net operating income Average operating assets Sales Operating expenses $ 30,000 $ 180,000 $ 500,000 $ 470,000 Lets calculate the new ROI. McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. Decreasing Operating Assets with no Change in Sales or Operating Expenses 12-54 Margin Turnover ROI =

Sales ROI = Net operating income Sales Average operating assets ROI = $30,000 $500,000 $500,000 $180,000 ROI = 6% 2.78 = 16.7% ROI ROI increased increased from from 15% 15% to to 16.7%. 16.7%. McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. Investing in Operating Assets to Increase Sales 12-55 Assume that Regale'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 Average operating assets Sales Operating expenses $ 50,000 $ 230,000 $ 535,000 $ 485,000 Lets calculate the new ROI. McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. Investing in Operating Assets to Increase Sales 12-56 Margin Turnover ROI = Sales ROI = Net operating income Sales Average operating assets

ROI = $50,000 $535,000 $535,000 $230,000 ROI = 9.35% 2.33 = 21.8% ROI ROI increased increased from from 15% 15% to to 21.8%. 21.8%. McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-57 ROI and the Balanced Scorecard It may not be obvious to managers how to increase sales, decrease costs, and decrease investments in a way that is consistent with the companys strategy. A well constructed balanced scorecard can provide managers with a road map that indicates how the company intends to increase ROI. Which internal business process should be improved?

Which customers should be targeted and how will they be attracted and retained at a profit? McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-58 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. McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-59 Residual Income - Another Measure of Performance

Net operating income above some minimum return on operating assets McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-60 Calculating Residual Income Residual = income Net operating income ( Average operating assets ) Minimum

required rate of return This computation differs from ROI. ROI measures net operating income earned relative to the investment in average operating assets. Residual income measures net operating income earned less the minimum required return on average operating assets. McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-61 Residual Income An Example The The Retail Retail Division Division of of Zephyr, Zephyr, Inc. Inc. has has average average operating operating assets assets of

of $100,000 $100,000 and and is is required required to to earn earn aa return return of of 20% 20% on on these these assets. assets. In In the the current current period, period, the the division division earns earns $30,000. $30,000. Lets calculate residual income. McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc.

12-62 Residual Income An Example Operating Operating assets assets Required Required rate rate of of return return Minimum Minimum required required return return $$100,000 100,000 20% 20% $$ 20,000 20,000 Actual Actual income income Minimum

Minimum required requiredreturn return Residual Residual income income McGraw-Hill/Irwin $$ 30,000 30,000 (20,000) (20,000) $$ 10,000 10,000 Copyright 2008, The McGraw-Hill Companies, Inc. 12-63 Motivation and Residual Income Residual income encourages managers to make profitable investments that would be rejected by managers using ROI. McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc.

12-64 Quick Check 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 divisions ROI? a. 25% b. 5% c. 15% d. 20% McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-65 Quick Check 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 divisions ROI? a. 25% b. 5% ROI = NOI/Average operating assets c. 15% = $60,000/$300,000 = 20%

d. 20% McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-66 Quick Check 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 McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-67 Quick Check 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 ROI = $78,000/$400,000 = 19.5% b. No This lowers the divisions ROI from 20.0% down to 19.5%. McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-68 Quick Check The companys 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 McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc.

12-69 Quick Check The companys 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? ROI = $18,000/$100,000 = 18% a. Yes b. No The return on the investment exceeds the minimum required rate of return. McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-70 Quick Check 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 divisions

residual income? a. $240,000 b. $ 45,000 c. $ 15,000 d. $ 51,000 McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-71 Quick Check 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 divisions residual income? a. $240,000 Net operating income $60,000 b. $ 45,000 Required return (15% of $300,000) (45,000) Residual income $15,000 c. $ 15,000 d. $ 51,000 McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc.

