management control system
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Management Control System
Author: Manohar Prasad
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3. BEHAVIOR IN ORGANIZATION Learning outcomes
1. GOALS & CONGRUENCE2. INFORMAL FACTORS THAT INFLUENCE GOAL
CONGRUENCE3. FORMAL CONTROL SYSTEMS4. TYPES OF ORGANIZATIONS5. FUNCTIONS OF THE CONTROLLER
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04/11/23 3
Organization Structure
• How tasks are divided, resources are deployed, and departments are coordinated– Set of formal tasks
– Formal reporting relationships
– Effective coordination of employees across departments
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TYPES OF ORGANIZATIONS
• FUNCTIONAL ORGANIZATIONS• BUSINESS UNIT ORGANIZATIONS• MATRIX ORGANIZATIONS
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04/11/23 5
Five Approaches to Structural Design
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04/11/23 6
Five Approaches to Structural Design
daft ch10 insert1.CLP
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FUNCTIONS OF THE COTROLLER
1. DESIGNING & OPERATING MCS2. FINANCIAL STATEMENTS & REPORTS3. TAX RETURNS4. PREPARATION AND ANALYSIS OF
PERFORMANCE REPORTS
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FUNCTIONS OF THE CONTROLLER(contd.)
5. BUDGET PROPOSALS WITH ANALYSIS & JUSTIFICATION
6. INTERNAL AUDITS FOR PREVENING FRAUD/THEFT
7. DEVELOPING PEOPLE IN CONTROL FUNCTION
8. BUSINESS UNIT CONTROLLER & CORPORATE CONTROLLER
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4. RESPONSIBILITY CENTERSLearning outcomes
1. TYPES OF RESPOSIBILITY CENTERS2. COST/EXPENSE CENTERS3. REVENUE/PROFIT CENTERS4. INVESTMENT CENTERS5. MEASURES USED TO EVALUATE THEIR
PERFORMANCES6. ROI, ROA, MVA
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THE CONTROLLER
BUSINESS UNIT CONTROLLER CORPORATE CONTROLLER RELATIOSHIP BETWEEN BOTH DOTTED LINE SOLID LINE
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RESPONSIBILITY CENTRES
1. RESPONSIBILITY CENTRES• MANAGER RESPONSIBLE
FOR ACTIVITIES• UNIT WITHIN COMPANY
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RESPONSIBILITY CENTRES
2. NATURE OF RESPONSIBILITY CENTRES
• OBJECTIVES• INPUTS/WORK/OUTPUT• RELATIONSHIP BETWEEN
INPUT & OUTPUT
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RESPONSIBILITY CENTRES
3. MEASURING INPUTS & OUTPUTS• PHYSICAL MEASUREMENT LIKE HRS,
KGS• TRANSLATED INTO MONETARY TERMS• COST –MONETARY MEASURE OF
RESOURCES USED BY RESPONSIBILITY CENTRE
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RESPONSIBILITY CENTRES
4. EFFICIENCY & EFFECTIVENESS• RATIO OF OUTPUT TO INPUT• RATIO OF OUTPUT TO ITS OBJECTIVES• EVERY RESPONSIBILITY CENTRE OUGHT TO
BE BOTH EFFICIENT AND EFFECTIVE• A RESONSIBILITY CENTRE IS EFFICIENT IF IT
DOES THINGS RIGHT, AND IT IS EFFECTIVE IF IT DOES THE RIGHT THINGS
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TYPES OF RESPONSIBILITY CENTRES
1. COST/EXPENSE CENRES2. TYPES a) ENGINEERED EXPENSE CENTRESb) DISCRETIONARY EXPENSE CENTRES
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TYPES OF RESPONSIBILITY CENTRES
2. REVENUE CENTRES• OUTPUT IS MEASURED IN MONETARY TERMS• NO FORMAL ATTEMPT TO RELATE TO INPUT
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Responsibility Accounting forProfit Centres
Based on detailed information about both controllable revenues and controllable costs
Manager controls operating revenues earned, such as sales,
Manager controls all variable costs (and expenses) incurred by the centre because they vary with sales
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Profit Centre
Shows budgeted budgeted and actualactual controllable revenues and costs
Prepared using the cost-volume-profit income statement format:– Deduct controllable fixed costs from the contribution
margin– Controllable marginControllable margin - excess of contribution
margin over controllable fixed costs – best measure of manager’s performance in controlling revenues and costs
– Do not not report non-controllable fixed costs
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Advantages of Profit Centre
Speed of operating decisions Quality of decisions Unit level day to day decisions Corporate can concentrate on long term planning Freedom for unit managers, less dependence on head
office Excellent training ground Profit consciousness among units Ready made infn on profitability of compny’s independent
units Competitive performance
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Measuring Profitability
Contribution margin Direct profit Controllable profit Income before taxes Net income Revenues
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Investment Center
An investment center is a subunit that is responsible for generating revenue, controlling costs, and investing in assets.
