Performance Measurement and Management Control Systems
What this domain tests
This domain tests divisional performance metrics, the balanced scorecard, transfer pricing, budgeting and variance analysis, and the behavioural consequences of control systems.
Core rules
- ROI = divisional profit ÷ invested capital. RI = profit − (required return × capital). EVA = NOPAT − (WACC × invested capital).
- ROI can cause underinvestment: managers may reject projects earning above the cost of capital but below the division's current ROI. RI and EVA reduce this goal-congruence problem.
- Balanced scorecard: financial, customer, internal process, and learning and growth perspectives; leading and lagging indicators linked by a strategy map.
- Transfer pricing: market-based, cost-based or negotiated; the aim is goal congruence and fair divisional evaluation.
- Simons' levers of control: beliefs, boundary, diagnostic and interactive controls.
- Variance analysis: price, efficiency, mix and yield variances; unexplained favourable variances may signal poor quality or underinvestment.
Worked example
A division earns $500,000 on capital of $2m; the required return is 12%. ROI = 25%; RI = $500,000 − $240,000 = $260,000. A new project needs $400,000 and earns $60,000, giving 15% ROI. That exceeds the 12% cost of capital but is below the division's 25% ROI, so an ROI-managed manager rejects it. RI rises by $60,000 − $48,000 = $12,000, so an RI-managed manager accepts. RI aligns the decision with corporate value.
Traps
Comparing ROI across divisions with different risk; using ROI for project acceptance; setting transfer prices above market; and assuming all favourable variances are good.