Chapter 10 Notes

Performance Evaluation
Learning Objectives
1. Understand decentralization and describe different types of responsibility centers
2. Develop performance reports
3. Calculate ROI, sales margin, and capital turnover
4. SKIP: Describe strategies and mechanisms for determining a transfer price.
5. Prepare and evaluate flexible budget performance reports
6. Describe the balanced scorecard and identify key performance indicators (KPIs) for each perspective

Centralized versus Decentralized Operations

 Centralized Operations: all major planning and operating decisions are made by top management.
o Top management makes all strategic and operational decisions, big-idea and day to day.
o Lower level managers just implements those decisions.
o Traditional organizational chart has a pyramid shape, illustrates the lines of responsibility flowing
from the CEO down through the vice-presidents, to senior- and middle-level managers.

 Decentralized Operations: Separating a business into divisions or operating units and delegating
responsibilities to lower levels of management.
o Flattens the hierarchy, and emphasizes teams.
o Top management focuses on firm-wide problems, strategic planning, and decision making.
o Lower level managers are given autonomy to decide how to manage their individual units.
o Can be organized by:
 Type of product or service
 Geographic areas
 Distribution channel (retail versus online sales)
 Type of responsibility (business function) give to divisional manager

o Advantages:
 Gathering and using local information and management specialization
 Focusing of central management.
 Training and motivating managers.
 Enhanced competition between managers.
o Disadvantages:
 Potential to duplicate resources.
 Opens up the door for managers to make decisions that are good for themselves or their
division, but which are not in the best interests of the firm as a whole.

Need for Performance Evaluation System

 Once a firm decentralizes, top management is no longer in control of day-to-day operations. Top
management needs a system that provides:
o feedback to maintain control over firm to ensure goal congruency
o performance evaluation for lower level management that reflects the appropriate level of
accountability and responsibility.
 An effective performance evaluation system should:
o Clearly communicate expectations
o Provide benchmarks
o Motive personnel (provide incentives to reach target goals)

ACCT 2301 Chapter 10 – Page 1

Responsibility Centers and Controllable Costs
 Responsibility center: a segment/division/unit manager assigned a set of activities for which they are
responsible and will be held accountable.
o Each responsibility center has a separate measure of revenues and costs.
o Within a decentralized structure, managers at all levels have authority to make decisions and are
held accountable for them, some more limited than others.

 Controllable costs: costs incurred directly by a level of responsibility that are controllable at that level.
o Top management is able to control all revenues and costs of the firm.
o Fewer costs controllable as one moves down to lower levels of management
 Noncontrollable costs: costs incurred indirectly which are allocated to a responsibility level

4 Types of Responsibility Centers

 The type of responsibility center varies according to what the managers can control and thus what the
mangers should be held responsible for.
1. Cost centers: division that incurs costs but does not directly generate revenue.
o Manager is evaluated on ability to control costs.
 Goal = minimize costs
 Evaluation Method: Use the flexible variance for costs.
o Examples:
 Production departments: mixing, packaging, distribution
 Service/support departments: maintenance, cafeteria, human resources, accounting
departments

2. Revenue Center: division that generates revenues

o Manager is evaluated on ability to generate revenues.
 Managers receive sales targets or quotas for a period and are evaluated on ability to meet
targets.
 Goal = maximize revenues
 Evaluation Method: Use the flexible budget variance for sales and sales volume
o Examples:
 Tele-marketing departments and Internet Sales division

3. Profit centers: division that generates revenues and incurs costs (Profit = Revenues – Costs)
o Profit center managers often supervise both cost and revenue center managers.
o Manager is evaluated on profitability of division
 Goal = maximize profit (revenues – costs)
 Evaluation Method: Segmented Income Statement: a contribution margin income
statement that splits fixed costs into direct/controllable and common /uncontrollable
o Examples:
 Store, district, region, division, or other business segment.
 Individual departments of a retail store such as clothing, furniture
 Branch office of a bank

