UNIVERSITY OF MUMBAI MANAGEMENT CONTROL SYSTEM

ANSWER SET: YEAR 2001 TO 2008
Selected Questions (Conceptual + Numerical)

INDEX
SR.NO 1 2 3 4 5 6 7 8 9 10 11 12 PARTICULAR Set 1 (numerical 2004 & 2008) Set 2 (numerical 2004 & 2008) Set 3 (numerical 2004 & 2007) Set 4 Set 5 (numerical 2004) Set 6 Set 7 Set 8 Set 9 Set 10 Set 11 Set 12 PAGE.NO. 3-11

12-20 21-31 32-43 44-65 66-74 75-86 87-91 92-96 97-103 104-112 113-128

2

SET. 1
Questions
1) Explain briefly features of an IDEAL management control system?

2)
3)

What is the concept of free cash flow as applied to an organization? Explain process of computation?

What is Balance Scorecard? What is the process of implementation and difficulties in implementation?

4)

Girish Engineering ( MCS-2004) Numerical?

5)

ABC ltd. (MCS-2008) Numerical?

3

Both should go hand in hand to achieve the best results.  Continuous process: It is a continuous process over the human and material resources. taking into consideration past performance. present trends and anticipated economic and technological changes. Management Control involves managing the overall activity of the enterprise for the future. The whole operational activity is regular and rhythmic.  Function of every manager: Manager at every level as to focus towards future operational and accounting data. These two provide a link between such future anticipations and actual performance.  Emphasis: Management control requires emphasis both on the search for planning as well as control. The coordination of the main division of an organization helps in smoother operations and less friction which results in the achievement of the predetermined objectives.  Existence of goals and plans: MANAGEMENT CONTROL SYSTEM is not possible without predetermined goals and plans.  People oriented: It is the managers. 4 . The nature.Q. The results of each responsibility centre in respect to production and resources are expressed in terms of a common denominator of money.  Coordinated System: It is a fully coordinated and integrated system. It demands vigilance at every step.  Forward looking: MANAGEMENT CONTROL SYSTEM is on the basis of evaluation of past performance that the future plans or guidelines can be laid down. engineers and operators which implement the ideas and objectives of the management. Some of the features of MANAGEMENT CONTROL SYSTEM are as follows:  Total System: MANAGEMENT CONTROL SYSTEM is an overall process of the enterprise which aims to fit together the separate plans for various segments as to assure that each harmonizes with the others and that the aggregate effect of all of them on the whole enterprise is satisfactory. Deciding. planning and regulating the activities of people associated in the common task of attaining the objectives of the organization is a the primary aim of MANAGEMENT CONTROL SYSTEM. It is a continuous process even if the plans are changed in the light of experience or technology.1) Explain briefly features of an IDEAL management control system? Management control is a process of assuming that resources are obtained and used effectively and efficiently in the accomplishment of the organization’s objectives.  Definite pattern: It follows a definite pattern and time table. It is a fundamental necessity for the success of a business and hence from time to time the current performance of the various operations is compared to a predetermined standard or ideal performance and in case of variance remedial measures are adopted to confirm operations to set plan or policy. It prevents deviations in operational goals. scope and level of control will be governed by the level of manager exercising it.  Monetary Standard: MANAGEMENT CONTROL SYSTEM is built around a financial structure and all the resources and outputs are expressed in terms of money.

