Financial and Managerial Accounting

Business

Quiz 25 :

Rewarding Business Performance

Quiz 25 :

Rewarding Business Performance

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EVA img To obtain a better understanding of economic value added, visit the Web site that outlines the EVA philosophy of Stern Stewart Company at: www.valuebasedmanagement.net/methods eva.html In the center of the page find information about usage of the EVA method. List at least four uses of EVA in a company and explain each one.
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Managers can do a better job of asset management and EVA can be used to hold management accountable for all economic outlays whether they appear in the income statement, on the balance sheet or in the footnotes to the financial statements. This is possible because EVA creates one financial statement that includes all the costs of being in business, while making managers aware of every dollar they spend.
Another benefit of using EVA is that it creates a common language for making decisions, especially long-term decisions. Examples are: resolving budgeting issues and evaluating the performance of organizational units and managers. EVA quantification of results in financial terms also helps to energize other management programs such as TQM, quick response and customer development by demanding and getting continuous financial improvement.
Managers and employees adopt a long-term focus and begin to think more like owners as they start to feel responsible for and take part in the economic value of the firm.

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What activities would make up the learning and growth component of the balanced scorecard for a large public accounting firm?
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Public accountants are required to undertake continuing professional education to maintain their certification. In addition, business practice changes typically lead to either new accounting standards or changes in existing standards. Public accountants must be knowledgeable about these changes. Large public accounting firms run their own training programs to keep their employees both knowledgeable and their certifications current. Thus, the activities in the learning
and growth component would include the number of training hours offered and attended for employees and the number of continuing professional education hours earned each year.

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The Triple Creek Golf Complex is a three-course complex where each course has its own restaurant and pro shop. Thus the complex is organized into three departments that are treated as investment centers. Budget information for the coming year for these three departments is shown below. The managers of each of the departments are evaluated and bonuses are awarded each year based on ROI. img Instructions a. Compute the ROI for each department, Use the DuPont method to analyze the return on sales and capital turnover. b. Assume the Pro Shops are considering installing new display eases. Upon investigating, the manager of the division finds that the cases would cost $60,000 and that sales revenue would increase by $10,000 per year as a result of the new cases. What is the ROI of the new cases? What impact does the investment in the display cases have on the Pro Shops' ROI? Would the manager of die Pro Shops be motivated to undertake such an investment? c. Compute the residual income for each department if the minimum required return for the Triple Creek Golf Complex is 18 percent. What would be the impact of the investment in b on the Pro Shops residual income?
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a.
img The following Formulae have been used :
ROI = Operating Earnings ÷ Average Investment
ROS = Operating Earnings ÷ sales Revenue
CT = Average Investment ÷ sales Revenue
b. ROI of the display cases = $10,000 ÷ $60,000 = 16.7%. Impact of the cases on the Pro Shops Department's ROI is:
($200,000 + $10,000) ÷ ($1,200,000 + $60,000) = 16.7%
The manager of the Pro Shops would be neutral to undertake the investment because it maintains the department's ROI.
c. Residual income for the departments are:
Golf Courses = $4,000,000 - ($10,000,000 x.18) = $2,200,000.
Restaurants = $1,400,000 - ($6,000,000 x.18) = $320,000.
Pro Shops = $200,000 - ($1,200,000 x.18) = -$16,000.
If the Pro Shops Depatment buys the equipment, its residual income will decline further and become more negative = $10,000 - ($60,000 x.18) = -$800.

