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Managerial Accounting

12.1 Explain the Importance of Performance Measurement

3 min readLast 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
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© 2025 Fiveable Inc. All rights reserved.
AP® and SAT® are trademarks registered by the College Board, which is not affiliated with, and does not endorse this website.

© 2025 Fiveable Inc. All rights reserved.
AP® and SAT® are trademarks registered by the College Board, which is not affiliated with, and does not endorse this website.