1. Concept of control
⢠Ensuring that implementation is done as per plans.
Steps :
1. Set standards
2. Communicate standards
3. Compare standards with actual performance
4. Report deviations
5. Take corrective actions.
1
2. Control Process in General
⢠Four basic elements â
â Detector (actual measurement)
â Assessor (comparison with standard)
â Effector (alteration of behavior, if required)
â Communication network (transmission of
2
information)
3. Elements of control process
3
Control device
(Assessor : compares
With standards)
Detector
(Provides information
About actual)
Effector
(Feedback for altering
Behaviour)
Entity being controlled
Communication
Network
Communication
Network
4. 4
Concept of MCS
⢠Management Control :
âMgt control is the process by which managers assure that the resources
obtained are used efficiently and effectively in the accomplishment of
organizational goalsâ : Anthony
Efficiency : doing the things right ie. Relationship between input and output
I/P efficiency O/P
Effectiveness : doing the right things ie. Relationship between output and
objectives
O/P effectiveness OBJECTIVES
System is a prescribed way or a systematic way of carrying out a set of
activities which are usually repetitive in nature
5. 5
MCS
⢠âMCS is a total system i.e. it covers all aspects of the
firmsâ operations to assure that all parts of the
operations are in balance with each otherâ: Anthony
⢠âMCS refers to a framework or a set up by which the
managers can ensure control over the actions of the
actions of his subordinates as well as control over
entire operations in the organization.â : Saravanavel
6. Characteristics of MCS
⢠Systematic method
⢠Result oriented
⢠Covers all operations
⢠Based on the concept of Responsibility Centres
⢠Covers both efficiency and effectiveness
⢠Control of managerial performance
⢠Regular process
⢠Ensures goal congruence
6
7. Designing MCS for an organization
⢠Pre â requisites
1. Control requires plans
2. Clear org structure
3. Active top mgt involvement
4. Participation and motivation of employees
5. Proper MIS
6. Proper accounting system ( responsibility
7
accounting)
8. âŚâŚâŚâŚâŚ..Designing
⢠Steps
1. Classifying org into responsibility centres(RC)
2. Fixing responsibility of each RC
3. Deciding key variables for performance assessment
4. Developing MIS
5. Finding deviations and relating it to individual responsibility
6. Performance reporting to top mgt
7. Short term remedial actions and long term measures for
8
controlling deviation
9. 9
Formal MCS
Responsibility
Center
performance
Mission,
Goals &
strategies
Strategic
Planning
Rules Other
Information
Budgeting
Report
Actual v/s
Plan
Was
Performance
Satisfactory?
Revise Revise
Corrective
action Measurement
Feedback
Communication
Reward (feedback)
Yes
No
10. General relationship between
Planning and control
Activity Nature of end Product
10
Strategy formulation
Management Control
Operational Control
Goals, Strategies, Policies
Implementation of Strategies
Effective and efficient
Performance of individual tasks
11. 3 levels of controls
11
Point Strategy formulation
(long term planning
based on environmental
analysis)
Management control
(ensuring managerial
performance in
accordance to
0bjectives )
Task control
(ensuring specific tasks
are performed
efficiently)
1. Nature of end product Goals, strategies &
policies
Implementation of
strategies
Efficient and effective
performance of individual
tasks
2. Degree of
systematization
Unstructured and
unprogrammed
Somewhat systematic
and regular
Most systematic
3. Time frame focus Focuses on long-run Focuses on medium-term Focuses on short-run
activities
4. Inputs Rough estimations of
future/external
Internal and Historical
and comprehensive
Uses current accurate
data related to specific
task only
5. Techniques SWOT, ETOP, Porters 5
force, BCG matrix, SAP
Budgeting , comparative
analysis
Variance analysis
6. Importance of planning
& control
Planning more important Planning & control
equally important
Control more important
12. SUB-SYSTEMS OF CONTROL
PROCESS : Formal
12
Formal Infrastructure
â˘Organization structure
â˘Patterns of autonomy
Formal Mgt style
and culture
â˘Autocratic / democratic
â˘Formal values and beliefs
Formal reward system
â˘Formal promotion policy
â˘Monetary incentives
Formal co-ordination /
co-operation
â˘Committees
â˘Formal meetings/conference
â˘Formal conflict resolution
techniques
Formal control
Process
13. SUB-SYSTEMS OF CONTROL
PROCESS : Informal
13
⢠Informal control is :