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The Empire Hotel is a full-service hotel in a large city. Empire is organized into three departments that are treated as investment centers. Budget information for the coming year for these three departments is shown below. The managers of each of the departments are evaluated and bonuses are awarded each year based on ROI. img Instructions a. Compute the ROI for each department. Use the DuPont method to analyze the return on sales and capital turnover. b. Assume the Health Club-Spa is considering installing new exercise equipment. Upon investigating, the manager of the division finds that the equipment would cost $50,000 and that operating earnings would increase by $8,000 per year as a result of the new equipment. What is the ROI of the investment in the new exercise equipment? What impact does the investment in the exercise equipment have on the Health Club-Spa's ROI? Would the manager of the Health Club-Spa be motivated to undertake such an investment? c. Compute the residual income for each department if the minimum required return for the Empire Hotel is 17 percent. What would be the impact of the investment in ( b ) on the Health Club-Spa's residual income?
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Balanced Scorecard Ricoh Company Ltd. , a leading supplier of office automation equipment and electronics, has implemented a balanced scorecard. Match each of the performance indicators from their scorecard below to the four balanced scorecard perspectives (Financial, Customer, Internal Processes, and Learning and Growth). a. Number of Customer Relationships Managed. b. Hours of Employee Training. c. Customer Service Quality Ratings. d. Revenue Growth. e. Customer's Total Cost of Ownership. f. Asset Utilization. g. Employee's Competitor Knowledge Increased. h. Pounds of Recycled Waste Products.
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Suppose you are interested in opening a new restaurant in your area. What specific activities would you identify as goals for your restaurant?
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Identify three ways that accounting systems help align the goals of employees and the goals of the organization.
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Evaluate Business Performance Using ROI Zylex Corporation has multiple factories across the United States. The upper management at Zylex evaluates each factory based on the capital turnover ratio from the DuPont system. Below is information for the factory in Pennsylvania for the past year. img Compute the capital turnover ratio using (1) total assets and (2) assets net of depreciation. Which investment base will the Pennsylvania factory manager prefer and why?
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Utease Corporation Utease Corporation has many production plants across the midwestern United States. A newly opened plant, the Bellingham plant, produces and sells one product. The plant is treated, for responsibility accounting purposes, as a profit center. The unit standard costs for a production unit, with overhead applied based on direct labor hours, are as follows: img Assume this is the first year of operations for the Bellingham plant. During the year, the company had the following activity: img In addition, all over- or underapplied overhead and all product cost variances are adjusted to cost of goods sold. Instructions a. Prepare a production budget for the coming year based on the available standards, expected sales, and desired ending inventories. b. Prepare a budgeted responsibility income statement for the Bellingham plant for the coming year. c. Find the direct labor variances. Indicate if they are favorable or unfavorable and why they would be considered as such. d. Find the direct materials variances (materials price variance and quantity variance). e. Find the total over- or underapplied (both fixed and variable) overhead. Would cost of goods sold be a larger or smaller expense item after the adjustment for over- or underapplied overhead? f. Calculate the actual plant operating profit for the year. g. Use a flexible budget to explain the difference between the budgeted operating profit and the actual operating profit for the Bellingham plant for its first year of operations. What part of the difference do you believe is the plant manager's responsibility? h. Assume Utease Corporation is planning to change its evaluation of business operations in all plants from the profit center format to the investment center format. If the average invested capital at the Bellingham plant is $8,050,000, compute the return on investment (ROI) for the first year of operations. Use the DuPont method of evaluation to compute the return on sales (ROS) and capital turnover (CT) for the plant. i. Assume that under the investment center evaluation plan the plant manager will be awarded a bonus based on ROI. If the manager has the opportunity in the coming year to invest in new equipment for $600,000 that will generate incremental earnings of $108,000 per year, would the manager undertake the project? Why or why not? What other evaluation tools could Utease use for its plants that might be better? j. The chief financial officer of Utease Corporation wants to include a charge in each investment center's income statement for corporatewide administrative expenses. Should the Bellingham plant manager's annual bonus be based on plant ROI after deducting the corporatewide administrative fee? Why or why not?
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Comparing ROI and Residual Income Use the information in Brief Exercise 25.2 to compute the ROI for the Pennsylvania factory using total assets and assets net of depreciation. Now find residual income if the company expects an 20 percent return on total assets. Is the Pennsylvania factory performing up to management's expectations? Brief Exercises 25.2 Evaluate Business Performance Using ROI Zylex Corporation has multiple factories across the United States. The upper management at Zylex evaluates each factory based on the capital turnover ratio from the DuPont system. Below is information for the factory in Pennsylvania for the past year. img Compute the capital turnover ratio using (1) total assets and (2) assets net of depreciation. Which investment base will the Pennsylvania factory manager prefer and why?
