52 terms

ATG 614: Chapter 18 - Strategic Performance Measurement (Cost Centers, Profit Centers, and the Balanced Scorecard)

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Performance measurement
The process by which managers at all levels gain information about the performance of tasks within the firm and judge that performance against preestablished criteria as set out in budgets, plans, and goals.
Management control
Refers to the evaluation of the performance of mid-level managers by upper-level managers.
Objectives for management control (3)
1. Motivate managers to exert a high level of effort
2. Provide an incentive for managers to make decisions consistent top management's goals
3. Provide a basis for a fair evaluation of managers' performance.
Operational control
Refers to the evaluation of operating-level employees by mid-level managers.
Strategic business unit (SBU)
Consists of a well-defined set of controllable operating activities over which an SBU manager is responsible.
Employment contract
An agreement between the manager and top management designed to provide incentives for the manager to act independently to achieve top management's objectives.
Principal-agent model
A conceptual model that contains the key elements that contracts must have to achieve the desired objectives.
3 aspects that affect contracting relationship
1. Uncertainty
2. Risk aversion
3. Lack of observability
1. Uncertainty
Managers operate in an environment that is influenced by factors beyond the manager's control
2. Risk aversion
Consider how a manager's risk preferences affect the way they make decisions - can interfere with proper decision-making.
3. Lack of observability
Efforts and decisions made by the manager are not observable to top management; top management can only observe the outcomes
4 recipients of performance reports (who's interested?)
1. owners
2. creditors
3. community or gov't units affected by operations
4. employees
What is being evaluated?
individual manager: effectiveness and efficiency of performance
SBU: expand or divest?
team of managers: try to avoid comparing performance of managers to one another
Consideration for timing of performance evaluation (when) (1)
Resources input to manager = uses master budget. Use when the outputs are difficult to measure or manager's control is not clear; evaluation takes place before the efforts and decisions have been made (ex ante)
example: not for profits
Consideration for timing of performance evaluation (when) (2)
Outputs of manager's efforts = uses flexible budget. Use when inputs and outputs are easy to measure; evaluation takes place based on actual outputs (ex post)
example: manufacturinng
Consideration for timing of performance evaluation (when) (3)
Tie to product life cycle = time from introduction to removal from market
early - nonfinancial measures (market penetration, customer dev., revenue, new customers, satisfaction, etc.)
acceptance - (profitability, asset management)
mature - (profitability focus, strategy issues: customer satisf., product modifications, new markets)
Formal systems
Developed with explicit management guidance. 4 important systems: 1. hiring, 2. promotion, 3. leadership development, 4. strategic performance measurement
Informal systems
Arise from the unmanaged, and sometimes unintended, behavior of managers and employees (reactions and feelings)
- individual and team levels
Strategic performance measurement
A system used by top management to evaluate SBU managers.
Decentralization
A decision-making approach in which top management chooses to delegate a significant amount of responsibility to SBU managers.
Benefits of centralized approach
benefits: top management retains control, utilize expertise of top management, effective coordination of activities across the firm
Benefits of decentralized approach
Top management cannot effectively manage operations at a detailed level (lacks local knowledge),
decisions at lower level made more timely to benefit customers (more responsive),
give SBU managers opportunity to demonstrate their skill,
training for top-level managers,
perceived to be more objective
Cost centers
A firm's production or support SBUs that evaluated on the basis of cost
3 strategic issues of cost centers
1. Cost shifting
2. Excessive short-term focus
3. Role of budget slack
1. Cost shifting
Occurs when a department replaces its controllable costs with noncontrollable costs.
- require analysis and justification for equipment upgrades and changes in work patterns that affect other departments
2. Excessive short-term focus
Occurs when there is a heavy focus on annual cost figures which motivates managers to only focus on ST costs and neglect LT issues
- use nonfinancial strategic considerations AND financial information on costs
3. Role of budget slack
Managers usually plan for slack in budgets that allow for unexpected unfavorable events but could make their goals easier to achieve.
Budget slack
The difference between budgeted performance and expected performance.
Discretionary-cost method
Considers costs largely uncontrollable and applies discretion at the planning state; input-oriented; outputs are ill-defined; focus on planning
Engineered-cost method
Considers costs to be variable and therefore engineered, or controllable; output-oriented approach; outputs are well-defined; focus on evaluation
Dual-allocation
A cost allocation method that separates fixed and variable costs. Variable costs are directly traced to user departments, and fixed costs are allocated on some logical basis.
Revenue center
Defined either by product line or by geographical area and focuses on the selling function.
Revenue drivers
The factors that affect sales volume, such as price changes, promotions, discounts, customer service, changes in product features, delivery dates, and other value-added factors
Order-getting costs
Expenditures to advertise and promote the product; discretionary cost center
Order-filling costs
Include freight, warehousing, packing and shipping, and collections; engineered cost center
Goal of profit center
Brings manager's incentives into congruence with those of top management: to improve the firm's profitability
3 strategic issues of profit centers (1/3)
Provide incentive for the desired coordination among the marketing, production, and support functions. Example: handling of rush orders
3 strategic issues of profit centers (2/3)
Motivate managers to consider their product/service as marketable to outside customers (not just internal departments)
Profit center
Both generates revenues and incurs the major portion of the cost for producing those revenues.
3 strategic issues of profit centers (3/3)
Motivate mangers to develop new ways to make profit from their products and services. Examples: service contracts
Investment center (more in ch 19)
Includes assets employed by the SBU as well as profits in performance evaluation.
Contribution income statement
Based on the contribution margin developed for each profit center and for each relevant group of profit centers. (variable costing)
Contribution by profit center (CPC)
Measures ALL costs traceable to, and therefore controllable by, the individual profit centers.
Controllable fixed costs
Those fixed costs that the profit center manager can influence in approximately a year or less.
Noncontrollable fixed costs
Those fixed costs that are not controllable within a year's time, usually including facilities-related costs such as depreciation, taxes, and insurance.
Controllable margin
Determined by subtracting short-term controllable fixed costs from the contribution margin
Variable costing
Use of contribution margin income statement; separates variable and fixed costs. Income not affected by changes in inventory.
Full costing
US GAAP approach (matching principle)
IRS - determining taxable income
Value stream income statement
Used in lean accounting when products and services are grouped into families. Similar to contribution income statement.
4 key perspectives of balanced scorecard
1. customer satisfaction
2. financial performance
3. internal business processes
4. learning and innovation
What makes balanced scorecard work?
- use financial and nonfinancial factors
- use multiple measures grouped into the 4 perspectives
- attend directly to firm's critical success factors
6 steps to maximize the value of nonfinancial measures
1. Develop causal model
2. Gather data
3. Turn the data into information
4. Continually refine the model
5. Base actions on findings
6. Assess outcomes