Topic 3: PERFORMANCE

MANAGEMENT SYSTEM
Well-designed management
accounting and control system
Responsibility accounting
Financial performance measures for
profit organisations
Performance evaluation for service
organisations

pms~nsam 2016

PERFORMANCE MANAGEMENT
SYSTEM

Performance evaluation for non-profit

organizations
Contemporary aspects of performance evaluation
Balances Scorecard & Benchmarking
Globalization and organizational development
Organizational Critical Success Factors
Non-financial measures

pms~nsam 2016

MANAGEMENT ACCOUNTING
AND CONTROL SYSTEM
Control is the process of ensuring that
firms activities conform to plans and that
their objectives are achieved
Merchant (1998) classified three types of control:
1. Action or behaviour controls
2. Personnel and cultural controls
3. Result or output controls
Management accounting system is normally
synonymous with output control; whereas
management control systems encompass all the
above (Drury, 2004)
pms~nsam 2016

MANAGEMENT ACCOUNTING
AND CONTROL SYSTEM
TWO core elements of MACS:
Formal planning processes
Responsibility accounting
Formal planning processes include
budgeting and other long term planning
processes
Responsibility accounting involves
creation of responsibility centres
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RESPONSIBILITY
ACCOUNTING
Is the practice of holding
managers responsible for the
activities and performance of
their area of the business
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RESPONSIBILITY ACCOUNTING
Responsibility centre is a unit of a firm where an
individual manager is held responsible for the units
performance
Responsibility centres enable accountability for
financial results to be allocated to individuals
throughout organisation
Four (4) responsibility centres:
cost centres, revenues centres, profit centres
and investment centres
pms~nsam 2016

RESPONSIBILITY
ACCOUNTING
IMPLEMENTATION include
Issuance of performance reports
that inform responsibility centres
of the deviations from targets for
which they are accountable and
are required to take action
Distinguish those items which
managers can control and for
which should be held
accountable
pms~nsam 2016

RESPONSIBILITY ACCOUNTING
IMPLEMENTATION INCLUDE
Determine how challenging

the financial targets should

be
Determine how much
influence managers should
have in the setting of
financial targets

pms~nsam 2016

MANAGEMENT ACCOUNTING
AND OUTPUT (RESULT)
CONTROL
ESTABLISH
PERFORMANCE
MEASURES
THAT MINIMISE
UNDESIRABLE
BEHAVIOUR

ESTABLISH
PERFORMANCE
TARGETS

MEASURE
ACTUAL
PERFORMANCE

pms~nsam 2016

PROVIDE
REWARD
OR
PUNISHMENT

CENTRALISATION versus
DECENTRALISATION

Many large firms exercise diversification and

operate in many different geographical areas
Due to complexity of operation, some firms
divide their operations into smaller segments
for easier control
Decentralisation is the structuring of an
organisation into smaller units, such as division
or department, each unit is assigned particular
operations and decision making responsibilities
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10

BENEFITS OF
DECENTRALISATION
Release top
management
from day to
day decision
making

Effective
management
of the smaller
areas
Increased
motivation of
the divisional
manager

Allow quick
response to
opportunities
and problems

Provides
training for
future
managers
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11

Issues and Challenges in

exercising Decentralisation

Narrow focus
among
managers

Conflict of
interest

Goal
incongruence

pms~nsam 2016

Duplication
of tasks

12

FINANCIAL PERFORMANCE MEASURES FOR

PROFIT CENTRES
The primary objective of a profit making
organization is to maximize
shareholders wealth
Therefore, performance measure should
be based on the value created by each
division of the organization

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13

FINANCIAL
PERFORMANCE
MEASURES
The commonly used measures by profit making
organizations in evaluating their investment
centres include:
Return on investment (ROI)
Residual income (RI)
Economic value added (EVA)
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14

FINANCIAL PERFORMANCE
Performance Measurement
MEASURES
Return on investment (ROI)

Residual income (RI)

Economic value added (EVA)

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15

RETURN ON

INVESTMENT
ROI expresses divisional profit as a
percentage of the assets employed in
the division
It shows how much profit has been
made in relation to the amount of
resources invested

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16

RETURN ON

INVESTMENT (ROI)

ROI =

Net Profit
Investment

pms~nsam 2016

17

Computing ROI
Profit defined:

