question

ROI formula

answer

(NOPAT / sales) x (sales / invested capital) = ROS x turnover

question

What are the benefits of ROI?

answer

Comprehensive measure (includes both the I/S and B/S); easy to calculate; easy to understand (25% high); data available for competitors

question

How is ROI improved?

answer

There are two ways: increase return on sales by reducing expenses, or increase capital turnover by decreasing investment.

question

EVA formula

answer

adjusted NOPAT - cc% x avg. adjusted capital

question

What's the purpose of the adjustments in EVA?

answer

The purpose of the adjusted NOPAT and the adjusted capital is to move EVA closer to a cash-based measure instead of an accrual-based (GAAP) measure.

question

What are some common adjustments to NOPAT and Capital for EVA?

answer

use taxes paid rather than tax expense; capitalize research and development expenses; use FIFO for inventory valuation (thus companies using LIFO must add back the LIFO reserve to invested capital and add the increase or deduct the decrease in the LIFO reserve to after-tax operating income; if a company deducts any interest expense in computing operating income, it must add this (after-tax) interest expense to its after-tax operating income

question

What are the benefits of EVA?

answer

comprehensive measure (information from both the I/S and B/S); when cc%<ROIi<ROIc, dysfunctional behavior is possible when ROI is used, but EVA solves this problem; consistent with DCF models; studies indicate higher association with stock price

question

What are the components of an EVA bonus system?

answer

Pay for increasing EVA; no thresholds or caps; a target bonus; a bonus bank; performance targets set by formula instead of negotiations

question

__ is called decentralization.

answer

The delegation of freedom to make decisions

question

__ is called centralization.

answer

The process by which decision making is concentrated within a particular location or group

question

What are the benefits of decentralization?

answer

Lower-level managers have the best information concerning local conditions; it promotes management skills which, in turn, helps ensure leadership continuity; managers enjoy higher status from being independent and thus are better motivated

question

What are the costs of decentralization?

answer

Managers may make decisions that are not in the organization's best interests; managers also tend to duplicate services that might be less expensive if centralized; costs of accumulating and processing information frequently rise

question

Managers in decentralized units may __

answer

waste time negotiating with other units about goods or services one unit provides to the other.

question

Many companies find that __

answer

decentralization works best in part of the company, while centralization works better in other parts.

question

Decentralization is most successful when __

answer

an organization's segments are relatively independent of one another.

question

If management has decided in favor of heavy decentralization, __

answer

segment autonomy, the delegation of decision-making power to managers of segments of an organization, is also crucial.

question

Design of a management control system should __

answer

consider two separate dimensions of control: responsibilities and autonomy.

question

Profit centers and decentralization are __

answer

two entirely separate concepts and one can exist without the other.

question

The management control system should be designed to achieve __

answer

the best possible alignment between local manager decisions and the actions central management seeks.

question

Agency theory __

answer

deals with contracting between an organization and the managers that it hires to make decisions on its behalf.

question

What are the 3 factors of the agency theory?

answer

incentive, risk, cost of measuring performance

question

RI

answer

Residual income - after-tax net operating income less a capital charge.

question

capital charge

answer

The cost of capital multiplied by the amount of the investment.

question

RI tells you __

answer

how much a company's after-tax operating income exceeds what it is paying for capital.

question

What's the message of ROI and of EVA?

answer

The message of ROI is to go forth and maximize your rate of return, a percentage; the EVA message is to go forth and maximize economic profit, an absolute dollar amount.

question

Should values be based on historical cost or some version of current value?

answer

Practice is overwhelmingly in favor of using net book value based on historical cost. Also, most companies use net book value in calculating their investment base.

question

transfer prices

answer

The price that one segment charges another segment of the same organization for a product or service is a transfer price.

question

The transfer price is __

answer

revenue to the producing company and cost to the acquiring segment.

question

What's the purpose of transfer pricing?

answer

A company wants profitability metrics that reward the segment manager for decisions that increase both a segment's profitability and the profitability of the entire copmany. Also, multinational companies use transfer pricing to minimize their worldwide taxes, duties, and tariffs.

question

Transfer prices should guide __

answer

managers to make the best possible decisions regarding whether to buy or sell products inside or outside the company.

question

What's the general equation for transfer price?

