MCS Paper Solution Final

8/2/2019 MCS Paper Solution Final

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MCS University Paper Solutions May 2001 to May 2011

MAY 2011

Q # 1.) Define MCS. Which levels of Managers are involved in it? How does MCS differ from

Simpler Control processes?

A # 1.)

MCS is a process by which management influences other members of the organisation

to implement the organisations strategies effectively and efficiently.

MCS is used by management to exercise control over the implementation of strategies

MCS differs from planning and control systems namely strategy formulation, operational

control and financial control in the following ways:

1. Systematic Strategy formulation is least systematic, operational control is the most

systematic, whereas management control lies in between.

2. Focus Strategy formulation focuses on long run, operational controls on short term

operating activities and management control system lies in between.

3. Estimates Strategy formulation is based on rough approximations of the future,

Operational control makes use of accurate data and MCS lies in between.

4. Degree of variation Planning is more important than control in strategy formulation.

While control process is more important in operational control. However, in MCS

planning and control both are of equal importance.

Q # 2.) Briefly describe Responsibility centre, engineered expense centre, discretionary

expense centre, revenue centre, profit centre. How is the performance of the head of these

centres evaluated?

A # 2.)

1. Responsibility centre A responsibility centre can be defined as an organisational unit

which is headed by a responsible person namely a manager. He is responsible for the

activities of the unit. Responsible centre is responsible for performing certain functions

which is its output.


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2. Engineered expense centre - engineered costs are the costs for which the right or

proper amount can be estimated with reasonable reliability. For example, cost of

material, labour, supplies, components and utilities, etc.

3. Discretionary expense centre - discretionary costs are those costs for which no such

engineered estimates are possible. The costs incurred in the discretionary expense

centre depend upon judgement of the management as to the appropriate amount under

the circumstances.

4. Revenue centre In revenue centre, output is measured in monetary terms. However,

there is no formal relationship between input and output. Marketing organisations are

the examples of revenue centres where no responsibility for profit exists.

5. Profit centre A profit centre is an organisational unit in which both revenues and

expenses are measured in monetary terms. Profit is a useful performance measure of a

responsibility centre. Thus the performance in a responsibility centre is measured in

terms of relevant revenue it earns and the cost it incurs.

Measures of performance management can be broadly defined in 2 categories

1.) Financial performance measures

Return on Investment

Residual Income

Earnings per share

Net present value

Economic Value added

2.) Non-financial performance measures

Balanced score card

Benchmarking

Q # 3.) Every SBU is a profit centre but not every profit centre may be SBU. Explain. Under

what conditions production, marketing and service dept. are converted into profit centre.


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A #3.) Conditions for an organization to be converted into a profit centre:

The manager should have access to the relevant information needed for making such a

decision.

There should be some way to measure the effectiveness of the trade-offs the manager

has made.

A major step in creating profit centres is to determine the lowest point in an organization where

these two conditions prevail.

Production dept.: Production department can be converted into a profit centre by the

manufacturing department to be credited with the sales proceeds of the products. The

estimated marketing expenses are debited. Other factors which influence on the mix and

volume of sales can produce better results if they are designed properly.

Marketing dept.: When the marketing department head is the best judge, regarding

principal cost and revenue trade-offs, the marketing dept is treated as a profit centre.

These expenses should be charged with the cost of product sold for the purpose of

converting a marketing dept into a profit centre.

Service dept.: The dept is credited with the charges for services rendered to other

departments in the organization. The service charges are calculated on a reasonable

basis and the departments using the services are charged on a reasonable basis. The

departments using the services can be given option of availing of such services from

other firms provided they offer the same quality and lower price.

Q # 4.) When are market based transfer prices most appropriate? How do we deal with the

condition of Limited Market, Situation of excess/shortage of capacity?


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A #4.) Market based transfer prices are most appropriate when they are determined by the

forces of demand and supply in the long run. The ideal situation when a market based transfer

price will induce goal congruence if following conditions exist:

Competent people

Good atmosphere

A market price

Freedom to serve

Full information

Negotiation

In case of Limited markets, the transfer price that best satisfies the requirements of a profit

centre system is the competitive price. Competitive prices measure the contribution of each

profit centre to the total company profits. Moreover, a competitive price measures how well a

profit centre may be performing against competitors.

In situation of excess capacity, the selling department does not sell in the outside market,

whereas the buying department may buy from outside vendors, though the inside capacity is

available in the company. However the company as a whole may not optimize its profits. A

cost-based transfer price using the variable cost of production will align incentives.

Q # 5.) What do you understand by Investment Centre? Explain two different methods

by which the performances of these centres are measured? Also discuss their relative

merits and demerits.

A #5.)

An Investment Centre is a responsibility centre in which the manager is held responsible for

the use of assets as well as for revenues and expenses of the centre. The manager is expected to

earn a satisfactory return on capital employed in the business units.

The two different methods by which the performance of Investment centre is measured are:

1.) Return on Investment (ROI)= Operating profit / Capital employed * 100


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Merits

1. To measure the operating performance of the organisation

2. To evaluate and control the capital expenditure projects

3. To make profit planning

4. To analyse the profit by operating divisions

5. To analyse the profit by product line

6. To price new products

7. To analyse major cost areas in a cost reduction programme

8. To determine the relative profitability of different projects

De-merits

1. Manipulative

2. Different bases for computation

3. Emphasis on short term profits

4. Poor measure

5. Allocation of resources

2.) Economic Value Added (EVA)= NOPAT Cost of Capital

Merits

1. Helps measure corporate performance and performance of business segment

2. Tells how managers are creating wealth

3. Most appropriate determination of cost of capital

4. Strong tool for business planning

De-merits


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1. failure to consider the future prospects of the company

2. Requires a lot of adjustments to financial information company

3. Requires a tradeoffs between accuracy and simplicity of calculation, since very

complicated adjustments result in a lack of credibility.

4. Doubt about universal suitability of EVA.

Q6)

6) Types of Organization:

a. Functional Organization

i. Oldest

ii. According to Functions

iii. Headed by an expert

iv. Special qualification needed

v. Better supervision and Control

vi. Higher efficiency

vii. Division of Labour

viii. Specialization

ix. Old, single product organizations

x. No diversification allowed

b. Divisional Organization

i. Specific product line

ii. As a separate company

iii. Responsible for planning and coordination

iv. Profitability of a division is performance measure


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v. Can buy/ sell / modify plant/ product

vi. A company within company

vii. Specialized knowledge related to product

viii. Complex Business

ix. Entrepreneurial spirit

x. Duplication of staff

c. Matrix Organization

i. Combination of Functional and Divisional

ii. Each division has target

iii. Project draws personnel from function

iv. 2 bosses

v. Better planning and control

vi. More flexible

vii. Improved communication

viii. Conflict between 2 or more functions

ix. No unity of command

Most appropriate form for control is Functional

Q7)

