1. Introduction to MCS

1)Explain briefly features of an IDEAL management control system?

Management control is a process of assuming that resources are obtained and used effectively and efficiently in the accomplishment of the organization’s objectives. It is a fundamental necessity for the success of a business and hence from time to time the current performance of the various operations is compared to a predetermined standard or ideal performance and in case of variance remedial measures are adopted to confirm operations to set plan or policy.

Some of the features of MANAGEMENT CONTROL SYSTEM are as follows: Total System: MCS is an overall process of the enterprise which aims to fit together the

separate plans for various segments as to assure that each harmonizes with the others and that the aggregate effect of all of them on the whole enterprise is satisfactory.

Monetary Standard: MCS is built around a financial structure and all the resources and outputs are expressed in terms of money. The results of each responsibility centre in respect to production and resources are expressed in terms of a common denominator of money.

Definite pattern: It follows a definite pattern and time table. The whole operational activity is regular and rhythmic. It is a continuous process even if the plans are changed in the light of experience or technology.

Coordinated System: It is a fully coordinated and integrated system.

Emphasis: Management control requires emphasis both on the search for planning as well as control. Both should go hand in hand to achieve the best results.

Function of every manager: Manager at every level as to focus towards future operational and accounting data, taking into consideration past performance, present trends and anticipated economic and technological changes. The nature, scope and level of control will be governed by the level of manager exercising it.

Existence of goals and plans: MCS is not possible without predetermined goals and plans. These two provide a link between such future anticipations and actual performance.

Forward looking: MCS is on the basis of evaluation of past performance that the future plans or guidelines can be laid down. Management Control involves managing the overall activity of the enterprise for the future. It prevents deviations in operational goals.

Continuous process: It is a continuous process over the human and material resources. It demands vigilance at every step. Deciding, planning and regulating the activities of people associated in the common task of attaining the objectives of the organization is a the primary aim of MCS

People oriented: It is the managers, engineers and operators which implement the ideas and objectives of the management. The coordination of the main division of an organization helps in smoother operations and less friction which results in the achievement of the predetermined objectives.

Scope of controlMCS is an important process in which accounting information is used to accomplish the organizations objectives. Therefore the scope of control is very wide which covers a very wide range of management activities.

Policies control: Success if a business depends on formulation of sound policies and their proper implementation.

Control over organization: It involves designing and organizing the various departments for the smooth running of the business. It attempts to remove the causes of such friction and rationalizes the organizational structure as and when the need arises.

Control over personnel: Anything that the business accomplishes is the result of the action of those people who work in the organization. It is the people, and not the figures, that get things done.

Control over costs: The cost accountant is responsible to control cost sets, cost standards, labour material and over heads. He makes comparisons of actual cost data with standard cost. Cost control is a delicate task and is supplemented by budgetary control systems.

Control over techniques: It involves the use of best methods and techniques so as to eliminate all wastages in time, energy and material. The task is accomplished by periodic analysis and checking of activities of each department with a view to avoid an eliminate all non-essential motions, functions and methods.

Control over capital Expenditure: Capital budget is prepared for the whole concern. Every project is evaluated in terms if the advantage it accrues to the firm. For this purpose capital budgeting, project analysis, study of cost of capital etc are carried out.

Overall control: A master plan is prepared for overall control and all the departments of the concern are involved in this procedure.

2. Explain briefly various stages of management control process citing salient features of each.

Management control process involves communication of information to the managers at various levels of hierarchy and their interactions arising out of them. These communications aim towards attaining the organization's goals. But individual managers have their personal goals also. For example, a young manager with good education, experience, personality and social background joins a company like Britannia Industries or Reliance. The company finds him fit for the position as per job specifications, appoints him and makes him aware of what the company expects of him. The young manager sets his goals of gaining rich experience for his career progress besides adequate compensation packages. Naturally, his actions will be directed towards achieving his own objectives and goals while serving the company. Thus, his self-interest and the best interest of the organization are apparently in conflict. But the best results can be achieved by perfectly matching the two interests and this is called 'goal congruence'.

It is quite apparent that perfect congruence between the goals of the individual and the organization individual's goals and the organization's goals can never happen. Yet, the main purpose of a management control system is to assure goal congruence between the interest of the individual and the organization as far as practicable.

