This is “How Do Managers Evaluate Performance in Decentralized Organizations?”, chapter 11 from the book Accounting for Managers (v. 1.0).
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Mandy Dwyer is the president and CEO of Game Products, Inc., a producer of games and sporting goods sold to a variety of retail stores. Game Products, Inc., has three divisions: Sporting Goods, Board Games, and Computer Games. Each division is relatively autonomous with a separate manager, who independently oversees each division. Mandy Dwyer is reviewing the results of the most recent fiscal year with Larry Meske, the company’s CFO:
|Mandy:||In reviewing our segmented income statement, it looks like the Board Games division had a terrific year. Profits increased substantially over last year, more than either of the other two divisions, and overall profit for this division is well above the other two. Carla Klesko, the Board Games division manager, is to be commended for her fine work! We should consider revising her compensation plan to increase her annual bonus based on these results.|
|Larry:||Not so quick, Mandy. I agree that the Board Games division has successfully increased profits, but we must consider more than just the bottom line (profits) in determining how substantial the increase is in comparison to the other divisions.|
|Mandy:||What do you have in mind?|
|Larry:||For starters, we should consider what resources were invested in the Board Games division, and determine the return produced from these resources. As you recall, Carla made a significant investment in her division, whereas the other division managers did not. So naturally, we would expect Board Games division profits to increase by more than the other divisions.|
|Mandy:||I’ve always focused on the bottom line for each division. What performance measures do you propose we use?|
|Larry:||We have several options. Return on investment (ROI), residual income (RI), and economic value added (EVA) are three commonly used measures. Perhaps we can discuss this further next month once I’ve had a chance to pull some information together.|
|Mandy:||Excellent idea. I look forward to getting your ideas on this issue next month.|
Mandy and Larry are looking for ways to evaluate the performance of the company’s three division managers. Since each division is responsible for more than just the cost of production, as was the case in Chapter 10 "How Do Managers Evaluate Performance Using Cost Variance Analysis?", top management must evaluate how productively each division manager is using assets to produce profits. The focus of this chapter is on how to evaluate the performance of division managers within a decentralized organization.