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Wolfe Computer manufactures computers and peripheral equipment. The following data relate to Wolfe's Printer Division for the year just ended: img The Printer Division is evaluated as an investment center. Wolfe expects all of its investment centers to earn a minimum annual return of 10 percent on average invested capital. Division managers receive a bonus equal to 1 percent of their division's residual income. The Printer Division's most popular product is a color printer called the XLC. The division has the capacity to manufacture 30.000 XLCs per year, at a manufacturing cost of $100 per unit. Last year it produced XLCs at full capacity: 25,000 of these printers were sold to independent computer stores for $250 per unit, and the other 5,000 were transferred to Wolfe's Mail-Order Division, which sells them for $300 per unit. Transfers of inventory among units of Wolfe Computer are recorded in the company's accounting records at cost. As Wolfe's new controller, you are attending a planning meeting of division managers. Kay Green, manager of the Mail-Order Division, has asked for 15,000 XLCs in the coming year. She states. "Net income will increase if the Mail-Order Division sells more XLCs. After all. we get the highest sales price." David Lee. manager of the Printer Division, replies. "Sorry Kay. we can't do that. Just look at last year-if we'd supplied you with 15.000 XLCs. we wouldn't have made minimum ROL" Instructions a. Compute the Printer Division's ROI and residual income based on last year's data. b. Evaluate the statements made by Green and Lee. (Show how supplying 15.000 XLCs to Mail- Order would have affected the Printer Division's ROI for last year.) c. Offer suggestions to resolve this situation. Show how your suggestions would have affected the Printer Division's results last year if they had been in effect then. d. Do you think that your comments in part c might raise an ethical dilemma to be resolved by Wolfe's top management? If so,explain the nature of this potential problem and your personal recommendations about how to resolve it. (Hint: Expect to hear from Lee before the day is over.)
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Employee Motivation Assume that a recent survey revealed that sixty percent of Taylor Company employees surf the Internet and play online video games while at work. What performance evaluation incentives might encourage or discourage these behaviors?
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The manager of Watson Cosmetics's Perfume Division is evaluated on her division's return on investment and residual income. The company requires that all divisions generate a minimum return on invested assets of 8 percent. Consistent failure to achieve this minimum target is grounds for the dismissal of a division manager. The annual bonus paid to division managers is 1 percent of residual income in excess of $100,000. The Perfume Division's operating margin for the year was $9 million, during which time its average invested capital was $60 million. Instructions a. Compute the Perfume Division's return on investment and residual income. b. Will the manager of the Perfume Division receive a bonus for her performance? If so, how much will it be? c. In reporting her investment center's performance for the past 10 years, the manager of the Perfume Division accounted for the depreciation of her division's assets by using an accelerated depreciation method allowed for tax purposes. As a result, virtually all of the assets under her control are fully depreciated. Given that the company's other division managers use straightline depreciation, is her use of an accelerated method ethical? Defend your answer.
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Consider the Triple Creek Golf Complex discussed in Problem 25. 1B. The manager of the Restaurants Department complains that sales and resulting earnings for the restaurants are not higher due to the poor reputation of the Pro Shops. Because the Pro Shops' staff is apparently rude and uninviting and because the Pro Shops seem shabby and are not tidy, the overall reputation of the total complex is slipping. The manager of the Pro Shops Department counters that, to keep operating expenses under control and improve ROI. staff wages have been cut. The manager of the Restaurant Department has requested that other evaluation techniques such as residual income or a balanced scorecard approach be considered in an effort to resolve this problem, Instructions Consider which balanced scorecard measures might be useful to the Triple Creek Golf Complex in evaluating the Pro Shops Department. In doing so, identify: a. The organizational goal that the measure is designed to support. b. The employee resources and efforts that will be affected by the measurement. c. How the employees should receive feedback and be rewarded for progress toward achieving goals.
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Listed below are eight terms introduced or emphasized in this chapter: img Each of the following statements may (or may not) describe one of these terms. For each statement, indicate the term described, or answer "none" if the statement does not correctly describe any of these terms. a. Tells managers the incremental operating earnings for each additional sales dollar. b. The focus of this business performance measurement is the sales dollars earned from each invested dollar. c. A tool used by managers and owners of organizations to align managers' goals with those of the organization. d. This method considers all costs borne by the consumer from purchase to disposal of a product. e. A business performance measurement that takes into account the minimum required return on the assets employed. f. Measures for this category of business performance are associated with eliminating nonvalue-added costs from the value chain. g. A method in which a product's selling price is determined by adding a fixed amount to the product's current production cost. h. This performance evaluation method is criticized for motivating managers, in some instances, to ignore investments that are in the best interest of the company as a whole. i. An important aspect of this method is the consideration of the many perspectives of the multiple stakeholders in an organization.
