Management Control System

Management Control System Author: Manohar Prasad

3. BEHAVIOR IN ORGANIZATION Learning outcomes GOALS & CONGRUENCE INFORMAL FACTORS THAT INFLUENCE GOAL CONGRUENCE FORMAL CONTROL SYSTEMS TYPES OF ORGANIZATIONS FUNCTIONS OF THE CONTROLLER

Organization Structure How tasks are divided, resources are deployed, and departments are coordinated Set of formal tasks Formal reporting relationships Effective coordination of employees across departments 11/21/11 0

TYPES OF ORGANIZATIONS FUNCTIONAL ORGANIZATIONS BUSINESS UNIT ORGANIZATIONS MATRIX ORGANIZATIONS

Five Approaches to Structural Design 11/21/11 0

FUNCTIONS OF THE COTROLLER DESIGNING & OPERATING MCS FINANCIAL STATEMENTS & REPORTS TAX RETURNS PREPARATION AND ANALYSIS OF PERFORMANCE REPORTS

FUNCTIONS OF THE CONTROLLER(contd.) BUDGET PROPOSALS WITH ANALYSIS & JUSTIFICATION INTERNAL AUDITS FOR PREVENING FRAUD/THEFT DEVELOPING PEOPLE IN CONTROL FUNCTION BUSINESS UNIT CONTROLLER & CORPORATE CONTROLLER

4. RESPONSIBILITY CENTERS Learning outcomes TYPES OF RESPOSIBILITY CENTERS COST/EXPENSE CENTERS REVENUE/PROFIT CENTERS INVESTMENT CENTERS MEASURES USED TO EVALUATE THEIR PERFORMANCES ROI, ROA, MVA

THE CONTROLLER BUSINESS UNIT CONTROLLER CORPORATE CONTROLLER RELATIOSHIP BETWEEN BOTH DOTTED LINE SOLID LINE

RESPONSIBILITY CENTRES RESPONSIBILITY CENTRES MANAGER RESPONSIBLE FOR ACTIVITIES UNIT WITHIN COMPANY

RESPONSIBILITY CENTRES NATURE OF RESPONSIBILITY CENTRES OBJECTIVES INPUTS/WORK/OUTPUT RELATIONSHIP BETWEEN INPUT & OUTPUT

RESPONSIBILITY CENTRES MEASURING INPUTS & OUTPUTS PHYSICAL MEASUREMENT LIKE HRS, KGS TRANSLATED INTO MONETARY TERMS COST –MONETARY MEASURE OF RESOURCES USED BY RESPONSIBILITY CENTRE

RESPONSIBILITY CENTRES EFFICIENCY & EFFECTIVENESS RATIO OF OUTPUT TO INPUT RATIO OF OUTPUT TO ITS OBJECTIVES EVERY RESPONSIBILITY CENTRE OUGHT TO BE BOTH EFFICIENT AND EFFECTIVE A RESONSIBILITY CENTRE IS EFFICIENT IF IT DOES THINGS RIGHT, AND IT IS EFFECTIVE IF IT DOES THE RIGHT THINGS

TYPES OF RESPONSIBILITY CENTRES COST/EXPENSE CENRES TYPES ENGINEERED EXPENSE CENTRES b) DISCRETIONARY EXPENSE CENTRES

TYPES OF RESPONSIBILITY CENTRES 2. REVENUE CENTRES OUTPUT IS MEASURED IN MONETARY TERMS NO FORMAL ATTEMPT TO RELATE TO INPUT

Responsibility Accounting for Profit Centres Based on detailed information about both controllable revenues and controllable costs Manager controls operating revenues earned, such as sales, Manager controls all variable costs (and expenses) incurred by the centre because they vary with sales

Profit Centre Shows budgeted and actual controllable revenues and costs Prepared using the cost-volume-profit income statement format: Deduct controllable fixed costs from the contribution margin Controllable margin - excess of contribution margin over controllable fixed costs – best measure of manager’s performance in controlling revenues and costs Do not report non-controllable fixed costs

Advantages of Profit Centre Speed of operating decisions Quality of decisions Unit level day to day decisions Corporate can concentrate on long term planning Freedom for unit managers, less dependence on head office Excellent training ground Profit consciousness among units Ready made infn on profitability of compny’s independent units Competitive performance

Measuring Profitability Contribution margin Direct profit Controllable profit Income before taxes Net income Revenues

Investment Center An investment center is a subunit that is responsible for generating revenue, controlling costs, and investing in assets. An investment center is charged with earning income consistent with the amount of assets invested in the segment. Most divisions of a company can be treated as either profit centers or investment centers.

6. Transfer Pricing Learning outcomes Objectives and need of Transfer pricing Methods of Transfer Pricing Cost Based Market price based Negotiated price Administration of TRANSFER PRICES

Need For Transfer Pricing Liberalization and Growth of multinationals More decentralization. Considerable autonomy Encourage them to perform well. Business units are supposed to work under the same organization Performance of business units.

