ACTG 6310

Chapter 14 – Management Accounting in a Changing

Environment

Determinants of Business Strategy, Organizational Architecture and Firm Value

Figure 14-1, Zimmerman 7e

Role of Accounting System in Firm Value

• Technological innovation and market conditions affect a company’s business strategy

• Business strategy interacts with the organizational architecture to provide incentives – Business strategy often causes changes in the

accounting systems used• Incentives rewarded through the performance

evaluation system affect the actions taken which affect the firm value

Quality

• Quality has become very important in today’s competitive environment.

• Definition – total features and characteristics of a product or a service made or performed according to specifications to satisfy customers at the time of purchase and during use.

Quality

• Consumer Viewpoint– Service– Quality– Cost– Customer satisfaction measures

• Producer’s Viewpoint– Technical measurements– Zero defects– Value-added versus non-value added– Total quality control

TQM Programs

• Elements in TQM Programs:– Quality is a firm wide process– Quality is defined by the customer– Quality requires organizational changes– Quality is designed into the product

• Knowledge of quality is often inside the organization.• Decentralization puts the decision rights in lower level

employees hands• Performance evaluation and reward systems must

also be revised.

Classification of Quality Costs

• Prevention costs – preclude nonconformance with specifications

• Appraisal costs – tests to determine conformance with specifications

• Internal failure costs – redo defective products in order to sell as a normal product

• External failure costs - costs incurred to right defective products in customer’s hands

• Prevention costs best, external failure costs worst

Measurement

• Lost profits – due to having to sell products at lower prices

• Opportunity costs – forgone sales due to defective products (word of mouth to friends)– Not an accounting cost in the general ledger but a true

economic cost

• Cost of quality report

Quality Programs

• Just-in Time– Throughput time – total time from when a product

starts the production process until it is ready for sale.• Six Sigma – 3 defects per million• Lean manufacturing and accounting – Eliminate

all non-value added activities• Lean Six Sigma• TQM programs cause accounting changes in the

firm

Potential Accounting Changes From JIT/Lean

• Labor and overhead costs combined into conversion costs.

• Factory overhead traced directly to JIT lines.• Material costs charged directly to products.• Conversion costs are assigned based on machine

time.• A single inventory, Raw in Process, is used combining

Raw Materials and Work in process.• Conversion costs are charged directly to finished

goods.

Balanced Scorecard• Developed by Robert S. Kaplan and David O. Norton

(Harvard Professors) in 1992• What is it?– An approach to performance measurement that combines

traditional financial measures with non-financial measures to provide managers with richer and more relevant information about activities they are managing

• It is an information system for employees of all levels of the organization

• The BSC translates a business unit’s mission and strategy into tangible goals and measures.

• Key performance indicators are identified and measured

Balanced Scorecard

• Why does a business need a balanced scorecard?– To monitor their business’ performance in the best

way possible– To align individual goals with the firm’s strategic

objectives (Goal congruence)– To recognize that performance measures influence

the behavior of employees– To provide feedback about the strategy– As an investment in the long-term

Balanced Scorecard

• Four perspectives:– Financial– Customer– Internal Business Process– Innovation and Learning (Learning and growth)

• Financial goals are the ultimate result for profit businesses but they are usually short-term

• The last three perspectives are long-term in nature and alert management about future problems/opportunities

Figure 9-1

Balanced Scorecard

• Critical Financial Performance Variables– Operating profit– Net income– Return on Investment– Return on Equity– Return on Capital Employed– Economic Value Added– Return on Sales– Cash flow

Balanced Scorecard

• Critical Customer Performance Variables– Bookings or contracts scheduled– Backorders– Customer satisfaction– Customer response cards• Surveys• Letters of complaint

– Customer retention• Average duration of relationship• Reasons for leaving

Balanced Scorecard

• Critical Customer Performance Variables (continued)– New customer acquisition– Customer profitability– Customer loyalty– Market share– Account share– Key account orders

Figure 9-2

Balanced Scorecard

• Critical Internal Process Performance Variables– Operations Processes• Capacity utilization• Inventory turnover• Quality measures

– Zero defects

• Cycle time measures– Lead time– On-time Delivery and delivery time

Balanced Scorecard

• Critical Internal Process Performance Variables– Operations Processes• Cycle time measures

