Management Control System

Presented by:Ravish prakash

Management Control System

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

Characteristics of Control System In Organization

• 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

Functions

• 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.

Responsibility CentresResponsibility Centres

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

Revenue 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.

Expenses Centre

• 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.

Profit Center

• 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.

Investment Center

• 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

AUDITING

• 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

Categories Of Audits

Audit category Brief description

Financial statement audit

•Gives an opinion on the accuracy of the financial statements•Ensures compliance with the relevant accounting standards and reporting framework

Internal audit •An independent appraisal function established within 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

Fraud auditing and forensic audit

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

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

Audit category Brief description

Information systems audit

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

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

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

Environmental audit

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

The auditing process

• 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

Benefits of Auditing

• Identify opportunities for improvement

• Identify outdated strategies

• Increase management’s ability to address concerns

• Enhance teamwork

• Reality check

THE BALANCE SCORECARD

• 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.

The BSC framework considers the customer perspective, internal business perspective, and the innovation/learning and growth perspective, in addition to the financial

perspective

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 perspective

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

Innovation/learning growth perspective

To achieve our vision, how will we sustain our ability to change and improve?

Implementing the BSC

• 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

TRANSFER PRICING

• 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

Objectives of TP policy

• 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

• 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

Steps in Budget Formulation

• 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 discretionary expenditures

Based on the management decision

Training, advertising, sales promotion and R&D

Flexible budget A static amount is established for discretionary and committed fixed costs and a variable rate is determined per unit of activity for variable cost

The static part: Salaries, depreciation, property taxes, and planned maintenance. The flexible part : direct material, direct labor, and variable overhead .sales commission

Capital budget Decisions regarding potential investments are made using discounted cash flow techniques

New plant and equipment

Master budget A comprehensive plan is developed for all revenue and expenditure

All revenue and expenditures for any organization

EVA

• 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.

Components of EVA

• NOPLATNet operating profit after tax

• Operating capitalNet 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

Calculating EVA

Net operating profit after tax (NOPAT)

- Capital charge (= WACC * Capital)

= Economic value added (EVA)