MANAGEMENT CONTROL

AND STRATEGIC
PERFORMANCE
MEASUREMENT;
STRATEGIC INVESTMENT
UNITS AND TRANSFER
PRICING
PERFORMANCE EVALUATION
AND CONTROL
Performance Evaluation is the
process by which managers at all
levels gain information about the
performance of tasks within the
firm and judge that performance
against preestablished criteria as
set out in budgets, plans, and
goals.
How is performance Evaluated?
 Itis evaluated at many different levels in
the firm:
MANAGEMENT CONTROL
Itrefers to the evaluation by
upper-level managers of the
performance of mid managers.
Operational control means the
evaluation of operating level
employees by mid-level
managers.
TOP MANAGEMENT LEVEL
Responsible for controlling and
overseeing the entire
organization.
Examples: Board of Directors,
President, CEO, CFO, and the
like
MIDDLE-LEVEL MANAGEMENT

Responsible for organizational

and directional functions,
inspiring low-level managers
Examples: General Managers,
Branch Managers, Department
Managers
LOWER-LEVEL MANAGEMENT
Responsible for assigning of
employee task, guiding,
inspiring employees, ensuring
QUALITY AND QUANTITY of
products.
Examples: Supervisors, Section
leads, Foremen
OBJECTIVES OF MANAGEMENT
CONTROL
Motivate Managers to exert
more effort
Provide the right incentive for
managers
Determine fairly the rewards
earned by managers
STRATEGIC PERFORMANCE
MEASUREMENT: BASIC CONCEPTS
Strategic Investment Unit
A.K.A Responsibility Center is a
specific unit of an organization
assigned to a manager who is
held accountable for its
operations and resources.
STRATEGIC PERFORMANCE
MEASUREMENT
This is also known as
Responsibility Accounting. It is
a system used by top
management to evaluate SIU
managers.
DECENTRALIZATION AND
SEGMENT REPORTING
 Decentralization – The authority to make
decisions is spread throughout the
organization.
BENEFITS AND LIMITATIONS
OF DECENTRALIZATION
BENIFITS DRAWBACKS
 Uses local knowledge  Can hinder
 Allows timely and coordination among
effective response to SIUs
customers
 Cancause potential
 Train managers
conflict among SIUs
 Motivate managers
 Offers objective
method of performance
evaluation
DECENTRALIZATION AND
SEGMENT REPORTING
For an effective strategic
performance measurement,
the following basic conditions
are necessary:
1.A well-defined organization
structure – This requires that the
spheres of jurisdiction which are
set forth in the organization
chart must be clearly established
and understood and that a
manager’s financial
responsibilities be defined in
advance.
2. Well-defined and established
standards of performance in
revenues, costs and investments
– This requires that an integrated
plan for the control of operations
which would provide for cost
standards, expense budgets, sales
forecasts, profit planning and
programs
3. A system of accounting
that identifies any
revenues, expenses, and
assets to specific units in
the organization.
4. A system that provides for
the preparation of regular
performance reports – This
requires that a system of
preparing the regular
segment reports showing the
planned results, actual results
and the variances should be
established.
COST SBU
Minimize cost
Budget of cost based on
expected level of operation
Performance report or
variance analysis reports
During the year, Department
7 manufactured 40,000 units
as budgeted. Budgeted and
actual costs for Department 7
are given below:
 Budget Actual
Direct materials P 210,000 P 208,600
Direct labor 136,000 137,800

Department costs:
Supervision 21,000 21,000
Indirect materials 14,200 14,700
Repairs and maintenance 2,100 2,200
Equipment operating cost 3,400 3,300
Depreciation, equipment 4,000 4,000

Allocated plant costs:

Superintendence 19,500 21,000
Heat, light and power 3,700 3,900
Taxes and insurance 5,400 6,100
Other plant occupancy cost 5,000 6,700
Depreciation plant 7,000 7,000
P 431,300 P 436,300
Budgeted cost per unit = P431,300
40,000
= P10.7825

