Affixing Responsibility

Lower-level managers may only be responsible/accountable for a small subset of business activities. As one moves up the organizational chart, mid and upper-level managers assume ever greater degrees of responsibility. The reporting system should mimic the expanded scope, and develop information which reveals the performance for all units within the control of a particular manager. At successively higher steps, individual performance reports are combined to reveal the success or failure of all activities beneath a particular manager. This can result in one manager being held accountable for a combination of cost, profit, and investment centers. A keen manager must be familiar with the specific techniques for managing and gauging the success of each!

Following is an organization chart for Out To Lunch Hamburgers. Out to Lunch is a rapidly growing fast-food restaurant chain. Their business model revolves around a uniquely flavored hamburger, and a very simple menu consisting of a hamburger, fries, and drinks. They provide simple "round number" pricing, few products, and rapid service. Out to Lunch also has a catering service for sporting events, corporate outings, and similar occasions.

The block colors in the organization chart indicate the character of performance/responsibility evaluation that is germane to each position. The Chief Executive Officer reports to the owners, and the owners are primarily interested in their return on investment. Three vice presidents report to the CEO:

The VP of operations is responsible

• for the overall investment in operations, which is driven heavily by the combined profits of each store. The VP of Operations oversees procurement, store management, and catering management.

• The Procurement Manager oversees purchasing of food and dishware.

- The Procurement activities are evaluated as cost centers, relying on budgets and standard costs to control activities.

• The Store and Catering managers oversee supervisors from each location.

- The Store and Catering Managers are responsible for producing profits, and are evaluated accordingly.

• The VP of Finance is viewed and evaluated as a cost center.

• The VP of Real Estate is responsible for site acquisition and construction. Although the activities are largely viewed in the context of a cost center, there is an expected rate of return for each new real estate investment. Therefore, the VP of Real Estate is evaluated for cost control and return on investments.

Responsibility Center Reports

A company's accounting system should support preparation of an accounting report for each responsibility center. This information is essential to monitor, control, and direct each business unit. The exact form and detail of a performance report depends on the particular organization and the nature of the responsibility center. Oftentimes, the reports will provide a comparison between budgeted and actual data, with the difference being reported as a variance from budget. These performance reports should be consistent with the organizational structure of the firm. At successively higher levels within an organization, the reports tend to include less transaction specific detail and more combinations of business units. For Out to Lunch Hamburgers, each store will likely have a customized performance report:

PERFORMANCE REPORT - STORE LOCATION A FOR THE YEAR ENDING DECEMBER 31, 20X5

Notice that Location A's performance report is very detailed, and provides a basis for analysis of numerous facets of the business. Graphics are frequently used to facilitate understanding by those not accustomed to accounting reports. For example, each store supervisor knows that fries and drinks have the highest profit margins and they are encouraged to train employees to soft-sell these items by asking customers "what type of drink did you prefer?" rather than "did you want a drink with this order?"

As a result, the report is "specialized" to show the product mix proportions. In addition, each manager gets a bonus if food costs are below 20% of sales; this incentive is designed to reduce food waste and encourage sales of high margin products. The report provides sufficient detail to show if the objectives are being met. Notice that unfavorable variances are highlighted in red. Summarizing the results for Location A, note that the budgeted goal for hamburger sales was not met. But, the profit objectives were nevertheless exceeded because the product mix of fries and drinks produced offsetting higher margins. In addition Location A managed to contain other variable costs.

The next step up in the organizational chart is the Senior Manager of Store Operations. This person is concerned with making sure that each unit is profitable. Underperforming stores are identified, problems are studied, and corrective measures are taken. Very little time is spent on locations that are meeting or exceeding corporate profit goals. Although this manager has access to the detailed reports for each store, the performance report of interest is a compilation of summary data for each location that quickly highlights the areas of needed improvement. Review the following performance report, noting the carry forward of Location A's data into the report. Obviously, some stores are performing much better than others; the senior manager will certainly want to focus on store E immediately! Also notice that there is $1,500,000 of fixed costs associated with store operations that are not traceable to any specific location; nevertheless, the senior manager of store operations must control this cost and it is subtracted in calculating the overall margin. Thus, the total fixed cost for all store operations is $9,500,000 ($8,000,000 + $1,500,000).

PERFORMANCE REPORT - ALL STORES FOR THE YEAR ENDING DECEMBER 31, 20X5

Continuing up the organizational chart, the VP of Operations will focus on summary data from store management, catering management, and procurement. Notice that the "stores" column (below) is derived from information found in the "combined" column (above). Again, note the presence of fixed costs that are not traceable to any specific operating segment ($1,300,000). Even though this cost is not assigned to a specific segment, it remains a cost for which the VP of Operations is responsible.

PERFORMANCE REPORT OPERATIONS FOR THE YEAR ENDING DECEMBER 31, 20X5

The next step in the corporate ladder is the CEO. This individual would most likely be evaluated on the overall financial statement outcomes. Although the CEO would have access to any and all of the reports from within the organization, they would mostly focus on the reports emanating from each vice president's unit.

The Power of a Data Base System

The static reports illustrated above are quite useful, but do suffer from an important limitation. Specifically, what you see is what you get. It is very difficult to "mine data" pertinent to a specific inquiry. For example, if the VP of Operations wanted to know the overall corporate sales mix proportions (hamburgers, fries, drinks) a specific request would be initiated to the store and catering managers. They would gather the individual reports from each location and develop a report to channel back up to the VP. The VP of Operations would then need to combine the two reports before having an answer to the inquiry. This is very inefficient and may have the undesirable outcome of forcing management to make decisions based on incomplete information. Increasingly, companies are developing customized electronic data base systems that capture data and store it in such a way as to enable accurate and real time retrieval of information relevant to an almost endless number of potential questions.

Traceable Versus Common Fixed Costs

You likely noticed that the above reports separated out variable and fixed expenses. The fixed expenses were further divided between those that were traceable to a specific business unit and common fixed costs. Traceable fixed costs would not exist if the unit under evaluation ceased to exist. Common fixed costs support the operations of more than one unit. Great care must be taken in distinguishing between traceable and common fixed costs. Remember that effective performance evaluations require a clear alignment of responsibility and accountability. To the extent a unit manager is burdened with allocations of common costs, poor signaling of performance can result. This is why such costs are usually segregated out in performance based reporting methods. This topic will be further explored in the next chapter's discussion of segment reporting.

Management by Expansion

"Underperforming stores are identified, problems are studied, and corrective measures are taken. Very little time is spent on locations that are meeting or exceeding corporate profit goals" These sentences are taken directly from the preceding discussion about how the senior manager of store operations uses the performance reports. This is an excellent illustration of what is meant by the concept of management by exception. The objective of management by exception is to focus attention on areas where corrective measures appear necessary. Performance evaluation tools that do not satisfy this objective are of little value. Importantly, not every exception requires a remedy. One characteristic of a strong manager is the ability to study problems, and differentiate between those requiring a solution and those that simply happened because of bad luck.