1. Ad- hoc ( as and when required)
2. Based on intuition, experience,
rationalization
3. No specific procedure.
14. SUB-SYSTEMS OF CONTROL
PROCESS : Informal
14
Informal Infrastructure
â˘Informal Organization
Structure (groups)
â˘Networks
Informal Mgt style
and culture
â˘Customs / traditions
â˘Prevailing individual styles
Informal reward system
â˘Appreciation
â˘Recognition / Status
Informal co-ordination /
co-operation
â˘Informal gatherings / outings
â˘Informal communication
â˘Informal conflict resolution
techniques
Informal
control
Process
15. Cybernetic Paradigm of control
15
Process
⢠Cybernetics is the theory of communication and
control
⢠Elements :
1. Sensors â collection of data formally/informal
2. Perception â Interpretation of data
3. Factual premises â belief about performance
4. Value premises â what is desired to be achieved
5. Behavioural repetoire - alternatives
16. Management Control Systems â
Cybernetic Paradigm & control
16
Environment Decision maker Goals
Value
premises
Factual
sensor Perception premises
Comparator
feedback
Behavior choice
Effector Behavioral
Repertoire
17. Cybernetic Paradigm & Control Process
Elements of a control process
1. Set goals and performance measures
2. Measure achievement
3. Compare achievement with goals
4. Compute variances
5. Report variances
6. Determine cause(s) of variances
7. Take action to eliminate variances
8. Follow-up to ensure goals are met
17
18. Attributes of good control system
18
(MCS)
1. A positive view of the control process
2. Objectives should be expressed in measurable terms
3. Objectives should have focus and should not be too many in numbers
4. Controls should seek balance among various aspects
5. No dual assignment of responsibility
6. True control is achieved by comparing projected performance against the
standard
7. Early warning predictors should be tracked
8. Use of sampling
9. Establish acceptable range of variation
10.Control by exception
11.Confirm severity of a problem; cause of the problem should be identified;
results of the corrective action should be monitored
12.Developing a discerning view of control
19. Understanding strategies â Concept
19
of strategy
⢠Strategy describes the general direction in
which an organization plans to move to attain
its goals
⢠Strategy formulation â Environmental analysis
pointing out opportunities and threats,
simultaneous internal analysis revealing
strengths and weaknesses, matching core
competencies with external opportunities and
deciding a strategy
20. Understanding strategies â
Corporate and unit-level strategies
⢠Corporate strategy is concerned more with where to compete
than how to compete; the latter is a matter of unit level
strategy
⢠Classification into 3 types for corporate level
20
â Single industry
â Related diversification
â Unrelated diversification
⢠Research has shown that, on average, related diversified
firms perform the best, single industry perform next best, and
unrelated diversified firms do not perform well over the long
run. This is because Corporate HQ, in the related diversified
firm, has the ability to transfer core competencies from one
business unit to another.
21. Understanding strategies â
Corporate level strategies-summary
21
of 3 generic strategies
Type Single industry Related diversified Unrelated diversified
Pictorial representation
Features Competes in only one
industry
Sharing core
competencies across
businesses
Totally autonomous
businesses in different
markets
Examples Wrigley, Ford Motor P & G, Gillete General Electric
22. Understanding strategies â
22
Unit-level strategies
⢠Business unit strategies depend on two interrelated aspects
1) its mission & 2)its competitive advantage
⢠There are a couple of famous models to fix the BU mission
⢠One is the BCG Model and the other one is the GE Planning
Model
⢠These models basically try to match the industry and the unit
in terms of opportunities/threats and strengths/weaknesses
⢠Control system designers need to know what is the BU
mission but not necessarily why the BU has chosen that
mission
23. Understanding strategies â
Business unit mission â BCG Model
High Low
High Low
23
âStarâ
Hold
âQuestion markâ
Build
âCash cowâ
Harvest
âDogâ
Divest
Market growth
rate
Relative Market share
High
Low
High
Low
24. Understanding strategies â
Business unit mission â GE Model
The Portfolio matrix &
Recommended Business Strategies
? Marks
Dominate/
Delay/Divest
Losers
Harvest/
Divest
Losers
Harvest/
Divest
24
Industry
Attractiveness
Winners
Invest
Selectively
Avg bus
Earn/
Protect
Losers
Harvest/
Divest
Business strength
High
Average
Low
Winners
Invest
Strongly
Winners
Invest
Selectively
Profit producers
Earn/
Protect
Strong Average Weak
25. Understanding strategies â Gaining
competitive advantage
⢠3 interrelated questions should be considered â
â What is the industry structure?
