Performance Measurement and Management Control Systems
What this domain tests
Performance measurement and control systems translate strategy into measures. The exam tests divisional metrics (ROI, residual income, EVA), the balanced scorecard, non-financial measures and the behavioural consequences of control.
Core rules
- ROI = divisional profit ÷ divisional investment. It encourages managers to reject projects below the current ROI even when they exceed the cost of capital - the under-investment problem.
- Residual income = profit − (investment × imputed interest rate). It aligns decisions with the cost of capital, but it is absolute, so larger divisions look better.
- EVA = NOPAT − (capital employed × WACC), with adjustments such as capitalising R&D and adding back provisions. It is a residual-income variant.
- The balanced scorecard uses four perspectives: financial, customer, internal process, learning and growth, linked by cause and effect.
- Fitzgerald and Moon's building blocks: dimensions (financial performance, competitiveness, quality, flexibility, resource utilisation, innovation) and determinants (quality of service, flexibility, resource utilisation, innovation).
- Controllability principle: managers are evaluated on what they can influence.
- Simons' levers of control: beliefs, boundary, diagnostic and interactive systems.
Worked example
Division X profit Rs. 1.2m on investment Rs. 8m; cost of capital 12%. ROI = 15%; RI = 1.2m − (8m × 0.12) = Rs. 240,000. A project needs Rs. 2m and earns Rs. 300,000, i.e. 15%. It adds Rs. 300,000 − Rs. 240,000 = Rs. 60,000 of RI but leaves ROI at 15%. A project earning 14% (Rs. 280,000) raises RI by Rs. 40,000 but lowers ROI to 14.8% - the ROI-evaluated manager may reject it, while RI would accept it.
Traps
Using ROI without recognising its investment disincentive; applying the imputed interest rate inconsistently; designing scorecard measures not linked causally; rewarding a measure the manager cannot control.