7) Non Profit Organizations

a. Cannot distribute asset or income

b. Employee compensation is allowed

c. Special purpose

d. No Profit


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e. Exempted from Income tax

f. Characteristics

i. Contributed capital

ii. Absence of profit

iii. Fund accounting

iv. Financial accounting

v. Governance

Product Pricing

a. Full cost

b. Peripheral activities at market price

c. Cost of admin work to be added

Performance Evaluation

a. Difficult as different activities

b. Budget allocation should match spending

Q8

8)

a. Implication of Organizational structure

Sr

No

Particulars Single

Industry

Related

Diversification

Unrelated

Diversification

1 Organizational

Structure

Functional Business Units Holding

company

2 Industry Familiarity

of Corporate mgmt

High Low


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3 Functional

Background

Relevant

operating exp

Mainly Finance

4 Decision-making

authority

More

centralization

More

decentralization

5 Size of corporate

staff

Large Small

6 Internal promotion High Low

7 Lateral transfers High Low

8 Corporate culture strong weak

Q 09

9) SN

a. Marketing by Service Organizations

i. No clear distinction between Marketing and production

ii. Difficult to assign responsibility for a particular sale

iii. Subjective rewards

iv. Sometimes as a percentage of project revenue

b. Balance Scorecard

i. Linking of Financial and Non-financial measures of performance

ii. A set of measures that give fast comprehensive view of the business

iii. Result of failure of traditional cost system

iv. Emphasis on the external reporting more than internal decision making

v. Better measure for Service industry


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vi. Aim of BS is to translate organizations strategic objectives to coherent

set of performance measures

vii. Cause and effect relationship

viii. Long term benefits for the business

ix. Four basic measures:

1. Financial

2. Customer

3. Internal business and production process

4. Learning and growth

c. Interactive Controls

i. Objective of IC is to facilitate the creation of a leaning organization

ii. Help to cope with changing environment

iii. Strategic uncertainties guide the use of a subset of management control

information interactively in developing new strategies

iv. Critical success factors are imp

v. Critical success factors are derived from chosen strategies

vi. They support implementation of strategies

vii. Strategic uncertainties are base for developing new strategies

viii. Alert system of troubles or opportunities

ix. Managers and subordinates meet face to face for discussion

x. They are not separate systems

xi. They are integral part of the MCS


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10)Problem

/unit 50% 80% 100%

Units 1 20000 32000 40000

Utilization 50% 80% 100%

Mat

cost

40/42/43.2 800000 1344000 1728000

Manu

cost

Fixed 9 180000 180000 180000

Var 21 420000 672000 840000

selling

cost

Fixed 4 80000 80000 80000

Var 6 120000 192000 240000

Admin

Cost

Fixed 5 100000 100000 100000

Var 5 100000 160000 200000

Total Cost 90 1800000 2728000 3368000

Profit 10 200000 312000 312000

S.P. 100 2000000 3040000 3680000

Company should work at 80%

Q11)

The actual sales are lesser than the budgeted sales. To find out the reason for this I

would investigate mainly 2 areas-

1. Sales promotion-


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This is a major driving factor for sales at all levels. The actual spend on sales

promotion is lesser than budgeted which means that not enough resources were

directed towards sales promotion which has resulted in lesser sales.

2. Fixed Assets-

The investment in fixed assets was also less than the budgeted amount. This may

imply that the production was hampered due to less investment in machinery or

plant and equipment.

Q12)

A B C

Capacity 10000 10000 10000

Cost of production:

Material Cost 10 10 10

Processing cost 20 10 10

Fixed Cost per unit 20 20 10

Transfer cost - 70 140

Required Return 20 30 40

70 140 210

Required Return for A= (10%*2000000)/10000= 20

Required Return for B= (15%*2000000)/10000= 30

Required Return for C= (20%*2000000)/10000= 40

Product transferred from to A to B- Rs. 70


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Product transferred from B to C- Rs. 140

Minimum price C should charge an external customer- Rs. 210

If the price of the product falls to Rs. 200, the company will not earn the required

return. Therefore unless the company is willing to reduce its profit expectations, it

should not manufacture the product.

Q13)

A B

2010 2011 2010 2011

ROTA 12% 13% 13% 12%

EVA 42 40 48 56

ROTA= PAT/TA

EVA for A, 2010= 72- 30 (10%* equity Capital)

EVA for A, 2011= 65- 25

EVA for B, 2010= 78- 30

EVA for B, 2011= 96- 40

(Assume Debt Equity ratio of 1:1 as no details are mentioned in the sum)

Based on ROTA division A has improved performance but based on EVA the division

B has performed better.

I feel Manager of division B is right as his division is adding value to the shareholders

which is the basic aim of running any business.


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MAY 2010

Q1)

Management control lies between strategy formulation and operational control. MCS has

certain limitations which are called as boundaries; that distinguish it from other planning and

control systems namely strategy formulation, operational control and financial control.

Strategy formulation has found to be the least systematic, operational control, the most

systematic and MCS falling in between. Strategy formulation focuses on the long run,

operational control on short term operating activities and MCS lies in between. Strategy

formulation is based on rough approximations of the future, operational control makes use of

current accurate data and MCS lies in between.

The three concepts are explained as follows-

1. Strategy formulation-

Its a planning process used by firms to decide on the goals of the organization and

strategies to be used for achieving these goals. Goals are the overall aims of the

organisation. Strategies are the plans for achieving the goals. Once a firm has

formulated its strategies, it operates in accordance with the strategies. They may be reexamined during the annual strategic planning exercise and some of them may be

changed or modified. Steps in strategy formulation are as follows-

a. Framing mission and objectives

b. Analysis of internal environment

c. Analysis of external environment

d. Gap analysis

e. Framing alternative strategies

f. Choice of strategy

2. Operational control-


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Its a process used for ensuring the tasks which are specified are carried out efficiently

and effectively. It involves the control of individual tasks. The rules to be followed for

accomplishing the tasks are prescribed as part of the management control process.

Many operational control activities are scientific in nature.

3. Management Control-

It involves the process of implementing strategies. There is generally a fixed time table

and a series of steps in accordance with which management control takes place. It is a

type of planning and control activity that is done by the organization. It is a process by

which management influences other members of the organisation to implement the

strategies effectively. Thus management control involves the behaviour of managers as

managers interact with other managers and this cannot be shown in the form of

equations.

Q2)

Expense centres are Responsibility centres whose inputs are measured in monetary terms but

outputs are not measured in monetary terms. In many cases it is not feasible to measure the

output in monetary terms. It is very difficult to measure the monetary value that the human

research department contributes to the organisation. If the control system measures the expense

incurred by the organisational unit but does not measure the monetary value of its output, the

unit is a expense centre.

There are two types of expense centres, engineered and discretionary.

1. Engineered Expense centres-

Engineered costs are the costs for which the right or proper amount can be estimated

with reasonable reliability e.g. costs of material, labour, supplies, components and

utilities etc.

In an engineered expense centre, an optimal relationship can be established between the

inputs and the outputs. They are generally found in manufacturing operations. Theyhave the following characteristics-


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a. Inputs can be measured in terms of money

b. Outputs can be measured in physical terms

c. Optimum amount of inputs which are required to produce one unit of output can be

established.

The output of an engineered expense centre gives the standard cost of finished product

if it is multiplied by standard cost of each unit manufactured. The difference between

the actual and the engineered costs represents the efficiency of the organisational unit.

2. Discretionary expense centres-

Discretionary costs are those costs for which no such engineered estimates are possible.These costs depend on the judgement of the management as to the appropriate amount

under the circumstances.

Discretionary expense centres include administrative and support units, R&D and

marketing activities e.g. accounting legal, industrial relations, public relations and

human resources. The output of these centres cannot be measured in monetary terms.

An optimum relationship cannot be established between input and output. The

difference between budgeted input and actual input measures the efficiency of

discretionary expense centres. This does not measure the value of the output.

Q3: SHORT NOTE ON ZERO BASED BUDGETING

ANS: Zero based budgeting (ZBB) is an alternative approach from the traditional cost

approach to budgeting. Under this method, the base line for the budget is zero rather than the

last years budget. So the manger must be able to justify each budget requirement instead of

simply making changes to the previous periods budget. In this way each function within an

organization is analysed for its needs and costs each year and around which the budget is built.

This method is usually used by governments and non-profit organizations.

