Dimple Patel

06/07/2017
ACT 5733
Homework #2

Question #1
Assume the CFO of your organization approaches you to ask your advice about implementing
and using the Balanced Scorecard at your organization.
a) List and describe the four perspectives of the Balanced Scorecard.

Companies align their capabilities with marketplace opportunities by implementing smart

strategies1. Balanced scorecards (BSC) help a company execute its strategies effectively
by translating the companys goals and strategies into performance measures1. There are
four perspectives of the balanced scorecard: financial, customer, internal, and
learning/growth1.

The financial perspective deals with how shareholders view the company1. The
organizations performance is measured in both the profits and value it creates for the
companys shareholders1. Examples of objectives of such strategies include growing
operating income and increasing shareholder value1. There are typically five metrics----
traditionally ones dealing with earnings per share and CFO performance1. Also, revenue
from new customers, revenue from new products, and percentage change of the
companys cost reduction provide more performance measures for this perspective1. An
example of an initiative of a performance measure to achieve an objective in the financial
perspective of the BSC would be to manage costs and unused capacity (initiative) to
improve productivity gain and operating income from such gains (measure) in order to
achieve overall operating income growth (final objective)1.

The customer perspective deals with how customers see the company1. This perspective
measures the companys success in a target market1. Specifically, the company must
build value proposition, or a statement as to why a consumer should buy their product or
use their service2. Metrics of the customer perspective include customer satisfaction,
customer retention, customer loyalty, number of new customers, customer profitability,
market share, and wallet share (a term that means how much of a consumers total
spending amount a company captures via its products/services)3. An example of an
initiative of a performance measure to achieve an objective in the customer perspective of
the BSC would be to identify new target-customer segments (initiative) to increase the
number of new customers (measure) to increase market share (final objective)1.

The internal perspective deals with things the company must excel at to achieve financial
and customer goals1. This perspective answers how a company delivers their value
proposition to customers and how it will achieve productivity improvements for financial
objectives1. Compared to the other perspectives, the internal perspective has many
(around 8-10) metrics1. The internal perspective includes innovation, operations, post-
sales service, and social/regulatory processes1. Innovation processes target R&D
 productivity to create products that serve customer needs1. Operations processes deal
with how to efficiently and consistently produce and deliver existing products to
customers1. Post-sales service processes focus on providing required customer services
efficiently by training customer-service employees and ensuring sound warranty and
repairamong other strategies1. Social/regulatory processes include ensuring positive
company measures in the arenas of environment, health/safety, employment practices,
and community investment1. An example of an initiative of a performance measure to
achieve an objective in the internal perspective of the BSC would be to organize
R&D/manufacturing teams to implement advanced controls (initiative) to increase the
percentage of processes with advanced controls (measure) to improve manufacturing
capability (final objective)1.

The learning and growth perspective deals with ways the company can continuously
learn, improve, innovate, and create value1. The key to success in this BSC perspective is
to identify skills and capabilities a companys employees must hone to achieve financial,
customer, and internal objectives1. The company must assess if they have the necessary
infrastructure to achieve the aforementioned objectives1. There are several metrics----
including spending on employee training, employee retention rate, percentage of
employees with a particular skill, employee satisfaction rates, and extent of technological
deployment in the workforce1. An example of an initiative of a performance measure to
achieve an objective in the learning-and-growth perspective of the BSC would be to
strengthen employee training programs (initiative) to increase percentage of employees
trained in process/quality management (measure) to increase development of processed
skills in the workforce (final objective)1.

b) What steps would you encourage him or her to take in order to successfully implement
and use the Scorecard to manage the organization? As part of your answer, be sure to
describe any roadblocks to be avoided. Be specific in describing the steps and
roadblocks.

A Chief Financial Officer (CFO) deals with internal audit, strategic planning, risk management,
investor relations, treasury, taxation, and controller areas (which in turn deals with global
financial planning, operations administration, inventory, etc.)1.