Operating profit before interest

and tax, not net cash flow

Profit computed considering

controllable costs only

Profit attained solely from

operation activities

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18

Computing ROI
Investment defined
Investment = Net Current Assets
+ Fixed Assets
Net Current Assets = Average value
for the year or working capital (TCA TCL)

Fixed Assets = can be NBV (maybe

misleading) or replacement cost
(most useful during inflation)

pms~nsam 2016

19

RETURN ON INVESTMENT (ROI)

Heartly Berhad reports the following:
Net Profit
Sales Revenue
Total Investment

RM30,000
RM500,000
RM200,000

Lets calculate ROI.

ROI = RM30,000 = 15%
RM200,000
pms~nsam 2016

20

Improving R0I: 3 ways

Increase
Sales Price
Decrease
Expenses
Lower

Capital
Investment
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21

Improving R0I:

Heartly Bhds manager was able to

increase sales revenue to RM600,000
which increased income to RM42,000.
There was no change in total investment.

Lets calculate the new ROI

ROI = RM42,000 x 100% = 21%
RM200,000
pms~nsam 2016

22

ROI: the advantages

Widely used to measure the

performance of units and managers

Encourages managers to focus on both profits, and
the assets required to generate those profits
o

Promotes understanding of the relationship between

revenues, costs and assets

Can be used to evaluate the relative performance of

investment centres, even when the business units
are of different sizes
13-23

pms~nsam 2016

The limitations of ROI

13-24

It may encourage managers to focus on

improving short-term financial
performance, which may reduce long-term
financial performance
May encourage managers to defer asset
replacement, to maintain a high ROI
Discourages managers from investing in
profitable projects which would decrease
the investment centres ROI

pms~nsam 2016

ROI - A Major Drawback

As division manager of Mahir Bhd, your remuneration
package includes bonus paid based on your divisions
ROI; the higher your divisions ROI, the bigger your
bonus.
The companys policy requires an ROI of 15% on all new
investments; whilst your division has been producing an
ROI of 30.33%.
You have an opportunity to invest in a new project that
will produce an ROI of 20%.
As division manager, would your division
invest in this new project?
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25

Minimising the behavioural

problems of ROI
Use ROI alongside other

13-26

performance measures that focus

on both short-term and long-term
performance
Consider alternative ways of
measuring invested capital to
minimise dysfunctional decisions
pms~nsam 2016

RESIDUAL INCOME (RI)

RI is the amount of profit that remains
after subtracting an imputed interest
charge
Imputed interest charge is the required rate
of return that a company expects of its
investments, which is based on the firms
cost of capital

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27

RESIDUAL INCOME (RI)

Net profit before tax
Investment charge
= Residual income

Total Investment
Imputed interest rate
= Investment charge

Investment centers
minimum required
rate of return
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28

RESIDUAL INCOME

Berduri Bhd has an

opportunity to invest
RM100,000 in a project that
will return RM25,000.
Berduri Bhd has a 20%
required rate of return and a
30% ROI on existing business.

Lets calculate Residual Income.

pms~nsam 2016

29

RESIDUAL INCOME
Net profit before tax
Investment charge
= Residual income

= RM25,000
= RM20,000
= RM 5,000

Investment capital
= $100,000
Imputed interest rate = 20%
= Investment charge
= $ 20,000

Investment centres
minimum required
rate of return
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30

RESIDUAL INCOME
As a manager at
Berduri, would you
invest the RM100,000
if you were evaluated
using Residual
Income?
Would your decision
be different if you
were evaluated using
ROI?
pms~nsam 2016

31

RESIDUAL INCOME
Residual income encourages
managers to make profitable
investments that would be rejected by
managers using ROI.

pms~nsam 2016

32

RESIDUAL INCOME:
the advantages

13-33

More likely to promote goal congruence,

compared to ROI
Takes account of the organisations required
rate of return in measuring performance
Encourages investment in projects which
yield a positive residual income to the
organisation

pms~nsam 2016

DISADVANTAGES OF RESIDUAL
INCOME

13-34

Cannot be used to assess the relative performance of

businesses that are of different sizes, unlike ROI
Formula is biased in favour of larger businesses
Can encourage short-term focus
Focus on financial aspect only

pms~nsam 2016

ECONOMIC VALUE ADDED (EVA)

