ACCT 102 Management Accounting Lecture 18

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ACCT 102Management AccountingLecture 18
Performance Measurement
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Behavioral Accounting
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Control Means
Control

• Getting people to do what organization wants
  (goal congruence)
• Or
• Getting people to always act to maintain or
  improve company value.
• Or
• Getting people to always act according to
  established rules or procedures.

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Motivation

• Motivational analysis involves
• 1. understanding the causes of behavior in
  organizations and the ways to correct negative
  behavior and to promote positive behaviour
• 2. predicting the effects of any managerial
  action
• 3. directing behavior so that organizational and
  individual goals can be achieved.

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Why Consider Motivation?

• Ultimately it is the people who achieve goals
• Remember, its still the people who are going to
  get you results. Don't burn them out. BT 24
  July 2000
• People - most important asset of an organization

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Ability (Skill)
Value of Rewards
Trai-ning Info
Performance
Rewards Intrinsic and Extrinsic
Effort (Will)
Prob that rewards depend upon effort
Commun-ication Good PM
Role Perception
Motivation Model adapted fromLawler Porter,
1967
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The Motivational Cycle
(Ill give you what you want, if you give me
what I want)
Goal Congruence (Get employees to do what we want)
Reward System (Offer adequate rewards)
Responsibility Based on Controllability (Employees
given power to decide)
Performance Measures (Measure the right things,
the right way)
Source Mackey
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Linking Individual and Organizational Objectives
The Organizations Perspective
Objectives what the orgn wants
The Individuals Perspective
Effort what the individual does
Rewards what the individual gets
Results what is measured
Outcomes what orgn gets
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Performance Assessment
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Performance Assessment

• Feedback in the form of performance reports is
  essential if the benefits of budgeting and other
  types of planning are to be fully realized
• Performance reports should include financial and
  non-financial measures.
• Managers need to know how actual results compare
  with current budgets and standards in order to
  control current operations and to improve future
  operations

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Performance Assessment

• According to the concept of management by
  exception, the absence of significant differences
  indicates that activities are proceeding as
  planned, whereas the presence of significant
  differences indicates a need to either take
  corrective action or revise plans
• Evaluation of performance takes place within the
  framework of the organizations overall mission,
  goals and strategies

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Accounting-Based Performance Measures

• Requires a six-step design process
• Choose Performance Measures that align with top
  managements financial goals
• Choose the time horizon of each Performance
  Measure
• Choose a definition of the components in each
  Performance Measure
• Choose a measurement alternative for each
  Performance Measure
• Choose a target level of performance
• Choose the timing of feedback

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Step 1 Choosing among Different Performance
Measures

• Four common measures of economic performance
• Return on Investment
• Residual Income
• Economic Value Added
• Return on Sales
• Selecting Subunit Operating Income as a metric is
  inappropriate since it obviously differs simply
  on the differing size of the subunits

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Return on Investment (ROI)

• ROI is an accounting measure of income divided by
  an accounting measure of investment

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ROI

• Most popular metric for two reasons
• Blends all the ingredients of profitability
  (revenues, costs, and investment) into a single
  percentage
• May be compared to other ROIs both inside and
  outside the firm
• Also called the Accounting Rate of Return (ARR)
  or the Accrual Accounting Rate of Return (AARR)

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ROI

• ROI may be decomposed into its two components as
  follows
• ROI Return on Sales X Investment Turnover
• This is known as the DuPont Method of
  Profitability Analysis

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Residual Income

• Residual Income (RI) is an accounting measure of
  income minus a dollar amount for required return
  on an accounting measure of investment
• RI Income (RRR x Investment)
• RRR Required Rate of Return
• Required Rate of Return times the Investment is
  the imputed cost of the investment
• Imputed costs are costs recognized in some
  situations, but not in the financial accounting
  records

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Economic Value Added (EVA)

• EVA is a specific type of residual income
  calculation that has recently gained popularity
• Weighted-average cost of capital equals the
  after-tax average cost of all long-term funds in
  use

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Return on Sales (ROS)

• Return on Sales is simply income divided by sales
• Simple to compute, and widely understood

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Step 2 Choosing the Time Horizon of the
Performance Measures

