Managerial Accounting Chapter 11

How managers should choose performance measures

-should be consistent with the company's strategy -be understandable and controllable to a significant extent by those being evaluated - the scorecard should not have too many performance measures. can lead to a lack of focus and confusion

financial performance measures should be integrated with non financial measures

1) financial measures are lag indicators that report on the results of past actions. non financial measures of key success drivers such as customer satisfaction are leading indicators of future financial performance 2) top managers are ordinarily responsible for the financial performance measures- not lower-level managers. the supervisor checks in determine the wait time, but they cant be held responsible for the entire company's profit. responsibility of airlines top managers.

Major Advantages of decentralization

1. giving the day-to-day problem solving to lower-level managers, top management can concentrate on bigger issues 2. lower-level managers tend to have the most up-to-date and detailed info about day to day operations 3. by eliminating layers of approval, orgs can respond more quickly to customers and changes in the environment 4. granting decision making helps train lower-level managers for higher-level positions 5. empowering lower level managers to make decisions can increase their motivation and job satisfaction

disadvantages of decentralization

1. lower-level managers can make decisions without fully understanding the big picture 2. if lower-level managers make their own decisions independently of each other, coordination may be lacking 3. lower-level managers may have objectives that clash with the organization. 4. spreading innovative ideas may be difficult in a decentralized organization

Balanced Scorecard

A balanced scorecard consists of an integrated set of performance measures that are derived from and support a company's strategy. Importantly, the measures included in a company's balanced scorecard are unique to its specific strategy. Ex: Southwest's strategy of operational excellence

criticisms of ROI

Just telling managers to increase ROI may not be enough. Managers may not know how to increase ROI in a manner that is consistent with the company's strategy. This is why ROI is best used as part of a balanced scorecard. A manager who takes over a business segment typically inherits many committed costs over which the manager has no control. This may make it difficult to assess this manager relative to other managers. A manager who is evaluated based on ROI may reject investment opportunities that are profitable for the whole company but that would have a negative impact on the manager's performance evaluation.

Net Book Value versus Gross Cost

Most companies use the net book value (i.e., acquisition cost less accumulated depreciation) of depreciable assets to calculate average operating assets. With this approach, ROI mechanically increases over time as the accumulated depreciation increases. Replacing a fully-depreciated asset with a new asset will decrease ROI. An alternative to using net book value is the use of the gross cost of the asset, which ignores accumulated depreciation. With this approach, ROI does not grow automatically over time, rather it stays constant; thus, replacing a fully-depreciated asset does not adversely affect ROI.

ROl can also be expressed in terms of margin and turnover as

ROI= margin x turnover where margin = net operating income/ sales and turnover = sales / average operating assets

performance measures used in balance scorecard: 4 groups

The balanced scorecard enables top management to translate its strategy into four groups of performance measures - financial, customer, internal business processes, and learning and growth - that employees can understand and influence. Idea underlying these groupings is that learning is necessary to improve customer satisfaction, which is necessary to improve financials . continual improvement is encouraged

Motivation and Residual Income

The residual income approach encourages managers to make investments that are profitable for the entire company but that would be rejected by managers who are evaluated using the ROI formula. It motivates managers to pursue investments where the ROI associated with those investments exceeds the company's minimum required return but is less than the ROI being earned by the managers.

Divisional Comparisons and Residual Income

The residual income approach has one major disadvantage. It cannot be used to compare the performance of divisions of different sizes.

Economic added value

an adaptation of residual income that has been adopted by many companies. Under EVA, companies often modify their accounting principles in various ways. when used to measure performance, the objective is to maximize the total amount of residual income or EVA, not to maximize ROI.

responsibility center

any part of an organization whose manager has control over and is accountable for cost, profit, or investments. The three primary types: cost centers, profit centers, investment centers

A company's strategy and the balanced scorecard

balanced scorecard lays out a theory of how the company can take concrete actions to attain its desired outcomes one of the advantages of the balanced scorecard is that it continually test the theories underlying managements strategy

both formulas

both formulas will give the same answer but the second provides some additional insights

decentralized organization

decision making authority is spread throughout the organization rather than being confined to a few top executives. all large organizations are decentralized to some extent. organizations do differ in the extent to which they are decentralized. strongly centralized: decision making reluctantly delegated to lower-level managers who have little freedom to make decisions strongly decentralized: even the lowest-level managers are empowered to make as many decisions as possible

Tying compensation to the Balanced Scorecard

incentive compensation for employees, such as bonuses, should be tied to the balanced scoreboard performance measures. should only be done after the org has been successfully managed with the scorecard for some time-year or more managers must be confident that the performance measures are reliable, sensible, understood by those being evaluated, and not easily manipulated

Operating assets

include cash, AR, inventory, plant and equipment, and all other assets held for operating purposes. most companies use the net book value (aquistion cost less accumulated depreciation) of depreciable assets to calculate average operating assets.

Net Operating Income

income before interest and taxes and is sometimes referred to as EBIT (earnings before interest and taxes). used in the formula b/c the base consists of operating assets. used to be consistent

importance of turnover

incorporates a crucial area of a managers responsibility- the investment in operating assets . excessive funds tied up in operating assets depress turnover and lower ROI

Profit Center

manager has control over both costs and revenue, but not over the use of investment funds. evaluated by comparing actual profit to targeted or budgeted profit. An example of a profit center is a company's cafeteria.

Investment Center

manager has control over cost, revenue, and investments in operating assets. evaluated using return on investment or residual income measures. Ex: general motors VP of manufacturing in america would have a great deal of discretion over investments in manufacturing. once top-managers approve VPs investment proposals, he is held responsible for making them pay off. An example of an investment center would be the corporate headquarters.

Cost Center

manager who has control over costs, but not over revenue or the use of investment funds. managers are expected to minimize costs while providing the level of products and services demanded by other parts of the organization. Service departments such as accounting, general administration, legal, and personnel are usually classified as cost centers, as are manufacturing facilities. Standard cost variances and flexible budget variances, such as those discussed in Chapters 10 and 11, are often used to evaluate cost center performance.

How managers can affect ROI

margin improved by increasing selling prices, reducing operating expenses, or increasing unit sales. increasing selling prices and reducing operating expenses both increase NOI and therefore margin. increasing unit sales also ordinarily increases the margin b/c of operating leverage

return on investment

net operating income / average operating assets. the higher a business segments ROI, the greater the profit earned per dollar invested in the segments operating assets

Residual Income

the net operating income that an investment center earns above the minimum required return on its operating assets

internal business processes

what the company does in an attempt to satisfy customers . Ex: in airline, handling baggage