ACTG 2300 Lecture 19: Day 19 Notes

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Day 19 3/10
Operating Income = Revenues COGS SG&A
COGS + SG&A = Operating Expenses
Net Income = Operating Income Interests Taxes
Interests + Taxes = Non-Operating Expenses
Gross Margin = Revenues COGS
Contribution Margin = Revenues TVC
COGS
Includes only manufacturing cost
Assets
Investments that help generate cash flow
Responsibility Accounting
Return on Investment (ROI) = Return / Investment = Profit / Assets
Achieving goals of organization or not
Return On Assets (ROA) = Profit / Assets
= Operating Income / Average Operating Assets
Profitability of the business
Measures the return on investments regardless of the financial structure
(whether we use internal or external funds)
= (Revenues Operating Expenses) / Average Operating Assets
Find who is responsible for each
Return on Equity (ROE) = Net Income / Average Equity
Operating Assets
Exclude unused assets (own but not using) and financial assets (investments)
Average Operating Assets
(Beginning Balance + Ending Balance) / 2
Who is responsible?
Revenue Center (revenues)
o Managers are held accountable for generating revenues (EX: sales)
Sales departments in commercial organizations
Controls some costs but typically are not related to the product
cost, strictly related to sales activity
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Fundraising managers in not-for-profit organizations
Cost Centers (operating expenses)
o Managers are held accountable for expenses
EX:
Accountant, production, purchasing, marketing,
manufacturing, warehousing, etc.
o Not responsible for actually selling the product\
Profit Centers (revenues & operating expenses)
o Managers are held accountable for generating profits
EX: Product manager
In charge or product the whole way, make sure people
make the product are efficient, etc.
EX: store manager, brands, business units, service lines,
customers, etc.
Investment Centers (entire ROA formula)
o Managers are held accountable for the accounting returns (profits) on
the investment made to generate those returns
EX: business divisions, subsidiaries, geographical areas,
business sectors, distribution channels
ROA
Pros
o Understandable
o Objective and precise (based on accounting numbers)
Cons
o Myopic
Short-sighted
Doesn’t look forward, looks into the past/today, not tomorrow
o Sub-optimization
If you use ROA as THE performance indicator, you will invest in
things that are not optimal, and reject investments that are
optimal
ROA doesn’t consider cost of capital debt & equity
o Easily Manipulated
Residual Income
Pros
o Does consider cost of capital, so doesn’t have sub-optimization effect
Cons
o Still heavily based on accounting numbers, so limitations still effect
the ratio
GAAP bound because we expense in the same period, but don’t
see profits yet
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