Management control systems jsb 606 part3


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Set 3 for the course Management Control Systems. This contains details of various control systems in use.Management Control Systems make management of an organization possible. This set of presentations tells you what they are and how to go about building them. The series is in four parts. If you need to download the presentations mail me at

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Management control systems jsb 606 part3

  1. 1. Management Control Systems Part 3 Debasis Das Exemplar Consultancy
  2. 2. Tools of Management Control Systems Debasis Das JSB 606 2
  3. 3. Strategic Planning as a Tool Debasis Das JSB 606 3
  4. 4. Introduction• Long term Process• Involves decisions of top management• Effective only when suitable infrastructure supports it• Strategic planning determines the effectiveness of management Debasis Das JSB 606 4
  5. 5. Strategic Planning Characteristics• Setting goals• Strategy formation• Needs long term perspective – Complex process, requires evaluation of multiple variables – Not a regular exercise but as required – Uses internal as well as external data – Setting goals through communicating (process, policy, objective) down the line – It is a creative process – End result oriented – At the top level it is conceptual, no measurement standards Debasis Das JSB 606 5
  6. 6. How it’s Done• Ensures success comes from within the organization• Key tool-capitalizing on the knowledge and skills in the organization• Document do’s and don’ts• Carried out through team building, personalized skills and effective organizational communication• Top management does this, typically 2/3 top people Debasis Das JSB 606 6
  7. 7. Benefits• Create a vision statement• Develop organization mission• Identify critical success factors• Define goals• Identify barriers• Translate goals into business plans• Translate goals and barriers into action plan with responsibility & accountability• Feedback & update process• Using team building, interpersonal and communications skills for individual & org success Debasis Das JSB 606 7
  8. 8. Strategic Planning Significance• Helps internalize strategic processes• No unpleasant surprises for managers as goals and processes are scrutinized closely• Environmental issues are factored in• Corporate culture gets considered• This being the overall plan, helps coordinate the other planning/ budgeting processes Debasis Das JSB 606 8
  9. 9. Process of Strategic Planning Reviewing & Updating the Strategic plan Decide on assumptions & guidelines Next Create strategic plan iteration Analysis of plan Final review & Approval Debasis Das JSB 606 9
  10. 10. Reviewing & Updating Strategic Plan• Review existing plan (last year’s)• Update with environmental and internal changes• Taken up any time it is required Debasis Das JSB 606 10
  11. 11. Deciding Assumptions & Guidelines• Incorporate necessary strategic elements• Data regarding current business situation incorporated , keep revenue implications minimal• Goals & objectives are aligned with business needs• Short and long range business plans synchronized• Decision to add or drop a line of business• Labor, salary, wages guidelines account Debasis Das JSB 606 11
  12. 12. First Iteration of Strategic Plan• Formulate business plan• Validity of data and assumptions carried out by business unit members and then unit managers• Top management to vet if in accordance with organizational needs• Income statements, balance sheet items are scrutinized, justifications confirmed Debasis Das JSB 606 12
  13. 13. Analysis of Plans• Meetings between business units and top management• Analyses gaps in planning• Discuss means to cover the gaps, acquisition if necessary• Strength and integration of current business units considered• Internal strength is estimated Debasis Das JSB 606 13
  14. 14. Second Iteration of Strategic Plan• Change in plans in view of recent developments• Generally short term changes• New technologies and other changes in the environment Debasis Das JSB 606 14
  15. 15. Final Review & Approval• Approval of top management including board of directors• Approval before budgeting• Budget is the key to implementing the strategic plan Debasis Das JSB 606 15
  16. 16. Allocation of Resources• Plan implementation can start only after resources are allocated• Some uncertainty will remain in long-term plans• Line of involvement of managers & accountability needs to be set up• Accountability to be set up• Approval and endorsement steps should be minimal• Personnel should be trained & educated about strategic business processes being enabled Debasis Das JSB 606 16
