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Chapter 8 Performance Management and Evaluation

Chapter 8 Performance Management and Evaluation. Fall 2007 Crosson. Learning Objectives:. Management Responsibility, Accountability, and Performance Responsibility centers and performance measures End-to-end accountability with the balanced scorecard

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Chapter 8 Performance Management and Evaluation

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  1. Chapter 8 Performance Management and Evaluation Fall 2007 Crosson

  2. Learning Objectives: • Management Responsibility, Accountability, and Performance • Responsibility centers and performance measures • End-to-end accountability with the balanced scorecard • Linking executive compensation and performance Use only with permission of Susan Crosson

  3. Responsibility, Accountability, and Performance • Responsibility accounting: An information system that classifies data according to areas of responsibility and reports each area’s activities by including only the revenues, cost, and resource categories that the assigned manager can control. • Organizational chart: • Line and staff relationships • Responsibility centers-5 kinds Use only with permission of Susan Crosson

  4. Example Use only with permission of Susan Crosson

  5. Responsibility Centers and Measures of Performance • Cost Centers-costs • Discretionary Cost Centers-costs • Revenue Centers-revenues • Profit Centers-income statement • Investment Centers-balance sheet and income statement: ROI, RI, EVA Use only with permission of Susan Crosson

  6. Cost Centers • A responsibility center whose manager is accountable for only controllable costs that have a well-defined relationship between the center’s resources and products or services • Example: Factory, directly traceable to products or services • Measures: • Compare Actual to Master and Flexible Budgets • Compute DM, DL, OH variances • SCM: Supply Chain Management (AP,AR, Sales, Inventory, Purchasing systems) Use only with permission of Susan Crosson

  7. Look and listen SE 4. Complete the following performance report for cost center C for the month ended December 31. Actual Results Variance Flexible Budget Variance Master Budget Units produced 80 0 ? 20(U) 100 Center costs Direct materials $ 84 $  ? $ 80 $   ? $100 Direct labor 150 ? ? 40(F) 200 Variable overhead ? 20(U) 240 ? 300 Fixed overhead 280 ?250 ?250 Total cost $ ?$44(U) $ ?$120(F) $850 Performance measures Defect-free units to total produced: 75% ? N/A 90% Average throughput time per unit 12 minutes ? N/A 10 minutes

  8. SE 4. Solution Complete the following performance report for cost center C for the month ended December 31. Actual Results Variance Flexible Budget Variance Master Budget Units produced 80 0 ?=80 20(U) 100 Center costs Direct materials $ 84 $  ?=4U $ 80 $   ?=20F $100 Direct labor 150 ?=10F ?=160 40(F) 200 Variable overhead ?=260 20(U) 240 ?=60F 300 Fixed overhead 280 ?=30U250 ?=0250 Total cost $ ?=774$44(U) $ ?=730$120(F) $850 Performance measures Defect-free units to total produced: 75% ?=15%F N/A 90% Average throughput time per unit 12 minutes ?=2U N/A 10 minutes

  9. Discretionary Cost Centers • A responsibility center whose manager is accountable for costs only and in which the relationship between resources and products or services is not well defined. • Example: HR, IT, Accounting, and other Administrative support • Measures: • Compare Actual to Master Budget • Compute variances • ERM: Enterprise Resource Management (PR,HR, Financial systems) Use only with permission of Susan Crosson

  10. Revenue Centers • A responsibility center whose manager is accountable primarily for revenue and whose success is based on its ability to generate revenue • Example: catalog, phone or e-commerce sales center • Measures: • Compare Actual to Master Budget • Compute sales related variances • CRM: Customer Relationship Management Use only with permission of Susan Crosson

  11. Profit Centers • A responsibility center whose manager is accountable for both revenues and costs and for the resulting operating income. • Examples: retail store • Measures: • Variable costing income statement or Traditional income statement-page 360 • Compare actual, flexible, and master budgeted income statements • Compute variances • CRM, SCM Use only with permission of Susan Crosson

