Management Accounting:
A Road of Discovery
Management Accounting:
A Road of Discovery
James T. Mackey
Michael F. Thomas
Presentations by:
Roderick S. Barclay
Texas A&M University - Commerce
James T. Mackey
California State University - Sacramento
© 2000 South-Western College Publishing
Chapter 14
How can we control the change
process?
Capital budgeting and the
balanced scorecard
Key Learning Objectives
• Define present value, and
compute the present value of a
lump sum and an annuity.
• Calculate an investment’s net
present value and relate NPV to
the investment’s time-adjusted
ROI.
• Discuss how the timing of
cashflows and risk affect capital
budgeting decisions, and
determine the payback period.
• Explain the need for multiple
capital budgeting methods, and
calculate the accounting rate of
return.
• Describe four perspectives for
long-run value and create a
balanced scorecard.
• [Appendix A] Incorporate taxes
into NPV and time-adjusted ROI
calculations.
Capital Budgeting



Capital Budgeting influences cashflows for
many years.
Capital projects usually involve large cash
outflows early and smaller cash inflows over
many years later in the project.
A thorough knowledge of the process and the
measurements involved is necessary to avoid
bad decisions.
Part I
The Time Value of Money
Compound Interest and
The Time Value of Money
Deposit $100 today
In 1 year
Savings account $100
beginning
balance
+ interest
earned
Beginning
balance x 10%
Savings account ending balance
In 2 years
$100
$110
Beginning
+ 10 balance x 10%
+ 11
$110
$121
‘FUTURE Value’ includes compounded returns — earning interest
on interest — the actual dollars received in the future.
Comparing Future Values and Present
Values
Present value
$100
x (1 + compound interest rate) =
x 1.21 =
Future value
$122
Future value
$121
 (1 + compound interest rate) =
1.21 =
Present value
$100
x (1 / 1.21) =
$100
x Present value (PV) factor
x 0.82644 =
Present value
$100
or
$121
Or
Future value
$121
The ‘Present Value’ of future cashflows is the value of future
cashflows in current dollars today.
Comparing Present Value Factors for
Lump Sums and Annuities
PV factor for a lump sum
at 10%
Year
Cashflow
Present Value
1
$200,000
x
0.9091
=
$181,820
2
$200,000
x
0.8264
=
165,280
3
$200,000
x
0l,7518
=
150,260
4
$200,000
x
0.6830
=
136,600
5
$200,000
x
0.6209
=
124,180
6
$200,000
x
0.5645
=
112,900
7
$200,000
x
0.5132
=
102,640
$200,000
x
4.8684
=
$973,680
10% PV factor for an annuity = the sum of
the PV factors for a lump sum
Because money today is more valuable than money in the
future, future money must be ‘discounted’ to today’s value.
Using ROI and NPV in Capital Budgeting





Review Exhibit 14-7, p. 514 and remember the
following constraints.
The ‘discount or interest’ rate is the opportunity cost
of investing in assets, like machines, rather than the
next best investment.
In practice discount rates could be the company’s
cost of capita, required Return On Investment, or a
‘risk adjusted’ Return On Investment.
Remember, to increase value we must only accept
projects that have more value than our existing uses
of cash.
Therefore, we only accept projects with positive NPV.
The idea is that the NPV is the value increase we can
expect if we make the investment.
Cashflow Issues




Review and analyze Exhibit 14-8, p. 515,
‘Cashflow Timing Effects on NPV and ROI’.
Review and analyze Exhibit 14-9, p. 516,
‘Comparing Present Value Factors for
Different Discount Rates’.
The value of future cashflows depends upon
the company’s current opportunities or some
version of their ROI.
Change ‘the time it takes to receive money’,
or ‘company’s ROI’, and the present value will
change.
The Cashflow ‘Teeter-Totter’ and Risk


Review Exhibit 14-10, p. 517, ‘Future
Cashflows are Less Valuable with Higher
Discount Rates.
Remember:


More RISK means future cashflows are more
uncertain.
More RISK requires higher expected returns to
compensate for the chances of NOT receiving
future cashflows.
More Risk Issues





