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Performance Evaluation

Performance Evaluation

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Performance Evaluation

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  1. Performance Evaluation Chapter 10

  2. Objective 1 Understand decentralization and describe the different types of responsibility centers

  3. Decentralization • Splitting operations into different operating segments • Advantages • Frees top management’s time • Use of expert knowledge • Improves customer relations • Provides training • Improves motivation and retention • Disadvantages • Duplication of costs • Potential problems achieving goal congruence

  4. Performance Evaluation Systems • Provide upper management with feedback • To be effective, should • Clearly communicate expectations • Provide benchmarks that promote goal congruence and coordination between segments • Motivate segment managers

  5. Responsibility Accounting • Responsibility Center - part of an organization whose manger is accountable for planning and controlling activities • Responsibility Accounting - system for evaluating performance of each responsibility center and its manger.

  6. Types of Responsibility Centers • Cost Center • Revenue Center • Profit Center • Investment Center

  7. Objective 2 Develop performance reports for different responsibility centers

  8. Responsibility Center Performance Reports • Performance Report – compares actual revenues and expenses to budgeted figures • Variance – difference between actual and budget • Favorable variance: causes operating income to be higher than budgeted • Unfavorable variance: causes operating income to be lower than budgeted • Management by exception

  9. Exhibit 10-3: Partial Performance Report for Revenue Center

  10. Segment Margin The operating income generated by a profit or investment center before subtracting common fixed costs that have been allocated to the center

  11. Exhibit 10-4: Performance Report Highlighting Segment Margin

  12. Organization-Wide Performance Reports • Performance reports for each level of management flow up • Controllable vs. uncontrollable variances

  13. Objective 3 Calculate ROI, Sales Margin, and Capital Turnover

  14. Evaluation of Investment Centers • Duties of Investment center manager similar to CEO • To assess performance • Return on Investment (ROI) • Residual Income (RI)

  15. Return on Investment (ROI) • Measures the amount of income an investment center earns relative to the size of its assets • ROI = Operating Income Total Assets

  16. Sales Margin and Capital Turnover • ROI = Operating Income x Sales___ SalesTotal Assets (ROI = Sales Margin x Capital Turnover)

  17. S10-6

  18. S10-6 • Functional Ingredients • Sales margin $5,445 / $21,780 = 25.0% • Capital turnover $21,780 / $12,100 = 1.8 • ROI 25.0% x 1.8 = 45.0% • Consumer Markets • Sales margin $2,075 / $20,750 = 10.0% • Capital turnover $20,750 / $8,300 = 2.5 • ROI 10.0% x 2.5 = 25.0% • Performance Markets • Sales margin $3,000 / $15,000 = 20.0% • Capital turnover $15,000 / $10,000 = 1.5 • ROI 20.0% x 1.5 = 30.0%

  19. Residual Income • Determines whether the division has created any excess (residual) income above management’s expectations • Incorporates Target Rate of Return RI = Operating Income – Minimal acceptable income RI = Operating Income – (Target rate of return x Total assets)

  20. S10-9

  21. S10-9 Snow Sports RI = $1,040,000 − ($4,000,000 × 16%) = $400,000 Non-Snow Sports RI = $1,680,000 − ($6,000,000 × 16%) = $720,000

  22. Goal Congruence Residual Income enhances goal congruence, whereas ROI may or may not

  23. Measurement Issues • Which balance sheet data should we use? • Should we include all assets? • Should we use gross book value or net book value of the assets? • Should we make other adjustments to income or assets?

  24. Limitations of Financial Performance Evaluation • Short-term focus • Potential Remedy: management can measure financial performance using a longer time horizon • Incentivizes segment managers to think long term rather than short term

  25. Transfer Pricing • The price charged for the internal sale between two different divisions of the same company • Encourage transfer only if the company would benefit by the exchange • Vertical Integration

  26. Exhibit 10-9: Strategies to Determine Transfer Price

  27. Global Considerations • Do the divisions operate under different taxing authorities such that income tax rates are higher for one division? • Would the amount paid to customs and duties be impacted by the transfer price used?

  28. Objective 4 Prepare and evaluate Flexible Budget Performance Reports

  29. Flexible Budget • A budget prepared for a different level of volume than that which was originally anticipated • Master Budget Variance – Difference between the actual revenues and expenses and the master budget • “Apples-to-oranges” comparison

  30. Exhibit 10-11 Creating a Flexible Budget Performance Report

  31. Volume Variance • The difference between the master budget and the flexible budget • Arises only because the actual volume differs from the volume originally anticipated in the master budget

  32. Exhibit 10-12 Volume Variances

  33. Flexible Budget Variance The difference between the flexible budget and the actual results

  34. Exhibit 10-13 Flexible Budget and Volume Variances

  35. Underlying Causes of the Variances • Management by exception • Use performance reports to see how operational decisions affected company’s finances

  36. Master Budget Variance: A Combination of Variances Flexible Budget Variance Volume Variance Master Budget Variance

  37. Objective 5 Describe the balanced scorecard and identify KPIs for each perspective

  38. Nonfinancial Performance Measurement • Lag indicators - reveal the results of past actions and decisions • Lead indicators - predict future performance

  39. The Balanced Scorecard • Management must consider both financial and operational performance measures • Major shift: financial indicators are no longer the sole measure of performance

  40. Four Perspectives of the Balanced Scorecard • Financial • Customer • Internal Business • Learning and Growth

  41. Key Performance Indicator (KPI) • Summary performance metric; assesses how well the company is achieving its goals • Continually measured • Reported on performance scorecard or performance dashboard

  42. Financial Perspective • “How do we look to shareholders?” • Must continually attempt to increase profits • Increase revenues • Control costs • Increase productivity

  43. Customer Perspective • “How do customers see us?” • Customers concerned with four product/service attributes: • Price • Quality • Sales service • Delivery time

  44. Internal Business Perspective • “At what business processes must we excel to satisfy customer and financial objectives?” • Three factors: • Innovation • Operations • Post-sales support

  45. Learning and Growth Perspective • “Can we continue to improve and create value?” • Three factors: • Employee capabilities • Information system capabilities • Company’s “climate for action”

  46. Sustainability and Performance Evaluation • Sustainability-related KPIs • Fifth perspective - “Sustainability” • Sixth perspective - “Community”

  47. End of Chapter 10