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1- PowerPoint presentation file2- A file Word containing a report on 5 students, divided into each student’s on what they do in this project.Avoid plagiarism,
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Project Presentation
Total Marks 10
Project presentation is to demonstrate cost accounting aspects providing social
responsibility
Note: This project is to replace our regular short exam)
Project theme:
Cost Accounting give right value to customers providing social
responsibility to the society”
Examine how social responsibility is influenced by decision-making and cost
optimization.
Please prepare a presentation choosing any topic from cost accounting that provides
social responsibility in your view.
Format:
1. Title
2. Introduction on on the topic chosen from cost accounting providing socisl
responsibility.
3. Define important key words.
4. Methodology used (Questionnaire or empirical study)
5. Interpretations on the method used
6. Discussion on how it effects social responsibility
7. Conclusion
8. References used
o
o
o
PREV Previous Chapter
CHAPTER 14: Measuring and Assigning Costs for Income Statements
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CHAPTER 16: Strategic Performance Measurement
CHAPTER
15
Performance Evaluation and Compensation
In Brief
When owners give managers authority to make decisions and guide operations, problems arise because owners’ and managers’ interests often
conflict. Owners use accounting information to measure performance, monitor managers’ actions, and motivate decisions that are in the
owners’ interest. Similarly, managers use accounting information to measure, monitor, and motivate the actions of employees. Before
managers or other employees can be held accountable for the results of their decisions and actions, their rights and responsibilities need to be
defined. Then return on investment, residual income, economic value added, or other measures can be used to gauge and reward
performance. In large organizations, resources may be transferred internally from one department to another. The prices set for these
transfers affect financial measures of performance. When these transfer prices are set appropriately, managers have incentives to increase the
value of the overall organization. However, transfer prices can encourage suboptimal decisions that may be beneficial at the local level, but
are not in the best interest of the global organization.
This Chapter Addresses the Following Questions:
•
•
Q1 What is agency theory?
Q2 How are decision-making responsibility and authority related to incentives and performance evaluation?
•
•
•
•
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Q3 How are responsibility centers used to measure, monitor, and motivate performance?
Q4 How do return on investment, residual income, and economic value added affect managers’ incentives and decisions?
Q5 How is compensation used to motivate performance?
Q6 What prices are used for transferring goods and services within an organization?
Q7 How do transfer prices affect managers’ incentives and decisions?
NUCOR: A GROUP OF PEOPLE IN HEADLONG PURSUIT OF A SHARED PURPOSE*
N
ucor Corporation is one of the largest North American manufacturers of steel products. The company primarily uses mini-
mill technology, which recycles scrap steel as raw material. Nucor has been highly profitable for many years, although economic recession
led to losses during 2009. Its profits are affected significantly by changes in the demand for steel products, the price of scrap steel, energy
costs, competition from imports and substitute products, and capital investments. Nucor’s strategy focuses on technological and product
innovation, high quality, competitive pricing, efficient operations, and customer service. The company has no research and development
department and instead relies on innovations at the plant level. To motivate employees to work with management toward achievement of
strategic objectives, Nucor has adopted a unique approach to organizational structure and employee incentives.
The company’s organization structure is relatively flat, with only 5 layers from the CEO to frontline workers. In addition, each Nucor facility
operates autonomously, with a general manager responsible for all decisions. Employees at all levels are encouraged to participate in
decision making and to take actions proactively. Workers can halt production when problems arise, spend time with customers to learn more
about improving quality from the customer’s perspective, and travel to another plant to help solve a production problem or to learn new
methods.
To promote efficiency, innovation, and collaboration, about two thirds of employee pay is related to performance. Employees at all levels
earn lower wage rates than in other companies, but employees typically earn higher than average pay including bonuses. Examples of
performance measures include the following:
•
•
•
All employees: 10% of companywide operating profit distributed annually
Plant work groups: Weekly bonuses based on production volume
Plant managers: Bonuses based on companywide return on equity
•
CEO: Bonuses based on a three-year measure tied to return on equity, return on capital, and revenue growth relative to peer
companies
During 2009, Nucor faced new challenges as customer demand and selling prices dropped dramatically. Outside contractors were eliminated
so that employees could have at least some work beyond steelmaking, such as maintenance, janitorial services, and grounds keeping.