• Multiple periods of evaluation are sometimes
  appropriate
• ROI, RI, EVA, and ROS all basically evaluate one
  period of time
• ROI, RI, EVA, and ROS may all be adapted to
  evaluate multiple periods of time

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Step 3 Choosing Alternative Definitions for
Performance Measures

• Four possible alternative definitions of
  investment
• Total Assets Available
• Total Assets Employed
• Total Assets Employed minus Current Liabilities
• Stockholders Equity

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Step 4 Choosing Measurement Alternatives for
Performance Measures

• Possible alternative definitions of cost
• Current Cost of Fixed Assets
• Gross Value of Fixed Assets
• Net Book Value of Fixed Assets

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Step 5 Choosing Target Levels of Performance

• Historically driven targets used to set target
  goals
• Goal may include a Continuous Improvement
  component

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Step 6 Choosing the Timing of the Feedback

• Timing of feedback depends on
• How critical the information is for the success
  of the organization
• The specific level of management receiving the
  feedback
• The sophistication of the organizations
  information technology

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Effectiveness vs Efficiency

• Effectiveness
• Degree to which a goal, objective, or target is
  met.
• Determined by process design
• Efficiency
• Degree to which inputs are used in relation to a
  given level of outputs.
• Determined by process design and how the process
  operates
• Performance may be effective, efficient, both, or
  neither.

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Performance Measures

• What You Measure Is What You Get
• You simply cant manage anything you cant
  measure Richard Quinn - Vice-President Sears
  Merchandising Group
• Measures provide clear, visible targets
  throughout the organization - Thomas Rosetta -
  Gilbarcos Manager

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Performance Measures

• What Gets Measured Gets Done,
• But If We Measure the Wrong things
• The Wrong Things Will be Done
• And
• The Wrong things May be Done Very Well

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Performance Measures

• Performance measures should be tailored towards
  making the organization more competitive.
• In todays globally competitive environment,
  factors important to competing effectively
  include
• Improve quality
• Improve on-time deliveries
• Reduce processing time / costs
• Improve customer satisfaction

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Responsibility Accounting
Responsibility accounting is the structuring of
performance reports addressed to individuals (or
group) members of an organization in a manner
that emphasizes the factors they are able to
control.
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Responsibility Accounting
or on various aspects of the value chain that
are accountable for the accomplishment of
specific activities or objectives.
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Responsibility Accounting
Lower-level managers also become frustrated with
the entire performance reporting system if they
believe upper-level managers expect them to
control items they cannot influence
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Responsibility Accounting
Responsibility accounting can lead to unethical
practices by managers in key positions if too
much pressure is placed on meeting performance
targets.
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Types of Responsibility Centers

• Cost Center
• Revenue Center
• Profit Center
• Investment Center

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Profitability Analysis of Strategic Business
Segments
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Strategic Business Segment

• A strategic business segment is generally one
  that has its own mission and set of goals to be
  achieved.
• The mission of the segment influences the
  decisions that its top managers make in both
  short-run and long-run situations.

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Decentralization
The advantages of decentralization include

• Firsthand decision making
• Timely decisions
• Specialization
• Motivation
• Focus
• Frees up higher level managements time

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Decentralization
The disadvantages of decentralization include

• Compatible performance measurements
• Suboptimization
• Duplication
• Lack of competent personnel

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Centralization
The advantages of centralization include

• Economies of scale
• Sophistication of applications
• Improved control

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Centralization
The disadvantages of centralization include

• Span of control
• Complexity
• Diseconomies of scale

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Segment Reports
What is a segment report?
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Segment Reports
Its an income statement that shows operating
results for portions or segments of a business.
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Segment Reports
Who uses them?
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Segment Reports
Companies where there are distinct divisions of
product lines, geographic territories, or
organization units.
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Segment Reports
Examples of Segment Reports

• Income statements for each retail store,
  district, or division.
• Income statements for each product line or
  service.
• Income statements for each sales territory or
  customer category.
• Cost reports for cost centers.

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Segment Reports
Functions Basic to the Preparation of Every Report

• Identification of the segment.
• Assignment of direct costs to the segment.
• Allocation of indirect costs to the segment.