ZBB requires considerable documentation. In addition to all of the schedules in the usual

master budget, the manager must prepare a series of decision packages in which all of the

activities of the department are ranked according to their relative importance and the cost of

each activity is identified. Higher level managers can then review the decision packages and cut

back in those areas that appear to be less critical or whose costs do not appear to be justified.


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ZBB is a good approach. The only issue is the frequency with which a ZBB review is carried

out which is on a yearly basis. Critics of such type of budgeting charge that properly executed

ZBB is too time consuming and too costly to justify on an annual basis. In addition, it is argued

that annual reviews soon become mathematical and that the whole purpose of zero based

budgeting is then lost. Whether or not a company should use annual reviews is a matter of

judgment. In some situations, annual zero based reviews may be justified; in other situations

they may not because of the time and cost involved. However, most managers would at least

agree that on occasion zero based reviews can be very helpful.

Advantages of ZBB:

1. Efficient allocation of resources, as it is based on needs and benefits.2. Drives managers to find cost effective ways to improve operations.

3. Detects inflated budgets.

4. Municipal planning departments are exempt from this budgeting practice.

5. Useful for service departments where the output is difficult to identify.

6. Increases staff motivation by providing greater initiative and responsibility in decision-

making.

7. Increases communication and coordination within the organization.

8. Identifies and eliminates wasteful and obsolete operations.

9. Identifies opportunities for outsourcing.

10. Forces cost centres to identify their mission and their relationship to overall goals.

Disadvantages of ZBB:

1. Difficult to define decision units and decision packages, as it is time-consuming and

exhaustive.2. Forced to justify every detail related to expenditure. The research and development

(R&D) department is threatened whereas the production department benefits.

3. Necessary to train managers. Zero based budgeting (ZBB) must be clearly understood

by managers at various levels to be successfully implemented. Difficult to administer

and communicate the budgeting because more managers are involved in the process.

4. In a large organization, the volume of forms may be so large that no one person could

read it all. Compressing the information down to a usable size might remove critically

important details.


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5. Honesty of the managers must be reliable and uniform. Any manager that exaggerates

skews the results.

Q3: SHORT NOTE ON FREE CASH FLOW

ANS:

1. Free cash flow (FCF) is a measure of financial performance calculated as operating

cash flow minus capital expenditures.

2. FCF represents the cash that a company is able to generate after laying out the money

required to maintain or expand its asset base.

3. FCF is important because it allows a company to pursue opportunities that enhance

shareholder value.

4. Without cash, it is tough to develop new products, make acquisitions, pay dividends

and reduce debts.

5. In corporate finance, FCF is the cash flow that is available for distribution among all

the securities holders of an organization. They include equity holders, debt holder,

preferred stock holders, and convertible security holders and so on.

6. We calculate FCF as: FCF = Net income + Amortization/Depreciation Changes in

working Capital Capital Expenditures.

7. However, the FCF definition should also allow for cash available to pay off the

companys short term debt. It should also take into account any dividends that the

company means to pay.

8. Therefore,: Net FCF = Operating cash flow Capital expenses to keep current level of

operation Dividends Current portion of long term debt Depreciation

9. Net of all the above fives the free cash that is available to be reinvested in operations

without having to take on additional debt.

10. Here, capital expenditure definition should not include additional investment on new

equipment. However, maintenance cost can be added. The dividend should be the bases

dividend that the company intends to distribute to its shareholders. The current portion

of long term debt is the minimum debt that the company needs to pay in order to create

no defaults. Depreciation is taken out since it accounts for future investment for

replacing the current property, plant and equipment. If the net income category includes

the income from discontinued operation and extraordinary income, it should not be a

part of free cash flow.


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4. Higher efficiency

5. Better customer services

6. Facilitates innovation

7. Improvement of corporate image

Disadvantages of SBU:

1. Increased expenditure

2. Difficulty in maintaining a single corporate image

3. Focus on performance of SBU may divert focus from corporates overall goals

4. Focus on short term performance

5. Distortion of information

When an entity is structured into strategic business units and the performance of these units is

measured in terms of accounting results, we use responsibility accounting. Managers are then

held accountable and rewarded on the basis of the results of their department. This is to lessen

the burden of top management by decentralising the responsibility along with authority and

decision-making. This also ensures more detailed and timely information that higher level

managers can use for making overall company policy-making decisions.

Under this method, revenues and expenses are accumulated and reported by levels of

responsibility so that actual cost is controlled by the appropriate manager responsible for its

incurrence by comparison with budgeted cost.

Q5: WHAT ARE THE OBJECTIVES OF A TRANSFER PRICING? WHAT ARE THE

DIFFERENT METHODS TO ARRIVE AT TRANSFER PRICE? DISCUSS THE

APPROPRIATENESS OF EACH METHOD. EXPLAIN WITH EXAMPLE.

ANS: the objectives of transfer pricing are as follows:

1. To foster a commercial attitude in those who are responsible for the performance of

profit centres. The main emphasis should be on profitability. It will force the units to

improve their profit position.

2. To optimise the profit of the company over a given period of time. For this purpose the

resources should be utilised to the maximum extent.

3. To make optimal use of companys financial resources. It should be based on relative

performance of various profit centres, which are influenced by transfer pricing policies.


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1.3.Standard cost: the transfer price is based on the standard cost which is a pre-determined

cost. The variances from standard cost are normally absorbed by the supplying unit or

sometimes transferred to the user unit. Therefore, inventories carried by both units are

at standard cost. Responsibility of profit performance is centralised. Profit performance

of each unit cannot be measured.

1.4.Cost of sales: also known as full cost, it allows for expenses on selling and distribution

in addition to the cost of production. However, there is no profit for the supplying unit.

Measurement of divisional profit is not possible under this method.

1.5.Cost plus a normal mark-up: this transfer price includes a profit margin or normal mark-

up in addition to the cost of production. The assumption is that the supplying unit is

selling to outside parties as well internal divisions, although the margins may not be the

same for both. This profit is expressed as a percentage of capital employed or cost of

sales. Profit performance of each unit is measurable and efficiency can be reasonable

determined. As the transfer price is arrived at by adding certain percentage of total cost,

the receiving division is not expected to pay for the inefficiency of the transferring

division. Hence this method is not very popular.

1.6.Opportunity based transfer pricing: when the goods being transferred have an external

market, the transfer price can be based on the opportunity cost of transferring the goods

internally. Opportunity cost represents the maximum contribution forgone by the

supplying unit in transferring the goods internally rather than selling them in the

external market. For this purpose a transfer price equal to market value is often treated

as an opportunity cost. The transfer price can be negotiated by recognising the levels of

output external sales and internal transfers that are best for the company as a whole. For

arriving at a transfer price that ensures all divisions is to maximise their profits at the

same level of output. The transfer price should be such that there is no more profitable

opportunity for individual divisions.

2. Contribution Margin Transfer Pricing:

Under this method, a company determines the total contribution margin earned after a

product is sold externally. The company allocates this margin back to each division based

on their respective proportions of the total product cost. This is used when the market prices

is not available. The company can use internal information for determination of transfer

price. This method can also used in special circumstances when a group benefits as a whole

from doing work internally rather than accepting an external quotation. It thus eliminates


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Q6: HOW IS AN INVESTMENT CENTRE DIFFERENT FROM A PROFIT CENTRE?

WHAT ARE THE DIFFERENT METHODS OF JUDGING THEIR PERFORMANCE?

WHICH IS A BETTER METHOD?

ANS:1. An investment centre is a responsibility centre in which the manager is held responsible

for the use of assets as well as for revenues and expenses of the centre.

2. A profit centre is the organisational unit in which both revenues and expenses are

measured in monetary terms.

3. For an investment centre, performance is based on return on capital employed

4. However, since it is difficult to measure the investment base or the capital employed

this is not the best measure of performance of an investment centre.