Actual cost per unit = P436,300

40,000
= P10.9075
 Meredith, Inc.
Department 7
Responsibility Cost Report
For the Year Ended December 31, 20X3
Direct costs Actual Budget Variance (Fav) Unf
Controllable costs
Direct materials P 208,600 P 210,000 P (1,400)
Direct labor 137,800 136,000 1,800
Indirect materials 14,700 14,200 500
Repairs and maintenance 2,200 2,100 100
Equipment and operating cost 3,300 3,400 (100)
Total P 366,600 P 365,700 P 900
Non-controllable costs
Supervision P 21,000 P 21,000 P -
Depreciation, equipment 4,000 4,000 -
Total 25,000 25,000 -
Total direct costs P 391,600 P 390,700 P 900
Indirect costs allocated to the department
Superintendence P 21,000 P 19,500 P 1,500
Heat, light and power 3,900 3,700 200
Taxes and insurance 6,100 5,400 700
Other plant occupancy cost 6,700 5,000 1,700
Depreciation plant 7,000 7,000 -
44,700 40,600 P 4,100
TOTAL P 436,300 P 431,300 P 5,000
PROFIT SBU
Generation of revenues and
control of costs
Budget for guidelines and
authority
Income statements using the
contribution margin
 Product Line
Total 1 2 3
Net sales P250,000 P120,000 P80,000 P50,000
Cost:
Cost of product P120,000 P60,000 P30,000 P30,000
Sales commissions (5%) 12,500 6,000 4,000 2,500
Fixed administrative costs
allocated to product lines 80,000 40,000 20,000 20,000
Total costs P212,500 P106,000 P54,000 P52,500
Operating income P37,500 P14,000 P26,000 P(2,500)
 Nicki Company
Profitability Analysis of Product 3

Net Sales P50,000

Less: Direct Cost and Expenses
Cost of Product P30,000
Sales Commission 2,500 32,500
Contribution to Indirect Expenses P17,500
INVESTMENT SBU
Objectives:
 Motivate managers to exert high level
of effort to achieve the goals of the
firm.
 Provide the right incentive for managers
to make decisions that are consistent
with the goals of top management
 Determine fairly the rewards earned by
the managers for their effort and skill
RETURN ON INVESTMENT
Advantages:
It is easily understood and has
gained wide usage
It is comparable to interest
rates of returns of alternative
investments.
Formulas:
𝑁𝑒𝑡 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐼𝑛𝑐𝑜𝑚𝑒
𝑅𝑂𝐼 = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐼𝑛𝑐𝑜𝑚𝑒

𝑅𝑂𝐼 = 𝑁𝑒𝑡 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐼𝑛𝑐𝑜𝑚𝑒

𝑆𝑎𝑙𝑒𝑠
x 𝑆𝑎𝑙𝑒𝑠
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑎𝑠𝑠𝑒𝑡
or

𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑃𝑟𝑜𝑓𝑖𝑡 𝐴𝑠𝑠𝑒𝑡 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟

𝑅𝑂𝐼 = 𝑀𝑎𝑟𝑔𝑖𝑛 𝑥 (𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑆𝑎𝑙𝑒𝑠)
NET OPERATING INCOME

Is generally used because

it is consistent with the
base to which it is
applied, that is,
operating assets.
OPERATING ASSETS
Include cash, accounts
receivable, inventory, plant
and equipment (net), and all
other assets held for
productive use in the
organization.
LIMITATIONS OF ROI
Subject to Criticisms
It results to disincentive for
high ROI units to invest in
projects with ROI greater
than the minimum rate of
return but less than unit’s
current ROI.
RESIDUAL INCOME
Advantages of Residual Income
A unit pursues an investment
opportunity costs as long as
the return from the investment
exceeds the minimum rate of
return set by the firm.
The firm can adjust the
required rates of return for
differences in risk and types of
assets.
It’s possible to calculate a
different investment charge
for different types of assets.
LIMITATIONS OF RESIDUAL
INCOME
 Since residual income is not a
percentage, it suffers the same
problem of profit SBUs in that it’s not
useful for composing unit of
significantly different sizes.
 It’s not as intuitive as ROI
 It may be difficult to obtain a
minimum rate of return.
ECONOMIC VALUE ADDED
It is a business unit’s income after
taxes and after deducting the cost
of capital.
The cost of capital is usually
obtained by calculating a weighted
average of the cost of the firm’s
two sources of funds – borrowing
and selling stock.
Performance Evaluation of an Investment
SBU
MNO, division of Aeon Manufacturing, has assets of
P450,000 and an operating income of P10,000.
a. ROI = Operating Income
Total assets
= P110,000
P450,000
= 24.44%