4. Investment centers: division that generates revenues, incurs costs, and controls the investment of funds
available for use.
o Manager is evaluated on profitability of division and efficient use of investment of assets.
 Goal = maximize profitability and ROI (Return on Investment)
 Evaluation Method: ROI and Residual Income (RI)
o Examples:
 Subsidiary company or Stand-alone division of the company.
Activity #1

ACCT 2301 Chapter 10 – Page 2

Responsibility Accounting
 Responsibility Accounting: a system for evaluating the performance of each responsibility center and its
manager.
 Assumes that all revenues and costs within the firm are able to be:
1. Directly associated with a specific responsibility center
2. Controlled by their responsibility center
 Manager’s performance is evaluated only on the revenues and costs that they can directly control
o Revenues and costs are accumulated and reported (budget data) on the basis of the manager who
has the authority to make the day-to-day decisions about the items
 Applies to both profit and not-for-profit entities
o Profit entities: maximize net income
o Not-for-profit: minimize cost of providing services

Responsibility Center Performance Report

 Responsibility Center Performance Report: compares actual revenues and costs against the budgeted
revenues and costs, with differences referred as variances.
o A responsibility center’s performance is evaluated on matters directly under that center’s control.
o Variable costs
 Directly traceable to the center and therefore controllable by center manager
o Fixed expenses are categorized by controllability:
 Direct Fixed Costs: directly traceable to one center and therefore controllable by center
manager
 Common (Indirect) Fixed Costs: jointly shared by two or more centers and NOT
controllable by any one center manager

 Segment Margin (Controllable Margin): the operating income for a segment BEFORE subtracting
common fixed costs; the operating income that is “controllable” by that responsibility center.
o Separates the costs that are within center manager’s control from those costs that are outside of
the manager’s control, supporting the concept of controllability principle.
o Used on the Performance Reports for both Profit Centers and Investment Centers.

Actual Sales Budgeted Sales Variance Variance %

Net Sales $2,367 $2,400 $33 U 1.4% U
Variable Costs:
- COGS (DM+DL+VOHD) $1,640 $1,600 $40 U 2.5% U
- Variable Selling/Admin Exp. $110 $120 $10 F 8.3% F
Contribution Margin $617 $680 $63 U 9.3% U
- Direct Fixed MOH $95 $100 $5 F 5.0% F
- Direct Fixed Selling/Admin Exp $65 $61 $4 U 6.5% U
Segment Margin (Controllable) * $457 $519 $62 U 11.9% U
- Common Fixed Expenses $180 $190 $10 F 5.3% F
Operating Income $277 $329 $52 U 15.8% U

* The segment manager is held accountable for the Segment Margin, not its operating income. They are
only responsible for those costs which they have control over.
 Variance: difference between the actual and budgeted amounts
 Favorable Variance: difference that causes operating income to be higher than budgeted
 Unfavorable Variance: difference that causes operating income to be lower than budgeted
 Management by Exception: only investigate those variances that are material (relatively large)

Activity #2

ACCT 2301 Chapter 10 – Page 3

Responsibility Reporting System
 A performance report is prepared for each level of responsibility in the firm's organization chart
 Begins with the lowest level of responsibility and moves upward to higher levels
 Permits management by exception at each level of responsibility
 Also permits comparative evaluations between departments
 Comparative rankings provide more incentive for a manager to control costs

How does Responsibility Accounting differ from Budgeting?

 Distinguishes between controllable and noncontrollable costs
 Emphasizes or includes only items controllable by the individual manager in performance reports

ACCT 2301 Chapter 10 – Page 4

Evaluation of Investment Centers
 Investment Center managers are responsible for generating profit (revenues – costs) and investing in
assets; therefore, they should be evaluated on profitability and efficient use of assets.
 2 Methods used to evaluate the performance of Investment Centers:
1. Return on Investments (ROI)
2. Residual Income (RI)

 Return on Investments (ROI): measures the amount of income an investment center earns relative to the
size of its assets.
o Combines Cost management with Asset management, which is essential for diversified firms.
Operating Income
Return on Investments (ROI) = = Sales Margin * Capital Turnover
Total Assets
o When expanded, ROI can separately measure 2 things:
1. Sales Margin: the amount of each dollar of net sales that is profit.
2. Capital Turnover: compares a division’s investment in operating assets with the ability
of those assets to generate revenues.
Operating Income Sales
Sales Margin = Capital Turnover =
Sales Total Assets
 Firms with low profit margin, such as discount stores, may rely upon a high turnover to
generate profits. Conversely, firms with a low turnover, such as a fine jeweler, may rely
upon high profit margins.

o How can ROI be improved?

