Chapter 25 – Rewarding Business Performance
Financial and Managerial Accounting, 17/e 25-1
25 REWARDING BUSINESS
PERFORMANCE
Chapter Summary
Incentives are formal and informal rewards based on performance that enhance
managerial effort towards the organizational goals. The chapter focuses on motivating
business employees, customers, suppliers, and others to help the organization achieve its
goals and objectives. Numerous performance measures such as ROI, residual income,
and economic value added are discussed in the chapter.
The DuPont system and components of return on investment (ROI) are discussed
and critiqued. We then present two other business performance measures, residual
income (RI) and economic value added (EVA) are then presented.
A major criticism of return on investment, residual income, and economic value
added as performance evaluation tools is that they focus on only one component of the
business, financial outcomes. As discussed in a previous chapter, total quality
management includes careful consideration of quality across the entire value chain. Thus,
performance measures that ignore the links in the value chain run the risk of a failure
somewhere on the chain. The balanced scorecard, a performance measurement approach
developed for setting strategic goals and measuring progress toward all goals across the
entire value chain, is then presented.
The chapter concludes with a discussion of management compensation and the
tradeoffs that compensation designers make.
Learning Objectives
1. Explain the importance of incentive systems for motivating performance.
2. Use the DuPont system to evaluate business performance.
3. Identify and explain the criticisms of using return on investment (ROI) as the only
performance measure.
4. Calculate and explain residual income (RI) and economic value added (EVA).
5. Use the balanced scorecard to identify, evaluate, and reward business performance.
6. Identify and explain the components of management compensation and the trade-offs
that compensation designers make.
Chapter 25 – Rewarding Business Performance
Brief topical outline
A Motivation and aligning goals and objectives
1 Communicating goals and objectives
2 Accounting information and feedback about goal achievement
3 Rewarding goal achievement
B The DuPont system
1 Return on investment
2 The components of return on investment
3 Return on sales – see Your Turn (page 1083)
4 Capital turnover – see Case in Point (page 1084)
C Criticisms of ROI
1 The short horizon problem
2 Failing to undertake profitable investments
3 Measurement problems – see Case in Point (page 1086)
D Residual income and economic value added
1 Residual income
2 Economic value added
E The balanced scorecard
1 The financial perspective
2 The customer perspective
3 The business process perspective
4 The learning and growth perspective
5 Difficulties with the balanced scorecard –
see Your Turn (page 1091)
F Management Compensation
1 Components of management compensation
a Fixed salary
b Bonuses
c Other types of incentives – see Ethics, Fraud & Corporate
Governance (page 1094)
2 International financial reporting standards and management compensation
3 Design choices for management compensation
a Choice of time horizon
b Choice of fixed versus variable bonus
c Choice of stock- versus accounting-based performance evaluation
d Choice of rewarding local versus companywide performance
e Choice of cooperative versus competitive incentive plans
4 Goals and rewards in life
G Concluding remarks
Chapter 25 – Rewarding Business Performance
Financial and Managerial Accounting, 17/e 25-3
Topical coverage and suggested assignment
Homework Assignment
(To Be Completed Prior to Class)
Class
Meetings
on Chapter
Topical
Outline
Coverage
Discussion
Questions
Brief
Exercises
Exercises
Critical
Thinking
Cases
1
A – D
1, 2, 3, 5
1, 5, 6
1, 3, 5
1
2
E – G
10, 11
2, 3, 4, 7
2, 3, 6
Comments and observations
Teaching objectives for Chapter 25
1 Explain and illustrate how incentive systems provide a tool that help align employee
goals with those of the organization.
2 Compute the two components of return on investment: return on sales and capital
turnover.
3 Discuss the advantages that residual income has over return on investment.
4 Explain economic value added.
5 Describe the four lenses to consider business performance.
General comments
The focus of this chapter is rewarding business performance using incentive
compensation systems to motivate decision makers to align their goals and objectives
with the organization’s. We discussed how the DuPont ROI system measures financial
performance and why some critics think ROI is flawed. We saw how RI and EVA can
correct some of the criticisms of ROI.
The balanced scorecard is a broader means for measuring and rewarding business
performance. Finally, we described the components of and design choices for
management compensation.
Chapter 25 – Rewarding Business Performance
An aside Harvard Business Review has selected the balanced scorecard as one of the
most important management practices of the past 75 years. Since being introduced in
1992, more than 100 articles have been published on the topic. Well-known enterprises
such as Microsoft, NASA, and the Department of Transportation are using the balanced
scorecard. To implement the balanced scorecard, managers must implement four key
steps: articulate the strategy to every employee; engage an employee team to design
measures that eliminate unnecessary tasks; provide measurement feedback routinely; and
make sure the system is accepted by employees and aligned to rewards.
Supplemental Exercises
Group Exercise
In a typical approach to the balanced scorecard method, a business will develop goals
and determine areas needing improvement, develop a system for measuring improvement,
provide feedback to employees, and reward achievements. Develop a mock business with
areas needing improvement. Identify the areas needing improvement and establish
measurement criteria in financial, operational, and customer-satisfaction practices.
Internet Exercise
Visit websites of several large corporations and governmental agencies including
Microsoft, the Department of Transportation, the Internal Revenue Service, Chase
Manhattan Bank, and Prudential Insurance Company. Do the websites provide any
information on how the corporations or agencies are using the balanced scorecard or
economic value added to improve performance?
Chapter 25 – Rewarding Business Performance
Financial and Managerial Accounting, 17/e 25-5
CHAPTER 25 NAME #
10-MINUTE QUIZ A SECTION
The following information regarding Greenwich Company is available:
Sales …………………………………………………………………………………………………………. $1,512,000
Cost of sales ………………………………………………………………………………………………. $882,000
Operating expenses …………………………………………………………………………………….. $252,000
Operating earnings ……………………………………………………………………………………… A
Average invested capital ……………………………………………………………………………… B
ROI …………………………………………………………………………………………………………… C
Return on sales …………………………………………………………………………………………… D
Capital turnover ………………………………………………………………………………………….. 40%
Compute the answers for items A–D.
A
B
C
D
Chapter 25 – Rewarding Business Performance
CHAPTER 25 NAME #
10-MINUTE QUIZ B SECTION
The following information regarding Baron Company is available:
Sales …………………………………………………………………………………………………………. $264,000
Cost of sales ………………………………………………………………………………………………. $99,000
Operating expense ………………………………………………………………………………………. A
Operating earnings ……………………………………………………………………………………… $66,000
Average invested capital ……………………………………………………………………………… $660,000
ROI …………………………………………………………………………………………………………… B
Return on sales …………………………………………………………………………………………… C
Capital turnover ………………………………………………………………………………………….. D
Compute the answers for items A–D.
A
B
C
D