I would encourage the CFO to outline the financial perspectives into two main objectives:
growing operating income and increasing shareholder value1. Performance measures that relate
to these aforementioned objectives including operating income from productivity gain, operating
income from growth, and revenue growth1. Specific initiatives that can help with such
performance measures include managing costs and unused capacity and building strong customer
relationships1. Some more measures include income ones relating to operating income and gross
margin percentages; revenue and cost measures relating to revenue growth, new product
revenues, and cost reductions in key areas; and income/investment measures relating to
economic value added (EVA) and return on investment1.
A specific step in the financial perspective that a CFO could take would be to evaluate how
much of the companys operating income derives from charging premium prices for its
products1. This strategy relates to building strong customer relationships; the company must
know how flexible or willing customers are to pay a premium price for their specific product or
service without looking for alternate options or substitutable products1. Usually, customer
retention despite increase in product price means that the customer is satisfied by the products
quality and the companys more intrinsic values1.

Another step the CFO could take would be to increase the selling price of the companys
product1. Increasing the selling price of the companys product or service could lead to a year-to-
year improvement in company revenues, thereby improving the way shareholders view the
company1. However, the CFO must be certain that such price hikes dont affect customer
demand negatively such that the revenues decrease despite the price change1.

The CFO must know that there are broad cause and effect linkages between each perspective in
the balanced scorecard1. Learning and growth perspective feeds into the internal business
perspective, which in turn feeds into the customer perspective to ultimately improve the financial
perspective1. For instance, the company can implement employee training programs to increase
employees processing skills in its learning-and-growth perspective1. This step could in turn
improve the customer-service process as measured by the service response time to better the
post-sales service aspect of the internal-business-process perspective1. Next, this previous
initiative can help increase the customer focus of the sales organization as measured by improved
customer-satisfaction ratings in the customer perspective1. In all, these steps build strong
customer relationships in such a way that it eventually feeds into the operating income from
market and revenue growth----thereby helping the financial perspective of the BSC by way of
growing operating income and increasing shareholder value1.

However, the CFO must be aware that there are many pitfalls in implementing a balanced
scorecard1. First, the CFO must not assume that the aforementioned cause-and-effect
relationships between the perspectives are precise1. To counter this pitfall, the CFO must
research and gather data on how strong the linkages are between the financial perspective and
nonfinancial perspectives1. The CFO must make sure to alter the BSC to reflect this concrete
evidence by adjusting initiatives relating to nonfinancial objectives causing eventual effects in
the financial performance of the company1. The key takeaway here is that the CFO should be
flexible and not focus on making the perfectly balanced scorecard, as the BSC should adjust
according to the companys changing needs1.

Another pitfall the CFO should be aware of is that it may be difficult to implement
improvements across all of the companys performance measures at the same time1. The
company needs to analyze the costs and benefits when making such initiatives1. If the company
were to, for instance, try to improve the timing of product manufacturing, the company would
need to make certain that the initiative isnt too costly or unwieldy or difficult to implement
among workers such that long-term profits get hurt1.

CFOs may be primarily interested in measured, objective performance markers in evaluating the
companys success1. However, the CFO should also know that subjective measures are equally
important in the balanced scorecard; subjective performance measures include gauging customer
satisfaction ratings and employee satisfaction ratings1. The CFO should make sure that managers
measure these ratings in an accurate and consistent manner as subjective measures can incur
errors from manipulation1.

Lastly, in relation to the previous pitfall, the CFO should not ignore taking into account non-
financial measures when evaluating themselves, managers, and employee1s. While exclusively
using objective performance measures for performance evaluations is tempting, nonfinancial
measures are important in determining improvements in the companys more salient features like
customer satisfaction and employee morale1.

More pitfalls include metrics that are not forward-looking enough, misaligned metrics that dont
fit corporate strategy, metrics excluded from performance evaluations, uncommitted senior
management, poor participation in the BSC implementation across companys disciplines,
treating BSC as a one-tine event, treating BSC as a side project, etc1.

