1. Measuring and Rewarding Performance
Chapter 15
Measuring and Rewarding Performance

2. Learning Objectives
1. Why should organizations use multiple performance measures to assess performance?
2. How are return on investment (ROI) and residual income (RI) similar and different?
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3. Continuing . . . Learning Objectives
3. Why has economic value added (EVA) become a popular performance measure?
4. Why are nonfinancial measures important to evaluating performance?
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4. Continuing . . . Learning Objectives
5. How are activity-based costing concepts related to performance measurement?
6. Why is it more difficult to measure performance in multinational firms than in solely domestic companies?
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5. Continuing . . . Learning Objectives
7. How should employee rewards, including compensation, and performance be linked?
8. How do expatriate reward systems differ from those of domestic operations?
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6. Performance Measurement
Organizational
Goals and
Objectives
General Rule #1:
Measures should
assess progress

7. Continuing . . . Performance Measurement
General Rule #2:
Persons being evaluated
should have had some input
in developing performance
measurements and should
be aware of them.

8. Continuing . . . Performance Measurement
General Rule #3:
Persons being evaluated should have
appropriate skills and be provided
the necessary equipment,
information, and authority
to be successful under
the measurement
system.

9. Continuing . . . Performance Measurement
General Rule #4:
Feedback relative to
performance should be
provided in a timely
and useful manner.

10. Need for Multiple Measures
Minimal lead time to market
Satisfactory
earnings
Customer
satisfaction
MULTIPLE
COMPANY
GOALS
Adequate
cash flow
Zero defects
Environmental social responsibility

11. Balanced Scorecard
A balanced scorecard ultimately links all aspects of performance to the company’s strategies.
The balanced scorecard provides a set of financial and nonfinancial measures that encompass both internal and external perspectives.

12. Balanced Scorecard
A balance scorecard examines the following questions:
How will we look to our stockholders if we succeed?
How must we look to our customers to achieve our strategies?
What business processes must we excel at to satisfy customers?
How must our organization function to achieve our strategies?

13. Appropriate Tools for Performance
Training
Support
Information
Authority
Equipment

14. Need for Feedback Performance monitored and feedback provided on a
continuous basis
Feedback
Adjustment
Monitor
performance

15. Financial Performance Measurements for Managers
Divisional Profits
Cash Flow
Return on Investment
Residual Income
Economic Value Added

16. Divisional Profits
Segment margin of a profit center or income of an investment center
Compare with budget
Also compare individual revenues and expenses with budget
Short-term measure
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17. Potential Manipulation of Segment Margin
Sales transactions can be shifted between periods.
If a cost flow method other than FIFO is being used, inventory purchases can be accelerated or deferred to change the Cost of Goods Sold.
If actual OH is allocated to inventory, an increase in production will cause cost per unit to decline because of the nature of fixed costs.
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18. Continuing . . . Potential Manipulation of Segment Margin
Replacement of workers who have resigned or been terminated can be deferred to minimize salary expense for the period.
Discretionary costs can be delayed or eliminated to reduce expenses.
Depreciation methods may be changed.
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19. Statement of Cash Flows
Provides information about the cash impacts of operating, investing, and financing activities
Helps managers to judge an entity’s ability to meet current fixed cash outflow commitments, undertake new commitments, and adapt to adverse changes in business conditions
Assists managers in judging the quality of the entity’s earnings
Can be manipulated
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20. Return on Investment (ROI)
ROI = Income  Assets or
ROI = Profit Margin x Asset Turnover
Income Sales ROI = x Sales Assets
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21. Return on Investment Questions
Income defined
Is income defined as segment or operating income?
Is income defined on a before-tax or after-tax basis?
Is income defined on a before-interest or after-interest basis?
Assets defined
Should assets be defined as total asset utilized; total assets available for use; or net assets?
Should plant assets be included in the asset denominator at original cost; depreciated book value; or current values?
Should beginning, ending, or average assets be used?
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22. Exhibit 15-3: Bellingham Machine Company
Materials Machinery Handling Tools
Segment Margin $ 2,800,000 $ , $ ,500
Assets Invested ,532, ,037, ,915,000
ROI % % %

23. Residual Income
Residual Income = Income - (Target Rate x Asset Base)
The profit earned that exceeds an amount “charged” for funds committed to an investment center
Concerned with dollars rather than percentages

