Comparison of Financial and Managerial Accounting
Jan 11, 2016
Comparison of Financial and Managerial Accounting
Opportunity Costs
The potential benefit that is given up when one alternative is selected over another.
Example: If you werenot attending college,you could be earning$15,000 per year. Your opportunity costof attending college for one year is $15,000.
Sunk Costs
Sunk costs have already been incurred and cannot be changed now or in the future. They should be ignored when making decisions.
Example: You bought an automobile that cost $10,000 two years ago. The $10,000 cost is sunk because whether you drive it, park it, trade it, or sell it, you cannot change the $10,000 cost.
The ProductThe Product
DirectMaterials
DirectMaterials
DirectLaborDirectLabor
ManufacturingOverhead
ManufacturingOverhead
Manufacturing Costs
Non-manufacturing Costs
Marketing or Selling Cost
Costs necessary to get the order and deliver
the product.
Administrative Cost
All executive, organizational, and
clerical costs.
Product Costs Versus Period Costs
Product costs include direct materials, direct labor, and manufacturing overhead.
Period costs include all marketing or selling costs and administrative costs.
Inventory Cost of Good Sold
BalanceSheet
IncomeStatement
Sale
Expense
IncomeStatement
Comparing Merchandising and Manufacturing Activities
Merchandisers . . .– Buy finished goods.
– Sell finished goods.
Manufacturers . . .– Buy raw materials.
– Produce and sell finished goods.
Types of Product Costing Systems
ProcessCosting
Job-orderCosting
A company produces many units of a single A company produces many units of a single product. product.
One unit of product is indistinguishable from One unit of product is indistinguishable from other units of product.other units of product.
The identical nature of each unit of product The identical nature of each unit of product enables enables assigning the same average cost per unit.assigning the same average cost per unit.
A company produces many units of a single A company produces many units of a single product. product.
One unit of product is indistinguishable from One unit of product is indistinguishable from other units of product.other units of product.
The identical nature of each unit of product The identical nature of each unit of product enables enables assigning the same average cost per unit.assigning the same average cost per unit.
Types of Product Costing Systems
ProcessCosting
Job-orderCosting
Many different products are produced each period. Many different products are produced each period.
Products are manufactured to order.Products are manufactured to order.
The unique nature of each order requires tracing or The unique nature of each order requires tracing or allocating costs to each job, and maintaining cost allocating costs to each job, and maintaining cost
records for each job.records for each job.
Many different products are produced each period. Many different products are produced each period.
Products are manufactured to order.Products are manufactured to order.
The unique nature of each order requires tracing or The unique nature of each order requires tracing or allocating costs to each job, and maintaining cost allocating costs to each job, and maintaining cost
records for each job.records for each job.
Manufacturing Overhead
Manufacturing Overhead
Job No. 1Job No. 1
Job No. 2Job No. 2
Job No. 3Job No. 3
Charge Charge direct direct
material and material and direct labor direct labor
costs to costs to each job as each job as
work is work is performed.performed.
Charge Charge direct direct
material and material and direct labor direct labor
costs to costs to each job as each job as
work is work is performed.performed.
Direct Manufacturing Costs
Direct MaterialsDirect Materials
Direct LaborDirect Labor
Manufacturing Manufacturing Overhead, Overhead, including including indirect indirect
materialsmaterials and and indirect laborindirect labor, ,
are allocated to are allocated to jobs rather than jobs rather than directly traced directly traced to each job.to each job.
Manufacturing Manufacturing Overhead, Overhead, including including indirect indirect
materialsmaterials and and indirect laborindirect labor, ,
are allocated to are allocated to jobs rather than jobs rather than directly traced directly traced to each job.to each job.
Indirect Manufacturing Costs
Direct MaterialsDirect Materials
Direct LaborDirect Labor
Job No. 1Job No. 1
Job No. 2Job No. 2
Job No. 3Job No. 3Manufacturing Overhead
Manufacturing Overhead
The predetermined overhead rate (POHR) used to apply overhead to jobs is determined before the
period begins.
