99765186 responsibility accounting
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Segment Reporting andDecentralization
UAA ACCT 202
Principles of Managerial AccountingDr. Fred Barbee
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Planning
Decision
Making
Organizing &Directing
Controlling
Evaluating
The Work of Management
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Controlling Operations
Management by exception
Responsibility Accounting Delegation of authority
Management by walking around
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Responsibility Accounting
. . . is a reporting system in which acost is charged to the lowest level of
management that has responsibility forit.
Vice PresidentMarketing
Vice PresidentProduction
Vice PresidentController
President
and CEO
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Installing ResponsibilityAccounting
Create a set of financialperformance goals (budgets).
Measure and report actualperformance.
Evaluate based on comparison ofactual with budget.
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Responsibility Accounting
Evaluation of responsibility centersdepends on . . .
The extent of delegation of authority; and
A managers preference
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Decentralization . . .
. . . the delegation of authority to thelowest level of management
responsibility that can make decisions.
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Centralization . . .
. . . A centralized organization is one inwhich little authority is delegated to
lower level managers.
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Decentralization
The more decentralized the firm, thegreater the need for control.
Monitor employees
Motivate employees
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Advantages of Decentralization
Top level managers are relieved ofmaking routine decisions.
Higher employee morale
Training
Decisions are made where the action istaking place.
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Disadvantages of Decentralization
Upper level management loses somecontrol.
Lack of goal congruence.
Duplication of effort.
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Decentralization and SegmentReporting
Quick MartAn Individual Store
A Sales Territory
A Service Center
Asegment is anypart or activity of
an organizationabout which amanager seekscost, revenue, or
profit data. Asegment can be
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Cost, Profit, and InvestmentsCenters
Responsibility
Centers
CostCenter
ProfitCenter
InvestmentCenter
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Responsibility Centers: A Systems Perspective
Processing StepsWithin
Information Systems
Data
(Inputs)
Information
(Outputs)
DM
DLMOH
Goods,
Services,Ideas
Working
CapitalEquipmentEtc.
Resources used . . . Capital . . . Output . . .
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Cost, Profit, and InvestmentsCenters
Cost CenterA segment whose
manager hascontrol over
costs,
but not overrevenues orinvestment funds.
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Responsibility Centers:A Systems Perspective
Input OutputProcess
Control only this
Cost Center
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Evaluation . . .
A cost center is evaluated by means ofperformance reports (i.e., comparison
of actual with standard).
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Responsibility Centers:A Systems Perspective
Input OutputProcess
Control these
Profit Center
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Cost, Profit, and InvestmentsCenters
Profit CenterA segment whose
manager hascontrol overboth
costs and
revenues,but no control overinvestment funds.
RevenuesSales
Interest
Other
CostsMfg. costs
CommissionsSalaries
Other
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A Profit Center . . .
A profit center is evaluated bymeans of contribution margin
income statements.
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Cost, Profit, and InvestmentsCenters
InvestmentCenter
A segment whosemanager has
control over costs,
revenues, andinvestments inoperating assets. Corporate Headquarters
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Responsibility Centers:A Systems Perspective
Input OutputProcess
Control these
Investment Center
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Investment Center
An investment center is evaluated bymeans of the Return on Investment
(ROI) or the Residual Income (RI) it isable to generate.
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Respo
nsibilityCenters
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Profit Center Vs. InvestmentCenter
Aprofit center is focused on profits asmeasured by the difference between
revenues and expenses. An investment center is compared with
the assets employed in earning
revenues.
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Levels of SegmentedStatements
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Levels of SegmentedStatements
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Levels of SegmentedStatements
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Lets look more closely at the Television
Divisions income statement.
Webber, Inc. has two divisions.
Computer Division Television Division
Webber, Inc.
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Our approach to segment reporting uses thecontribution format.
Income Statement
Contribution Margin Format
Television Division
Sales 300,000$Variable COGS 120,000
Other variable costs 30,000
Total variable costs 150,000
Contribution margin 150,000Traceable fixed costs 90,000
Division margin 60,000$
Cost of goodssold consists of
variable
manufacturingcosts.
