Management control-system

REFORMULATED by:
MUHAMMADU SATHIK RAJA

Is the process of evaluating, monitoring and
controlling the various sub-units of the
organization so that there is effective and
efficient allocation and utilization of resources
in achieving the predetermined goals

 Involvement of people
 Information about the actual state of the
organization is compiled by people.
 It is compared by people.
 With the desired state decided by people.
 For significant difference, a course of action is
recommended by people
 Action taken by people

 The management decides the desired state or
standards against which performance is
compared.
 It decides what the organization plans to
achieve in a given time framework which is
known as Planning Process.
 Actual Performance is compared to Planned
Performance in control, so planning and
controlling are interlinked and are known as
P&C systems

 Planning activities of an organization
 Coordinating activities of an organization
 Communication information to different levels
of the hierarchical structure
 Evaluating information and deciding the
actions to be taken
 Influencing people to change their behavior.

A responsibility centre is an organisation unit that
is headed by manager who is responsible for its
activities.
 delegation of responsibility for specific to
successive lower levels of organisation.
 motivation of the level of management to
which a certain task has been delegated.
 measurement of the achievement of specified
objectives.

The key consideration in determining the
responsibility centre is
 ability to control cost or revenue
 determining the question of controllability
 evaluation of responsibility centre as per
predetermined criteria

The responsibility centres may be classified as
 Revenue Centres
 Expense Centres
 (III) Profit Centres
 (IV) Investment Centres

 In a revenue centre, output (I.e., revenue) is measured
in monetary terms, but no formal attempt is made to
relate input (I.e., expenses or cost) to output.
 The main focus of management’s efforts will be on
revenue generated by it.
 The sales department is an example for a revenue
centre.
 The effectiveness of the centre is not judged by how
much sales revenue exceeds the cost of the centre.
 Sales budget are prepared for revenue centre and
budgeted figures are compared with actual sales.
 Generally the costs are not related to output.

 It is the lowest level of responsibility centre in an
organization.
 Its manager is basically responsible for production of a
product or service; his decision authority relates to how
human resource, machinery and materials should be
used to produce the product or service.
 Expense centre manager has no control over revenues,
profits or investment.
 He has no control over marketing decisions or
investment decisions.
 Total performance of an expense centre manager
depends on how effectively and efficiently an expense
centre is operated.

 Effectiveness of an expense centre manager will
depend on a host of non-financial parameters such as
maintaining quality level of output, compliance with
production schedules and targets, maintaining morale
of the workers and so on.
 Normally, separate reporting systems are used to
report effectiveness.
 Efficiency is judged in terms of financial performance.
 It is measured and reported by the responsibility
accounting system.
 Evaluation of the financial performance of an expense
centre manager is by comparing the actual expenses of
the centre against the budgeted expenses.

 A profit centre is an organizational unit responsible for
both revenues and costs.
 Profit centre manager has no control over the
investment in the centre’s assets.
 Managers are concerned with both the production and
marketing of the products.
 Activities of the manager is much more broader than
that of a revenue centre manager because of the
responsibility to produce the product most efficiently.
 Profit centre’s performance measured in terms of
profit.
 It enhances profit consciousness
 Example:division of a company that produces and
markets different products.

 An investment centre is responsible for the
production, marketing and investment in the
assets employed in the segment.
 An investment centre manager decides on
aspects such as the credit policies, inventory
policies, and within broad framework.
 Investment centre manager responsible for
profit in relation to amounts invested in the
division.
 Financial performance of the manager of the
division is measured by comparing the actual
with projected rate of return on investments of
the centres

 Audit is the activity of examination and
verification of records and other evidence by an
individual or a body of persons so as to
confirm whether these records and evidence
present a true and fair picture of whatever they
are supposed to reflect. Audits are most
commonly used in the accounting and finance
functions

Audit category Brief description
•Gives an opinion on the accuracy of the financial
Financial statements
statement audit •Ensures compliance with the relevant accounting
standards and reporting framework
•An independent appraisal function established within
Internal audit an organization to examine and evaluate its activities
as a service to the organization
•Need not be limited to books of accounts and related
records

•Deters, detects, investigates, and reports fraud
Fraud auditing and •Forensic: related to the legal system, especially
forensic audit issues of evidence

•Audits operational aspects of the enterprise
Operational audit •Quality audit, R&D audit, etc

Audit category Brief description
•Audit of computer systems
Information •Checks whether the computer system safeguards
systems audit assets, maintains data integrity, and contributes to
organizational effectiveness and efficiency

•Audit of the management, as a tool for evaluation
Management audit and control of organizational performance
•Examines the conditions and provides a diagnosis of
deficiencies with recommendations for correcting
them

•Audit of the enterprise's reported performance in
Social audit meeting its declared social , community, or
environmental objectives

•Environmental compliance audit: a checking
Environmental mechanism
audit •Environmental management audit: an evaluation
mechanism

 Staffing the audit team
 Creating an audit project plan
 Laying the ground work
 Conducting the audit
 Analyzing audit results
 Sharing audit results
 Writing audit reports
 Dealing with resistance to audit
recommendations
 Building an ongoing audit program

 Identify opportunities for improvement
 Identify outdated strategies
 Increase management’s ability to address
concerns
 Enhance teamwork
 Reality check