Manufacturing Overhead Application
Estimated total manufacturingoverhead cost for the coming period
Estimated total units in theallocation base for the coming period
POHR =
Ideally, the allocation base is a cost driver that causes
overhead.
Ideally, the allocation base is a cost driver that causes
overhead.
Using a predetermined rate makes itpossible to estimate total job costs sooner.
Actual overhead for the period is notknown until the end of the period.
The Need for a POHR
Actual amount of the allocation based upon the actual level of
activity.
Actual amount of the allocation based upon the actual level of
activity.
Based on estimates, and determined before the
period begins.
Based on estimates, and determined before the
period begins.
Application of Manufacturing Overhead
Overhead applied = POHR × Actual activity
For each direct labor hour worked on a particular job, $4.00 of factory overhead
will be applied to that job.
For each direct labor hour worked on a particular job, $4.00 of factory overhead
will be applied to that job.
Overhead Application Rate
POHR = $4.00 per DLH
$640,000
160,000 direct labor hours (DLH)POHR =
Estimated total manufacturingoverhead cost for the coming period
Estimated total units in theallocation base for the coming period
POHR =
Job-Order Cost Accounting
Cost Classifications for Predicting Cost Behavior
How a cost will react to changes in the level of activity
within the relevant range.
– Total variable costs change when activity changes.
– Total fixed costs remain unchanged when activity changes.
How a cost will react to changes in the level of activity
within the relevant range.
– Total variable costs change when activity changes.
– Total fixed costs remain unchanged when activity changes.
Cost Classifications for Predicting Cost Behavior
Behavior of Cost (within the relevant range)
Cost In Total Per Unit
Variable Total variable cost changes Variable cost per unit remainsas activity level changes. the same over wide ranges
of activity.
Fixed Total fixed cost remains Average fixed cost per unit goesthe same even when the down as activity level goes up.
activity level changes.
The Activity Base
A measure of what causes the
incurrence of a variable cost
A measure of what causes the
incurrence of a variable cost
UnitsUnitsproducedproduced
UnitsUnitsproducedproduced
Miles driven
Miles driven
Labor hours
Labor hours
Machine hours
Machine hours
Extent of Variable Costs
The proportion of variable costs differs across organizations. For example . . .
A public utility withA public utility withlarge investments inlarge investments inequipment will tendequipment will tend
to have to have fewerfewervariable costs.variable costs.
A public utility withA public utility withlarge investments inlarge investments inequipment will tendequipment will tend
to have to have fewerfewervariable costs.variable costs.
A manufacturing companyA manufacturing companywill often have will often have manymany
variable costs.variable costs.
A manufacturing companyA manufacturing companywill often have will often have manymany
variable costs.variable costs.
A merchandising companyA merchandising companyusually will have a usually will have a highhigh
proportionproportion of variable costs of variable costslike cost of sales.like cost of sales.
A merchandising companyA merchandising companyusually will have a usually will have a highhigh
proportionproportion of variable costs of variable costslike cost of sales.like cost of sales.
A service companyA service companywill normally have a will normally have a highhigh
proportionproportion of variable costs. of variable costs.
A service companyA service companywill normally have a will normally have a highhigh
proportionproportion of variable costs. of variable costs.
Examples of Variable Costs
1. Merchandising companies – cost of goods sold.
2. Manufacturing companies – direct materials, direct labor, and variable overhead.
3. Merchandising and manufacturing companies – commissions, shipping costs, and clerical costs such as invoicing.
4. Service companies – supplies, travel, and clerical.
1. Merchandising companies – cost of goods sold.
2. Manufacturing companies – direct materials, direct labor, and variable overhead.
3. Merchandising and manufacturing companies – commissions, shipping costs, and clerical costs such as invoicing.
4. Service companies – supplies, travel, and clerical.
RelevantRange
A straight line closely
approximates a curvilinear
variable cost line within the
relevant range.
A straight line closely
approximates a curvilinear
variable cost line within the
relevant range.