Hence, some companies use a ‘RISK-Adjusted Rate of
Return’ for riskier investments.
Because the future is never certain, most companies
use multiple measures to evaluate capital
investments.
THE TIME ADJUSTED RETURN ON INVESTMENT is
the discount rate that makes the value of the cash
investment exactly equal to the cash returned. That
is, the net present value is zero.
Usually this calculation requires a computer.
The time adjusted ROI is the breakeven return for
the project. If the time adjusted ROI is greater than
the company’s current ROI, then the project will
increase the company’s value — Accept.
Concept Review


Revisit Exhibit 14-6, p. 513, and 14-7, p. 514.
Apply the understanding of those exhibits
with the knowledge you have gained from the
succeeding exhibits and you should have a
thorough understanding of the concepts
underlying NPV and the Time Value of Money.
Part II
Payback Period —
Another Way to Look at the Project
Payback Questions



How long will our investment be at risk?
When do we get our original cash investment
back?
Let’s review some alternatives.
Payback Period for a Constant Annuity
Year
Investment
Now
$1,000,000
Annuity received
Net cashflow
($1,000,000)
1
$400,000
( 600,000)
2
$400,000
( 200,000)
3
$400,000
200,000
4
$400,000
600,000
$200,000
Payback period = 2 years +
$400,000
Payback period = 2.5 years
Payback Period for a Variable Annuity
Year
Investment
Now
$1,000,000
Annuity received
Net cashflow
($1,000,000)
1
$100,000
( 900,000)
2
$200,000
( 700,000)
3
$400,000
( 300,000)
4
$700,000
400,000
$300,000
Payback period = 3 years +
$700,000
Payback period = 3.5 years
Part III
Accounting Rate of Return on
Investment
Accounting Rate of Return (ARR)
Investment’s average annual profit
ARR =
Investment’s average book value
$ 30,000
ARR =
$100,000 2
ARR =
60%
Annual ARR calculations follow on the next two slides
Depreciation and Book Value Table
Year
Beginning
book value
Less
depreciation
Ending book
value
Average book
value
1
$100,000
($20,000)
$80,000
$90,000
2
80,000
($20,000)
60,000
70,000
3
60,000
($20,000)
40,000
50,000
4
40,000
($20,000)
20,000
30,000
5
20,000
($20,000)
0
10,000
Annual ARR calculations
Year
Profit

Average book value
=
ARR
1
$30,000 
$90,000
=
33%
2
$30,000 
70,000
=
43%
3
$30,000 
50,000
=
60%
4
$30,000 
30,000
=
100%
5
$30,000 
10,000
=
300%
Management Considerations in Using
Capital Budgeting Methods
Capital budgeting method
Net present value (NPV)
Time adjusted ROI (IRR)
Payback period
Accounting rate of return
(ARR)
Differentiating features
Reinvests cashflows at the discount
rate.
Reinvests cashflows at the project’s
ROI.
Measures the length of time our
investment is at risk, but does not
consider the time value of money
(the interest we can earn from the
returns).
How the outside world sees us. How
investments affect our financial
statements (again without
considering the time value of
money).
Using Multiple Capital Budgeting Methods
is an International Phenomenon



Visit Exhibit 14-14, p. 522.
Notice that all companies do not use the
same methods for evaluating capital
budgeting.
Note also that not all companies use the
same accounting standards.
Part IV
Nonfinancial Decision Criteria —
The Balance Scorecard
Stakeholders


Stakeholders can significantly influence the
value of an organization.
Therefore, we need to measure factors
important to stakeholder value.
Stakeholder Value
Stakeholders
Source of Value
Measurement Objective
Investors &
creditors
Financial value
Financial returns of the
company compared to
other companies.
Customers
Value of the company’s
goods or services
Characteristics of goods or
services that influence
their value for customers.
Workers &
management
Efficiency of processes
that produce goods &
services
Relative value added by
internal processes.
Workers &
Management
Learning and
Innovation
The value of continuous
improvement
Four Perspectives for a Balanced
Scorecard
The Glass Box
Internal processes
focus — Which
process reflect how
our processes
create value?
Innovation and
Learning focus —
Which measures
reflect continuous
improvement?
The Black Box
Financial focus — Which
measures covey our value to
stockholders and lenders?
Customer focus —
Which measures
reflect our value to
customers?
Reasons for a Balanced Scorecard



The cost of a product doesn’t determine the
value of a product. Value only exists in the
eyes of the customer.
We believe financial measures alone are NOT
sufficient to measure long-term value.
We believe financial measures alone do NOT
always direct management to make valueadding decisions.
Examples of Financial Focus Goals and
Measures
Company
Goals
Measures
Underwater
engineering and
construction



