copyright 1998 dekker, ltd. 1. 2 capital budgeting understand capital budgeting as a tool to...
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Capital BudgetingCapital 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
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Capital BudgetingCapital 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
ReturnThe increased cash flows in the future
resulting from the assets acquired
ReturnThe increased cash flows in the future
resulting from the assets acquired
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Dekke
r, Ltd.Time Value of MoneyTime 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
$1.0000
Year 5
$1.2763
Value of $1.00 today Value 5 years from today
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Number of PeriodsNumber of Periods
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
In this case, n = 5
10-21 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.
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Rate of ReturnRate of Return
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
5% 5% 5% 5% 5%
10-23 1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young
Rate of Return expected from the investment each YEAR
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Future ValueFuture Value
6-15 1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young
5%Year 0
$1.0000
5%Year 1
5%Year 2
5%Year 3
5%Year 4 Year 5
$1.2763
The Future Value of $1.00
5 years from now at a 5% annual rate of return
10-25 1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young
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Dekke
r, Ltd.Compound Growth
of InvestmentCompound Growth
of Investment
6-16 1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young
5%Year 0
$1.0000
5%Year 1
5%Year 2
5%Year 3
5%Year 4 Year 5
$1.2763$1.0500 $1.1025 $1.1576 $1.2155
AND THIS IS HOW IT
WOULD GET THERE!!
AND THIS IS HOW IT
WOULD GET THERE!!
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Dekke
r, Ltd.Compound Growth
of Future ValueCompound Growth
of Future Value
6-16 1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young
0
10
20
30
40
1 5 9 13 17
5%
10%
15%
20%
Periods
Val
ue
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Dekke
r, Ltd.Present Value
The current monetary worth of an amount to be paid in the future under stated conditions of
interest and compounding
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
$0.7835
5%Year 1
5%Year 2
5%Year 3
5%Year 4 Year 5
$1.000
The Present Value of $1.00 in 5 years at a 5% annual rate of return
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Capital BudgetingCapital 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
ReturnThe increased cash flows in the future
resulting from the assets acquired
ReturnThe increased cash flows in the future
resulting from the assets acquired
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Dekke
r, Ltd.Future Value of an Annuity Future Value of an Annuity
6-16 1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young
5%Year 0
$0.7835
5%Year 1
5%Year 2
5%Year 3
5%Year 4 Year 5
$1.000
The Future Value of an Annuity is the sum of payments plus accumulated interest
$1.000$1.000
$1.000
$1.2151.1571.1031.0501.000
$5.525
10-31 1996 Prentice Hall Business Publishing Management Accounting, 2nd ed., Atkinson, Banker, Kaplan, and Young
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Dekke
r, Ltd.Present Value
of an Annuity
Present Valueof 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 4 Year 5
$0.7835$1.000
$1.000$1.000
$1.000
$0.783.823.864.907.952
$4.329
$1.000
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Dekke
r, Ltd.Required Rate of Return ®
The interest rate used to compute present values. It is also known as
the Discount Rate.
Required Rate of Return ®The interest rate used to compute
present values. It is also known as the Discount Rate.