To effectively report the activities of a
business segment, management should use the
contribution approach, which focuses on the
contribution made by each segment to cover common
costs and to provide for a profit.
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Direct Versus CommonSegment Costs
The segment margin represents the amount that a
segment contributes toward the common costs of
the organization and toward profits.
Direct segment costs are costs that would not be
incurred if the segment being evaluated were to
be discontinued.
Common segment costs are related to more than one
segment and are not directly traceable to a
particular segment.
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Segment Reports

• Common costs not controllable by the segment
  managers should not be used as part of the
  evaluation of segment managers

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Performance Measurement in Multinational Companies

• Additional Difficulties faced by Multinational
  Companies
• The economic, legal, political, social, and
  cultural environments differ significantly across
  countries
• Governments in some countries may impose controls
  and limit selling prices of a companys products
• Availability of materials and skilled labor, as
  well as costs of materials, labor, and
  infrastructure may differ across countries
• Divisions operating in different countries
  account for their performance in different
  currencies

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The Trade-Off Creating Incentives vs. Imposing
Risk

• An inherent trade-off exists between creating
  incentives and imposing risk
• An incentive should be some reward for
  performance
• An incentive may create an environment in which
  suboptimal behavior may occur the goals of the
  firm are sacrificed in order to meet a managers
  personal goals

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Moral Hazard

• Moral Hazard describes situations in which an
  employee prefers to exert less effort (or report
  distorted information) compared with the effort
  (or accurate information) desired by the owner
  because the employees effort (or the validity of
  the reported information) cannot be accurately
  monitored and enforced

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Intensity of Incentives

• Intensity of Incentives how large the incentive
  component of a managers compensation is relative
  to their salary component

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Compensation for Multiple Tasks

• If the employer wants an employee to focus on
  multiple tasks of a job, then the employer must
  measure and compensate performance on each of
  those tasks

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Team-Based Compensation

• Companies use teams extensively for problem
  solving
• Teams achieve better results than individual
  employees acting alone
• Companies must reward individuals on a team based
  on team performance

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Executive Compensation Plans

• Based on both financial and nonfinancial
  performance measures, and include a mix of
• Base Salary
• Annual Incentives, such as cash bonuses
• Long-Run Incentives, such as stock options
• Well-designed plans use a compensation mix that
  balances risk (the effect of uncontrollable
  factors on the performance measure, and hence
  compensation) with short-run and long-run
  incentives to achieve the firms goals

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What is the Balanced Scorecard?
It is a performance measurement system that
includes financial and operational measures which
are related to the organizational goals.
Generally it relates resulting performance to the
reward system within each organizational unit.
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Why a Balanced Scorecard?

• Financial measures alone are NOT sufficient to
  measure long-term value.
• Financial measures alone do NOT always direct
  management to make value-adding decisions.
• Link strategic objectives to a set of financial
  and operational measures in order to clarify and
  communicate them and to use them for evaluating
  performance
• Act as a guide to implement strategy

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Balanced Scorecard
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Elements of a Balanced Scorecard
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Elements of a Balanced Scorecard
Financial Measures

• Revenue Growth
• Productivity
• ROE

Customer Measures

• Market Share, customer retention,
• acquisition, satisfaction, profitability

Internal Business Process Measures

• Innovation
• Operations
• Service-after-sale

Learning and Growth Measures

• 1. Employee Capabilities, 2. Information systems
  capabilities
• 3. Motivation, empowerment and alignment

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Elements of a Balanced Scorecard
Increase profits, ROI
Increase Sales And margin
Financial
Increase customer Satisfaction, loyalty,
retention
Increase Market Share
Customer
Reduce defects, costs Improve quality
Improve Skills
Internal Business Process
Quality Training
Learning Growth
Adapted from Hansen Mowen
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Customer Perspective
Market Share
Customer Profitability
Customer Retention
Customer Acquisition
Customer Satisfaction
Source - Kaplan Norton p 68
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Internal Business Process Perspective
Post- Sale Service Process
Operations Process
Innovation Process
Create Product/ Service Offering
Customer Need Satisfied
Service the Customer
Deliver the Products/ Services
Build the Products/Services
Identify the Market
Source Kaplan Norton p104
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Learning and Growth
Results
Core Outcome Measures
Employee Productivity
Employee Retention
Employee Satisfaction
Technology Infrastructure
Staff Skills and Competencies
Culture
Enablers
o Strategic Skills o Training Levels o Skill
Leverage
o Information Systems o Experience Capture o
Intellectual Property
o Motivation o Empowerment o Personal Alignment
Source Kaplan Norton
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Learning and Growth

• Developing employee productivity
• Performance evaluation.
• Retention rates.
• Employee satisfaction.
• Strengthening information systems
• Increasing the quality of the systems.
• Making the systems accessible.
• Producing relevant, accurate, and timely
  information.