â How should the BU exploit it?
â What will be the basis of the BUâs competitive advantage?
⢠Michael Porter has suggested 2 analytical
approaches to develop & sustain competitive
advantage â
25
Industry analysis & Value chain analysis
26. Understanding strategies â Industry
26
structure analysis â
Porters 5 forces model
Threat of
New
Entrants
Intensity of
Industry
Competition
Threat
From
Substitutes
Suppliers
Bargaining
Power
Customers
Bargaining
power
27. Understanding strategies â Industry
27
structure analysis â
Porters 5 forces model
⢠3 observations with regard to industry analysis
â More powerful the 5 forces less profitable an industry is
likely to be; conversely in high profitable industries these 5
forces are not strong
â Depending on relative strength of the 5 forces the strategic
issues would emerge and would differ from industry to
industry
â Understanding the nature of each force helps the firm to
formulate effective strategies
28. Understanding strategies â
Gaining competitive advantage â Porters model
⢠The 5 force analysis is starting point to
develop competitive advantage as it helps
understanding external environment
⢠Response from the firm can be on two fronts â
low cost & differentiation
⢠A firm should strive to achieve cost leadership
and/or product differentiation to gain
competitive advantage
28
29. Understanding strategies â
Gaining competitive advantage â Porters model
Superior Inferior
29
Cost-cum-
Differentiation
advantage
Differentiation
advantage
Low cost
Advantage
Stuck-in-
The-middle
Relative
Differentiation
position
Relative Cost Position
Superior
Inferior
30. Understanding strategies â
Gaining competitive advantage â
30
Value chain analysis
⢠Value chain disaggregates the firm into its
distinct strategic activities
⢠It is a complete set of activities involved in a
product beginning with extraction of raw
material and ending with after sales service
⢠The VC framework is a method of breaking
down the chain into specific activities in order
to understand behavior of costs and sources
of differentiation.
31. Understanding strategies â
31
Gaining competitive advantage â
Value chain analysis
Product
Development Manufacturing Marketing
And Sales
Services/
Logistics
Support Activities : - Finance, Human Resources, IT
32. Understanding strategies â
Gaining competitive advantage â
32
Value chain analysis
⢠For each value added activity, key questions are â
1. Can we reduce costs in this activity, holding value (revenues)?
2. Can we increase value (revenues) in this activity holding costs
constant?
3. Can we reduce assets in this activity holding costs and value
(revenues) constant?
4. Most importantly can we do 1, 2 & 3 simultaneously?
⢠By systematically analyzing costs, revenues and assets
in each activity, BU can achieve cost-cum-differentiation
advantage.
33. Goal Congruence
⢠Central purpose of a MCS is to ensure a high level of
33
goal congruence
⢠In a goal congruent process actions people are led to
take in accordance with their perceived self-interest are
also in the best interest of the organization
⢠In evaluating any management control practice, 2 most
important questions are â
⢠What actions does it motivate people to take in their own self-interest?
⢠Are these actions in the best interest of the organization?
34. Goal Congruence-
Influencing factors
34
⢠INFORMAL FACTORS
⢠External
⢠Work ethic â overall attitude of the working community
⢠Internal
⢠Organization culture
⢠Management style
⢠Informal organization
⢠Perception and Communication
⢠FORMAL CONTROL SYSTEM
⢠MCS
⢠Rules â Physical controls, Manuals, System safeguards etc
35. 35
Goal congruence-
Formal MCS
Responsibility
Center
performance
Goals &
strategies
Strategic
Planning
Rules Other
Information
Budgeting
Report
Actual v/s
Plan
Was
Performance
Satisfactory?
Revise Revise
Corrective
action Measurement
Feedback
Communication
Reward (feedback)
Yes
No
36. Types of organizations â
A. Functional organization
36
CEO
Manufacturing
Manager
Marketing
Manager
Staff
Manager
Plant 1
Manager
Plant 2
Manager
Plant 3
Manager
Region A
Manager
Region B
Manager
Region C
Staff Staff
37. Types of organizations â
B. Business unit organization
37
CEO
Manager
BU X
Manager
BU Y
Staff
Plant
Manager
Marketing
Manager
Plant
Manager
Marketing
Manager
Staff Staff
Manager
BU Z
Plant
Manager
Marketing
Manager
Staff
38. Types of organizations â
C. Matrix organization
38
Chief Executive Officer
Staff
Function A
Manager
Function B
Manager
Function C
Manager
Project X
Manager
Project Y
Manager
Project Z
Manager
39. Organization Structure & implications
39
for system design
⢠Designers might be tempted to recommend the
BU structure because of the apparently clear-cut
profit responsibility. However they should not
forget other considerations.