12-72 Quick Check 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 McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-73 Quick Check 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 $78,000 b. No Net operating income Required return (15% of $400,000) Residual income

(60,000) $18,000 Yields an increase of $3,000 in the residual income. McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-74 Divisional Comparisons and Residual Income The residual income approach has one major disadvantage. It cannot be used to compare performance of divisions of different sizes. McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-75

Zephyr, Inc. - Continued Recall the following information for the Retail Division of Zephyr, Inc. Assume the following information for the Wholesale Division of Zephyr, Inc. Retail Retail $$ 100,000 100,000 20% 20% $$ 20,000 20,000 Wholesale Wholesale $$ 1,000,000 1,000,000 20% 20% $$ 200,000 200,000 Retail

Retail Actual $$ 30,000 Actual income income 30,000 Minimum (20,000) Minimum required required return return (20,000) Residual $$ 10,000 Residual income income 10,000 Wholesale Wholesale $$ 220,000 220,000 (200,000) (200,000) $$ 20,000 20,000 Operating

Operating assets assets Required Required rate rate of ofreturn return Minimum Minimum required required return return McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc. 12-76 Zephyr, Inc. - Continued The residual income numbers suggest that the Wholesale Division outperformed the Retail Division because its residual income is $10,000 higher. However, the Retail Division earned an ROI of 30% compared to an ROI of 22% for the Wholesale Division. The Wholesale Divisions residual income is larger than the Retail Division simply because it is a bigger division. Retail Retail $$ 100,000 100,000

20% 20% $$ 20,000 20,000 Wholesale Wholesale $$ 1,000,000 1,000,000 20% 20% $$ 200,000 200,000 Retail Retail Actual $$ 30,000 Actual income income 30,000 Minimum (20,000) Minimum required required return return (20,000) Residual $$ 10,000

Residual income income 10,000 Wholesale Wholesale $$ 220,000 220,000 (200,000) (200,000) $$ 20,000 20,000 Operating Operating assets assets Required Required rate rate of ofreturn return Minimum Minimum required required return return McGraw-Hill/Irwin

Copyright 2008, The McGraw-Hill Companies, Inc.

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    Tom Shelton - MO will be the NACS Representative on this taskforce. Will be looking for ways to improve the hiring process… finding sticking points…..and looking for solutions. Working with HR division. Training for state and county hiring managers.
  • American Realism (Regionalism & Naturalism)

    American Realism (Regionalism & Naturalism)

    American Realism (Regionalism & Naturalism)That man up there looks kind of scary; don't he? And don't look now, but how many points are on that pitchfork? And what does that pitchfork mean? It ain't really a pitchfork! 1860-1920. ... It's...
  • Stocks - carlisle.k12.ky.us

    Stocks - carlisle.k12.ky.us

    Stocks. By: Devin Hawthorne, Danny Goode, Morgan Booker, Keaton Marlow, Erica Shambo, and Tommy Roach!!!!! ... Specialists- traders who help to make a market in one or more stocks by taking the position opposite of orders placed by clients.
  • The Martian Meteorite

    The Martian Meteorite

    METEO 466 Planetary Atmospheres December 2011 data release Candidate label Candidate size (RE) Number of candidates Earth-size Rp < 1.25 207 Super-Earths 1.25 < Rp < 2.0 680 Neptune-size 2.0 < Rp < 6.0 1181 Jupiter-size 6.0 < Rp <...
  • The History of Foreign Language Teaching in the U.S.

    The History of Foreign Language Teaching in the U.S.

    What is Communicate Language Teaching? Theory: The primary function of language is communicative. ... "Today we will learn the present progressive to express preferences." ... Have students write during class note taking reinforcement after oral/choral practice Use writing as a...
  • Intro to Musical Theatre - St Pius X School

    Intro to Musical Theatre - St Pius X School

    The Lion King plays in London's Lyceum Theatre in the West End. ... One of the oldest styles of theaters that was originally built outside, this theater is a half circle of seating raised up to look down on the...
  • The Joy Luck Club - Pearland High School

    The Joy Luck Club - Pearland High School

    The Jong Family: WaverlyJong - From her mother, Waverly inherits her "invisible strength"—her ability to conceal her thoughts and strategize. Although she applies these to chess as a child, she later turns them on her mother, Lindo, as well, imagining...
  • Show Video Welcome to Superhero High  I Want

    Show Video Welcome to Superhero High I Want

    My superhero can _____. lift (things) What can your superhero do? My superhero can _____. What can your superhero do? My superhero can _____. stretch Make your Super symbol Make your Superhero symbol Create your own superhero. Drawing or role...