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Learning and Growth

• Conducting a well-run organization
• Effective communication.
• Alignment of goals.
• Integration of team efforts across departments.
• Clearly defined planning, controlling, and
  evaluating processes.

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Summary of Objectives and Measures Financial
Objectives
Measures
Revenue Growth Increase the number of new
products Percentage of revenue from new
products Create new applications Percentage of
revenue from new applications Develop new
customers and markets Percentage of revenue from
new sources Adopt a new pricing strategy Product
and customer profitability Cost Reduction Reduce
unit product cost Unit product cost Reduce unit
customer cost Unit customer cost Reduce
distribution channel cost Cost per distribution
channel Asset Utilization Improve asset
utilization ROI, RI, EVA
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Summary of Objectives and Measures Customer
Objectives
Measures
Core Market share Market share (percentage of
market) Customer retention Percentage growth of
business from existing customers
Percentage of repeating customers Customer
acquisition Number of new customers Customer
satisfaction Ratings from customer
surveys Customer profitability Customer
profitability Performance Value Decrease
price Price Decrease postpurchase
costs Postpurchase costs Improve product
functionality Ratings from customer
surveys Improve product quality Percentage of
returns Increase delivery reliability On-time
delivery percentage Aging schedule Improve
product image and reputation Ratings from
customer surveys
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Summary of Objectives and Measures Internal
Business Process
Objectives
Measures
Innovation Increase the number of new
products Number of new products vs.
planned Increase proprietary products Percentage
revenue from proprietary products Decrease
new product development time Time to market (from
start to finish) Operations Increase process
quality Quality costs Output yields Percentage
of defective units Increase process
efficiency Unit cost trends Output/input(s) Decre
ase process time Cycle time and velocity MCE
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Summary of Objectives and Measures Internal
Business Process
Objectives
Measures
Postsales Service Increase service
quality First-pass yields Increase service
efficiency Cost trends Output/input Decrease
service time Cycle time
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Summary of Objectives and Measures Learning and
Growth
Objectives
Measures
Increase employee capabilities Employee
satisfaction ratings Employee turnover
percentages Employee productivity
(revenue/employee) Hours of training Strategic
job coverage ratio (percentage of critical
job requirements filled) Increase motivation and
alignment Suggestions per employee Suggestions
implemented per employee Increase information
systems capabilities Percentage of processes with
real-time feedback capabilities Percentage
of customer-facing employees with on-line
access to customer and product information
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Implementing a Balanced Scorecard
Mission - Identifies organizations broad
objectives
Specify Long-term Goals Objectives
Planning
Control
Define Strategies including the organizations
form, resource allocations
Define measures of strategy
Integrate measures into MAS
Frequently review measures and results
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Aligning the Balanced Scorecard to Strategy

• Different strategies call for different
  scorecards.
• Therefore, Balanced Scorecard must be
  organization specific

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Features of a Good Balanced Scorecard

• It tells the story of a companys strategy by
  articulating a sequence of cause-and-effect
  relationships.
• It assists in communicating the strategy to all
  members of the organization by translating the
  strategy into a coherent and linked set of
  measurable operational targets.

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Features of a Good Balanced Scorecard

• In for-profit companies, the balanced scorecard
  places strong emphasis on financial objectives
  and measures.
• The scorecard limits the number of measures used
  by identifying only the most critical ones.
• The scorecard highlights sub-optimal tradeoffs
  that managers may make.

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Pitfalls to Avoid When Implementing a Balanced
Scorecard

• Dont assume the cause-and-effect linkages to be
  precise.
• Dont seek improvements across all measures all
  the time.
• Dont use only objective measures on the
  scorecard.

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Pitfalls to Avoid When Implementing a Balanced
Scorecard

• Dont fail to consider both costs and benefits of
  initiatives such as spending on information
  technology and research and development.
• Dont ignore non-financial measures when
  evaluating managers and employees.