  17. 17. Investment decision Making- Bower’s Model• Based on discrepancies between plan and actual process of implementation• Based on discrepancies key variables are determined and moderated• 3 level functioning of strategic planning – Lower level-basic data – Middle level-synchronizes it – Top level- design the action plan• Rewards and line of authority is set up by top management Debasis Das JSB 606 17
  18. 18. Budget as a Tool Debasis Das JSB 606 18
  19. 19. Budgetary Control• Use of short and long term organizational budget to control & guide business processes• Compare with actual results, calculating variance and taking corrective action (if required)• Appropriate authority, responsibility and accountability should rest with assigned manager Debasis Das JSB 606 19
  20. 20. Budgetary Control- Advantages• Corporate intent in measurable monetary terms• Bridges the gap between plan and performance• Promotes specialization and focuses business processes (budget is divided based on functions and cost allocation)• Budget creation requires integration of functions. Promotes coordination and integration between business policies• Brings objectivity to business by tagging monetary value Debasis Das JSB 606 20
  21. 21. Need for Budgetary Control• Budget helps provide management control, strategy implementation• Reduces uncertainty• Increases coordination between SBUs• Identifying weaknesses and focuses on strengths• Keeps expenses under check• Identifying deviations Debasis Das JSB 606 21
  22. 22. Objectives of Budgetary Control• Establishes and ensures strategy is implemented• Creates measurable standards and comparable standards• Provides a common thread of coordination Debasis Das JSB 606 22
  23. 23. Organizational Set up• Budget center• Budget manual• Personnel & operational set up – Controller of budget – Budget committees – Budget period – Determining key budget factors – Budget reports Debasis Das JSB 606 23
  24. 24. Formation of Budget• Guidelines• Budget Proposal• Negotiations• Review & approval• Revision of budget Debasis Das JSB 606 24
  25. 25. Administration of Budget• Determination of objectives• Establishing the objectives• Availability of accounting & verifiable records• Budget org chart and fixing responsibility• Establishing budget committees• Preparation of budget manual• Selecting budget period• Locating key budget factors• Determining cost allocations Debasis Das JSB 606 25
  26. 26. Types of Budget• Responsibility budget• Program budget• Operation budget – Sales, production, production, selling, distribution costs• Function budget – Sales, research, purchase, finance, etc.• Financial budget – Source & utilization of cash, budgeted P&L and balance sheet• Capital budget – Capital expenditure and investments Debasis Das JSB 606 26
  27. 27. Budgeting Process• Top-up budgeting• Bottom down budgeting• Budget report & variance analysis Debasis Das JSB 606 27
  28. 28. Capital Budgeting• Process of capital budgeting• Techniques of capital budgeting – Non discounted techniques – Discounted techniques• Concepts of capital rationing – External factors – Internal factors – Risk factors• Limitations of capital budgeting Debasis Das JSB 606 28
  29. 29. Capital Budgeting Non discounted techniques• Payback period method – (Cash outlay of project) / (annual cash inflow)• Accounting rate of return method – ARR= (average income)/(average investment) Debasis Das JSB 606 29
  30. 30. Capital Budgeting Discounted techniques• Net present value – PV= discounted inflow if it was available now• Internal rate of return – IRR= PV inflow/PV outflow• Profitability index method – PI=(PV inflow)/(PV of outflow) Debasis Das JSB 606 30
  31. 31. Limitations of Capital Budgeting• Alternatives may not be mutually exclusive• Estimation of future inflow is hazardous always• Goodwill, relationships and such factors cannot be accounted for• Urgency of decision making could skew the estimates Debasis Das JSB 606 31
  32. 32. Valuation as a Tool Debasis Das JSB 606 32
  33. 33. Assets & Liabilities• Income=liability=distribute to owners• Expenses=basic functions of business to create assets• Management control maximizes efficiency such that value of business is increased and assets of the stakeholders• Maintain a balance between increasing value, decreasing costs Debasis Das JSB 606 33
  34. 34. Measuring Liability Employed• Valuation Based on Earnings – Based on book value, does not reflect market value• Capital charges – Profit carried over to capital & reserves – Deferred expenses difficult to value (as they arise in current year but accrue in a later time) Debasis Das JSB 606 34
  35. 35. Measuring Asset Employed• Is the decision regarding employment of asset correct?• Have the assets deployed been used correctly? – Cash • Actual receipts-payments, handled centrally and allocated to units, 3 to 4 times annual sales – Receivables • Influenced by sales & credit period, collection pattern – Inventories • Similar to receivables, value would depend on inflow and outflow – Overall working capital • Gross or net valuation, gross-only current assets, net-excess of current assets over current liabilities – Property, plant & equipment • Book vale less depreciation Debasis Das JSB 606 35