Although worker hours were cut back, Nucor maintained its policy of not laying off any employees.
In this chapter, we learn about the advantages and disadvantages of decentralized decision making, including incentive problems. We will
explore the ways that organizations assign responsibility and methods to develop internal prices when goods or services are transferred
between sub-units. We will also study the benefits and drawbacks of performance measures including return on investment, residual income,
and economic value added.
SOURCES: Nucor Corporation, “Nucor Reports Results for Third Quarter and First Nine Months of 2009,” press release, October 22, 2009;
Nucor Corporation, “Our Story,” available at www.nucor.com; N. Byrnes with M. Arndt, “The Art of Motivation,” Business Week, May 1,
2006; C. Helman, “Test of Mettle,” Forbes.com, November 5, 2009.
AGENCY THEORY
Q1 What is agency theory?
Agency theory is an analytical framework that examines potential conflicts between owners and managers and between managers and
employees; it suggests solutions to align the incentives. Agency problems arise when managers do not own firms. In for-profit firms, owners
often sell off part of the firm at some point in time, as the organization grows. Not-for-profit firms are often owned by organizations, such as
churches or governments. Within agency theory, the two types of information consumers are principals and agents. Principals hire agents to
make decisions for them and to act in their behalf. As shown in Exhibit 15.1, shareholders of a corporation are principals, and the chief
executive officer (CEO) is their agent. In not-for-profit organizations, stakeholders such as donors own the organization and hire the CEO.
As the top manager of an organization owned by shareholders or other stakeholders, the CEO makes decisions, plans strategies, and protects
the interests of the owners. At the same time, the CEO is a principal and the lower-level managers and employees are agents for both the
CEO and, in turn, the owners.
AGENCY COSTS
Problems arise when the goals of principals are not completely shared by their agents. For example, employees may exert insufficient effort,
or managers may waste organizational resources. The costs that arise when agents fail to act in the interest of principals are agency
costs. Exhibit 15.2 shows several types of agency costs, including the direct costs that occur when agents do not work in the principals’ best
interests, as well as costs incurred to monitor and motivate agent performance.
When organizations are small, principals minimize agency costs by personally overseeing agent behavior and performance. However, as
organizations grow larger, agent behavior is more difficult to observe, and agency costs tend to increase. To reduce agency costs,
organizations establish accounting systems to monitor and influence agent behavior. For example, public companies publish audited
financial statements, and employees are often paid bonuses for achieving profit goals. Thus, accounting information is used not only to
measure and monitor an organization’s activities, but also to measure, monitor, and motivate the performance of agents.
It is impossible to completely eliminate agency costs because agent behavior and decision making cannot be perfectly observed or measured.
Poor results might be caused by poor agent performance or by circumstances outside of the agent’s control. Similarly, favorable results
cannot be attributed to the agent’s performance alone. For example, the sales generated by a salesperson are partly a function of the effort
and skills of the salesperson and partly a function of the price and quality of the product, economic conditions, competition, customer tastes,
and so on.
ALTERNATIVE THEORIES OF MANAGER AND EMPLOYEE BEHAVIOR
Agency theory assumes that people are self interested, which compels organizations to develop systems to monitor effort and results to
control or reduce suboptimal behavior. Other theories of behavior do not make this assumption. For example, Simons’ levers of control
model is based on the ideas that people naturally want to exhibit positive behavior and that organizational systems create blocks that
encourage suboptimal behavior. According to Simons, beliefs systems lead to positive behavior by improving communication of
organizational core values and mission. Boundary systems promote proper behavior by reducing pressures and temptations. Diagnostic
control systems support achievement by clarifying resource needs and by helping managers and employees focus on clear targets. Interactive
control systems trigger learning by prompting organizational dialogue.1
EXHIBIT 15.1
Principals and Agents
EXHIBIT 15.2 Agency Costs
CHAPTER REFERENCE
Simons’ four levers of control are introduced in Chapter 1.
DECISION-MAKING AUTHORITY AND RESPONSIBILITY
Q2 How are decision-making responsibility and authority related to performance evaluation?