Question #2
The ABC Audit Company performs financial statement audits for public and private companies.
It competes and plans to grow by performing high-quality audits and by completing the audits
faster than other firms. There are many other accounting firms in the industry capable of auditing
public and private companies. ABC believes it needs to continuously improve its audit processes
and that having satisfied employees who have earned their CPA license are both critical to its
long-term success.

List, describe, and justify eight metrics (2 in each of the Balanced Scorecard perspectives) that
you believe ABC should include in its Balanced Scorecard.

A. Learning-and-growth perspective: two metrics can deal with improving spending on

training initiatives and increasing employee satisfaction rate1. Employees can participate
in a suggestions program to build a sense of teamwork which in turn will build
camaraderie and improve employee satisfaction ratings1. No employee wants to work in a
company where their own feedback on company processes and rules are ignored as
employees are typically the heart of most companies as they know best the companys
strengths and weaknesses1.

A second metric would be for the company to pay for the fees employees incur in
studying and earning their CPA license to ensure long-term success1. Not only would this
initiative increase the percentage of employees trained in quality management with
development of high-level skills, but it would also boost the employees confidence that
the company cares about the employees long-term career goals1. Satisfied employees
could differentiate ABC from the many other accounting firms in the industry capable of
auditing1.

B. Internal-business-process perspective two metrics that this perspective can deal with
are yield of products and order-delivery time of said products1. In regards to the former,
 managers of the audit team could identify root causes of any past problems with audits
and improve quality by keeping up with any auditing changes1. For instance, when the
Sarbanes-Oxley act passed, the ABC Audit Company could have made certain that its
employees were versed in the acts auditing changes and implemented said changes in the
audits of its clients to preclude potential problems in the future1.

Second, ABC can reengineer order-delivery processes to ensure on-time delivery of

audits1. ABC seems keen on delivering fast audits to both the public and private
companies it serves1. Therefore, the managers at ABC should measure how many
auditors and assistants are needed per audit to complete said audit at the fastest speed
(and highest quality) possible 1. For example, by concretely gathering evidence that
proves that 3 junior auditors and 1 senior auditor are needed for audits of small firms and
6 junior auditors and 2-3 senior auditors are needed for audits of large companies, ABC
can play a hand in assigning and scheduling work accordingly to ensure a fast delivery
process1. Lightning-speed delivery times could differentiate ABC from the many other
accounting firms in the industry capable of auditing1.

C. Customer perspective two metrics here can deal with increasing number of new
customers and improving customer satisfaction ratings1. The former can be initiated by
identifying new target customer segments. ABC primarily provides services to public and
private companies1. But perhaps ABC should do some research and expand its services to
non-profit organizations, state governmental agencies, and high net-worth individuals if
there is potential for growth1. Research must support that the benefits of providing
auditing services to these new customer segments outweigh the costs of providing said
services1.

Next, ABC can increase the customer focus of its organization to increase customer-
satisfaction ratings1. Perhaps ABC should conduct surveys with its customers and gauge
their satisfaction in the quality of the prepared audits1. Maybe consumers want process
auditing and verification auditing for internal company use and improvement1. Or
perhaps the consumers are not well-versed in financial terms and would like a
supplementary Auditing for Dummies guide to understanding said audits1. Either way,
ABC can ensure great customer satisfaction ratings by continuously measuring customer
satisfaction and feedback on their products1. Increased customer-satisfaction ratings
could different ABC from other auditing companies1.

D. Financial perspective two metrics including increasing operating income from

productivity gain and increasing revenue growth1. The former metric can be implemented
by managing costs and unused capacity1. For instance, ABC can make sure that more
junior auditors work on together as a team on difficult audits even though they were
formerly not assigned to such tasks; by including this part of ABCs capacity, ABC is
tapping into more of its production potential1. Also, ABC can be diligent in streamlining
labor costs by making sure employees do not incur overtime hours and only receive
performance-based bonuses1. Such cost-saving measures can decrease the amount of
 money spent on ABCs labor (in this case, auditors salaries) and ensure overall product
costs are kept down1.

