Performance Management and Evaluation 25. Performance Measurement OBJECTIVE 1: Define a performance management and evaluation system, and describe how

Performance Management and Evaluation25

Performance Measurement

OBJECTIVE 1: Define a performance management and evaluation system, and describe how the balanced scorecard aligns performance with organizational goals.

Figure 1: Sample Balanced Scorecard of Linked Objectives, Measures, and Targets


• What to measure, how to measure– Performance measurement is the use of

quantitative tools to gauge performance in relation to a specific goal or expected outcome.


• What to measure, how to measure (cont.)– Managers develop a group of measures that

identify changes in performance quality so that employees can determine what needs to be done to improve performance.


• Other measurement issues– In developing performance measures that are

appropriate to the needs of their organizations, managers must consider not only the basic questions of what to measure and how to measure, but a variety of other issues as well.


• The balanced scorecard and the management process– Planning: The balanced scorecard provides a

framework that enables managers to translate their organization’s vision and strategy into operational terms.


• The balanced scorecard and the management process (cont.)– Performing:

• Managers use the organization’s strategic objectives as the basis for decision making.

• Managers verify and track causal relationships to improve performance.


• The balanced scorecard and the management process (cont.)– Evaluating

• Managers compare financial and nonfinancial results with performance targets.

• Managers analyze results and recommend changes.

– Communicating: Managers prepare reports for various stakeholder groups.

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Responsibility Accounting

OBJECTIVE 2: Define responsibility accounting, and describe the role that responsibility centers play in performance management and evaluation.

Table 1: Types of Responsibility Centers

Table 1: Types of Responsibility Centers

Figure 2: Partial Organization Chart of a Restaurant Division


• Responsibility accounting classifies data according to areas of responsibility and reports each area’s activities.– Includes only the revenue, cost, and resource

categories that the assigned manager can control.


• Responsibility accounting classifies data according to areas of responsibility and reports each area’s activities. (cont.)– A responsibility center is an organizational unit

whose manager has been assigned the responsibility of managing a portion of the organization’s resources.


• Responsibility accounting classifies data according to areas of responsibility and reports each area’s activities. (cont.)– Such costs and revenues are called controllable

costs and revenues because they are the result of a manager’s actions, influence, or decisions.


• Types of responsibility centers– Cost center: Manager is accountable only for

controllable costs that have well-defined relationships between resources and products or services.

– Discretionary cost center: Manager is accountable for costs only; the relationship between resources and products or services produced is not well defined.


• Types of responsibility centers (cont.)– Revenue center: Manager is accountable

primarily for revenue; his or her success is based on the center’s ability to generate revenue.

– Profit center: Manager is accountable for both revenue and costs and the resulting operating income.


• Types of responsibility centers (cont.)– Investment center: Manager is accountable for

profit generation and can also make decisions about the resources the center uses.


• Organizational structure and performance management– A company’s organizational structure

formalizes its lines of managerial authority and control.

– An organizational chart is a visual representation of a company’s hierarchy of responsibility.


• Organizational structure and performance management (cont.)– Performance reporting by responsibility center

enables an organization to trace the source of a cost, revenue, or resource to the manager who controls it and to evaluate the manager’s performance accordingly.


Performance Evaluation of Cost Centers and Profit Centers

OBJECTIVE 3: Prepare performance reports for cost centers using flexible budgets and for profit centers using variable costing.

Exhibit 1: Central Kitchen’s Performance Report on House Dressing

Exhibit 2: Variable Costing Income Statement Versus Traditional Income Statement for Trenton Restaurant

Exhibit 3: Performance Report Based on Variable Costing and Flexible Budgeting for Trenton Restaurant


• A performance report should contain information only about the costs, revenues, and resources that a manager can control.– Performance reports allow comparisons

between actual performance and budget expectations.


• A performance report should contain information only about the costs, revenues, and resources that a manager can control. (cont.)– The content and format of a performance

report depend on the nature of the responsibility center.


• A cost center’s performance can be evaluated by comparing its actual costs with the corresponding amounts in the flexible and master budgets.– The resulting variances between actual costs

and the flexible budget can be further examined by using standard costing to compute specific variances for direct materials, direct labor, and overhead.


• A profit center’s performance is usually evaluated by comparing its actual income statement results with its budgeted income statement.– Variable costing is a method of preparing

profit center performance reports that classifies a manager’s controllable costs as variable or fixed.


• A profit center’s performance is usually evaluated by comparing its actual income statement results with its budgeted income statement. (cont.)– Variable costing produces a variable costing

income statement that has the format of the contribution income statement used in cost-volume-profit analysis.


• A profit center’s performance is usually evaluated by comparing its actual income statement results with its budgeted income statement. (cont.)– Performance reports may also use flexible

budgeting and variable costing to measure and evaluate nonfinancial information.


Performance Evaluation of Investment Centers

OBJECTIVE 4: Prepare performance reports for investment centers using the traditional measures of return on investment and residual income and the newer measure of economic value added.

Exhibit 4: Performance Report Based on Return on Investment for the Restaurant Division

Figure 3: Factors Affecting the Computation of Return on Investment

Exhibit 5: Performance Report Based on Residual Income for the Restaurant Division

Exhibit 6: Performance Report Based on Economic Value Added for the Restaurant Division

Figure 4: Factors Affecting the Computation of Economic Value Added


• The evaluation of an investment center’s performance requires additional performance measures that evaluate the manager’s control over revenues, costs, and capital investments.


• Return on investment is the most common performance measure.– Takes into account both operating income and

the assets invested to earn that income, which is computed by dividing operating income by the assets invested.


• Return on investment is the most common performance measure. (cont.)– Another approach to the ROI computation is to

multiply profit margin (the ratio of operating income to sales) by asset turnover (the ratio of sales to average assets invested).


• Residual income is the operating income an investment center earns above a minimum desired return on invested assets.– Residual income is a dollar amount, not a ratio

like return on investment.


• Economic value added measures the shareholder wealth created by an investment center.– Although EVA can be quite complex, the basic

formula is EVA = After-Tax Operating Income – Cost of Capital in Dollars.

– Cost of capital is defined as the cost of capital multiplied by the difference between total assets and current liabilities.


• To be effective, a performance management system must consider both operating results and multiple performance measures.– Comparison of actual results with budgeted

figures adds meaning to the evaluation.– Analysis of nonfinancial performance

measures ensures a more balanced view of a business and how to improve it.


Performance Incentives and Goals

OBJECTIVE 5: Explain how properly linked performance incentives and measures add value for all stakeholders in performance management and evaluation.


• Performance incentives– The links between goals and performance

objectives, measures, and targets must be logical and apparent.

– Performance-based pay ties compensation incentives to targets to foster their achievement.


• The coordination of goals– The circumstances of each organization

determine which mix of compensation incentives and measures will work best for it.

– The effectiveness of a performance management and evaluation system relies on the coordination of responsibility center, managerial, and company goals.


Documents

Performance Management and Evaluation 25. Performance Measurement OBJECTIVE 1: Define a performance management and evaluation system, and describe how