 Increasing Operating Income
 Increase sales, decreasing variable costs, or decreasing controllable fixed costs
 Reducing average operating assets (this action may not be prudent)

o Advantages of ROI:
 Encourages Managers to focus on:
 The relationship among sales, expenses, and investments
 Cost efficiency
 Operating asset efficiency
 Helps management decide how to invest excess funds
 A division with a higher ROI is more likely to receive extra funds because it has
a record of producing a higher return on investment
 ROI can be used to compare performance across divisions and over time to see if the
division is becoming more/less profitable.

o Disadvantages of ROI:
 Myopic Behavior: Focus on the short-run at the expense of the long-term benefit.
 For example, a manager might cut research and development expenses in the
short run to improve ROI, but the cuts may not be in the best long-term interests
of the division.
 Sub-optimization: when the responsibility center manager makes decisions best for their
responsibility center, but perhaps to the detriment of the whole firm.
 For example, projects with an ROI less than a division’s current ROI would be
rejected by the division manager. Although the project would increases the
profitability of the firm as a whole, this project would decreases the division’s
ROI, which would reflect poorly on the manager.
Activity #3

ACCT 2301 Chapter 10 – Page 5

  Residual Income (RI): the difference between operating income and the minimum dollar return required
on a firm’s operating assets.

Residual Income (RI) = Operating Income – (Minimum or Target rate of return * Operating Assets)

o RI Interpretation:
 If RI > 0, then the center is earning more than the minimum required rate of return.

o Advantages of Residual Income:

 Using RI encourages managers to accept any project that earns above the minimum rate
of return, this resolves the problem with sub-optimization.
 Any project with RI > 0 will be desirable to divisions and will improve
performance.
 An RI > 0 indicates the investment will earn a higher rate of return than the
minimum target.

o Disadvantages of Residual Income:

 Like ROI, RI can encourage managers to have a “short-run” orientation.
 Unlike ROI, because RI is stated in dollars, RI is not a relative measure of profitability.
 Consequently, using RI to compare investment centers of different sizes is
difficult.
o For instance, an investment center with operating assets of $10,000,000
should not be compared to an investment center with operating assets of
$1,000,000.
 One way to address this criticism is to use both ROI and RI for performance
evaluation.

 Finally thoughts on ROI and RI:

o Both ROI and RI are lagging indicators of financial performance
 They are based on historical information
 They tell how well a division or a company has done in the past but not necessarily how
well it will do in the future.
o Many of the actions that managers take to improve a firm’s financial performance in the short run
can prove harmful in the long run (myopic behavior and sub-optimization).
 To avoid these problems, firms should evaluate and reward managers based on more than
just short-term financial results.

Activity #4

ACCT 2301 Chapter 10 – Page 6

Master Budget versus Flexible Budget
 Master Budget: a budget prepared for one level of activity
o Uses expected sales volume.
o Prepared at the BEGINNING of the period.
o Used for planning purposes

 Flexible Budget: a budget prepared for a different level of volume than the one originally anticipated
o The master budget is “flexed” to accommodate different level of sales.
 Keeps all master budget estimates the same, like selling price standard costs
o Prepared at the BEGINNING of the period for “what if” scenarios by flexing the sales volume to
different levels.
o Prepared at the END of the period using actual sales volume
 The actual sales volume isn’t know until the end of the period.
 Used for control purposes, specifically performance evaluation.

