Copyright 1998 Dekker, Ltd. 1

2 Capital Budgeting understand capital budgeting as a tool to evaluate investment proposals and the related concepts of payback, accounting rate of return, net present value, return on investment, and added economic value Understand the effect of taxes on investment decisions identify the role and nature of what-if and sensitivity analysis in capital budgeting understand capital budgeting as a tool to evaluate investment proposals and the related concepts of payback, accounting rate of return, net present value, return on investment, and added economic value Understand the effect of taxes on investment decisions identify the role and nature of what-if and sensitivity analysis in capital budgeting

Copyright 1998 Dekker, Ltd. 3 Capital Budgeting The collection of tools planners use to evaluate the desirability of the acquisition of long-term assets The collection of tools planners use to evaluate the desirability of the acquisition of long-term assets Return The increased cash flows in the future resulting from the assets acquired Return The increased cash flows in the future resulting from the assets acquired

Copyright 1998 Dekker, Ltd. 4 Time Value of Money Because money can earn a return, its value depends on the time period in which it is received Because money can earn a return, its value depends on the time period in which it is received Today $ Year 5 $ Value of $1.00 today Value 5 years from today

Copyright 1998 Dekker, Ltd. 5 Number of Periods Year 0 Year 1Year 2 Year 3Year 4Year 5 In this case, n =  1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young The number of periods considered in the investment analysis. Common period lengths are a month, a quarter, or a year.

Copyright 1998 Dekker, Ltd. 6 Rate of Return Year 0 Year 1Year 2 Year 3Year 4Year 5 5%  1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young Rate of Return expected from the investment each YEAR

Copyright 1998 Dekker, Ltd. 7 Future Value 6-15  1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young 5% Year 0 $ % Year 1 5% Year 2 5% Year 3 5% Year 4Year 5 $ The Future Value of $ years from now at a 5% annual rate of return  1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young

Copyright 1998 Dekker, Ltd. 8 Compound Growth of Investment 6-16  1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young 5% Year 0 $ % Year 1 5% Year 2 5% Year 3 5% Year 4Year 5 $1.2763$1.0500$1.1025$ $ AND THIS IS HOW IT WOULD GET THERE!! AND THIS IS HOW IT WOULD GET THERE!!

Copyright 1998 Dekker, Ltd. 9 Compound Growth of Future Value 6-16  1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young % 10% 15% 20% Periods Value

Copyright 1998 Dekker, Ltd. 10 Present Value The current monetary worth of an amount to be paid in the future under stated conditions of interest and compounding 6-16  1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young 5% Year 0 $ % Year 1 5% Year 2 5% Year 3 5% Year 4Year 5 $1.000 The Present Value of $1.00 in 5 years at a 5% annual rate of return

Copyright 1998 Dekker, Ltd. 11 Capital Budgeting The collection of tools planners use to evaluate the desirability of the acquisition of long-term assets The collection of tools planners use to evaluate the desirability of the acquisition of long-term assets Return The increased cash flows in the future resulting from the assets acquired Return The increased cash flows in the future resulting from the assets acquired

Copyright 1998 Dekker, Ltd. 12 Future Value of an Annuity 6-16  1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young 5% Year 0 $ % Year 1 5% Year 2 5% Year 3 5% Year 4Year 5 $1.000 The Future Value of an Annuity is the sum of payments plus accumulated interest $1.000 $ $  1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young

Copyright 1998 Dekker, Ltd. 13 Present Value of an Annuity 6-16  1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young The Present Value of an Annuity is the value today of a series of future payments or receipts 5% Year 0 5% Year 1 5% Year 2 5% Year 3 5% Year 4Year 5 $ $1.000 $ $4.329 $1.000

Copyright 1998 Dekker, Ltd. 14 Required Rate of Return ® The interest rate used to compute present values. It is also known as the Discount Rate. Cost of Capital The minimum return that the organization must earn on its investments to meet its investors’ return requirements Cost of Capital The minimum return that the organization must earn on its investments to meet its investors’ return requirements

