A note on “control systems and performance measurement” terms in advanced management accounting study

A note on  “control systems and performance measurement” terms in advanced management accounting study

Briefly describe the following “control systems and performance measurement” terms in advanced management accounting study

(Terms used in Chapter 19)

 

1.    Financial and non-financial performance measures

2.    On return on investment, residual income and economic value added

3.    Alternative definitions of investment

4.    Alternative performance measures: current cost, long-term assets (gross or net book value)

5.    Choosing target levels of performance and timing of feedback

6.    Distinction between managers and organizational units: the basic trade-off about creating incentives versus imposing risk

7.    Distinction between managers and organizational units: intensity of incentives and financial & non-financial measurements

8.    Distinction between managers and organizational units: benchmarks and relative performance evaluation

9.    Performance at the individual activity level

10.          Environmental and ethical responsibilities

11.          Strategy and levers of control

 

These terms concern how management-accounting systems measure results, motivate managers, and ensure that behavior supports organizational strategy—not merely short-term profit.

Core measures

1.    Financial and non-financial performance measures
Financial measures assess monetary outcomes, such as profit, cash flow, ROI, residual income, and EVA. Non-financial measures assess operational and strategic drivers of future financial results, such as product quality, customer retention, delivery reliability, employee capability, innovation, safety, and carbon emissions. Effective systems normally combine both, because financial results are lagging indicators while many non-financial measures are leading indicators.

2.    Return on investment, residual income and economic value added

• ROI measures accounting profit relative to invested assets: ROI = Operating profit / Investment 
• It indicates how efficiently assets generate profit, but may discourage managers from accepting projects that earn above the cost of capital but below their division’s existing ROI.
• Residual income (RI) measures profit after charging for capital employed: RI = Operating profit − (Required rate of return × Investment)

It supports value-creating investment decisions because any project earning above the required return increases RI.

• EVA is a refined residual-income measure based on after-tax operating profit and a weighted-average cost-of-capital charge, often with accounting adjustments intended to better represent economic performance. It focuses on shareholder value creation.

Investment and accounting choices

3.    Alternative definitions of investment
The denominator in ROI or the capital base used for RI/EVA can be defined differently: total assets, net operating assets, assets less current liabilities, equity employed, or controllable assets only. The preferred definition should match the assets the manager can influence and avoid holding them accountable for corporate assets or financing decisions outside their control.

4.    Alternative performance measures: current cost, long-term assets, gross or net book value
Asset valuation affects reported returns and incentives. Historical-cost accounting may understate old assets during inflation; current-cost measures restate assets and depreciation closer to replacement value. Long-term assets may be measured at:

• Gross book value: original cost before accumulated depreciation; more stable across an asset’s life.
• Net book value: original cost less accumulated depreciation; it can mechanically inflate ROI as assets age, potentially encouraging managers to retain obsolete equipment or delay replacement.
  A consistent approach is important for fair comparisons among divisions of different ages.

5.    Choosing target performance levels and timing feedback
Targets should be demanding but attainable, aligned with strategy, and based on controllable performance. They may be absolute targets (e.g., 95% on-time delivery), budget targets, prior-period improvement, or benchmark-relative targets. Feedback should arrive soon enough for managers to correct performance, but some strategic outcomes—brand building, innovation, capability development—require longer evaluation horizons than monthly accounting reports.

Incentives and responsibility

6.    Managers versus organizational units: incentives versus risk
A business unit’s results are not identical to its manager’s contribution. Unit performance can be affected by exchange rates, market demand, inherited assets, other departments, or corporate decisions. Linking pay tightly to unit outcomes creates strong incentives, but also imposes risk on managers for factors they cannot control. The design challenge is to reward accountable effort and decisions without making compensation excessively dependent on uncontrollable uncertainty.

7.    Managers versus organizational units: incentive intensity and mixed measures
Incentive intensity means how strongly rewards or penalties vary with measured performance—for example, the size of a bonus relative to salary. Strong financial incentives may motivate effort but can cause gaming, short-termism, manipulation, or neglect of unmeasured activities. A balanced mix of financial and non-financial measures reduces this risk: profit can be paired with customer satisfaction, quality, compliance, innovation, and employee-development measures.

8.    Managers versus organizational units: benchmarks and relative performance evaluation
Relative performance evaluation compares a manager or unit with a peer group facing similar external conditions—for example, comparing a Hong Kong retail manager with comparable regional stores rather than against an absolute sales target alone. It helps filter out common shocks, such as an economy-wide downturn, and can reduce uncontrollable risk. Its usefulness depends on finding genuinely comparable peers and avoiding rivalry that undermines cooperation.

9.    Performance at the individual activity level
Performance measurement should extend beyond divisional profit to critical activities and processes, such as order fulfilment time, error rates, inventory accuracy, complaint resolution, production yield, or marketing campaign conversion. Activity-level measures identify operational causes of financial outcomes and support continuous improvement, but should not create excessive measurement burden or local optimization.

Wider control and strategy

10.                    Environmental and ethical responsibilities
Performance systems should include responsibilities that profit measures can overlook: emissions, energy use, waste, product safety, supplier labor standards, data privacy, anti-corruption, and fair treatment of customers and employees. Including these measures, controls, and minimum standards reduces the risk that managers improve financial results through socially harmful or unethical behavior. Some should be non-negotiable constraints rather than bonus trade-offs.

11.                    Strategy and levers of control
Performance measurement is a strategic control tool. In Simons’ Levers of Control framework, organizations balance four systems:

• Belief systems: communicate purpose, values, and opportunity.
• Boundary systems: specify prohibited conduct, risks, and ethical limits.
• Diagnostic control systems: monitor outcomes against targets and correct deviations.
• Interactive control systems: involve senior managers in recurring dialogue about strategic uncertainties, emerging threats, and opportunities.

Together, these controls help an organization pursue innovation and strategic objectives while maintaining accountability and acceptable risk.

Videos to study: ROI and residual income; levers of control;