5. Similarly, using assets employed, valuation of fixed and current assets and valuation of

liabilities becomes difficult.

6. Accounting rate of return is another fairly good measure of performance of the business

manager.

7. Therefore, the best method to measure performance in an investment centre is economic

value added.

8. In a profit centre, performance is measured by one comprehensive indicator rather than

many indicators and that is profit which is the excess of revenues over expenses.

9. In terms of profitability, the manager can be evaluated based on his effectiveness and

efficiency or actual economic profitability.

10. In case of non-profit making organisations, the term financial performance centres is

used as an alternative concept.

Q7: WHAT DO YOU UNDERSTAND BY BALANCE SCORECARD? EXPLAIN WITH

AN EXAMPLE.

ANS:

The linking of financial and non-financial measures of performance and identification

of key performance measures helps to devise the balance score card, a set of measures

that give top managers a fast but comprehensive view of the business.

It assists management in strategic policy formulation and achievement.

It emphasises the need to provide the user with a set of information which addresses all

the relevant areas of performance in an objective an unbiased fashion.


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The aim of balanced scorecard is to provide a comprehensive framework for translating

a companys strategic objectives into a coherent set of performance measures.

The term became popular after an article in 1992 in the Harvard Business Review by

Robert Kaplan and David Norton. It has four concepts which are- focus on strategies for each business unit, assessing lead

and lag indicators which suggest financial and non-financial measures of performance,

inclusion of financial and non-financial measures of performance, communication with

employees.

The four basic perspectives of a balanced score card are- financial perspective (cash

flow, return on equity, etc), customer perspective (%of sales from a new product, on

time delivery), business and production process perspective (cycle time, unit cost) andlearning and growth perspective (time to develop next generation, new product

introduction)

Q8: HOW DOES A SERVICE ORGANISATION DIFFER FROM A

MANUFACTURING ORGANIZATION? HOW IS A PROFESSIONAL SERVICE

ORGANISATION DIFFERENT FROM A NORMAL SERVICE ORGANISATION?

HOW IS PRICING AND MARKETING DONE BY PROFESSIONAL SERVICE

organisation ?


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ANS: Manufacturing Organisation engaged in the production of goods (finished products) that

have value in the marketplace. These Organisations are further classified into two as Process

Organisation (Flow production or continuous process production industries) and Discrete

Manufacturing Organisation. Service Organisation includes those Organisations that do not

produce goods, but provide certain services. The peculiarity of these organisations is that often

the consumption of the service takes place while it is in the generation. Typically, this sector

includes hospitality, advertising, banking, insurance, consultancy, logistics, etc. The significant

difference between the various types of organisations is observed when we analyze the

manufacturing or service environment in which they operate. Elements of the manufacturingenvironment include external environmental forces, corporate strategy, business unit strategy,

other functional strategies (marketing, engineering, finance, etc.), product selection,

product/process design, product/process technology and management of competencies.

Ultimately, what matters is the framework in which the overall manufacturing or service

strategy is developed and implemented.

Professional Organisation


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Professional Organisation is labour intensive and the labour is of a special type. Many

professionals prefer to work independently, rather than as part of a team. Professional who are

also managers tend to work only part time on management activities; senior partners in the

accounting firm participate actively in audit engagement; senior partners in the law firm have

clients. In most professional, education does not include education in management; quite

naturally it stresses the importance of the professional, rather than that of management; for this

and other reason, professional tend to look down on manager. Professionals tend to give

inadequate weight to the financial implication of their decisions; they want to do the best job

they can, regardless of its cost. Because professional are the organisations most important

resources, some authors have advocated that the value of these professional should be counted

as assets. The system that does this is called Human Resource Accounting, but the problem of

measuring the value of human assets is intractable.

Marketing in Professional Organisation

In a manufacturing company there is a clear dividing line between marketing activities and

production activities; only senior management is concerned with both. Such a clean separation

does not exist in most professional organisation, however. In some, such as law, medicine and

accounting, the professionals ethical code limits the amount and the character of overt

marketing efforts by professional. Marketing is an essential activity in almost all organisations,

however. If it cant be conducted openly, it takes the form of personal contact, speeches,

articles, golf and similar activities. These marketing activities are conducted by professionals,

usually by professional who spend much of their time in production work that is working for

clients.

Pricing in Professional Organisation

The selling price of work is set in a traditional way in many professional firms. If the

profession is one in which members are accustomed to keeping track of their time, fee

generally are related to professional time spent on the engagement. The hourly billing rate

typically is based on the compensation of the grade of the professional plus a loading

for overhead costs and profit. In other professions such, as investment banking, the fee

typically is based on the monetary size of the security issue. In still others, there is a fixed

price for the project. Prices vary widely among professions; they are relatively low for research

scientists and relatively high for accountants and physicians.

Q.9


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Corporate Level Strategy

Corporate level strategy occupies the highest level of strategic decision-making and

covers actions dealing with the objective of the firm, acquisition and allocation of

resources and coordination of strategies of various SBUs for optimal performance.

Top management of the organization makes such decisions. The nature of strategic

decisions tends to be value-oriented, conceptual and less concrete than decisions at the

business or functional level.

Business Unit level Strategy

Business-level strategy is applicable in those organizations, which have different

businesses-and each business is treated as strategic business unit (SBU).

The fundamental concept in SBU is to identify the discrete independent product/market

segments served by an organization. Since each product/market segment has a distinct

environment, a SBU is created for each such segment.

There-fore, it requires different strategies for its different product groups. Thus, where

SBU concept is applied, each SBU sets its own strategies to make the best use of its

resources (its strategic advantages) given the environment it faces.

At such a level, strategy is a comprehensive plan providing objectives for SBUs,

allocation of re-sources among functional areas and coordination between them for

making optimal contribution to the achievement of corporate-level objectives. Such

strategies operate within the overall strategies of the organization.

The corporate strategy sets the long-term objectives of the firm and the broad constraints and

policies within which a SBU operates. The corporate level will help the SBU define its scope of

operations and also limit or enhance the SBUs operations by the resources the corporate level

assigns to it.

For example, in an organization of any size or diversity, corporate strategy usually applies to

the whole enterprise, while business strategy, less comprehensive, defines the choice of product

or service and market of individual business within the firm. In other words, business strategy

relates to the how and corporate strategy to the what. Corporate strategy defines the

business in which a company will compete preferably in a way that focuses resources to

convert distinctive competence into competitive advantage.


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Corporate strategy is not the sum total of business strategies of the corporation but it deals with

different subject matter. While the corporation is concerned with and has impact on business

strategy, the former is concerned with the shape and balancing of growth and renewal rather

than in market execution.

