Control Systems And Performance Measurement

Question 1

Introduction

Answer 1

Performance measures are a central component of management control systems.
Making good planning and control decisions requires information about how different subunits of the organisation have performed.
Looking at the design, implementation and uses of performance measures.

Question 2

Financial and non-financial performance measures

Answer 2

Many widely used performance measures, such as operating profit, rely on internal financial information.
Companies are supplementing internal financial measures with measures based on:
External financial information
Internal non-financial information
External non-financial information

Question 3

The balanced scorecard

Answer 3

Some organisations present financial and non-financial performance measures for their subunits in a single report.
Most scorecards include:
Profitability measures
Customer satisfaction measures
Internal measures of efficiency, quality and time
Innovation measures
- some performance measures have a long-run time horizon
- other measures have a short run time horizon

Question 4

Accounting-based performance measure

Answer 4

Designing an accounting based performance measure requires 5 steps:

1) choose the variable that represent top management’s financial goal
2) choose definitions of the items included in the variables in step 1
3) choose measures for the items included in variables in step 1
4) Choose a target against which to gauge performance
5) Choose the timing of feedback

Question 5

Major weakness of comparing operating profits

Answer 5

Is ignoring differences in the size of the investments in each hotel.
Investment refers to the resource of assets used to generate profit.

Question 6

Approaches include investment in the performance measure:

Answer 6

Return on investment
Residual income
Economic value added
Return on sales

Question 7

Return on investment

Answer 7

Is an accounting measure of income divided by an accounting measure of investment.
Some companies use operating profit for the numerator.
Other companies use net profit.
Some companies use total assets in the denominator.
Others use total assets minus current liabilities.
- Return on investment is also called the accounting rate of return.
- The return on investment can be compared with the rate of return on opportunities elsewhere, inside and outside the company.

Question 8

Return on investment

Answer 8

Method of profitability analysis recognises that there are two basic ingredients in profit making:
Using assets to generate more revenue
Increasing income per unit of revenue

Question 9

The residual income method

Answer 9

An accounting measure of profit minus a required monetary unit (e.g £€) return on an accounting measure of investment.
It looks at what is left over when the required return has been recovered.
Goal congruence is more likely to be promoted by using residual income rather than return on investment.
The objective of maximising ROI may induce managers of highly profitable divisions to reject projects that, from the viewpoint of the organisation as a whole, should be accepted.

Question 10

Economic value added

Answer 10

Is a specific type of residual profit calculation that has recently attracted considerable attention.
EVA substitutes the following specific numbers in the RI calculations:
1) Income equal to after-tax operating profit
2) A required rate of return equal to the weighted-average cost of capital
3) Investment equal to total assets minus current liabilities

Question 11

What can managers do to improve their EVA?

Answer 11

Earn more after-tax operating profit with the same capital.
Use less capital to earn the same after-tax operating profit.
Invest capital in high return projects.

Question 12

Why are ROI or RI measures more appropriate than ROS to evaluate overall aggregate performance?

Answer 12

Because they consider both income earned and investments made.
RI measures overcome some of the goal-congruence problems that ROI measures might introduce

Question 13

Choosing definitions (Step 2)

Answer 13

Definitions include:
Total assets available - includes all assets, regardless of their particular purpose.
Total assets employed - includes total assets available minus the sum of idle assets and assets purchased for further expansions.
Working capital (current assets - current liabilities) plus long-term assets - excludes that portion of total assets employed that are financed by short term creditors
Shareholders equity - requires allocation of the long-term liabilities to the three hotels, which would then be deducted from the total assets of each hotel.

Question 14

Step 3 choosing measures

Answer 14

The current cost of an asset is the cost now of purchasing an identical asset to the one currently held (can be difficult to find)
Historical-cost asset measurement methods generally consider the net book value of the asset.
The proponents of using net book value as an investment base maintain that it is less confusing

Question 15

Step 4 choosing a target level of performance

Answer 15

Historical cost measures are often inadequate for measuring economic returns on new investments and sometimes create disincentives for expansion.
Despite these problems, historical cost ROI can be used to evaluate current performance by establishing target ROIS
The alternative of comparing actual results to target performance is frequently overlooked.

Question 16

Step 5 - Choosing the timing of feedback

Answer 16

Timing of feedback depends largely on how critical the information is for the:
Success of the organisation
Specific level of management involved
Sophistication of the organisation.
Problems in any performance measure can be overcome by emphasising budgets and targets that stress steady improvement

Question 17

Moral hazard

Answer 17

Describes contexts in which an employee prefers to exert less effort than the effort desired by the owner because the employee’s effort or information cannot be accurately monitored and enforced

Question 18

Salaries and incentive

Answer 18

Performance evaluation often affects managers and employees rewards.
Compensation arrangements run range from a flat salary with no direct performance-based incentive to rewards based only on performance.
Managers may face risks because factors beyond their controls may also affect performance.
Owners choose a mix of salary and incentive compensation to trade off the incentive benefit against the cost of imposing risk.
Most often, a managers total compensation includes some combination of salary and a performance-based incentive.

Question 19

Intensity of incentives

Answer 19

Preferred performance measures are ones that are sensitive to, or change significantly with the managers performance and do not change much with changes in factors that are beyond the manager’s control.
Obtaining performance measures that are more sensitive to employee performance is critical for implementing strong incentives.
Benchmarks representing best practice may be available inside or outside the organisation.
- Many practices in management accounting, such as the design of responsibility centres and the establishment of financial and non-financial measures, have as their goal better performance evaluation.

Question 20

Other issues in evaluating performance

Answer 20

Designing performance measures for activities that require multiple tasks.
Team based compensation arrangements
Executive performance measures and compensation
Environmental and ethical responsibilities

Question 21

Four levels of control

Answer 21

Diagnostic systems = measures that help diagnose whether a company is performing to expectations
Boundary systems = these describe standards of behaviour and codes of conduct
Belief systems = these articulate the mission, purpose and core values of a company
Interactive control systems = these help managers to focus organisational and learning on key strategic issues