978-1111971724 Kinney 9e IM Ch 14 Lecture Note Part 1

Learning Objectives

4. What are the common short-term financial performance measures, and how are they calculated

and used?

9. What is compensation strategy, and what factors must be considered in designing the

10. What difficulties are encountered in trying to measure performance and design compensation

PERFORMANCE MEASUREMENT,

BALANCED SCORECARDS, AND

PERFORMANCE REWARDS

CHAPTER

14

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Terminology

Asset turnover: a ratio that measures asset productivity and shows the number of sales dollars

Carbon footprint: reflects the total of all greenhouse gas emissions created by an organization’s

activities during a specified time

Compensation strategy: a foundation for the compensation plan that addresses the role compensation

should play in the firm

Employee Stock Ownership Plan (ESOP): a profit sharing compensation program in which investments

are made in the securities of the employer

Expatriate: parent companies or third-country nationals assigned to a foreign subsidiary or foreign

nationals assigned to the parent company

Profit margin: the ratio of income to sales, and an indicator of what proportion of each sales dollar is not

used for expenses

Residual income (RI): profit earned that exceeds an amount charged for funds committed to an

investment center

Return on investment (ROI): a ratio that relates income generated by the investment center to the

resources (or asset base) used to produce that income

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Lecture Outline

LO.1: Why is a mission statement important to an organization?

A. Introduction

1. Historically, managers focused almost exclusively on short–run financial performance measures

unavailable.

2. Because many of the recent accounting scandals resulted from intense pressure on managers to

a longer horizon to gauge performance.

4. This chapter discusses one of the most important ways of motivating employees to maximize

measurement and reward systems.

B. Organization Mission Statements

long-term needs of the firm are met.

3. A Values Statement reflects the organization’s culture by identifying fundamental beliefs about

what is important to the organization.

a. Such values may be either objective or subjective. Examples include safety of employees,

customer orientation, ethical behavior, respect for individuals, and environmental concerns.

4. Mission and values statements are two of the underlying bases for setting organizational goals

and objectives.

ii. Without long-term planning, short-run success will rapidly fade.

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C. Organizational Roles of Performance Measures

1. Managers design and implement strategies that apply organizational resources to activities in

fulfilling organizational missions.

maximize efficiency and effectiveness of resources used.

c. Managers must devise appropriate information systems to track resource applications.

d. Management resources can be gauged effectively and efficiently only if the terms “effective”

formulated.

e. As indicated in text Exhibit 14.1 (p. 552), performance measures should exist for all

2. Internal Performance Measures

a. Internal process measures must reflect concern for streamlined production, high quality, and

minimization of product complexity.

advantage needed for success.

c. Developing performance measures for each competitive dimension can identify alternative

ways to leverage a firm’s competencies.

comparing actual to budgeted results in responsibility accounting reports.

f. Performance measures also compare individuals’ work to make judgments about promotions

satisfaction, and production efficiency.

g. Performance measures could also address a firm’s environmental sustainability which could

cover an organization’s impact on the environment from their facilities design, to resource

3. External Performance Measures

a. Externally, performance measures must reflect an organization’s ability to satisfy its

customers.

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b. Meeting or exceeding the performance targets set for customers should result in the

increased likelihood of meeting or exceeding the performance targets set for investors and

creditors.

c. The most common performance measure used for all organizations is profit, which can be

d. Generally accepted accounting principles are formulated to provide information that is

comparable across firms which facilitates investor/creditor judgments about which firms

dismissed.

i. Meeting or exceeding the market’s expectations of performance should create the capital

inflows that will result in improved processes, more qualified employees, and more

satisfied customers.

ii. Recent accounting scandals in the business community should remind management that

“managing” either revenues or expenses.

f. Environmental sustainability could also be addressed by external performance measures.

LO.3: What guidelines or criteria apply to the design of performance measures?

D. Designing a Performance Measurement System

2. General Criteria

a. As illustrated in text Exhibit 14.2 (p. 554), five general criteria should be considered in

designing a performance measurement system:

i. the measures should be established to assess progress toward organizational goals and

objectives;

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intracompany, intercompany, and multinational comparisons.

i. See text Exhibit 14.3 (p. 557) for alternative definitions and preferred definitions.

profit margin and asset turnover.

ROI = Profit Margin x Asset Turnover

= (Income ÷ Sales) x (Sales ÷ Assets Invested)

c. Profit margin is the ratio of income to sales and indicates what proportion of each sales

dollar is not used for expenses and, thus, becomes profit.

income and asset base definitions.

i. Segment margin is preferred to operating income in the ROI computation if the

f. Sales prices, volume and mix of products sold, expenses, and capital asset acquisitions and

dispositions affect ROI.

6. Residual Income

a. Residual income (RI) is the profit earned that exceeds an amount “charged” for funds

committed to an investment center. The RI calculation is:

investment centers.

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i. The “charged” amount is equal to a specified target rate of return multiplied by the asset

fluctuations or to compensate for risk.

ii. Residual income yields a dollar figure rather than a percentage.

iii. Expansion (or additional asset investments) should occur in an investment center if

c. One difficulty in using RI as a performance measure is that it is hard to make valid

comparisons among divisions of various sizes.

7. Economic Value Added (EVA)

a. One of the most well-known measures that has been developed to directly align the interests

c. The EVA calculation is as follows:

EVA = After-Tax Profits – (Cost of Capital % x Market Value of Invested Capital)

f. Despite its growing popularity, EVA cannot measure all dimensions of performance and is

short-term focused.

nonfinancial performance measures.

8. Limitations of ROI, RI, and EVA

time value of money.

b. Asset investment is difficult to properly measure and assign to center managers since assets

suboptimization of resources can result.