Q.10

(a) ROE = PAT________ x 100

Total Equity

= (39/300) x 100

= 13%

ROCE = PBIT__________ x 100

Capital Employed

= (80/400) x 100

= 20%

After expansion

Sales 700

Variable cost 455

Contribution 245

Less: Fixed Cost 42

Less: Depreciation 40

PBIT 163Less: Interest 30

PBT 133

Tax @ 40% 53.2

PAT 79.8

Working:

1. Sales = 500 * 1.4 = 700

2. Variable cost to selling price in 2009-10 = (350/500)* 100 = 70


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Therefore new Variable cost to selling price = 70 5 = 65%

3. Depreciation in 2009-10 = 30 (10% of 300 lakhs)

Depreciation after expansion = 10% of (300 + 100) = 40

4. Interest in 2009-10 = 15 (15% of 100)

Interest after expansion = 15% of (100 + 100) = 30

ROE = (79.8/400) * 100 = 19.95%

ROCE = (163/600) * 100 = 27.17%

Asset Turnover ratio = Sales/Total Assets

= 700/600 = 1.17 times

Q.12

50% 60% 80%

(10000 units) (12000 units) (16000 units)

Sales 20,00,000 23,52,000 30,40,000

Less: Variable Cost

Materials 10,00,000 12,24,000 16,80,000Labour 3,00,000 3,60,000 4,80,000

Factory Overheads 1,80,000 2,16,000 2,88,000

Admin Overheads 1,00,000 1,20,000 1,60,000

Contribution 4,20,000 4,32,000 4,32,000

Less: Fixed cost

Factory Overheads 1,20,000 1,20,000 1,20,000

Admin Overheads 1,00,000 1,00,000 1,00,000

Profit 2,00,000 2,12,000 2,12,000

Working:

Units @ 60% = (10000/50%) * 60% = 12,000

Units @ 80% = (10000/50%) * 80% = 16,000

Q.13

Budget Actual Variance

In Rs. cr In Rs. cr In Rs. cr

Sales 40 34 6


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Less: Operating costs

Factory costs 21 17 4

Marketing costs 7 3 4

Freight 1 .8 .2

Admin expenses 3 3.2 -.2

32 24 8Operating profits 8 10 -2

Operating assets

Accounts receivable 8 8.5 -.5

Cash 4 2 2

Inventory 18 21.5 -3.5

Fixed assets 20 20 0

50 52 -2

ROI=Operating profit/Operating assets 16% 19.23% -3.23

(b) Budgeted ROI was 16% whereas actual ROI for the first quarter 1s 19.23% which is higher.

Thus, the performance of the division is satisfactory. The second quarter budget is favorable

because the sales are budgeted less and cost is also less as compared to the first quarter.

However. The amount of fixed assets is rs. 2 crores as against Rs 20 crores for fixed assets. The

second revision may be for sales of Rs 36vcrores which may be higher and should be reduced

to some extent because all other costs are also reduced. Moreover budgeted sales for the first

quarter were Rs 40 crores and actual sales realized were only Rs 34 crores.


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MAY 2009

Q1 Stages in Management control process

The control process involves carefully collecting information about a system, process, person,

or group of people in order to make necessary decisions about each. Managers set up

control systems that consist of four key steps:

1. Establish standards to measure performance. Within an organization's

overall strategic plan, managers define goals for organizational departments in specific,

operational terms that include standards of performance to compare with organizational

activities.

2. Measure actual performance. Most organizations prepare formal reports of

performance measurements that managers review regularly. These measurements should

be related to the standards set in the first step of the control process. For example, if sales

growth is a target, the organization should have a means of gathering and reporting sales

data.

3. Compare performance with the standards. This step compares actual

activities to performance standards. When managers read computer reports or walk

through their plants, they identify whether actual performance meets, exceeds, or falls

short of standards. Typically, performance reports simplify such comparison by placing

the performance standards for the reporting period alongside the actual performance for

the same period and by computing the variancethat is, the difference between each

actual amount and the associated standard.

4. Take corrective actions. When performance deviates from standards, managers

must determine what changes, if any, are necessary and how to apply them. In the

productivity and quality-centered environment, workers and managers are often

empowered to evaluate their own work. After the evaluator determines the cause or

causes of deviation, he or she can take the fourth stepcorrective action. The most

effective course may be prescribed by policies or may be best left up to employees'

judgment and initiative.

These steps must be repeated periodically until the organizational goal is achieved.


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income to the value of the capital employed. In practice, the term investment centreis not

widely used. Instead, the term profitcentreis used indiscriminately to describe centres that are

always assigned responsibility for revenues and expenses, but may or may not be assigned

responsibility for the capital investment. It is defined as a responsibility centre in which inputs

are measured in terms of cost / expenses and outputs are measured in terms of revenues and in

which assets employed are also measured.

Nature of responsibility centres

A responsibility centre exist one or more purpose are its objectives. The company as a whole

has goals, and senior management has decided on a set of strategies to accomplish these goals.

The objectives of responsibility centres are to help implement these strategies

Q3) Every SBU is a profit center but every profit center is not a SBU? What are the

conditions that should be fulfill for an organization unit to be converted into a profit

center? What are the different ways to measure the performance of profit center? Discuss

their relevant merits and demerits.

Conditions for an organization to be converted into a profit centre: Many management

decisions involve proposals to increase expenses with the expectation of an even greater

increase in sales revenue. Such decisions are said to involve expense/revenue trade-offs.

Additional advertising expense is an example. Before it is safe to delegate such a trade-off

decision to a lower-level manager, two conditions should exist.

The manager should have access to the relevant information needed for making such a

decision.

There should be some way to measure the effectiveness of the trade-offs the manager has

made.

A major step in creating profit centres is to determine the lowest point in an organization

where these two conditions prevail. All responsibility centres fit into a continuum ranging

from those that clearly should be profit centres to those that clearly should not. Management

must decide whether the advantages of giving profit responsibility offset the disadvantages,

which are discussed below. As with all management control system design choices, there is no

clear line of demarcation.


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entirely controllable. Many expense items are discretionary; that is, they can be changed at the

discretion of the profit centre manager. Presumably, senior management wants the profit centre

to keep these discretionary expenses in line with amounts agreed on in the budget formulation

process. A focus on the contribution margin tends to direct attention away from this

responsibility. Further, even if an expense, such as administrative salaries, cannot be changed

in the short run, the profit centre manager is still responsible for controlling employees'

efficiency and productivity.

(2) Direct Profit:

This measure reflects a profit center's contribution to the general overhead and profit of the

corporation. It incorporates all expenses either incurred by or directly traceable to the profitcentre, regardless of whether or not these items are within the profit centre manager's control.

Expenses incurred at headquarters, however, are not included in this calculation. A weakness

of the direct profit measure is that it does not recognize the motivational benefit of charging

headquarters costs.

(3) Controllable Profit:

Headquarters expenses can be divided into two categories: controllable and non controllable.

The former category includes expenses that are controllable, at least to a degree, by the

business unit manager-information technology services, for example. If these costs are

included in the measurement system, profit will be what remains after the deduction of all

expenses that may be influenced by the profit centre manager. A major disadvantage of this

measure is that because it excludes non controllable headquarters expenses it cannot be

directly compared with either published data or trade association data reporting the profits of

other companies in the industry.

(4) Income before Taxes:

In this measure, all corporate overhead is allocated to profit centres based on the relative

amount of expense each profit centre incurs. There are two arguments against such allocations.

First, since the costs incurred by corporate staff departments such as finance, accounting, and

human resource management are not controllable by profit centre managers, these managers

should not be held accountable for them. Second, it may be difficult to allocate corporate staff


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services in a manner that would properly reflect the amount of costs incurred by each profit

centre.

There are, however, three arguments in favour of incorporating a portion of corporate overhead

into the profit centres' performance reports. First, corporate service units have a tendency to

increase their power base and to enhance their own excellence without regard to their effect on

the company as a whole. Allocating corporate overhead costs to profit centres increases the

likelihood that profit centre manager will question these costs, thus serving to keep head

office spending in check. (Some companies have actually been known to sell their corporate

jets because of complaints from profit centre managers about the cost of these expensive

items.) Second, the performance of each profit centre will become more realistic and more

readily comparable to the performance of competitors who pay for similar services. Finally,

when managers know that their respective centres will not show a profit unless all-costs,

including the allocated share of corporate overhead, are recovered, they are motivated to make

optimum long-term marketing decisions as to pricing, product mix, and so forth, that will

ultimately benefit (and even ensure the viability of) the company as a whole.