Cost of CapitalThe minimum return that the organization
must earn on its investments to meetits investors’ return requirements
Cost of CapitalThe minimum return that the organization
must earn on its investments to meetits investors’ return requirements
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Payback CriterionPayback Criterion
Year 0
-$70,000
$70,000
Year 1 Year 2 Year 3 Year 4 Year 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
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Dekke
r, Ltd.Accounting Rate of ReturnAccounting Rate of Return
Average IncomeAverage Investment
$8,000$30,000=
26.67%
Average IncomeAverage Investment
$8,000$30,000=
26.67%
Accounting Rate of Return =
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Dekke
r, Ltd.Net Present ValueNet Present Value
Net Present Value = PV Cash Inflows - PV Cash Outflows
Net Present Value = PV Cash Inflows - PV Cash Outflows
This model is the most widely recommended approach to capital
budgeting since it specifically considers the time value of money and provides a
basis for valuing the firm
This model is the most widely recommended approach to capital
budgeting since it specifically considers the time value of money and provides a
basis for valuing the firm
(where is ‘the sum of’)(where is ‘the sum of’)
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Steps in Computing NPVSteps in Computing NPV
Choose the period lengthIdentify the firm’s cost of capitalIdentify the incremental cash flows for
each periodCompute the present value of each period’s
cash flowsSum the project’s cash inflows and outflows
and determine the NPVIf the NPV is positive, then the project is
acceptable from an economic perspective
Choose the period lengthIdentify the firm’s cost of capitalIdentify the incremental cash flows for
each periodCompute the present value of each period’s
cash flowsSum the project’s cash inflows and outflows
and determine the NPVIf the NPV is positive, then the project is
acceptable from an economic perspective
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Dekke
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ExampleNet Present Value
ExampleCost of Capital 10%
Time Amount PV Factor PV0 (70,000)$ 1.0000 (70,000.00)$ 1 20,000 0.9091 18,181.822 20,000 0.8264 16,528.933 20,000 0.7513 15,026.304 20,000 0.6830 13,660.275 30,000 0.6209 18,627.64
12,024.95$ Net Present Value
See Exhibit 10-4, P. 467See Exhibit 10-4, P. 467
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Dekke
r, Ltd.Return on Investment (ROI)Return on Investment (ROI)
The discount rate that makes a project’snet present value equal zero.
Also called the Internal Rate of Return
The discount rate that makes a project’snet present value equal zero.
Also called the Internal Rate of Return
Return on Investment 16.14%
Time Amount PV Factor PV0 (70,000)$ 1.0000 (70,000.00)$ 1 20,000 0.8610 17,220.602 20,000 0.7414 14,827.453 20,000 0.6383 12,766.874 20,000 0.5496 10,992.665 30,000 0.4733 14,197.51
5.08$ NET PRESENT VALUE
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Dekke
r, Ltd.Applying the ConceptsApplying the Concepts
Exercise #1
Turn to page 494 and work Problem 10-47.
Exercise #1
Turn to page 494 and work Problem 10-47.
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Tax Effects of Capital InvestmentsTax 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
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NPV with Taxes
NPV with Taxes
Time Cash Flow Depreciation Tax Income Tax @ 40% Net Cash Flow PV Factor PV
0 (70,000) (70,000) 1.0000 ($70,000)1 20,000 12,000 8,000 3,200 16,800 0.9346 $15,7012 20,000 12,000 8,000 3,200 16,800 0.8734 $14,6743 20,000 12,000 8,000 3,200 16,800 0.8163 $13,7144 20,000 12,000 8,000 3,200 16,800 0.7629 $12,8175 20,000 12,000 8,000 3,200 16,800 0.7130 $11,9785 10,000 0 0 0 10,000 0.7130 $7,130
Total $6,013
Tax Reduces Cash Flow by Amount of
Tax
Tax Reduces Cash Flow by Amount of
Tax
Assumed Tax Rate 40%
Assumed Tax Rate 40%
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What-if and SensitivityAnalysis
What-if and SensitivityAnalysis
• 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
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Dekke
r, Ltd.What-if and Sensitivity
Analysis
What-if and SensitivityAnalysis
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 forWhat-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 forWhat-if analysis.
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Dekke
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Analysis
What-if and SensitivityAnalysis
ONE MORE POINT!!A Very Detailed Analysis is
required because it provides fora post implementation audit which
is an opportunity to re-evaluatea past decision to purchase along-term asset by comparingexpected and actual inflows
and outflows
ONE MORE POINT!!A Very Detailed Analysis is
required because it provides fora post implementation audit which
is an opportunity to re-evaluatea past decision to purchase along-term asset by comparingexpected and actual inflows
and outflows
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Dekke
r, Ltd.Applying the ConceptsApplying the Concepts
Exercise #2
Turn to page 495 and work Problem 10-52.
Exercise #2
Turn to page 495 and work Problem 10-52.
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Contemporary Management Accounting
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
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Dekke
r, Ltd.Recent Innovations in
Management AccountingLife Cycle Concepts and Contemporary
Management Accounting MethodsLife Cycle Concepts and Contemporary
Management Accounting Methods
ManufacturingCycle
Post-Sale Serviceand
DisposalCycle
Research,Development and Engineering
Cycle
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Research, Developmentand Engineering Cycle
Research, Developmentand 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
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Manufacturing Cycle Costs
Manufacturing Cycle Costs
Costs incurred in the
production of the product.
