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
Copyright2012byTheMcGrawHillCompanies,Inc.Allrightsreserved.

11-2

Decentralization in Organizations
Benefits of
Decentralization

Top
Top management
management
freed
freed to
to 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 in
in
decision-making.
Decision-making
decision-making.
Decision-making
authority
authority leads
leads to
to
job
job satisfaction.
satisfaction.

11-3

Decentralization in Organizations

May
May be
be aa lack
lack of
of
coordination
coordination among
among
autonomous
autonomous
managers.
managers.
Lower-level
Lower-level managers
managers
objectives
objectives may
may not
not
be
be those
those of
of the
the
organization.
organization.

Lower-level
Lower-level managers
managers
may
may make
make decisions
decisions
without
without seeing
seeing the
the
big
big picture.
picture.

Disadvantages of
Decentralization
May
May be
be difficult
difficult to
to
spread
spread innovative
innovative ideas
ideas
in
in the
the organization.
organization.

11-4

Cost, Profit, and Investments Centers

Cost
Cost
Center
Center

Cost, profit,
and investment
centers are all
known as
responsibility
centers.

Profit
Profit
Center
Center

Responsibility
Responsibility
Center
Center

Investment
Investment
Center
Center

11-5

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

11-6

Profit Center
A segment whose
manager has control
over both costs and
revenues,
but no control over
investment funds.

Revenues
Sales
Interest
Other

Costs
Mfg. costs
Commissions
Salaries
Other

11-7

Investment Center
Corporate Headquarters

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
before interest
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
ROI =
Average operating assets
Net operating income
Margin =
Sales
Sales
Turnover =
Average operating
assets
Turnover
ROI Margin
=

11-12

Increasing ROI An Example

Regal Company reports the following:
Net operating income
Average operating assets
Sales
Operating expenses

$ 30,000
$ 200,000
$ 500,000
$ 470,000

WhatisRegalCompanysROI?

ROI Margin
=
Turnover

Sales
ROI = Net operating income
Sales
Average operating assets

11-13

Increasing ROI An Example

ROI Margin
=
Turnover
ROI =

Net operating income

Sales

Sales
Average operating assets

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
Average operating assets
Sales
Operating expenses

$ 50,000
$ 230,000
$ 535,000
$ 485,000

Lets calculate the new ROI.

11-15

Investing in Operating Assets to

Increase Sales
ROI Margin
=
Turnover

Sales
ROI = Net operating income
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

Residual
=
income

Net
operating income

Average
operating
assets

Minimum
required rate of
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 to
to 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.

Lets calculate residual income.

11-21

Residual Income An Example

Operating
Operating assets
assets
Required
Required rate
rate of
of return
return
Minimum
Minimum required
required return
return

$$100,000
100,000
20%
20%
$$ 20,000
20,000

Actual
Actual income
income
Minimum
Minimum required
requiredreturn
return
Residual
Residual income
income

$$ 30,000
30,000
(20,000)
(20,000)
$$ 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 divisions 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 divisions ROI?

a. 25%
b. 5%
c. 15%
d. 20%

ROI = NOI/Average operating assets

= $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
b. No

This lowers the divisions ROI from

20.0% down to 19.5%.

11-27

Quick Check

The companys 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 companys 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 divisions 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 divisions residual income?

a. $240,000
b. $ 45,000
c. $ 15,000
d. $ 51,000

Net operating income

Required return (15% of $300,000)
Residual income

$60,000
(45,000)
$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
b. No

Net operating income

Required return (15% of $400,000)
Residual income

$78,000
(60,000)
$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
information for the Retail
Division of Zephyr, Inc.

Assume the following

information for the Wholesale
Division of Zephyr, Inc.

Retail
Retail
$$ 100,000
100,000
20%
20%
$$ 20,000
20,000

Wholesale
Wholesale
$$ 1,000,000
1,000,000
20%
20%
$$ 200,000
200,000

Retail
Retail
Actual
$$ 30,000
Actual income
income
30,000
Minimum
(20,000)
Minimum required
required return
return
(20,000)
Residual
$$ 10,000
Residual income
income
10,000

Wholesale
Wholesale
$$ 220,000
220,000
(200,000)
(200,000)
$$
20,000
20,000

Operating
Operating assets
assets
Required
Required rate
rate of
ofreturn
return
Minimum
Minimum required
required return
return

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 Divisions residual income is larger than the
Retail Division simply because it is a bigger division.

Retail
Retail
$$ 100,000
100,000
20%
20%
$$ 20,000
20,000

Wholesale
Wholesale
$$ 1,000,000
1,000,000
20%
20%
$$ 200,000
200,000

Retail
Retail
Actual
$$ 30,000
Actual income
income
30,000
Minimum
(20,000)
Minimum required
required return
return
(20,000)
Residual
$$ 10,000
Residual income
income
10,000

Wholesale
Wholesale
$$ 220,000
220,000
(200,000)
(200,000)
$$
20,000
20,000

Operating
Operating assets
assets
Required
Required rate
rate of
ofreturn
return
Minimum
Minimum required
required return
return

11-36

Learning Objective 3
Compute delivery cycle
time, throughput time,
and manufacturing cycle
efficiency (MCE).