EVA tells us how

much shareholders
wealth is being
created

pms~nsam 2016

35

ECONOMIC VALUE ADDED (EVA)

Investment centres profit after-tax
Investment charge
= Economic Value Added

Investment
centres
current liabilities

Cost of
Market
value
debt
after-tax
of debt
Market
value
of debt

Cost of
Market
equity value
capital
of equity
Market
value
of equity

) (

Weighted
average
cost of capital

Investment

centres
total assets

pms~nsam 2016

36

ECONOMIC VALUE ADDED

The Southern Division of SunTan Food Centres
reported the following results for the most recent period:
Southern's pre-tax profit
Southern's total assets
Southern's current liabilities
Market value of Sun Tan's debt
Market value of Sun Tan's equity
Interest rate on Sun Tan's debt
Cost of Sun Tan's equity capital
Tax rate

RM6,750,000
RM45,000,000
RM600,000
RM40,000,000
RM60,000,000
9%
12%
30%

Compute Southern Divs EVA !

pms~nsam 2016

37

ECONOMIC VALUE ADDED

First, lets compute the
weighted-average cost of capital (wacc)
Cost of
Market
Cost of
Market
value
debt
value
equity
after-tax of debt
capital
of equity
Market value
Market value
of debt
of equity

)(

(9% (1 30%) RM40,000,000) + (12% RM60,000,000)

= 0.0972
(RM40,000,000 + RM60,000,000)

pms~nsam 2016

38

ECONOMIC VALUE ADDED

RM6,750,000 (1 30%)

RM4,725,000 Operating profit after tax

RM4,315,680
= RM409,320 Economic value added
(RM45,000,000 RM600,000) 0.0972 = RM4,315,680

(9% (1 30%) RM40,000,000) + (.12 RM60,000,000)

= 0.0972
(RM40,000,000 + RM60,000,000)
pms~nsam 2016

39

EXERCISES
Q1B &Q2 DEC 2015
Q1B &Q2 JUN 2015

Q1B JAN 2015

Q2 JAN 2015
Q3 JUN 2014
Q3 JUN 2013

Q1 JAN 2013
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40

EFFECTIVE PERFORMANCE
MANAGEMENT SYSTEM (PMS)
Effective PM is vital in ensuring

successful implementation of
organisational strategies
Its about monitoring organizations
effectiveness in fulfilling its own
goals or the requirements of the
stakeholders
Successful company performs well
financially as well as in term of
quality, flexibility, value etc.
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41

Features of effective
PMS

Performance measure should link to

organisational strategies and goals to promote
goal congruence
Measures used are understandable and
communicated to employees
Measures are related to activities and
processes that are under employees control
Measures are reported as close as possible to
the period they relate
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42

Features of effective PMS

Measures are benchmarked to

high external standards
Embrace employees
participation & empowerment in
formulating and operating the
system
PMS should linked to the reward
system
It should be holistic that covers
various perspectives
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43

NON FINANCIAL PERFORMANCE

MEASUREMENT using

BALANCED
SCORECARD

pms~nsam 2016

44

BALANCED
SCORE CARD
BALANCED
SCORECARD

an instrument designed
and used to assist
managers to evaluate
past performance to
drive future performance

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45

BALANCED SCORECARD
was originated in 1992 by

Kaplan and Norton as a

performance measurement
framework
added strategic non-financial
performance measures to
traditional financial metrics
to give managers a more
'balanced' view of
organizational performance
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46

Balanced Scorecard: THE 4 perspectives

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47

BALANCED SCORECARD
provides a framework that helps
planners identify what should be
done and measured.
provides a clear prescription as to
what companies should measure in
order to 'balance' the financial
perspective.
is not only a measurement system,
it also enables organizations to
clarify their vision and strategy and
translate them into action.
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48

The new Balanced Scorecard

Adapted from Robert S. Kaplan and David P. Norton, Using the Balanced
Scorecard
as a Strategic Management System,
pms~nsam
2016
Harvard Business Review (January-February 1996): 76.