Management control systems

Formal and Informal CommunicationAs mentioned earlier, all the communication of information may be either formal or informal. The formal communication system involves strategic plan, budgets, standards and reports whereas the informal communication is made through letters and memos, verbally or even by facial expression.Formal communications are all documented and addressed to the responsible managers for their information and actions, if necessary. However, the actions depend on the perception of the individual managers.Informal communication, on the other hand, relates to some external factors-work ethics, management style and culture. Added to these factors is the existence of an informal organization within the structured formal organization.

Informality refers to the relaxation of sharp differentiation and explicit description of behavior as indicated in the hierarchy and thereby, moving away from superior/subordinate relationship. However, such relations depend on the personal capabilities of the manager such as education, experience, expertise, trust and cooperation. For example, Accounts Manager of

Nasik Plant (see the organization chart in the diagram 3.2) reports to the General Manager of the Plant. While visiting the Corporate Office for attending a Training Course, he meets other colleagues, parallel officers and even the Finance Director. The latter communicates some important matter to him verbally and wants action thereon. Accounts Manager carried out the instructions so given. As per the organization chart, he should inform his General Manager, but it depends on his own perception of the situation, and he mayor may not report to the General Manager.

Work Ethics, Management Style and Culture

External factors like work ethics vary from place to place. Therefore, organization work culture depends on the general behavior of the people in the society where the organization situates. Work culture generally differs because of the life style and the attitude towards the work. For example, people of Mumbai lead very fast life. Time has more value at Mumbai as compared to Kolkata, where people take things easily and leisurely. Japanese and Korean people have reputation for their excellent work culture.However, the most important internal factor is the organization's culture and climate. The culture refers to the set of common beliefs, attitudes, norms, relationships and assumptions that are explicitly or implicitly accepted and evidenced throughout the organization. The writer joined Union Carbide as an Assistant just three days before Christmas Eve. On the very second day, when he attended Christmas lunch, his table was shared by none other than the General Sales Manager Dr. W.R. Correa. He kept us amused with various stories of his recent tour abroad and recited Urdu 'shairies', even sharing jokes. Such a situation was unthinkable in Jessop & Co., where sharp differences were maintained at every level of hierarchy.

Management control systems

Climate is used to designate the quality of the internal environment that conditions the quality of cooperation, the development of individuals, the extent of members' dedication or commitment to organizational purpose and the efficiency with which that purpose is translated into results. Climate is the atmosphere in which individuals work help, judge, and reward, constrain and find out about each other. It influences moral-the attitude of the individual towards his/her work and environment.

Culture differs between the organizations, but cultural norms are extremely important. They are not written like formal communication. But the existence of a good culture can be felt from the behavior of the members of the organization. Once the writer landed up with his family at Hyderabad in the early morning to discover that nobody had come to receive them at the station. His visit was arranged through non other than the Director of the company himself. His unit being new, telephone directory did not include any number of his unit, but the parent organization's telephone number was located. When an executive of the parent company was contacted, he immediately sent an officer of the company with a car to pick us up to their Guest

House, entertain with coffee and then put up in a Hotel. What subsequently happened is a different matter, but the attitude and treatment of that member of organization speak volumes about their excellent culture.

In any organization, the culture remains unchanged as long as the Chief Executive remains in position. When a new executive replaces him, there is likelihood of some change in the culture, unless the new Chief follows the footsteps of his predecessor and maintains it. Generally, if higher positions are filled in through promotion of internal executives, the culture remains unchanged and the traditions are maintained.

The other important internal factor which influences management control system is management style-that is the attitude of the superior to his subordinates and the latter's reaction through their perception of the attitude of their superiors. Again, the attitude ultimately stems from the temperament of the Chief Executive, who controls the entire organization. That is why R. W. Emerson said "an institute is the lengthened shadow of a man".

Importance of Informal Communication

An organization indulges in informal control process when encountering non-routine decision--making or when seeking new information to increase understanding of some problem areas. During a very critical period in an organization, the writer found that the Chief Executive used to call managers informally at his residence or club to extract information in a relaxed manner rather than in a tense situation prevailing in the factory.

