Performance Measurement

in Decentralized
Organizations
CHAPTER 11

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA

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 11-2

Decentralization in Organizations:
Benefits
Benefits of
Decentralizati Top management
freed to concentrate
on on strategy.
Lower-level decisions
often based on
better information. Lower level managers
can respond quickly to
customers.
Lower-level managers
gain experience in
decision-making. Decision-making
authority leads to
job satisfaction.
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 11-3

Decentralization in Organizations:
Disadvantages
Lower-level managers
may make decisions
without seeing the
May be a lack of “big picture.”
coordination among
autonomous Disadvantage
managers. s of
Decentralizati
Lower-level manager’s on
objectives may not
be those of the May be difficult to
organization. spread innovative ideas
in the organization.

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 11-4

Responsibility Accounting

Invest
Cost Profit
ment
Center Center
Center

Cost, profit, and

investment centers
are all known as Responsibility
Responsibility Center
Centers.

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 11-5

Cost Center

A segment whose manager

has control over costs, but
not over revenues or
investment funds.

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 11-6

Profit Center
Revenue
s Sales
A segment whose manager Interes
has control over both costs t
and revenues, Other
but no control over Cost
investment funds. s Mfg. costs
Commission
s
Salaries
Other
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 11-7

Investment Center

A segment whose manager

has control over costs,
revenues, and investments in
operating assets.

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 11-8

Learning Objective 1

Compute return on
investment (ROI) and show
how changes in sales,
expenses, and assets affect
ROI.

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 11-9

Return on Investment (ROI)

Formula
Income before interest
and taxes (EBIT)

Net operating income

ROI = Average operating assets

Cash, accounts receivable, inventory,

plant and equipment, and other
productive assets.

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 11-10

Net Book Value versus Gross Cost

Most companies use the net book value of
depreciable assets to calculate average
operating assets.

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 11-11

Understanding ROI

Net operating income

Margin = Sales

Sales
Turnover =
Average operating assets

ROI = Margin × Turnover

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 11-12

Increasing ROI: An Example

Regal Company reports the following:
Net operating income $ 30,000
Average operating assets $ 200,000
Sales $ 500,000
Operating expenses $ 470,000

What is Regal Company’s ROI?

ROI = Margin × Turnover
Net operating income Sales
ROI = ×
Sales Average operating assets
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 11-13

Increasing ROI – An Example: Solution

ROI = Margin × Turnover

Net operating income Sales
ROI = × Average operating assets
Sales

ROI = $30,000 ×
$500,000
$500,000 $200,000

ROI = 6% × 2.5 = 15%

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 11-14

Investing in Operating Assets to

Increase Sales – An Example

Assume that Regal’s manager invests in a

$30,000 piece of equipment that increases sales
by $35,000, while increasing operating
expenses by $15,000.

Regal Company reports the following:

Net operating income $ 50,000
Average operating assets $ 230,000
Sales $ 535,000
Operating expenses $ 485,000

Let’s calculate the new ROI.

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 11-15

Investing in Operating Assets to

Increase Sales – An Example: Solution

ROI = Margin × Turnover

Net operating income Sales

ROI = ×
Sales Average operating assets

ROI = $50,000 ×
$535,000
$535,000 $230,000

ROI = 9.35% × 2.33 = 21.8%

ROI increased from 15% to 21.8%.

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 11-16

Criticisms of ROI
In the absence of the balanced
scorecard, management may
not know how to increase ROI.

Managers often inherit many

committed costs over which
they have no control.

Managers evaluated on ROI

may reject profitable
investment opportunities.
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 11-17

Learning Objective 2

Compute residual income

and understand its strengths
and weaknesses.

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 11-18

Residual Income –
Another Measure of Performance

Residual Income is net

operating income above
some minimum return on
operating assets.

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 11-19

Calculating Residual Income

( )
This computation differs from ROI.
ROI measures net operating income earned relative
to the investment in average operating assets.
Residual income measures net operating income
earned less the minimum required return on average
operating assets.

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 11-20

Residual Income – An Example

The Retail Division of Zephyr, Inc. has average

operating assets of $100,000 and is required to
earn a return of 20% on these assets.
In the current period, the division earns $30,000.

Let’s calculate residual income.

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 11-21

Residual Income – An Example:

Solution

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 11-22

Motivation and Residual Income

Residual income encourages managers to

make profitable investments that would be
rejected by managers using ROI.

