12.1 Explain the Importance of Performance Measurement
3 min read•Last Updated on June 18, 2024
Performance measurement in managerial accounting is crucial for aligning company strategy with individual goals. It involves setting up systems that translate big-picture objectives into specific targets for managers and employees, fostering goal congruence and motivating high performance through incentives and rewards.
Different types of responsibility centers, like cost centers and profit centers, help organize performance evaluation. While accounting-based measures offer objectivity and comparability, they have limitations. Comprehensive systems like the Balanced Scorecard aim to provide a more holistic view of performance by including both financial and non-financial indicators.
Performance Measurement in Managerial Accounting
Alignment of strategy and goals
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Performance measurement systems translate corporate strategy into specific goals and objectives for managers and employees
Ensures individual and departmental goals align with overall organizational strategy
Provides framework for evaluating progress towards strategic objectives
Effective performance measurement systems foster goal congruence
Goal congruence achieved when actions and decisions of managers and employees support organization's overall objectives
Encourages managers to make decisions benefiting company as a whole rather than focusing solely on their own department or personal interests
Performance measures serve as basis for managerial incentives and rewards
Linking compensation and rewards to performance measures motivates managers to work towards achieving strategic goals
Helps attract and retain high-performing managers driven by opportunity to earn performance-based rewards (bonuses, promotions)
Types of responsibility centers
Cost centers
Managers responsible for controlling costs within specified budget
Performance evaluated based on ability to minimize costs while meeting quality and quantity standards
Examples include production departments (manufacturing) and administrative support units (human resources)
Revenue centers
Managers responsible for generating revenue through sales or other income-producing activities
Performance assessed based on ability to maximize revenue
Examples include sales departments (business-to-business sales) and retail outlets (brick-and-mortar stores)
Profit centers
Managers responsible for both revenues and costs, with goal of maximizing profit
Performance evaluated based on ability to generate target level of profit
Examples include business units (product divisions) or product lines with dedicated sales and production resources
Investment centers
Managers responsible for both profit and assets used to generate that profit
Performance assessed based on ability to earn satisfactory return on invested assets (return on investment - ROI)
Examples include divisions (regional operations) or subsidiaries that have control over their own assets and investment decisions
Accounting-based performance measures
Advantages of accounting-based performance measures
Objectivity and verifiability
Accounting measures based on historical financial data that can be independently verified
Reduces risk of subjective or biased performance evaluations
Comparability across time periods and business units
Consistent application of accounting principles allows for meaningful comparisons of performance over time and between different parts of organization
Facilitates benchmarking against industry standards or competitors
Alignment with financial reporting and external stakeholder expectations
Accounting measures consistent with metrics used in financial statements and other external reports
Helps ensure managerial performance evaluated using criteria important to investors and other stakeholders (analysts, regulators)
Limitations of accounting-based performance measures
Short-term focus
Overemphasis on accounting measures may encourage managers to prioritize short-term financial results at expense of long-term value creation
May lead to myopic decision-making and underinvestment in intangible assets (brand equity) or long-term projects (research and development)
Incomplete picture of performance
Accounting measures do not capture all aspects of managerial performance, such as customer satisfaction, employee morale, or innovation
Relying solely on financial metrics may overlook important non-financial performance measures (sustainability initiatives, talent development)
Potential for manipulation
Managers may engage in earnings management or other accounting manipulations to artificially boost their performance measures
May lead to distorted decision-making and erosion of trust in performance measurement system (Enron scandal)
Comprehensive Performance Measurement Systems
Balanced Scorecard
Integrates financial and non-financial measures across multiple perspectives
Helps align performance measurement with organizational strategy
Key Performance Indicators (KPIs)
Specific metrics chosen to reflect critical success factors for the organization
Can include both financial and non-financial measures
Importance of selecting appropriate measures
Measures should be aligned with organizational strategy and goals
Regular review and adjustment of performance measures to ensure continued relevance