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fundamentals of management control system
- 1. Fundamentals of Management Control Systems Chapter 12 Copyright ยฉ 2011 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin
- 2. Alignment of Managerial and Organizational Interests L.O. 1 Explain the role of a management control system. โข A management control system is designed to help managers make decisions that will increase the organizationโs performance. 12 - 2
- 3. Decentralized Organizations L.O. 2 Identify the advantages and disadvantages of decentralization. โข Decentralization is the delegation to subordinates of authority to make decisions in the organizationโs name. 12 - 3
- 4. Advantages of Decentralization LO2 โข Better use of local knowledge โข Faster response โข Wiser use of top managementโs time โข Reduction of problems to more manageable size โข Training, evaluation, and motivation of local managers 12 - 4
- 5. Disadvantages of Decentralization LO2 โข Dysfunctional decision making: Local managers can make decisions in their interest, which can differ from those of the organization. โข Duplication of administration: Local managers make the same types of decisions made at headquarters. 12 - 5
- 6. Management Control System L.O. 3 Describe and explain the basic framework for management control systems. โข It is a system designed to influence subordinates to act in the organizationโs interest. โข Principals (owners) use this system to influence agentsโ (managersโ) behavior. 12 - 6
- 7. Elements of a Management Control System LO3 โข Delegated decision authority โข Performance evaluation and measurement systems โข Compensation and reward systems 12 - 7
- 8. Responsibility Accounting L.O. 4 Explain the relation between organization structure and responsibility centers. โข Responsibility accounting reports revenues and costs at the level within the organization having the related responsibility. Responsibility Cost centers Revenue centers Profit centers Investment centers 12 - 8
- 9. Evaluating Performance L.O. 5 Understand how managers evaluate performance. โข Controllability concept: Managers should be held responsible for costs or profits over which they have decision-making authority. โข Relative performance evaluation (RPE): Compares divisional performance with that of peer group divisions 12 - 9
- 10. Corporate Cost Allocation L.O. 6 Analyze the effect of dual- versus single-rate allocation systems. Global Electronics Latin America Division Income for the Year ($000) Revenue (Percentage of corporate revenue) Direct division costs Allocated corporate overhead* Operating profit $70,000 16% 51,800 4,800 $13,400 $70,000 14% 51,800 3,500 $14,700 * Global Electronics allocates corporate overhead based on relative revenue. Corporate overhead was $25 million. Actual Target 12 - 10
- 11. Corporate Cost Allocation LO6 Global Electronics Latin America Division Income for the Year ($000) Revenue Direct division costs $70,000 51,800 $70,000 51,800 Actual Target My revenue and costs were on target. 12 - 11
- 12. Corporate Cost Allocation LO6 Global Electronics Latin America Division Income for the Year ($000) Revenue (Percentage of corporate revenue) Corporate revenue $ 70,000 16% $437,500a $ 70,000 14% $500,000b Actual Target a $70,000 รท 16% b $70,000 รท 14% I'm not responsible for corporate revenue. 12 - 12
- 13. Corporate Cost Allocation LO6 Global Electronics Latin America Division Income for the Year ($000) Allocated corporate overhead (Percentage of corporate revenue) Corporate costs $ 4,800 16% $30,000a $ 3,500 14% $25,000b Actual Target a $4,800 รท 16% b $3,500 รท 14% I'm not responsible for corporate costs. 12 - 13
- 14. Corporate Cost Allocation LO6 โข Dual rate method: This is a cost allocation method that separatesa common cost into fixed and variable components and then allocates each component using a different allocation base. Cost Activity Level Cost Activity Level 12 - 14
- 15. Performance Evaluation Systems Incentives L.O. 7 Understand the potential link between incentives and illegal or unethical behavior. โข Fundamental questions regarding a performance measurement system: โข Does the measure reflect the results of those actions that improve the organizationโs performance? โข What actions might managers be taking that improve reported performance but are actually detrimental to organizational performance? 12 - 15
- 16. Internal Controls L.O. 8 Understand how internal controls can help protect assets. โข Internal control is a process designed to provide reasonable assurance that an organization will achieve its objectives in the following categories: โข Effectiveness and efficiency of operations โข Reliability of financial reporting โข Compliance with applicable laws and regulations 12 - 16
- 17. End of Chapter 12 Copyright ยฉ 2011 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin
Editor's Notes
- In the previous chapters we considered how information could be developed to help managers make decisions. In this chapter we will discuss the fundamentals of management control systems.
- A management control system is designed to influence subordinates to act in the organizationโs interest.
- In a decentralized organization, subordinates have the authority to make decisions in the organizationโs name. The more decentralized the organization, the further down the organization chart decisions are made.
- Moving the decision-making authority to lower levels of management has some advantages. Local managers close to the decision in question have information about the conditions related to the decision and can react more quickly than top managers who may be removed from the information. Allowing the managers close to the issues to make decisions results in job satisfaction for the managers. Also, having local managers make some decisions frees top managersโ time allowing them to focus on strategically related issues.
- However, when local managers make decisions in their interest, those decisions may not be in the interest of the organization. There may also be some duplication of efforts if the same types of decisions are being made at headquarters.
- In a decentralized organization it is critical that the management control system is designed to influence subordinates to act in the organizationโs interest rather than their own.
- An effective management control system must allow for delegation of decision authority, performance and evaluation measurement, and compensation and reward systems.
- In responsibility accounting, costs and revenues are reported at the level within the organization having the related responsibility. Four types of responsibility centers exist: cost centers, revenue centers, profit centers, and investment centers.
- When evaluating managersโ performance, managers should only be held responsible for costs or profits over which they have decision-making authority.
- From previous chapters, we understand that indirect costs must be allocated for product pricing decisions and other management decisions. However, letโs look at what happens when costs, which a manager has no control over, are allocated to the managersโ division. Look at the Latin America Division of Global Electronics where managers are rewarded based on the operating profits of their division. This is one confused manager. Operating profit was $1,300,000 less than target.
- Targeted revenues of $70,000,000 and targeted direct costs of $51,800,000 were met. The manager did exactly what was planned. So, why is the manager not rewarded accordingly?
- Well, corporate revenue was targeted at $500,000,000 of which the $70,000,000 for the Latin America Division was 14%. Therefore, 14% of indirect costs from corporate overhead were targeted to be allocated to the Latin America Division. However, actual corporate revenue was only $437,500,000 indicating some other division or divisions did not meet targeted revenue, and so the Latin America Divisionโs revenue was 16% rather than 14% of total corporate revenue. Now the Latin America Division is going to be allocated 16% rather than 14% of corporate overhead. โPoofโ, the Latin America Division does not meet targeted profit!
- How can the manager of the Latin America Division be penalized because other managers did not meet target? You see the importance of responsibility accounting and goal congruence here.
- When using a dual rate method for allocating corporate costs, the organization separates variable and fixed corporate costs. The costs that vary with activity are allocated based on activity. For example, as activity in the Latin America Division changes, the amount of cost allocated changes. In this case, the actual activity was the same as targeted, so the amount allocated would be the same as the amount targeted. However, the fixed costs that the manager has no control over are allocated as originally targeted. The change in activity at the corporate level does not affect the cost allocated to the Latin America Division.
- A performance measurement system should identify what actions can improve the reported performance of the organization and reflect the results of those actions. The system should be structured so that managers have no reason or incentive to use illegal or unethical behavior to improve their performance evaluation and, therefore, their reward.
- Internal control is a process which provides top management and investors reasonable assurance that an organization will be effective and efficient, provide reliable financial reporting, and comply with the applicable laws and regulations.