The task is accomplished by periodic analysis and checking of activities of each department with a view to avoid an eliminate all non-essential motions.  Overall control: A master plan is prepared for overall control and all the departments of the concern are involved in this procedure. project analysis. He makes comparisons of actual cost data with standard cost.Scope of control MANAGEMENT CONTROL SYSTEM is an important process in which accounting information is used to accomplish the organizations objectives.  Control over techniques: It involves the use of best methods and techniques so as to eliminate all wastages in time. functions and methods. Every project is evaluated in terms if the advantage it accrues to the firm. Cost control is a delicate task and is supplemented by budgetary control systems.  Control over personnel: Anything that the business accomplishes is the result of the action of those people who work in the organization. Therefore the scope of control is very wide which covers a very wide range of management activities.  Policies control: Success if a business depends on formulation of sound policies and their proper implementation. It is the people. energy and material. study of cost of capital etc are carried out. and not the figures. labour material and over heads.  Control over capital Expenditure: Capital budget is prepared for the whole concern. 5 .  Control over costs: The cost accountant is responsible to control cost sets. cost standards. that get things done.  Control over organization: It involves designing and organizing the various departments for the smooth running of the business. For this purpose capital budgeting. It attempts to remove the causes of such friction and rationalizes the organizational structure as and when the need arises.

Buy marketable securities or other non operating assets. but the net cash flow from these five activities is equal to free cash flows. To be more specific.800 at the end of 2001. Pay dividends to shareholders. at the end of 2000. Repay debt holders. Operating cash flow =NOPAT +depreciation (non cash adjustment) = $17. most companies combine these five uses in such a way that the net total is equal to FCF.$1.Q.it made a net investment in operating assets of Net investment in operating assets = $18. Repurchase stock from shareholders. 3. issue new debts. So management is not completely free to use its cash flows however it chooses. which is accounting profit. 2.3million and depreciation is only the non cash charge which is $100million then its operating cash flow in 2001 would be NOPAT plus any non cash adjustment on the statement of cash flows. For example. Therefore the way for managers to make their companies more valuable is to increase their free cash flow. When we studied income statement in accounting the emphasis was probably on the firm’s net income. Pay interest to debt holders. that is. pay off some of debt. Explain We define net cash flow as net income plus non cash adjustment which typically means net income plus depreciation though that cash flows cannot be maintained over time unless depreciated fixed assets are replaced. Uses of FCF: 1.2 What is the concept process of computation? of free cash flow as applied to organization. Some of these activities are cash outflows (paying interest and dividends) and some are cash inflows (issuing debt and selling marketable securities). 5. Therefore we define the term free cash flows. but $1.455 = $345million 6 . Computation of free cash flows: Eg: Suppose the company had a 2001 NOPAT of $170. In practice. keeping in mind that the net cost to the company is the after tax interest expense. defined as after. a company might pay interest and dividends. also sell some of its marketable securities.tax operating profit minus the amount of new investment in working capital and fixed assets necessary to sustain the business. 00 . However the value of company’s operation is determined by the stream of cash flows that the operations will generate now and in the future.455million operating assets.03 + $100 = $270. the value of operation depends on all the future expected free cash flows. 4.3 Company has $1. Free cash flow is the cash flow actually available for distribution to investor after the company has made all the investment in fixed assets and working capital necessary to sustain ongoing operation.

the Balanced Scorecard helps provide a more comprehensive view of a business.$445 = . market share / penetration. and to develop metrics.3. its very high investment in operating assets resulted in a negative free cash flow.3) What is Balance Scorecard? What is the process of implementation and difficulties in implementation? The Balanced Scorecard (BSC) is a performance management tool which began as a concept for measuring whether the smaller-scale operational activities of a company are aligned with its larger-scale objectives in terms of vision and strategy. In practice. long term learning and skills development.3 . but investor actually had to provide additional money to keep the business ongoing.$174. which in turn helps organizations act in their best long-term interests.If net fixed assets rose from $870million to $1000million however company reported So its gross investment in fixed assets would be Gross investment = net investment + depreciation = $130 + $100 = $230million Company free cash flows in 2001 was FCF = operating cash flow – gross investment in operating assets = $270." "Internal Business Processes" and "Learning and Growth. Even though company had a positive NOPAT.7million An algebraically equivalent equation is FCF = NOPAT . as these are "lag" measures. even it causes negative free cash flow in the short term Q.$174. early Scorecards achieved this balance by encouraging managers to select measures from three additional categories or perspectives: "Customer. collect data and analyze it relative to each of these perspectives: 7 . and so on.Net investment in operating assets = $170. The underlying rationale is that organizations cannot directly influence financial outcomes.7million $100million of depreciation.$345 = . Because free cash flow is what is available for distribution to investor. not only was there nothing for investors. A negative current FCF not necessarily bad provided it is due to the high growth or to support the growth. Organizations were encouraged to measure—in addition to financial outputs—what influenced such financial outputs. the early versions of the Balanced Scorecard helped organizations achieve a degree of "balance" in selection of performance measures. In so doing. There is nothing wrong with profitable growth. For example. and that the use of financial measures alone to inform the strategic control of the firm is unwise. Organizations should instead also measure those areas where direct management intervention is possible. process performance." The balance scorecard suggests that we view the organization from four perspectives. marketing and developmental inputs to these. By focusing not only on financial outcomes but also on the operational.