b. Operating income P110,000

Less: Minimum required return
(12% x P450,000) 54,000
Residual Income P 56,000
REVENUE SBU
This is a unit or segment
within an organization where
the manager is responsible
for selling budgeted
quantities of various
products or services at
budgeted price.
Three types of
variances and their
formulas are useful to
revenue SBU managers
in meeting their goals:
1.SALES PRICE VARIANCE
𝑀𝑎𝑠𝑡𝑒𝑟 𝐵𝑢𝑑𝑔𝑒𝑡 𝐴𝑐𝑡𝑢𝑎𝑙
= 𝐴𝑐𝑡𝑢𝑎𝑙 𝑆𝑎𝑙𝑒𝑠 𝑃𝑟𝑖𝑐𝑒 − x 𝑈𝑛𝑖𝑡 𝑆𝑎𝑙𝑒𝑠
𝑆𝑎𝑙𝑒𝑠 𝑃𝑟𝑖𝑐𝑒

2. SALES VOLUME VARIANCE

𝑀𝑎𝑠𝑡𝑒𝑟 𝐵𝑢𝑑𝑔𝑒𝑡
= 𝐴𝑐𝑡𝑢𝑎𝑙 𝑈𝑛𝑖𝑡 𝑆𝑎𝑙𝑒𝑠 − x 𝑀𝑎𝑠𝑡𝑒𝑟 𝐵𝑢𝑑𝑔𝑒𝑡 𝐴𝑣𝑒𝑟𝑎𝑔𝑒
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑀𝑎𝑟𝑔𝑖𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
*
𝑈𝑛𝑖𝑡 𝑆𝑎𝑙𝑒𝑠

* Master Budget Average Contribution Margin per unit

𝑀𝑎𝑠𝑡𝑒𝑟 𝑏𝑢𝑑𝑔𝑒𝑡 𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑛𝑡𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑀𝑎𝑟𝑔𝑖𝑛
=
𝑀𝑎𝑠𝑡𝑒𝑟 𝑏𝑢𝑑𝑔𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
3. SALES MIX VARIANCE
𝐹𝑙𝑒𝑥𝑖𝑏𝑙𝑒 𝐵𝑢𝑑𝑔𝑒𝑡 𝐴𝑣𝑒𝑟𝑎𝑔𝑒
= ቀ𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑀𝑎𝑟𝑔𝑖𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡∗∗∗ −
 Karen Company’s actual and budgeted sales
and expense data for April are as follows:
Actual Budget

𝑷𝒓𝒐𝒅𝒖𝒄𝒕 𝑷𝒓𝒐𝒅𝒖𝒄𝒕 𝑷𝒓𝒐𝒅𝒖𝒄𝒕 𝑷𝒓𝒐𝒅𝒖𝒄𝒕

𝒁𝒊𝒎 𝒁𝒐𝒐𝒎 𝒁𝒊𝒎 𝒁𝒐𝒐𝒎

Sales in units 4800 5300 5000 5000

Selling price per unit P12.50 P10.00 P13.00 P10.00
Variable expenses per unit P6.00 P5.65 P7.00 P5.50
Contribution Margin per unit P5.60 P4.35 P6.00 P4.50
Fixed expenses for the month
for both products P40,360 P40,000
Sales Price Variance
Product Zim = (P12.50 – P13) x 4,800 units
= P2,400 unfavorable
Product Zoom = (P10 – P10) x 5,300 units
= P0
Total Sales Price Variance
Zim P2,400 unfavorable
Zoom 0
P2,400 unfavorable
 Sales Volume Variance
= (10,100 units – 10,000 units) x P5.25 per unit*
= P525 favorable

∗ 𝑀𝑎𝑠𝑡𝑒𝑟 𝐵𝑢𝑑𝑔𝑒𝑡 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 5,000 𝑥 𝑃6 +(5,000 𝑥 𝑃4.50)

=
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑀𝑎𝑟𝑔𝑖𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 10,000 𝑢𝑛𝑖𝑡𝑠

= P5.25
 Sales Mix Variance
= (P5.21287** - P5.25) x 10,100 units
= P375 unfavorable

∗∗ 𝐹𝑙𝑒𝑥𝑖𝑏𝑙𝑒 𝐵𝑢𝑑𝑔𝑒𝑡 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 4,800 𝑥 𝑃6 +(5,300 𝑥 𝑃4.50)

=
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑀𝑎𝑟𝑔𝑖𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 10,100 𝑢𝑛𝑖𝑡𝑠

