Chapter 14 Cost Allocation, Profitability

mission statement

expresses an organization's purpose and should identify how the organization will meet targeted customers' needs through its products or services

short-run objectives

focus on the effective and efficient management of current operating, investing, and financing activities

process quality yield

good units/total units

Employee Stock Ownership Plan (ESOP)

investments are made in the employer's securities

long-term objectives

involve resource investments and proactive efforts, such as customer satisfaction, quality, delivery, price, service, and sustainability to enhance competitive position

leading indicators

reflect causes, measurements for improving performance should involve tracking leading indicators

Performance measures should exist for all elements that are critical to an organization's success in a competitive market

...

management should strive to increase throughput by engaging in one or several of the following methods:

1. Decreasing NVA activities 2. Increasing total unit production and sales 3. Decreasing the per-unit processing time 4. Increasing process quality yield

short-term financial performance measures for management

1. Divisional profits 2. Cash Flow 3. Return on Investment 4. Residual Income 5. Economic Value Added (EVA)

quality measures (NFM) (exhibit 14.12)

1. Prevention 2. Appraisal 3. Internal Failure 4. External Failure

ROI, RI, and EVA have three primary limitations

1. Reflects the use of accounting income 2. Relates to the asset investment base used; asset investment can be difficult to properly measure and assign to center managers 3. The measures direct attention to how well an investment center performed in isolation rather than relative to companywide objectives; such a focus can result in resource sub optimization so that the firm is not maximizing its operational effectiveness and efficiency

general criteria should be considered in designing a performance measurement system:

1. The measures should be established to assess progress toward the organizational mission and its related goals and objectives 2. The persons being evaluated should be aware of the measurements being used and have had some input in developing them 3. The persons being evaluated should have the appropriate skills, equipment, information, and authority to be successful under the measurement system 4. Feedback of accomplishment should be provided in a timely and useful manner 5. They system should be flexible enough to adapt to new conditions in the organization's environment

appropriate nonfinancial metrics are those that:

1. can be clearly articulated and defined 2. are relevant to the objective 3. can trace responsibility 4. rely on valid data 5. have target objectives 6. have established internal and/ or external benchmarks

The balanced scorecard should reflect the organization's mission and strategy and typically includes performance measures from four perspectives:

1. financial 2. internal business 3. customer 4. learning and growth

definitions of effective and efficient may relate to:

1. historical organizational performance 2. competitive benchmarks 3. stakeholder expectations

To succeed, an entity or an investment center must meet two requirements:

1. long-run profitability 2. continuous liquidity

two additional factors should be considered in the actual determination of throughput:

1. organizations should not count units, services, or work performed as truly being throughput unless they would be deemed acceptable for purchase by customers 2. because a firm's primary goal is to earn income, only goods or services that are actually sold should be considered throughput

ROI can be increased through various management actions including:

1. raising sales prices if demand will not be impaired 2. decreasing expenses 3. decreasing investment in assets, especially nonproductive ones

improved throughput means a greater ability to :

1. respond to customer needs and demands 2. reduce production costs 3. reduce inventory levels, and therefore, the NVA costs of moving and storing goods

internal process measures should reflect concern for

1. streamlined production 2. high quality 3. minimization of product complexity 4. reduction/elimination of negative environmental impacts

For an organization to be successful, managers must devise appropriate information systems to track and gauge the effective and efficient use of organizational resources. Two conditions must exist to make such determinations:

1. the terms effective and efficient must be defined 2. measures consistent with those definitions must be formulated

research has indicated that pay-for-performance is increasing in large organizations for four primary reasons:

1. to better align activities with business strategies 2. to create better linkages between corporate and individual performance 3. to improvement organizational or team performance 4. to ensure market competitiveness

carbon footprint

NFPM, which reflects the total of all greenhouse gas emissions created by that organization's activities during a specified time

lead time

a NFPM related to customer service is lead time, which reflects how quickly customers receive their goods after placing their orders

Economic Value Added (EVA)

a measure that has been developed to more directly align managerial interests with common stockholders' interests, EVA measures the profit produced above the cost of capital EVA=After-tax profits - (Cost of Capital % X Market value of invested capital)

lagging indicators

both the financial measures and the score are reflections of past decisions, reflect effects or outcomes

quantitative measures

are of two types: 1. financial 2. nonfinancial

qualitative measures

are often objective

expatriates (expats)

are parent-company and third-country nationals assigned to a foreign subsidiary or foreign nationals assigned to the parent company

return on investment (ROI)

is a ratio relating income generated by an investment center or organization to the resources (or asset base) used to produce that income ROI= Income/Assets Invested

Residual Income

is the profit earned that exceeds an amount "charged" for funds committed to the center. The "charged" amount is equal to a specified target rate of return multiplied by the asset base and is comparable to an imputed rate of interest on the divisional assets used. Residual Income= Income-(Target Rate X Asset Base)

Profit Margin

is the ratio of income to sales and indicates what proportion of each sale dollar is NOT used for expenses (and, thus, becomes profit)

learning and growth measures of the BSC:

lead customer perspective measures and should focus on using the organization's intellectual capital to adapt to changing customer needs or influence new customer needs and expectations through product or service innovations

customer measures of the BSC:

lead financial perspective measures and should indicate how the organization is faring relative to customer issues of speed (delivery time), quality, service, and price (both at and after purchase)

throughput calculation:

manufacturing cycle efficiency X process productivity X process quality yield = throughput OR (value-added processing time/Total time) X (Total Units/VA processing time) X (good units/total units) = throughput

Asset Turnover

measures asset productivity and shows the number of sales dollars generated by each dollar of assets

external performance measures

must signal an organization's ability to satisfy its customers, investors/creditors, and other stakeholders

balanced scorecard

provides a set of measurements that "complements financial measures of past performance with measures of the drivers of future performance"

values statement

reflects the organization's culture by identifying fundamental beliefs about what is important to the organization; mission and values statements are two of the underlying bases for setting organizational goals (abstract targets to be achieved) and objectives (quantified targets with expected completion dates)

The performance measurement system

should be designed to encourage behaviors that will result in outcomes that generate organizational success

internal process measure of the BSC:

should focus on organizational actions designed to meet customer needs and expectations

financial measures of the BSC:

should reflect stakeholder-relevant issues of profitability, organizational growth, and market price of stock

As the difference between the market value of invested capital (total equity and interest-bearing debt) and the book value of assets increases...

so do the relative benefits of using EVA rather than RI as a performance measure

Du Pont model

the ROI formula can be restated to provide useful information about two individual factors that compose the rate of return: 1. Profit Margin 2. Asset Turnover ROI=Profit Margin X Asset Turnover= (Income/Sales) X (Sales/Assets)

divisional profits

the segment margin of profit or investment center is frequently used to measure divisional performance; actual and budgeted margins are compared, and variances are computed to determine the points

cash flow

the statement of cash flows provides information about the sources and uses of cash from operating, investing, and financing activities; it is useful when managing cash outflow commitments, adapting to adverse changes in business conditions, and assessing new cash commitments; assists managers in judging the reliability of the entity's earnings

process productivity

total units produced/VA processing time

nonfinancial performance measures

use information contained in the cost management, rather than the financial accounting, system; NFPMs are based on nonmonetary details, such as time, quantities, and ratios

throughput (NFPM):

which reflects the movement of inputs through a process to become outputs, provides a measure of productive activity for firms