  36. 36. Book Value: Gross & Net• Disposition of assets – Dispose of low value assets first before replacement• Depreciation – Straight line or reducing balance method• Leased assets – Type of debt, lower capital cost• Idle assets – Affect ROI, lowers it• Intangible assets – R&D expenses for example• EVA vs. ROI – EVA=net profit-capital charges, ROI-cost of capital Debasis Das JSB 606 36
  37. 37. Evaluation of Economic Performance• Economic analysis provides diagnostics• Helps understanding business strategies• Measures levels of success achieved Debasis Das JSB 606 37
  38. 38. Transfer Pricing as a Tool Debasis Das JSB 606 38
  39. 39. Objectives of Transfer Pricing• Provide relevant information to the value chain to determine optimum trade off between cost & revenue• Induce goal congruence by providing a competent atmosphere, freedom to source out & negotiate• Measure economic performance of a profit center• Single mechanism that’s easy to administer Debasis Das JSB 606 39
  40. 40. Fundamental Assumptions• Dependent on assumptions of two managerial decisions – Sourcing decision: make or buy – Price at which item to be transferred if a “make” decision is made• Transfer price approximately market price not including costs that do not apply• When competitive price not available take cost + profit• Cost based transfer could be made based on standard cost + profit margin or a two step pricing Debasis Das JSB 606 40
  41. 41. Ideal Situation for Transfer Pricing• Integration of business along value line• Not diversified to unrelated businesses• Works best in horizontally integrated business• There is common basis for calculating fixed & variable costs• Multi-location business, Debasis Das JSB 606 41
  42. 42. Limitations• Ideal when external market exists for components in the value chain (not often, it is not so)• If captive capacity exists. Internal prices are far better than external market prices• Investing in large facilities are often a strategic decision. Negotiating with external market would not make sense Debasis Das JSB 606 42
  43. 43. Methods of Transfer Pricing• Full cost based – Full cost minus mark up• Marginal cost based – Variable cost is used as reference cost of transfer• Negotiated – Negotiated between the units, based on external market price Debasis Das JSB 606 43
  44. 44. Problems with Transfer Pricing• Problem of integration of fixed costs in the upstream value chain – Profit centers higher in the value chain are not aware of cost & profit coming up to them. They will be reluctant to negotiate own profits to optimize company’s profit• Profit sharing – Product transferred to marketing at standard variable cost – Business units share the contribution realized from sale• Two sets of transfer pricing – Each unit sold, a standard variable cost of production is charged, a periodic charge fixed costs associated with facilities associated with facilities reserved by the buying unit Debasis Das JSB 606 44
  45. 45. Administering Transfer Prices• Negotiations – Between heads of the two units involved• Arbitration & conflict resolution – Top management intervenes as arbitrators, formally or informally• Product classification – Some products that can be benchmarked against market price will have transfer price fixed by top management, others by negotiation Debasis Das JSB 606 45
  46. 46. Theoretical Basis of Transfer Pricing• Economic model – Fixed model of 1956 by Hirschleifier. Does not provide for negotiations and applies in specific assumptions• Linear programming model – Uses companywide optimum production patterns, marginal costs and demand curves, not very practical• Shapely value – Method of dividing profits between participants based on contribution• Practical application of admin regulations & guidelines Debasis Das JSB 606 46
  47. 47. Management Control of Responsibility Centers through Audit Debasis Das JSB 606 47
  48. 48. Audit of Responsibility Centers• It is necessary because – Responsibility are the key functions of business, auditing these tells you a lot about business health – A management audit enables business to set up standards and propose compliance as the business requires – Responsibility centers create value in the business. Functions of the end to end chain is also required Debasis Das JSB 606 48
  49. 49. Role of Audit• A deep look into the business processes• Look at opportunities to improve• Find if there are risks• Strategize for future• Check if desired path is being followed• Create a required reward system Debasis Das JSB 606 49
