Module 22

1

• Module 22
• Segment Reporting and
• Balanced Scorecard
• (omit pp. 22-7 to 22-11)

2
Decentralization

• Decentralization - a form of organization in
  which sub-unit managers are given authority to
  make substantive decisions.
• Strongly decentralized - lowest level of
  managers/workers making various quality
  decisions.
• Strongly centralized - all major decisions made
  at the top level.
• The key issue is whether the sub-unit has some
  degree of autonomy over its affairs.

3
Advantages of Decentralization

• Top management is freed to concentrate on
  strategic and other high-level issues.
• Lower level managers have greater and better
  information, which leads to greater
  responsiveness to local needs and quicker and
  better decision making.
• Increases motivation and job satisfaction.
• Aids management development and learning.
• Sharpens the focus of managers and aids in
  performance evaluation.

4
Disadvantages of Decentralization

• Lower-level managers may pursue goals that are
  incongruent with the goals of the organization as
  a whole.
• Activities may be uncoordinated among lower-level
  managers.
• Communication among divisions may be hindered.
• Lower-level managers may not see the big
  picture and may have less loyalty toward the
  organization as a whole.

5
Responsibility Accounting

• Characteristics of responsibility centers are
• The knowledge held the centers managers is
  difficult to acquire, maintain, or analyze at
  higher levels.
• The duties that a particular individual in an
  organization is expected to perform are specified
  for each center.
• Types of responsibility centers (more later)
• Cost center.
• Profit center.
• Investment center.

6
Segmented Reporting

• Effective decentralization requires segmented
  reporting.
• The concept of segmented reporting can be
  extended to the customer level as well (e.g.,
  customer profitability analysis).
• Segment reports separate fixed costs into direct
  segment costs (costs traceable to the segment)
  and allocated common segment costs.
• When analyzing segments, the relevant common
  costs are those that are avoidable (e.g., can be
  changed in the short run.)

7
Cost Center

• Cost center manager has control over costs but
  not revenue or investment.
• Examples include most service departments in an
  organization, but manufacturing departments may
  also be cost centers.
• Goal is to minimize costs while providing
  services or products to other parts of the
  organization.
• Minimizing costs does not necessarily maximize
  profits. Cost centers have an incentive to
  produce more units to spread fixed costs over a
  large number of units.
• Quality of products produced by cost center must
  be monitored.

8
Profit Center

• Profit center manager has control over both costs
  and revenues.
• Examples may include branches or segments of a
  company where a manager sets pricing and
  production policies, but cannot control
  investment decisions. Example "Six Flags"
  amusement parks.
• Problems with profit centers
• How to allocate traceable fixed costs or common
  fixed costs to profit centers.
• Profit centers that focus only on their own
  profits often ignore how their actions affect
  other responsibility centers.

9
Investment Centers

• Investment center manager has control of
  investment opportunities as well as operating
  decisions.
• Authority and responsibilities of investment
  center manager
• Approve and monitor decisions of cost and profit
  centers.
• Decide amount of capital invested or disposed.
• Performance measurements for investment center
• Return on investment (ROI)
• Residual income (RI).
• Problems with evaluation of investment centers
• Disputes over how to measure income and capital.
• Difficult to compare investment centers of
  different sizes.

10
Return on Investment

• Return on investment (ROI) for an investment
  center
• Net operating income/Average operating
  assets
• DuPont formula separates ROI into two components
• ROI Sales (Asset) turnover x Return on sales
  (Profit margin)
• ROI (Sales /Avg. assets) x (Net
  op. income / Sales)
• ROI increases with smaller investments and larger
  profit margins.
• Three ways to increase ROI
• Increase sales more than costs (and increase
  operating income).
• Decrease costs (and increase operating income).
• Reduce operating assets.
• Performance evaluation using ROI can lead to
  under-investment, actions not consistent with the
  organizations strategy, and may lead to unfair
  evaluations when committed costs are significant
  components in ROI measures.

11
Residual Income

• Residual income (RI)
• Acct. Income (Minimum return x Avg.
  Assets)
• RI is determined with financial accounting
  measurements of net income and capital.
• Each investment center could be assigned a
  different required rate of return depending on
  its risk.
• RI can be increased by increasing income or
  decreasing investment.
• Residual income does not lend itself well to
  evaluating responsibility centers of different
  size.

12
The Balanced Scorecard

• No single summary measure can provide a clear
  performance target or can focus attention on the
  critical areas of the business.
• More firms are using a portfolio of measures to
  assess performance. These measures are both
  financial and operational (nonfinancial).
• Kaplan and Norton (1992) have devised a balanced
  scorecard that they argue provides managers with
  a fast but comprehensive view of the business.
• The scorecard consists of (1) financial measures
  to summarize the results of actions already
  taken, and (2) operational measures that are the
  drivers of future performance.

13
Strategic Dimensions of The Scorecard

• The balanced scorecard is a way to clarify,
  simplify, and then operationalize the vision at
  the top of the organization.
• Perspectives of concern
• Financial perspective.
• Customer perspective.
• Internal business perspective.
• Innovation and learning perspective.

14
Measuring Components of Balanced Scorecard

• Employee skills - proficiency exams.
• Employee training - courses taken.
• Process quality - measure number of defects.
• Process cycle time - measure time to process
  (manufacturing cycle efficiency).
• On-time delivery - measure number of on-time
  deliveries or length of delayed deliveries.
• Customer loyalty - number of repeat customers.
• Return on capital - ROI, earnings per share, P/E
  ratio.

15
A Restaurant Example

• A new restaurant is being developed at a small
  ski area. Previously, only snacks were
  available, and skiers would bring their own
  meals. The restaurant is being developed to meet
  more customers needs, and to add to the profit
  of the ski area.
• Given IL (innovation and learning),
• IB (internal business processes),
• C (customer perspective),
• and F (financial perspective).
• Classify the following activities measured for
  the first month of the new restaurant.

16
A Restaurant Example

• 1.Customer satisfaction with service, as measured
  by customer surveys.
• 2.Total restaurant profit for the month.
• 3.Dining area cleanliness, rated by a secret
  customer.
• 4.Average time to prepare an order.
• 5.Number of menu items.
• 6.Customer satisfaction with menu choices,
  measured by a customer survey.
• 7.Average time to take an order.
• 8.Percent of kitchen staff completing cooking
  course.
• 9.Sales
• 10.Percentage of staff completing a hospitality
• course.

C
F
IB
IB
IB
C
IB
IL
F
IL