Define strategy.  They maintain alignment of measure to ever changing strategies. it is important that the individual measures be linked with each other in a cause effect manner  Integrated Measures into the management system The balanced scorecard must be integrated with the organization formal and informal structure. 1. 2. otherwise management will be overloaded with measures.  Define Measures of Strategy The next step is to develop measures in support of the articulate strategy. its culture. 4. Review measures and result frequently. • • • The learning and growth perspective : “To achieve our vision.  Review Measures and result Frequently Once the balance scorecard is up and running it must be consistently reviewed by senior management. the measures can still become unbalanced by others system in the organization such as compensation policies that compensate the manager strictly based on financial performance. Integrate measures into the management system. and its human resources practice. how will we sustain our ability to change and improve?” The business process perspective : “To satisfy our shareholders and customers what business processes must we excel at?” The customer perspective : “To achieve our vision. As a result it is necessary to begin the process of defining a balanced scorecard by defining the organization goals are explicit and what that targets have been developed. Each of these steps is iterative.  They show that management is serious about the importance of these measures. While the balanced Scorecard gives some means for balancing measures. The organization should be looking for the following     How do the outcome measures say the organization is doing? How do the driver measures say the organization is doing? How has the organization’s strategy changed since the last review? How has the scorecard measures changed? The most important aspects of these reviews are as follows. 3. They tell management whether the strategy is being implemented correctly and how successfully the strategy is working. requiring the participation of senior executive and employees throughout the organization  Define Strategy The balance scorecard builds a link between strategy and operational action. how should we appear to our shareholders?” Implementing a Balanced Scorecard We can summarize the implantation of a balanced scorecard in four general steps.  8 . how should we appear to our customer?” The financial perspective : “To succeed financially. Define measure of strategy. It is imperative that the organization focuses on a few critical measures at this point. Also.

This is probably the biggest problem with the balanced scorecard because there is an inherent assumption that future profitability does follow from achieving the scorecard measures.  Measurement overload How many critical measures can one manager track at one time without losing? Unfortunately there is no right answer to this question except it is more than 1 and less than 50.Unfortunately achieving many of these goals require complete shifts in the way that business is done yet the company often does not have mechanism to make those shifts . missing those targets and readjusting the targets to reflect what was actually achieved. improvements are unlikely to consistently happen no matter how good the stretch goal sound. While this does not mean that the balanced Scorecard should be abandoned it is imp that comp adopting such a system understand that the links between nonfinancial measures and financial performance are still poorly understood. Shareholder are vocal and the board of directors often applies pressure on the stakeholders behalf . • Measures overload. These changes do not happen overnight nor do they respond automatically to a new stretch targets. Inertia often works against the company employees are accustomed to a self limited cycle of setting targets. It too few then the manager is ignoring measures that are critical to creating success. Difficulties in implementing Balanced Scorecard The following problems unless suitably dealt with.  Non mechanism for Improvement One of the most overlooked pitfalls of the balanced scorecard is that a company cannot achieve Stretch goals if the Company has no mechanism for improvement .  Poor Correlation between Nonfinancial measures and result Simply put there is no guarantee that future profitably will allow targets achievement in any nonfinancial area. • No mechanism for improvement. could limit the usefulness of the balanced scorecard approach: • Poor correlation between nonfinancial measures and result. 9 .this pressure often overwhelms the long term uncertain payback of the nonfinancial measures. This will be a problem with any system that is trying to develop proxy measures for future performance. If it too many then the manager may risk losing focus and trying to do too many things at once.  Fixation on Financial Results As previously discussed not only are most senior managers well trained and very adept with financial measures but they also most keenly feel pressure regarding the financial performance of their comp. Without a method for making improvement. No mechanism for improvement. • Fixation on financial result. The mechanism available takes additional resource and requires a changed in the company culture. identifying the cause effect relationships among the different measures is easier said than done.