 Flexible Budget Assumptions:

o Activity level is within the relevant range
o Variable cost per unit remains the same
o Fixed costs in total remain the same

Variance
 Variance: the difference between the actual and budgeted or standard amounts.
o Indicate that actual performance is not going according to plan.
o Do not indicate the cause of the variance or responsibility.
o Must be analyzed to determine significance.

 Favorable Variance: difference that causes operating income to be higher than budgeted.
o Efficiencies in using materials and labor or incurring costs
o A variance is not favorable if quality control standards are sacrificed.
 Using lower quality material to decrease costs might decrease product quality.

 Unfavorable Variance: difference that causes operating income to be lower than budgeted.
o Inefficiencies in using materials and labor or paying too much for materials and labor.

ACCT 2301 Chapter 10 – Page 7

Master Budget Variance
 Master Budget Variance: the difference between the actual revenues and costs (based on actual sales
volume) and the master budget revenues and costs (based on budgeted/planned sales volume).
o “Apples-to-oranges” comparison, since the sales volumes are different. This is not useful for
evaluation because we are unable to determine cause of variance.

o Master Budget Variance has two components:

1. Flexible Budget Variance: the difference between the flexible budget and the actual
results, based on actual volume of activity
 the portion that is due to factors other than volume.

2.Volume Variance: the difference between the flexible budget and the master budget
 the portion that is due to changes in volume
 Measures how effective management is at meeting the sales goals.

Actual Results Flexible Budget Master Budget

Actual Sales Volume Actual Sales Volume Budgeted Sales Volume
@ Actual Quantity Used @ Standard Quantity Allowed @ Budgeted Quantity
@ Actual Price/Rates @ Standard Price/Rates @ Standard Price/Rates
(Actual Qty x Actual $$) (Standard Qty x Standard $$) (Budgeted Qty x Std $$)
(AQ x AP) (SQA x SP) (BQ x SP)
|_____________________________| |____________________________|
= Flexible Budget Variance = Volume Variance
= (AQ x AP) - (SQA x SP) = SP (SQA - BQ)
|___________________________________________________________|
= Master Budget Variance
= (AQ x AP) - (BQ x SP)

Flexible Budget Variance

 Flexible Budget Variance: the difference between the actual revenues and costs (based on actual sales
volume) and the master budget “flexed” revenues and costs (based on actual sales volume).
o By using the same actual sales volume, the flexible budget has eliminated the volume variance in
the master budget variance.

o Flexible Budget Variance can only be contributed to factors other than volume.

o “Apples-to-apples” comparison, since the sales volumes are the same. Consequently, in
evaluation we can now compare actual revenues and costs to the revenues and costs that should
have been at this sales volume.

 Using the Flexible Budget to Control and Evaluate

o Variances: differences between standards and actual results
 Favorable: Actual Revenues > Flex Budget Revenues
Actual Costs < Flex Budget Costs

 Unfavorable: Actual Revenues < Flex Budget Revenues

Actual Costs > Flex Budget Costs

o By identifying variances, this allows management to isolate problem areas and focus on ways to
correct the variance and ultimately better control costs.

Always use the Flexible Budget for Performance Evaluation!

ACCT 2301 Chapter 10 – Page 8

Example: Based on the Master Budget Example for Sparky Company in our Chapter 9 notes.

Sparky Company
Flexible Budget Performance Report
For the Year Ending December 31, 201xx
Flexible
Budget Flexible Volume Master
Actual Variance Budget Variance Budget
Sales Volume (units) 14,800 14,800 200 U 15,000