24. Exhibit 15-5: Bellingham Machine Company
Materials Machinery Handling Tools
Segment Margin $ 2,800, $ 460, $ ,500
Assets Invested $11,532, $1,037, $8,915,000
Targeted ROI x % x % x %
$ 1,383, $ 124, $1,069,800
RI $ 1,416, $ 335, $ (416,300)
========= ======== ========

25. Limitations of ROI and Residual Income
Problems related to income
Income can be manipulated on a short-run basis
All investment centers must use same accounting methods
Does not consider cash flows
Does not consider time value of money
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26. Continuing . . . Limitations of ROI and Residual Income
Problems related to asset base
Some asset investment values are difficult to measure
Some investments may not have been authorized by current manager
Inflation causes investment book values to be understated unless they are price-level adjusted
Measures how well center performs without regard to company-wide objectives
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27. Economic Value Added
EVA = After-tax Profits - (Capital Invested x Cost of capital %)
From Exhibit 15-7:
EVA = $1,942,710 - ($45,000,000 x 0.12) = $(3,457,290)

28. Nonfinancial Performance Measures
Directly measure an entity’s performance in the activities that create shareholder wealth
May better predict the direction of future cash flows
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29. Continuing . . . Nonfinancial Performance Measures
Selection of nonfinancial measures
Identify critical success factors
Select attributes relating to measurement of critical success factors
Can be qualitative or quantitative
Focuses on the activities that can improve the future
Establishment of comparison bases
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30. Performance Evaluation System
ISSUES
FREQUENCY
Top
management
Broad
Less
Middle
management
Lower-level management
Immediate
More

31. Throughput The number of good units or quantity of services
produced and sold within a time period
Throughput =
Process
Productivity
Manufacturing
Cycle
Efficiency
Quality
Yield x

32. Throughput Example Worked 15,000 hours Value-added was 6,000 hours
Units started, completed and sold was 30,000 units
Good units were 27,000 units

33. Manufacturing Cycle Efficiency
MCE = Value-added Processing Time Total Time
MCE = 6,000  15,000 = 40%

34. Process Productivity
Process Productivity = Total Units Value-Added Processing Time
Process Productivity = 30,000  6,000 = 5.0

35. Process Quality Yield Process Quality Yield = Good Units Total Units
90%
===

36. Throughput Example Throughput = .40 x 5.0 x .9 = 1.80 units
The division produced and sold only 1.80 good units for every hour of total actual processing time.
This is quite different from the 5.0 units indicated as process productivity.

37. Quality Indicators Cost of Quality Classifications Measure
Prevention Prevention cost Total cost of quality
Appraisal Number of inspections
Internal failure Number of pieces rejected
External failure Number of customer complaints

38. Activity-Based Costing and Performance Measurement
Traditional performance measurements include non-value-added activities
Non-value-added activities must be removed from performance evaluation measurements
Value-added activities must be substituted
Stresses external performance measurements
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39. Performance Evaluation in Multinational Settings
Recognize differences in comparing multinational units
Culture and economies
Accounting standards and reporting practices
Government regulations
Investment base may differ substantially; assign different target rate to compute residual income
Consider trade tariffs, income tax rates, currency fluctuations, restrictions on transfer of goods and currency
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40. Relating Compensation and Performance

41. Plan-Performance-Reward Model
Set strategic goals
Identify critical success factors;
set operational targets and
compensation strategy
Employee/employee
groups perform tasks
Measure/monitor performance
Identify performance measures
Set performance rewards
Determine reward

42. Pay-for-Performance Plans
Must be highly correlated with operational targets
Should encourage employees to adopt a long-run perspective
Appropriate time horizon
At basic worker level, performance should be specific and focus on cost and/or quality control
At higher levels, focus on longer time horizon
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43. Compensation Packages
Lower-level workers
Hourly wage
Bonus above some specified quantitative measure
Middle managers
Salaries
Opportunity for raise based on performance
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44. Continuing . . . Compensation Packages
Top management
Significant incentive pay
All levels some monetary and some nonmonetary rewards
Balance incentives for both groups and individuals
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45. Nonfinancial Factors Recognition of efforts
Compliments and small awards
Allow subordinates to participate in decisions
Job security
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46. Global Compensation
Begin with base salary and fringe benefits that employee would get domestically and adjust for:
Labor market factors
Cost-of-living considerations
Currency fluctuations
Tax consequences