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 11-23

Quick Check 1
Redmond Awnings, a division of Wrap-up Corp., has
a net operating income of $60,000 and average
operating assets of $300,000. The required rate of
return for the company is 15%. What is the division’s
ROI?
a. 25%
b. 5%
c. 15%
d. 20%

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 11-24

Quick Check 1a
Redmond Awnings, a division of Wrap-up Corp., has
a net operating income of $60,000 and average
operating assets of $300,000. The required rate of
return for the company is 15%. What is the division’s
ROI?
a. 25%
b. 5%
c. 15% ROI = NOI/Average operating assets
d. 20%
= $60,000/$300,000 = 20%

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 11-25

Quick Check 2
Redmond Awnings, a division of Wrap-up Corp., has
a net operating income of $60,000 and average
operating assets of $300,000. If the manager of the
division is evaluated based on ROI, will she want to
make an investment of $100,000 that would generate
additional net operating income of $18,000 per year?
a. Yes
b. No

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 11-26

Quick Check 2a
Redmond Awnings, a division of Wrap-up Corp.,
has a net operating income of $60,000 and average
operating assets of $300,000. If the manager of the
division is evaluated based on ROI, will she want to
make an investment of $100,000 that would
generate additional net operating income of $18,000
per year?
a. Yes
b. No ROI = $78,000/$400,000 = 19.5%
This lowers the division’s ROI from
20.0% down to 19.5%.
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 11-27

Quick Check 3
The company’s required rate of return is 15%.
Would the company want the manager of the
Redmond Awnings division to make an investment of
$100,000 that would generate additional net
operating income of $18,000 per year?
a. Yes
b. No

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 11-28

Quick Check 3a
The company’s required rate of return is 15%.
Would the company want the manager of the
Redmond Awnings division to make an investment of
$100,000 that would generate additional net
operating income of $18,000 per year?
a. Yes
b. No ROI = $18,000/$100,000 = 18%
The return on the investment
exceeds the minimum required rate
of return.

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 11-29

Quick Check 4
Redmond Awnings, a division of Wrap-up Corp., has
a net operating income of $60,000 and average
operating assets of $300,000. The required rate of
return for the company is 15%. What is the division’s
residual income?
a. $240,000
b. $ 45,000
c. $ 15,000
d. $ 51,000

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 11-30

Quick Check 4a
Redmond Awnings, a division of Wrap-up Corp.,
has a net operating income of $60,000 and average
operating assets of $300,000. The required rate of
return for the company is 15%. What is the division’s
residual income?
a. $240,000
b. $ 45,000
c. $ 15,000 Net operating income $60,000
Required return (15% of $300,000) (45,000)
d. $ 51,000 Residual income $15,000

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 11-31

Quick Check 5
If the manager of the Redmond Awnings division is
evaluated based on residual income, will she want to
make an investment of $100,000 that would generate
additional net operating income of $18,000 per year?
a. Yes
b. No

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 11-32

Quick Check 5a
If the manager of the Redmond Awnings division is
evaluated based on residual income, will she want to
make an investment of $100,000 that would
generate additional net operating income of $18,000
per year?
a. Yes Net operating income $78,000
b. No Required return (15% of $400,000) (60,000)
Residual income $18,000

Yields an increase of $3,000 in the residual income.

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 11-33

Divisional Comparisons and Residual

Income

The residual
income approach
has one major
disadvantage.
It cannot be used
to compare the
performance of
divisions of
different sizes.

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 11-34

Zephyr, Inc. – Part 1

Recall the following Assume the following
information for the Retail information for the Wholesale
Division of Zephyr, Inc. Division of Zephyr, Inc.

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 11-35

Zephyr, Inc. – Part 2

The residual income numbers suggest that the Wholesale Division outperformed the Retail
Division because its residual income is $10,000 higher. However, the Retail Division earned
an ROI of 30% compared to an ROI of 22% for the Wholesale Division. The Wholesale
Division’s residual income is larger than the Retail Division simply because it is a bigger
division.

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 11-36

Learning Objective 3

Compute throughput time,

delivery cycle time, and
manufacturing cycle
efficiency (MCE).

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 11-37

Delivery Performance Measures – Part

1
Order Production Goods
Received Started Shipped

Process Time + Inspection Time

Wait Time + Move Time + Queue Time

Throughput Time

Delivery Cycle Time

Process time is the only value-added time.

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 11-38

Delivery Performance Measures – Part

2
Order Production Goods
Received Started Shipped

Process Time + Inspection Time

Wait Time + Move Time + Queue Time

Throughput Time

Delivery Cycle Time

Manufacturing Value-added time
Cycle = Manufacturing cycle time
Efficiency
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 11-39

Quick Check 6
A TQM team at Narton Corp has recorded the following average
times for production:
Wait 3.0 days Move 0.5 days
Inspection 0.4 days Queue 9.3 days
Process 0.2 days
What is the throughput time?
a. 10.4 days.
b. 0.2 days.
c. 4.1 days.
d. 13.4 days.

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 11-40

Quick Check 6a
A TQM team at Narton Corp has recorded the following average
times for production:
Wait 3.0 days Move 0.5 days
Inspection 0.4 days Queue 9.3 days
Process 0.2 days
What is the throughput time?
a. 10.4 days.
b. 0.2 days.
c. 4.1 days.
d. 13.4 days.
Throughput time = Process + Inspection + Move + Queue
= 0.2 days + 0.4 days + 0.5 days + 9.3 days
= 10.4 days

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 11-41

Quick Check 7
A TQM team at Narton Corp has recorded the following average
times for production:
Wait 3.0 days Move 0.5 days
Inspection 0.4 days Queue 9.3 days
Process 0.2 days
What is the delivery cycle time (DCT)?
a. 0.5 days.
b. 0.7 days.
c. 13.4 days.
d. 10.4 days.