Lacs Actual Variance Direct Labour 100. So. and making a fair and reasonable charge to all projects using the resource does this.4) Girish Engineering (MCS-2004) Numerical Responsibility budgeting was introduced in a medium sized organization Girish Engineering. Thus as it is charged based upon an estimate the budgeted figure is the same as the actual figure and hence no variances. . As the above overhead expenses would have certain portion of fixed expenses this is hard to control. These are different to the Incurred costs because these costs are not exclusively related to any individual project.34 8.21 (Favourable) Indirect Labour 66. they can be managed and changed with the managerial decisions and output.e. That’s why no variance is shown for departmental fixed costs. these should not be a part of controllable cost.Q.47 8. Solution (b): Overhead Expenses mentioned above should not be included in controllable costs because some costs are uncontrollable like fixed costs. The key difference between costs and Allocated costs is that the latter will be charged based upon an estimate.82 -------Allocated Costs 53.62 -------Questions: 1. However.13 0.50 (Unfavourable) Department Fixed Costs 38. since these costs are not affected by either the volume of sales or the volume of production. where the same resource is also used by other activities. 10 . the cost of the resource still needs to be recovered. They don't vary with the change in short run managerial decisions and output. Allocated costs are a share of the costs of a resource used by a project. And some costs are controllable i. Monthly report (in part) for an expense centre in factory is: All figures in Rs.10 (Unfavourable) Total Controllable Costs 168. rather than actual cash values. Should overhead expenses mentioned above be included in Controllable Costs? Why? Why not? Solution (a): Variances between actual and budgeted departmental fixed costs are obtained simply by subtraction. Why no variance is shown in two items? Is this correct approach in performance reporting? 2.

Q.) 26% 500 lacs 100 Lacs 26 lacs Analyze and comment upon performances of both the divisions Solution: Division X ROI Profit Profit margin = = = = = = = = = = = = = = = = = = (Profit / investment)* 100 (28/100)*25lacs 7lacs (Profit/sales)*100 (7/100)*100 7lacs (Sales/investment)*100 (100/25)*100 4 times (Profit / investment)* 100 (26/100)*100lacs 26lacs (Profit/sales)*100 (26/500)*100 5.) 28% 100 Lacs 25 lacs 7 Lacs Division Y (Rs. Hence cost management of Division X is better than Division Y. 11 . Turnover of investment of division Y is better than Division X.2lacs (Sales/investment)*100 (500/100)*100 5 times Turnover of investments Division Y ROI Profit Profit margin Turnover of investments Profit margin of X is better than profit margin of division Y.5ABC ltd. (MCS-2008) Numerical Particulars ROI Sales Investment EBIT Division X (Rs.

