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Chapter 12Performance Evaluation and the Balanced ScorecardChapter Review QuizAnswers:1. b3. c5. d7. c 9. b2. d4. c6. a8. a10. cExplanations:6.a.Sales margin=Operating income Sales=$850,000 $4,250,000=20%7.c.Capital turnover=Sales Total assets=$4,250,000 $5,000,000=85%8.a.ROI=Operating income Total assets=$850,000 $5,000,000=17%9.b.RI=Operating income (Target rate of return Total assets)=$850,000 (12% $5,000,000)=$850,000 $600,000=$250,000Short Exercises(5 min.) S 12-1Companies usually decentralize when they grow too large for one person to manage the entire organizations daily operations. Decentralization is often based on geographical area, product line, customer base, or business function. Management must determine the manner of decentralization that best suits the companys strategy.Student answers may vary.(5min.) S 12-2The four most common types of responsibility centers, and their responsibilities, include:1.Cost Centersresponsible for controlling costs2.Revenue Centersresponsible for generating revenue3.Profit Centersresponsible for generating profit through controlling costs and generating revenue4.Investment Centersresponsible for generating profit and efficiently managing the divisions invested capital (the divisions assets)(5 min.) S 12-31. Revenue center2. Profit centers3. Investment center4. Cost center5. Investment center6. Cost center(5 min.) S 12-4a. Providing feedbackb. Communicating expectationsc. Benchmarkingd. Motivating unit managerse. Promoting goal congruence and coordinationf. Benchmarkingg. Motivating unit managers(5-10 min.) S 12-5a. Number of employee suggestions implementedLearning and Growth perspectiveb. Revenue growthFinancial perspectivec. Number of on-time deliveriesCustomer perspective OR Internal Business perspectived. Percentage of sales force with access to real-time inventory levelsLearning and Growth perspectivee. Customer satisfaction ratingsCustomer perspectivef. Number of defects found during manufacturingInternal Business perspectiveg. Number of warranty claimsInternal Business perspective(or Customer perspective)h. Return on investmentFinancial perspective(5-10 min.) S 12-6a. Variable cost per unitFinancial perspectiveb. Percentage of market shareCustomer perspectivec. Number of hours of employee trainingLearning and Growth perspectived. Number of new products developedInternal Business perspectivee. Yield rate (number of units produced per hour)Internal Business perspectivef. Average repair timeInternal Business perspectiveg. Employee satisfactionLearning and Growth perspectiveh. Number of repeat customersCustomer perspective(5 min.) S 12-7Performance reports for cost, revenue and profit centers typically list both actual and budgeted amounts, along with dollar and percentage variances. Management by exception is a tool that allows management to focus its attention on important differences between actual and budgeted amounts. Using management by exception, management only investigates variances exceeding a certain dollar amount (e.g., variances over $10,000) and/or variances exceeding a certain percentage (e.g., variances over 10%). Management does not bother investigating smaller variances, since the cost of doing so would most likely outweigh the benefit.(5-10 min.) S 12-8The concept of “profitability” can be interpreted in different ways. The International Division provides more operating income ($10 million), in sheer dollars terms, than the Domestic Division ($6 million). Therefore, one might say the International Division is more profitable than the Domestic Division. However, if one considers each divisions operating income in light of the assets that are available to generate income, the Domestic division is more profitable. The Domestic Division earns $0.30 on every dollar of assets ($6 million $20 million) whereas the International Division earns about $0.29 on every dollar of assets ($10 million $35 million). Therefore, one could also argue that the Domestic Division is more profitable than the International Division.(5-10 min.) S 12-9Req. 1ROI = Operating Income Total AssetsSnow SportsNon-snow SportsOperating income $900,000$1,440,000 Total assets $4,000,000 $6,000,000Return on investment22.5%24%Req. 2Top management will probably allocate any extra funds to the Non-snow Sports Division because it has a higher ROI. The higher ROI means the division has been able to generate more income from its capital (assets) than has the Snow Sports Division of the company. The Non-snow Sports Division has been able to earn $0.24 on each dollar of assets whereas the Snow Sports Division has earned slightly less ($0.225) on each dollar of assets.Req. 3The basic ROI formula simply shows that the Non-snow Sports Division has been able to generate more income from its invested assets than has the Snow Sports Division. However, it doesnt offer any clues as to why this is the case. Management could learn more about the underlying factors by using the expanded ROI formula which calculates sales margin and capital turnover separately.(5-10 min.) S 12-10Sales Margin = Operating Income SalesSnow SportsNon-snow SportsOperating income $900,000$1,440,000 Sales$5,000,000 $8,000,000Sales margin18%18%Both divisions had 18% sales margins. This means that both divisions were able to earn $0.18 of income on each dollar of sales. In other words, they were both equally profitable on sales. Therefore, sales margin had nothing to do with the divisions differing ROI.