⢠The system designer must always fit the system
to the organization rather than the other way
around
40. Functions of the Controller
⢠Design and operate information and control systems
⢠Preparing financial statements and reports
⢠Preparing and analyzing performance reports
⢠Compiling the annual operating plan (budget)
⢠Supervising internal audit and accounting control
40
procedures
⢠Developing subordinates
41. Nature of Controllers role
41
⢠Relation to line organization
⢠Controllership is a staff function
⢠Controller designs system, its use is done by line
managers
⢠Decisions made by controllers are primarily those that
implement policies decided by line management
⢠Controllers play important role in preparation of
strategic plans and budgets.
⢠They are also called to scrutinize reports prepared by
line managers
42. Nature of Controllers role
42
Business
Unit Mgr
BUC BUC
CC â Corporate Controller BUC â Business unit controller
Business
Unit Mgr
43. Responsibility Centers - Basic
⢠Responsibility Centers (RC) constitute the
structure of a control system and the assignment
of responsibility to organizational units must
reflect the organizations strategy.
⢠RC is an organization unit that is headed by a
manager who is responsible for its activities
⢠RC exists to accomplish some purpose that are
43
called as its objectives
44. Responsibility Centers â Core operation
⢠RC receives inputs. Using capital and assets it converts
this input in an output, that can be either tangible (goods)
or intangible (services)
Inputs Outputs
Work
Resources used
Measured by âcostâ
Goods or services
⢠Management is responsible for ensuring the optimum
44
relationship between inputs and outputs
45. Responsibility Centers â Measuring inputs
45
and outputs
⢠Cost is a monetary measure of the amount of
resources used by a RC
⢠It is much easier to measure the cost of input
than to calculate the value of outputs. For
example, a college can easily measure how
many students have passed but it is difficult to
measure how much education each of them
acquired
46. Responsibility Centers â Measuring inputs
and outputs â Efficiency and Effectiveness
⢠Efficiency and effectiveness are the 2 performance
46
measurement criteria for RC
⢠Efficiency is a ratio of input to output (doing things right)
⢠Effectiveness is determined by the relationship between
a RCâs output and its objectives (doing right things)
⢠These 2 eâs are not mutually exclusive; each RC has to
be efficient and effective as well
⢠Profit as a measure of performance measures both
efficiency and effectiveness because profit is the major
objective (effectiveness) and it is also the difference
between output and input (efficiency)
47. Responsibility Centers - Types
47
Inputs
Optimal relationship
Can be established
Work
Outputs
(monetary value) (physical)
Example â Manufacturing Function
Above is the relationship between input and output in case of
An ENGINEERED EXPENSE CENTER
Characteristics : - 1. Input can be measured in monetary terms
2. Output can be measured in physical terms
3. Optimum relationship between amount of input
for one unit of output can be established
48. Responsibility Centers - Types
48
Inputs
Optimal relationship
cant be established
Work
Outputs
(monetary value) (physical)
Example â R & D Function
Above is the relationship between input and output in case of
An DISCRETIONARY EXPENSE CENTER
49. Responsibility Centers - Types
49
Inputs
Work
Outputs
(monetary value
only for costs
directly incurred)
(monetary value)
Inputs not related to
outputs
Example â Marketing Function
Above is the relationship between input and output in case of
a REVENUE CENTER
50. Responsibility Centers - Types
50
Inputs
Inputs are related to
outputs
Work
Outputs
(monetary value) (monetary value)
Example â BU
Above is the relationship between input and output in case of
a PROFIT CENTER
51. Responsibility Centers - Types
51
Inputs
Profits are related to
capital employed
Capital
employed
Outputs
(monetary value) (monetary value)
Example â BU
Above is the relationship between input and output in case of
an INVESTMENT CENTER
52. Responsibility centers â difference between
engineered & discretionary expense center
Point Engineered EC Discretionary EC
52
Nature of expenditure Engineered costs are those for
which standards can be easily
established
Discretionary costs are those for
which standards cant be easily
established
I/p - o/p relationship Optimal relationship can be
established
Optimal relationship cant be
established
Application Manufacturing function Service function
Budget preparation Budget represents unit cost of
performing task efficiently
Budget determined by the
magnitude of the job to be done
Budgetary control Difference between budget and
actual is a measure of efficiency
(since input and output optimum
relationship can be established)
Being âwithin budgetâ is important
Difference between budget &
actual is not a measure of
efficiency (since input and output
optimum relationship cant be
established)
Doing the task is more important
(doesnât mean that budget is not to
be adhered; emphasis differs)
Financial control During performance More at planning stage
53. Responsibility centers â difference between
53
Profit center & revenue center
Point Profit Center Revenue Center
Meaning A responsibility center that is
responsible for both revenues and
expenses is profit center.