just as there are in evaluating an organization as a whole.  Measuring Profitability There are two types of profitability measurements used in evaluating a profit center. coordinating. First. The messages conveyed by these two measures may be quite different from each other. and controlling the profit center's day-to-day activities and as a device for providing the proper motivation for its manager. the management performance report for a branch store may show that the store's manager is doing an excellent job under the circumstances. The strategy's success depends on its soundness.SET. there is a measure of management performance. the company has implemented its strategy. if they are improved. The goal of performance measurement systems is to implement strategy. Because the management report is used frequently. 12 . Second. while the economic report is prepared only on those occasions when economic decisions must be made. the system should be designed to measure management performance routinely. There should be different measures used for evaluating profit performance and capital investment performance as needed. while the economic performance report may indicate that because of economic and competitive conditions in its area the store is a losing proposition and should be closed. which focuses on how well the profit center is doing as an economic entity. In setting up such systems. senior management selects measures that best represent the company's strategy. MCS designers apparently disagree whether single measure to evaluate the profit performance and capital investment performance is preferable or SEPARATE measures for each are preferable – COMMENT ? ANS. with economic information being derived from these performance reports as well as from other sources. 2 Q1. The necessary information for both purposes usually cannot be obtained from a single set of data. which focuses on how well the manager is doing. This measure is used for planning. These measures can be seen as current and future critical success factors. considerations relating to management performance measurement have first priority in systems design-that is. A performance measurement system is simply a mechanism that improves the likelihood the organisation will implement its strategy successfully. there is the measure of economic performance. For example.

conceptually.as an example. Capital Investment Measurement Most proposals require significant new capital. There are at least four reasons for not using present value techniques in analyzing all proposals. or safety. This situation is common when the results are heavily dependent on estimates of sales volume of new products for which no good market data exist. but many proposed investments win approval on the grounds that they improve employee morale. A newly developed machine that reduces costs so substantially that it will pay for itself in a year is an example. 13 . 1) The proposal may be so obviously attractive that a calculation of its net present value is unnecessary. 3) The rationale for the proposal is something other than increased profitability. An important point is that these techniques are used in only about half the situations in which. the company's image. 4) There is no feasible alternative to adoption. Techniques for analyzing capital investment proposals attempt to find either (a) The net present value of the project. that is. Many projects do not fit into a mechanical ranking scheme. they are applicable. The present value approach assumes that the "objective function" is to increase profits. the "payback period" criterion is used frequently. Systems that attempt to rank non-quantifiable projects in order of profitability won't work. Environmental laws may require investment in a new program. or (b) The internal rate of return implicit in the relationship between inflows and outflows. 2) The estimates involved in the proposal are so uncertain that making present value calculations is believed to be not worth the effort-one can't draw a reliable conclusion from unreliable data. the excess of the present value of the estimated cash inflows over the amount of investment required. The management control system should provide an orderly way of deciding on proposals that cannot be analyzed by quantitative techniques. In these situations.

Q2: What are the different methods to measure profits of a profit center in organizations? Which different messages each type of measure is likely to convey to managers? Ans: When financial performance in a responsibility center is measured in terms of profit. Consequently. regardless of whether these items are entirely controllable by the profit center manager. But the problem with this is that some fixed costs are controllable and all fixed costs are partially controllable. A focus on the contribution margin tends to direct attention away from this responsibility. The message given by these two measures may be quite different. just as there are for the organization as a whole. which is the difference between the revenues and expenses. There are two types of profitability measurements in a profit center. a measure of management performance. 3) Controllable Profit: Headquarters expenses are divided into two categories: controllable and noncontrollable. the responsibility center is called a profit center. 1) Contribution Margin: The logic behind using contribution margin as a measure is that fixed expenses are not controllable by the manager. and therefore he should focus on maximizing the spread between revenue and expenses. coordinating and controlling the day-to-day activities of the profit center. There is. It incorporates all expenses incurred in or directly traced to the profit center. one must use net income after allocating all costs. This measure is used for planning. The controllable expenses are controlled by business unit manager. first. 14 . any of five different measures of profitability can be used. Second. in which the focus is on how well the manager is doing. 2) Direct Profit: This measure shows the amount that the profit center contributes to the general overhead and profit of the corporation. A weakness of this measure is that it does not recognize the motivational benefit of charging headquarters costs.  Types of Profitability measures: In order to evaluate the economic performance of a profit center.Profit as a measure of performance is especially useful since it enables senior management to use one comprehensive measure instead of several measures that often point to different directions. if these costs are included in the management system. in which the focus is on how well the profit center is doing as an economic entity. the profit will be after the deduction of all expenses that are influenced by profit center manager. there is a measure of economic performance. in evaluating the performance of manager. However.