An investment center is charged with earning income consistent with the amount of assets invested in the segment.
Most divisions of a company can be treated as either profit centers or investment centers.
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6. Transfer Pricing Learning outcomes
1. Objectives and need of Transfer pricing2. Methods of Transfer Pricing3. Cost Based4. Market price based5. Negotiated price6. Administration of TRANSFER PRICES
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Need For Transfer Pricing
Liberalization and Growth of multinationals More decentralization. Considerable autonomy Encourage them to perform well. Business units are supposed to work under
the same organization Performance of business units.
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OBJECTIVES OF TRANSFER PRICES
1. Proper distribution of revenue between profit centers. 2. Resulting profit has to be shared between the profit
centers. 3. Providing relevant information to the profit centers4. Inducing goal-congruent decisions,
-improve the profits of business units and also improve the profits of the company
4. Measure the economic performance of profit centers 5. Minimizing tax liability
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Goal Congruence
Some of the prerequisites for achieving goal congruency are
1.Competent people 2.Good organizational atmosphere 3.Details of market prices 4.Freedom to source 5.Availability of information 6.Scope for negotiation
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Transfer Price Defined
The price that is used to value internal transfers of goods and services within the same company is
known as the transfer price.
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Transfer Pricing
The fundamental principle is that the transfer price should be similar to the price that would be charged if the product were sold to outside customers or purchased from outside vendors.
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Transfer Pricing
• Not used for external pricing • Used to set prices for transfers within a
company’s departments, divisions, or segments
Transfer prices do not affect revenues and costs of
the company as a whole Transfer prices do affect revenues and costs of the
divisions involved.
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Pricing for Internal Providers of
Goods and Services
Transfer pricing enables a business to assess both the internal and external profitability of its products or services
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Methods of calculating transfer price
The three methods of calculating transfer price that are used commonly are: 1.Cost-based pricing method 2.Negotiated pricing method 3.Market-Based Pricing Method
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Cost Based Pricing
• How to define cost?– Actual cost– Standard cost– Percentage of cost– Percentage of investment
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Market Based Pricing
1. Market Price Information2. Freedom to source3. Full Information4. Negotiation5. Constraints
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Negotiated Transfer PriceMay be based on an agreement to use a cost plus
a profit percentageWill be between the negotiation floor and the
negotiation ceilingNegotiation floor: the selling division’s variable
costNegotiation ceiling-the market price
This approach allows for cost recovery while still allowing the selling division to return a profit
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Administration of TRANSFER PRICES
Implementing transfer pricing involves Long negotiations between heads of various unitsClassification of products, Arbitration conflict resolution in case conflicts arise.
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Transfer Pricing in Multinational Settings
• Extremely difficult to set– Tax systems– Customs duties– Freight and insurance costs– Import/export regulations– Foreign exchange controls– Internal and external objectives of transfer differ
• May use different transfer prices for different countries; make certain of legality.