Fixed andvariable costs
are listed inseparatesections.
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Segment marginis Televisionscontribution
to profits.
Income Statement
Contribution Margin Format
Television Division
Sales 300,000$
Variable COGS 120,000
Other variable costs 30,000
Total variable costs 150,000
Contribution margin 150,000
Traceable fixed costs 90,000Division margin 60,000$
Our approach to segment reporting uses thecontribution format.
Division Segment Margin
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Traceable and Common Costs
FixedCosts
Traceable
Costs arise becauseof the existence of
a particular segment
Common
A cost that supports more than onesegment but that would not goaway if any particular segment
were eliminated.
Dont allocatecommon costs.
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Identifying Traceable FixedCosts
Traceable costswould disappear overtime if the segment itself disappeared.
No computerdivision means . . .
No computerdivision manager.
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Identifying Common FixedCostsCommon costsarise because of overalloperation of the company and are not due tothe existence of a particular segment.
No computerdivision but . . .
We still have acompany president.
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Levels of SegmentedStatements
Income Statement
Company Television Computer
Sales 500,000$ 300,000$ 200,000$
Variable costs 230,000 150,000 80,000
CM 270,000 150,000 120,000Traceable FC 170,000 90,000 80,000
Division margin 100,000 60,000$ 40,000$
Common costs 25,000
Net operatingincome 75,000$
Common costs should not
be allocated to thedivisions. These costs
would remain even if oneof the divisions were
eliminated.
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Traceable Costs Can BecomeCommon Costs
Fixed costs that are traceable on onesegmented statement can become
common if the company is divided intosmaller segments.
Lets see how this works!
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U.S. Sales Foreign Sales
Regular
U.S. Sales Foreign Sales
Big Screen
Television
Division
Traceable Costs Can BecomeCommon Costs
ProductLines
SalesTerritories
Webbers Television Division
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Income StatementTelevision
Division Regular Big Screen
Sales 300,000$ 200,000$ 100,000$
Variable costs 150,000 95,000 55,000
CM 150,000 105,000 45,000Traceable FC 80,000 45,000 35,000
Product line margin 70,000 60,000$ 10,000$
Common costs 10,000
Divisional margin 60,000$
Traceable Costs Can BecomeCommon Costs
Fixed costs directly tracedto the Television Division
$80,000 + $10,000 = $90,000
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Traceable Costs Can BecomeCommon Costs
Of the $90,000 cost directly traced to the TelevisionDivision, $45,000 is traceable to Regular and $35,000
traceable to Big Screen product lines.
Income StatementTelevision
Division Regular Big Screen
Sales 300,000$ 200,000$ 100,000$
Variable costs 150,000 95,000 55,000
CM 150,000 105,000 45,000Traceable FC 80,000 45,000 35,000
Product line margin 70,000 60,000$ 10,000$
Common costs 10,000
Divisional margin 60,000$
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Income StatementTelevision
Division Regular Big Screen
Sales 300,000$ 200,000$ 100,000$
Variable costs 150,000 95,000 55,000
CM 150,000 105,000 45,000Traceable FC 80,000 45,000 35,000
Product line margin 70,000 60,000$ 10,000$
Common costs 10,000
Divisional margin 60,000$
Traceable Costs Can BecomeCommon Costs
The remaining $10,000 cannot be traced toeither the Regular or Big Screen product lines.
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Segment Margin
The segment margin is the best gauge ofthe long-run profitability of a segment.
Time
P
rofits
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Responsibility and Controllability
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Controllability is . . .
The degree of influence that a specificmanager has over costs, revenues, or
other items in question.
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Controllability
Few costs are
clearly under thesole influence ofone manager.
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Controllability
With a longenough time
span, all costswill come undersomeones
control.
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The Controllability Principle
ManagementActions
UncontrollableEnvironmental
Effects
CostsManagers onlypartially control
costs.
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Rewards
. . . lead to more predictablerewards for managers.Management
Actions
Uncontrollable
EnvironmentalEffects
PerformanceMeasures
Costs
The Controllability Principle
Performance measurementsystems that are based on
controllable costs . . .
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The performance measures and rewardswill influence management to focus on the
controllable costs.