49

Strategy Mapping

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50

BENEFITS OF BSC

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51

BENEFITS OF BSC

Better Strategic Planning BSC forces managers to think

about cause-and-effect relationships.
The performance outcomes and their key drivers identified in
BSC create a complete picture of the strategy.
Improved Strategy Communication & Execution
BSC map all strategies with its interrelated objectives on a piece
of paper allows companies to easily communicate strategy
internally and externally.
This facilitates understanding of strategy among all staffs
Better Management Information The BSC approach
forces organisations to design KPIs for their various strategic
objectives.
This ensures companies to measure what actually matters.

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52

BENEFITS OF BSC

Improved Performance Reporting

companies tend to produce better performance
reports & more transparent to create meaningful
management reports to communicate
performance internally and externally.
Better Strategic Alignment BSC allow
better alignment of organisation with their
strategic objectives. To execute a plan well,
organisations need to ensure that all business
units are working towards the same goals.
Better Organisational Alignment BSC help
to align organisational processes such as
budgeting & risk management, with the strategic
priorities.
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53

ADVANTAGES OF BSC
Holistic all critical areas in the
organisation that produce financial
outcomes are assessed.
Forward looking vital for strategic
management process
Ease communication & coordination

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54

BENCHMARKING
Benchmarking is a continuous process of
measuring a firms products, services or
activities against the other best performing
organizations, either internal or external to
the firm with the aim to improve firms
performance.

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55

BENCHMARKING
The objective is to ascertain how the
processes and the activities can be improved
and to implement the best practice.
It involves an external focus on the latest
developments, best practice and model
examples that can be incorporated within
various operations of business organizations.
It represents the ideal way of moving forward
and achieving high competitive standards
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56

TYPES OF BENCHMARKING
Strategic benchmarking (examine long-term
strategies)
Performance /competitive benchmarking
(with partners in the same sector)
Process benchmarking (focus on critical
processes to be improved)
Functional benchmarking (with partners from
different sectors)
Internal benchmarking
External benchmarking
International benchmarking
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57

STAGES IN BENCHMARKING
1. Set objectives and determine areas to
2.
3.
4.
5.
6.

benchmark
Establish key performance measures
Choose benchmarking partner
Measure own & others performance, and
compare performance
Design & implement improvement
programmes
Monitor improvement
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58

THE STAGES IN BENCHMARKING

Identifying the functions or activities to be benchmarked
and performance measures.
Choose the organization to be benchmarked or the
benchmarking partner

Benchmarking partner maybe internal or external to the

organisation. It must be the best performer in the area
under study

Obtain and analyze data

gather information from various sources including customers

and the benchmarked organisations management.
Any gap should be clarified at this stage.
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59

THE STAGES IN BENCHMARKING

Establish performance goals and plan new processes

new processes and practices should suit the plant and to be

able to achieve its performance goals

Implement plans
o

may involve enhancing the firms database , restructuring

certain areas, staff training , communicating effectively the
changes that needs to be made & etc

Monitor results continuously

o

Measure performance against benchmarks regularly and

motivate staff continuously to enhance processes.
Full and continuous commitment from top management is
greatly required
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60

ISSUES IN PERFORMANCE
MANAGEMENT SYSTEM
PMS in Service Businesses
PMS in Non-Profit Organisations
Globalisation & Organisational

Development
Critical Success Factors
Non-Financial Measures

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61

Performance Evaluation for Service

Organizations
Appropriate performance measures should be selected

in the light of companys strategic intentions to suit its

competitive environment
Authors from various management disciplines suggested
the following performance indicators for service firms:

Competitive advantage
Flexibility
Financial performance
Resource utilization
Service quality
Innovation etc

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62

Performance Measurement in
Service Businesses (Fitzgerald et al,1999 )
Performance
dimension

Types of performance
measures

Competitiveness

Relative market share & position, sales

growth, etc

Financial
performance
Service quality

Profitability, liquidity, market ratios, capital

structure etc.
Reliability, responsiveness, availability,
appearance, cleanliness, comfort,
communication, security, courtesy,
friendliness, etc
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63

Performance Measurement in
Service Businesses (Fitzgerald et al,1999)
Performance
dimension

Types of performance
measures

Flexibility

Volume flexibility, specification and speed of

delivery flexibility

Resource utilization
Innovation

Productivity, efficiency, etc.