A responsibility center that is
responsible for revenues but not
for the expenses is revenue center.
I/p - o/p relationship Optimal relationship is established
between value of output (revenue)
and value of input (expense)
Optimal relationship cant be
established between value of
output (revenue) and value of input
(expense)
Application Business units Marketing offices
Goal Maximizing profit by controlling
both revenue and expenses
Maximizing revenue
54. Responsibility Centers â
General control characteristics of Discretionary ECâs
⢠Budget preparation â based on the magnitude of the task
54
to be done
⢠Tasks divided into 2 â continuing and special
⢠MBO technique used
⢠Incremental Budgeting
⢠ZBB review
⢠Cost variability â not in short run
⢠Type of Financial control â planning important
⢠Measurement of performance â Doing the planned work
is important
55. Responsibility Centers â
Administrative and Support Centers â control problems & budget preparation
⢠2 important reasons for control problems
55
⢠Difficulty in measuring output
⢠Lack of goal congruence
⢠Budget preparation
⢠Section covering costs of âbeing in businessâ
⢠Discretionary activities
⢠Justification for proposed increases in budget
56. Responsibility Centers â
R&D centersâcontrol problems, budget preparation & performance measurement
⢠2 important reasons for control problems
56
⢠Difficulty in relating results to output
⢠Lack of goal congruence
⢠Budget preparation
⢠One should understand R & D continuum
⢠Basic research â applied research â development â production engineering â
testing
⢠No scientific way of determining R & D budget
⢠Some companies use % of revenue for R&D budget
⢠For basic research, budget can be a lump-sum amount
⢠For testing, number of testing can be a budget base
⢠Performance measurement
⢠Monthly/quarterly reports on budgeted and actual expense
⢠2 types of financial reports â one reporting total R & D expense, the other
reporting it separately for each RC
⢠Effectiveness of research is informed though progress reports ( these are not
financial reports)
57. Responsibility Centers â
Marketing Centers â activities and related controls
57
⢠Logistic Activities
⢠These RCs are similar to expense centers in
manufacturing plants and can be safely called as
engineered expense centers
⢠Marketing activities â control problems
⢠Measuring output is easy, evaluating effectiveness is difficult
because of influence of âotherâ factors on sales
⢠Marketing expenses are often budgeted at % of sales not
because sales volume cause marketing expenses but
because it gives larger affordability
⢠âOrder-getting costsâ are that way discretionary and controls
cannot be easily standardized
58. Responsibility Centers â
58
Profit Centers
⢠2 conditions for delegating profit responsibility
⢠Access to relevant information needed for decision
making
⢠Measurement of effectiveness of the trade-offs made
by managers should be possible
59. Responsibility Centers â
59
Profit Centers
⢠Advantages of profit centers
⢠Improved quality of decisions
⢠Quick decisions
⢠HQ relieved from day-to-day decision making
⢠Effective use of imagination and initiative
⢠Training ground for managers
⢠Enhanced profit consciousness
⢠Information on profitability of individual units
⢠They respond well to improvement initiatives since
their output is so readily measurable
60. Responsibility Centers â
60
Profit Centers
⢠Difficulties with profit centers
⢠Loss of control
⢠Reduced quality of decisions
⢠Increased friction amongst units and HQ
⢠In-house competition may get substituted for
cooperation
⢠Additional costs
⢠Non-availability of competent GMs
⢠Too much emphasis on short-run profitability
61. Responsibility Centers â
61
Profit Centers
⢠Measurement of performance â Management
performance and economic performance
⢠Measures of economic performance â measures
of profitability
⢠Contribution margin
⢠Direct profit
⢠Controllable profit
⢠PBT
⢠PAT
62. Responsibility Centers â
Investment centers
62
⢠Difficulties in measuring assets employed
⢠Cash- actual cash held at HQ much less than that would have been required as
an independent company
⢠Receivables â whether to include at SP or COGS?