the amount of net income after income tax. 5) Net Income: Here. all corporate overhead is allocated to profit centers. so there is no advantage in incorporating income taxes 2) many decisions that have impact on income taxes are made at headquarters. The basis of allocation reflects the relative amount of expense that is incurred for each profit center. There are two arguments 1) Income after tax is constant percentage of the pretax income.4) Income before Taxes: In this measure. Then the performance report will show an identical amount in the “budget” and “actual” columns for such overheads. companies measure performance of domestic profit centers at the bottom line. should be allocated. not actual costs. If corporate overheads are allocated to profit centers. and it is believed that profit center manager should not be judged by the consequences of these decisions. 15 . budgeted costs.

3. Output and input measurement The output of a profession organisation cannot be measured in physical terms. Because profession are the organization most important resource some authors have advocated that the value of these profession should be counted as assets the system that does this is called human resource accounting .nevertheless difficult problem arise in deciding how time should be charged to clients . Goals A goal of a manufacturing company is to earn a satisfactory profit specially a satisfaction profit. Professional tends to give in adequate weight to the financial implication of their decision they want to do the best job they can regardless of its cost. Some profession notably scientist engineer. use in setting selling price and for other management purposes .the problem of measuring the value of human assets is intractable. 2.in the 1970’s many books and articles were written on this subject but few comp actually such a system and we do not know of any that one current .their financial goal is to provide adequate compensation to the professional.separation of fixed and variable cost and analyses of variance were built on the foundation are example of organization whose product are professional service. specially a satisfactory return on assets its principle assets is the skill of its professional staff which doesn’t appear on its balance sheet . Professionals Professional organization is labour intensive and the labour is of a special type.Q3: Explain special characteristics of professional organizations which impact Management Control.standard cost system .return on assets employed therefore is essential meaningless in such organization . Research and development organization use in setting selling price and for other management purposes .and otherwise keeping up to date? 16 . We can measures the number of patient a physician treats n a day and even classify these visit by type of complaint but this is by no means equivalent to measuring the amt or quality earned is one measures of output in some professional organization but these monetary amts at most relate to the quantity of service rendered not to their quality.this reluctant seems to have its root in tradition usually it can be overcome if senior management is willing to put appropriate emphasis on the necessity for accurate time reporting .if the normal work week is 40 hrs should a job be charged for 1/40th of a week compensation for each other spent on it? If so how should work done on evening and weekend be counted how to account for time spent reading literature . What are interactive controls? Special Characteristic of a Professional Organization: 1. seperstion of fixed and variable cost and analyses of variance were built on the foundation. and professional are reluctant to keep track of how they spend their time and this complicate the track of measuring performance .standard cost system.going to meeting .

