Performance evaluation Flashcards
What is the term feedback used to describe?
The process of reporting back control information to management and the control information itself.
What are the steps in the feedback loop?
(0 - Set objectives) 1 - Plan, target or budget 2 - Operations 3 - Measure outputs 4 - Feedback of information 5 - Compare actual results with plan 6 - Control action
What can management do by comparing actual and planned results?
- Take control action
- Decide to do nothing
- Alter the plan or target
What are the features of effective feedback?
- ‘Exception principle’ should be applied so only significant differences between the target and actual results are highlighted for investigation
- Controllable costs and revenues should be separately identified
- Reports should be made available to managers in a timely fashion
- Information should be concise and sufficiently accurate for the purpose intended
- Reports should be communicated to the manager who has responsibility and authority to act on the information.
What are the three ways of using budgetary information to evaluate managerial performance identified by Hopwood?
Budget constrained - Managers’ performance is measured on ability to meet budget
Profit conscious - Managers’ focus is on increasing the effectiveness of a unit’s operations. Goal is to generate a positive return to shareholders
Non-accounting - Managers’ focus is non-financial. Measures such as feedback from colleagues is how performance is measured.
How might budget bias be introduced?
- Put slack into budgets (underestimate revenue or overestimate costs)
- Inflate budget to ensure spending is protected
What is divisionalisation?
The division of a business into more or less autonomous regional or product-centred businesses, each with its own revenues, expenditures and investments.
Generally leads to decentralisation of decision-making process.
What are the advantages of decentralisation?
- Senior managers are freed from detailed involvement in day to day operations and can devote more time to strategic issues
- Quality of decisions may improve
- Increased responsibility should motivate managers
- Decisions can be taken more quickly
- Valuable training for future senior managers
What are the disadvantages of decentralisation?
- It can be difficult to co-ordinate the activities of the organisation as the organisation divides into a number of self-interested segments
- Senior managers are less involved with day to day activities so the link between the top and bottom of the organisation becomes weaker
- Performance management becomes more difficult
- Some duplication of roles
What is responsibility accounting?
Decentralisation of authority, with the performance of the decentralised units or responsibility centres measured in terms of accounting results.
What are the four main types of responsibility centre?
- Cost centre
- Revenue centre
- Profit centre
- Investment centre
How can performance of investment centres be measured?
Using profit earned in relation to the amount of capital invested.
ROI or RI.
What should the amount of capital employed attributed to an investment centre consist of?
Only DIRECTLY attributable non-current assets and working capital (net current assets).
What do shared service centres do?
Consolidate the transaction-processing activities of many operations within a company, e.g. HR, payroll, accounting and IT may be carried out in a shared service centres.
What is the aim of a shared service centre?
To achieve significant cost reductions while improving service levels through the use of standardised technology and processes and service level agreements.
What are the disadvantages of shared service centres?
- Loss of business-specific knowledge
- Weakened relationships and removal from day to day realities
What are hosted applications?
Involve using your own desktop or server accounting application and accessing the accounting software using the internet.
What does software as a service SaaS involve?
Using a cloud accounting supplier’s server where the accounting software and data are stored.
What are the benefits of cloud accounting?
- Accounting information can be accessed from anywhere, at any time, from a browser or mobile device, as long as internet access is available. Information can therefore be accessed quickly by management and employees can be deployed anywhere.
- The security systems in place will often be better than a small business can provide.
- The software updates and back-ups are managed by the cloud accounting supplier.
- Applications are usually rented rather than purchased meaning that there are no upfront costs.
- Overhead costs, such as in-house technical experts costs, can be reduced.
- There is no need to worry about whether PCs are powerful enough as the software is running in the cloud, not on the PC
- Collaboration between users is easier as files can be shared via invitations rather than physically exchanging files
- If the business grows then more cloud accounting licences can be purchased.
What are the risks of cloud accounting?
- The supplied could fail and so a contingency plan is required.
- There is a permanent need for internet access. Operations could be hampered if there is a problem with internet access.
- There is a risk of security breaches, including data loss or theft and privacy issues.
- There are legislation risks if the cloud supplier operates from a jurisdiction where the laws are different from the country in which the data is being used (particularly privacy laws)
- Unannounced changes or upgrades to software could be disruptive.
What should effective performance measures do?
- Promote goal congruence
- Incorporate only those factors over which the responsibility centre manager has control
- Encourage the pursuit of longer term objectives
What problems may arise through the use of inappropriate performance measures?
- Managers may manipulate information
- Measures might cause demotivation and stress-related conflict
- Measures might promote excess concern for the control of short-term costs
- Measures may lead to the assessment of a responsibility centre as an isolated unit (contrary to goal congruence)
What may be appropriate performance measures for an investment centre?
Working capital ratios e.g.:
- Liquidity ratios (quick/current ratio)
- Rate of inventory turnover
- Receivables and payables periods
Return on investment (ROI)
Residual income (RI)
How is ROI calculated?
ROI = (Controllable divisional profit / Divisional capital employed) x 100%
Profit should be BEFORE interest and tax
Capital can be opening value OR average value of opening and closing
What is the decision rule with ROI?
Accept project if it increases current ROI
What are the problems with ROI?
- Can cause dysfunctional behaviour, as projects that increase ROI may be accepted at the expense of long-term growth in corporate profits
- Ratio will be distorted by the age of the assets (disincentive to invest in new assets)
- Profit can be manipulated
Is ROI an absolute or relative measure?
Relative
Is residual income a relative or absolute measure?
Absolute
How is RI calculated?
RI = Controllable profit - Imputed interest charge on controllable investment
What is the decision rule with RI?
Accept project if it generates a positive RI
What are the advantages of using RI?
- Acceptable projects increase the RI of a division giving a simpler decision rule
- RI can be more flexible as different costs of capital can be applied to investments with different risk characteristics (e.g. if there is an increase in risk, demand a higher cost of capital/higher return)
What are the disadvantages of using RI?
- Comparisons are more difficult
- RI does not relate the size of a centre’s income to the size of the investment (as it is absolute not relative)
When will RI increase?
When a new investment is undertaken which earns a profit in excess of the imputed interest charge on the value of the asset.
How would ROI and RI yield different results on a potential marginally profitable investment?
RI will likely cause investment to be undertaken if profit in excess of imputed interest charge.
ROI is far less likely to cause a marginally profitable investment to be undertaken as it would reduce average ROI earned by the centre as a whole.
What is the balanced scorecard?
Focuses on four different perspectives and aims to establish goals for each together with measures which can be used to evaluate whether these goals have been achieved.
What are the four perspectives of the balanced scorecard?
- Financial
- Internal business
- Customer
- Innovation and learning
What are the features of the balanced scorecard?
- Focuses on both internal and external factors and links performance measures to key elements of a company’s strategy
- Requires balanced consideration of financial and non-financial measures and goals to prevent improvements being made in one area at the expense of another
- Attempts to identify the needs and concerns of customers to identify new products and markets and focuses on comparison with competitors to establish best practice