Formal Control Process

Formal communication system is structured as per the 'hierarchy outlined in the organization chart. The system has the following four components:

(a) Strategic plan and programme(b) Budgeting

(c) Operations and measurement in responsibility centers (d) Reporting

(a) Strategic Plan and ProgrammeThe foundation of management control process lies in the organization's goals and its strategies for attaining these goals. A strategic plan is prepared in order to implement the strategies, after carefully considering opportunities and threats in the external environment as well as the strengths and weaknesses in the internal environment. Thus, a strategic plan and programme is prepared as a guideline to budgeting.

(b) Budgeting

The strategic plan is converted to an annual budget incorporating planned expenditure and revenues for individual responsibility centers. Expenses and revenues are marked for each responsibility centre period wise, say monthly, quarterly, half yearly, and annually.

(c) Operations and Measurement

Responsibility centers operate within the framework of the budget, established standards, standing instructions, practices and operating procedures embodied in 'rules', and 'manuals'. Thus, besides budget, the responsibility centers are also guided by a large number of rules. They record the resources actually used and revenue earned. They also classify the data by programmes as well as by responsibility centers for performance measurement.

(d) Reporting

Actual performance is analyzed, measured and reported against plan, indicating variances and highlighting areas of weaknesses. If the performance is satisfactory, feedback information is sent to the responsibility centre concerned for praise or reward. If the same is unsatisfactory feedback communication is sent to the responsibility centre concerned for corrective action. If such action requires to be included in the budget, then the latter is revised to give effect to the changed position. If required, then the plan itself can be revised and a new basis of control may be established.

The aforesaid formal control process has been presented in the following diagram:

3.Describe and illustrate significance of human behavior patterns in management

control system.

Ans. Management control systems influence human behavior. Good management control systems influence behavior in a goal congruent manner; that is, they ensure that individual actions taken to achieve personal goals also help to achieve the organization's goals. The concept of goal congruence, describing how it is affected both by informal actions and by formal systems.Senior management wants the organization to attain the organization's goals. But the individual members of the organization have their own personal goals, and they are not necessarily consistent with those of the organization. The central purpose of a management control system, then, is to ensure a high level of what is called "goal congruence." In a goal congruent process, the actions people are led to take in accordance with their perceived self interest are also in the best interest of the organization.The significance of human behavior patterns in management control system can be explained

with the help of Informal Factors that influence Goal Congruence. In the informal forces both

internal and external factors play a key role.

External Factors

External factors are norms of desirable behavior that exist in the society of which the organization is a part. These norms include a set of attitudes, often collectively referred to as the work ethic, which is manifested in employees' loyalty to the organization, their diligence, their spirit, and their pride in doing a good job (rather than just putting in time). Some of these attitudes are local that is, specific to the city or region in which the organization does its work. In encouraging companies to locate in their city or state, chambers of commerce and other promotional organizations often claim that their locality has a loyal, diligent workforce. Other attitudes and norms are industry-specific. Still others are national; some countries, such as Japan and Singapore, have a reputation for excellent work ethics.

Internal Factors

CultureThe most important internal factor is the organization's own culture-the common beliefs, shared values, norms of behavior and assumptions that are implicitly and explicitly manifested throughout the organization. Cultural norms are extremely important since they explain why two organizations with identical formal management control systems, may vary in terms of actual control. A company's culture usually exists unchanged for many years. Certain practices become

rituals, carried on almost automatically because "this is the way things are done here." Others are taboo ("we just don't do that here"), although no one may remember why. Organizational culture is also influenced strongly by the personality and policies of the CEO, and by those of lower-level managers with respect to the areas they control. If the organization is unionized, the rules and norms accepted by the union also have a major influence on the organization's culture. Attempts to change practices almost always meet with resistance, and the larger and more mature the organization, the greater the resistance is.

Management StyleThe internal factor that probably has the strongest impact on management control is management style. Usually, subordinates' attitudes reflect what they perceive their superiors' attitudes to be, and their superiors' attitudes ultimately stem from the CEO. Managers come in all shapes and sizes. Some are charismatic and outgoing; others are less ebullient. Some spend much time looking and talking to people (management by walking around); others rely more heavily on written reports.