(10 min.) S 12-11Req. 1Capital Turnover = Sales Total AssetsSnow SportsNon-snow SportsSales $5,000,000$8,000,000 Total assets$4,000,000 $6,000,000Capital turnover1.25 1.33 (rounded)The Non-snow Sports Division had a higher capital turnover (1.33) than the Snow Sports Division (1.25). This means that the Non-snow Sports Division was able to generate $1.33 of sales for every dollar of assets invested in the division, whereas the Snow Sports Division was able to generate $1.25 for every dollar of assets invested. The Non-snow Sports Division was able to use its assets more efficiently to generate sales revenue. The higher capital turnover accounts for its higher ROI.Req. 2ROI = Sales Margin Capital TurnoverSnow SportsNon-snow SportsSales margin (from S 12-10) 18%18% Capital turnover (from part 1)1.251.33 (rounded)ROI22.5%24% (rounded)The results of the expanded ROI formula agree to those found using the simple ROI formula in S 12-9. (5-10 min.) S 12-12 RI= Operating income Minimum acceptable income=Operating income (Target rate of return Total assets)Snow Sports RI= $900,000 ($4,000,000 15%)= $900,000 $600,000= $300,000Non-snow Sports RI = $1,440,000 ($6,000,000 15%)= $1,440,000 $900,000= $540,000Both divisions have positive residual income. Positive residual income means that the divisions are earning income at a rate that exceeds managements minimum expectations. Managements minimum desired rate of return is 15%, so both divisions must be earning a higher rate of return. This result is consistent with the ROI calculations in S 12-9. The Snow Sports Division had an ROI of 22.5% and the Non-snow Sports Division had an ROI of 24% both are higher than 15%.(10-15 min.) S 12-13EVA = (After-tax operating income) (Total assets Current liabilities) WACC%Snow EVA=($900,0000 65%) ($4,000,000 $350,000) 12%=$585,000 ($3,650,000 12%)=$585,000 $438,000=$147,000Non-snow EVA=($1,440,000 65%) ($6,000,000 $600,000) 12%=$936,000 ($5,400,000 12%)=$936,000 $648,000=$288,000Both divisions have positive economic value added (EVA). This means that the divisions are generating income for investors and long-term creditors at a rate that exceeds the expectations of these two groups of stakeholders.Exercises(10-15 min.) E 12-14Since the business is getting too large for Grandma Jones to handle, she would probably benefit from decentralizing her business. First, decentralization would free Grandma Jones from the day-to-day operations, and allow her the opportunity to work on long-term strategic planning and other critical decisions. Second, she could also benefit from hiring personnel with expert knowledge in the fields of baking, packaging, distribution, sales and finance, as well as other areas expertise she will need if her business continues to expand. Since her business was a homegrown effort, she probably doesnt possess expertise in all of these areas and could increase the efficiency and profitability of her company by employing such expertise. (continued) E 12-14Third, Grandma Jones may be able to use her time to develop good customer relationships with larger clients, such as corporate event planners. This should help increase her sales in the future. As Grandma Jones continues to age, she will eventually want someone else to run her company for her. Decentralization provides good training ground for unit managers one of whom she may choose as her successor. Finally, by giving unit managers decision-making responsibility, decentralization often increases employee motivation, satisfaction, and retention. Grandma Jones should also be made aware of the potential disadvantages of decentralization. Since she will no longer be making all of the decisions, she will need to make sure her subunit managers make decisions that are consistent with her goals. She will also need to make sure her subunit managers are not duplicating costs or assets that could be shared. (continued) E 12-14Grandma Jones could decentralize in a number of different ways, for example:1. By geographical areasince she has customers all across the country2. By customer typesince she has both consumer and corporate event planners for customers3. By functionfor example, baking, sales and marketing4. A combination of the abovefor example, baking by geographical area, etc.Grandma Jones should choose the method of decentralization that best supports her business objectives.Student answers may vary.(10-15 min.) E 12-15Lag indicators are performance measures that tend to reveal the results of past actions. They lag, or come after, decisions and actions taken in the past. On the other hand, lead indicators are performance measures that tend to indicate future performance. They come before, and drive, future performance.Financial measures tend to be lag indicators. The financial results of a period are driven by actions taken in the past. For example, L.L. Beans fourth quarter sales are the result of managements earlier decisions to feature certain clothing styles and colors in their fall and winter catalogs.Operational measures tend to be lead indicators. Current customer satisfaction ratings, defect rates, and on-time delivery rates predict how well the company will do in the future. If L.L. Beans customers arent currently satisfied (because of issues with quality or delivery speed or any other factor), chances are they will not become repeat customers, and may tell others about their bad experience with the company. In such a case, future sales may decline. On the other hand, if L. L. Beans customers are currently satisfied, they probably will come back, driving up future sales.Student answers may vary.