Sales ($75 per unit) $ 1,132,200 $ 22,200 F $ 1,110,000 $ 15,000 U $ 1,125,000

Less Variable Expenses:
COGS:
DM Cost $8 per unit 123,728 5,328 U 118,400 1,600 F 120,000
DL Cost $30 per unit 419,580 24,420 F 444,000 6,000 F 450,000
VMOH Cost per unit
Indirect materials $3 per unit 44,400 0 F 44,400 600 F 45,000
Indirect labor $4.80 per unit 63,936 7,104 F 71,040 960 F 72,000
Utilities $0.60 per unit 8,880 0 F 8,880 120 F 9,000
Maintenance $0.30 per unit 4,440 0 F 4,440 60 F 4,500
Sales Commisions $4 per unit 59,200 0 F 59,200 800 F 60,000
Freight-Out $1 per unit 14,800 0 F 14,800 200 F 15,000
Contribution Margin $ 393,236 $ 48,396 F $ 344,840 $ 4,660 U $ 349,500
Less Fixed Expenses:
Fixed MOH Costs:
Supervisory Salaries 85,000 5,000 U 80,000 0 F 80,000
Depreciation 14,000 1,200 F 15,200 0 F 15,200
Property Tax & Ins. 35,300 700 F 36,000 0 F 36,000
Maintenance 21,000 1,800 F 22,800 0 F 22,800
Fixed Operating Expenses:
Advertising 26,000 6,000 U 20,000 0 F 20,000
Sales Salaries 58,000 2,000 F 60,000 0 F 60,000
Office Salaries 29,000 1,000 F 30,000 0 F 30,000
Depreciation 4,300 300 U 4,000 0 F 4,000
Property Tax & Ins. 5,850 150 F 6,000 0 F 6,000
Operating Income $ 114,786 $ 43,946 F $ 70,840 $ 4,660 U $ 75,500

Master Budget Variance = Flexible Budget Variance + Volume Variance

Master Budget Variance = $ 39,286 F

Activity #5

ACCT 2301 Chapter 10 – Page 9

Balanced Scorecard
 Key Performance Indicators (KPI): summary performance metrics that assess how well firms are
achieving their goals.

 Balanced Scorecard: a comprehensive performance measurement system that translates the

organization’s vision and strategy into a set of operational performance measures using four key
dimensions:

1. Learning and Growth Perspective: a lead indicator that predicts future performance that
focuses on the firm’s ability to change and improve through 3 factors:
a. Employee Capabilities: critical and creative thinkers, skilled, knowledgeable, and
motivated.
b. Information System Capabilities: a system that provides timely and accurate data
c. Firm’s “Climate for Action”: firm’s culture that supports communication, teamwork,
change, and employee growth.

Common KPIs: Employee skills and satisfaction, amount of time and money spent on
employee education and training, employee turnover, percentage of processes with real-time
feedback, employee access to real-time data, number of employee suggestions implemented,
percentage of employees involved in problem solving teams, employee rating of
communication and corporate culture.

2. Internal Business Processes: a lead indicator that predicts future performance that focuses on
the internal processes required to meet customer needs through 3 factors:
a. Innovation: develop new products
b. Operations: use lean operating techniques to increase efficiency
c. Post-Sales Support: provide excellent customer service after the sale.

Common KPIs: number of new products developed, new product development time, defect
rate, manufacturing lead time, yield rate, number of warranty claims received, average
customer wait time for customer service, and average repair time

3. Consumer Perspective: a lead indicator that predicts future performance that focuses on the
customer’s satisfaction on 4 product or service attributes:
a. Price: the lower, the better
b. Quality: the higher, the better
c. Sales Service: the importance of knowledgeable and helpful salespeople
d. Delivery Time: the shorter, the better

Common KPIs: Customer retention (repeat customers), market share, rate of on-time
deliveries, customer satisfaction with price, quality, and customer service

4. Financial Perspective: a lag indicator that reflects prior performance that focuses on firm’s
ability to increase profits through 3 ways:
a. Increasing Revenue: introduce new products, gain new customers, expand into new
markets
b. Controlling Costs: minimize costs without jeopardizing quality or long-run success,
eliminating costs associated with wasteful activities
c. Increasing Productivity: use existing assets as efficiently as possible

Common KPIs: Return on investment (ROI), Residual income (RI), average stock price,
sales revenue, and profit

ACCT 2301 Chapter 10 – Page 10

  Benefits of Balanced Scorecard:
o Good for communicating what is important to firm’s long term success.

o Supplements financial measures of performance with nonfinancial measures.

 Nonfinancial measures may assist management in assessing performance and
anticipating future results.