OBJECTIVES OF TRANSFER PRICES Proper distribution of revenue between profit centers. Resulting profit has to be shared between the profit centers. Providing relevant information to the profit centers Inducing goal-congruent decisions, -improve the profits of business units and also improve the profits of the company Measure the economic performance of profit centers Minimizing tax liability

Goal Congruence Some of the prerequisites for achieving goal congruency are Competent people Good organizational atmosphere Details of market prices Freedom to source Availability of information Scope for negotiation

Transfer Price Defined The price that is used to value internal transfers of goods and services within the same company is known as the transfer price.

Transfer Pricing The fundamental principle is that the transfer price should be similar to the price that would be charged if the product were sold to outside customers or purchased from outside vendors.

Transfer Pricing Not used for external pricing Used to set prices for transfers within a company’s departments, divisions, or segments Transfer prices do not affect revenues and costs of the company as a whole Transfer prices do affect revenues and costs of the divisions involved.

Pricing for Internal Providers of Goods and Services Transfer pricing enables a business to assess both the internal and external profitability of its products or services

Methods of calculating transfer price The three methods of calculating transfer price that are used commonly are: Cost-based pricing method Negotiated pricing method Market-Based Pricing Method

Cost Based Pricing How to define cost? Actual cost Standard cost Percentage of cost Percentage of investment

Market Based Pricing Market Price Information Freedom to source Full Information Negotiation Constraints

Negotiated Transfer Price May be based on an agreement to use a cost plus a profit percentage Will be between the negotiation floor and the negotiation ceiling Negotiation floor: the selling division’s variable cost Negotiation ceiling-the market price This approach allows for cost recovery while still allowing the selling division to return a profit

Administration of TRANSFER PRICES Implementing transfer pricing involves Long negotiations between heads of various units Classification of products, Arbitration conflict resolution in case conflicts arise.

Transfer Pricing in Multinational Settings Extremely difficult to set Tax systems Customs duties Freight and insurance costs Import/export regulations Foreign exchange controls Internal and external objectives of transfer differ May use different transfer prices for different countries; make certain of legality.

7.Measuring & Controlling Assets Prof.S.G.Patwardhan

Measuring & Controlling Assets Why long term investment is a strategic issue? Why long term investments is a control issue?

Characteristics of long-term assets Long-term assets (Building, Plant, Machinery, Information Technology) Long-term assets - an organization is committed for a long period of time. The lack of investment could cause opportunity losses or the investment could cause excess capacity. The investment amount is usually large.

Why relate profits to investments? Profits are generated ONLY if you have investments. Therefore, earning a satisfactory return on the investments employed is necessary. To compare two units, A and B, without considering the investment made in each is meaningless.

Responsibility Accounting Types of Responsibility Centers Cost center : only responsible for costs Revenue center : only responsible for revenues Profit center : responsible for both revenues and costs Investment center : responsible for revenues, costs, and investments

Measuring the Performance of Investment Centres Return on Investment (ROI) Residual Income (RI) Economic Value Added (EVA)

Accounting-Based Performance Measures Choose Performance Measures that align with top management’s financial goals Choose the time horizon of each Performance Measure Choose a definition of the components in each Performance Measure Choose a measurement alternative for each Performance Measure Choose a target level of performance Choose the timing of feedback

Effectiveness Degree to which a goal, objective, or target is met. Determined by process design Effectiveness vs Efficiency

Efficiency Degree to which inputs are used in relation to a given level of outputs. Determined by process design and how the process operates Performance may be effective, efficient, both, or neither. Effectiveness vs Efficiency

Return on Investment (ROI) ROI is an accounting measure of income divided by an accounting measure of investment

ROI ROI may be decomposed into its two components as follows: ROI = Return on Sales X Investment Turnover This is known as the DuPont Method of Profitability Analysis

A. The Components of ROI ROI has a distinct advantage over income as a measure of performance since it considers both income (the numerator) and investment (the denominator). or The breakdown of the formula shows that managers can increase return by more profit and/or generating more sales for each investment dollar. ROI = Income Invested capital ROI = Income Sales x Sales Invested capital Profit Margin Investment Turnover

Measuring the Performance of Investment Centers Margin : portion of sales available for interest, taxes and profit Turnover : how productively assets are being used to generate sales

D. Residual Income (RI) as an Alternative to ROI Residual Income = NOPAT – Required Profit = NOPAT – Cost of Capital x Investment = NOPAT – Cost of Capital x (Total Assets – Noninterest Bearing Current Liabilities) Residual Income (RI) overcomes the underinvestment problem of ROI since any investment earning more than the cost of capital will increase residual income.

Measuring the Performance of Investment Centers Residual income the difference between operating income and the minimum Rs. return required on a company’s operating assets

Components of RI Decomposition of the RI formula: RI = Operating income- (Minimum rate of return x Operating assets) = Operating income – Minimum return on Assets

Economic Value Added Economic value added (EVA) is after-tax operating profit minus the total annual cost of capital. EVA = After-tax operating income - (Weighted average cost of capital x total capital employed)

Measuring the Performance of Investment Centers Economic value added (EVA) after-tax operating profit minus the total annual cost of capital. Total capital employed = capital assets plus other expenditures meant to have a long-term payoff

MVA Market Value Added (MVA) Difference between the market value of a corporation and capital contributed by shareholders and lenders.

Management Control System

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Management Control System

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