ManagementActions
Performance
MeasuresCosts Rewards
The Controllability Principle
Performance
Measures
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When performance measuresare affected by uncontrollable
environmental effects . . .
ManagementActions
Uncontrollable
EnvironmentalEffects
PerformanceMeasures
Costs Rewards
The Controllability Principle
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. . . management may try to controlthe performance measure rather than
the underlying cost.
ManagementActions
Uncontrollable
EnvironmentalEffects
PerformanceMeasures
Costs Rewards
The Controllability Principle
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Hi d t P C t
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Hindrances to Proper CostAssignment
The Problems
Omission of some
costs in the
assignment process.
Assignment of costs
to segments that are
really common costs of
the entire organization.
The use of inappropriate
methods for allocating
costs among segments.
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Omission of Costs
Costs assigned to a segment should includeall costs attributable to that segment from
the companys entirevalue chain.
Product CustomerR&D Design Manufacturing Marketing Distribution Service
Business FunctionsMaking Up The
Value Chain
I i t M th d f All ti
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Inappropriate Methods of AllocatingCosts Among Segments
Segment1
Segment3
Segment4
Failure to tracecosts directly
Arbitrarily dividingcommon costs
among segments
Inappropriateallocation base
Segment2
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Return on Investment
The ROI formula is expressed as:
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Return on Investment
Where . . .
IncomeMargin = --------------------
Sales
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Return on Investment
Where . . .
SalesTurnover = ------------------------------
Invested Capital
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Income------------------------------
Sales
Sales------------------------------
Invested Capital
x
Return on Investment
The ratio of
operating
income to sales
The efficiencyof asset
utilization.
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Income
------------------------------
Sales
Sales
------------------------------
Invested Capital
x
Return on Investment
The ratio ofoperating
income to sales
The efficiencyof asset
utilization.
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Income
------------------------------
Invested Capital= ROI
Return on Investment
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SellingExpense
Admin.
Expense
Cost of
Goods Sold
Sales
OperatingExpenses
Net Oper.
Income
Sales
Margin
Sales - OE
NOI / Sales
Margin is a measure of managements
ability to control operating expenses in
relation to sales.
T i f th t f
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Accounts
Receivable
Inventory
PP&E
Other
Assets
Cash
Current
Assets
Noncurr.
Assets
Ave Oper
Assets
Sales
Turnover
CA + NCA
Sales / AOA
Turnover is a measure of the amount of
sales that can be generated in an
investment center for each dollar investedin operating assets.
Sales
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Selling
ExpenseAdmin.
Expense
Accounts
Receivable
Inventory
PP&E
Other
Assets
Cost of
Goods Sold
Cash
Sales
Operating
Expenses
Net Oper.
Income
Sales
Margin
ROI
Current
Assets
Noncurr.
Assets
Ave Oper
Assets
Sales
Turnover
Sales - OE
CA + NCA
M x T
NOI / Sales
Sales / AOA
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Measuring Income andInvested Capital
Income
------------------------------
Sales
Sales
------------------------------
Invested Capitalx
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Measuring Income
Variety of possibilities
Text uses EBIT (Net Operating Income)
Earnings Before Interestand Taxes
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Measuring Invested Capital
Variety of possibilities
Text uses Net Book Value
Consistent with how PP&E is listed on theBalance Sheet.
Consistent with the computation ofoperating income.
Return on Investment (ROI)
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Return on Investment (ROI)Formula
ROI = Net operating incomeAverage operating assets
Cash, accounts receivable, inventory,plant and equipment, and other
productive assets.
Income before interestand taxes (EBIT)
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Improving the ROI
IncreaseSales
ReduceExpenses Reduce
Assets
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XYZ Company
Income (EBIT)
Sales
Invested Capital
$30,000
$500,000
$200,000
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$30,000--------------
$500,000
$500,000--------------
$200,000
x
Return on Investment
6% 2.5
x15%=
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Approach #1:Increase Sales
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Increase Sales . . .
Assume that XYZ is able to increasesales to $600,000.
Net Operating Income increases to$42,000.
Average Operating Assets remain
unchanged.