 In the rapidly changing world of business, considering
only the financial measures of performance gives an
incomplete picture of the overall organizational
performance. It has become increasingly necessary for
organizations to simultaneously look at non financial
measures for this purpose.
 Concepts like JIT, TQM, and SIX SIGMA have brought
out the growing importance of non financial measures
for evaluating the organizations overall performance.
 A combination of financial and non financial measures
gives a better picture of organizational performance.
One concept which has received universal acclaim is
the “Balance Scorecard” (BSC), proposed by Robert
Kaplan and David Norton in 1992.

perspective Underlying question
Customer perspective To achieve our vision, how
should we appear to our
customer

Financial perspective To succeed financially, how
should we appear to our
shareholders

Internal business To satisfy our customer and
shareholders, at what business
perspective processes must we excel?

Innovation/learning To achieve our vision, how
growth perspective will we sustain our ability to
change and improve?

 If an organization emphasizes only short-term
or financial goals, it will not be able to
successfully execute its strategies and excel in
the business. The balance scorecard serves as a
tool for strategic performance control by
clarifying the vision and strategy of the
organization and articulating the top
management's expectations

 A transfer is referred to the movement of goods
from a responsibility center to another, within
the same company

 Different types of responsibility center,
belonging to different organizational levels, are
involved in the transfers

Many organizations set up business units that
cater to the needs of other business units within
their own fold. For example, one business unit
may manufacture components that are used by
another business unit to assemble the final
product.
 Here , there is a transfer of goods from the first

business to the second and the concept of
transfer pricing comes into play.

 Decentralization is one of the approaches that
many large organizations use to attain
operational effectiveness. However , the main
challenges in operating in a decentralized
manner lie in designing responsibility
structures and formulating appropriate policies
and methods to determine the performance of
the responsibility centers.
 The technique of transfer pricing plays an
important role in the smooth functioning of
responsibility structures in such an
organization

 Goal congruence:- the divisional manager in
maximizing the profits of his division, should not
engage in decision-making that fails to optimize the
organization’s performance.
 Performance appraisal :-it should aid in reliable and
objective assessment of the value added activities by
profit centers toward the organization as a whole
 Divisional autonomy:- each divisional manger should
be free to satisfy the requirements of his profit center
from internal or external sources. There should be no
interference in the process by other divisions like
buying centers and selling centers

 Budgets are business plans that are stated in
quantitative terms and are usually based on
estimations.
 These plans aid an organization in the
successful execution of strategies.
 Due to the uncertainties in the business
environment and / or due to wrong estimation,
there may be significant deviations between the
a c t u a l s and the plans.
 Budgeting as a control tool, provides an action
plan for the organization to ensure least
deviations

 Budgets are used to give an overview of the
organization and its operations. They are
useful in resource allocation whereby resources
are allocated in such a way that the processes
which are expected to give the highest returns
are given priority.
 Budgets are also used as forecast tools and
make the organization better prepared to adapt
to changes in the environment

 Budget preparation requires the participation
of managers from different functions /
departments. This helps in integrating the
tactical and operational strategies of the
departments with the corporate strategy of the
organization.
 Budgets act as a means to verify the progress of
the various activities undertaken to achieve the
planned objectives. The verification is done by
comparing the a c t u a l s against standards

 They help in the delegation of authority and
allocation of responsibility and accountability
to more people in an organization. They thus
promote division of labor, which , in turn,
promotes the process of specialization.
Functional specialization leads to the overall
efficiency of the organization

 Creating a budget department or appointing a budget
controller
 Developing guidelines for budget preparation
 Developing budget proposals at department/business
unit level
 Developing the budget for the entire organization
 Determining the budget period and key budgets
factors
 Benchmarking the budget
 Budget review and approval
 Monitoring progress and revising the budgets

Types of Budgets Characteristics Examples

Appropriation budget A ceiling is set for certain Training, advertising, sales
discretionary expenditures promotion and R&D
Based on the management
decision

Flexible budget A static amount is established The static part: Salaries,
for discretionary and committed depreciation, property taxes,
fixed costs and a variable rate is and planned maintenance. The
determined per unit of activity flexible part : direct material,
for variable cost direct labor, and variable
overhead .sales commission

Capital budget Decisions regarding potential New plant and equipment
investments are made using
discounted cash flow
techniques
Master budget A comprehensive plan is All revenue and expenditures
developed for all revenue and for any organization
expenditure

 What is EVA
EVA = Economic profit
 Not the same as accounting profit
 Difference between revenues and costs
 Costs include not only expenses but also cost of capital
 Economic profit adjusts for distortions caused by accounting
methods
 Doesn’t have to follow GAAP
 R&D, advertising, restructuring costs, ...
 Cost of capital accounted for explicitly
 Rate of return required by suppliers of a firm’s debt and equity
capital
 Represents minimum acceptable return.

 NOPLAT
Net operating profit after tax
 Operating capital
Net operating working capital, net PP&E, goodwill,
and other operating assets
 Cost of capital
Weighted average cost of capital %
 Capital charge
Cost of capital % * operating capital
 Economic value added
NOPLAT less the capital charge

Net operating profit after tax (NOPAT)
- Capital charge (= WACC * Capital)
= Economic value added (EVA)

Management control-system

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