Performance Measurement in

Decentralized Organizations
Chapter 11

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
11-2

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

Decentralization in Organizations
Lower-level
Lower-level managers
managers
may
may make
make decisions
decisions
without
without seeing
seeing the
the
May
May be
be aa lack
lack of
of “big
“big picture.”
picture.”
coordination
coordination among
among
autonomous
autonomous
managers.
managers. Disadvantages of
Decentralization
Lower-level
Lower-level manager’s
manager’s
objectives
objectives may
may not
not
be
be those
those of
of the
the May
May bebe difficult
difficult to
to
organization.
organization. spread
spread innovative
innovative ideas
ideas
in
in the
the organization.
organization.
11-4

Responsibility Accounting

Cost
Cost Profit
Profit Investment
Investment
Center
Center Center
Center Center
Center

Cost, profit,
and investment
centers are all Responsibility
Responsibility
known as Center
Center
responsibility
centers.
11-5

Cost Center
A segment whose manager has control over
costs, but not over revenues or investment
funds.
11-6

Profit Center

Revenues
A segment whose
Sales
manager has control
Interest
over both costs and
Other
revenues,
Costs
but no control over
investment funds. Mfg. costs
Commissions
Salaries
Other
11-7

Investment Center

A segment whose
manager has control
over costs,
revenues, and
investments in
operating assets.
11-8

Learning Objective 1

Compute return on
investment (ROI) and
show how changes in
sales, expenses, and
assets affect ROI.
11-9

Return on Investment (ROI) Formula

Income
Incomebefore
beforeinterest
interest
and
andtaxes
taxes(EBIT)
(EBIT)

Net operating income

ROI =
Average operating assets

Cash,
Cash, accounts
accountsreceivable,
receivable, inventory,
inventory,
plant
plantand
andequipment,
equipment, and
andother
other
productive
productiveassets.
assets.
11-10

Net Book Value versus Gross Cost

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

Acquisition cost
Less: Accumulated depreciation
Net book value
11-11

Understanding ROI

Net operating income

Margin =
Sales

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

Increasing ROI – An Example

ROI =
Margin  Turnover
Sales
ROI = Net operating income × Average operating assets
Sales

ROI = $30,000 × $500,000

$500,000 $200,000

ROI =6%  2.5 = 15%

11-14

Investing in Operating Assets to

Increase Sales
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.

11-15

Investing in Operating Assets to

Increase Sales

ROI =
Margin  Turnover
ROI = Net operating income × Sales
Sales Average operating assets

ROI = $50,000 × $535,000

$535,000 $230,000

ROI =
9.35%  2.33 = 21.8%

ROI
ROI increased
increased from
from 15%
15% to
to 21.8%.
21.8%.
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.
11-17

Learning Objective 2

Compute residual
income and understand
its strengths and
weaknesses.
11-18

Residual Income - Another Measure of

Performance

Net operating income

above some minimum
return on operating
assets
11-19

Calculating Residual Income

( )
Net Average Minimum
Residual  required rate of
= operating - operating
income
income assets return

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.
11-20

Residual Income – An Example

••The
The Retail
Retail Division
Division of
of Zephyr,
Zephyr, Inc.
Inc. has
has
average
average operating
operating assets
assets of
of $100,000
$100,000 and
and is
is
required
required toto earn
earn aa return
return of
of 20%
20% on
on these
these
assets.
assets.
••InIn the
the current
current period,
period, the
the division
division earns
earns
$30,000.
$30,000.

Let’s calculate residual income.

11-21

Residual Income – An Example

Operating
Operating assets
assets $$100,000
100,000
Required
Required rate
rate of
of return
return ×× 20%
20%
Minimum
Minimum required
required return
return $$ 20,000
20,000

Actual
Actual income
income $$ 30,000
30,000
Minimum
Minimum required
requiredreturn
return (20,000)
(20,000)
Residual
Residual income
income $$ 10,000
10,000
11-22

Motivation and Residual Income

Residual income encourages managers to

make profitable investments that would
be rejected by managers using ROI.
11-23

Quick Check 
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%
11-24

Quick Check 
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%
ROI = NOI/Average operating assets
c. 15%
d. 20% = $60,000/$300,000 = 20%
11-25

Quick Check 
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
11-26

Quick Check 
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? ROI = $78,000/$400,000 = 19.5%
a. Yes
This lowers the division’s ROI from
b. No
20.0% down to 19.5%.
11-27

Quick Check 
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
11-28

Quick Check 
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?
ROI = $18,000/$100,000 = 18%
a. Yes
b. No The return on the investment
exceeds the minimum required rate
of return.
11-29

Quick Check 
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
11-30

Quick Check 
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
11-31

Quick Check 
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
11-32

Quick Check 
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.