 Problems with Balanced Scorecard:

o Not balanced: Most managers are still compensated based on the short-term financial metrics
(this year’s profit)

o Not a scorecard: No comparison is made between firm and the competition.

Activity #6

ACCT 2301 Chapter 10 – Page 11

Activity #1 – Responsibility Centers (modified from S10-1 in Textbook)

Complete the following statements with one of the terms listed here. You may use a term more than once and
some terms may not be used at all.

a. Cost Center d. Profit Center g. Higher

b. Decentralized e. Responsibility Center h. Lower
c. Investment Center f. Revenue Center i. The same

1. Honda North America, a division of the Honda Motor Company is a(n) _________________.

2. The production line at the Ford Rouge plant in Dearborn, Michigan, where Ford F-150 trucks are
manufactured, is considered to be a(n) _________________.

3. The Champaign, Illinois, location of the Outback chain restaurant would be a(n) _________________.

4. Managers of cost and revenue centers are at _________________ levels of the organization than are
managers of investment centers.

5. The sales manager in charge of Patagonia’s Northwest sales territory oversees a(n) _________________.

6. Companies who have split their operations into different operating segments and delegated decision making
responsibility to the segment managers are _________________.

7. The payroll department of Kohl’s Corporation, a retailer, is a(n) _________________.

8. A(n) _________________ is any segment of the business whose manager is accountable for specific
activities.

9. The Prepared Foods department of Whole Foods Market, Inc., would be considered to be a(n)
_________________.

10. The J.M. Smucker Company headquarters, located in Orrville, Ohio, would be a(n) _________________.

11. The Floral Department at the Crowley, Texas, Kroger grocery store would be considered to be a(n)
_________________.

12. A clothing store in Chandler that is responsible for its own revenues and costs and is owned by an
international clothing chain would be considered to be a(n) _________________.

13. Disneyland Resorts, a stand-alone division of ABC Entertainment may be classified as a(n)
_________________.

ACCT 2301 Chapter 10 – Page 12

Activity #2 – Calculate Performance Report Variances (modified from S10-5 in textbook)

The following is a partial performance report for a revenue center for the Eastern Division of Peony Restaurants.
Fill in the missing amounts. Indicate whether each variance is Favorable (F) or Unfavorable (U).

Budgeted Variance
PRODUCT Actual Sales Variance
Sales Percentage

Food $159,580 $158,000

Dessert $22,800 $24,000

Bar $71,550 $67,500

Catering $43,120 $44,000

ACCT 2301 Chapter 10 – Page 13

Activity #3 – Return on Investment

The Winter Company has three divisions which are considered investment centers: Rudolph Heaters, Frosty Air
Conditioners and Santa Filtration. Winter desires a 15% return on investment. You have the following
information for each division:
Rudolph Frosty Air Santa
Heaters Conditioners Filtration
Sales $5,000,000 $15,000,000 $25,000,000
Operating income $570,000 $1,500,000 $1,980,000
Total Assets $3,000,000 $12,000,000 $12,000,000
ROI

Sales Margin

Capital Turnover

a. What is the current ROI, Sales Margin and Capital Turnover for each division (put information in table
above)?

b. Who is performing the best? The worst? What does sales margin and capital turnover tell us?

c. Assume Frosty Air Conditioners wanted to increase their ROI to 16%. They think that they could increase
operating profit next year to $1,800,000. What would be the needed decrease to invested capital to achieve a
16% ROI?

ACCT 2301 Chapter 10 – Page 14

Activity #3 – (Continued)

d. Assume that each division had the opportunity to invest in a piece of equipment to simplify the wiring and
electrical work in their products. It would cost $1,000,000 to invest in this equipment and the investment
would generate an additional $160,000 of pre-tax operating profit. What is the ROI of this investment?
Should the divisions invest in the equipment?

e. Assume that EVERY division invests in the equipment. What is the new ROI for each division?