Usually little ability to engineer change product costs.
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Dekke
r, Ltd.Post-Sale Service
and Disposal CyclePost-Sale Service
and Disposal Cycle
Begins when the first unit produced is in the hands of the customer
Three Stages:Rapid growthTransitionMaturity
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Target CostingTarget 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
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
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A Target Costing ExampleA 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 = $ 15.00
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
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Concerns About Target Costing
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
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Dekke
r, Ltd.Applying the ConceptsApplying the Concepts
Exercise #3
Turn to page 639 and work Problem 13-52.
Exercise #3
Turn to page 639 and work Problem 13-52.
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Nonconformance(Quality)
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
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Dekke
r, Ltd.International Quality
StandardsInternational 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)
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Dekke
r, Ltd.Those who become ISO
9000 registeredThose 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
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Dekke
r, Ltd.Industrial Standard
Z8101-1981Industrial Standard
Z8101-1981
Q Series of Quality StandardsQ Series of Quality Standards
Sets Japanese standards for quality management
Sets Japanese standards for quality management
• Set of quality standards developed by the American Quality Control Society
• Set of quality standards developed by the American Quality Control Society
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Cost of Quality CategoriesCost 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
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Dekke
r, Ltd.Examples of Quality-
Related CostsExamples of Quality-
Related Costs
Prevention Costs
Quality EngineeringQuality Training
Statistical Process ControlSupplier Certification
research of Customer Needs
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Dekke
r, Ltd.Examples of Quality-
Related CostsExamples of Quality-
Related Costs
Appraisal Costs
Inspection of Incoming MaterialsMaintenance of test equipmentProcessing-Control Monitoring
Product Quality Audits
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Dekke
r, Ltd.Examples of Quality-
Related CostsExamples of Quality-
Related Costs
Internal Failure Costs
Overtime Due DefectsWaste
Net Cost of ScrapRework Costs
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Dekke
r, Ltd.Examples of Quality-
Related CostsExamples of Quality-
Related Costs
External Related Costs
Product Liability LawsuitsRepair Costs in the Field
Returned ProductsProduct Liability Recalls
Service CallsWarranty Claims
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Dekke
r, Ltd.Examples of Quality-
Related CostsExamples of Quality-
Related Costs
External Related Costs
Worst of All
Permanent Loss of Customers
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MANAGEMENT ACCOUNTING AND CONTROL SYSTEM DESIGN
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
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Goals of a MACSGoals of a MACS
Planning for the futureMonitoring events
Measuring & recording results of activities
Motivating individuals and groups
Evaluating the performance
of individuals and groups
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Dekke
r, Ltd.Human Resources Model
Most Recent Model
Human Resources ModelMost 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
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Dekke
r, Ltd.Human Resources Model
Most Recent Model
Human Resources ModelMost Recent Model
Managers usually focus on three key aspects of employee motivation
DirectionIntensity
Persistence
Managers usually focus on three key aspects of employee motivation
DirectionIntensity
Persistence
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Dekke
r, Ltd.A well-designed MACS
should include: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
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Dekke
r, Ltd.A well designed MACS
should include: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
The development and use of both quantitative and qualitative
information in a timely fashion for control, motivation, and
performance evaluation
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Dekke
r, Ltd.A well designed MACS
should include: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
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
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Dekke
r, Ltd.A well designed MACS
should include:A well designed MACS
should include:
An appropriate reward system to foster goal congruence between employees and the organization
and to reduce dysfunctional behavior
An appropriate reward system to foster goal congruence between employees and the organization
and to reduce dysfunctional behavior
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Dekke
r, Ltd.Behavioral Consequences of Poorly
Designed Measurement SystemsBehavioral Consequences of Poorly
Designed Measurement Systems
Lack of Goal Congruence.
Smoothing .
Gaming .
Data Falsification
Lack of Goal Congruence.
Smoothing .
Gaming .
Data Falsification
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Exercise #4
Turn to page 681 and work Problem 14-50.
Exercise #4
Turn to page 681 and work Problem 14-50.