Cash, Short-term Investments and Accounts Receivable

Cash, Short-term Investmentsand Accounts Receivable Chapter 4 Chapter 4

Chapter 14 Activity-Based Management and Performance Measurement/Reward

Learning Objectives Chapter 14 • Distinguish between value-added and non-value-added activities as part of activity-based management. • Identify cost drivers of activities. • Allocate costs using activity-based costing. • Identify financial and nonfinancial performance measurements for different responsibility centers. • Discuss the use of a balanced scorecard in performance evaluation. • Align the use of rewards with the performance of measurement system. Chapter 14

Value Added or Non Value Added Research & Development Engineering Production Moving Storage Scheduling Set-ups Waiting Inspecting Rework Chapter 14

Cost Drivers A cost driver is the factor that has a direct cause-effect relationship on a cost. Examples include: CostDriver Direct Materials Units produced Maintenance Expense Machine Hours Supervisor Salary Labor Hours Insurance Square Footage Chapter 14

Activity Based Costing • classifying costs into multiple levels of incurrence • (2) accumulating costs by cost drivers • (3) using cost drivers to assign costs to products and services. Activity-based costing (ABC) is an overhead allocation method. Chapter 14

Allocation Overhead: Traditional versus Activity-Based Costing Chapter 14

Activity-Based Costing Example • Assume that Hyde, Inc. produces two products: • Product Q sells for $40 and has direct material and direct labor costs of $27. Product Q requires 2.5 labor hours. • Product R sells for $150 and has direct material and direct labor of $89. Product R requires 6 labor hours. • In 2009, Hyde produced and sold 70,000 units of Q and 8,000 units of R. • Total overhead for 2009 was $579,000. • The next slide illustrates Hyde, Inc.’s overhead allocation process using the traditional cost driver of direct labor hours. Chapter 14

Hyde, Inc. Overhead Allocation (Traditional) Chapter 14

Activity-Based Costing Example • If Hyde, Inc. used activity-based costing, the overhead would be divided into groups, and each group would be applied using a different driver. • Assume that the $579,800 of total overhead consists of $240,000 in material movement costs, $189,000 in utilities, $126,800 in cleanup costs, and $24,000 in setup costs. • The next two slide indicate the overhead allocations to the two products if ABC were used. • We have four drivers and allocation bases, one for each overhead category. Chapter 14

Hyde , Inc. Overhead Allocation (Activity-Based Costing) Chapter 14

Overhead Cost Comparison Chapter 14

Responsibility Centers • Cost Center • Profit Center • Investment Center Chapter 14

Cost Center • In a cost center, the only means to judge performance is an assessment of whether the center’s costs were in line with budgeted amounts. • Actual costs are compared to budgeted costs at the same level of activity to determine the variance amount. Chapter 14

Cost Center Example • Lee Larkind is the manager of the Reservations Department in HLS Corp. • For October, the department’s budget was as follows, based on an activity level of 480 hours (three people working 40 hours per week for four weeks in the month): Chapter 14

Cost Center Example Continued • During October, company management gave reservations employees a $0.50 per hour wage increase. • The employees worked a total of 500 hours, and the department reported the following costs: Chapter 14

Cost Center Example Continued • At first glance, it appears that Larkind has not controlled departmental costs well during October. • However, the two sets of figures should not be compared directly because they have been calculated using different levels of activity. • The original budget first needs to be restated at the actual activity level of 500 hours before making the comparison. Chapter 14

Profit Center • In a profit center, performance can be judged on both cost control and revenue generation. • A profit center manager’s goal is to maximize the center’s net income. • Performance evaluation in a profit center will also include revenue and profit measurements. • We can calculate two variances for a profit center. • The sales price variance is the difference between total actual selling price and budgeted selling price at actual volume. • The sales volume variance is the difference between budgeted selling price at actual volume and total budgeted sales. • The next slide shows the revenue variance model. Chapter 14

Revenue Variance Model Chapter 14

Revenue Center Example • Assume that the Reservations Department from our previous example is a profit center, rather than a cost center. • The Reservations Department charges the hotel $10 for each reservation generated by the department. • It was estimated that the department would make 2,000 reservations during October; thus, expected revenue for the department was $20,000. • In October, the department actually generated 2,200 reservations. During the month, a new reservation system was implemented that reduced the work involved; therefore, the hotel charge per reservation was lowered to $9.50. • Price, volume, and revenue variances for October are shown on the next slide. Chapter 14

