Chapter
Fifteen
Performance
Evaluation
© 2015 McGraw-Hill Education.
Responsibility Accounting
An accounting system that
provides information . . .
Relating to the
responsibilities of
individual managers.
To evaluate
managers on
controllable items.
15-2
Decentralization
Improves quality
of decisions.
Improves
productivity.
Improves
performance
evaluation.
Develops
lower-level
managers.
Advantages
Encourages upper-level management to
concentrate on strategic decisions.
15-3
Responsibility Centers
Investment
Center
Profit Center
Cost Center
15-4
Managerial Performance
Measurement
Evaluation Measures
Cost
Center
Cost control
Quantity and quality
of services
Profit
Center
Profitability
Investment
Center
Return on investment (ROI)
Residual income (RI)
15-5
Controllability Concept
Managers should
only be evaluated on
revenues or costs
they control.
I’m in
control
Since the exercise of control may be clouded,
managers are usually held responsible for items
over which they have predominant rather
than absolute control.
15-6
Preparing Flexible Budgets
The master budget, sometimes called a static
budget, is based solely on the planned volume
of activity. Flexible budgets differ from static
budgets in that they show expected revenues
and costs at a variety of volume levels.
15-7
Determining Variances for
Performance Evaluation
The differences between standard and actual
amounts are called variances. A variance may be
favorable or unfavorable. When actual sales are
less than expected, an unfavorable sales
variance exists. When actual sales revenue is
greater than expected revenue, a company has a
favorable sales variance.
15-8
Determining Variances for
Performance Evaluation
Variances are not limited to the evaluation of
revenues. They can also be used to understand
the differences between standard and actual
amounts of costs. When actual costs are less
than standard costs, cost variances are favorable
because lower costs increase net income.
Unfavorable cost variances exist when actual
costs are more than standard costs.
15-9
Sales Volume Variances
The difference between the static budget sales amount
and the flexible budget sales amount is a measure of
the sales volume variance.
Exhibit 15.2
Melrose Manufacturing Company’s Volume Variances
15-10
Interpreting the Volume Variances
In a standard cost system, marketing managers are
usually responsible for the volume variance. Because
sales volume drives production, production managers
have little control over volume variance.
In the case of Melrose, the marketing manager exceeded
planned sales volume by 1,000 units, resulting in an
$80,000 favorable revenue variance ($80 × 1,000). The
unfavorable cost variances are somewhat misleading.
Melrose incurred higher costs because it manufactured
and sold more units than planned.
15-11
Fixed Cost Considerations
The fixed costs are the same in both
the static and flexible budgets.
Spending
Variance
The difference
between the
budgeted fixed
costs and the actual
fixed costs
Fixed Cost
Volume Variance
The difference
between costs
at planned
volume versus
actual
volume
15-12
Flexible Budget Variances
For effective performance evaluation, management must
compare the actual results achieved to the flexible
budget based on the actual volume of activity. Here is a
comparison of the standard amount and actual amount
per unit for the current period for Melrose.
Sales price
Variable material cost
Variable labor cost
Variable overhead cost
Variable GS&A cost
Standard
$ 80.00
12.00
16.80
5.60
15.00
Actual
$ 78.00
11.78
17.25
5.75
14.90
15-13
Calculating Sales Price Variance
Actual sales (19,000 × $78)
Expected sales (18,000 × $80)
Favorable total sales variance
$ 1,482,000
1,440,000
$
42,000
or
Activity variance (volume)
Sales price variance
Favorable total sales variance
$ 80,000 F
(38,000) U
$ 42,000 F
15-14
The Human Element Associated
with Flexible Budget Variances
•
The flexible budget cost variances offer
insight into management efficiency.
• As with sales variances, cost variances
require careful analysis.
• A favorable materials variance could mean
that purchasing agents are good
negotiators or it might be caused by paying
low prices for inferior goods.
15-15
Management by Exception
Management focuses on areas not
performing as expected.
Management by exception
Upper-level management
does not receive operating
detail unless problems arise.
The vice president of operations
receives summarized information
from each unit.
Businesses cannot
afford to have
managers spend
large amounts of
time on operations
that function
normally.
15-16
Return on Investment
Return on investment is the ratio of
income to the investment used to
generate the income.
ROI = Operating Income
Operating Assets
15-17
Return on Investment
Lumber
=
Manufacturing
Home
Building
=
Furniture
=
Manufacturing
$60,000
$300,000
=
20%
$46,080
$256,000
=
18%
$81,940
$482,000
=
17%
All other things being equal,
higher ROIs indicate better performance.
15-18
Factors Affecting ROI
Operating Income
ROI =
Operating Assets
Operating Income
ROI =
×
Sales
Margin
Sales
Operating Assets
Turnover
15-19
Factors Affecting ROI
2 Reduce
Expenses
1 Increase
Sales
3 Reduce
Operating
Assets
(The investment base)
Three ways to improve ROI
15-20
Residual Income
Operating Income
– Investment charge
= Residual income
Operating Assets
× Desired ROI
= Investment charge
Investment center’s
cost of acquiring
investment capital
15-21
Residual Income
Residual income encourages managers to
make profitable investments that would
be rejected by managers using ROI.
Suboptimization
occurs with ROI
when managers
benefit
themselves at
the expense of
the company
15-22
End of Chapter Fifteen
15-23