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Chapter 18 - Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
CHAPTER 18:
STRATEGIC PERFORMANCE MEASUREMENT: COST
CENTERS, PROFIT CENTERS, AND THE BALANCED
SCORECARD
QUESTIONS
18-1 Performance evaluation can be thought of as the process by which managers at
all levels in the firm gain information about the performance of tasks within the
firm and judge that performance against pre-established criteria as set out in
budgets, plans, and goals. In management accounting there are two types of
of operating level employees by mid-level managers.
18-2 Strategic performance measurement is a management accounting system used
by top management for the evaluation of business unit managers. It is used
when the conditions are such that responsibility can be effectively delegated to
18-3 An effective performance evaluation system must consider both the individual
and team aspects of work and performance in the firm. In management
accounting, we focus on the individual aspects primarily in strategic performance
18-4 The systems for management control are of two types -- formal and informal.
Formal systems are developed from explicit management guidance, while
informal systems arise from the unmanaged, and sometimes unintended,
behavior of managers and employees. Informal systems reflect the managers'
and employees' reactions and feelings that arise from the positive and negative
18-1
Education.
Chapter 18 - Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
18-5 The two organizational designs are centralized and decentralized. A centralized
firm reserves much of the decision-making at the top management level. In
contrast, a decentralized firm delegates a significant amount of responsibility to
bottom-up.
18-6 A cost center is a production or support unit within a firm that is evaluated on the
basis of cost.
A revenue center focuses on the selling function and is defined either by product
line or by geographical area.
A profit center generates both revenues and incurs the major portion of the cost
18-7 While net income determined using full costing is affected by changes in
inventory levels, net income using variable costing is not affected. This means
that the proper interpretation of net income under full costing, unlike variable
18-8 There are four behavioral/implementation issues for SBUs:
1. Cost shifting, wherein a department replaces its controllable costs with
non-controllable costs. For example, a manager might attempt to replace variable
costs such as manufacturing labor with fixed costs such as advanced equipment
18-2
Education.
Chapter 18 - Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
aspect of SBUs, a result of managers attempting to make their performance
18-9 A pervasive issue when using cost centers is how the jointly incurred costs of
service departments -- such as data processing, engineering, human resources,
18-10 Strategic performance measurement can be used for both service and not-for-
profit firms as well as manufacturing firms. Cost centers are particularly
appropriate across all organization types, as the organization attempts to identify
18-11 Cost centers are used when the firm wishes to focus the manager’s attention
exclusively on costs. This makes sense particularly when for example the
manager is producing a product that requires little coordination with marketing or
design. There are therefore few times when the manager will need to adjust the
functionality of the product or adjust the production schedule to suit the needs of
a certain customer. The manager can then focus her or his attention primarily on
the cost of manufacture.
providers of the good or service, inside or outside the firm.
18-12 (See also 18-5) Centralized firms have a strong hierarchical organization in which
information flows upward and management flows downward in the hierarchy.
Centralized firms are effective in quickly implementing policy changes and in
18-3
Education.
appropriate decisions for the firm. The key factor in decentralized firms is to
develop management controls processes which provide the right incentives to
local managers -- so that they independently work hard for top management
goals.
A key advantage of the centralized firm is that it has strong control over
operations, while a key disadvantage is that top management may lack the
important day-to-day knowledge of local managers which can make local
18-13 The marketing department can be viewed as both a revenue center and a cost
center. The marketing department is viewed as a revenue center because there
is a revenue-generating process. The marketing manager must therefore report
revenues, typically by product line, and sometimes also by sales area and
18-4
Education.
Chapter 18 - Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
BRIEF EXERCISES
18-14 The discretionary cost center has a planning focus since it is used
when the unit’s outputs are hard to measure and the costs are largely
18-15 Risk preferences have implications for performance evaluation. For
example, the risk-averse manager is most likely to be motivated by
supervision and rewards that reduce risk, while the reverse may be
outcome. For proper motivation and decision making, management
control systems should be designed to reduce the negative effects of
risk preferences.
18-16 The engineered cost approach is equivalent to the flexible budget
method explained in chapter 14; a standard usage is set for the
activity, and a usage variance is calculated. In contrast, under the
18-17 Response: D. Investment center
Feedback: The mining company is maintaining control over all its
18-5
Chapter 18 - Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
Feedback: Colleen’s business unit is only responsible for selling the
18-19
Net Revenues $1,000,000
Variable Costs 300,000
Contribution Margin $700,000
18-20 In the short run, Pepper’s will lose $100,000 in profits, shown by the
Controllable Margin for intake valves. However, in the long run,
18-6
Chapter 18 - Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
18-21
Name Brand:
Contribution Margin $500,000
Controllable Fixed Costs 200,000
Controllable Margin $300,000
Noncontrollable Fixed Costs 50,000
Total CPC $250,000
Generic:
Contribution Margin $200,000
Total CPC $50,000
Total Company Operating Income:
Name Brand Contribution $250,000
18-22
Net Revenue $10,000,000
Variable Costs 5,000,000
Contribution Margin $5,000,000
Controllable Fixed Costs 2,000,000
18-7
Chapter 18 - Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
18-23 For the Winter Outerwear division, the short-term effect would be a
loss of $500,000 in profits as shown by the Controllable Margin.
The long-term effect would be an increase of $250,000 in profits,
shown by the CPC. For the High-End Suits the short-term effect
company was more concerned with long-term positioning, it would
drop the High-End Suits division due to a higher savings in the long
run.
18-24
Contribution Margin $500,000
Controllable Fixed Costs 200,000
18-8
Chapter 18 - Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
EXERCISES
18-25 Risk Aversion and Decision Making (20 min)
1.
John will choose the household glue, because being risk
averse, the 100% chance of the $310,000 profit will look much better
2.
The company would prefer the space-age bonding formula,
3.
The company can reduce the size of the bonus and increase
the salary, thus removing the risk “penalty” in the mind of the risk-
18-9
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Chapter 18 - Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
18-26 Risk Aversion; Strategy (20 min)
John’s decision about scheduling the special order involves the
conflict of three key factors: the need for maintenance, the delay of
currently scheduled jobs, and the value of the new customer in terms
of current contribution to profits as well as the later contribution to
risk aversion issue directly. This can be done by making sure that
John’s performance evaluation includes a reward for accepting the
special order, and that any scheduling difficulties or additional costs
due to the special order will not be charged directly to him, but
against the contribution of the special order. In this way, John’s
interests are more in line with those of the entire firm.
18-10
Education.