  50. 50. Process of an Audit• Establish an audit team – 3 or 4 persons conversant with the process – Internal or external• Create an audit plan – Right timing, adequate resources are essential• Execute the audit – Team must clearly understand the purpose Debasis Das JSB 606 50
  51. 51. Scheduling an Audit• Seasonal fluctuations of a business – Schedule audit at a time that is a normally active period• Time when most people are available – Peak work period is a bad time• Choose the period that reflects overall performance – Should reflect the period when organization performs at its best Debasis Das JSB 606 51
  52. 52. Audit Plan• Proper utilization of manpower and resources• Balance right number of people and resources w/o affecting normal business• Clear and time bound picture to be made available Debasis Das JSB 606 52
  53. 53. Tools & Techniques• Surveys – Types, advantages, disadvantages, using survey properly• Questionnaire – Closed & open ended questionnaire, how to, structure, advantages, disadvantages• Focus groups – Participants from a homogenous group with moderator, focused response, participants and moderator need to be skilled• Interviews – Structured, semi-structured, unstructured interviews, free information flow, could be expensive• Direct observations – Freedom of expression, observer need to have expertise• Which method to be used? – Normally a mix to be used, depends on time, resources and expertise availability Debasis Das JSB 606 53
  54. 54. Continuous Improvement Through Audit• Improvement in processes need continuous improvements• Audits provide input as to what needs to change• Audit is the starting point of problem solving & analysis Debasis Das JSB 606 54
  55. 55. Gaining Strategic Advantage• Characteristics of continuous change – No improvement can be done in one step, implementation should be on a continuous basis – Need for improvement change continuously – Change is not precise always – Priorities change – Feedback of performance needed to decide corrective action• Acquiring competitive advantage• Improvement through trigger point• Action planning Debasis Das JSB 606 55
  56. 56. Acquiring Competitive Advantage• Audits should help understand strengths, weaknesses, threats & opportunities• Identify capabilities that could be converted to strengths• Findings should help discussions on changes planned Debasis Das JSB 606 56
  57. 57. Improvement through a Trigger Point• When organizations face significant changes – Mergers, acquisitions – New entrants – Technology change• Can happen at any point – functional, entry, maturity or saturation points Debasis Das JSB 606 57
  58. 58. Action Planning• Action must follow an audit• Action plans must include – person to prepare an action plan – Time of action plan – Content of action plan – Person in charge of the action plan – Actions to be taken and people who have to carry them out – Role of auditor in the follow up action plan Debasis Das JSB 606 58
  59. 59. Management Control ofOperational Processes Debasis Das JSB 606 59
  60. 60. Role of Information in Operational Management• Information is a natural outcome of business processes• Business process is about information interchange by people responsible for the process• A business process supports the system of an operation, provides information that supports the business Debasis Das JSB 606 60
  61. 61. Type of information for Operation• Formal & informal operation• Budget information• Task information• Audit information Debasis Das JSB 606 61
  62. 62. Approaches to Control of Operations• Total quality control – Documentation of processes – Responsibility of quality – Product design – Dealing with suppliers• Decision support systems – Streamlines task delivery – Second line of options – Helps understand processes & be proactive Debasis Das JSB 606 62
  63. 63. Continuous Process Improvements• Process modification is the key to process improvement• With continuous improvement process can be refined to deliver better quality and improve cost and delivery times• Focus on limited areas at a time• People need training and education to participate whole-heartedly Debasis Das JSB 606 63
  64. 64. Tools in Continuous Process Improvement• Target costing – Planning phase, development phase, production phase• Advantages of target costing – Fix the cost of design & product in great detail – Direct right products to right group of consumers – Failure of products is reduced – Helps set realistic goals Debasis Das JSB 606 64
  65. 65. Benchmarking-1• Continuously compare with standard and best practices• Choose the best practices – Planning phase – Analysis phase – Bench trending • Determine market by size, preference, competitors • Direction of industry, technology and geopolitics • Determine strengths of potential competitors • Performance data of competitors • Baseline business performance • Identify a set of activities that will improve strength of business Debasis Das JSB 606 65