Moreover the profession al who is responsible for obtaining the engagement may not personally involved in carrying it out .if the normal work.such a clean separation does not exist in most Professional organisation. A subset of the management control information that has a bearing on the strategic uncertainties facing the buss becomes the focal point. In such situation it is difficult to assign appropriate credit to the person responsible for selling a new customer.  What is Interactive Control? Interactive control alerts management of strategic uncertainties either trouble or opportunities that become the basis for manager to adapt to a rapidly changing environments by thinking about new strategies. Senior executive take such information seriously. perhaps as a percentage of the project revenue. Marketing In a manufacturing company there is a dividing line between marketing activities and production activities only senior management is concerned with both .this reluctant seems to have its root in tradition usually it can be overcome if senior management is willing to put appropriate emphasis on the necessity for accurate time reporting.thus there is less need for a sophisticated management control system . 17 . if the person who hold sold the project can be identified.professional organisations are relatively small and operate at a single location . if the person revenue.some organisation now give explicit credit.until fairly recently these marketing contribution were rewarded subjectively –that is they were taken into account in promotion and compensation decisions .4. however their time and this complicate the track of measuring performance . Nevertheless difficult problem arise in deciding how time should be charged to clients . 5. 2.and a way relating compensation to performance. usually by professional who spend much of their time in production work that is working for clients. Managers at all levels of the org focus attention on the information produced by the system. Small Size With a few exception such as some law firm and accounting firms . 3.with profit centres and formal performance reports nevertheless even a small organisations need a budget a regular comparison of performance against budget . in a consulting firm for example a new engagement may result from a conversation between a member of the firm or from the reputation of one of the firm professional as an outgrowth of speeches or articles.senior management in such organisations can personally observe what is going on and personally motivate employee . 1. These marketing activities are conducted by professional usually by professional.

company’s market share. we see that there is a certain amount of variance between the budgeted operating profit and actual operating profit. However. this factor is beyond the managements control and largely dependent on the state of economy. could be a result of selling price variance. One more factor could have been the overall industry volume. Results from variance computation are actionable if changes in actual results are analyzed against each of this expectation. The profit budget has embedded in it certain expectations about the state of total industry.Q4: Kiran Company (MCS-2004) Numerical Budget versus Actual comparison for div Z of Kiran company is as follows: Budget Actual Actual better (worse) than budget Sales and other income Variable expenses Fixed expenses Sales promotional expenses Operating profit Net working capital Fixed assets 800 480 120 40 160 400 160 740 436 120 28 156 412 148 (60) 44 0 12 4 12 (12) (a) Carry out and overall performance analysis to decide areas needing investigation. namely. In order to analyze the variances. revenues and cost structure. A combination of above three factors must have been unfavorable that is either the volume of sales must have been below the budgeted volumes ( this must be particularly true since actual variable expenses are less than budgeted) and/or the selling price must have been below expectation and/or the proportion of products sold with a higher contribution must have been less than budgeted.  Revenue variances. we need to understand the key causal factors that affect profit. 18 . selling prices and cost structure. that is a negative Rs 60 lakhs. From the given data. mixed variance and/or volume variance.

quality standards and promotional efforts.Sales promotional expenses also show a negative variance which could be a cause of lower sales volumes. product mix could be improved by selling more of higher contribution products. Better credit management to recover receivables. Another issue is that the fixed assets are lower than the budget by Rs 12 lakhs which may indicate slower capacity expansion then expected or distressed sale of assets to tide over cash flow. (b) What are the remedial measures if any would you suggest based on analysis? The budgeted estimates may be too optimistic and far from reality. one needs to ensure that estimates the as realistic as possible. will ensure improve cash flow situation since less capital will be tied up in working capital. Better sales will ensure a higher inventory turnover. the management needs to take corrective action areas needing improvement. Variable expenses : are directly proportional to volumes and hence as is evident are less than budgeted. 19 . the net working capital is more than budgeted which indicates capital block in higher inventory. sales volume could be improved by better marketing. in that case depending upon the above analysis.A cause of concern is that despite lower sales. Given the estimates are correct.

