1. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-1 Responsibility Centers A responsibility center is the point in an organization where the control over revenue or expense is located, e.g. division,department or a single machine. A responsibility center may be divided into three categories  cost  profit  investment

2. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-2 Cost Types of Responsibility Centers Cost Center A business segment that incurs expenses but does not generate revenue.

3. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-3 Profit Center A part of the business that has control over both revenues and expenses, but no control over investment funds. Revenues Sales Interest Other Expenses Manufacturing Commissions Salaries Other Types of Responsibility Centers

4. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-4 Investment Center A profit center where management also makes capital investment decisions. Corporate Headquarters Types of Responsibility Centers

5. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-5 Measuring Managerial Performance Return on investment (ROI) Residual income (RI) Cost Center Cost control Quantity and quality of services Profit Center Investment Center Evaluation Measures Profitability

6. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-6 Return on investment is the ratio of income to the investment used to generate the income. ROI = Net Income Investment Return on Investment

7. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-7 ROI = Net Income Investment ROI = Net Income Sales × Investment Margin Turnover Return on Investment

8. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-8 Cola Company reports the following: Net Income $ 30,000 Sales $ 500,000 Investment $ 200,000 Let’s calculate ROI. Return on Investment

9. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-9 ROI = 6% × 2.5 = 15% Return on Investment ROI = Net Income Sales × Investment ROI = $30,000 $500,000 × $200,000

10. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-10 Improving R0I Three ways to improve ROI Ê Increase Sales Ë Reduce Expenses Ì Reduce Investment

11. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-11 Cola Company’s manager was able to increase sales to $600,000 which increased net income to $42,000. There was no change in investment. Let’s calculate the new ROI. Improving R0I

12. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-12 Cola Company increased ROI from 15% to 21%. ROI = 7% × 3 = 21% ROI = Net Income Sales × Investment ROI = $42,000 $600,000 × $200,000 Improving R0I

13. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-13 ROI - A Major Drawback As division manager at Cola Company, your compensation package includes a salary plus bonus based on your division’s ROI -- the higher your ROI, the bigger your bonus. The company requires an ROI of 20% on all new investments -- your division has been producing an ROI of 30%. You have an opportunity to invest in a new project that will produce an ROI of 25%. As division manager would you invest in this project?

14. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 9-14 ROI - A Major Drawback As division manager, I wouldn’t invest in that project because it would lower my pay! Gee... I thought we were supposed to do what was best for the company!