If profit centres are to be charged for a portion of corporate overhead, this item should be

calculated on the basis of budgeted, rather than actual, costs, in which case the "budget" and

"actual" columns in the profit center's performance report will show identical amounts for this

particular item. This ensures that profit centre managers will not complain about either the

arbitrariness of the allocation or their lack of control over these costs, since their performance

reports will show no variance in the overhead allocation. Instead, such variances would appear

in the reports of the responsibility centre that actually incurred these costs. .

(5) Net Income:

Here, companies measure the performance of domestic profit centres according to the bottom

line, the amount of net income after income tax. There are two principal arguments against

using this measure: (1) after tax income is often a constant percentage of the pretax income, in

which case there would be no advantage in incorporating income taxes, and (2) since many of

the decisions that affect income taxes are made at headquarters, it is not appropriate to judge

profit centre managers on the consequences of these decisions. There are situations, however,

in which the effective income tax rate does vary among profit centres. For example, foreign

subsidiaries or business units with foreign operations may have different effective income tax


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By limited market it means that the markets for buying and selling profit centres may be

limited.

Even in case of limited market the transfer price that is ideal or satisfies the requirement of a

profit centre system is the competitive price. In case if a company is not buying or selling its

product in an outside market there are some ways to find the competitive price. They are as

follows:

1. If published market prices are available, they can be used to establish transfer prices.

However, these should be prices actually paid in the market-place and the conditions that exist

in the outside market should be consistent with those existing within the company. For

example, market prices that are applicable to relatively small purchases are not valid in thiscase.

2.Market prices are set by bids. This generally can be done only if the low bidder has a

reasonable chance of obtaining the business. One company accomplishes this by buying about

one-half of a particular group of products outside the company and one-half inside the

company

3.If the production profit centre sells similar products in outside markets, it is often possible to

replicate a competitive price on the basis of the outside price.

4.If the buying profit centre purchases similar products from the outside market, it may be

possible to replicate competitive prices for its proprietary products.

Q 5 Sum done in class

Q6) Enumerate the differences among the following types of audits:

a) Financial Audit (Statutory)

b) Cost Audit

c) Efficiency Audit

d) Management Audit

A6) Pg 243 onwards in the book

a) Financial Audit:


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Financial Audit is a historically oriented, independent evaluation performed by internal

auditor or external auditor for the purpose of attesting to the fairness, accuracy and

reliability of the financial data, providing protection for the entity's assets; evaluating

the adequacy and accomplishment of the system (internal control) designed, provide for

the aforementioned Fairness and Protection, Financial data, while not being the only

source of evidence, are the primary evidential source. The evaluation is performed on a

planned basis rather than a request".

Financial audit takes care of the protective aspect of the business and it does not

normally carry out constructive appraisal function of the business operations. It helps in

detection and prevention of fraud. It also verifies whether documentation and flow of

activities arc in conformity with the internal control system introduced and developedwithin the organization. It helps coordinating with statutory auditor to help them in

proper discharge of their function. Besides, financial audit also ensures compliance with

statutory laws especially in financial and accounting matters.

Objectivesof Financial Audit-

-To see that established accounting systems and procedures have been complied with

-To see that proper records have been maintained for the fixed assets of the Concern to

look into correctness of the financial data and records along with correctness of the

accounting procedure followed.

-To see whether scrap, salvage and surplus materials have been properly accounted for

etc.

-To see that internal control system has been working properly.

-To see that any abrupt variation in sales, purchases etc.; with respect to immediate

previous year are not due to any irregularity

-To see that the credit control has been strictly followed.

-To see that all payments have been made with proper authorization and approval. .

-To see that preparation of salary and wage pay roll has been properly done.

The opinion expressed by the auditors shall be based on verified data, reference to

which shall also be made here and, if practicable, included after the company has been

forded on opportunity to comment on them.

b) Cost Audit:


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Cost Audit is defined as the verification of correctness of cost records and check on the

adherence to the cost accounting plan. It is an audit process for the verification of the

cost of manufacture or production of any article on the basis of accounts relating to

utilization of material, labour and other items of cost maintained by the company with

the accepted principles of cost accounting. Cost Audit is an audit of efficiency.

Objectives of Cost Audit:

-Verification of Cost Accounts with a view to ascertain that those have been properly

maintained and compiled according to the cost accounting system.

- Ensure that the prescribed procedure of cost accounting is duly adhered to.

- Detection of errors and frauds.

- Determination of inventory valuation

- Facilitating the fixation of prices and goods or services

- Periodical reconciliation between cost accounts and financial accounts

- Ensuring optimal utilization of human, physical and financial resources of the

company.

- Detection and correction of abnormal losses

- Inculcation of cost consciousness

- Advising management as regards the areas where performance calls for improvement.

c) Efficiency Audit:

Efficiency Audit ensures application of the basic economic principles i.e. resources

flow into the most remunerative channels. The main purpose of Efficiency audit is to

ensure that:

(a) Every rupee invested in capital or in other resources gives the optimum returns, and

(b) The planning of investment between the different functions and aspects is designed

to give optimum results.

From the above point of view, cost audit can be appropriately called as Efficiency

Audit. Efficiency audit is thus defined as systematic analysis of activities to assess the

efficiency with which resources are utilized.

The purpose of efficiency audit is to control rising costs and inflation. By adherence to

efficiency, audit norms will enable the company to sell its products in the competitive


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Q7) Organizations with Business Divisions (Profit Centre) format have observed

that Divisional Controllers experience divided loyalty in carrying out their

functions, causing a possible dysfunction. How could such a situation be resolved?

Define role of controller which suits your suggestion.

A7) To the extent the decision are decentralized top management may lose some

control. Relying on control reports is not as effective as personal knowledge of an

operation. With profit centre, top management must change its approach to control.

Instead of personal direction senior management must rely to a considerable extent on

management control reports.

Competent units that were once cooperating as functional units may now compete with

one another disadvantageously. An increase in one managers profit may decrease those

of another. This decrease in cooperation may manifest itself in a manager unwillingness

to refer sales lead to another business unit, even though that unit is better qualified to

follow up on the lead in production decision that have undesirable cost consequence on

other units or in the hoarding of personnel or equipment that from the overall company

standpoint would be better off used in another units.

There may be too much emphasis on short run profitability at the expense of long run

profitability. In the desire to report high current profits, the profit centre manager may

skip on R&D, training, maintenance. This tendency is especially prevalent when the

turnover of profit centre managers is relatively high. In these circumstances, manager

may have good reason to believe that their action may not affect profitability until after

they have moved to other job.

There is no complete satisfactory system for ensuring that each profit centre by

optimizing its own profit will optimize company profits.

If headquarter management is more capable or has better information then the average

profit centre manager the quality of some of the decision may be reduced.

Divisionalization may cause additional cost because it may require additional

management staff personnel and recordkeeping and may lead to redundant at each

profit centre.

Business units as profit centres:


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The informal organization The official authority-responsibility relationship of each

manager is shown in the line chart of an organization. However, in an informal

organization, there is no clear-cut authority-responsibility relationship. The finance

managers interaction with the managers in the marketing or production department

constitutes the informal organization. It is important in enabling the managers to

comprehend the realities underlying the process of management control. Thus, the

realities of the management control process cannot be understood without recognizing

the importance of the relationships that constitute the informal organization.