The next metric can be achieved by building strong customer relationships to increase
revenue growth1. If ABC can indeed deliver the fastest audits in the market that are of
high quality, then ABC should research how an increase in its product price would affect
consumer demand of said product1. Perhaps their clients would be willing to pay an
increased cost if that meant ABC could achieve the fastest audit delivery among its
competitors and the consumers valued such an attribute1. If data and customer feedback
supported such a notion and ABC did hike up its product prices without losing consumer
demand, then ABC could see huge revenue growth and thereby increase shareholder
value of the company1. Price change of a high-quality product could differentiate the
revenue growth of ABC from those of other auditing firms1.

Question #3
How can a manager use the strategic analysis of operating income to determine if a firm has
successfully implemented its strategy? Be sure to provide specific examples.

Strategic analysis of operating income includes techniques for comparing changes in operating
income (OI) from one period to another1. Some of these OI changes can stem from change in
quantity of products or services sold, changes in prices of inputs and product outputs, and
changes in quantity of inputs used1. There are several components to OI strategy analysis:
growth component, price-recovery component, and productivity component1.

Growth component measures increase in revenues and costs from selling more units on a year-to-
year basis1. The growth component sees an increase in revenue by selling more units - - - aptly
named the revenue effect1. In this case, the manager must observe the increase in revenues and
the related increase in costs from selling more products (under the assumption that all other
things about increased production are held equal) 1. First, in terms of the revenue effect of
growth, the manager needs to calculate the difference between the number of products sold in the
current year from the amount sold in the previous year1. This difference is then multiplied by the
products selling price in the previous year; then the manager must determine if the revenue effect
is favorable (increase in operating income) or unfavorable (decrease in operating income) 1. For
example, if Hersheys chocolate company increased production of its candies by 10,000 from
2016 to 2017 and its unit selling price was $1.50 in 2016, then the revenue effect of growth
would be $15,000 favorable, which would increase the companys operating income.

However, the manager also needs to be mindful of another part of the growth component: the
cost effect of growth1. The cost effect of growth includes the difference of units of input required
to produce at the current years capacity in the previous year from the units of input actually used
to produce the number of products in the previous year1. Typically, this measurement includes
variable costs as the increase of production may increase variable (but not fixed) costs1. Variable
costs may include direct materials1. This difference in variable costs from production changes is
then multiplied by the input price of the previous year1. If Hersheys chocolate needed 7,500
ounces in input in 2016 to yield 5,000 chocolate bar units and proportionally needed 22,500
ounces in input to yield chocolate bar 15,000 units in 2017 and if each input price were $0.50 per
ounce in 2016, then the amount of cost effect of growth for direct materials would be $7,500
unfavorable as production costs increased by that much1. The manager should also observe that
conversion costs are fixed costs and typically do not change the cost effect of growth1.

The revenue effect of growth was $15,000 F; the cost effect of growth, $7,500 U. The resulting
change in operating income due to growth is the difference between these elements: $7,500 F.
Therefore, the manager successfully analyzed that the companys increased production strategy
helped operating income growth1.

Next, the manager should focus on the price-recovery component of change in operating
income1. This component measures increase in revenues and costs from product price changes1.
The revenue effect of price recovery is determined by the formula:

= ( 2017
2016)
2017

In this example, the actual units of output in 2017 are 15,000 units. The selling price of chocolate
bars in 2016 was $1.50. The selling price of chocolate bars in 2017 was $1.00. The revenue
effect of price recovery is calculated as below:

= ($1.00 $1.50) 15,000 = $,

Next, the manager needs to focus on the cost effect of price recovery1. This part of the
component should include both variable and fixed costs for the product1. Assume that the price
per unit increased from $0.50 in 2016 to $0.75 in 2017 and that the units of input required to
produce 2017s output in 2016 is as previously calculated: 22,500 ounces of input.