  66. 66. Benchmarking-2• Bench trending is carried out – Requirements of the process understood – Flowchart of process is described – Specific objectives identified – Bench trending methods of competitors identified – Best suited practices are chosen and adopted Debasis Das JSB 606 66
  67. 67. Bechmarking-3• Communication & integration – Information gathered from benchmarking and bench trending must be integrated and implemented• Implementation – Set realistic goals – Teams take care of implementation – Processes streamlined & linked Debasis Das JSB 606 67
  68. 68. Production Control Debasis Das JSB 606 68
  69. 69. Production Controls• Nature of the production process• Degree of mechanization involved – Continuous process – Discrete or assembly line process Debasis Das JSB 606 69
  70. 70. Production Issues in Discrete Processes• Production of finished goods as per design• Finished components per time standards• Synchronization of production processes to avoid excess of one type• Right balance of production capacity of different production chains of various components• Ensuring work layout is appropriately designed• Specify maximum stacking of input/outputs• Number of persons that can be present on shop floor• Defining spoilage and wastage• Defining quality norms Debasis Das JSB 606 70
  71. 71. Measuring Production Performance• Productivity, efficiency of converting input to output• Productivity measurements – Labor productivity – Material productivity – Multi factor productivity – Total productivity Debasis Das JSB 606 71
  72. 72. Production Control Reports• Production efficiency• Production planning• Daily production• Downtime analysis• Shift handover Debasis Das JSB 606 72
  73. 73. Marketing Control Debasis Das JSB 606 73
  74. 74. Types of Marketing Control• Strategic control – Premise control, implementation control, strategic surveillance, special alert control• Annual plan control• Profitability control• Efficiency & effectiveness control – Marketing effectiveness • Customer philosophy, marketing orientation, info about marketing, strategic orientation, operational efficiency Debasis Das JSB 606 74
  75. 75. Marketing Audit• Tool for improving marketing effectiveness• Roles it performs – Introduces or changes marketing orientation & practices – Act as a framework for organizational analysis & control Debasis Das JSB 606 75
  76. 76. External & Internal Audits• External audit – Audit of external environment – Auditors must know the organization & the industry – Opportunities & threats will be identified – Help identify marketing resources, skills, assets• Internal audit – Audit of internal environment – Strengths & weaknesses of the organization & its products – Identifies & analyses positioning, pricing and target strategies – Analysis of marketing activities and channels Debasis Das JSB 606 76
  77. 77. Characteristics of effective Marketing Audit• Systematic• Comprehensive• Independent• Periodic• Conducting an audit – Extensive analysis of present and past marketing activities – Forecast of growth relative to market changes – Suggestions for improvement of quality of plans & marketing performance Debasis Das JSB 606 77
  78. 78. Sales Control• Sales budgets – Sales revenue, selling expense, departmental administrative budgets – (rolling budgets followed often)• Methods of budgeting for selling expenses – Affordability, percentage of sales, competitive parity, objective & task and return oriented methods• Control through budgets – Establishes objectives & responsibilities, coordination between different business segments Debasis Das JSB 606 78
  79. 79. Sales Quotas• Can be set as sales volume or value, profit, expenses or activities• For individuals or a team or a territory• Product categories or class of customers• Punishments or rewards follow on achievement• Quotas should be fair, challenging• Can be from sales forecast, negotiations Debasis Das JSB 606 79
  80. 80. Importance of Sales Quotas• Performance of targets – Must be communicated properly. Challenging targets stretch performance, unrealistic target could be de- motivating• Standards – Basis for judging performance• Control – Helps judge variance and hence control is easier• Change of direction – May be necessary for strategic/operational reasons• Motivating the sales force – Specific targets help sales force perform better Debasis Das JSB 606 80
  81. 81. Sales & Cost Analysis• Gathering, classifying and studying sales data• Helps sales managers plan & direct sales efforts• Helps identify strengths and weaknesses of the organization• Cost analysis helps identify ways to increase efficiency of sales efforts Debasis Das JSB 606 81
  82. 82. Sales Variance Analysis• Value method or profit method• Variances calculated at sales value & profit value respectively• Sales volume variance is divided into sales price variance and sales volume variance• Sales volume variance is divide into sales quantity and sales mix variance Debasis Das JSB 606 82