The Informal OrganizationThe lines on an organization chart depict the formal relationships-that is, the official authority and responsibilities-of each manager. The chart may show, for example, that the production manager of Division A reports to the general manager of Division A. But in the course of fulfilling his or her responsibilities, the production manager of Division A actually communicates with many other people in the organization, as well as with other managers, support units, the headquarters staff, and people who are simply friends and acquaintances. In extreme situations, the production manager, with all these other communication sources available, may not pay adequate attention to messages received from the general manager; this is especially likely to occur when the production manager is evaluated on production efficiency rather than on overall performance. The realities of the management control process cannot be understood without recognizing the importance of the relationships that constitute the informal organization.

Perception and CommunicationIn working toward the goals of the organization, operating managers must know what these goals are and what actions they are supposed to take in order to achieve them. They receive this information through various channels, both formal (e.g., budgets and other official documents) and informal (e.g., conversations). Despite this range of channels, it is not always clear what senior management wants done. An organization is a complicated entity, and the actions that should be taken by anyone part to further the common goals cannot be stated with absolute clarity even in the best of circumstances.Moreover, the messages received from different sources may conflict with one another, or be subject to differing interpretations. For example, the budget mechanism may convey the

impression that managers are supposed to aim for the highest profits possible in a given year, whereas senior management does not actually want them to skimp on maintenance or employee training since such actions, although increasing current profits, might reduce future profitability.

The informal factors discussed above have a major influence on the effectiveness of an organization’s management control. The other major influence is the formal systems. These systems can be classified into two types: (1) the management control system itself and (2) rules, which are described in this section.

The Formal Control System

Rules

We use the word rules as shorthand for all types of formal instructions and controls, including: standing instructions, job descriptions, standard operating procedures, manuals, and ethical guidelines. Rules range from the most trivial (e.g., paper clips will be issued only on the basis of a signed requisition) to the most important):e.g., capital expenditures of over $5 million must be approved by the board' of directors).Some rules are guides; that is, organization members are permitted, and indeed expected, to depart from them, either under specified circumstances or when their own best judgment indicates that a departure would be in the best interests of the organization.Some rules are positive requirements that certain actions be taken (e.g., fire drills at prescribed intervals). Others are prohibitions against unethical, illegal, or other undesirable actions. Finally, there are rules that should never be broken under any circumstances: a rule prohibiting the payment of bribes, for example, or a rule that airline pilots must never take off without permission from the air traffic controller.Some specific types of rules are listed below:

Physical ControlsSecurity guards, locked storerooms, vaults, computer passwords, television surveillance, and other physical controls may be part of the control structure.

ManualsMuch judgment is involved in deciding which rules should be written into a manual, which should be considered to be guidelines rather than fiats, how much discretion should be allowed, and a host of other considerations. Manuals in bureaucratic organizations are more detailed than are those in other organizations; large organizations have more manuals and rules than small ones; centralized organizations have more than decentralized ones; and or-ganizations with geographically dispersed units performing similar functions (such as fast-food restaurant chains) have more than do single-site organizations System Safeguards

Various safeguards are built into the information processing system to ensure that the information flowing through the system is accurate, and to prevent (or at least minimize) fraud of every sort. These include: cross-checking totals with details, requiring signatures and other evidence that a transaction has been authorized, separating duties, counting cash and other portable assets frequently, and a number of other procedures described in texts on auditing.

Task Control SystemsTask control is the process of assuring that specific tasks are carried out efficiently and effectively. Many of these tasks are controlled by rules. If a task is automated, the automated system itself provides the control.

4. Discuss and illustrate differences and similarities between

a. Strategy Formulation and Management Control

b. Management Control and Task Control

Some Distinction between Strategy Formulation and management Control

Characteristics Strategy Formulation Management Controla) Focus of plan On one aspect at a time On entire organisationb) Complexities Many variables hence

complexLess complex

c) Nature of information Tailor-made for the issue, more external and predictive, less accurate.