One way to reduce agency costs is to give specific decision-making authority to agents and then hold them responsible for the results of their
decisions. This idea lies behind the corporate form of business organization. Shareholders give managers authority to decide how
corporations’ resources are used. Then shareholders hold the managers responsible for creating shareholder value. Similarly, the authority for
decisions can be dispersed throughout an organization. To reduce agency costs, individual employees are held responsible for their
decisions, and limits are placed on their decision-making authority. For example, the maitre d’ in a restaurant is responsible for seating
people and has the authority to choose where customers sit. However, the maitre d’ has no responsibility for the menu items; the chef has the
authority to purchase food and to choose the items to be offered on the menu.
Many different approaches can be taken in assigning decision-making authority. Managers can also periodically restructure authority within
organizations. For example, Nucor Corporation allows frontline steelworkers to make decisions that in most companies would be restricted
to supervisors or plant managers. As the business environment becomes increasingly technical and competitive, the timeliness of decision
making becomes increasingly important to economic success. The need for more timely decision making often encourages managers to
reconsider how decision-making authority is assigned.
CENTRALIZED AND DECENTRALIZED ORGANIZATIONS
When managers make choices about locating decision-making authority, they are also making choices about the organization’s
structure. Organizational structure is the system within an organization that defines roles and responsibilities, flows of information, and
ability to influence the work of others. In organizations with centralized decision making, the right to make or authorize decisions lies
within top levels of management. In organizations with decentralized decision making, these rights are distributed to lower levels of
management. Nucor’s decision-making authority is highly decentralized, extending to frontline workers. In the current dynamic business
environment, many factors influence organizational structures, and changes in these structures are made over time.
GENERAL VERSUS SPECIFIC KNOWLEDGE
Knowledge is an important resource within organizations. The type of knowledge needed to make high-quality decisions affects the location
of authority within organizations. General knowledge, such as information about volume of sales or product prices when organizations sell
few products, is usually easy to transfer from one person to the next. Decisions based on general knowledge are likely to be centralized,
made primarily by the chief executive officer (CEO) and other top managers. Transferring the general knowledge needed for decision
making to an organization’s headquarters is relatively easy and, therefore, not very costly. Examples of centralized organizations include
small businesses where the owner makes most of the operating decisions and relies on a few employees to carry out those decisions. Large
businesses that produce few products, such as steel companies, are often centralized.
Some decisions require specific knowledge, that is, detailed information about particular processes, customers, or products—information
that is costly to transfer within the organization. Examples of specific knowledge are the technical details of the manufacturing or service
delivery processes and information gained over time from working with individual customers. When decision makers need specific
knowledge, they must either have the knowledge themselves or seek ways to obtain it. At Nucor, specific knowledge of customer
preferences is important to organizational success. Accordingly, plant managers are responsible for identifying customer needs and for
producing products at an appropriate quality and price to meet those needs.
TECHNOLOGY AND GLOBALIZATION
Technology has enhanced global communications and reduced the costs of business transactions so that organizations can more easily
operate in other countries. Accordingly, organizations have become increasingly multinational. When organizations expand to other
countries, managers within each country are likely to have specific knowledge of cultural and customer preferences. Decisions made at the
unit level are likely to be more timely and of higher quality because local decision makers best understand how to gather information
relevant to operations in that country.
CHOOSING A CENTRALIZED VERSUS DECENTRALIZED ORGANIZATIONAL STRUCTURE
Advantages and disadvantages for each type of organizational form are listed in Exhibit 15.3. Whether decision making within an
organization should be centralized or decentralized is not always a straightforward decision. Organizations often begin with centralized
decision making, then adopt a decentralized structure as they grow large. However, some large organizations find that a centralized approach
is best because it leads to greater alignment of decisions with the organizational vision and strategies.
EXHIBIT 15.3 Advantages and Disadvantages of Centralized and Decentralized Organizations
ORGANIZATIONAL STRUCTURE AND SPAN OF CONTROL
Once organizational structure and decision-making authority are established, responsibility for performance can be assigned to individuals
within an organization. The span of control refers to the scope of people or other resources over which an individual is given decisionmaking authority and is, therefore, held accountable. A span of control can range from narrow to wide. For example, a CEO with extensive
authority has a wide span of control, while a retail store clerk with little authority has anarrow span of control.