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.
11-34

Zephyr, Inc. - Continued

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

Retail
Retail Wholesale
Wholesale
Operating
Operating assets
assets $$ 100,000
100,000 $$ 1,000,000
1,000,000
Required
Required rate
rate of
ofreturn
return ×× 20%
20% 20%
20%
Minimum
Minimum required
required return
return $$ 20,000
20,000 $$ 200,000
200,000

Retail
Retail Wholesale
Wholesale
Actual
Actual income
income $$ 30,000
30,000 $$ 220,000
220,000
Minimum
Minimum required
required return
return (20,000)
(20,000) (200,000)
(200,000)
Residual
Residual income
income $$ 10,000
10,000 $$ 20,000
20,000
11-35

Zephyr, Inc. - Continued

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.
Retail
Retail Wholesale
Wholesale
Operating
Operating assets
assets $$ 100,000
100,000 $$ 1,000,000
1,000,000
Required
Required rate
rate of
ofreturn
return ×× 20%
20% 20%
20%
Minimum
Minimum required
required return
return $$ 20,000
20,000 $$ 200,000
200,000

Retail
Retail Wholesale
Wholesale
Actual
Actual income
income $$ 30,000
30,000 $$ 220,000
220,000
Minimum
Minimum required
required return
return (20,000)
(20,000) (200,000)
(200,000)
Residual
Residual income
income $$ 10,000
10,000 $$ 20,000
20,000
11-36

Learning Objective 3

Compute delivery cycle

time, throughput time,
and manufacturing cycle
efficiency (MCE).
11-37

Delivery Performance Measures

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.

11-38

Delivery Performance Measures

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 =
Efficiency Manufacturing cycle time
11-39

Quick Check 
AA TQM
TQM team
team at
at Narton
Narton Corp
Corp hashas recorded
recorded the
the
following
following average
average times
times for
for production:
production:
Wait
Wait 3.0
3.0 days
days Move
Move 0.5
0.5 days
days
Inspection
Inspection 0.4
0.4 days
days Queue
Queue 9.3
9.3 days
days
Process
Process 0.20.2 days
days
What
What is
is the
the throughput
throughput time?
time?
a.
a. 10.4
10.4 days.
days.
b.
b. 0.2
0.2 days.
days.
c.
c. 4.1
4.1 days.
days.
d.
d. 13.4
13.4 days.
days.
11-40

Quick Check 
AA TQM
TQM team
team at
at Narton
Narton Corp
Corp hashas recorded
recorded the
the
following
following average
average times
times for
for production:
production:
Wait
Wait 3.0
3.0 days
days Move
Move 0.5
0.5 days
days
Inspection
Inspection 0.4
0.4 days
days Queue
Queue 9.3
9.3 days
days
Process
Process 0.20.2 days
days
What
What is
is the
the throughput
throughput time?
time?
a.
a. 10.4
10.4 days.
days.
b. 0.2 days.
Throughput days.
b. 0.2 time = Process + Inspection + Move + Queue
c.
c. 4.1
4.1 days.
days.= 0.2 days + 0.4 days + 0.5 days + 9.3 days
d.
d. 13.4
13.4 days.
days.= 10.4 days
11-41

Quick Check 
AA TQM
TQM team
team at
at Narton
Narton Corp
Corp hashas recorded
recorded the
the
following
following average
average times
times for
for production:
production:
Wait
Wait 3.0
3.0 days
days Move
Move 0.5
0.5 days
days
Inspection
Inspection 0.4
0.4 days
days Queue
Queue 9.3
9.3 days
days
Process
Process 0.20.2 days
days
What
What is
is the
the Manufacturing
Manufacturing Cycle
Cycle Efficiency
Efficiency
(MCE)?
(MCE)?
a.
a. 50.0%.
50.0%.
b.
b. 1.9%.
1.9%.
c.
c. 52.0%.
52.0%.
d.
d. 5.1%.
5.1%.
11-42