= ( 2017
2016)
2017 2016

= ($0.75 $0.50 ) 22,500 = $,

Now the manager should focus on the cost effect of price recovery for fixed costs1. Assume that
the price per unit of capacity in 2016 was $0.10; in 2017, $0.20. Also, assume that the actual
units of capacity in 2016 are used in this cost effect equation as theres enough production
capacity in 2016 to produce the amount of chocolate bar products in 2017. Assume production
capacity is at 22,500 ounces of input.

= ( 2017
2016) 2016

= ($0.20 $0.10 ) 22,500 = $, .

Finally, the manager needs to bring all these elements together to get a better picture of the
change in operating income due to price recovery1:

Revenue effect of price $7,500 U

recovery
Cost effect of price recovery
Direct material costs $5,625 U
Conversion costs $2,250 U
Change in operating income $15,375 U
due to price recovery

Using this strategic analysis of operating income, the manager can conclude that the price-
recovery analysis shows that as the cost of inputs increased, the selling price of the chocolate
bars decreased in 2017, so Hersheys couldnt mitigate its input-price increases by passing such
costs onto its chocolate customers1.

Lastly, the manager needs to be mindful of the productivity component of change in operating
income1. This component measures how costs have changed from using a different amount of
inputs or from improving input mixes in 2017 compared to the amount of inputs and capacity
used in 20161.

The cost effect of productivity for variable costs can be calculated as below1:

= ( 2017
2017 2016)
2017

= (20,000 22,500 ) $0.75 = $,

Next, the manager needs to focus on the cost effect of productivity in relation to fixed costs1.
Assume that the units of capacity were 22,500 ounces for both 2016 and 2017. Also, assume that
the price per unit of capacity in 2017 was $0.20. Some cases of productivity may assume that the
actual units of capacity in the previous year of production exceed the actual units of capacity of
production in the current year1.

= ( 2017 2016)
2017

= (22,500 22,500 ) $0.20 = $0

Cost effect of productivity

Direct material costs $1, 875 F
Conversion costs $0
Change in operating income $1,875 F
due to price recovery

In this example, the manager at Hersheys should assume that the productivity component
increased operating income for 2017 by improving both quality and productivity to reduce costs1.
Question #4
Consider the following quality cost report:

Year 1 Year 2 Year 3

Prevention $4,500 $5,700 $5,700
Appraisal $5,400 $5,400 $5,200
Internal failure $5,800 $5,800 $5,100
External failure $6,500 $6,200 $5,700
Total quality costs $22,200 $23,100 $21,700
Total revenues $1,600,000 $1,700,000 $1,900,000

Do you believe this firms quality initiatives have been successful? Be sure to justify your
opinion with specific information from the quality report.

Balanced score cards include measures like revenue growth and operating income1. These
financial performance measures are affected by quality1. A company usually has the goal to
identify poor quality and build in quality as soon as possible. Moreover, its better for the
company to focus on the cost of conformance than that of non-conformance1. In other words, it is
more cost-effective to preclude problems in the bud than to fix them outright. It is therefore
imperative to include a direct financial measure of quality: costs of quality1. Costs of quality are
the costs to prevent the production of a sub-par product1. There are four types of costs of quality:
prevention costs, appraisal costs, internal failure costs, and external failure costs1.

Prevention costs stop production of the companys products that do not meet specifications or
high standards1. Appraisal costs are costs needed to identify which products do not meet
specifications or high standards1. Internal failure costs are costs the company faces on sub-par
products before they are delivered to customers1. External failure costs are costs post-delivery to
customers1.

Companies usually identify specific cost items that fall into one of the four previously mentioned
categories1. For instance, prevention costs could include training and maintenance1. Appraisal
costs could include production testing and statistical quality control plan1. Internal failures deal
with costs related to rework and scrap material1. External failures costs deal with product repairs
and product liability claims1.

