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Performance Management and Evaluation System

… is a set of procedures that account for and report on
both financial and nonfinancial performance.

Used to identify
How well a company is doing
Where it is going
What improvements will make it more profitable

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What to Measure, How to
Measure
Performance measurement
The use of quantitative tools to gauge an organization’s
performance in relation to a specific goal or an expected
outcome
 To succeed, managers must be able to distinguish between
what is being measured and the actual measures used to
monitor performance

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Other Measurement Issues
A unique set of performance measures must be
developed that are appropriate to each
organization’s situation
Issues to consider other than what to measure and
how to measure it.
What performance measures can be used?
How can managers
 Monitor the level of product or service quality?
 Monitor production and other business processes to
identify areas that need improvement?
 Measure customer satisfaction?
 Monitor financial performance?

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Other Measurement Issues
(cont’d)
Are there other stakeholders to whom a manager is
accountable?
What performance measures do government entities
impose on the company?
How can a manager measure the company’s effect on
the environment?

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Responsibility Accounting
Define responsibility accounting, and describe the role
that responsibility centers play in performance
management and evaluation
As part of their performance management
systems, many organizations
 Assign resources to specific areas of responsibility
 Track how the managers of those areas use those
resources
 Evaluate managers at all levels in terms of their ability
to manage their area of responsibility in keeping with
organizational goals.

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Responsibility Accounting (cont’d)
Is an information system
Classifies data according to areas of responsibility
Reports each area’s activities by including only the
revenue, cost, and resource categories that the
assigned manager can control
Responsibility center
An organizational unit whose manager has been
assigned the responsibility of managing a portion of
the organization’s resources
 The activity of the responsibility center dictates the
extent of a manager’s responsibility

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Types of Responsibility Centers
1. Cost centers
2. Discretionary cost centers
3. Revenue centers
4. Profit centers
5. Investment centers

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Cost Center
A responsibility center whose manager is accountable only for
controllable costs that have well-defined relationships between the
center’s resources and products or services.
Performance is usually evaluated by comparing an activity’s actual
cost with its budgeted cost and analyzing the resulting variances.
Examples
Assembly plants in manufacturing organizations
 Relationship between the costs of resources and resulting
products is well defined.
Food services in hospitals and nursing homes
 Clear relationship between costs of food and direct labor and
the number of inpatient meals served.

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Discretionary Cost Center
A responsibility center whose manager is accountable
for costs only and in which the relationship between
resources and products or services produced is not
well defined
Cost-based measures cannot usually be used to evaluate
performance

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Discretionary Cost Centers (cont’d)
Examples
Administrative activities
 Accounting
 Human resources
 Legal services

Research and Development

 Might measure number of patents obtained and number of cost-
saving innovations developed
Service organizations
 United Way might measure administrative activities by how low
their costs are as a percentage of total contributions

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Revenue Center
 A responsibility center whose manager is accountable primarily for revenue
and whose success is based on its ability to generate revenue.
 Performance is usually evaluated by comparing its actual revenue with its
budgeted revenue and analyzing variances.
Examples
 Car rental reservation center
 Clothing retailer e-commerce order department
 Performance measures for both manufacturing and service organizations
may include:
 Sales dollars
 Number of customer sales
 Sales revenue per minute

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Profit Center
A responsibility center whose manager is
accountable for both revenue and costs and for
the resulting operating income.
Example
Local store of a national chain such as Showa
shopping center, Fantu Supermarket, Xavior mar,
Chuchu supermarket…etc
Performance evaluated by comparing figures
from actual income statements with figures in
its master or flexible budget income statement.

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Investment Center
A responsibility center whose manager is
accountable for profit generation and can also
make significant decisions about the resources the
center uses
Performance of both manufacturing and service
organizations usually evaluated using measures
such as
Return on investment
Residual income
Economic value added

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Return on Investment
Takes into account both operating income and the
assets invested to earn that income
Common measure

Operating Income
Return on Investment (ROI) 
Assets Invested

Assets invested is the average of the beginning

and ending asset balances for the period

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Return on Investment (cont’d)
Income and assets specifically controlled by a
manager must be properly measured
Critical to the quality of ROI
ROI may be used to evaluate the manager of any
investment center
An entire company
A unit within the company
 Subsidiary, division, or other segment

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Performance Report Based on Return on Investment for the Café
Cubano Restaurant Division

