Unit 5: Performance Measurement and Control

1. Introduction to Performance Measurement and Control

Performance measurement and control are the foundation of organizational management, where
activity is coordinated with strategic goals and operates effectively. Performance measurement is the
process of measuring the efficiency and effectiveness of actions, while control ensures that these
actions have led to organizational goals being achieved. They're in a feedback loop that supports
decision-making and strategy formulation.

Importance of Performance Measurement and Control

 Aids to set well-defined goals and track progress.

 Distinguishes regions of inefficiency and possible enhancement.

 Enhances decision-making through evidence-based data.

 Enhances worker performance and accountability.

 Ensures consistency with strategic goals.

Example:

An organization that is seeking to reduce its carbon emissions tracks emissions on a quarterly basis
(measurement of performance) and practices energy conservation measures (control) for
sustainability goal attainment.

2. Responsibility Accounting and Segment Reporting

Responsibility Accounting:
Responsibility accounting assigns responsibility to different parts of a firm so that the performance
can be evaluated on controllable factors.

Types of Responsibility Centers

 Cost Centers: Departments whose role is cost centers (e.g., production department).

 Revenue Centers: Departments who are responsible for revenue generation (e.g., sales
department).

 Profit Centers: Departments who are responsible for both revenues and costs to maximize
profits (e.g., regional offices).

 Investment Centers: Units that are responsible for both revenue, costs, and investment (for
example, corporate head office).

Example

In a manufacturing firm, cost center is controlled by the manufacturing manager, who tries to
minimize manufacturing costs, while the revenue center is controlled by the sales manager, who tries
to sell as much as possible.

Segment Reporting

Segment reporting provides financial details regarding different business segments, product
segments, or geographic segments and allows stakeholders to analyze performance and make
decisions on that account.

Example:

A multinational company discloses revenues of its North America, Europe, and Asia segments
separately, providing room for regional strategy.

3. Performance Measurement Systems & Key Performance Indicators (KPIs)

Performance measurement systems use Key Performance Indicators (KPIs) to monitor achievement
in pursuing strategic objectives.

Types of KPIs:

 Financial KPIs: Revenues growth, profit margin, return on investment (ROI), earnings per
share (EPS).

 Operational KPIs: Production efficiency, order fulfillment duration, inventory turns.

 Customer KPIs: Customer satisfaction measurement, retention level, Net Promoter Score
(NPS).

 Employee KPIs: Turnover rate for employees, effectiveness of training, productivity metrics.

Example:

Customer service department tracks average response time to customer inquires as a KPI in order to
increase customer satisfaction through reduction in response time.

4. Balanced Scorecard Approach

Robert Kaplan and David Norton designed the Balanced Scorecard, which presents an all-
encompassing organizational performance from four views:

 Financial Perspective: It captures profitability, cost containment, and value addition.

 Customer Perspective: Captures customer satisfaction, loyalty, and market position.

 Internal Business Processes: Captures operating effectiveness, quality maintenance, and

innovation.
  Learning and Growth Perspective: Focused on the training of employees, skills, and culture.

Example

A technology company uses the Balanced Scorecard to connect its research and development
operations (learning and growth) with customer requirements (customer), refine product
development (internal processes), and achieve financial goals.

5. Transfer Pricing and Performance Measurement

Transfer Pricing

The value of goods, services, or intangible properties being transferred from one division to another
of the same firm.

Methods of Transfer Pricing:

Market-Based Pricing: Price set by the outside market.

Cost-Based Pricing: Production cost plus a margin of mark-up.

Negotiated Pricing: Price negotiated between departments.

Illustration:

A maker of motor vehicles establishes a transfer price on motors exported by its subsidiary to make
possible equitable evaluation of performance as well as conformity with tax authorities.

Impact on Performance Evaluation:

 Affects different divisions' reported profits.

 Has influence on management's evaluation and decision-making.

  Encourages goal congruence among departments.

Illustration:

Because the engine subsidiary has high transfer prices, it makes higher profits, but profitability for
the assembly division appears lower, which influences managerial assessments.

6. Cost of Quality and Environmental Accounting

Cost of Quality (COQ):

COQ is all the expenses related to maintaining product and service quality as follows:

 Prevention Costs: Expenses incurred to prevent defects (e.g., employee training, quality
improvement programs).

 Appraisal Costs: Inspection and testing costs of products.

 Internal Failure Costs: Expenses incurred for defects found prior to delivery (e.g., rework,
scrap).

 External Failure Costs: Costs incurred due to defects after delivery (e.g., product recall,
warranty claims).

Example:

An electronics manufacturing company incurs on employee training (prevention cost) to reduce

defects, checks products (appraisal cost), pays warranty claims (external failure cost), and reworks
defective products (internal failure cost).

Environmental Accounting
Environmental accounting identifies environmental costs and incorporates them into decision-
making.

Types of Environmental Accounting

 Financial Environmental Accounting: Tracks regulatory compliance expenses, pollution

expenses, and sustainability measure expenses.

 Management Environmental Accounting: Allows organizations to take the environment into

account when making decisions and formulating operations strategy.

Example:

A manufacturing firm calculates waste management expenses and spends on clean technologies to
reduce environmental footprints and comply with regulations.

Conclusion

Performance measurement and control of sound are key to organizational success. With the
adoption of responsibility accounting by means of using KPIs, the implementation of formats like the
Balanced Scorecard, management of transfer prices, and consolidation of environmental and quality
costs, organizations enhance efficiency, profitability, and sustainability. Such activities position
organizations to compete, achieve strategic objectives, and meet stakeholders' demands.