– Order fulfillment cycle - receipt of order to delivery– Throughput time - time to manufacture– Manufacturing Cycle Efficiency = Process time/Throughput

time (Goal = 100%)

• Cost measures

Balanced Scorecard

• Critical Internal Process Performance Variables– Innovation Processes• Number of new products• Market position in new products

– Post-Sale Service Processes• Warranty and repair activities• Customer service• Invoicing and collection

Balanced Scorecard

• Critical Innovation and Learning Performance Variables– People• Train people• Give them advancement potential• Employee satisfaction

– Systems• Provide for upgrades and improvements

– Organizational Procedures• Align organizational procedures and routines

Example

Managing Strategy and the Balanced Scorecard

• Short-run versus long-run measures• Features of good balanced scorecards– Measures are appropriate for achieving strategy– Communicates strategy to all employees– Places strong emphasis on financial objectives and

measures with nonfinancial measures as leading indicators of future financial performance

– Limits the number of measures used to those most critical– Highlights problems that could affect future performance

Managing Strategy and the Balanced Scorecard

• Pitfalls when implementing a balanced scorecard– Use actual cause and effect linkages not perceived linkages– Seek improvements through tradeoffs over time– Include subjective and objective measures that are hard to

manipulate– Use nonfinancial along with financial measures– Use critical measures to focus attention rather than using

too many measures– There is no guarantee that future profitability will follow

target achievements in any nonfinancial area.– Poorly designed incentive programs

Example of BSC

• Mayo Clinic Rochester– A BSC is used to guide physicians and other

employees to achieve success– Perspectives include• Quality• Scholarships• Patient satisfaction

– Performance Measures include peer-reviewed papers, numbers of presentations, and number of grants awarded

Example of BSC

• Southwest Airlines Co.– Performance Measures include • Load factors (percentage of seats occupied)• On time performance• Available seat miles• Denied boarding rates• Flight cancellation rates• Customer complaints filed with the Department of

Transportation

Example of BSC

• PriceWaterhouse Coopers– Used a version of the BSC with the following

measurements:• Divisional income – 60%• Generating cross-division income – 10%• Customer satisfaction (measured with surveys) – 10%• Development of new customers (new business) – 10%• Employee turnover (difference between company norm

of 20% per year) – 10%

Example of BSC

• Tri-Cities Community Bank• Financial: Improved loan, deposit, and non-interest

income• Customer: Customer retention rate, customer

satisfaction ratings on quarterly surveys• Internal business: Number of successful referrals

and/or cross-sells• Learning and growth: number of training hours

employees receive, employee scores on in-house tests about sales, service, and product knowledge

Example of BSC

• Dell Computer Corporation– Financial measures

• Selling price• Margins• Overhead costs• Profits

– Nonfinancial measures• Inventory turns• Accounts receivable days• Accounts payable days• Cash-conversion cycle

Balanced Scorecard• According to a recent survey by Bain & Co.,

approximately 50% of Fortune 1000 companies in North America and about 40% in Europe have adopted some version of the BSC. Additional implementers include the following:– ABB Switzerland (Engineering company)– AT&T Canada– Chemical Bank– Hilton Hotels– Sears– UPS– Wells Fargo Online Financial Services– Wendy’s International

Performance Measurement Systems

• Important to use both financial and nonfinancial performance measurements

• Outcome measures – lagging indicators– Based on what has happened in the past

• Driver measures – leading indicators – Often nonfinancial in nature– Information helps determine future results– Ex: Poor quality will lead to reduced sales and net income

• Must focus on both external and internal measures

How Many Measures Per Employee?

• Employees should be accountable for no more measures than they can remember

• Magic number is 7 plus or minus 2

Difficulties in Implementing Performance Measurement Systems

• Poor correlation between nonfinancial measures and results

• Fixation on financial results• Measures are not updated• Measurement overload (too many)– Managers will choose easiest measurements if

given too many• Difficulty in establishing trade-offs between

financial and nonfinancial measurements

Homework

• P14-1 – British Airways• P14-3 – Fiedler International• P14-4 – Guest Watches• P14-6 – Old Town Roasters• P14-7 – The Pottery Store• DUE WEDNESDAY, APRIL 8