Performance Measurement and Management Control Systems
Performance measurement and management control systems tests how responsibility centres are measured, how divisional performance is evaluated, and how control systems align behaviour. Expect ROI, residual income, transfer pricing and balanced-scorecard reasoning.
Core rules
- Responsibility centres are cost, revenue, profit and investment centres, matched to controllability.
- ROI = divisional profit / invested capital. Residual income = profit - (capital employed × required return). EVA adjusts accounting profit and capital for capital charges.
- Transfer price range: minimum for seller = variable cost + lost contribution; maximum for buyer = external market price or outside purchase cost.
- The balanced scorecard uses financial, customer, internal-process and learning-and-growth perspectives; non-financial measures can anticipate future financial performance.
Worked example
A division earns ₦120,000 on capital employed of ₦800,000; the company's required return is 10%. ROI = 15%; RI = 120,000 - (800,000×10%) = ₦40,000. A project requires ₦250,000 and earns ₦30,000, giving ROI of 12% and RI of 30,000 - 25,000 = ₦5,000. A manager evaluated on ROI rejects the project because 12% < 15%, although it adds ₦5,000 of residual income and is good for the company. The reasoning: ROI is a ratio and can encourage under-investment; RI is an absolute amount and is more congruent with company value, but it is harder to compare across divisions.
Traps
Using controllable profit with non-controllable assets; comparing RI across different-sized divisions; setting a transfer price below the seller's minimum; treating balanced-scorecard measures as independent; ignoring goal congruence.