Cooperation and conflict The top management is primarily concerned with the

responsibility of achieving the goals of the organization. The management makes

decisions from time to time and the same is communicated to responsibility centremanagers lower down the hierarchy for implementation. Responsibility centre

managers have their personal goals. The interactions among managers have an effect on

the manner in which the plans are executed. There may be a strained relationship

between the production departments and service departments. The circulars carrying

instructions to responsibility centre managers have adverse reactions on the middle

managers. These factors affect the personal needs of the managers. Thus, there are

conflicts between the managers in the organization. Those conflicts are part and parcel

of organizational life. Cooperation is opposite of conflict. Many a times we find that

there is effective cooperation between the people in the organization and the

responsibility centre managers. They have to achieve the organizations goals. The

cooperation may arise out of personal relations or mutual independence. There should

be a proper balance between cooperation and conflicts. Conflicts resulting from

competition among managers for increments or promotions are healthy but there should

be some limit. On the other hand, there should be some amount of cooperation for the

smooth functioning of an organization.

Q9) Write Short Notes on any 2 of the following:

i) Zero Based Budgeting

ii) Free Cash Flow

iii) MCS in the Matrix Organization


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A9)

(i) Zero Based Budgeting:

Zero-based budgeting is a technique of planning and decision-making which reverses the

working process of traditionalbudgeting. In traditional incremental budgeting, departmental

managers justify only increases over the previous year budget and what has been already spent

is automatically sanctioned. No reference is made to the previous level of expenditure. By

contrast, in zero-based budgeting, every department function is reviewed comprehensively and

all expenditures must be approved, rather than only increases.[1] Zero-based budgeting requires

the budget request be justified in complete detail by each division manager starting from the

zero-base. The zero-base is indifferent to whether the total budget is increasing or decreasing.

The term "zero-based budgeting" is sometimes used in personal finance to describe the

practice of budgeting every dollar of income received, and then adjusting some part of the

budget downward for every other part that needs to be adjusted upward. It would be more

technically correct to refer to this practice as "active-balanced budgeting".

ii) Free Cash Flow: Pg. 27 in the book

A companys value depends on its free cash flow (FCF) which is defined as

FCF= Net op profit after tax Net Inv in Op. Cap

If a company can reduce its inventories, its cash holding or even its receivables, then its net inv

in op profit will go down. If these actions do not harm op profit then free cash flows will

increase, which will lead to a higher stock price.

Cash conversion Cycle:

Companies typically follow a cycle in which they purchase inventory, sell goods on credit and

then collect accounts receivables. This cycle is called the Cash conversion cycle.

- Inventory conversion period: Average Time required to convert materials into finished

goods and then to sell those goods.
http://en.wikipedia.org/wiki/Budgetinghttp://en.wikipedia.org/wiki/Budgethttp://en.wikipedia.org/wiki/Zero_Based_Budgeting#cite_note-0http://en.wikipedia.org/wiki/Zero_Based_Budgeting#cite_note-0http://en.wikipedia.org/wiki/Budgethttp://en.wikipedia.org/wiki/Zero_Based_Budgeting#cite_note-0http://en.wikipedia.org/wiki/Budgeting


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a) Explain with full justification which of the 2 standards (1) or (2) is more meaningful

for expense control.

b) Can the supervisor be held responsible for all overhead expenses included? Why or

why not?

Q11)

Division Profit Fixed Assets Current Assets ROTA =PAT/TA Cost of Capital EVA

A 300 800 160 31.25% 9.17% 212

B 220 400 1600 11.00% 6.00% 100

C 100 600 1000 6.25% 6.88% -10.00

D 110 400 800 9.17% 6.67% 30

E 180 200 800 18.00% 6.00% 120

Based on Return on assets Division A has performed the best followed by E, B, D and C.

The divisions rank in the same order when evaluated based on the EVA as well.

However, it is to be noted that Division C though showing a return of 6.25% has a negative

EVA and the company could review its investment decision.

Item Standard at Normal

Value (1)

Budgeted at Actual

Volume (2)

Actual

Management

Supervision

720 720 582

Indirect Labour 12706 11322 12552

Idle time 420 361 711

Materials, Tools 3600 3096 3114

Maintenance, Scrap 14840 13909 17329

Allocated expenses 21040 21040 21218

Total per ton (Rs.) 2133.04 2103.39 2413.30


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Q1b What are the considerations involved in regulating R&D function by the top

management especially in view of challenges faced on account of globalisation?

Ans: Research and development is an important function in modern organisation.

Liberalisation and globalisation have thrown up a number of opportunities and challenges.

This has increased the importance of R&D activities.

Type of financial control: The financial control exercised in a discretionary expense

centre is quite different from that in engineered centre the latter attempts to minimize

operating cost by setting a standard and reporting actual costs against this standards.

The main purpose of a discretionary expense budget on the other hand is to allow the

manager to control Cost for particular in the planning. Costs are controlled primarily by

deciding what task should be undertaken and what level of effort is appropriate for

each. Thus in a discretionary expense centre financial control is primary exercised at

the planning stage before the amount are incurred.

Measurement of performance: The primary job of the manager of a discretionary

expense centre is to accomplish the desired output spending an amount that is on budget

is satisfactory. This is in contrast with the report in an engineered expense centre which

helps higher management to evaluate the manger efficiency. If these two types ofresponsibility centre are carefully distinguished management may treat the performance

report for the discretionary expense centre as if it were an indication of efficiency

Control over spending can be exercised by requiring that the manger approved be

obtain before the budget is over sometimes a certain percentage of overrun is permitted

without additional approval if the budget really set forth the best estimate of actual cost

there is 50 percent probability that it will overrun and this is the reason that some

latitude is often permitted.

Control problems: The control of R & D centres, which are also discretionary expense

centre is difficult for the following at least a semi tangible output reasons.

The considerations involved in regulating R&D functions:

Unrealistic expectations: The head of R&D centre generally feels inclined to have an

excellent department which may be beyond the companys means.


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Lack of business insight: It is also found that the persons engaged in R&D

occasionally do not have interests in the business. They may have inadequate

knowledge of the business in order to provide direction to research.

Difficultly in measuring output: It is difficult to measure the output of R&D centres

as the output are semi-intangible in the form of patents, new product, new designs,

processes, etc.

Input-output relationship: It is also difficult to establish relationship between the

inputs and outputs of the R&D activities. A product may take several years of efforts to

evolve and as a result the inputs provided for in the annual budget may bear no relations

to output.

May not be possible to control annually: As research efforts take several years to

bear fruit, it is difficult to control R&D in an effective manner on an annual basis.

Manpower: The main element of expenditure is manpower cost and getting highly

skilled personnel is difficult.

The goal congruence problem in R&D centre is similar to that in administrative

centres. The research managers typically want to build the best research organization

that money can buy, even though this is more expensive than the company can afford.

A further problem is that research people often may not have sufficient knowledge of

the business to determine the optimum direction of the research efforts.

Research and development can seldom be controlled effectively on an annual basis. A

research project may take year s to reach fruition, and the organization must be built up

slowly over a long time period. The principal cost is for the work force obtaining highly

skilled scientific talented is often difficult, and short term fluctuation in the work force

are in efficient. It is not reasonable, therefore to reduce R&D costs in years when profits

are low and increase them in year when profits are high. R&D should be looked at as a

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The R&D continuum: Activities conducted by R&D organization lie along a continuum. At

one extreme is basic research; the other extreme is product testing. Basic research has two

characteristics: first, it is unplanned management at most can specify the general area that is to

be explored second there is often a very long time lag before basic research result in successful

new product introductions. Financial control system has little value in managing basic research

activities. In some companies, basic research in included as a lump sum in the research

program and budget. In others, no specific allowance is made for basic research as such; there

is an understanding that scientists and engineers can devote part of their time to explorations in

whatever direction they find most interesting, subject only to informal agreement with their

supervisor. For product testing projects, on the other hand, the time and financial requirement

can be estimated, not as accurately as production activities.

Q 2a Answer was not available in any of the library books or online

Q2 bWhat are the challenges faced in pricing corporate services provided to Business

Units operating as profit centres?

