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Managerial accounting > Performance Evaluation & Measurement Systems > Flashcards

Performance Evaluation & Measurement Systems Flashcards

1
Q

Why evaluate divisions and not solely overall performance?

A
  • hard to pinpoint true cause of the problem

- motivation and contributions of each division

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2
Q

Modern changes on performance evaluation

A
  • large companies: decentralization is unavoidable

- need to delegate decision making authorities to each division

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3
Q

Advantages of decentralization

A
  • organizations respond more quickly to issues: simultaneous problem solving
  • specialized knowledge of divisional managers that top management might not have
  • frees top management from daily operations: focus on strategic levels for the whole
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4
Q

Challenges of decentralization

A
  • goal congruence: coordination throughout top and middle managers
  • company has to express overall strategy to all levels
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5
Q

Responsibility accounting

A
  • system to track, report, and evaluate performance of divisional management at all levels
  • fosters goal congruence
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6
Q

Responsibility centers

A
  • cost center
  • profit center
  • investment center
  • revenue center
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7
Q

How to measure employee performance at all levels

A
  • financial measures: top managers

- non-financial measures: bottom of hierarchy

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8
Q

Disadvantages of using only one measure (financial or non) for bottom or top hierarchy

A
  • only using non-financial measures for low level employees might not give right incentive (ignore their financial impacts)
  • using non-financial measures for top management makes sure they are aware of issues and encourages to check on middle-bottom managers
  • operational and financial measures should supplement each other
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9
Q

Advantages of profit centers

A
  • quality of decisions likely to improve (divisional managers have better market knowledge)
  • provides training for managers, prepares them for top promotions
  • profit consciousness is enhanced
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10
Q

Difficulties of profit centers

A
  • loss of control: inconsistency in decisions
  • lack of competent general managers: get used to delegating decisions, become less prepared
  • too much emphasis on short run profits: hinders long term profitability
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11
Q

Investment centers

A

How much profit increases whilst taking capital invested into account

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12
Q

3 methods of evaluating performance of an investment center

A
  • Return on Investment (ROI)
  • Residual Income (RI)
  • Economic Value Added (EVA)
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13
Q

Advantages of using accounting measures for divisional performance evaluation

A
  • income statement and balance beet provide comprehensive measures
  • this data is readily available
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14
Q

Alternative of using accounting measures for divisional performance evaluation

A
  • using market measures

- share price (stock market)

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15
Q

Disadvantages of using market measures for performance evaluation

A
  • volatile: external impacts which manager has no control over
  • unavailable for private firms
  • employee efforts does not affect share price
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16
Q

Return on Investment theoretic calculation

A

ROI = profit / assets

17
Q

How ROI lead to underinvestment

A
  • if ROI is higher than Cost of Capital, project should be accepted
  • however, managers are incentivized to decline projects that have lower ROI than the average ROI
    E.g.
    ROI = 15%
    ave. ROI = 16%
    CoC = 14%
18
Q

How ROI leads to overinvestment

A
  • if ROI is lower than Cost of Capital, project should be rejected
  • managers are incentivized to accept projects that have higher ROI than average ROI
    E.g.
    ROI = 17%
    ave. ROI = 15%
    CoC = 18%
19
Q

Problems with using ROI to measure performance

A
  • managers are incentivized to keep old assets in the books as this results in a lower denominator and in turn a higher ROI
  • misleading performance signals: portrays performance at a positive light
  • horizon problems: short term (myopic) view incentivizes managers to increase ROI in the short run
20
Q

Advantages of using financial measures for performance evaluation

A
  • helps assign financial responsibilities to subunits

- controllability principle: hold managers accountable for their decisions

21
Q

Using performance evaluation to prepare performance reports

A
  • calculate variances between budgeted and actual amounts
22
Q

3 ways to improve ROI (increase ratio)

A
  • increase sales prices (revenue center)
  • decrease expenses (cost center)
  • lower invested capital (investment center)
23
Q

Residual Income calculation

A

RI = operating profit - capital charge

Capital charge = investment base x cost of capital

Investment base = assets

24
Q

Acceptance rule for RI

A
  • accept: RI is greater than 0 (positive)
25
Q

Advantages of RI for performance evaluation

A
  • aligns decisions with shareholder wealth
  • financial measure: easy to retrieve and compute
  • overcomes ROI disadvantages:
    • fosters goal congruency
    • focuses on operational profit only
26
Q

Disadvantages of RI for performance evaluation

A
  • does not overcome misleading signals of ROI: management of book values to project in positive light
  • only in longer run does RI result in optimal decisions
27
Q

Economic Value Added calculation

A

EVA = adjusted net operating profits after taxes - CoC x adjusted assets employed

28
Q

Advantages of EVA for performance evaluation

A
  • overcomes problem of ROI/RI using book values
  • an ‘adjusted’ version of RI, more reflective/accurate measure
  • aligns decisions with shareholder wealth
  • simple and easy to understand
  • Overcomes disadvantage of multiple inconsistent goals
29
Q

Main adjustments made to the EVA

A
  • undo ‘accounting conservatism’ ideal
  • discourage earnings management
  • take into account past errors when computing

Managerial accounting (10 decks)

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