In general, individuals toward the top of an organization’s hierarchy have wide spans of control while individuals toward the bottom of the
hierarchy have narrow spans of control. As shown in Exhibit 15.4, overall organizational structure also influences the span of control. When
decision making is centralized, most employees have fairly narrow spans of control; the most flexibility in decision making is restricted to
top managers. When decision making is decentralized, employees throughout the organization have greater authority. The overall
hierarchical structure is shorter because fewer managers are needed; more employees report to a single manager (i.e., more employees and
other resources are under the span of control for each manager).
EXHIBIT 15.4 Span of Control and Organizational Structure
RESPONSIBILITY ACCOUNTING
Q3 How are responsibility centers used to measure, monitor, and motivate performance?
Accounting information is used in both centralized and decentralized organizations to measure, monitor, and reward performance. In
centralized organizations, information produced by the accounting system for decision making is used primarily by top managers who are
held responsible for both their effort and the quality of their decisions. Employees carry out tasks that result from these decisions and are
held responsible for their effort and compliance with top-down decisions. Therefore, individual and team efforts require close monitoring to
determine their contributions toward success. Managers use variance and productivity reports to gauge employee (individual and team)
efforts.
In decentralized organizations, decision making occurs throughout management levels and in the field. Employees in lower levels are held
responsible for their efforts and the quality of their decisions. Therefore, accounting systems are used to provide decision-making
information for all levels, from management to front-line employees. Broader accounting measures related to overall financial performance
are then used to measure and monitor performance.
Responsibility accounting is the process of assigning authority and responsibility to managers of subunits and then measuring and
evaluating their performance. under responsibility accounting, managers are usually held responsible only for factors within their span of
control. However, individuals may be held responsible for performance beyond their direct control. For example, Nucor rewarded plant
managers based on companywide return on equity, which included the performance of all plants. This reward system encourages plant
managers to share innovations and efficient practices.Responsibility centers are subunits (e.g., segments, divisions, departments) in which
managers are accountable for specific types of operating activities. Four common types of responsibility centers are cost centers, revenue
centers, profit centers, and investment centers. Exhibit 15.5 provides specific examples of each responsibility center and examples of
performance measures that are likely to be used in these centers.
EXHIBIT 15.5 Examples of Responsibility Centers and Performance Measures
COST CENTERS
In cost centers, managers are held responsible only for the costs under their control. Some cost centers provide support services that are
relatively easy to monitor because their outputs are measurable. Cost centers are also used for subunits that produce goods or services
eventually sold by others. Managers in these cost centers are responsible for producing their goods or services efficiently. In discretionary
cost centers, the output is not easily measurable in dollars or activities. Cost centers are found in for-profit, not-for-profit, and government
organizations.
Cost center managers are expected either to minimize costs for a certain level of output or to maximize output for a certain level of cost.
Cost center performance is measured and monitored several ways. Some organizations rely on cost budgets and variances. Measures of other
factors such as quality and timeliness of delivery are also relevant.
CHAPTER REFERENCE
Budgets are addressed in Chapter 10, and revenue and cost variances are addressed in Chapter 11.
REVENUE CENTERS
In revenue centers, managers are held responsible for the revenues under their control. Revenue centers frequently sell products from
manufacturing subunits. Managers are expected to maximize sales. If the manager in a revenue center is responsible for setting prices, gross
revenues can be used as a performance measure. If corporate headquarters, rather than the manager, sets prices, then managers’ performance
can be evaluated using a combination of sales volumes measured in units and sales mix. Many organizations treat their sales departments as
revenue centers and reward employees based on sales generated. In not-for-profit organizations, fundraising activities might be treated as a
revenue center.
PROFIT CENTERS
Managers in profit centers are held responsible for both revenues and costs under their control. Profit centers produce and sell goods or
services, and may include one or several cost centers. Profit center managers are responsible for decisions about inputs, product mix, pricing,
and volume of goods or services produced. Because profit centers include both revenues and costs, performance is typically measured using
some combination of revenue and cost measures. Not-for-profit organizations tend to use revenue and cost budgets and variances as
performance measures, although some focus managers’ attention on operating margins when performance is poor. For-profit organizations
use some measure of profits such as accounting earnings.