11-37

Delivery Performance Measures

Order
Received

Wait Time

Production
Started

Goods
Shipped

Process Time + Inspection Time

+ Move Time + Queue Time
Throughput Time
Delivery Cycle Time

Process time is the only value-added time.

11-38

Delivery Performance Measures

Order
Received

Wait Time

Production
Started

Goods
Shipped

Process Time + Inspection Time

+ Move Time + Queue Time
Throughput Time
Delivery Cycle Time

Manufacturing
Cycle
=
Efficiency

Value-added time
Manufacturing cycle time

11-39

Quick Check
A
A TQM
TQM team
team at
at Narton
Narton Corp
Corp has
has recorded
recorded the
the
following
following average
average times
times for
for production:
production:
Wait
Wait
Inspection
Inspection
Process
Process

3.0
3.0 days
days
0.4
0.4 days
days
0.2
0.2 days
days

Move
Move
Queue
Queue

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.

0.5
0.5 days
days
9.3
9.3 days
days

11-40

Quick Check
A
A TQM
TQM team
team at
at Narton
Narton Corp
Corp has
has recorded
recorded the
the
following
following average
average times
times for
for production:
production:
Wait
Wait
Inspection
Inspection
Process
Process

3.0
3.0 days
days
0.4
0.4 days
days
0.2
0.2 days
days

Move
Move
Queue
Queue

0.5
0.5 days
days
9.3
9.3 days
days

What
What is
is the
the throughput
throughput time?
time?
a.
a. 10.4
10.4 days.
days.
b.
0.2
days.
b.
0.2
Throughput days.
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
A
A TQM
TQM team
team at
at Narton
Narton Corp
Corp has
has recorded
recorded the
the
following
following average
average times
times for
for production:
production:
Wait
Wait
Inspection
Inspection
Process
Process

3.0
3.0 days
days
0.4
0.4 days
days
0.2
0.2 days
days

Move
Move
Queue
Queue

0.5
0.5 days
days
9.3
9.3 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
A
A TQM
TQM team
team at
at Narton
Narton Corp
Corp has
has recorded
recorded the
the
following
following average
average times
times for
for production:
production:
Wait
Wait
Inspection
Inspection
Process
Process

3.0
3.0 days
days
0.4
0.4 days
days
0.2
0.2 days
days

Move
Move
Queue
Queue

0.5
0.5 days
days
9.3
9.3 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%.
d.
d. 5.1%.
5.1%.

= 1.9%

11-43

Quick Check
A
A TQM
TQM team
team at
at Narton
Narton Corp
Corp has
has recorded
recorded the
the
following
following average
average times
times for
for production:
production:
Wait
Wait
Inspection
Inspection
Process
Process

3.0
3.0 days
days
0.4
0.4 days
days
0.2
0.2 days
days

Move
Move
Queue
Queue

0.5
0.5 days
days
9.3
9.3 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
A
A TQM
TQM team
team at
at Narton
Narton Corp
Corp has
has recorded
recorded the
the
following
following average
average times
times for
for production:
production:
Wait
Wait
Inspection
Inspection
Process
Process

3.0
3.0 days
days
0.4
0.4 days
days
0.2
0.2 days
days

Move
Move
Queue
Queue

0.5
0.5 days
days
9.3
9.3 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.

DCT = Wait time + Throughput time

= 3.0 days + 10.4 days
= 13.4 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.
Customer

Financial

Performance
measures
Internal
business
processes

Learning
and growth

11-47

The Balanced Scorecard: From

Strategy
to
Performance
Measures
Performance Measures
Financial

Has our financial

performance improved?

What are our

financial goals?

Customer

What customers do
we want to serve and
how are we going to
win and retain them?

Internal Business Processes

What internal business processes are

critical to providing
value to customers?

Do customers recognize that

we are delivering more value?

Have we improved key business

processes so that we can deliver
more value to customers?

Learning and Growth

Are we maintaining our ability

to change and improve?

Vision
and
Strategy

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 for
for 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
should have an overall
balanced scorecard.

Each individual should

have a personal
balanced scorecard.

AApersonal
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
one performance
measure . . .

Then

Another desired
performance 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
Processes
Learning
and Growth

Number of
options available

Time to
install option

Employee skills in
installing options

11-53

The Balanced Scorecard Jaguar

Example
Profit
Contribution per car
Number of cars sold
Customer satisfaction
with options

Strategies
Increase
Options
Increase
Skills

Number of
options available

Time to
install option

Employee skills in
installing options

Results
Satisfaction
Increases
Time
Decreases

11-54

The Balanced Scorecard Jaguar

Example
Profit
Contribution per car

Results
Number of cars sold
Customer satisfaction
with options
Number of
options available

Time to
install option

Employee skills in
installing options

Cars sold
Increase
Satisfaction
Increases

11-55

The Balanced Scorecard Jaguar

Example
Profit

Results

Contribution per car

Contribution
Increases

Number of cars sold

Customer satisfaction
with options
Number of
options available

Time to
install option

Employee skills in
installing options

Satisfaction
Increases
Time
Decreases

11-56

The Balanced Scorecard Jaguar

Results
Example
Profit
If number
of cars sold
and contribution
per car increase,
profit should
increase.

Profits
Increase

Contribution per car

Contribution
Increases

Number of cars sold

Cars Sold
Increases

Customer satisfaction
with options

Number of
options available

Time to
install option

Employee skills in
installing options