⢠Inventories â how to deal with creditors?
⢠Working Capital in general â treatment of current liabilities â 2 extreme treatments
⢠Fixed Assets â which value to consider? Problems with depreciation
⢠Leased assets â preference for leased assets over owned assets so as to reduce
capital charge
⢠Idle assets â exclusion from computation of assets employed
⢠Intangible assets â Capitalization of items like R & D and its repercussion on EVA
â if capitalized, very less incentive to cut such expenditure as it would only reduce
a part of if by way of capital charge
63. Responsibility centers â Performance
measures of an Investment center â ROI v/s EVA
63
Point RoI EVA
Meaning RoI is the comparison of the
income generated with the
assets employed.
EVA is the residual profit after
taking into account the capital
charge.
Calculation RoI is a ratio. Numerator is
income and denominator is
assets employed.
EVA is a value. It is found out
by subtracting capital charge
from Profit after Tax.
Superiority Conceptually EVA is superior
than RoI
Conceptually EVA is superior
than RoI
Popularity As per one survey carried by
Vijay Govindarajan of Fortune
1000 companies, RoI is more
popular than EVA
As per one survey carried by
Vijay Govindarajan of Fortune
1000 companies, RoI is more
popular than EVA
Simplicity of calculation RoI is comparatively easy to
calculate
EVA is a bit difficult to
calculate given the problems
with calculating the capital
charge
64. Responsibility centers â
Performance measures of an Investment center â RoI
⢠Advantages of RoI
â It is a comprehensive measure â anything that
affects the financial statements affect the RoI.
â Simple to calculate, easy to understand and
meaningful in an absolute sense
â It is a common denominator that may be applied
to any organizational unit responsible for
profitability regardless of size or type of business
64
65. Responsibility centers â
Performance measures of an Investment center â Superiority of EVA over RoI
⢠4 points
â EVA offer same profit objective for comparable investments, unlike RoI which may make
a manager reluctant to accept lower RoI (20%) opportunities than the current RoI (30%)
levels despite being more than CoC (10%). RoI creates a bias towards little or no
expansion in high-profit business units while at the same time low-profit units are making
investments at rates of returns well below those rejected by high-profit units.
â Units can increase RoI by actually decreasing its overall profits. This thing will not
65
happen if EVA is measured.
â Different interest rates can be used for different types of assets. For more riskier assets,
higher rates of costs of capital can be used. With RoI this is not possible.
â EVA as compared to RoI has a stronger positive correlation with changes in a
companyâs market value. To induce managers at the BU level to enhance shareholders
value, managers can be told to create and grow EVA.
66. Strategic Planning Process
1. Reviewing and updating the strategic plan from
66
last year
2. Deciding on assumptions and guidelines
3. First iteration of the new strategic plan
4. Analysis
5. Second iteration of the new strategic plan
6. Final review and approval
67. Budgetary control â
Budget preparation process
67
⢠Organization
⢠Budget Department
⢠Budget Committee
⢠Issuance of guidelines
⢠Initial budget proposal
⢠Negotiation
⢠Review and approval
⢠Budget revisions
⢠Procedures that provide for systematic updation
⢠Procedures that allow revisions under special circumstances
68. Budgetary control â
Types of budgets & importance
68
â Types
⢠Fixed and flexible budgets
⢠Functional budgets
⢠Incremental & Zero Base budgets
⢠Annual, quarterly, monthly and weekly budgets
⢠Importance
â It translates the strategic plan into an annual operating plan with
reasonable details
â It provides a basis for translating the strategic decisions into actions
during the forthcoming year
â It provides a good basis for controlling the actuals. Variances can be
analyzed and corrective actions can be taken.
â It relieves the top management from day-to-day intervention and
botheration as it can look only into activities that are outside the budget
69. Budgetary control â
Zero based budgeting
⢠In contrast to incremental budgeting, ZBB starts the budget
from the scratch (de novo)
⢠Managers are required to justify the items with proper
bases
⢠Thus ZBB is an intensive review of the budgetary
allocations
⢠Certain basic questions are asked like â should the activity
under review be performed at all? What should the quality
level be?
⢠It is a good way of doing budgeting and can eliminate a lot
of waste. However it demands some time and energy.
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70. Transfer Pricing - basics
⢠If 2 or more profit centers are jointly responsible for
developing, manufacturing and marketing of a product they
should share the revenue when the product is finally sold.
The transfer price is the mechanism for distributing this
revenue.