Copyright 1998 Dekker, Ltd. 15 Payback Criterion Year 0 -$70,000 $70,000 Year 1Year 2 Year 3Year 4Year 5 Cash Flow Remaining to be Recovered $20,000 -$30,000 $20,000 -$10,000 $20,000 $10,000 $20,000 $30,000 $20,000 $50,000

Copyright 1998 Dekker, Ltd. 16 Accounting Rate of Return Average Income Average Investment $8,000 $30,000 = 26.67% Average Income Average Investment $8,000 $30,000 = 26.67% Accounting Rate of Return =

Copyright 1998 Dekker, Ltd. 17 Net Present Value Net Present Value =  PV Cash Inflows -  PV Cash Outflows Net Present Value =  PV Cash Inflows -  PV Cash Outflows This model is the most widely recommended approach to capital budgeting since it specifically considers the time value of money and provides a basis for valuing the firm (where  is ‘the sum of’)

Copyright 1998 Dekker, Ltd. 18 Steps in Computing NPV Choose the period length Identify the firm’s cost of capital Identify the incremental cash flows for each period Compute the present value of each period’s cash flows Sum the project’s cash inflows and outflows and determine the NPV If the NPV is positive, then the project is acceptable from an economic perspective Choose the period length Identify the firm’s cost of capital Identify the incremental cash flows for each period Compute the present value of each period’s cash flows Sum the project’s cash inflows and outflows and determine the NPV If the NPV is positive, then the project is acceptable from an economic perspective

Copyright 1998 Dekker, Ltd. 19 Net Present Value Example Cost of Capital10% TimeAmountPV FactorPV 0(70,000)$ (70,000.00)$ 120, , , , , , , , , , ,024.95$ Net Present Value See Exhibit 10-4, P. 467

Copyright 1998 Dekker, Ltd. 20 Return on Investment (ROI) The discount rate that makes a project’s net present value equal zero. Also called the Internal Rate of Return The discount rate that makes a project’s net present value equal zero. Also called the Internal Rate of Return NET PRESENT VALUE

Copyright 1998 Dekker, Ltd. 21 Applying the Concepts Exercise #1 Turn to page 494 and work Problem Exercise #1 Turn to page 494 and work Problem

22 Tax Effects of Capital Investments Organizations must pay taxes on net benefits (taxable income) The allocation of the cost of a capital investment through depreciation can offset some taxes Taxable income, the tax rate, and tax depreciation method are determined by legislation Organizations must pay taxes on net benefits (taxable income) The allocation of the cost of a capital investment through depreciation can offset some taxes Taxable income, the tax rate, and tax depreciation method are determined by legislation

Copyright 1998 Dekker, Ltd. 23 NPV with Taxes Tax Reduces Cash Flow by Amount of Tax Assumed Tax Rate 40%

24 What-if and Sensitivity Analysis What-if Analysis is the process of varying the assumptions underlying a forecasting model to determine the effects of those assumptions on the forecasted amounts Sensitivity Analysis is the process of varying the assumptions underlying a decision to determine the decision’s sensitivity to those assumptions What-if Analysis is the process of varying the assumptions underlying a forecasting model to determine the effects of those assumptions on the forecasted amounts Sensitivity Analysis is the process of varying the assumptions underlying a decision to determine the decision’s sensitivity to those assumptions

Copyright 1998 Dekker, Ltd. 25 What-if and Sensitivity Analysis What-if and sensitivity analysis are important tools because they provide decision-makers with the opportunity to estimate the opportunity cost of the imperfect information upon which decisions are based. Spreadsheets are excellent for What-if analysis. What-if and sensitivity analysis are important tools because they provide decision-makers with the opportunity to estimate the opportunity cost of the imperfect information upon which decisions are based. Spreadsheets are excellent for What-if analysis.