Activity
To
tal
Co
st
Economist’sCurvilinear Cost
Function
The Linearity Assumption and the Relevant Range
Accountant’s Straight-Line Approximation (constant
unit variable cost)
ExamplesAdvertising and Research and Development
ExamplesAdvertising and Research and Development
ExamplesDepreciation on Equipment and
Real Estate Taxes
ExamplesDepreciation on Equipment and
Real Estate Taxes
Types of Fixed Costs
DiscretionaryMay be altered in the short-term by current managerial decisions
DiscretionaryMay be altered in the short-term by current managerial decisions
CommittedLong-term, cannot be significantly reduced
in the short term.
CommittedLong-term, cannot be significantly reduced
in the short term.
The Trend Toward Fixed Costs
The trend in many industries is toward greater fixed costs relative to variable costs.
As machines take overAs machines take overmany mundane tasksmany mundane taskspreviously performedpreviously performed
by humans, by humans, ““knowledge workersknowledge workers””
are demanded forare demanded fortheir minds rathertheir minds ratherthan their musclesthan their muscles
As machines take overAs machines take overmany mundane tasksmany mundane taskspreviously performedpreviously performed
by humans, by humans, ““knowledge workersknowledge workers””
are demanded forare demanded fortheir minds rathertheir minds ratherthan their musclesthan their muscles
Knowledge workersKnowledge workerstend to be salaried,tend to be salaried,highly-trained andhighly-trained and
difficult to replace. Thedifficult to replace. Thecost to compensatecost to compensate
these valued employeesthese valued employeesis is relatively fixedrelatively fixed
rather than variable.rather than variable.
Knowledge workersKnowledge workerstend to be salaried,tend to be salaried,highly-trained andhighly-trained and
difficult to replace. Thedifficult to replace. Thecost to compensatecost to compensate
these valued employeesthese valued employeesis is relatively fixedrelatively fixed
rather than variable.rather than variable.
Ren
t C
ost
in
T
ho
usa
nd
s o
f D
oll
ars
0 1,000 2,000 3,000 Rented Area (Square Feet)
0
30
60
Fixed Costs and Relevant Range
90
Relevant
Range
Total cost doesn’t change for a wide range of activity,
and then jumps to a new higher cost for
the next higher range of activity.
Total cost doesn’t change for a wide range of activity,
and then jumps to a new higher cost for
the next higher range of activity.
Let’s put our knowledge of cost
behavior to work by preparing a
contribution format income statement.
The Contribution Format
Total Unit
Sales Revenue 100,000$ 50$
Less: Variable costs 60,000 30
Contribution margin 40,000$ 20$
Less: Fixed costs 30,000
Net operating income 10,000$
Total Unit
Sales Revenue 100,000$ 50$
Less: Variable costs 60,000 30
Contribution margin 40,000$ 20$
Less: Fixed costs 30,000
Net operating income 10,000$
The contribution margin format emphasizes The contribution margin format emphasizes cost behavior. Contribution margin covers fixed cost behavior. Contribution margin covers fixed
costs and provides for income.costs and provides for income.
The contribution margin format emphasizes The contribution margin format emphasizes cost behavior. Contribution margin covers fixed cost behavior. Contribution margin covers fixed
costs and provides for income.costs and provides for income.
The Contribution Format
Used primarily forUsed primarily forexternal reporting.external reporting.
Used primarily byUsed primarily bymanagement.management.
Break-Even Analysis
Here is the information from Racing Bicycle Company:
Total Per Unit PercentSales (500 bikes) 250,000$ 500$ 100%Less: variable expenses 150,000 300 60%Contribution margin 100,000$ 200$ 40%
Less: fixed expenses 80,000 Net operating income 20,000$
Total Per Unit PercentSales (500 bikes) 250,000$ 500$ 100%Less: variable expenses 150,000 300 60%Contribution margin 100,000$ 200$ 40%
Less: fixed expenses 80,000 Net operating income 20,000$
Contribution Margin Method
The contribution margin method has two key equations.
Fixed expensesUnit contribution margin
=Break-even point
in units sold
Fixed expenses CM ratio
=Break-even point intotal sales dollars
Contribution Margin Method
Let’s use the contribution margin method to calculate the break-even point in total sales
dollars at Racing.
