PERFORMANCE MEASUREMENT

SYSTEMS

Responsibility Budgeting &

Accounting

The Rise of Bureaucracy

Perfected by Prussians during 19th Century
detailed centralized materials requirements
and logistical planning (input budgets),
control by rules, standard operating
procedures, and the merit principle,
functional administrative design, distinction
between staff and line
decomposition of tasks to their simplest
components,
Sequential processing.

Bureaucracy
made large, complex organizations possible;
also made them inevitable
POSDCORB functions were all treated as
separate concerns, performed by staff
specialists and coordinated by top mgmt.
substantial staff resources needed to gather
and process data for top mgmt. to coordinate
activities and allocate resources

Marketing
managers
Analysis
Planning

TheMarketing
Marketing
Information System
Information
System
Developing
information
Assessing
information
needs

Internal
records

Marketing
intelligence

Implementation

Marketing
environment
Test
markets
Marketing
channels
Competitors

Control
Distributing
information

Marketing
decision
support
analysis

Marketing
research

Marketing decisions and communication

Publics
Macroenvironment
forces

Managing at Arms Length

Multi-product, or M-form, organizational
structure
each major operating division serves a distinct
product market

Decentralized control
by the numbers, using the DuPont system of
financial controls, return-on-assets target

Coordination
short run via transfer prices
Long run via modern capital budgeting system

Responsibility Budgeting
The most common decentralized control system
used by large-scale organizations
(a) units and managers are evaluated relative to the
targets they accept,
(b) only financial measures are used to measure and
reward accomplishment or punish failure, and
(c) financial success or failure is attributed entirely to
managerial decisions and/or employee performance.

Types of Responsibility Centers

Discretionary & Engineered expense
centers
Revenue centers
Cost centers
Standardcostcenters
Quasiprofitcenters

Profit centers
Investment Centers

EXPENSE CENTERS
Managers are
OE & Program Budgets
responsible for
are Discretionary
executing the budget
Expense Budgets
(Spending as planned)
(given recipe]
Little discretion to
Performance Budgets
acquire assets; no
are Engineered
discretion to exceed
Expense Budgets
authorized spending
levels
[recipe varies with
volume]

Revenue centers
In some cases, expense center managers are
evaluated in terms of the number and type of
activities performed by their center.
Revenue centers are expense centers that earn
revenue or are assigned notational revenue
(transfer price) by the organization's controller as
a direct result of the activities they perform.

Cost centers
Cost center managers are responsible for
producing a stated quantity and/or quality of
output at the lowest feasible cost. Someone else
within the organization usually determines the
output of a cost center.
Cost center managers are usually free to acquire
short-term assets (those that are wholly
consumed within a performance measurement
cycle), to hire temporary or contract personnel,
and to manage inventories.

Standardcostcenters
In a standard cost center, output levels are
determined by requests from other
responsibility centers
The manager's budget for each performance
measurement cycle is determined by
multiplying actual output by standard cost
per unit.
Performance is measured against this figure
-- the difference between actual costs and
standard costs.

Quasiprofitcenters
In a quasi-profit center, performance is
measured by the difference between the
notational revenue earned and costs
For example,
aVAhospitalradiologydepartmentperforms
500chestXraysand200skullXrays.
Thenotationalrevenueearnedis$25perchest
Xray(500)=$12,500and$50perskullXray
(200)=$10,000,or$22,500total.
Ifthedepartmentscostsare$18,000,itearnsa
quasiprofitof$4,500($22,500$18,000).

Profit centers
In profit centers, managers are responsible for
both revenues and costs. Profit is the difference
between revenue and cost (or expense).
In addition to the authority to acquire short-term
assets, to hire temporary or contract personnel,
and to manage inventories, profit center
managers are usually given the authority to make
long-term hires, set salary and promotion
schedules (subject to organization wide
standards), organize their units, and acquire longlived assets costing less than some specified
amount.

Investment Centers
In investment centers, managers are
responsible for both profit and the assets used
in generating the profit.
Investment center managers are typically
evaluated in terms of return on assets (ROA) -the ratio of profit to assets employed.
In recent years many have turned to economic
value added (EVA), net operating "profit" less an
appropriate capital charge.

Responsibility
budgets
I centers the budget
For expense
is a spending plan
For discretionary expense
centers, fixed spending targets
For engineered expense centers,
flexible spending targets (i.e.,
the budget has two components,
a discretionary component and a
component that varies directly
with volume)

Responsibility budgets
II
For a cost or profit centers the
budget is a performance target
or goal
For cost centers, the target is a
unit-cost standard
For quasi-profit centers, the target
is a quasi-profit measure:
(Standard Cost [units delivered]
Actual Unit Cost [units delivered]).

