Economic Value Added Managerial Accounting Prepared by Diane Tanner University of North Florida Chapter 26

Evaluation Measurement Options  Methods which help solve over-investment and under-investment problems  Residual income  Balanced scorecard  Goes beyond financial measures to include multiple performance dimensions  Economic value added  Makes investing in longer term projects beneficial 2

Economic Value Added (EVA)  A variation of residual income  Potentially solves both over- and under- investment problems  Compels investment in the range between required rate of return and current ROI 3

How EVA Differs from Residual Income  Removes the incentive for management to avoid spending money on enhancements which impact the long-term business operations  Treats certain costs as assets instead of the GAAP-mandated treatment as expenses  Considered accounting distortions  R&D  Employee training costs  Customer development costs 4

Calculating EVA  Calculate NOPAT and invested capital in the same manner as with residual income  Draw accounts for potential intangibles and amortize for all years involved  Calculate the accounting distortions effect on net income, and adjust for income taxes. Add or subtract from NOPAT depending on the effect.  Calculate the accounting distortions effect on invested capital, and add to invested capital 5 NOPAT +/- [Acctg Distortions, nt] Invested Capital +Acctg distortions ‒ WACC EVA =

6 The End