  12. SE 5. Complete the following performance report for profit center P for the month ended December 31. Master Budget Actual VarianceSales $120 ? $  20 (F)Controllable variable costsVariable cost of goods sold ?    25 10 (U)Variable selling and administrative expenses 515 ?Contribution margin $100 $100 $   ?Controllable fixed costs 60 ?10 (F)Profit center income ?$ 50$ 10 (F)Performance measuresNumber of orders processed ?    50 20 (F)Average daily sale $4.00 ? .66 (F)Number of units sold ?   100 40 (F)

  13. SE 5. Complete the following performance report for profit center P for the month ended December 31. Master Budget Actual VarianceSales $120 ?=140 $  20 (F)Controllable variable costsVariable cost of goods sold ?=15    25 10 (U)Variable selling and administrative expenses 515 ?=10UContribution margin $100 $100 $   ?=0Controllable fixed costs 60 ?=5010 (F)Profit center income ?=40$ 50$ 10 (F)Performance measuresNumber of orders processed ?=30    50 20 (F)Average daily sale $4.00 ?=4.66 .66 (F)Number of units sold ?=60   100 40 (F)

  14. Investment Centers • A responsibility center whose manager is accountable for profit generation and can also make significant decisions about the resources the center uses. • Examples: A division, product-line, company • Measures: • Compare actual, flexible, and master budgeted income statements and balance sheets • Compute ROI, residual income, and EVA variances • Time to market analyses • Value/Cost analyses • ERM, SCM, CRM Use only with permission of Susan Crosson

  15. Return On Investment Use only with permission of Susan Crosson

  16. E 12. Momence Associates is evaluating the performance of three divisions: Maple, Oaks, and Juniper. Using the following data, compute the return on investment and residual income for each division, compare the divisions’ performance, and comment on the factors that influenced performance. Maple Oaks Juniper Sales $100,000 $100,000 $100,000 Operating income $ 10,000 $ 10,000 $ 20,000 Assets invested $ 25,000 $ 12,500 $ 25,000 Desired ROI 40% 40% 40%

  17. E 12. Solution Momence Associates is evaluating the performance of three divisions: Maple, Oaks, and Juniper. Using the following data, compute the return on investment and residual income for each division, compare the divisions’ performance, and comment on the factors that influenced performance. Maple Oaks Juniper Sales $100,000 $100,000 $100,000 Operating income $ 10,000 $ 10,000 $ 20,000 Assets invested $ 25,000 $ 12,500 $ 25,000 Desired ROI 40% 40% 40% ROI=Operating Income/Assets Invested Maple= $10,000/$25,000= 40% Oaks= $10,000/$12,500= 80% Residual Income=Operating Income-(Desired ROI x Assets Invested) Maple= $10,000-(40% x $25,000)= $0 Oaks= $10,000-(40% x $12,500)= $5,000

  18. Economic Value Added Use only with permission of Susan Crosson

  19. E 13. Leesburg, LLP, is evaluating the performance of three divisions: Lake, Sumter, and Poe. Using the following data, compute the economic value added by each division and comment on each division’s performance. Lake Sumter PoeSales $100,000 $100,000 $100,000After-tax operating income $ 10,000 $ 10,000 $ 20,000Total assets $ 25,000 $ 12,500 $ 25,000Current liabilities $  5,000 $  5,000 $  5,000Cost of capital 15% 15% 15%

  20. E 13. SolutionLeesburg, LLP, is evaluating the performance of three divisions: Lake, Sumter, and Poe. Using the following data, compute the economic value added by each division and comment on each division’s performance. Lake Sumter PoeSales $100,000 $100,000 $100,000After-tax operating income $ 10,000 $ 10,000 $ 20,000Total assets $ 25,000 $ 12,500 $ 25,000Current liabilities $  5,000 $  5,000 $  5,000Cost of capital 15% 15% 15%EVA= After-tax operating income - Cost of capital(TA-CL)Lake: $10,000 – 15%($25,000-$5,000) = $7,000Sumter: $10,000 – 15%($12,500-$5,000) = $8,875