Business Units as Profit Centres

Most business units are created as profit centres since managers in charge of such units

typically control product development, manufacturing, and marketing resources. These

managers are in a position to influence revenues and costs and as such can be held accountable

for the "bottom line." However, as pointed out in the next section, a business unit manager's

authority may be constrained in various ways, which ought to be reflected in a profit centres

design and operation.

Constraints on Business Unit Authority

To realize fully the benefits of the profit centre concept, the business unit manager would have

to be as autonomous as the president of an independent company. As a practical matter,

however, such autonomy is not feasible. If a company were divided into completely

independent units, the organization would lose the advantages of size and synergy.

Furthermore in delegating to business unit management all the authority that the board of

directors has given to the CEO, senior management would be abdicating its own responsibility.

Consequently, business unit structures represent trade-offs between business unit autonomy

and corporate constraints. The effectiveness of a business unit organization is largely

dependent on how well these trade-offs are made.


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Constraints from Other Business Units.

One of the main problems occurs when business units must deal with one another. It is useful

to think of managing a profit centre in terms of control over three types of decisions:

(1) The product decision (what goods or services to make and sell),

(2) The marketing decision (how, where, and for how much are these goods or services to be

sold?), and

(3) The procurement or sourcing decision (how to obtain or manufacture the goods or

services). If a business unit manager controls all three activities, there is usually no difficulty

in assigning profit responsibility and measuring performance. In general, the greater the degree

of integration within a company,

the more difficult it becomes to assign responsibility to a single profit centre for all three

activities in a given product line; that is, if the production, procurement, and marketing

decisions for a single product line are split among two or more business units, separating the

contribution of each business unit to the overall success of the product line may be difficult.

Constraints from Corporate Management

The constraints imposed by corporate management can be grouped into three types:

(1) Those resulting from strategic considerations,

(2) Those resulting because uniformity is required, and

(3) Those resulting from the economies of centralization.

Most companies retain certain decisions, especially financial decisions, at the corporate level,

at least for domestic activities. Consequently, one of the major constraints on business units

results from corporate control over new investments. Business units must compete with one

another for a share of the available funds. Thus, a business unit could find its expansion plans

thwarted because another unit has convinced senior management that it has a more attractive

program.

Corporate management also imposes other constraints. Each business unit has a "charter" that

specifies the marketing and/or production activities that it is permitted to undertake, and itmust refrain from operating beyond its charter, even though it sees profit opportunities in


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doing so. Also, the maintenance of the proper corporate image may require constraints on the

quality of products or on public relations activities.

Companies impose some constraints on business units because of the necessity for Uniformity.

One-constraint is that business Units must conform to corporate accounting and MCS This

constraint is especially troublesome for units that have been acquired from another company

and that have been accustomed to using different systems.

Q 3a) What is two step transfer pricing and profit sharing approach? Narrate Merits

and demerits

Transfer pricing: If two or more profit centers are jointly responsible for product

development manufacturing and marketing, each should share in the revenue that is

generated when the product is finally sold. The transfer price is not primarily an

accounting tool; rather, it is a behavioral tool that motivates manager to make the right

decisions. In particular the transfer price should be designed so that it accomplishes the

following objective: It should provide each segment with the relevant information

required to determine the optimum tradeoff between company cost and revenues It

should induce goal congruent decisions that is the system should be so designed that

decision improve business unit to earn more profit It should help measure the economic

performance of the individual profit center

Two step pricing: First, a charge is made for each unit sold that is equal to the

standard variable cost of production. Second a periodic charge is made for the buying

unit. One or both of these components should include a profit margin. The two step

pricing method correct this problem by transferring variable cost on a per unit basis,

and transferring fixed cost and profit on a lump sum basis under this method the

transfer price for product A would be 5$ for each unit that unit Y purchases plus

$20000 per month for fixed cost. Plus $10000 per month for profit: if transfer of

product A in a certain month are at the expected amount 5000 units then under the two

step method unit y will pay the variable cost of $25000 plus $30000 for the fixed cost

and profit a total of $55000 .this is the same amount as the amount it would pay unit x

if the transfer price is less than 5000 units say 4000unoits.unit y would pay $50000

under the two step methods compared with the $44000 it would pay if the transfer price


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were $11 per unit. The difference is their transfer prices were for not using a portion of

unit X capacity that it has reserved. Note that fewer than two step methods the

company variable cost for product A is identifiable to unit Y variable cost for the

product, and unit Y will make the correct short term marketing decisions. Unit Y also

has information on upstream fixed costs and profit related to product A and it can use

these data for long term decision. The fixed cost calculation in the two step pricing

method is based on the capacity that is reserved for the production of product A that is

sold to unit Y the investment represented by this capacity is allocated to product A. The

return on investment that unit X earns on competitive product is calculated and

multiplied by the investment assigned to the product. In the example we calculated the

profit allowance as a fixed monthly amount. It would be appropriate under some

circumstance to divide the investment into variable and fixed component. Then, a profit

allowance based on a return on investment on variable assets would be added to the

standard variable cost for each unit sold.

Profit sharing: If the two step pricing system just described is not feasible, a profit

sharing system might be used to ensure congruence of business unit interest with

company interest. This system operates somewhat as follows.1. The product is transferred to the marketing unit at standard variable cost.

2. After the product is sold, the business units share the contribution earned which is

selling price minus the variable manufacturing and marketing costs.

This method of pricing may be appropriate if the demand for the manufactured product

is not steady enough to warrant the permanent assignment of facilities as in the two

step method. In general, this method accomplished the purpose of making the

marketing units interest congruent with the companies. There are several practical

problems in implementing such profit sharing system. First, there can be arguments

over the way contribution is divided between the two profit centres. Which is costly,

time consuming and work against basic reason for decentralization namely autonomy of

the business units mangers. Second, arbitrarily divided up the profit between units does

not give valid information on the profitability of each segment of the organization.


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Third since the contribution is not allocated until after the sale has been made the

manufacturing units contribution depends upon the marketing units ability to sell and

on the actual selling price. Manufacturing units may perceive this situation to be unfair

Q3b) "Adopting profit centre approach may not be an appropriate solution always". Do

you agree? Give reasons for answer quoting various situations in the business.

A profit centre is a unit of a company that generates revenue in excess of its expenses. It is

expected that, through the sale of goods or services, the unit will turn a profit. This is in

contrast to a cost centre, which is a unit inside a company that generates expenses with no

responsibility for creating revenue. The only expectation a cost centre has is to lower expenses

whenever possible while staying with a specific budget that is determined at the corporate

level. Beyond that simple definition, the term "profit centre" has also come to represent a form

of management accounting that is organized around the profit centre concept. Companies that

have adopted the profit centre system have organized all of their business units as either profit

Centerior cost centres, and all company financial results are reported in that manner. Adopting

a profit enter system often requires a radical shift in corporate philosophy and culture, but itcan yield great returns in net before tax (NBT) profits. According to an article in Business

Solutions, The data collection company Data Recognition, Inc. made the shift to a profit

centre-based system and was pleased with the results. The profit centres allows bettering

identifying specific gains and losses. And that's critically important for a growing business. All

companies, no matter what size, have both cost and profit

For example, in most companies, units such as human resources and purchasing are strictly

cost centres. The company has to spend money to operate those units, and neither has any

means of producing a profit to offset those expenses. They exist solely to make it possible for

other areas of the company to make money. However, without those two departments, the

company could not survive. All companies have profit centres and cost centres, but not all

companies organize their accounting practices around the profit centre concept. In fact, most

companies do things the time-honoured way, producing overall profit and loss statements for

the company as a whole, without making each business unit accountable for generating a

profit. A cost centre may actually provide services that could generate a profit if they w

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