Bangalore University - M.Com III semester : Accounting & Taxation specialization : Subject : Accounting For Managerial Decisions - Performance Measurement System - Theory with Examples.

1. Divisional
Performance
Measurement
Accounting for Managerial Decisions :
Module 03
Asst. Prof. Sangeetha S
New Zeal Academy Bangalore

2. Performance measurement System
Determine the appropriate and best organizational
structure
Evaluate the degree of delegation of control and
identify the responsibility centers
Establish the performance measures (both financial
and Non-financial) and target for each measure
Review the performance (with help of KPI
Dashboard) and take corrective actions (if required)

3. Divisional Performance
measures
A good performance measure should –
 Provide the reasonable incentive to the divisional manager to make
decisions which are in the best interests of the overall company (goal
congruence).
 Only include factors for which the divisional manager can be held
accountable
 Recognize the long-term objectives as well as the short-term
objectives

4. Performance Measures (or indicators)
Performance measures (or indicators)
Financial Measures
Return on Investment (ROI)
Residual Income (RI)
Economic Value Added
(EVA)
Non Financial Measures &
tools
Balanced Score card
The performance pyramid
Building Block Model
The performance Prism
Triple Bottom Line (TBL)

5. Financial Measures :
ROI : Return on Investment
 DuPont, An American Company during the 1920s recognized ROI.
 ‘ROI expresses divisional profit as a percentage of the asset employed in the
division. Assets employed can be defined as total divisional assets, assets
controllable by the divisional manager or net assets.’

6. Financial Measures :
ROI : Return on Investment
 It also called as ROCE – Return on Capital Employed Method.
 ROCE is calculated as a ratio of net divisional profit (before tax) to the
net assets (at book values) employed in the division.
 Formulas:
ROCE=
𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛
𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝑐𝑎𝑝𝑖𝑡𝑎𝑙
𝑋 100
ROCE=
𝑆𝑎𝑙𝑒𝑠 𝑅𝑒𝑣𝑒𝑛𝑢𝑒
𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝐶𝑎𝑝𝑖𝑡𝑎𝑙
𝑋
𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛
𝑆𝑎𝑙𝑒𝑠 𝑅𝑒𝑣𝑒𝑛𝑢𝑒
𝑋 100
ROCE= 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑋 Margin of sales

7. Example : X division of a company financial
statements for the year ended 31st march 2017
Profit and loss account Balance sheet
Sales revenue 1,500 Fixed assets 400
- Cost of goods sold 850 Current assets 1,300
Gross profit 650 Current liabilities (500) 800
- Administration expenses 350 Net assets 1,200
EBIT 300 Equity 900
- Interest Payable 50 Long-term debt 300
Profit before tax 250 Capital employed 1,200
- Tax 100
Profit after tax 150

8. Financial Measures :
ROI : Return on Investment
 Return on Capital Employed (ROCE) is calculated as follows.
 Profit before interest and tax (EBIT), divided by net assets (Capital
employed)
 Invested capital or Net assets = Total assets – current liabilities
ROCE=
𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛
𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝑐𝑎𝑝𝑖𝑡𝑎𝑙
𝑋 100
ROCE=
300
1,200
𝑋 100
ROCE= 25%

9. Financial Measures :
RI : Residual Income
‘Residual income is excess of controllable profit over a predetermined
organization-wide minimum hurdle rate (cost of capital charge) on the
investment controllable by the divisional manager. So higher the residual
income means better the performance’.
RI = Profit – Capital charge
RI = Profit – (Required rate of return X Investment)

10. Financial Measures :
RI : Residual Income
Division A has an income of ₹ 80,000 and an investment in the division of ₹
3,00,000. the average cost of capital for the firm is 18%. Calculate residual
income of Division A.
RI = Profit – Capital charge
RI = Profit – (Required rate of return X Investment)

11. Financial Measures :
RI : Residual Income
Division A has an income of ₹ 80,000 and an investment in the division of ₹
3,00,000. the average cost of capital for the firm is 18%. Calculate residual
income of Division A.
RI = Profit – Capital charge
RI = Profit – (Required rate of return X Investment)
Particulars Amount ₹
Investment in division A 3,00,000
Divisional income 80,000
Return on investment (18% on ₹ 3,00,000) (54,000)
Residual income (RI) 26,000

12. Financial Measures :
RI : Residual Income
Particulars Amount ₹
Revenue xxx
Less : Variable costs xxx
Contribution xxx
Less : Controllable Fixed costs xxx
Controllable Profit xxx
Less : Interest on controllable investment xxx
Controllable Residual income xxx
Less : Uncontrollable cost (allocated head office charges) xxx
Less : Interest on Uncontrollable investment xxx
Net Residual income xxx

13. Financial Measures :
RI : Residual Income

14. Financial Measures :
EVA : Economic Value Added

15. Financial Measures :
EVA : Economic Value Added

16. Financial Measures :
EVA : Economic Value Added :
Example

17. Financial Measures :
EVA : Economic Value Added :
Example
Particulars Amount ₹
NOPBIT 7,500
Less : Taxes (7,500 X 30%) 2,250
NOPAT 5,250
Less : WACC (12,500 X 8%) 1,000
EVA 4,250

18.  Develops agreed measures of activity
 Define and Clarifies the objectives of the organization
 Helps in the setting targets for managers
 Greater understanding of the process
 Facilitate comparison between divisions
 Promotes accountability to stakeholders
Advantages of Responsibility
accounting or performance
measures

19.  Tunnel Vision
 Sub-optimization
 Myopia
 Ossification
 Irrelevance
 Gaming
 Misrepresentation
 Misinterpretation
Disadvantages of Responsibility
accounting or performance
measures