Chapter Summary

Employees may have goals and objectives that differ from those of the organization. Incentive systems provide a tool that helps align employee goals with those of the organization by drawing attention to the organization's goals, by choosing to measure particular components of performance, and by rewarding employees for the actual outcomes associated with those components of performance being measured.

The Dupont system measures return on investment (ROI) by dividing the operating earnings of a product line or division by the average invested capital used in that product line or division. ROI can be broken into two components, return on sales and capital turnover. Return on sales is computed by dividing the operating income by the total sales for the particular business segment or product line. It tells managers the amount of earnings generated from one dollar of sales. Capital turnover is a measure created by dividing sales by the average invested capital to generate those sales. Capital turnover tells managers the amount of sales generated by a dollar of invested capital.

Return on investment provides a systematic method for evaluating a product line or business segment. It is a percent that can be used to compare financial performance across products and/or business segments. ROI can be broken into its component parts to further analyze business performance. Criticisms of ROI include that it motivates short-term decision making, that managers choose to underinvest in projects with acceptable ROIs from the firm's perspective, that it is difficult to match invested capital with sales and operating earnings, and that ROI focuses only on financial measures and ignores other important components of the value chain.

Residual income is the amount by which operating earnings exceed a minimum acceptable return on the average invested capital. Economic value added is a refinement of the residual income measure that makes many adjustments for items such as taxes, interest, and amortization. Like RI, EVA does not motivate managers to turn down investments expected to earn a return below their current ROI, but above the minimum acceptable return to the firm.

The balanced scorecard uses four lenses to consider business performance. These lenses provide financial, business process, customer, and learning and growth perspectives. Each of these perspectives helps to identify goals, strategies to achieve the goals, and measures to assess goal achievement.

In creating management compensation plans designers consider multiple characteristics such as fixed salary versus bonuses and the types of bonuses (cash, stock, or stock options). In addition, numerous design trade-offs include choosing to emphasize local versus global performance or choosing a cooperative or a competitive incentive scheme.

The focus of this chapter is rewarding business performance using incentive compensation systems to motivate decision makers to align their goals and objectives with the organization's. We discussed how the DuPont ROI system measures financial performance and why some critics think ROI is flawed. We saw how RI and EVA can correct some of the criticisms of ROI. The balanced scorecard is a broader means for measuring and rewarding business performance. Finally, we described the components of and design choices for management compensation. In the remaining chapter we discuss capital budgeting tools. These are financial tools that managers use to decide which major investments to undertake.

Personal competence and professional judgment are, perhaps, the most important factors in ensuring the integrity of financial information. Competence is demonstrated by one's education and professional certification (CPA, CMA, CIA). Professional judgment is important because accounting information is often based on inexact measurements and assumptions are required. Ethical behavior refers to the quality of accountants being motivated to "do the right thing" in applying their skills.

Accounting opens the door to many diverse career opportunities. Public accounting is the segment of the profession where professionals offer audit, tax, and consulting services to clients. Management, or managerial, accounting refers to that segment of the accounting profession where professional accountants work for individual companies in a wide variety of capacities. Many accountants work for various governmental agencies. Some accountants choose education as a career and work to prepare students for future careers in one of the other segments of the accounting profession. While keeping detailed records (that is, bookkeeping) is a part of accounting, it is not a distinguishing characteristic of a career in accounting; in fact, many accounting careers involve little or no bookkeeping.

In this chapter we have established a framework for your study of accounting. You have learned how financial accounting provides information for external users, primarily investors and creditors, and how management accounting provides information for internal management. We have established the importance of integrity in accounting information and have learned about several things that build integrity. Looking ahead, in Chapter 2 we begin to look in greater depth at financial accounting and, more specifically, financial statements. You will be introduced to the three primary financial statements that provide information for investors and creditors. As the text progresses, you will learn more about the wealth of important information that these financial statements provide and how that information is used to make important financial decisions.