INVESTMENT CENTERS
Managers of investment centers are held responsible for the revenues, costs, and investments under their control. Investments include any
assets related to the investment center, such as fixed assets, inventory, intangible assets, and accounts receivable. Investment centers
resemble profit centers, where profitability is related to the assets used to generate the profits. Because investment centers include revenues,
costs, and investment, performance measures need to address all of these factors. Later in this chapter we will learn about three commonly
used measures: return on investment (ROI), residual income, and economic value added (EVA).
RESPONSIBILITY CENTERS, MANAGERS’ INCENTIVES, AND DIAGNOSTIC CONTROLS
Top managers use judgment to decide the best types of responsibility centers for the organization. The choices depend on the size of the
organization, the nature of operations, and the organizational structure and belief systems. Ideally, responsibility centers should reduce
agency costs by holding managers responsible for decisions over which they have authority. For example, accounting departments are often
viewed as cost centers because their managers have authority primarily over the use and cost of resources. Similarly, business segments are
generally treated as investment centers because segment managers have authority over revenues, costs, and investment.
Nevertheless, responsibility center accounting sometimes leads to suboptimal decision making. Asuboptimal decision is optimal for a
person, department, or business unit, but is suboptimal for the organization as a whole. Each type of responsibility center has a specific set of
agency problems. Managers in cost centers focus on minimizing costs and maximizing efficiency, which can lead to declines in quality and
delivery timeliness. In turn, sales could drop and the overall organization suffers. Similarly, revenue center managers, who are typically
rewarded for increasing revenues, may fail to consider product contribution margins and inappropriately emphasize less-profitable products.
These managers have incentives to offer discounts and generous payment terms that reduce overall profitability. In profit centers, managers
are encouraged to stress short-run profits by cutting maintenance, research and development, and advertising costs that benefit long-term
performance. Similarly in investment centers, managers may reduce investment to increase short-term results. Or, they may invest in
projects that are more or less risky than is appropriate for the organization. To address these agency problems, diagnostic control systems
typically include appropriate performance measures and incentive reward systems. Appropriate measures increase goal congruence,
creating agreement between the interests of individual managers and the organization as a whole.
INVESTMENT CENTER PERFORMANCE EVALUATION
Q4 How do return on investment, residual income, and economic value added affect managers’ incentives and decisions?
Investment centers are common in large decentralized organizations. Because managers are responsible for costs and revenues, as well as for
investments, the measures used for monitoring and motivating purposes typically include the return and the size of investment. Three
measures commonly used to evaluate investment center performance are:
•
•
•
Return on investment
Residual income
Economic value added
RETURN ON INVESTMENT
Return on investment (ROI) is the ratio of operating income to investment. Operating income is calculated as earnings before interest and
taxes (EBIT). Investment is usually measured as total assets. Sometimes nonoperating assets, such as investments in other companies or
property and equipment currently rented to other companies, are excluded from this calculation. When evaluating the entire company’s
performance, all assets would be included because owners want to evaluate their return based on the entire investment. But when evaluating
the performance of a subunit, judgment is used to determine which assets should be included. Any assets included should be under the
control of the managers being evaluated. For internal management, investment is sometimes measured as the average of beginning and
ending operating assets for several reasons. First, the measure is intended to capture operations over a period of time, not just at the end of
the time period. Second, the measure could be manipulated by temporarily decreasing investment at the time performance is measured. For
simplicity, the examples in this textbook use total rather than average assets.
ALTERNATIVE TERMS
Return on assets (ROI) is sometimes called accounting rate of return or accrual accounting rate of return (seeChapter 12).
ROI is used to evaluate investment center performance. It can be compared across sub-units within a single organization, among a group of
firms within an industry, and within a single organization across time.2 In addition, ROI can be decomposed into two components that
provide additional information about performance. ROI is decomposed by multiplying both the numerator and denominator by revenue and
then rearranging terms:
Because revenue divided by total assets represents investment turnover, and operating income divided by revenue represents the return on
sales, we can now rewrite the ROI formula as:
ROI = Investment turnover × Return on sales
The decomposition of ROI into investment turnover and return on sales is often referred to as DuPont analysis. The method originated at
the DuPont Company in the early 1900s so that results from a wider range of business activities could be compared. Investment
turnover is a measure of the sales generated by each dollar invested in operating assets. Return on sales (ROS) measures managers’
abilities to control the operating expenses related to sales. Focusing on these two measures encourages managers to improve profitability by
using assets more efficiently (i.e., by generating more revenue, reducing the investment in assets, or both) and by conducting operations
more efficiently (i.e., by controlling costs to provide greater profit for each dollar of revenue). An extended version of DuPont analysis is
sometimes used to evaluate performance at lower organizational levels, as discussed later in the chapter. Computer Wizards (Part 1)
demonstrates the use of ROI and DuPont analysis to evaluate alternatives for improving profitability.