What is the impact on ROI?
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$42,000--------------
$600,000
$600,000--------------
$200,000
x
Return on Investment
7% 3.0x
21%=
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Reduce Expenses . . .
Assume that XYZ is able to reduceexpenses by $10,000
Net Operating Income increases to$40,000.
Average Operating Assets and sales
remain unchanged.
What is the impact on ROI?
R I
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$40,000--------------
$500,000
$500,000--------------
$200,000
x
Return on Investment
8% 2.5x
20%=
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Reduce Assets . . .
Assume that XYZ is able to reduceits operating assets from $200,000
to $125,000. Sales and Net Operating Income
remain unchanged.
What is the impact on ROI?
R t I t t
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$30,000--------------
$500,000
$500,000--------------
$125,000
x
Return on Investment
6% 2.4x
24%=
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Advantages of ROI . . .
It encourages managers to focus on therelationship among sales, expenses,
and investment. It encourages managers to focus on
cost efficiency.
It encourages managers to focus onoperating asset efficiency.
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Disadvantages of ROI
It can produce a narrow focus ondivisional profitability at the expense of
profitability for the overall firm. It encourages managers to focus on the
short run at the expense of the long
run.
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Overinvestment
Evaluation in terms ofprofit can leadto overinvestment.
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Overinvestment
Increases inAssets
Increases inProfits
Manager
Company
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Underinvestment
Evaluation in terms ofROI can lead tounderinvestment.
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Overinvestment
Decreases inAssets
Increases inROI
Manager
Company
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Criticisms of ROI . . .
ROI tends to emphasize short-runperformance over long-run profitability.
ROI may not be completely controllableby the division manager due tocommitted costs.
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Multiple Criteria . . .
Growth in market share
Increases in productivity
Dollar profits
Receivables turnover
Inventory turnover Product innovation
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Residual Income . . .
. . . is the net operating incomethat an investment center is able to
earn above some minimum rate ofreturn on its operating assets.
Residual Income = EBIT Required Profit
= EBIT Cost of Capital x Investment
Residual Income Example
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Residual Income Example
Division BDivision A
Invested Capital
EBIT Last Year
*Min. Required R of R
Residual Income
$1,000,000
200,000
120,000
$80,000
$3,000,000
450,000
360,000
$90,000
*Minimum Required Rate of Return = 12%
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Problem with RI . . .
RI cannot be used to compareperformance of divisions of different
sizes.
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Advantage of RI . . .
RI encourages managers to makeprofitable investments that would be
rejected under the ROI approach.
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Example . . .
Assume that ABC Companys Division Ahas an opportunity to make an
investment of $250,000 that wouldgenerate a 16% return.
The Divisions current ROI is 20%.
Should the investment be made?
Marsh Company
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Return on Investment
OverallNew
Invested Capital (1)
NOPAT (2)
ROI (1)/(2)
*$250,000 x 16% = $40,000
$250,000
*40,000
16%
$1,250,000
240,000
19.2%20%
200,000
$1,000,000
Present
Marsh Company
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Return on Investment
OverallNew
Invested Capital (1)
NOPAT (2)
ROI (1)/(2)
*$250,000 x 16% = $40,000
$250,000
*40,000
16%
$1,250,000
240,000
19.2%20%
200,000
$1,000,000
Present
Reject - Reduces overall ROI!!!
Marsh Company
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Residual Income
OverallNew
Invested Capital (1)
NOPAT (2)
Minimum RofR*
Residual Income
$250,000
40,000
$30,000
$1,250,000
240,000
$150,000$120,000
200,000
$1,000,000
Present
$80,000 $10,000 $90,000
*Minimum Required Rate of Return = 12% x Invested Capital
Accept - Positive Residual Income!!!
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Economic Value Added
Economic Value Added (EVA) is after-tax operating profit minus the total
annual cost of capital If EVA is positive, the company is creating
wealth.
If EVA is negative, the company isdestroying capital.
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Calculating EVA . . .
EVA = After-tax operating incomeminus (the weighted-average cost of
capital times total capital employed) Determine weighted average cost of capital
Determine total dollar amount of capital
employed
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