4. Financial Performance Measures and Reward System

Question 1

What is centralised decision making?

Answer 1

A system in which decisions are made at the top level and lower-level managers implement the decisions

Question 2

What is decentralised decision making?

Answer 2

A system in which decisions are made and implemented by lower-level managers

Question 3

What is responsibility accounting?

Answer 3

A system that measures the results of responsibility centres according to the information managers need to operate their centre.

Question 4

What is a responsibility centre?

Answer 4

A segment of a business whose manager is accountable for specified sets of activities

Question 5

What are the 4 types of responsibility centres?

Answer 5

Cost centre (manages costs)
Revenue centre (responsible for sales)
Profit centre (both revenue and cost)
Investment centre (revenues, costs and investments)

Question 6

What are the 5 types of performance-related reward system?

Answer 6

Group incentive plans
Individual incentive plans
Profit-sharing plans
Gain sharing
Employee share plans

Question 7

How is ROI (return on investment) calculated?

Answer 7

Operating income / average operating assets

Question 8

Whats assets turnover?

Answer 8

Compares a division’s investment in operating assets with the ability of those assets to generate revenues

Question 9

What are the three advantages of ROI?

Answer 9

Encourages managers to focus on the relationship between sales, expenses and investment.
Encourages managers to focus on cost efficiency
Encourages managers to focus on operating asset efficiency

Question 10

What are the two disadvantages of ROI measure?

Answer 10

Encourages managers to focus on short term interests

It discourages managers from investing into projects which would decrease the ROI in the short term

Question 11

What is RI (residual income)?

Answer 11

RI=Income-(required rate of return x investment)

Question 12

What are the three advantages of RI measure?

Answer 12

More likely to create goal congruence
Takes account of the organisations RRR in measuring performance.
Encourages investments in projects which yield a positive residual income.

Question 13

What are the 3 disadvantages of RI measure?

Answer 13

Cannot be used to assess the relative performance of businesses that are of different sizes
Formula is biased (in favour of large businesses)
Can encourage short term focus

Question 14

What is EVA (Economic value added)?

Answer 14

It is a more refined type of residual income calculation.

EVA = After-tax operating income - (weighted average cost of capital x total capital employed)

Question 15

In the EVA calculation what does total capital employed include?

Answer 15

Amounts paid for buildings, land, machinery

Other expenditures meant to have a long-term pay off such as R&D and employee training

Question 16

What are the effects of EVA?

Answer 16

Encourages reduction in assets

Encourages take up of any project which has a positive EVA

Question 17

Why is it helpful to focus on the two component ratios of the RIO calculation?

Answer 17

For example, when comparing ROI over several years examining the two components of ROI can assist in identifying whether a decreasing ROI is due to a reduction in return on sales or a reduction in investment turnover. If the reason is a poor return on sales, this can lead to a search for reasons why profitability has decreased and the formulation of strategies to improve return on sales and hence improve future ROI.