Fixed expenses CM ratio
=Break-even point intotal sales dollars
$80,000$80,00040%40% = $200,000 break-even sales= $200,000 break-even sales
Contribution Margin Method
Let’s use the contribution margin method to calculate the break-even point in units sold at
Racing.
Fixed expenses Unit CM
=Break-even point in
Units sold
$80,000$80,000$200/unit$200/unit = 400 break-even units= 400 break-even units
Target Profit Analysis
The contribution margin method can be used to determine the sales volume needed to achieve a target
profit.
Suppose Racing Bicycle Company wants to know how many bikes must be sold to earn a
profit of $100,000.
The Contribution Margin Approach
The contribution margin method can be used to determine that 900 bikes must be sold to earn the
target profit of $100,000.
Fixed expenses + Target profit Unit contribution margin
=Unit sales to attain
the target profit
$80,000 + $100,000 $200/bike
= 900 bikes
Cost Structure and Profit Stability
Cost structure refers to the relative proportion of fixed and variable costs in an organization.
Managers often have some latitude in determining their organization’s cost structure.
Operating Leverage
• A measure of how sensitive net operating income is to percentage changes in sales.
Contribution margin Net operating income
Degree ofoperating leverage
=
Operating Leverage Example
Low-Lev Company High-Lev Company
(1,000,000 units) (1,000,000 units)
Amount % Amount %
Sales $1,000,000 100 $1,000,000 100
Var. Costs 750,000 75 250,000 25
CM 250,000 25 750,000 75
Fixed Costs 50,000 5 550,000 55
Operating Profit
200,000 20 200,000 20
Breakeven Point
200,000 units 733,334
CM per unit $0.25/unit $0.75/unit
Operating Leverage
1.25 3.75
Operating Leverage Example
Low-Lev Company High-Lev Company
(1,100,000 units) (1,100,000 units)
Amount % Amount %
Sales $1,100,000 100 $1,100,000 100
Var. Costs 825,000 75 275,000 25
CM 275,000 25 825,000 75
Fixed Costs 50,000 5 550,000 55
Operating Profit
225,000 20 275,000 20
Breakeven Point
200,000 units 733,334
CM per unit $0.25/unit $0.75/unit
Operating Leverage
1.25 3.75
10% increase in sales
10% * 1.25 = 12.5%increase in profit
10% * 3.75 = 37.5%increase in profit
Cost Structure and Profit Stability
There are advantages and disadvantages to high fixed cost (or low variable cost) and low fixed
cost (or high variable cost) structures.
An advantage of a high fixedcost structure is that incomewill be higher in good years
compared to companieswith lower proportion of
fixed costs.
An advantage of a high fixedcost structure is that incomewill be higher in good years
compared to companieswith lower proportion of
fixed costs.
A disadvantage of a high fixedcost structure is that income
will be lower in bad yearscompared to companieswith lower proportion of
fixed costs.
A disadvantage of a high fixedcost structure is that income
will be lower in bad yearscompared to companieswith lower proportion of
fixed costs.
The Basic Framework of Budgeting
A budget is a detailed quantitative plan for acquiring and using financial and other resources
over a specified forthcoming time period.
1. The act of preparing a budget is called budgeting.
2. The use of budgets to control an organization’s activity is known as budgetary control.
Planning and Control
PlanningPlanning – – involves developing involves developing objectives and preparing objectives and preparing various budgets to various budgets to achieve these objectives.achieve these objectives.
PlanningPlanning – – involves developing involves developing objectives and preparing objectives and preparing various budgets to various budgets to achieve these objectives.achieve these objectives.
ControlControl – – involves the steps taken involves the steps taken by management that by management that attempt to ensure the attempt to ensure the objectives are attained.objectives are attained.
ControlControl – – involves the steps taken involves the steps taken by management that by management that attempt to ensure the attempt to ensure the objectives are attained.objectives are attained.
Advantages of Budgeting
Advantages
Define goalDefine goaland objectivesand objectives
Uncover potentialUncover potentialbottlenecksbottlenecks
CoordinateCoordinateactivitiesactivities
CommunicateCommunicateplansplans
Think about andThink about andplan for the futureplan for the future
Means of allocatingMeans of allocatingresourcesresources
Responsibility Accounting
Managers should be held responsible for those items — Managers should be held responsible for those items — and and onlyonly those items — that those items — that
the manager can actually controlthe manager can actually controlto a significant extent.to a significant extent.