ALTERNATIVE TERMS
The term asset turnover means the same as investment turnover. Similarly, the term profit margin ratio means the same as return on sales.
COMPUTER WIZARDS (PART 1)
RETURN ON INVESTMENT AND DUPONT ANALYSIS
Computer Wizards produces and sells computer monitors nationally and internationally. Jason Black is responsible for Ontario operations
and Cecilia Earnhart manages the New Jersey division. The top managers of Computer Wizards measure the performance of its divisions
using ROI.
Jason was recently hired from outside of the company to improve operations in the Ontario division. One of his objectives is to achieve an
ROI at least as high as the New Jersey division. Jason calculates the ROI of the two divisions and performs DuPont analysis as follows (all
amounts in U.S. dollars).
From this analysis, Jason learns that the Ontario division has lower performance in investment efficiency and operating efficiency, as well as
overall ROI. He decides to investigate options for improving the division’s profitability.
STRATEGIES FOR INCREASING ROI
The first option Jason investigates is to focus on increased sales. The Ontario division currently has idle capacity, and Jason would like to
emphasize a new group of products. He believes that current capacity can support an increase in sales of $600,000, without requiring
additional investment except for additional marketing costs. He estimates that operating income would increase by $60,000.
The second option is to reduce expenses. Jason believes that manufacturing costs could be reduced by as much as $100,000. He would
implement this plan using kaizen costing, that is, by organizing a team with members from marketing, accounting, and engineering to
analyze production activities and identify non-value-added activities that could be eliminated. Also, the products and manufacturing
processes could be redesigned to reduce the number of parts or processes.
CHAPTER REFERENCE
Kaizen costing was introduced in Chapter 13.
The third option is to reduce the investment in assets. Jason knows that internal processes are inefficient; inventory and work in process are
built up throughout different manufacturing areas. He would like to implement cellular production and just-in-time inventory practices.
These modifications would allow the division to sell a small building currently in use. Jason estimates that assets could be reduced by
$400,000.
Jason summarizes the effects on the Ontario division’s ROI for each option individually and combined, as follows.
Jason knows that increasing sales, reducing costs, and changing production processes are all worthy long-term goals, but it will take a year
or longer to see the results for all of these plans. He would prefer to increase ROI within a shorter time frame. Recently a competitor made
an offer to sell the Ontario division a component that is currently manufactured in-house. If Jason purchases the component, operating
earnings would decrease by $50,000. However, he could easily sell the small building because most of it houses the production facility for
the component. Investment turnover would be 3.1 times (the same as option 3), but return on sales would drop to 9% ($450,000 ÷
$5,000,000), and ROI would increase to 27%.
CHOOSING A PLAN OF ACTION
Jason decides to discuss his options with Renee Forsyth, the Director of Finance for Computer Wizards. All of the plans he is considering
require a great deal of time and effort. He believes that the strategies are sound, but is uncertain whether his expectations can be met. An
increase in sales depends in part on the continuing upswing of the economy. Cost reductions take time and concentrated effort on the part of
employees. Changing the manufacturing process could take several years because a new floor plan would have to be laid out, teams would
have to be established, and work would be disrupted while implementing the new lines. Furthermore, the employees might need several
months to work efficiently under the new system. The easiest choice is to outsource, and Jason knows that outsourcing would improve his
ROI in the short run. However, he believes that focusing on in-house manufacturing cost reductions would be a better strategy for Computer
Wizards in the long run. The company’s use of ROI to measure performance discourages this type of strategy, so Jason wonders whether a
different performance measure could be adopted that would better reward behavior to benefi