Performance of innovation process,
performance of individual innovations, etc.

pms~nsam 2016

64

Performance Evaluation For

Non-profit Organizations
Value for Money (5Es):

Espirit de Corps
Economics
Efficiency
Effectiveness
Ethics
pms~nsam 2016

65

PMS , Globalisation & Organizational

Development

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66

GLOBALISATION
Globalisation is the process by which the
experience of everyday life is becoming
standardised around the world

Globalisation occurs due to among others:

o increased sophisticated in communications &
transportation technologies and services
o outgrown national markets that cross national frontiers
o international agreements that reduce the cost of doing
business in foreign countries & etc
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67

PMS & Globalization

Globalization offers huge

potential profits to companies,
but complicated by widely
differing expectations, standards
of living, cultures and values,
legal systems as well as
unexpected global cause-andeffect linkages.

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68

PMS & Globalization

Therefore, PMS needs

to be developed to
meet the changes in
the organization
global structure and
culture.

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69

CRITICAL SUCCESS
FACTORS (CSF)

CSF refers to the element

that is necessary for an
organization or project to
achieve its mission.
It is a critical factor or
activity required for
ensuring the success of an
organization.
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70

CRITICAL SUCCESS FACTORS

Is the managerial/enterprise
areas, that must be given
special and continual attention
to bring high performance.
It include issues that are vital to
an organization's current
operating activities and to its
future success.

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71

CRITICAL SUCCESS FACTORS

Statistical research into CSFs on organizations has
shown there are seven key areas which include:
1. Training and education
2. Quality data and reporting
3. Management commitment to customer
satisfaction
4. Staff Orientation
5. Role of the quality department
6. Communication to improve quality, and
7. Continuous improvement

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72

NON FINANCIAL MEASURES (NFM)

Kaplan states: if senior managers

place too much emphasis on
managing by the financial numbers,
the organizations long term
viability becomes threaten.

Solely financial indicators is an

incomplete management tools set

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73

THE ESSENTIAL OF NFM

1.

Not all aspects of corporate activity can

be expressed in monetary term

2. If managers aim for excellence in their

own aspects of the business, then the
companys bottom line will take care of its
self

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74

NON FINANCIAL MEASURES

the influence of globalisation,

environmental crises and widespread
ethical breakdown, pressure management
to identify and report new non-traditional,
and non-financial measures of
performance to get at newly recognized
dimensions of enterprise value, success and
significance.

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75

NON FINANCIAL
MEASURES (NFM)

...non-financial measures of
performance... emerge from a belief that
social, environmental, ethical, and
geopolitical factors materially impact the
ability of a company or enterprise to
perform favourably

(KLM Inc.,2004)
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76

NFM KEY AREAS

The areas are drawn from the strategic risks and

opportunities associated with sustainability in the
social, environmental, and ethical dimensions
The issues that receive great attention at this time
include corporate governance, transparency,
attestable financial integrity, corporate social
responsibility, environmental impact, and corporate
ethical character.

pms~nsam 2016

77

The
end
pms~nsam 2016

78

Question 1(a) DEC2013

Cargoes Division

Buses Division:

Profit margin = RM19,600,000 RM10,000,000 RM3,000,000

= RM6,600,000
ROI = RM6,600,000 /RM55,000,000 = 12%

Variable costs= Service revenue Contribution margin

= RM900,000 RM360,000 = RM540,000
Profit margin = Contribution margin fixed costs
= RM360,000 RM220,000 = RM140,000
ROI = Profit margin Average operating assets
Average operating assets = RM140,000 10% = RM1,400,000
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79

Q1(a) DEC2013

Limos Division:

ROI = Profit margin Average operating assets

= RM 320,000 RM4,000,000 = 8%
Fixed costs = Contribution margin profit margin

= RM760,000 RM320,000 = RM440,000

Service revenue = Contribution margin + Variable costs
= RM760,000 + RM640,000 = RM1,400,000

pms~nsam 2016

80

Q1(b) DEC2013
Cargo Division
Residual income
ROI
= RM6,600,000 - (55,000,000 x 11%)
12%
= 6,600,000 6,050,000 = 550,000
The performance is good. The positive residual income indicates that the
investment covers the imputed interest charge.
The ROI also indicate that the divisional performance is well above the required rate
of return
Buses Division
Residual income
ROI
= RM140,000 - (1,400,000 x 11%)
10%
= 140,000 - 154,000 = (RM14,000)
This investment is unattractive. The negative residual income indicates that the
investment fail to cover the imputed interest charge.
Division ROI is below the required rate of return indicates poor performance.
pms~nsam 2016

81

Q1(b) DEC2013
Limos Division
Residual income
ROI
= RM320,000 - (3,200,000 x 11%)
8%
= 320,000 - 352,000 = (RM32,000)
This investment is unattractive. The negative residual income indicates that the
investment fail to cover the imputed interest charge.
The ROI is well below minimum required rate of return shows that the division is not
performing well .