Managers should be held responsible for those items — Managers should be held responsible for those items — and and onlyonly those items — that those items — that
the manager can actually controlthe manager can actually controlto a significant extent.to a significant extent.
Human Factors in Budgeting
The success of budgeting depends upon three important The success of budgeting depends upon three important factors:factors:
1.1. Top management must be enthusiastic and committed to Top management must be enthusiastic and committed to the budget process.the budget process.
2.2. Top management must not use the budget to pressure Top management must not use the budget to pressure employees or blame them when something goes wrong.employees or blame them when something goes wrong.
3.3. Highly achievable budget targets are usually preferred Highly achievable budget targets are usually preferred when managers are rewarded based on meeting budget when managers are rewarded based on meeting budget targets.targets.
The success of budgeting depends upon three important The success of budgeting depends upon three important factors:factors:
1.1. Top management must be enthusiastic and committed to Top management must be enthusiastic and committed to the budget process.the budget process.
2.2. Top management must not use the budget to pressure Top management must not use the budget to pressure employees or blame them when something goes wrong.employees or blame them when something goes wrong.
3.3. Highly achievable budget targets are usually preferred Highly achievable budget targets are usually preferred when managers are rewarded based on meeting budget when managers are rewarded based on meeting budget targets.targets.
The Master Budget: An Overview
ProductionBudget
ProductionBudget
Selling andAdministrative
Budget
Selling andAdministrative
Budget
DirectMaterialsBudget
DirectMaterialsBudget
ManufacturingOverhead
Budget
ManufacturingOverhead
Budget
DirectLabor
Budget
DirectLabor
Budget
CashBudgetCash
Budget
SalesBudgetSales
Budget
Budgeted Financial StatementsBudgeted Financial StatementsBudgeted Financial StatementsBudgeted Financial Statements
EndingFinished GoodsBudget
EndingFinished GoodsBudget
Budgeting Example
Royal Company is preparing budgets for the quarter ending Royal Company is preparing budgets for the quarter ending June 30.June 30.
Budgeted sales for the next five months are:Budgeted sales for the next five months are: April April 20,000 units20,000 units May May 50,000 units50,000 units June June 30,000 units30,000 units July July 25,000 units25,000 units August August 15,000 units.15,000 units.
The selling price is $10 per unit.The selling price is $10 per unit.
Royal Company is preparing budgets for the quarter ending Royal Company is preparing budgets for the quarter ending June 30.June 30.
Budgeted sales for the next five months are:Budgeted sales for the next five months are: April April 20,000 units20,000 units May May 50,000 units50,000 units June June 30,000 units30,000 units July July 25,000 units25,000 units August August 15,000 units.15,000 units.
The selling price is $10 per unit.The selling price is $10 per unit.
Expected Cash Collections
• All sales are on account.All sales are on account.• Royal’s collection pattern is:Royal’s collection pattern is:
70% collected in the month of sale,70% collected in the month of sale, 25% collected in the month following sale,25% collected in the month following sale, 5% uncollectible.5% uncollectible.
• The March 31 accounts receivable balance of $30,000 The March 31 accounts receivable balance of $30,000 will be collected in full.will be collected in full.
• All sales are on account.All sales are on account.• Royal’s collection pattern is:Royal’s collection pattern is:
70% collected in the month of sale,70% collected in the month of sale, 25% collected in the month following sale,25% collected in the month following sale, 5% uncollectible.5% uncollectible.
• The March 31 accounts receivable balance of $30,000 The March 31 accounts receivable balance of $30,000 will be collected in full.will be collected in full.
Expected Cash Collections
Expected Cash Collections
From the Sales Budget for April.From the Sales Budget for April.From the Sales Budget for April.From the Sales Budget for April.
Expected Cash Collections
From the Sales Budget for May.From the Sales Budget for May.From the Sales Budget for May.From the Sales Budget for May.
