15 Nov Performance Evaluation of Accounting Personnel In this week’s lecture, we talked about ‘performance evaluation’ and its relationship with service cost allocation, agency theory, respo
Performance Evaluation of Accounting Personnel
In this week's lecture, we talked about "performance evaluation" and its relationship with service cost allocation, agency theory, responsibility center, and employee morale. Based on what you have learned so far, how should the performance of accounting personnel in a large organization be evaluated?
Chapter 14 Performance Evaluation
Strategic Management Accounting
Dr. Tien Lee, Ph.D., PMP, CISA, CISSP [email protected] | (415)644-TIEN
San Francisco State University Lam Family College of Business
What is “accounting income”?
Accounting income is profitability that has been compiled using the accrual basis of accounting with adjustments made to reflect the change in net assets during a reporting period.
“Real” income vs. accounting income – What’s the difference?
What’s Real Income?
Cash flow cannot be used to reflect income.
REAL INCOME does not exist!
Accounting Income Terms
Operating Income (& other income)
After tax income; NIAT
Analysis by financial statement
Across different period
Across different division
Report each amount on financial statement as a percentage of _______.
Compare performance on vertical value-chains functions.
Select proper Time Horizon: this is actually quite easily missed. Even for professionals, sometimes mistakes are made comparing two subjects on different time span, or period.
Select comparable subjects: i.e., comparable responsibilities;
Relevant Information: Historical cost? Replacement costs? Book value? Opportunity Cost? Cost of Idle Capacity? Relevant range of the fixed cost?
Performance measurement can be done on different levels:
On Industry Level: Compare against industry benchmark
On Market level: Compare against competitors
On Firm Level: Horizontal or Vertical Analysis
On Board Level: Compare against board specified strategies or objectives.
On Senior management level: Benchmark ROI, growth, cost leadership strategies
On Line management level: variance analysis on efficiency, input cost, ABM, MBO.
On Staff level: HR, incentive compensation, internal control initiatives.
Return on Investment (ROI)
ROI is an accounting measure of income divided by an accounting measure of investment (usually, Total Asset)
ROI may be broken into its two components as follows:
Return on Investment (ROI)
Most popular approach:
Blends all major ingredients of profitability (revenues, costs, and investment) into a single number
Compared to other ROIs both inside and outside the firm
Also called the accounting rate of return (ARR) or the accrual accounting rate of return (AARR)
Numerator: operating income, net income
Denominator: total assets, total assets less current liabilities
Return on Investment (ROI)
Important! ROI is a general ratio which DOES NOT specify a strict definition on “return” or “Investment”
The “Return” can be any ACCOUNTING INCOME NUMBER.
The “Investment” can also be interpreted as “cost of investment”
It is important when comparing two ROI ratios that the definitions of return and investment are consistent!
Using Division Income for Performance Measurement
Easy to Understand and compare
Results of decisions and costs are summarized.
Size of the division?
Responsibility of the division?
Cannot be used to determine if managers have made GOOD decisions.
May produce misleading performance benchmark.
Residual Income (RI)
Income minus a required dollar return on the investment
Required rate of return (ROR) is the company’s weighted-average cost of capital (WACC)
The after-tax average cost of all long-term funding
RI = Income – (Required rate of return x Investment)
Economic Value Added (EVA®)
Type of residual income calculation that has recently gained popularity
Does not use a reported GAAP accrual in the numerator
The calculation of Cost of Capital is not covered in this course
Select the Time Horizon of the Performance Measures
ROI, RI, EVA, and ROS evaluate one period of time
May be adapted to evaluate multiple periods of time
Prevents actions that cause short-run increases in these measures but conflict with long-run interests of the organization
Benefits of actions taken in current year may take several years to be measured
Alternative Definitions of Costs: Current Cost
The cost of purchasing an identical asset today to the one currently held.
The cost of acquiring the services provided by that asset if an identical asset cannot be currently purchased.
ROIs calculated using current costs will differ from those calculated using historical costs.
Alternative Definitions of Costs: Long-Term Assets
Cost measured at gross book value (original cost), or
Cost measured at net book value (original cost less accumulated depreciation)
Using net book value results in a higher ROI due to the smaller base (which decreases every year)
Net book value is consistent with total assets shown on the balance sheet and with net income (includes depreciation expense)
Incentive for retaining old property, plant and equipment
Performance evaluation is a SERIOUS business!
You need to build an arsenal of “evaluation toolkits” for yourself. Look at it often.
Always ask yourself:
What makes it significant?
What are the risks that came with the performance?
What would cause the most impact?
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