Slide 1

Management Control system

Citra dewi wulansari14/374248/PEK/19683reguler 36Ch.4 Responsibility Center & Revenue Expenses

Concept of MCS2Management Control :is the process by which managers assure that the resources obtained are used efficiently and effectively in the accomplishment of organizational goals : Anthony

Efficiency : doing the things right ie. Relationship between input and outputI/P efficiency O/P

Effectiveness : doing the right things ie. Relationship between output and objectivesO/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

Responsibility Centers - Basic3Responsibility 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 called as its objectives

4Responsibility Centers Core operationRC receives inputs. Using capital and assets it converts this input in an output, that can be either tangible (goods) or intangible (services)

Management is responsible for ensuring the optimum relationship between inputs and outputs

WorkInputs Outputs

Resources usedMeasured by costGoods or services

Responsibility Centers Measuring inputs and outputs5Cost 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

Responsibility Centers Measuring inputs and outputs Efficiency and Effectiveness6Efficiency and effectiveness are the 2 performance measurement criteria for RC

Efficiency is a ratio of input to output (doing things right)

Effectiveness is determined by the relationship between a RCs output and its objectives (doing right things)

These 2 es 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)

7Responsibility Centers - Types

InputsWorkOutputs (monetary value)(physical)

Optimal relationshipCan be establishedExample Manufacturing FunctionAbove is the relationship between input and output in case ofAn ENGINEERED EXPENSE CENTER

Characteristics : - 1. Input can be measured in monetary terms2. Output can be measured in physical terms3. Optimum relationship between amount of input for one unit of output can be established

8Responsibility Centers - Types

InputsWorkOutputs (monetary value)(physical)

Optimal relationshipcant be establishedExample R & D FunctionAbove is the relationship between input and output in case ofAn DISCRETIONARY EXPENSE CENTERReflects managements decisions regarding certain policiesWeather to match or exceed the marketing efforts of competitorsTo find the appropriate amounts to spend for R&D

9Responsibility Centers - Types

InputsWorkOutputs (monetary value only for costs directly incurred)(monetary value)

Inputs not related to outputsExample Marketing FunctionAbove is the relationship between input and output in case ofa REVENUE CENTERMostly are sales unit that do not have authority to set selling priceFocus on target revenue onlyMarket demands is hard to predict

10Responsibility Centers - Types

InputsWorkOutputs (monetary value)(monetary value)

Inputs are related to outputsExample BUAbove is the relationship between input and output in case ofa PROFIT CENTER, the role of profit :Profit as an objectives is an important measure of effectivenessProfit is the difference between revenue (output) and expense (input)Thus, profit measures both effectiveness and efficiency

Who may be effective but not efficient, with the frugal manager, who uses less input but produces less than the optimum output ?

11Responsibility Centers - Types

Inputs Capital employedOutputs (monetary value)(monetary value)

Profits are related to capital employedExample BUAbove is the relationship between input and output in case ofan INVESTMENT CENTER : - Chapter 7 Measuring & Controlling Asset Employed

Responsibility centersEngineered & Discretionary expense center12PointEngineered ECDiscretionary ECNature of expenditureEngineered costs are those for which standards can be easily establishedDiscretionary costs are those for which standards cant be easily establishedI/p - o/p relationshipOptimal relationship can be establishedOptimal relationship cant be establishedApplicationManufacturing functionService functionBudget preparationBudget represents unit cost of performing task efficientlyBudget determined by the magnitude of the job to be doneBudgetary controlDifference between budget and actual is a measure of efficiency (since input and output optimum relationship can be established)Being within budget is importantDifference between budget & actual is not a measure of efficiency (since input and output optimum relationship cant be established)Doing the task is more important (doesnt mean that budget is not to be adhered; emphasis differs)Financial controlDuring performanceMore at planning stage

Responsibility centersProfit center & Revenue center13Profit CenterRevenue CenterMeaningA 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 relationshipOptimal 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)ApplicationBusiness unitsMarketing officesGoalMaximizing profit by controlling both revenue and expensesMaximizing revenue

Responsibility Centers General control characteristics of Discretionary ECs14Budget preparation based on the magnitude of the task to be done. Tasks divided into 2 :ContinuingSpecial

Incremental Budgeting

Zero Based Review

Cost variability not in short run

Type of Financial control planning important

Measurement of performance Doing the planned work is important

Incremental budgeting is budgeting based on slight changes from the preceding period's budgeted results or actual results.

This is a common approach in businesses where management does not intend to spend a great deal of time formulating budgets, or where it does not perceive any great need to conduct a thorough re-evaluation of the business.

Budgetary control Incremental Budgeting

Drawbacks in incremental budgeting method :

The current levels expenditure is accepted and not reexamined during the budget preparation process.

Managers typically want to increase the resource level, thus tend to request additional budget.

Overhead cost are sometimes drastically reduced without any adverse consequences.Budgetary control Incremental Budgeting

Budgetary control Zero based review17In contrast to incremental budgeting, Zero Based Review starts the budget from the scratch (de novo)

Managers are required to justify the items with proper bases

Thus ZBR is an intensive review of the budgetary allocations

Certain basic questions are asked like 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.

Variable costsare costs that change in proportion to the good or service that a business produces.

Discretionary expense centers, managers tend to approve changes that correspond to anticipated changes in sales volume.

Uneconomical to adjust the work force for short-run fluctuations.

Example : allowing additional personal when volume is expected to increase and layoff when volume is decrease.

Budgetary control Variable cost

The objective is to become cost competitive by setting a standard and measuring the actual cost.

Allowing the manager to participate in the planning of discretionary expense budgeting.

Financial control is primarily exercised at the planning stage before the cost are incurred.Budgetary control Financial control

Spending amount that is on budget is satisfactory, spending more may will cause for concern, spending less may indicate the planned work is poorly done.

Total control over discretionary expense centers is achieved primarily through nonfinancial performance measure.

The best indication for quality service is the satisfaction and opinion of the user.Budgetary control Measurement of Performance

Responsibility Centers Administrative & Support Centers Control problems & Budget preparation212 important reasons for control problemsDifficulty in measuring outputLack of goal congruence

Budget preparationSection covering costs of being in businessDiscretionary activitiesJustification for proposed increases in budget

Responsibility Centers R&D centers control problems, budget preparation & performance measurement22Budget preparationOne should understand R & D continuumBasic research applied research development production engineering testingNo scientific way of determining R & D budgetSome companies use % of revenue for R&D budgetFor basic research, budget can be a lump-sum amountFor testing, number of testing can be a budget base

Performance measurementMonthly/quarterly reports on budgeted and actual expense2 types of financial reports one reporting total R&D expense, the other reporting it separately for each RCEffectiveness of research is informed though progress reports ( these are not financial reports)

Responsibility Centers Marketing Centers activities and related controls23Logistic ActivitiesThese RCs are similar to expense centers in manufacturing plants and can be safely called as engineered expense centers

Marketing activities control problemsMeasuring output is easy, evaluating effectiveness is difficult because of influence of other factors on salesMarketing expenses are often budgeted at % of sales not because sales volume cause marketing expenses but because it gives larger affordabilityOrder-getting costs are that way discretionary and controls cannot be easily standardized