Investor value
Liquidity
Project success



ROI
Cashflow
Project profitability
Electronics firm



Sales growth
Profitability
Prosperity

Annual change in
sales and profits
ROI
Cashflow

Aggressive global
expansion
Retain the preferred
supplier
Increasing share of
market growth

Food company






Ratio of U.S. to
international sales
Volume and revenue
trends by type of
business
Company growth
versus industry
growth
More Examples of Financial Focus Goals
and Measures
Company
Commercial bank
Goals



Efficiency
Loan loss
minimization
Loan delinquencies
Measures



Biotechnology firm



Growth
Profitability
Industry leadership



Overhead expense
ratios
Number of problem
loans, early
detection
Number of bad loans
underwritten
Revenue percentage
increase
ROI, Earnings per
share
Market share
Examples of Customer Focus Goals and
Measures
Company
Underwater
engineering and
construction
Goals



Value for the money
Hassle free
relationships
Innovation
Measures



Electronics firm



Customer support
Delivery
Quality



Competitive price
comparisons
Customer
satisfaction surveys
Market share
Response time
On time delivery
ratio
Number of defects,
number of visits to
customers
Examples of Customer Focus Goals and
Measures
Company
Food company
Goals



Commercial bank



Measures
Customize products
for local customers
Lowest cost supplier
Product expansion


Personalized service
Pricing
Competitive
products




Cross-sell ratio
Total cost comparison
with competition
Percentage of R&D
products being test
marketed by
customers
Number of complaints
Competitive
comparisons
Number of products
offered per year
Examples of Customer Focus Goals and
Measures
Company
Biotechnology firm
Goals



New products
Accurate invoices
Early payment
Measures



Percentage of sales
from new products
Percentage of error
free invoices
Percentage of
customers paying
early
Examples of Internal Processes Focus
Goals and Measures
Company
Underwater
engineering and
construction
Goals



Workplace safety
Project success
Project quality
Measures



Electronics firm



Manufacturing
efficiency
Innovation
New businesses



Safety incident index
Project performance
index
Rework
Lead time
Rate of new product
introductions per
quarter
Number of new
business starts per year
Examples of Internal Processes Focus
Goals and Measures
Company
Food company
Goals



Predictable
production
Lowest cost base
Distribution
efficiency
Measures



First pass success
rate
Comparison against
lowest cost
competitor
Percent of perfect
orders
Commercial bank

Incorporated in
customer focus

Incorporated in
customer focus
Biotechnology firm



Low cost products
Inventory reduction
New products

Per unit cost versus
competition
Inventory vs.
percentage of sales
Budget vs. actual
number introduced


Examples of Innovation and Learning
Focus Goals and Measures
Company
Goals
Measures
Underwater
engineering and
construction



Employee innovation 
Revenue generation

Employee morale

Number of suggestions
per employee
Revenue per employee
Staff attitude survey
Electronics firm

Research and
development
Market leadership
Technology
leadership
Number of patents
Market share in all
major markets
Product performance
compared to
competition





Examples of Innovation and Learning
Focus Goals and Measures
Company
Food company
Goals



Commercial bank 


Measures
Culture supports
innovation
Linking strategies to
rewards
Develop core
competencies

Enhanced job skills
Participation in firm’s
success
Competitive wages
and benefits





Annual preparedness
assessment
Net income per dollar
of payroll
Percent competency
deployment matrix
filled
Training, schooling
Bonuses based on
corporate and
personal
performances
Annual market survey
Examples of Innovation and Learning
Focus Goals and Measures
Company
Biotechnology
firm
Goals


New active
ingredients
Prprietary position
Measures


Number of new
ingredients identified
Number of new
patents
Criteria for Choosing Performance
Measures
The Communication focus
 Measures should reflect longterm value creation
 Communicate to external
stakeholders that we are
creating long-term value
 Communicate to internal
stakeholders that they are
creating long-term value
The Behavioral focus
 Is this what we want our
people to do?
 Does this measure correctly
motivate them?
 Is
this measure
understanding and common
sense to those being
evaluated by it?
Multree Homes


Review Exhibit 14-21, p. 532 ‘Multree Homes
Balanced Scorecard’.
This will provide you an example of the
Balanced Scorecard methodology applied to a
company with which you are intimately
familiar.