University:
California State University, Northridge
Course:
ACCT 230 | Introduction to Managerial Accounting
Academic year:

2024
Views:

329

Pages:

18
Author:

Kevin Leon

Chapter 10 Decentralization Part 2 Learning Objective LO1 To compute the return on investment (ROI) and show how changes in sales, expenses, and assets affect an organization’s ROI. 10-15 Return on Investment (ROI) Formula Income before interest and taxes (EBIT) Net operating income ROI = Average operating assets Cash, accounts receivable, inventory, plant and equipment, and other productive assets. 10-16 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 10-17 Return on Investment (ROI) Formula Net operating income ROI = Average operating assets Margin = Turnover = Net operating income Sales Sales Average operating assets ROI = Margin × Turnover 10-18 Increasing ROI There are three ways to increase ROI . . . Increase Sales Reduce Expenses Reduce Assets 10-19 Increasing ROI – An Example Regal Company reports the following: Net operating income $ 30,000 Average operating assets $ 200,000 Sales $ 500,000 Operating expenses $ 470,000 What is Regal Company’s ROI? ROI = Margin × Turnover ROI = Net operating income Sales × Sales Average operating assets 10-20 Increasing ROI – An Example ROI = Margin × Turnover ROI = Net operating income Sales $30,000 ROI = $500,000 × × Sales Average operating assets $500,000 $200,000 ROI = 6% × 2.5 = 15% 10-21 Increasing Sales Without an Increase in Operating Assets  Regal’s manager was able to increase sales to $600,000 while operating expenses increased to $558,000.  Regal’s net operating income increased to $42,000.  There was no change in the average operating assets of the segment. Let’s calculate the new ROI. 10-22 Increasing Sales Without an Increase in Operating Assets ROI = Margin × Turnover ROI = Net operating income Sales $42,000 ROI = $600,000 × × Sales Average operating assets $600,000 $200,000 ROI = 7% × 3.0 = 21% ROI increased from 15% to 21%. 10-23 Decreasing Operating Expenses with no Change in Sales or Operating Assets Assume that Regal’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 Let’s calculate the new ROI. 10-24 Decreasing Operating Expenses with no Change in Sales or Operating Assets ROI = Margin × Turnover ROI = Net operating income Sales $40,000 ROI = $500,000 × × Sales Average operating assets $500,000 $200,000 ROI = 8% × 2.5 = 20% ROI increased from 15% to 20%. 10-25 Decreasing Operating Assets with no Change in Sales or Operating Expenses Assume that Regal’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 Let’s calculate the new ROI. 10-26 Decreasing Operating Assets with no Change in Sales or Operating Expenses ROI = Margin × Turnover ROI = Net operating income Sales $30,000 ROI = $500,000 × × Sales Average operating assets $500,000 $180,000 ROI = 6% × 2.777 = 16.66% ROI increased from 15% to 16.66%. 10-27 Investing in Operating Assets to Increase Sales Assume that Regal’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 Let’s calculate the new ROI. 10-28 Investing in Operating Assets to Increase Sales ROI = Margin × Turnover ROI = Net operating income Sales $50,000 ROI = $535,000 × × Sales Average operating assets $535,000 $230,000 ROI = 9.35% × 2.33 = 21.8% ROI increased from 15% to 21.8%. 10-29 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 company’s 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? 10-30 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. 10-31