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Return on Investment (cont’d)
The ROI computation is the aggregate
measure of many interrelationships
The basic ROI equation can be rewritten to show
the many elements a manager can influence

Operating Income
ROI 
Assets Invested

Operating Income Sales

ROI  
Sales Assets Invested

ROI  Profit Margin  Asset Turnover

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Return on Investment (cont’d)
 Two important indicators of performance
 Profit margin
 Ratio of operating income to sales
 Represents the percentage of each sales dollar the results in profit
 Asset turnover
 Ratio of sales to average assets invested
 Indicates the productivity of assets
 Number of sales dollars generated by each dollar invested in
assets
 Profit margin and asset turnover help to explain
 Changes in ROI for a single investment center
 Differences of ROI among investment centers
 ROI formula is useful for analyzing and interpreting the elements that
make up a business’s overall return on investment

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Return on Investment (cont’d)
A single ROI number is a composite index of many
cause-and-effect relationships and interdependent
financial elements
Managers can improve ROI by
Increasing sales
Decreasing costs
Decreasing assets

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Return on Investment (cont’d)
ROI should be used cautiously in evaluating
performance
Affected by many factors
If overemphasized
Investment center managers may make business
decisions that favor their personal ROI
 At the expense of companywide profits or long-term success of
other investment centers
To avoid this problem, always use other performance
measures in conjunction with ROI

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Return on Investment (cont’d)
Other performance measures to use in
conjunction with ROI
Comparisons of revenues, costs, and operating income
with budgeted amounts or past trends
Sales growth percentages
Market share percentages
Other key variables in the organization's activity
Ratio of ROI to budgeted goals and past ROI trends
 Changes in this ratio over time can be more revealing than any
single number

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Residual Income (cont’d)
RI is the operating income that an investment center earns above a minimum
desired return on invested assets.
 Developed because of pitfalls in using ROI as a performance measure.
 Is not a ratio but a dollar amount
 Amount of profit left after subtracting a predetermined desired income
target for an investment center.

Residual Income  Operating Income  (Desired ROI  Assets Invested)

As with ROI computations, assets invested is the average of the

center’s beginning and ending asset balances for the period

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Residual Income (cont’d)
The desired RI will vary among investment centers
depending on the
Type of business
Level of risk assumed

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Performance Report Based on Residual Income for the
Café Cubano Restaurant Division.

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Residual Income (cont’d)
Comparisons with other RI figures will strengthen
the analysis.
To add context to the analysis, the following
questions should be answered.
How does the division’s RI for this year compare with
previous years?
Did actual RI exceed budgeted RI?
How does this division’s RI compare with the RI of
other investment centers of the company?

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Residual Income (cont’d)
When comparing a division’s RI with the RI of
other investment centers of the company, caution
should be used.
For RI figures to be comparable, all investment centers
must have:
 Equal access to resources
 Similar asset investment bases

Managers may be able to produce a larger RI simply

because their investment centers are larger
 May not reflect better performance

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Economic Value Added
EVA is the shareholder wealth created by an investment center
Used as an indicator of performance
Is a registered trademark of the consulting firm Stern Stewart
& Company.

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Economic Value Added (cont’d)
Calculation can be complex
 Makes various cost of capital and accounting principles
adjustments
EVA is expressed as a dollar amount

EVA  After - Tax Operating Income  Cost of Capital in Dollars

or

EVA  AfterTax Operating Income 

[Cost of Capital  (Total Assets  Current Liabilities)]

Cost of capital is the minimum desired rate of return on an

investment, such as assets invested in an investment center

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Performance Report Based on Economic Value Added
for the Café Cubano Restaurant Division

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Economic Value Added (cont’d)
Caution should be used when evaluating performance
using EVA.
Many factors affect the economic value of an
investment center.
Compare the current EVA with
EVAs from previous periods
Target EVAs
EVAs from other investment centers

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Economic Value Added (cont’d)
An investment center’s EVA is affected by a
manager’s decisions on:
Pricing
Product sales volume
Taxes
Cost of capital
Capital investments
Other financial decisions

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Economic Value Added (cont’d)
The EVA number is a composite index drawn
from many cause-and-effect relationships and
interdependent financial elements
Managers can improve the EVA of an investment
center by
Increasing sales
Decreasing costs
Decreasing assets
Lowering the cost of capital

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End of Chapter 5

Thank You!!!

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