answer

transfer price = outlay cost + opportunity cost

question

What are the different kinds of transfer-pricing systems?

answer

Market-based transfer prices; cost-based transfer prices: a) variable cost, b) full cost (possibly plus profit); negotiated transfer prices

question

Should market prices be used for transfer prices?

answer

If a market price exists, use it. Using the market price as a transfer price will generally lead to the desired goal congruence and managerial effort, and in this case the market price is equal to the variable cost plus the opportunity cost. Sometimes market prices are not always available for items transferred internally.

question

When market prices don't exist, __

answer

companies resort to cost-based transfer prices .Cost-based transfer prices are easy to understand and use, but they lead to dysfuctional decisions - decisions in conflict with the company's goals.

question

The __ system is most appropriate when the selling division __

answer

variable-cost pricing; forgoes no opportunity when it transfers the item internally.

question

When does the variable-cost pricing system cause dysfunctional decisions?

answer

When the selling segment has significant opportunity costs.

question

The __ system includes not only variable cost but __

answer

full-cost pricing; also an allocation of fixed costs (and, if included, the profit mark-up). It is implicitly assumed that the allocation is a good approximation of the opportunity cost.

question

When does the full-cost pricing system cause dysfunctional decisions?

answer

They arise with the full-cost transfer prices when the selling segment has opportunity costs that differ significantly from the allocation of fixed costs and profit.

question

Companies heavily committed to __

answer

segment autonomy often allow managers to negotiate transfer prices.

question

Open negotiation __

answer

allows managers to make optimal decisions.

question

Critics of negotiated prices focus on __

answer

the time and effort spent negotiating, an activity that adds nothing directly to the profits of the company.

question

MBO

answer

Management by Objectives - describes the joint formulation by a manager and his or her superior of a set of goals and plans for achieving the goals for a forthcoming period. The manager's performance is then evaluated in relation to these agreed-upon budgeted objectives.

question

Many of the troublesome motivational effects of performance evaluation systems __

answer

can be minimized by the astute use of budgets.

question

The desirability of tailoring __

answer

a budget to particular managers cannot be overemphasized.

question

Companies that make meeting a budget too important __

answer

can motivate unethical behavior.

question

What are return on sales and capital turnover?

answer

ROI = income / invested capital, which can be broken down (income / revenue) x (revenue / invested capital), or return on sales x capital turnover

question

Although evaluation based on ROI cuases managers to consider both income and investment in their decisions, __

answer

it may provide inappropriate incentives for managers to reject profitable investment opportunities or accept unprofitable investment opportunities.

question

NOPAT

answer

net operating profit after-tax

question

capital charge

answer

the company's cost of capital multiplied by the amount of investment

question

cost of capital

answer

the cost of long-term liabilities and stockholders' equity weighted by their relative size

question

What are the different possible definitions of invested capital?

answer

Total assets, total assets less short-term liabilities and stockholder's equity.

question

If the division manager's mission is to put all assets to their best use without regard to their financing, __. If the manager has direct control over obtaining short-term credit, __.

answer

then total assets is best.; then total assets less current liabilities is best.

question

To increase return or economic profit measures, managers will focus on attention on ___

answer

reducing the measure of invested capital that a company adopts. In practice, most companies using ROI or economic profit include all assets in invested capital, and about half (primarily companies using EVA) deduct some portion of current liabilities.

question

Practice is overwhelmingly in favor of __ (in regards to gross book value or net book value).

answer

using net book value based on historical cost.

question

The rate of return on __. In contrast, the rate of return on __.

answer

net book value increases as the equipment ages; gross book value is unchanged if operating income does not change

question

Managers in firms using net book value have __

answer

incentives to keep old assets with their low book value.

question

Each organization must design its management control system to __

answer

achieve the bets possible decisino making, taking into account the cost-benefit tradeoff.

question

What is contribution margin?

answer

A cost accounting concept that allows a company to determine the profitability of individual products. It is calculated as follows: (Product Revenue - Product Variable Cost) / Product Revenue The phrase "contribution margin" can also refer to a per unit measure of a product's gross operating margin, calculated simply as the product's price minus its total variable costs.

Introduction to Management Accounting, Horngren, 15th edition – Flashcards

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