In the following table, I took each cost of quality and divided it by both the total costs of quality
and the total revenues for the firm in question1. Each ratio was converted to a percentage to two
decimal points1.

In terms of the prevention cost of quality, the percentage of this COQ to the total costs of quality
gradually increased from year 1 to year 2 to year 3. Therefore, there was no improvement---
rather, a deterioration in this quality initiative---after several years. The biggest increase in
prevention costs were from the first year to the second year. In relation to the firms total
revenues, this cost of quality fluctuated in performance from year to year. From the first year to
the second year, its proportion to the revenue unfortunately increased, but then this amount
dropped nicely in the third year. Because the difference between the percentage of prevention
cost of quality to total revenues increased by a net of 0.02% from year 1 to year 2, this
component neither saw an improvement or deterioration (if the firm qualifies a 0.02% change as
negligible).

In terms of the appraisal cost of quality, there was slight improvement in terms of the percentage
of this COQ to the total costs of quality. The percentage rates decreased by almost 1% from year
1 to year 2, but then the percentage crept up by 0.6%. Regardless, the slight improvement in
appraisal cost of quality should be recognized in this measure. As far as the percentage of this
COQ to the firms total revenues, there was steady improvement year to year. The COQ
decreased in this measure by 0.02% from year 1 to 2 and then further decreased by 0.05% upon
approaching year 3.

In terms of the internal failure cost of quality, again there was slight improvement in the
percentage of internal failure cost of quality to the total cost of quality. The percentage decreased
by a little over 1% from year 1 to 2 and then further decreased by 1.61% from year 2 to 3.
Therefore, there was overall improvement in internal failure COQ relative to total COQ. Again,
improvement was seen in the percentages of the internal failure COQ to the firms total revenues.
There was a 0.02% decrease from year 1 to year 2 and then a 0.07% decrease from year 2 to year
3. The firm succeeded in improving costs of quality in relation to internal failures.

There was also improvement in the percentage of external failure cost of quality to the firms
total costs of quality. From year 1 to year 2, there was a 2.5% improvement in the ratio between
the external failure COQ to the total COQ; then from year 2 to year 3, there was a smaller 0.57%
improvement. In terms of the percentage of the external failure COQ to the total revenues, there
was good improvement from year to year. From year 1 to year 2, the external failure COQ
percentage improved by 0.05% and then improved even more by 0.06%. Therefore, external
failure COQ succeeded in both regards.

In conclusion, I would say that the firms quality initiatives were mildly successful for these
three costs of quality measures: appraisal, internal failure, and external failure1. However, the
prevention cost of quality did not improve over time, and, in relation to the total cost of quality,
worsened from year 1 to year 2 to year 3. Its impact on revenue is negligible, but the firm should
reassess its production processes to prevent costs of stopping production of sub-par productions
that do not meet company specifications or high standards1.

Year 1 Year 2 Year 3

% of
% of % % of % qlty- %
qlty-cost revenue qlty-cost revenue cost revenue
Prevention 20.27% 0.28% 24.68% 0.34% 26.27% 0.30%
Appraisal 24.32% 0.34% 23.38% 0.32% 23.96% 0.27%
Internal
failure 26.13% 0.36% 25.11% 0.34% 23.50% 0.27%
External
failure 29.28% 0.41% 26.84% 0.36% 26.27% 0.30%
References

1. Horngren, C., Datar, S., & Rajan, M. (2012). Cost Accounting: A Managerial Emphasis.
Ice Hall.

2. Investopedia. (2015, January 30). Value Proposition. Retrieved June 07, 2017, from
http://www.investopedia.com/terms/v/valueproposition.asp

3. Investopedia. (2008, May 21). Share Of Wallet - SOW. Retrieved June 07, 2017, from
http://www.investopedia.com/terms/s/share-of-wallet.asp