⢠Objective of TP â
⢠To provide each BU with information to determine optimum
tradeoffs between company costs and revenues
⢠To induce goal congruent decisions
⢠To measure economic performance of BUâs
⢠It should be simple to understand and easy to administer
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71. Transfer Pricing - methods
⢠Fundamental principle is that the TP should be similar to
the price that would have been if the product was sold in
outside market.
⢠Methods â
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⢠Cost based
⢠Marginal Costs plus markup
⢠Standard cost plus mark up
⢠Actual cost plus mark up
⢠Full cost plus mark up
72. Transfer Pricing - methods
72
⢠Market price based
â Equal to market price
â Less than the market price
â More than the market price
⢠Profit sharing : Profit of company distributed between
the departments
⢠Negotiated price
73. Transfer Pricing - methods
⢠Two-step pricing
⢠Instead of building the fixed cost and profit
element on a unit level as a part of the TP, the
same is charged to the transferee unit on a
periodical basis
⢠Thus the two-step pricing would mean â the first
step to charge the variable cost as the TP and in
the second step a lump-sum charging of the fixed
cost and the profit.
⢠This method helps the transferee division to
make appropriate short-term marketing decisions
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74. Transfer Pricing - methods
74
⢠Dual Pricing (2 sets of prices)
⢠Crediting transferor with outside sales price
⢠But charging the transferee with total standard costs
⢠Difference to be charged to a HQ account that will get
eliminated at the time of consolidation
⢠This method is used when there are conflicts between the
transferor and transferee division and any other method is not
working
75. 75
52%
31%
17%
Cost based
Market Price
Negotiated
price/other
Transfer Pricing - methods
Comparative usage of the TP methods by fortune 1000
Companies as per survey by Vijay Govindarajan
76. PERFORMANCE EVALUATION
⢠Framework for designing performance measurement and
performance evaluation lays emphasis on what is to be
measured and why it should be measured
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What counts,
Gets measured
What gets measured ,
Gets done
What gets done,
Gets rewarded
What gets rewarded,
Really counts. Strategy
77. Multiple criteria for performance
77
evaluation
⢠Financial and Non financial variables
⢠Internal and External measures
⢠Long term and short term indicators
⢠Separate controllable and uncontrollable
variables
78. Performance indicators
⢠Performance indicators can be:-
1.Results achieved : e.g. sales, profit
2.Efforts taken :- e.g. numbers of tests undertaken,
number of new customers contacted
3.Costs incurred : e.g. cost of production
4.Resources employed : e.g. human resource, capital
resources.
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79. Performance Measurement â
Balanced Score Card
79
⢠Developed by Kaplan and Norton
⢠Provides a mechanism for linking strategy to
action
⢠Translates strategy into measurable parameters
80. Performance Measurement â
Balanced Score Card
⢠Four perspectives to measure performance
⢠Customer : How do customers see us?
⢠Internal Business : What most we excel at ?
⢠Innovation and learning: Can we continue to create
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value?
⢠Financial: How do we look to shareholders?
⢠For each of this perspective appropriate
performance measures should be developed
81. Performance Measurement â Balanced
Score Card â Difference between financial and non-financial measures
Point Financial measures Non-financial measures
Meaning These are performance measures
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that are expressed in terms of
financial parameters
These are performance
measures that are not
expressed in terms of financial
parameters
Examples Return on Investment, EVA, Profit
Margin etc
Customer satisfaction,
Employee Morale etc
Degree of accuracy in
measurement
These measures can be quite
accurately measured
It is quite difficult to measure
and quantify these measures
Degree of attention Since these measures are easily
quantifiable and comparable,
practically they are widely applied
Since these measures are not
easily quantifiable and
comparable, practically they
are not that widely applied.
However with the advent of
BSC these measures are also
getting importance.
82. Balanced scorecard
82
Financial Perspective
Goals Measures
Learning and Growth
Perspective
Goals Measures
Internal Business
Process Perspective
Goals Measures
Customer Perspective
Goals Measures
Vision and
Strategy
83. Activity Based Costing (ABC)-
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Nature, Benefits
⢠ABC tries to allocate costs on rational basis instead of ad-hoc basis like
labor hours and machine hours or percentage of labor cost/material cost
⢠Cost drivers are identified. These are real causes of cost incurrence. For
example in purchasing activity, number of purchase orders is the cost
driver â it causes costs to happen in the purchase department
⢠The concept is quite useful given the fact that these days OHs are
significant elements of costs and the number of products produced by a
firm have increased. ABC gives more accurate costing of the products as
compared to traditional methods.