Revenue Center Example Continued Budgeted profits for the Reservations Department should also be compared to actual profits in evaluating performance as follows: Chapter 14

Investment Center • In an investment center, performance can be judged on the basis of cost control, revenue generation, and return on investment. • Center managers can acquire, use, and sell plant assets to earn the highest rate of return on the center’s asset base. • In addition to the measures shown previously for cost and profit centers, an investment center’s performance can also be measure by calculating return on investment (ROI). ROI = Income Assets Chapter 14

Investment Center Example • Assume that Larkind of the Reservations Department has control over the department’s asset base of $50,000. • Using the actual income of $5,075, ROI is computed as: Chapter 14

Du Pont Model Profit Margin = Income ¸ Revenues Asset Turnover = Revenues ÷ Assets ROI = Profit Margin - Asset Turnover Chapter 14

Du Pont Model Example Using the information from the Reservations Department, we can use the Du Pont model of ROI. Chapter 14

Review During the past twelve months, the McDonald Company had a net income of $50,000. What is the amount of assets if the return on investment is 20%? • $100,000 • $200,000 • $250,000 • $500,000 Chapter 14 27

Review During the past twelve months, the McDonald Company had a net income of $50,000. What is the amount of assets if the return on investment is 20%? • $100,000 • $200,000 • $250,000 • $500,000 Chapter 14 28

Review Return on investment can be increased by • increasing assets. • decreasing assets. • decreasing revenue. • both (b) and (c). Chapter 14 29

Review Return on investment can be increased by • increasing assets. • decreasing assets. • decreasing revenue. • both (b) and (c). Chapter 14 30

Problem Review Museum Corporation uses the investment center concept for the museums that it manages. Select operating data for three of its museums for 2010 are as • Compute the return on investment for each division. • Which museum manager is doing best based on ROI? Why? Chapter 14

Problem Review Solution • a. ROI St. Louis = $51,000/$300,000 = 17% • ROI Dallas = $56,000/$250,000 = 22% • ROI Miami = $59,000/$350,000 = 17% • b. Dallas is generating $.22 of income for every $1.00 of assets. The St. Louis and Miami museums are only generating $.17 per $1.00 of assets. Chapter 14

Balanced Scorecard • Financial • Customer • Internal Process • Learning and Growth Chapter 14

Balanced Scorecard Illustration Chapter 14

Balanced Scorecard Illustration Continued • Each balanced scorecard section should indicate specific measurements that would help assess the organization’s process toward its long-run goals and objectives. • The measurements should be easy to understand and to compute. • The following slide shows some examples of nonmonetary measurements for each scorecard area other than the financial section. Chapter 14

Balanced Scorecard Nonmonetary Measurements Chapter 14

Review The balanced scorecard measures an organization’s performance from all of the following perspectives except: • learning and growth • customer • government • financial Chapter 14 37

Review The balanced scorecard measures an organization’s performance from all of the following perspectives except: • learning and growth • customer • government • financial Chapter 14 38

Review Measures of the balanced scorecard’s customer perspective include: • percentage of employees retained • market share • number of patents obtained • hours of training per employee Chapter 14 39

Review Measures of the balanced scorecard’s customer perspective include: • percentage of employees retained • market share • number of patents obtained • hours of training per employee Chapter 14 40

Activity-Based Management Activity-based management(ABM) is concerned with the activities performed during the manufacturing or service process and the related costs of those activities. • Analyzing Activities • Identification • Value or Non Value Added • Activity Costs Chapter 14

Motivation Benchmarking Performance Measurement Rewards: Financial Non Financial Chapter 14

Choice of Performance Measures Chapter 14

Conclusions • Activities Drive Costs • ABC Provides More Accurate Information • A Performance Measurement System Allows Activities to be monitored and rewarded. • Success is Judged by Financial and Non Financial Measures Chapter 14

THE END! Chapter 14 45 45

Cash, Short-term Investments and Accounts Receivable