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 11-42

Quick Check 7a
A TQM team at Narton Corp has recorded the following average
times for production:
Wait 3.0 days Move 0.5 days
Inspection 0.4 days Queue 9.3 days
Process 0.2 days
What is the delivery cycle time (DCT)?
a. 0.5 days.
b. 0.7 days.
c. 13.4 days. DCT = Wait time + Throughput time
d. 10.4 days. = 3.0 days + 10.4 days
= 13.4 days

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 11-43

Quick Check 8
A TQM team at Narton Corp has recorded the following average
times for production:
Wait 3.0 days Move 0.5 days
Inspection 0.4 days Queue 9.3 days
Process 0.2 days
What is the Manufacturing Cycle Efficiency (MCE)?
a. 50.0%.
b. 1.9%.
c. 52.0%.
d. 5.1%.

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 11-44

Quick Check 8a
A TQM team at Narton Corp has recorded the following average
times for production:
Wait 3.0 days Move 0.5 days
Inspection 0.4 days Queue 9.3 days
Process 0.2 days
What is the Manufacturing Cycle Efficiency (MCE)?
a. 50.0%.
b. 1.9%. MCE = Value-added time ÷ Throughput time
c. 52.0%. = Process time ÷ Throughput time
d. 5.1%. = 0.2 days ÷ 10.4 days
= 1.9%

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 11-45

Learning Objective 4

Understand how to
construct and use a
balanced scorecard.

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 11-46

The Balanced Scorecard

Management translates its strategy into
performance measures that employees
understand and influence.

Financial Customer

Performan
ce
Internal measures
Learning
business and growth
processes
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 11-47

The Balanced Scorecard – From

Strategy to Performance Measures
Performance Measures
Financial What are our
Has our financial
financial goals?
performance improved?

Customer What customers do Vision

we want to serve and
Do customers recognize that
how are we going to and
we are delivering more value? Strategy
win and retain them?

Internal Business Processes What internal busi-

Have we improved key business ness processes are
processes so that we can deliver critical to providing
more value to customers? value to customers?

Learning and Growth

Are we maintaining our ability
to change and improve?
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 11-48

The Balanced Scorecard – Non-financial

Measures
The balanced scorecard relies on non-financial measures in
addition to financial measures for two reasons:

❶ Financial measures are lag indicators that summarize

the results of past actions. Non-financial measures are
leading indicators of future financial performance.

❷ Top managers are ordinarily responsible for financial

performance measures – not lower level managers.
Non-financial measures are more likely to be
understood and controlled by lower level managers.

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 11-49

The Balanced Scorecard for Individuals

The entire organization Each individual should

should have an overall have a personal balanced
balanced scorecard. scorecard.

A personal scorecard should contain measures that can be

influenced by the individual being evaluated and that support
the measures in the overall balanced scorecard.

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 11-50

The Balanced Scorecard – Important

Links

A balanced scorecard should have measures

that are linked together on a cause-and-effect basis.

Another
If we improve
Then desired
one
performance
performance
measure
measure . . .
will improve.

The balanced scorecard lays out concrete

actions to attain desired outcomes.

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 11-51

The Balanced Scorecard and

Compensation

Incentive compensation
should be linked to
balanced scorecard
performance measures.

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 11-52

The Balanced Scorecard – Jaguar

Example – Part 1
Profit
Financial
Contribution per car

Number of cars sold

Customer
Customer satisfaction
with options

Internal
Number of Time to
Business options available install option
Processes
Learning Employee skills in
and Growth installing options
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 11-53

The Balanced Scorecard – Jaguar

Example – Part 2
Profit

Contribution per car

Number of cars sold

Customer satisfaction Results

with options Satisfaction
Increases
Strategies
Increase Number of Time to
Options options available install option Time
Decreases

Increase Employee skills in

Skills installing options
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 11-54

The Balanced Scorecard – Jaguar

Example – Part 3
Profit

Contribution per car

Results
Cars sold
Number of cars sold Increase

Customer satisfaction
with options Satisfaction
Increases

Number of Time to
options available install option

Employee skills in
installing options
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 11-55

The Balanced Scorecard – Jaguar

Example – Part 4
Profit
Results
Contribution per car Contribution
Increases

Number of cars sold

Customer satisfaction
with options Satisfaction
Increases

Number of Time to
options available install option Time
Decreases

Employee skills in
installing options
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 11-56

The Balanced Scorecard – Jaguar

Example – Part 5
If number Results
Profit Profits
of cars sold Increase
and
Contribution per car Contribution
contributio Increases
n
Cars Sold
per car Number of cars sold
Increases
increase,
profit Customer satisfaction
should with options
increase.
Number of Time to
options available install option

Employee skills in
installing options
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 11-57

End of Chapter 11

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