  21. What Do You Know?Responsibility Centers • Types: E 5, Look and listen SE2 • Cost Center: C2 • Profit Center: E9, E 10 • Investment Center: P 8, Look and listen SE7, SE8, SE9. Use only with permission of Susan Crosson

  22. Look and listen SE 2. Identify each of the following as a cost center, a discretionary cost center, a revenue center, a profit center, or an investment center. 1. The manager of center A is responsible for generating cash inflows and incurring costs with the goal of making money for the company. The manager has no responsibility for assets. 2. Center B produces a product that is not sold to an external party. 3. The manager of center C is responsible for the telephone order operations of a large retailer. 4. Center D designs, produces, and sells products to external parties. The manager makes both long-term and short-term decisions. 5. Center E provides human resource support for the other centers in the company.

  23. SE 2.Solution Identify each of the following as a cost center, a discretionary cost center, a revenue center, a profit center, or an investment center. 1. The manager of center A is responsible for generating cash inflows and incurring costs with the goal of making money for the company. The manager has no responsibility for assets. P 2. Center B produces a product that is not sold to an external party. C 3. The manager of center C is responsible for the telephone order operations of a large retailer. R 4. Center D designs, produces, and sells products to external parties. The manager makes both long-term and short-term decisions. I 5. Center E provides human resource support for the other centers in the company. DC

  24. E 5. Identify the most appropriate type of responsibility center for each of the following organizational units. 1. A pizza store in a pizza chain 2. The ticket sales center of a major airline 3. The South American segment of a multinational company 4. A subsidiary of a business conglomerate 5. The information technology area of a company 6. A manufacturing department of a large corporation 7. An eye clinic in a community hospital 8. The food-service function at a nursing home 9. The food-preparation plant of a large restaurant chain 10. The catalog order department of a retailer

  25. E 5.Solution Identify the most appropriate type of responsibility center for each of the following organizational units. 1. A pizza store in a pizza chain P 2. The ticket sales center of a major airline R 3. The South American segment of a multinational company I 4. A subsidiary of a business conglomerate I 5. The information technology area of a company DC 6. A manufacturing department of a large corporation C 7. An eye clinic in a community hospital P 8. The food-service function at a nursing home C 9. The food-preparation plant of a large restaurant chain C 10. The catalog order department of a retailer R

  26. E 10. The income statement in the traditional reporting format for Green Products, Inc., for the year ended December 31, is as follows. Green Products, Inc. Income Statement For the Year Ended December 31 Total fixed manufacturing costs for year were $16,750. All administrative expenses are considered to be fixed. Using this information, prepare an income statement for the company for the year ended December 31, using the variable costing format.

  27. E 10. Solution The income statement in the traditional reporting format for Green Products, Inc., for the year ended December 31, is as follows. Green Products, Inc. Income Statement For the Year Ended December 31 Total fixed manufacturing costs for year were $16,750. All administrative expenses are considered to be fixed. Using this information, prepare an income statement for the company for the year ended December 31, using the variable costing format.

  28. P 8. Micanopy Company makes replicas of Indian artifacts. The balance sheet for the Arrowhead Division showed that the company had invested assets of $300,000 at the beginning of the year and $500,000 at the end of the year. During the year, the Arrowhead Division’s operating income was $80,000 on sales of $1,200,000. 1. Compute the Arrowhead Division’s residual income if the desired ROI is 20 percent. 2. Compute the following performance measures for the division: a. Profit margin b. Asset turnover c. Return on investment 3. Compute Micanopy Company’s economic value added if total corporate assets are $6,000,000, current liabilities are $800,000, after-tax operating income is $750,000, and the cost of capital is 12 percent.