(10 min.) E 12-16Well-designed performance evaluation systems offer companies many benefits. Management uses performance evaluation systems to coordinate the activities of subunits and direct them towards achieving the organizations goals. In other words, performance evaluations systems promote goal congruence. They also serve as one of managements primary methods of communicating expectations and motivating unit managers to meet those expectations. Care must be exercised in developing the performance evaluation targets, because subunit managers tend to do whatever is necessary to meet the targets even if that means making sacrifices that would not necessarily be good for the company as a whole. Performance evaluation systems give management feedback by allowing them to compare expectations to actual results. This feedback allows management to make organizational and strategic changes and fine-tune their target expectations. Management can also benchmark actual performance with past performance trends, as well as industry standards and competitors performance. Student answers may vary.1007 Chapter 12 Performance Evaluation and the Balanced Scorecard (10-15 min.) E 12-171. Financial Perspective- “How do we look to shareholders?”2. Customer Perspective-“How do customers see us?”4. Learning and GrowthPerspective-“Can we continue to improve and create value?” 3. Internal Business Perspective- “At what business processes must we excel?” RevenuesExpensesInnovationOperationsPost -sales serviceInformation system capabilities Climate for actionEmployee capabilitiesPriceQualitySales serviceDelivery timeProductivityStudent sketch may vary. However, it should contain the same elements.(10-20 min.) E 12-18Student answers will vary. This answer should only serve as a guide.Financial Revenue - percentage revenue growth Expenses- gross margin Productivity- capital turnover- ROI -EVACustomer Price- percentage of products priced within 5% of competitors- percentage price increase over last period Quality- number of customer complaints - number of customer returns Sales Service- customer satisfaction ratings on retail sales service- retailers satisfaction ratings on corporate sales staff Delivery Time- percentage of deliveries within 5 days of order- percentage of on-time deliveries(continued) E 12-18Internal Business Innovation- number of new products developed.- new product/innovation development time Operations- manufacturing cycle time- defect rate - number of units produced per hour Post-sales service- average customer response time- number of warranty claims received - average repair timeLearning and Growth Employee Capabilities- number of hours of employee training- percentage of critical positions filled - Employee satisfaction - Employee turnover System Capabilities- percentage of sales staff with access to real-time inventory levels- percentage of automated material and supply orders Climate for Action- number of employee suggestions implemented- employee morale and job satisfaction ratings (10-15 min.) E 12-19a.Number of customer complaintsCustomer perspectiveb.Number of information system upgrades completed Learning and Growth perspectivec.Economic value addedFinancial perspectived.New product development timeInternal Business perspective e.Employee turnover rateLearning and Growth perspectivef.Percentage of products with online help manualsInternal Business perspective (post-sales service)g.Customer retentionCustomer perspectiveh.Percentage of compensation based on performanceLearning and Growth perspectivei.Percentage of orders filled each weekInternal Business perspective OR Customer perspectivej.Gross margin growthFinancial perspectivek.Number of new patentsInternal Business perspectivel.Employee satisfaction ratingsLearning and Growth perspective(10-15 min.) E 12-20a.Manufacturing cycle time (average length of production process)Internal Business perspectiveb.Earnings growthFinancial perspectivec.Average machine setup timeInternal Business perspectived.Number of new customersCustomer perspectivee.Employee promotion rateLearning and Growth perspectivef.Cash flow from operationsFinancial perspectiveg.Customer satisfaction ratingsCustomer perspectiveh.Machine downtimeInternal Business perspectivei.Finished products per day per employeeInternal Business perspectivej.Percentage of employees with access to upgraded computer systemLearning and Growth perspectivek.Wait time per order prior to start of productionInternal Business perspectivel. Capital turnoverFinancial Perspective(10-15 min.) E 12-21Req. 1RacerSubunit XActualFlexibleBudgetFlexible BudgetVariance(U or F)% Variance(U or F)Direct Materials$ 28,100$ 26,000$2,100 U 8.08% UDirect Labor13,50014,000 500 F 3.57% FIndirect Labor26,00023,0003,000 U13.04% UUtilities12,00011,0001,000 U9.09% UDepreciation25,00025,000 0 0Repairs and Maintenance 4,300 5,000 700 F14.00% F Total$108,900$104,000$4,900 U 4.71% UReq. 2Since only cost data is presented, we can conclude that this subunit must be a cost center. Req. 3Management only investigates variances exceeding $3,000 or 10%. Therefore, management would only investigate the variances associated with indirect labor costs and repairs and maintenance costs. (continued) E 12
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