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Business Unit Performance

Measurement
Chapter 14

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA

McGraw-Hill/Irwin

Copyright 2014 by The McGraw-Hill Companies, Inc. All rights reserved.

LO
14-1

Accounting Income
LO 14-1

Evaluate divisional accounting income as a performanc

measure.

Divisional Income
Division revenues minus division costs
Investors use accounting income to
assess a firm's performance.
Firms use a divisions income to
Assess divisional performance.
14-3

LO
14-1

Divisional Income

14-4

LO
14-1

Some Simple Financial Ratios

Mustang Fashions
Selected Financial Ratios
For Year 1

14-5

LO
14-2

Return on Investment
LO 14-2

Interpret and use return on investment (ROI).

Return on Investment (ROI)

Ratio of profits to investment in the asset that
generates those profits

Provides a comparison of different size divisions

14-6

LO
14-2

Return on Investment

14-7

LO
14-2

Return on Investment

14-8

LO
14-2

Return on Investment

14-9

LO
14-3

Residual Income Measures

LO 14-3

Interpret and use residual income (RI).

Residual Income (RI)

This is the excess of actual profit over
the cost of invested capital in the unit.

14-10

LO
14-3

Residual Income Measures

Cost of Capital
This is the opportunity cost of the resources
(equity and debt capital) invested in the business.

14-11

LO
14-4

Economic Value Added (EVA)

LO 14-4

Interpret and use economic value added (EVA).

EVA is the annual after-tax (adjusted)

divisional income minus the total annual
cost of (adjusted) capital.
It makes adjustments to after-tax income and
capital to eliminate accounting distortions.

14-12

LO
14-5

Measuring the Investment Base

LO 14-5

Explain how historical cost and net book value-based accou

measures can be misleading in evaluating performance.

Performance measures use divisional assets

or investments in the calculation.
How should divisional assets be measured?
Gross book value versus net book value
Historical cost versus current cost
Beginning, ending, or average balance

14-13

LO
14-5

Other Issues in Divisional

Performance Measurement

Divisional income, ROI, residual income, and EVA are

financial performance measures that consider the
activities of the business unit independently of other
units in the firm.
Measuring the manager only on the divisions results
risks suboptimal decision making because the manager
ignores the effect of the decisions on other business
units.

14-14

End of Chapter 14

14-15