  83. 83. Market Share Analysis• Compare sales with total sales of industry• Regular analysis required• Develop action plan• Forecast demand Debasis Das JSB 606 83
  84. 84. Sales Expense-to-Sales Variance Analysis• Fixed and variable expenses• Sales and marketing expense budgets take these into account• Amount of sales and expenses are compared with targets to find variability• Fixed budget basis, fixed expenses are taken into account• With flexible budget take fixed and variable components into account Debasis Das JSB 606 84
  85. 85. Sales Reporting• Reports form sales force – Call reports, expense reports, sales work plan, potential new business reports, lost sales report• Report from sales management – Periodic sales forecasts & actual sales – Sales promotions, expected results, actual results Debasis Das JSB 606 85
  86. 86. Credit Control• Credit to customers & channel partners should be guided by a formulated policy• Analyze accounts receivables & bad debts as also amount and type of receivables, credit rating of customers and channel partners Debasis Das JSB 606 86
  87. 87. Receivables Management• Devising & implementing an appropriate portfolio strategy(collection strategies)• Precise fulfillment strategy & invoicing• Efficient conflict resolution procedure Debasis Das JSB 606 87
  88. 88. Credit Rating• Amount of credit that can be given• Rate customers/channels partners through no-risk to high-risk categories• W/o the rating in place, it is either no credit or same credit to all customers, both are high risk Debasis Das JSB 606 88
  89. 89. Performance Evaluation• Formal & planned system for evaluation of sales personnel• Tool for motivation• Discovering areas that can be improved• Bad performers can be counseled, repeated bad performers should be taken out of the system Debasis Das JSB 606 89
  90. 90. Compensation & Incentives• Usually salary & incentives• Incentives are linked to what can be attributed to the efforts of an individual• Salary component is higher when it takes team effort, organization is a leader in the market, uncertain and or risky environment Debasis Das JSB 606 90
  91. 91. Sales Force Management Audit• Cross functional audit of selling function• Involves environment, planning system, organizational evaluation and sales functions• Identify problems, prevent recurrence of problems Debasis Das JSB 606 91
  92. 92. Distribution Control• Channel integration – Vertical management systems • Channel leader oversees functions of channel members • Corporate VMS, Administered VMS, Contractual VMS – Horizontal management systems • Cooperating organizations pool their resources• Channel management – Recruit and select right channel members – Motivating channel members & increasing profitability – Periodically evaluate channel member performance Debasis Das JSB 606 92
  93. 93. Evaluation of Channel Performance• Macro level performance – Channel efficiency, productivity, effectiveness and equity• Micro level performance – ROI, liquidity, financial leverage, growth pattern & potential of the individual member• Managing channel conflicts – Structural, attitudinal, faulty channel design, goal divergence or incompatibility• Conflict resolution strategies – Negotiations & bargaining, problem-solving strategies, persuasion, political strategies and cooperation Debasis Das JSB 606 93
  94. 94. Marketing communication Control• Advertising – Measuring ad effectiveness – Measuring effectiveness of Internet advertising• Sales promotion – Measuring effectiveness of sales promotion• Direct marketing – Evaluation of direct marketing campaigns• Public relations – Measurement of PR output – Measurement of PR outtake – Measurement of PR outcome Debasis Das JSB 606 94
  95. 95. Marketing Control in Branding• Brand equity – Value of a brand to consumers and the organization, helps attract new customers, retain old customers, higher equity less promotional expenses – Brand assets, brand strength and brand value• Brand measurement – Perception, performance and financial measurements• Brand portfolio management – Less than 20% of brands contribute to profit – Brand Audit • Review brand to find market share, percentage contribution, positioning Debasis Das JSB 606 95
  96. 96. Information Systems for Marketing Control• Marketing DSS – Helps marketing data analysis and decision making – Benefits • Increases effectiveness, breakdown of complex problems, analysis capabilities, identifying deviations early• Marketing intelligence – Correlation between marketing activities and business outcomes Debasis Das JSB 606 96