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7.Measuring & Controlling Assets
Prof.S.G.Patwardhan
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Measuring & Controlling Assets
Why long term investment is a strategic issue?
Why long term investments is a control issue?
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Characteristics of long-term assets Long-term assets (Building, Plant, Machinery,
Information Technology) Long-term assets - an organization is committed for a
long period of time. The lack of investment could cause opportunity
losses or the investment could cause excess capacity.
The investment amount is usually large.
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Why relate profits to investments?
• Profits are generated ONLY if you have investments.• Therefore, earning a satisfactory return on the
investments employed is necessary.• To compare two units, A and B, without considering
the investment made in each is meaningless.
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Responsibility Accounting
Types of Responsibility Centers1. Cost center: only responsible for costs2. Revenue center: only responsible for revenues3. Profit center: responsible for both revenues and
costs4. Investment center: responsible for revenues,
costs, and investments
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Measuring the Performance of Investment Centres
• Return on Investment (ROI)
• Residual Income (RI)
• Economic Value Added (EVA)
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Accounting-Based Performance Measures
Accounting-Based Performance Measures
1. Choose Performance Measures that align with top management’s financial goals
2. Choose the time horizon of each Performance Measure
3. Choose a definition of the components in each Performance Measure
4. Choose a measurement alternative for each Performance Measure
5. Choose a target level of performance
6. Choose the timing of feedback
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EffectivenessDegree to which a goal,
objective, or target is met.
Determined by process design
Effectiveness vs Efficiency Effectiveness vs Efficiency
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EfficiencyDegree to which inputs are used in
relation to a given level of outputs.Determined by process design and
how the process operatesPerformance may be effective, efficient,
both, or neither.
Effectiveness vs Efficiency Effectiveness vs Efficiency
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Return on Investment (ROI)Return on Investment (ROI)
ROI is an accounting measure of income divided
by an accounting measure of investment
IncomeInvestmentROI =
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ROIROI
• ROI may be decomposed into its two components as follows:
• ROI = Return on Sales X Investment Turnover
• This is known as the DuPont Method of Profitability Analysis
Income Income RevenuesInvestment Revenues InvestmentX=
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A. The Components of ROIROI has a distinct advantage over income as a measure
of performance since it considers both income (the numerator) and investment (the denominator).
ROI = Income
Invested capital
ROI = Income
Salesx
Sales
Invested capital
Profit Margin Investment Turnover
The breakdown of the formula shows that managers can increase return by more profit and/or generating more sales for each investment dollar.
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Measuring the Performance of Investment Centers
Margin: portion of sales
available for interest, taxes
and profit
Operating income
Sales
Turnover: how productively
assets are being used to generate
sales
Sales
Average operating assets
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D. Residual Income (RI) as an Alternative to ROI
Residual Income = NOPAT – Required Profit
= NOPAT – Cost of Capital x Investment
= NOPAT – Cost of Capital x (Total Assets – Noninterest Bearing Current Liabilities)
Residual Income (RI) overcomes the underinvestment problem ofROI since any investment earning more than the cost of capital will
increase residual income.
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Residual incomethe difference between operating income and the minimum Rs. return required on a company’s operating assets
Measuring the Performance of Investment Centers
Residual Operating Minimum rate of return= -Income Income Operating assets
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Components of RI
Decomposition of the RI formula:
RI = Operating income- (Minimum rate of return x Operating assets)
= Operating income – Minimum return on Assets
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Economic Value Added
Economic value added (EVA) is after-tax operating profit minus the total annual cost of capital.
EVA = After-tax operating income - (Weighted average cost of capital x total capital employed)
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Economic value added (EVA)after-tax operating profit minus the total annual cost of capital.
Measuring the Performance of Investment Centers
After-tax Weighted average cost of capitalEVA = operating - Total capital employedincome
Total capital employed = capital assets plus other expenditures meant to have a
long-term payoff
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MVA
Market Value Added (MVA)–Difference between the market
value of a corporation and capital contributed by shareholders and lenders.
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Thank you !