Integrated, more internal and historical, more accurate.

d) Structure Unstructured and irregular, each problem being different

Rhythmic, definite pattern, set procedure

e) Communication of information

Relatively simple Relatively difficult

f) Purpose of estimates Show expected results Lead to desired resultg) Persons involved Staff and top management Line and top managementh) No. of persons involved Small Largei) Mental activity Creative, analytical Administrative, persuasivej) Planning and control Planning dominant but some

controlEmphasis on both planning and control

k) Time horizon Tends to be long Tends to be shortl) End result Policies and precedents Action within policies laidm) Appraisal of job done Extremely difficult Less difficult

b) Some Distinction between Management Control and Task Control

Characteristics Task Control Management controla) Focus of plan Single task or transaction On entire organizationb) Nature of information Tailor-made to operation,

specific, often non- financial, real time

Integrated, more internal and historical, more accurate

c) Persons involved Supervisors Line and top managementd) Mental activity Follow directives or none as

in case of machines or set objectives

Administrative, persuasive

e) Time horizon Day to day Tends to be shortf) Type of cost Engineered- Existence of

objective standard against which actuals can be compared makes control easier.

Discretionary- Control is more difficult due to subjective consideration.

5. What the concept of free cash flow is as applied to organization. Explain process of computation?

We define net cash flow as net income plus non cash adjustment which typically means net income plus depreciation though that cash flows cannot be maintained over time unless depreciated fixed assets are replaced. So management is not completely free to use its cash flows however it chooses. Therefore we define the term free cash flows.

Free cash flow is the cash flow actually available for distribution to investor after the company has made all the investment in fixed assets and working capital necessary to sustain ongoing operation. When we studied income statement in accounting the emphasis was probably on the firm’s net income, which is accounting profit. However the value of company’s operation is determined by the stream of cash flows that the operations will generate now and in the future. To be more specific, the value of operation depends on all the future expected free cash flows, defined as after- tax operating profit minus the amount of new investment in working capital and fixed assets necessary to sustain the business. Therefore the way for managers to make their companies more valuable is to increase their free cash flow.

Uses of FCF:1. Pay interest to debt holders, keeping in mind that the net cost to the company is the after

tax interest expense.2. Repay debt holders, that is, pay off some of debt.

3. Pay dividends to shareholders.4. Repurchase stock from shareholders.5. Buy marketable securities or other non operating assets.

In practice, most companies combine these five uses in such a way that the net total is equal to FCF. For example, a company might pay interest and dividends, issue new debts, also sell some of its marketable securities. Some of these activities are cash outflows (paying interest and dividends) and some are cash inflows (issuing debt and selling marketable securities), but the net cash flow from these five activities is equal to free cash flows.Computation of free cash flows:Eg:Suppose the company had a 2001 NOPAT of $170.3million and depreciation is only the non cash charge which is $100million then its operating cash flow in 2001 would be NOPAT plus any non cash adjustment on the statement of cash flows.

Operating cash flow =NOPAT +depreciation (non cash adjustment) = $17.03 + $100 = $270.3

Company has $1,455 million operating assets, at the end of 2000, but $1,800 at the end of 2001.it made a net investment in operating assets of Net investment in operating assets = $18, 00 - $1,455 = $345millionIf net fixed assets rose from $870million to $1000million however company reported $100million of depreciation. So its gross investment in fixed assets would be

Gross investment = net investment + depreciation = $345 + $100 = $445million

Company free cash flows in 2001 was FCF = operating cash flow – gross investment in operating assets = $270.3 - $445 {345 + 100} = - $174.7million

An algebraically equivalent equation is

FCF = NOPAT - Net investment in operating assets = $170.3- $345 = - $174.7million

Even though company had a positive NOPAT, its very high investment in operating assets resulted in a negative free cash flow. Because free cash flow is what is available for distribution to investor, not only was there nothing for investors, but investor actually had to provide additional money to keep the business ongoing. A negative current FCF not necessarily bad provided it is due to the high growth or to support the growth. There is nothing wrong with profitable growth; even it causes negative free cash flow in the short term.

2. Performance Measurement System

1. Explain the concept of ROI. What are its advantages?

Return on investment (ROI) is the ratio of profit before tax to the gross investment.