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82

Q1(c) DEC2013

Under responsibility accounting, a managers performance is

evaluated on matters directly under that managers control. All costs
and revenues are controllable at some level of responsibility within a
company .
The critical issue under responsibility accounting is whether the cost
or revenue is controllable at the level of responsibility with which it
is associated .
A cost over which a manager has control is called a controllable
cost, that is, costs incurred directly by a level of responsibility are
controllable at that level .
As such, all costs are controllable by top management because of the
broad range of its authority. However, as one move down to each
lower lever of managerial responsibility, fewer costs are controllable
because of the managers decreasing authority .

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83

Q1(d) DEC2013

The terms help to distinguish between the performance of the

manager of a unit and the performance of the unit itself.
In evaluating the managers performance, only revenues and
costs that the manager can control or significantly influence
should be included in the profit measure (profit margin
controllable by unit manager) .
In contrast, when evaluating the economic performance of a unit
we focus on revenues and costs that are attributable to that unit
which refers to profit margin attributable to unit .
However many businesses do not recognize the distinction
between business unit performance and managerial performance
evaluation. If unfavorable events occur that are beyond his or her
control, then the manager must skillfully manage around those
events .
pms~nsam 2016

84

Q1(e) DEC2013
Differences between BPR and Continuous Improvement
(Kaizen)
Business Process
Reengineering
Expensive

Continuous improvement
(Kaizen)
Cost reduction

Technology oriented

More people-oriented

Enables radical changes

Provides only a small pace of

changes
Easier to implement

Harder to implement and often

risky
Requires considerable change
management skills

Requires long-term discipline

pms~nsam 2016

85

Q1(e) DEC2013:
Four steps that Transtate Bhd should undertake in
business process reengineering:

Prepare a business process map

o

Establish goals
o

Management establishes clear goals for the re-engineered process,

based on the business sources of customer value

Reorganise work flow

o

A flowchart of the activities that make up the business process is

prepared

Management works out how to reorganize the flow of work so that

these goals can be achieved

Implementation
o

Management realizes that business process reengineering involves

substantial change.
pms~nsam 2016

86

Question on EVA:
SMSS finances its investment using both equity and debt capital. The
expected cost of:
equity capital = 10.8%
debt capital = 6.7% (before tax)
The market value of:
equity capital = RM3,840,000
long-term debts = RM2,400,000
The income tax rate is at 30% and the forecasted financial results for
the two divisions for the coming year are as follows:

Divisions

Milk Drinks
Fruit Juice Drinks

Total current Total current Total net

assets
liabilities fixed assets
RM
RM
RM

187,500
210,000

495,000
525,000

2,977,500
3,022,500

Net Profit
after tax
RM

252,000
163,800

Required: Determine the EVA of the two divisions

pms~nsam 2016

87

To calculate EVA, firstly determine the weighted average cost of capital

(WACC):
WACC = (6.7% x 70%) (RM2.4 m) + (10.8% x RM3.84 m)
(RM2.4 m + RM3.84 m)

= RM112,560 + RM414,720
RM6,240,000

= 8.45%

Then, determine Total Net Assets (TNA):

TNA = TCA + TNCA TCL

Milk Drinks Division:
TNA = RM187,500 + RM2,977,500 RM495,000
= RM2,670,000
Fruit Juice Drinks Division:
TNA = RM210,000 + RM3,022,500 RM525,000
= RM2,707,500
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Finally, EVA = PAT [TNA x WACC]

Milk Drinks Division :
= RM252,000 [RM2.67m x 8.45%]
= RM26,385
Fruit Juice Drinks Division:
= RM163,800 [RM2,707,500 x 8.45%]
= RM(64,984)

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89

pms~nsam 2016

90