  29. Balanced Scorecard • End-to-end Accountability • One type of a Manager’s Dashboard • Key Performance Objectives, Measures and Targets Linked Use only with permission of Susan Crosson

  30. The Balanced Scorecard • Developed by Robert S. Kaplan and David P. Norton • A framework that links the perspectives of an organization’s four basic stakeholder groups with the organization’s mission and vision, performance measures, strategic plan, and resources. Use only with permission of Susan Crosson

  31. Classic Balanced Scorecard Perspectives • Financial (investors) • Learning and growth (employees) • Internal business processes • Customers To succeed, an organization must add value for all groups in both the short and long term…… Use only with permission of Susan Crosson

  32. Other Balanced Scorecard Perspectives • Community • Government • Financial (investors) • Learning and growth (employees) • Internal business processes • Customers To succeed, an organization must add value for all groups in both the short and long term…… Use only with permission of Susan Crosson

  33. Balanced Scorecard Framework Ideally, everyone in the organization should be able to see how their actions contribute to the achievement of organizational goals from multiple perspectives….. Lead indicators Lag indicators

  34. Strategic Planning and the Balanced Scorecard For each perspective, develop its scorecard based on the organization’s mission/vision and resources

  35. Financial Balanced Scorecard Framework Customer Internal Business Process Organization’s Mission/Vision Learning and Growth All perspectives are linked and balanced in the scorecard…

  36. Scorecard Process • Performance objectives are linked and balanced in planning process • Performance measures are specified for organizational units • Quantifiable targets are set for organizational units • Actual performance is measured and organizational units are held accountable An organizational unit may be a department, a product line, a location, a curriculum, an individual, or a course… Use only with permission of Susan Crosson

  37. Corporate Scorecard Example: Who are the Stakeholders? • Financial • Customers • Internal Business Processes • Learning and Growth • Government • Community Use only with permission of Susan Crosson

  38. Financial A Corporate Scorecard Example Customers Internal Business Processes Organization’s Mission/Vision Learning and Growth: Employees Community Government

  39. Corporate Mission/Vision • Harley Davidson’s “Fulfills dreams through the experience of motorcycling” Use only with permission of Susan Crosson

  40. Financial Sample Corporate Scorecard for Harley Davidson: Customers Internal Business Processes Fulfills dreams through the experience of motorcycling Learning and Growth: Employees Community Government

  41. What Do You Know?Balanced Scorecard • E 15 • Scorecard for Review Problem Use only with permission of Susan Crosson

  42. Financial/Funding Sources: Build a Balanced Scorecard for Winter Wonderland Resort Customers: Internal Administrative Processes “Mission Statement” Learning and Growth: Community Government

  43. Introducing Strategy Value Chain Balanced Scorecard Use only with permission of Susan Crosson

  44. Strategic Positioning • Michael Porter… • Cost Leadership • Differentiation • (Focus) Use only with permission of Susan Crosson

  45. Value Chain AnalysisA Detailed Look at Strategy… Upstream Manufacturing/Operations Downstream Use only with permission of Susan Crosson

  46. The Balanced Scorecard:TheStrategy Map-a causal value chain Internal External 5. Environmental Impact 1. People 3. Customer Relationships 2. Operations/ Processes 4. Financial Results – Short-term – Long-term Use only with permission of Susan Crosson

  47. Cause-and-Effect Chain Illustration for a Bank Learning and GrowthPerspective Internal-Business Perspective CustomerPerspective FinancialPerspective Customer Retention Rate: percent of last year’s customers still with bank Number of Training Hours Employees Receive Improved Loan, Deposits, and Non-Interest Income Customer Satisfaction Ratings on Quarterly Surveys Employee Scores on in-house tests about sales, service, and product knowledge Number of Successful Referrals and/or Cross-sales Causal Chain Explanation: If employees receive training in sales effectiveness, customer service, product profitability, and local bank knowledge, then better customer service and higher quality interactions with existing clients can take place. Bank employees will be better able to ascertain the needs of customers, thereby making higher quality referrals and cross-sell proposals to customers, and customers will be more satisfied and choose to continue banking with bank. Increased referrals or cross-sales increases non-interest income and provides the basis for growth in deposit and loan balances.

  48. Balanced Scorecard feeds back to Strategy Value Chain Balanced Scorecard Use only with permission of Susan Crosson

  49. Linking executive compensation and performance • Performance-based pay • Profit sharing • Cash bonus • Stock options, ESOPs • Restricted stock • You get what you measure Use only with permission of Susan Crosson

  50. Homework • P 3 Use only with permission of Susan Crosson

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