Responsibility budgets
III
For profit centers, the budget is a
profit target [revenue cost of
goods sold.]
The budget of an investment center
is also a target or goal usually
return on assets [ROA or ROI] or
residual income [EVA or RI]
The main difference between
investment centers and all other
responsibility centers is that the
former approve their own capital
budgets

Capital budgeting I
is concerned with changes that
have multi-period consequences
for the responsibility center in
question
e.g. investment in new plant or
equipment, a new program, a major
process enhancement, etc.

Where cost and profit centers are

concerned, some higher authority
must approve these kinds of
projects. And, each time a project is
approved, the targets for the current
period should be adjusted accordingly, as
should future year targets.

Capital budgeting II
IN CONTRAST, investment
center mangers make
these kinds of decisions
without the approval of a
higher authority.
Their budgets are expressed
in terms that reflect their
skill in managing assets:
ROA, EVA.

Formerly, individual production units were

typically standard cost centers; staff units were
typically discretionary expense centers. Mission
centers were investment centers.

Mission centers in private sector organizations

produce final products that are easily priced and
that are expensed following generally accepted
accounting practice.
In contrast, support centers produce intermediate
products and these were, until recently, hard to
cost, let alone price, with accuracy. Attempts to do
so were often either excessively arbitrary or
prohibitively costly.

Modern Control
Methods
New developments in
management control
technique
Recognized that firms in Japan
and Germany were producing
higher quality goods and
services at a lower cost:
JIT, Cycle-time analysis, Cost of
Quality Analysis, Balanced
Scorecards, and the Rules of BPR

The German Critique

Narrow rather than
comprehensive
Uses wrong cost drivers
Unwillingness to rely on
statistical cost measures and
estimates
Poor averaging, especially
temporal averaging
Failure to distinguish between
needs of financial reporting and
management control

Investment Centers
(Charging for Assets Used] I
The charge for invested capital =
[working capital + fixed capita] *
discount rate
This approach contains three errors
[assumed to be self-correcting]
HC is used rather than replacement cost;
A nominal rather than a real rate is used
(not adjusted for inflation), and
An average rate is used rather than a
marginal rate.

Investment Centers (Charging

for Assets Used] II
The proper way to measure the use
of invested capital would = the
market rent that could be earned
on each item
The rental rate per asset = interest
foregone, plus depreciation, minus
any price appreciation or decline
[Replacement Cost * (r+d-a)]

The Japanese
Critique I

Importance of inventories
and overheads,
insignificance of labor hours
Quality
Solution: manage process
through product design and
process value management so
as to minimize the discrepancy
between Process time and
Cycle time [inefficiency = 1
(PT/CT)]

Process value analysis

(PVA)
Chart the flow of activities needed to
design, create, and deliver a service

For each activity and step within the

activity determine its associated cost
and its cause
Determine how the step adds value or, if
it is non-value adding, identify ways to
eliminate it and its associated cost;
Determine the cycle time of each activity
and calculate its cycle efficiency (valueadded time/total time); and
Seek ways to improve cycle efficiency
and reduce associated costs due to
delays, excesses, and unevenness in
activities.

Business Process
Reengineering
Jobs should be designed around an objective or
outcome instead of a single function;

Functional specialization and sequential execution

are inherently inimical to expeditious processing;
Those who use the output of activity should
perform the activity and the people who produce
information should process it, since they have
the greatest need for information and the
greatest interest in its accuracy;
Information should be captured once and at the
source;
Parallel activities should be coordinated during
their performance, not after they are completed;
The people who do the work should be responsible
for decision making and control built into job
designs

Reflects Assumptions of Flexible

Production

Nobody but the front-line worker adds value,

Front-line workers can perform most functions
better than specialists (lean manufacturing),
Every step of the service delivery process should
be done perfectly (TQM)
This reduces the need for buffer stocks (JIT) and
produces a higher quality end-product.

Modern IT: reduced economies of

scale and scope
Multidisciplinary teams, members work
together from start of job to completion
push exercise of judgment down to teams that
do an organization's work
more equal distribution of knowledge,
authority, and responsibility
average firm size falling for the last twenty
years

The Balanced Scorecard

Four perspectives .
Financial
Customer
Internal Business Processes
Learning and Growth Perspective