= P5.21287
TRANSFER PRICING
A problem common to most
companies operating with
decentralized segments is
that of placing a fair value of
exchange of goods and
services between segments
within the company.
The transfer price of
interdivisional sales will
affect the selling division
sales and the buying division
cost but will not have any
direct effect on the
company’s profit.
A particular transfer pricing
basis may also be an excellent
management tool
For motivating division
managers
For establishing and
maintaining cost control
systems and for measuring
internal performance
ALTERNATIVE TRANSFER
PRICING SCHEMES
In practice, four general
approaches are used on
setting transfer price.
 MINIMUM TRANSFER PRICE
A general rule for making transfers to
maximize a company’s profits in
either perfect or imperfect market
uses the formula:
𝑻𝒓𝒂𝒏𝒔𝒇𝒆𝒓 = 𝑫𝒊𝒇𝒇𝒆𝒓𝒆𝒏𝒕𝒊𝒂𝒍 𝒄𝒐𝒔𝒕𝒔 + 𝑳𝒐𝒔𝒕 𝒄𝒐𝒏𝒕𝒓𝒊𝒃𝒖𝒕𝒊𝒐𝒏 𝒎𝒂𝒓𝒈𝒊𝒏
𝒑𝒆𝒓 𝒖𝒏𝒊𝒕 𝒐𝒏 𝒐𝒖𝒕𝒔𝒊𝒅𝒆 𝒔𝒂𝒍𝒆𝒔
𝑷𝒓𝒊𝒄𝒆 𝒑𝒆𝒓 𝒖𝒏𝒊𝒕
(𝒐𝒓 𝒐𝒑𝒑𝒐𝒓𝒕𝒖𝒏𝒊𝒕𝒚 𝒄𝒐𝒔𝒕𝒔 𝒑𝒆𝒓 𝒖𝒏𝒊𝒕)
MARKET-BASED TRANSFER
PRICE
Under this approach,
the transfer price is the
price at which the goods
are sold on the open
market.
The market price approach
is designed for situations in
where there is an outside
market for transferred
product or services; the
product or services is sold
in its present form to
outside costumers.
COST-BASED TRANSFER PRICE

Under this approach, the

transfer price is based
only on variable or
differential costs.
The advantage using this
approach is that it ensures in
the short-run the best use of
total corporate facilities
because it focuses attention
on the contribution margin a
transfer generates and on
how it increases short-run
profitability.
DISADVANTAGES
A company must cover all
costs before earning profit.
If fixed costs are ignored, a
variable cost transfer price
may be profitable in the
short-run, but not in the long
run.
Itallows one segment
manager to make a profit at
the expense of another
segment manager because
the receiving segment
receives all the profit.
A.VARIABLE COST
Variable cost-based pricing
approach is useful when the
selling division is operating
below capacity. These costs
are direct materials, direct
labour and variable factory
overhead.
B. ACTUAL FULL COST

Itis based on the total

product cost per unit
which will include direct
materials, direct labour
and factory overhead.
C. FULL COST PLUS
PROFIT MARGIN
Include the allowed cost
of the item plus a mark
up or other profit
allowance.
D. STANDARD COSTS

In actual cost approaches,

there is a problem of
measuring cost. Actual cost
does not provide any
incentive to the selling
division to control cost.
NEGOTIATED PRICES
Negotiated prices are generally
preferred as a middle solution
between market prices and
cost- based prices.
Avoids mistrusts, bad feelings
and undesirable bargaining
interests among divisional
managers.
ADVANTAGES
Some Form of Outside Market
for the Intermediate Product
Sharing of all Market
Information Among the
Negotiators
Freedom to Buy or Sell Outside
Support and Occasional
Involvement of Top Management
DISADVANTAGES
A great deal of management
effort, time and resources can be
consumed in the negotiating
process.
The final emerging negotiated
price may depend more on the
divisional manager’s ability and
skill to negotiate than on the other
factors.
One divisional manager
having some private
information may take
advantage of another
divisional manager.
It is time-consuming for the
managers involved.
It leads to conflicts between
divisions.
DISTRESS PRICE
It is when a firm chooses
to mark down the price of
an item or service instead
of discontinuing the
product or service
altogether.
MULTINATIONAL
TRANSFER PRICING
A company will usually
concentrate on satisfying a
single objective, namely:
“minimize income
taxation”.
TRANSFER PRICING IN THE
SERVICE INDUSTRY
Service industry firms and
nonprofit organizations use
transfer pricing when
services are transferred
between responsibility
centers.
DUAL PRICES
Under dual prices of transfer
pricing, selling division sells
the transferred goods at a (i)
market or negotiated market
price or (ii) cost plus some
profit margin.