Performance

Evaluation and the

Balanced Scorecard
CHAPTER 11

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Explain why and how companies

decentralize.

OBJECTIVE 1

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Centralized and Decentralized Operations

Centralized
Decision
making and
planning

Decentralized

Owner/Manager

Delegated to unit managers

Application
base

Small scope of operations

Business characteristic Geographic area, product line,

customer base, business
function, other.

Advantages

Frees management time

Uses experts knowledge
Avoids duplication of costs Improves Customer Relations
Simplifies goal congruence Vast training and experience
Increases managers
motivation and retention

Disadvantage
s

Limits management time

Managers knowledge
limited
Duplicates certain costs or
Customer Relations
assets
strained
Problems with Goal
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Costly Training for one
Congruence
Inc.

Responsibility Centers
Responsibility
Center

Manager is
responsible
for

Examples

Cost Center

Controlling Costs

Production line at
Dell computer

Revenue Center

Generating Sales
Revenue

Midwest sales region

at Pace Foods

Profit Center

Producing profit
Product line at
through generating
Anheuser-Busch
sales and controlling
costs

Investment Center

Producing profit and

managing the
divisions invested
capital
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Company divisions
such as Walt Disney
World Resorts
4

Explain why companies use performance

evaluation systems.

OBJECTIVE 2

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Goals of Performance
Evaluation Systems
Promoting goal congruence and
coordination
Communicating expectations
Motivating unit managers
Providing feedback
Benchmarking

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Limitations of Financial
Performance Measures
Management needs both:
Lag indicators
Lead indicators

Tendency to focus on short-term

achievements

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Describe the balanced scorecard and

identify key performance indicators for
each perspective.

OBJECTIVE 3

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Balanced Scorecard
Measure companys activities in
terms of its vision and strategies
Financial and operational
performance measures are
considered
Link company goals to key
performance indicators

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Linking Goals to Key Performance

Indicators (See examples at Exhibit 11-2)

COMPANY GOALS

CRITICAL FACTORS
(customer satisfaction, operational efficiency,
employee excellence, financial profitability)
KEY PERFORMANCE INDICATORS (KPIs)
(market share, yield rate, employee training
hours, revenue growth)
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Four Perspectives
Financial perspective
How do we look to shareholders?

Customer perspective
How do customers see us?

Internal business perspective

At what business processes must we
excel to satisfy customer and financial
objectives?

Learning and growth perspective

Can we continue to improve and create
value?
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11

Use performance reports to evaluate cost,

revenue, and profit centers.

OBJECTIVE 4

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Performance Reports
Report financial performance of
responsibility centers
Cost center: focus on flexible budget variance
Revenue center: focus on flexible budget
variance and sales volume variance
Profit center: focus on flexible budget variance
Includes allocated charges from service
departments

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Cost Center Performance Reports:

Exhibit 11-4
HOUSE AND
GARDEN DEPOT
QUEBEC REGION

Salary & wages

Payroll benefits
Equipment
depreciation
Supplies
Other
Total

Flexible
%
Flexible budget
Actual
Varianc
budget varianc
e
e
$18,500 $18,000 $500 U 2.8% U
1,100 22.0%
6,100
5,000
U
U
3,000

3,000

3,000

1,850

2,000

1,900

2,000

150 F 7.5% F
5.0% F
100 F

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$31,350 $30,000

$1,350

0%

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4.5% U

Revenue Center Performance Reports:

Exhibit 11-5

Sales
Revenue
Benjamin
Moore
Flat:
Volume
(gallons)
Revenue

Flexibl
Sales
Static
e
Flexibl Volum
Actual
(Master
budget
e
e
Sales
)
varian budget Varian
Budget
ce
ce

2,480

-0-

2,480

155 F

2,325

$40,92 $3,720 $44,64

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2015U
Pearson Canada0
0
Inc.

2,790
F

$41,85
150

Profit Center Performance Reports:

Exhibit 11-6
Subunit X
Sales Revenue
Operating
expenses
Income from
operations
before service
department
charges
Service
department
charges

Actual
$5,243,60
0

Flexible
budget

Flexible
%
budget Varianc
variance
e

$5,000,0
00
4,000,00
0

$243,60
0F
183,500
U

1,060,100

1,000,00
0

60,100 F

84,300

75,000

4,183,500

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4.9% F
4.6% U

6.0% F

9,300 U 12.4%16 U

Centralized Services Decision Tree

Top Management
Decision:
Provide centralized
service departments?
YE
S
Charge subunits
for

NO

Subunits must
provide
or outsource their
own services

their use of
centralized
service
departments?
YE
S service
Centralized

department costs
are
allocated between
subunits

NO

Centralized services
are provided
free of charge
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Use return on investment (ROI), residual

income (RI), and economic value added
(EVA) to evaluate investment centers.

OBJECTIVE 5

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Investment Centers
Financial evaluation must measure
Income generated
Effective use of centers assets

Performance measures
Return on investment (ROI)
Residual income (RI)
Economic value added (EVA)

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Summary Performance Measures

Summary Performance Measures for
Investment Centers
These three measures take into
consideration:
1. The divisions operating income
2. The divisions assets

Return on
Investment
(ROI)

Economic
Value Added
(EVA)
Residual
Income (RI)
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Return On Investment (ROI)

Operating income
Total assets
Or
Operating income
Sales

Sales margin

Sales
Total assets

Capital turnover

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ROI
Advantages:
Expanded equation provides additional
information
Can be used to compare across divisions
and with other companies
Useful for resource allocation
Drawback:
Provides an incentive to select projects
that are expected to increase ROI
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Residual Income
Compares divisions operating
income with minimum operating
income expected, given the size of
the divisions assets
Positive income exceeds target rate of
return

Negative

income
does
not meet
target
RI = Operating
income
Minimum
acceptable
income
rate of return
RI = Operating income (Target rate of return x Total
assets)

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Economic Value Added

Looks at a divisions RI through the eyes of the
companys primary stakeholders: its investors
and long-term creditors
EVA = After-tax operating income [(Total
assets Current liabilities) WACC%]

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RI vs EVA
Both calculate whether the division
created any income above and beyond
expectations
Differences:
The EVA calculation uses after-tax
operating income
Total assets is reduced by current
liabilities
The WACC replaces managements
target rate of return
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Limitations of Financial
Performance Measures
Measurement issues
Total Assets beginning or end of year
All Assets or exclude nonproductive assets
Use Gross Book Value vs Net Book Value

Short-term focus
Time frame of one year or less

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Summary Performance Measures

Summary Performance Measures for
Investment Centers
These three measures take into
consideration:
1. The divisions operating income
2. The divisions assets
Economic Value
Added (EVA)

Return on
Investment (ROI)
ROI = Operating
income
Total assets

Residual Income
(RI)
RI = Operating
income Minimum
acceptable income
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EVA = After-tax
operating income
[(Total assets
Current liabilities)
WACC%]

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