⢠Information provided by ABC can be used in policies relating to: -
â Full-line versus focused product line
â Product pricing
â Make or buy decision
â Product mix decisions
â Elimination of non-value-added activities etc
84. Activity Based Costing (ABC)-
comparison with traditional costing
84
Point Traditional Costing ABC
Key concepts Cost Center, basis of
allocation
Activity, cost driver
Basis of OH allocation Machine Hour, Labor
Hour etc
Based on actual
consumption of resource
measured through
different cost drivers
Accuracy in costs Less accurate product
costing
More accurate product
costing
Simplicity Relatively simple to use Relatively difficult to use
Suitability Lesser number of
products; OH cost
relatively less
More number of
products; OH cost
relatively high
85. MCS in service sector
⢠Characteristics of service organizations in
general
⢠Absence of inventory buffer
⢠Difficulty in controlling quality
⢠Labor intensive
⢠Multi-unit organizations
â The above characteristics peculiar to service
sector are the causes of differences in the nature
of MCS that is used in the Manufacturing Sector
85
86. MCS in service sector â
Professional service organizations
86
⢠Special Characteristics
⢠Goals
⢠Professionals
⢠Output and input measurement
⢠Small size
⢠Marketing
⢠MCS
⢠Pricing
⢠Profit Centers and TP
⢠Strategic planning and budgeting
⢠Control of operations
⢠Performance measurement and appraisal
87. MCS in service sector â
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Financial service organizations
⢠Special Characteristics
⢠Monetary assets
⢠Time period for transactions
⢠Risk and reward
⢠Technology
⢠MCS
⢠General principles of MCS apply but they need to be
adapted to the above mentioned special
characteristics
88. MCS in service sector â
88
Health Care Organizations
⢠Special Characteristics
⢠Difficult social problem
⢠Change in mix of providers
⢠Third-party payers
⢠Professionals
⢠Importance of quality control
⢠MCS
⢠General principles of MCS apply
⢠Because of high cost of equipments, strategic planning process is
important
⢠Annual budget preparation is conventional
⢠Huge quantity of information are available quickly for controlling of
operating activities
⢠Financial performance is analyzed by comparison of revenues and
expenses with budgets
89. MCS in service sector â
89
Nonprofit Organizations
⢠Special Characteristics
⢠Absence of the profit measure
⢠Contributed Capital
⢠Fund Accounting
⢠Governance
⢠MCS
⢠Product pricing
⢠Strategic planning and budget preparation
⢠Operation and evaluation
90. Auditing as a control tool
⢠Auditing is a control tool that ensures through checking,
verification of documents and evidence that the plans/policies of
the management are implemented as desired
⢠Many big organizations have a special internal audit department
that carries internal audit to see to it that the internal controls and
checks as set by the management are being adhered to
⢠There are different types of audits like financial audit, internal
audit, cost audit, management audit etc. Purpose of these audits
are different.
⢠An audit system makes the staff more vigilant. Audits like
concurrent audit in banks actually act a continuous control
system. Findings from an audit can help strengthen future
controls.
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91. Auditing as a control tool â Different
91
types
Point Financial Cost Internal Management
Purpose To verify trueness
and fairness of
financial statements
To check that the
cost accounting
plan is adhered
to
To check that the
internal checks
and controls are
being observed
To investigate
into specific
issues or check
effectiveness of
corporate
planning
Auditor Qualified CA Qualified ICWA Not necessarily
CA
Not necessarily
CA
Appointment By shareholders By Government
& Management
By Board of
Directors
By Management
Nature Mandatory as per
statute. Also known
as statutory audit.
Ordered by the
Central Govt.
Otherwise not
mandatory.
Usually optional. Optional.
Emphasis Compliance of
Accounting
Standards in
preparation and
Efficient use of
resources,
control over costs
Propriety/judiciou
sness of
decisions,
detection of
Effectiveness of
management
functions
92. Management Audit
⢠Management Audit as the name suggests is the audit of the
management itself, that is, the management auditor judges the
effectiveness of the functions performed by the management.
⢠The Management Auditor will check the planning, decision
making, controlling and other such functions performed by the
management.
⢠Management Auditor generally is a senior person with good all-round
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knowledge and experience.
⢠He uses tools like questionnaire to gather audit evidence.
⢠If used properly Management Audit can be a good control tool to
provide feedback to the management about its own
effectiveness.