Quick Check
What will be the total cash collections for the quarter? What will be the total cash collections for the quarter?
a. $700,000a. $700,000
b. $220,000b. $220,000
c. $190,000c. $190,000
d. $905,000d. $905,000
What will be the total cash collections for the quarter? What will be the total cash collections for the quarter?
a. $700,000a. $700,000
b. $220,000b. $220,000
c. $190,000c. $190,000
d. $905,000d. $905,000
The Production Budget
Production must be adequate to meet budgetedProduction must be adequate to meet budgetedsales and provide for sufficient ending inventory.sales and provide for sufficient ending inventory.
The Production Budget
• The management at Royal Company wants ending The management at Royal Company wants ending inventory to be equal to inventory to be equal to 20%20% of the following month’s of the following month’s budgeted sales in units.budgeted sales in units.
• On March 31, 4,000 units were on hand.On March 31, 4,000 units were on hand.
Let’s prepare the production budget.Let’s prepare the production budget.
• The management at Royal Company wants ending The management at Royal Company wants ending inventory to be equal to inventory to be equal to 20%20% of the following month’s of the following month’s budgeted sales in units.budgeted sales in units.
• On March 31, 4,000 units were on hand.On March 31, 4,000 units were on hand.
Let’s prepare the production budget.Let’s prepare the production budget.
The Production Budget
The Production Budget
March 31March 31ending inventoryending inventory
March 31March 31ending inventoryending inventory
Budgeted May sales 50,000
Desired ending inventory % 20%Desired ending inventory 10,000
Quick Check
What is the required production for May? What is the required production for May?
a. 56,000 unitsa. 56,000 units
b. 46,000 unitsb. 46,000 units
c. 62,000 unitsc. 62,000 units
d. 52,000 unitsd. 52,000 units
What is the required production for May? What is the required production for May?
a. 56,000 unitsa. 56,000 units
b. 46,000 unitsb. 46,000 units
c. 62,000 unitsc. 62,000 units
d. 52,000 unitsd. 52,000 units
The Cash Budget
The Budgeted Income Statement
Royal CompanyBudgeted Income Statement
For the Three Months Ended June 30
Sales (100,000 units @ $10) 1,000,000$ Cost of goods sold (100,000 @ $4.99) 499,000 Gross margin 501,000 Selling and administrative expenses 260,000 Operating income 241,000 Interest expense 2,000 Net income 239,000$
Royal CompanyBudgeted Balance Sheet
June 30
Current assets Cash 43,000$ Accounts receivable 75,000 Raw materials inventory 4,600 Finished goods inventory 24,950 Total current assets 147,550 Property and equipment Land 50,000 Equipment 367,000 Total property and equipment 417,000 Total assets 564,550$
Accounts payable 28,400$ Common stock 200,000 Retained earnings 336,150 Total liabilities and equities 564,550$
Cost, Profit, and Investments Centers
ResponsibilityCenter
ResponsibilityCenter
CostCenterCost
CenterProfit
CenterProfit
CenterInvestment
CenterInvestment
Center
Cost, profit,and investmentcenters are allknown asresponsibilitycenters.
Cost, Profit, and Investments Centers
Cost Center A segment whose manager has control over costs,
but not over revenues or investment funds.
Cost, Profit, and Investments Centers
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
Cost, Profit, and Investments Centers
Investment Center
A segment whose manager has control over costs, revenues, and investments in operating assets.
Evaluating Investment Center Performance:Return on Investment (ROI) Formula
ROI = ROI = Net operating incomeNet operating incomeAverage operating assets Average operating assets
Cash, accounts receivable, inventory,plant and equipment, and other
productive assets.
Cash, accounts receivable, inventory,plant and equipment, and other
productive assets.
Income before interestand taxes (EBIT)
Income before interestand taxes (EBIT)
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.
Residual Income – An Example
• The Retail Division of Zepher, 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 $30,000.
Let’s calculate residual income.Let’s calculate residual income.