Copyright 1998 Dekker, Ltd. 26 What-if and Sensitivity Analysis ONE MORE POINT!! A Very Detailed Analysis is required because it provides for a post implementation audit which is an opportunity to re-evaluate a past decision to purchase a long-term asset by comparing expected and actual inflows and outflows ONE MORE POINT!! A Very Detailed Analysis is required because it provides for a post implementation audit which is an opportunity to re-evaluate a past decision to purchase a long-term asset by comparing expected and actual inflows and outflows

Copyright 1998 Dekker, Ltd. 27 Applying the Concepts Exercise #2 Turn to page 495 and work Problem Exercise #2 Turn to page 495 and work Problem

28 Contemporary Management Accounting describe the total life cycle costing approach to managing product costs in a comprehensive manner explain the method of target costing - a management accounting method used to reduce product costs before the manufacturing cycle begins understand the importance and process of controlling the costs of nonconformance of products to established quality standards understand a model for benchmarking the best practices of other organizations describe the total life cycle costing approach to managing product costs in a comprehensive manner explain the method of target costing - a management accounting method used to reduce product costs before the manufacturing cycle begins understand the importance and process of controlling the costs of nonconformance of products to established quality standards understand a model for benchmarking the best practices of other organizations

Copyright 1998 Dekker, Ltd. 29 Recent Innovations in Management Accounting Life Cycle Concepts and Contemporary Management Accounting Methods Manufacturing Cycle Post-Sale Service and Disposal Cycle Research, Development and Engineering Cycle

Copyright 1998 Dekker, Ltd. 30 Research, Development and Engineering Cycle 1. Idea generation for new products 2. Product design 3. Product development 1. Idea generation for new products 2. Product design 3. Product development

Copyright 1998 Dekker, Ltd. 31 Manufacturing Cycle Costs Costs incurred in the production of the product. Usually little ability to engineer change product costs.

Copyright 1998 Dekker, Ltd. 32 Post-Sale Service and Disposal Cycle Begins when the first unit produced is in the hands of the customer Three Stages: Rapid growth Transition Maturity

Copyright 1998 Dekker, Ltd. 33 Target Costing A cost planning method used during the RD&E cycle that focuses on reducing costs for products that require discrete manufacturing processes and reasonably short product life cycles

Copyright 1998 Dekker, Ltd. 34 A Target Costing Example Target Sales (100,000 units)$2,000,000 Less: Target Profit (25%) 500,000 Target Cost$1,500,000 Unit Cost $1,500,000/100,000 = $ Target Sales (100,000 units)$2,000,000 Less: Target Profit (25%) 500,000 Target Cost$1,500,000 Unit Cost $1,500,000/100,000 = $ 15.00

Copyright 1998 Dekker, Ltd. 35 Concerns About Target Costing Conflicts between parties involved in the target costing process Burnout due to pressure Increase in development time Conflicts between parties involved in the target costing process Burnout due to pressure Increase in development time

Copyright 1998 Dekker, Ltd. 36 Applying the Concepts Exercise #3 Turn to page 639 and work Problem Exercise #3 Turn to page 639 and work Problem

37 Nonconformance (Quality) If products and services to not meet quality standards, the resultant cost is known as the cost of nonconformance (CONC) Factors Which Determine Quality a. satisfying customer expectations regarding the attributes and performance of the product, such as its functionality and features b. Ensuring that the technical aspects of the product’s design and performance conform to standards from the perspective of the manufacturer If products and services to not meet quality standards, the resultant cost is known as the cost of nonconformance (CONC) Factors Which Determine Quality a. satisfying customer expectations regarding the attributes and performance of the product, such as its functionality and features b. Ensuring that the technical aspects of the product’s design and performance conform to standards from the perspective of the manufacturer

Copyright 1998 Dekker, Ltd. 38 International Quality Standards ISO 9000 series of standards Quality standards developed by the International Organization for Standardization (ISO) ISO 9000 series of standards Quality standards developed by the International Organization for Standardization (ISO)

Copyright 1998 Dekker, Ltd. 39 Those who become ISO 9000 registered Comply with external regulatory agencies Meet or exceed customer requirements Implement a quality-improvement program to remain competitive Comply with external regulatory agencies Meet or exceed customer requirements Implement a quality-improvement program to remain competitive