Rudolph Frosty Air Santa

Heaters Conditioners Filtration
New Operating profit (pre-tax) $730,000 $1,660,000 $2,140,000
New Total Assets $4,000,000 $13,000,000 $13,000,000
New ROI

f. Given your answer in part ‘e’, how do you think that each divisional manager would behave?

ACCT 2301 Chapter 10 – Page 15

Activity #4 – Residual Income

The Winter Company has three divisions which are considered investment centers: Rudolph Heaters, Frosty Air
Conditioners and Santa Filtration. Winter desires a 15% return on investment. You have the following
information for each division:
Rudolph Frosty Air Santa
Heaters Conditioners Filtration
Operating profit (pre-tax) $570,000 $1,500,000 $1,980,000
Total Assets $3,000,000 $12,000,000 $12,000,000

a. What is the current residual income for each division?

b. Assume that each division had the opportunity to invest in a piece of equipment to simplify the wiring and
electrical work in their products. It would cost $1,000,000 to invest in this equipment and the investment
would generate $160,000 of pre-tax operating profit. What is the residual income generated from this
investment? Should the divisions invest in the equipment?

ACCT 2301 Chapter 10 – Page 16

Activity #4 – (Continued)

c. Assume that ALL divisions invest in the equipment. What is the new residual income for each division?

Rudolph Frosty Air Santa

Heaters Conditioners Filtration
New Operating profit (pre-tax) $730,000 $1,660,000 $2,140,000
New Total Assets $4,000,000 $13,000,000 $13,000,000

New Residual Income

d. Given your answer in part ‘c’, how do you think that each divisional manager would behave?

e. How useful is residual income for comparing the performance of various divisions? How about ROI? (Look
back at the ROI calculations in the previous activity)

f. How are ROI and Residual Income related? For example, if Residual income is positive, what does that tell
us about ROI? If ROI is less than the desired return, what does that tell us about residual income?

ACCT 2301 Chapter 10 – Page 17

Activity #5 – Flexible Budget Performance Report (modified from S10-13 in textbook)

First, construct a flexible budget performance report for the company for the year. Be sure to indicate whether
each variance is favorable (F) or unfavorable (U).

Sweet Earth Organic Chocolates had the following information for last year:
Flexible
Budget Volume Master
Actual Variance Flexible Budget Variance Budget
Sales Volume (batches sold) 13,400 12,100

Sales Revenue ($26 per batch) $344,900 $314,600

Variable Operating Expenses

Sales Expense ($2 per batch) $26,300 $24,200

Shipping Expense ($1 per batch) $15,600 $12,100

Commissions (3% of Revenue) $10,150 $9,438

Fixed Operating Expenses:

Salaries $10,300 $9,800

Office Rent $1,000 $1,000

Total Operating Expenses $63,350 $56,538

Operating Income

ACCT 2301 Chapter 10 – Page 18

Activity #5 – (Continued)

Answer the following questions:

a. Do favorable variances mean it’s good and unfavorable mean bad?

b. Which items should be investigated if part of the management’s decision criteria is to investigate all
variances exceeding $2,000? Interpret your results (what could cause these variances? What impact might
these variances have on company inventory levels and operations?)

ACCT 2301 Chapter 10 – Page 19

Activity #6 – Balanced Scorecard (based on S10-14 in the textbook)

Classify each of the following key performance indicators according to the balanced scorecard perspective it
addresses. Choose from financial perspective, customer perspective, internal business perspective or learning and
growth perspective.
Internal Learning &
Financial Customer Business Growth
Perspective Perspective Perspective Perspective
1. Return on Investment (ROI)

2. New Product Development Time

3. Employee Turnover Rate

4. Percentage of Products with online help

manuals available for customer service
representatives.

5. Customer satisfaction survey ratings

6. Downtime (the amount of time service is not

available)

7. Percentage of orders filled each week.

8. Gross margin growth

9. Number of new products developed during

the period

10. Employee satisfaction ratings

11. Sales Growth

12. Number of customer complaints

13. Number of information system upgrades

completed.

14. Number of product defects.

15. Market Share in Europe

16. Percentage of employees cross-trained

ACCT 2301 Chapter 10 – Page 20