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Marsha's Pet Store employs six employees. Their duties are to sell pets, replenish the stock, keep the pets' cages clean, feed the pets, and maintain good records. Marsha pays a fixed hourly rate and a commission on sales of pets. Lately Marsha has been finding that the records have not been well maintained and the stock has not been replenished. However, pet sales are good and the pets' cages arc clean. How might Marsha's current reward structure be motivating the employees to pay more attention to the pets than lo their other duties?
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Empire Hotel and Balanced Scorecard Consider the Empire Hotel discussed in Problem 25.1A. The manager of the Restaurants Department complains that sales and resulting earnings for the restaurants are not higher due to the poor reputation of the Hotel Rooms Department. Because the Hotel Rooms Department does not have the best housekeeping staff, the overall reputation of the hotel is slipping. The manager of the Hotel Rooms Department counters that, to keep operating expenses under control and improve ROI, wages for housekeeping have been cut. The manager of the Restaurant Department has requested that other evaluation techniques such as residual income or a balanced scorecard approach be considered in an effort to resolve this problem. Instructions Consider which balanced scorecard measures might be useful to the Empire Hotel in evaluating the Hotel Rooms Department. In doing so, identify: a. The organizational goal that the measure is designed to support. b. The employee resources and efforts that will be affected by the measurement. c. How the employees should receive feedback and be rewarded for progress toward achieving the goals. Problem 25.1A The Empire Hotel is a full-service hotel in a large city. Empire is organized into three departments that are treated as investment centers. Budget information for the coming year for these three departments is shown below. The managers of each of the departments are evaluated and bonuses are awarded each year based on ROI. img Instructions a. Compute the ROI for each department. Use the DuPont method to analyze the return on sales and capital turnover. b. Assume the Health Club-Spa is considering installing new exercise equipment. Upon investigating, the manager of the division finds that the equipment would cost $50,000 and that operating earnings would increase by $8,000 per year as a result of the new equipment. What is the ROI of the investment in the new exercise equipment? What impact does the investment in the exercise equipment have on the Health Club-Spa's ROI? Would the manager of the Health Club-Spa be motivated to undertake such an investment? c. Compute the residual income for each department if the minimum required return for the Empire Hotel is 17 percent. What would be the impact of the investment in ( b ) on the Health Club-Spa's residual income?
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The manager of Wilson's Toy Division is evaluated on her division's return on investment and residual income. The company requires that all divisions generate a minimum return on invested assets of 10 percent. Consistent failure to achieve this minimum target is grounds for the dismissal of a division manager. The annual bonus paid to division managers is 1.5 percent of residual income in excess of $200,000. The Toy Division's operating margin for the year was $10 million, during which time its average invested capital was $75 million. Instructions a. Compute the Toy Division's return on investment and residual income. b. Will the manager of the Toy Division receive a bonus for her performance? If so, how much will it be? c. What are some advantages and disadvantages of using ROI as a performance measurement criterion?
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Expansion of Big Bertha Sub Big Bertha Sub Shops has more than 150 locations in the Midwest with approximately 70 percent owner operated through franchise agreements. Big Bertha evaluates its shop managers based on ROI each year and those managers have the right to make menu-related decisions. Big Bertha is offering its locations the opportunity to add toasted sub sandwiches to their menus. The Indianapolis and Cleveland shops are among the best-managed shops among the Big Bertha locations. Both locations are considering adding toasted sub sandwiches to their menus. Purchase and installation of the necessary equipment to toast subs is $195,000 per sub shop. Additional profit from adding toasted subs to the menu is expected to be $33,600. The current investment bases in the Cleveland and Indianapolis shops are $900,000 and $1,370,000, respectively. Last year, the Cleveland shops' annual revenue and expenses were $880,400 and $739,536, respectively, and the Indianapolis shops' were $1,443,856 and $1,197,344, respectively. Instructions a. Find the ROI for both the Cleveland and Indianapolis location for (1) last year's results, (2) the toasted sub addition to the menu, and (3) assuming similar operating profit results next year but adding in proposed menu change. b. Assume that the cost of capital is 15 percent. Calculate the residual income for both the Cleveland and Indianapolis locations for (1) last year's results, (2) the toasted sub addition to the menu, and (3) assuming similar operating profit results next year but adding in the proposed menu change. c. Assuming the Cleveland and Indianapolis shops are owned by Big Bertha, will the managers choose to expand the menu to include the toasted subs? Explain. Would your answer change if the two shops were independently franchised units with independent owners?
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Assume you have just been hired as the management accountant in charge of providing your firm's managers with product information. What activities might you undertake if you were participating in the design of a balanced scorecard?
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