Copyright 1998 Dekker, Ltd. 40 Industrial Standard Z Q Series of Quality Standards Sets Japanese standards for quality management Set of quality standards developed by the American Quality Control Society

Copyright 1998 Dekker, Ltd. 41 Cost of Quality Categories 1. Prevention Costs 2. Appraisal Costs 3. Internal-Failure Costs 4. External-Failure Costs 1. Prevention Costs 2. Appraisal Costs 3. Internal-Failure Costs 4. External-Failure Costs

Copyright 1998 Dekker, Ltd. 42 Examples of Quality- Related Costs Prevention Costs Quality Engineering Quality Training Statistical Process Control Supplier Certification research of Customer Needs

Copyright 1998 Dekker, Ltd. 43 Examples of Quality- Related Costs Appraisal Costs Inspection of Incoming Materials Maintenance of test equipment Processing-Control Monitoring Product Quality Audits

Copyright 1998 Dekker, Ltd. 44 Examples of Quality- Related Costs Internal Failure Costs Overtime Due Defects Waste Net Cost of Scrap Rework Costs

Copyright 1998 Dekker, Ltd. 45 Examples of Quality- Related Costs External Related Costs Product Liability Lawsuits Repair Costs in the Field Returned Products Product Liability Recalls Service Calls Warranty Claims

Copyright 1998 Dekker, Ltd. 46 Examples of Quality- Related Costs External Related Costs Worst of All Permanent Loss of Customers

47 MANAGEMENT ACCOUNTING AND CONTROL SYSTEM DESIGN Understand the managerial approaches to motivation and, in particular, the Human Resources Model Concepts of motivation, ethics, control and performance and the design of management accounting and control systems (MACS) Identify the human factors to consider when changing and implementing a new MACS Understand the managerial approaches to motivation and, in particular, the Human Resources Model Concepts of motivation, ethics, control and performance and the design of management accounting and control systems (MACS) Identify the human factors to consider when changing and implementing a new MACS

Copyright 1998 Dekker, Ltd. 48 Goals of a MACS Planning for the future Monitoring events Measuring & recording results of activities Motivating individuals and groups Evaluating the performance of individuals and groups

Copyright 1998 Dekker, Ltd. 49 Human Resources Model Most Recent Model People do not find work objectionable People want to participate in developing objectives and obtaining goals People have a great deal of informational knowledge to contribute to the organization People are creative People are responsible People desire opportunities to affect change People do not find work objectionable People want to participate in developing objectives and obtaining goals People have a great deal of informational knowledge to contribute to the organization People are creative People are responsible People desire opportunities to affect change

Copyright 1998 Dekker, Ltd. 50 Human Resources Model Most Recent Model Managers usually focus on three key aspects of employee motivation Direction Intensity Persistence Managers usually focus on three key aspects of employee motivation Direction Intensity Persistence

Copyright 1998 Dekker, Ltd. 51 A well-designed MACS should include: Multiple perspectives approach to management accounting systems design Incorporation of ethical responsibilities for all firm employees Multiple perspectives approach to management accounting systems design Incorporation of ethical responsibilities for all firm employees

Copyright 1998 Dekker, Ltd. 52 A well designed MACS should include: The development and use of both quantitative and qualitative information in a timely fashion for control, motivation, and performance evaluation

Copyright 1998 Dekker, Ltd. 53 A well designed MACS should include: Participation and empowerment of employees in system design and improvements, and continuous education of employees in understanding how the system functions and how the information can be interpreted meaningfully

Copyright 1998 Dekker, Ltd. 54 A well designed MACS should include: An appropriate reward system to foster goal congruence between employees and the organization and to reduce dysfunctional behavior

Copyright 1998 Dekker, Ltd. 55 Behavioral Consequences of Poorly Designed Measurement Systems Lack of Goal Congruence. Smoothing. Gaming. Data Falsification Lack of Goal Congruence. Smoothing. Gaming. Data Falsification

Copyright 1998 Dekker, Ltd. 56 Exercise #4 Turn to page 681 and work Problem Exercise #4 Turn to page 681 and work Problem