  97. 97. Sales Force Automation as Control Tool• Surveillance & control – Close supervising and monitoring behavior of the sales force – Standardization in conduct of business• Accountability – Increased interaction between manager & the sales force – Voice questions easily and get answers Debasis Das JSB 606 97
  98. 98. Mobile CRM• Mobile, remote access or wireless component application extension of the corporate CRM• Mobile sales force automation (SFA)• Mobile field service management (FSM) Debasis Das JSB 606 98
  99. 99. Enterprise-wide Applications• Improves overall control over business operations – Customer relationship management – Enterprise resource planning – Sales force automation Debasis Das JSB 606 99
  100. 100. Performance Reports & Reward System Debasis Das JSB 606 100
  101. 101. Analysis of Variance-1• Financial aspects: Expenses & Income(Revenue)• Variance: variances in revenue and income• Volume variance and price variance• Expenses: manufacturing & non manufacturing• Manufacturing costs: variable, semi- variable & fixed Debasis Das JSB 606 101
  102. 102. Analysis of Variance-2• Costs: determine extent & dimension to which revenues are affected by business operations• Costs are measured against standard costs set up by management• Variance analysis helps by – Identifying key factor that may affect operational profit – Focus on key variables, if variance is negative – Segregate the causal factor – Identify sequence of impact on the variables and impact on operational profit Debasis Das JSB 606 102
  103. 103. Analysis of Variance-3 Total varianceNon Mfg MFG costs Revenue Cost Semi Selling Variable Fixed variable Volume price costs costs costsa. Adminb. Selling c. R&D d. Mktg Market share Selling volume a. Material b. Direct labor c. Variable overheads Debasis Das JSB 606 103
  104. 104. Standards in Standard Costing• Current standards – Prevailing short time standards• Ideal standards – Standards under ideal conditions• Expected/attainable standards – Realistic attainable standards Debasis Das JSB 606 104
  105. 105. Setting Standards• Set up committee of key people from key functions and all management levels• Identify costs for which standards are needed – Labor costs where standard quantity and standard price is determined – Direct labor costs involving standard time & rate – Overhead costs where standard variables overhead and standard overhead are considered Debasis Das JSB 606 105
  106. 106. Analysis of Variance Debasis Das JSB 606 106
  107. 107. Material Cost Variance• Material cost variances• Material price variances• Material usage variance• Material mix variance• Material yield variance Debasis Das JSB 606 107
  108. 108. Labor Variance• Labor cost Variance• Labor rate(pay) variance• Total labor efficiency variance• Labor efficiency variance Debasis Das JSB 606 108
  109. 109. Overhead Variance• Variable overhead variance• Fixed overhead variance Debasis Das JSB 606 109
  110. 110. Other Variances• Selling price variance• Market penetration and industry volume variance• Expense variance Debasis Das JSB 606 110
  111. 111. Variance in Practice• Time period comparison• Focus on margin• Evaluation standards – Predetermined standards – Historical standards – External standards• Full cost system Debasis Das JSB 606 111
  112. 112. Limitations of Variance Analysis• Why the variance cannot be determined• Is a variance significant?• When aggregating plus or minus variances can balance out• Variances can happen due to extraneous factors such as inflation Debasis Das JSB 606 112
  113. 113. Tight vs. Loose Control• Variance analysis helps in tight control, it directly measures performance• In tight control, employees are given specific goals and are monitored to perform as expected• Loose control chooses the right people and it is expected they would do their best. Variance analysis acts as just an indicator Debasis Das JSB 606 113
  114. 114. Reward for good Performance• Rewards induce good performance• Good variance indicates good performance• Reward system integrated with overall goal realization of the organization Debasis Das JSB 606 114
  115. 115. Purpose of Reward System• Recognition of good work• Creates sense of belonging• Good communication line• Aspirations of employees need to be reflected in the appraisal system• Acts as a morale booster Debasis Das JSB 606 115
  116. 116. Reward through Compensation• Salary – Fixed• Benefits – Fixed• Incentives – Variable Debasis Das JSB 606 116
  117. 117. Performance Variables• Controllable• Non-controllable• Financial• Non-financial• Feedback Debasis Das JSB 606 117
  118. 118. Designing a Reward System• Understanding what is a reward for the management and the managers• Linking reward to the control system provides autonomy to the manager• Values & culture of an organization influence the reward system• Targets should be attainable• Both formal and informal rewards should be considered Debasis Das JSB 606 118
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