Quick Check 
AA TQM
TQM team
team at
at Narton
Narton Corp
Corp hashas recorded
recorded the
the
following
following average
average times
times for
for production:
production:
Wait
Wait 3.0
3.0 days
days Move
Move 0.5
0.5 days
days
Inspection
Inspection 0.4
0.4 days
days Queue
Queue 9.3
9.3 days
days
Process
Process 0.20.2 days
days
What
What is
is the
the Manufacturing
Manufacturing Cycle
Cycle Efficiency
Efficiency
(MCE)?
(MCE)? MCE = Value-added time ÷ Throughput time
a.
a. 50.0%.
50.0%. = Process time ÷ Throughput time
b.
b. 1.9%.
1.9%. = 0.2 days ÷ 10.4 days
c.
c. 52.0%.
52.0%. = 1.9%
d.
d. 5.1%.
5.1%.
11-43

Quick Check 
AA TQM
TQM team
team at
at Narton
Narton Corp
Corp hashas recorded
recorded the
the
following
following average
average times
times for
for production:
production:
Wait
Wait 3.0
3.0 days
days Move
Move 0.5
0.5 days
days
Inspection
Inspection 0.4
0.4 days
days Queue
Queue 9.3
9.3 days
days
Process
Process 0.20.2 days
days
What
What is
is the
the delivery
delivery cycle
cycle time
time (DCT)?
(DCT)?
a.
a. 0.5
0.5 days.
days.
b.
b. 0.7
0.7 days.
days.
c.
c. 13.4
13.4 days.
days.
d.
d. 10.4
10.4 days.
days.
11-44

Quick Check 
AA TQM
TQM team
team at
at Narton
Narton Corp
Corp hashas recorded
recorded the
the
following
following average
average times
times for
for production:
production:
Wait
Wait 3.0
3.0 days
days Move
Move 0.5
0.5 days
days
Inspection
Inspection 0.4
0.4 days
days Queue
Queue 9.3
9.3 days
days
Process
Process 0.20.2 days
days
What
What is
is the
the delivery
delivery cycle
cycle time
time (DCT)?
(DCT)?
a.
a. 0.5
0.5 days.
days.
b.
b. 0.7
0.7 days.
days. DCT = Wait time + Throughput time
c.
c. 13.4
13.4 days.
days. = 3.0 days + 10.4 days
d. = 13.4 days
d. 10.4
10.4 days.
days.
11-45

Learning Objective 4

Understand how to
construct and use a
balanced scorecard.
11-46

The Balanced Scorecard

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

Financial Customer

Performance
measures
Internal Learning
business and growth
processes
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? win and retain them? Strategy

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?
11-48

The Balanced Scorecard:

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


 Financial
Financial measures
measures are are lag
lag indicators
indicators that
that summarize
summarize
the
the results
results of
of past
past actions.
actions. Non-financial
Non-financial measures
measures are
are
leading
leading indicators
indicators of
of future
future financial
financial performance.
performance.


 Top
Top managers
managers are
are ordinarily
ordinarily responsible
responsible forfor financial
financial
performance
performance measures
measures –– not
not lower
lower level
level managers.
managers.
Non-financial
Non-financial measures
measures are
are more
more likely
likely to
to be
be
understood
understood and
and controlled
controlled by
by lower
lower level
level managers.
managers.
11-49

The Balanced Scorecard for Individuals

The entire organization Each individual should

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

AA personal
personal scorecard
scorecard should
should contain
contain measures
measures that
that can
can be
be
influenced
influenced by
by the
the individual
individual being
being evaluated
evaluated and
and that
that
support
support the
the measures
measures in in the
the overall
overall balanced
balanced scorecard.
scorecard.
11-50

The Balanced Scorecard

A balanced scorecard should have measures
that are linked together on a cause-and-effect basis.

If we improve Another desired

Then
one performance performance measure
measure . . . will improve.

The balanced scorecard lays out concrete

actions to attain desired outcomes.
11-51

The Balanced Scorecard and

Compensation
Incentive compensation should be linked to

balanced scorecard performance

measures.
11-52

The Balanced Scorecard ─ Jaguar

Example
Profit
Financial
Contribution per car

Number of cars sold

Customer
Customer satisfaction
with options

Internal
Business Number of Time to
options available install option
Processes

Learning Employee skills in

and Growth installing options
11-53

The Balanced Scorecard ─ Jaguar

Example
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
11-54

The Balanced Scorecard ─ Jaguar

Example
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
11-55

The Balanced Scorecard ─ Jaguar

Example
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
11-56

The Balanced Scorecard ─ Jaguar

Example Results
Profit Profits
Increase
If number
Contribution per car Contribution
of cars sold Increases
and contribution
Cars Sold
per car increase, Number of cars sold Increases
profit should
increase. Customer satisfaction
with options

Number of Time to
options available install option

Employee skills in
installing options
11-57

End of Chapter 11