ROI is calculated with the help of the following formula:

ROI = (Pre-Tax Profit/Sales) X (Sales/Net Assets) or (Pre-Tax Profits/Net Assets)

The numerator is profit before tax as reported in the P&L account. The profit should include only the profits arising out of the normal activities of the division. Unusual items of receipts and expenses should be excluded from the profit figure. One should also ignore windfalls and income from investments not related to the operations of the division. Tax is excluded from the numerator because the marginal of the SBU is not responsible for or in control of the tax paid.

Capital employed can be ascertained from the balance sheet by including fixed and current assets. Assets not currently put to divisional use should be excluded from the investment base. One also needs to exclude their relative earnings if any. The company should also exclude intangible assets like goodwill, deferred revenue expenses, preliminary expenses, etc.

ROI can be improved by:

a) Increasing the profit margin on sales.

b) Increasing the capital turnover

c) Increasing both profit margin and capital turnover.

d) Reducing cost as that adds to the total earnings of the firm.

e) Increasing the profits by expanding present operations or developing new product line, increasing market share, etc.

f) Diversifying, introducing productivity imporevement measures, expansion, replacement of old equipments

Advantages of ROI

a) ROI relates return to the level of investment and not sales as the rate of return is more realistic.

b) ROI can be decomposed into other variables as shown. These variables have tremendous analytical value.

c) ROI is an effective tool for inter-firm comparison.

2. Many experts regard EVA as a concept superior to ROI and yet in certain cases, EVA does not do justice to the evaluation of investment center. EVA does not solve all the problems of measuring profitability in an investment center. In particular, it does not solve the

problem of accounting for fixed assets discussed above unless annuity depreciation is also used, and this is rarely done in practice. If gross book value is used, a business unit can increase its EVA by taking actions contrary to the interests of the company, If net book value is used, EVA will increase simply due to the passage of time. Furthermore, EVA will be temporarily depressed by new investments because of the high net book value in the early years. EVA does solve the problem created by differing profit potentials. All business units, regardless of profitability, will be motivated to increase investments if the rate of return from a potential investment exceeds the required rate prescribed by the measurement system.

Moreover, some assets may be undervalued when they are capitalized, and others when they are expensed. Although the purchase cost of fixed assets is ordinarily capitalized, a substantial amount of investment in start-up costs, new product development, dealer organization, and so forth may be written off as expenses, and, therefore, not appear in the investment base. This situation applies especially in marketing units. In these units the investment amount may be limited to inventories, receivables, and office furniture and equipment. When a group of units with varying degrees of marketing responsibility are ranked, the unit with the relatively larger marketing operations will tend to have the highest EVA.

In view of all these problems, some companies have decided to exclude fixed assets from the investment base. These companies make an interest charge for controllable assets only, and they control fixed assets by separate devices. Controllable assets are, essentially, receivables and inventory. Business unit management can make day-to-day decisions that affect the level of these assets. If these decisions are wrong, serious consequences can occur-quickly. For example, if inventories are too high, unnecessary capital is tied up, and the risk of obsolescence is increased; whereas, if inventories are too low, production interruptions or lost customer business can result from the stockouts. To focus attention on these important controllable items, some companies, such as Quaker Oats, 17 include a capital charge for the items as an element of cost in the busi-ness unit income statement. This acts both to motivate business unit management properly and also to measure the real cost of resources committed to these items.

Investments in fixed assets are controlled by the capital budgeting process before the fact and by post completion audits to determine whether the anticipated cash flows, in fact, materialized. This is far from being completely satisfactory because actual savings or revenues from a fixed asset acquisition may not be identifiable. For example, if a new machine produces a variety of products, the cost accounting system usually will not identify the savings attributable to each product.

The argument for evaluating profits and capital investments separately is that this often is consistent with what senior management wants the business unit manager to accomplish; namely, to obtain the maximum long-run cash flow from the capital investments the business unit manager controls and to add capital investments only when they will provide a net return in excess of the company's cost of funding that investment. Investment decisions, then, are

controlled at the point where these decisions are made. Consequently, the capital investment analysis procedure is of primary importance in investment control. Once the investment has been made, it is largely a sunk cost and should not influence future decisions. Nevertheless, management wants to know when capital investment decisions have been made incorrectly, not only because some action may be appropriate with respect to the person responsible for the mis-takes but also because safeguards to prevent a recurrence may be appropriate.