Residual Income – An Example
Operating assets 100,000$ Required rate of return × 20%Minimum required return 20,000$
Operating assets 100,000$ Required rate of return × 20%Minimum required return 20,000$
Actual income 30,000$ Minimum required return (20,000) Residual income 10,000$
Actual income 30,000$ Minimum required return (20,000) Residual income 10,000$
ROI vs. Residual Income
Retail WholesaleOperating assets 100,000$ 1,000,000$ Required rate of return × 20% 20%Minimum required return 20,000$ 200,000$
Retail WholesaleActual income 30,000$ 220,000$ Minimum required return (20,000) (200,000) Residual income 10,000$ 20,000$
Retail WholesaleOperating assets 100,000$ 1,000,000$ Required rate of return × 20% 20%Minimum required return 20,000$ 200,000$
Retail WholesaleActual income 30,000$ 220,000$ Minimum required return (20,000) (200,000) Residual income 10,000$ 20,000$
The residual income numbers below 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 Division’s residual income is larger than
the Retail Division simply because it is a bigger division.
The Balanced Scorecard
Management translates its strategy into performance measures that employees
understand and accept.
Management translates its strategy into performance measures that employees
understand and accept.
Performancemeasures
Customers
Learningand growth
Internalbusiness
processes
Financial
The Balanced Scorecard: FromStrategy to Performance Measures
Exh.10-11
FinancialHas our financial
performance improved?
CustomerDo customers recognize that
we are delivering more value?
Internal Business ProcessesHave we improved key business processes so that we can deliver
more value to customers?
Learning and GrowthAre we maintaining our ability
to change and improve?
Performance Measures
What are ourfinancial goals?
What customers dowe want to serve andhow are we going towin and retain them?
What internal busi-ness processes arecritical to providing
value to customers?
Vision and
Strategy
The Balanced Scorecard:Non-financial Measures
The balanced scorecard relies on non-financial measures in addition to financial measures for two reasons:
Financial measures are lag indicators that summarize the results of past actions. Non-financial measures are leading indicators of future financial performance.
Financial measures are lag indicators that summarize the results of past actions. Non-financial measures are leading indicators of future financial performance.
Top managers are ordinarily responsible for financial performance measures – not lower level managers. Non-financial measures are more likely to be understood and controlled by lower level managers.
Top managers are ordinarily responsible for financial performance measures – not lower level managers. Non-financial measures are more likely to be understood and controlled by lower level managers.
The balanced scorecard lays out concrete actions to attain desired outcomes.
A balanced scorecard should have measuresthat are linked together on a cause-and-effect basis.
If we improveone performance
measure . . .
Another desiredperformance measure
will improve.
The Balanced Scorecard
Then
The Balanced Scorecardand Compensation
Incentive compensation should be linked to balanced scorecard
performance measures.
You get the behavior you reward!!
The Balanced ScorecardJaguar Example
Employee skills in installing options
Number ofoptions available
Time toinstall option
Customer satisfactionwith options
Number of cars sold
Contribution per car
Profit
Learningand Growth
Internal Business
Processes
Customer
Financial
Exh.10-13
The Balanced ScorecardJaguar Example
Employee skills in installing options
Number ofoptions available
Time toinstall option
Customer satisfactionwith options
Number of cars sold
Contribution per car
Profit
Increase Options Time
Decreases
Strategies
Satisfaction Increases
Increase Skills
Results
Employee skills in installing options
Number ofoptions available
Time toinstall option
Customer satisfactionwith options
Number of cars sold
Contribution per car
Profit
Increase Options
Strategies
Satisfaction Increases
ResultsCars sold Increase
The Balanced ScorecardJaguar Example
Employee skills in installing options
Number ofoptions available
Time toinstall option
Customer satisfactionwith options
Number of cars sold
Contribution per car
Profit
Strategies
Results
The Balanced ScorecardJaguar Example
TimeDecreases
Increase Skills
ContributionIncreases
The Balanced ScorecardJaguar Example
Employee skills in installing options
Number ofoptions available
Time toinstall option
Customer satisfactionwith options
Number of cars sold
Contribution per car
ProfitResults
TimeDecreases
Increase Skills
ContributionIncreases
ProfitsIncrease
If numberof cars sold
and contributionper car increase,
profits increase.
Increase Options
Strategies
Satisfaction Increases