Third advantage of EVA is that different interest rates may be used for different types of assets. on the other hand.3 MANAGEMENT CONTROL SYSTEM 20 . the EVA approach has some inherent advantages over ROA. while computing EVA relevant data are given below :Particulars Div A Budgeted Profit Current Assets Fixed Assets 360 400 1600 Actual 320 360 1600 Div B Budgeted 220 800 1600 Actual 240 760 1800 Div C Budgeted 200 1200 2000 Actual 200 1400 2200 Total Budgeted 780 2400 5200 Actual 760 2520 5600 Solution: Particulars Div A Budgeted ROA EVA 18% 208 Actual 16% 170. For example. based on results. ROI data is available for competitors that can be used as a basis for comparison. Finally.4 Div C Budgeted 6% -32 Actual 6% -60 Total Budgeted 10% 220 Actual 9% 160. Second.8 b) Comment upon both methods. no matter what its size or what business it practices. a relatively low rate May be used for inventories while a higher rate may be used for different types of fixed assets. ROA is easy to calculate. with EVA all business units have the same profit objective for comparable investments. Also. The performance of different units may be compared directly to each other. SET . a business unit that is currently achieving 30% ROA would be most reluctant to expand unless it is able to earn a ROI of 30% or more on additional assets. it is a common denominator that may be applied to any organizational units responsible for profitability. For example. First. First. There are three apparent benefits of an ROA measure. it is a comprehensive measure in that anything that effects the financial statements is reflected in this ratio. decision that increase a centre’s ROI may decrease its overall profits. Nevertheless. Secondly. (MCS-2008) Numerical Shandilya Ltd. and meaningful in absolute sense.4 Div B Budgeted 9% 44 Actual 9% 50. Company charges 6% for current assets and 8 % for Fixed Assets.B and C. The ROI approach. There are three compelling reasons to use EVA over ROI. has adopted Economic Value Added (EVA) technique for the appraisal of performance of its three divisions A. easy to understand.Q5: Shandilya Ltd. provides different incentives for investment across business units.

Their output can be measured in physical terms.Engineered expense centers: Engineered expense center have the following characteristics: 1. Engineered costs are elements of cost for which the right or proper amount of costs that should be incurred can be estimated with a reasonable degree of reliability. They correspond to two types of costs. We emphasize that engineered expense centers have other important tasks not measured by cast alone. 3. 21 . trucking and similar units in the marketing organization also may be engineered expense center and so many certain responsibility center within administrative and support department. Therefore the type and amount of production is prescribed and specific quality standards are set so that manufacturing costs are not minimized at the expense of quality. Even in highly automated production department the amount of indirect labour and of various services used can vary with management discretion.Expense centers: Expenses center are responsibility centers for which input or expenses are measured in monetary terms.1) Describe differences in budgeting perspective of engineered and discretionary expense centre 1. Moreover manager of engineered expense center may be responsible for activities such a training that are not related to current production judgment about their performance should include an appraisal of how well they carry out these responsibilities. the difference between the two represents the efficiency of the organization unit being measured. Thus. 2. Examples are accounts receivable account payable and payroll section in the controller department personnel record and cafeteria in the human resource department shareholder record in the corporate secretary department and the company motor pool. There are two general types: engineered expense center and discretionary expense center. When this cost is compared to actual costs. Their inputs can be measured in monetary terms. There are few if any responsibility center in which all cost items are engineered.. Costs incurred in factory for direct labour direct material component supplies and utilities are examples. distribution. The optimal dollar amount of input required to produce one unit of output can be established Engineered expense center usually are found in manufacturing operations. Q. Such units perform repetitive task for which standard cost can be developed In an engineered expense center the output multiplied by the standard cost or each unit produced represents what the finished product should have cost. but for which outputs are not measured in monetary terms. Warehousing. the term engineered costs center refers to responsibility center in which engineered cost predominate but it does not imply that valid engineering estimates can be made for each and every cost item. 2. For example expenses center supervisor are responsible for the quality of good and for the volume of production in addition to their responsibility for cost efficiency. The effectiveness of these aspects of performance should be controlled.

 This problem is especially compounded by the fact that the current level of expenditure in the discretionary expenses center is taken for granted and is not re-examined during the budget preparation process. if actual expense do not exceed the budget amount. There are two drawbacks to incremental budgeting. however management principal task is to decide on the magnitude of the job that should be done. The difference between budgeted and actual expense is not a measure of efficiency in a discretionary expense centre it is simply the difference between the budgeted input and the actual input.Discretionary expense center: The output of discretionary expenses center cannot be measured in monetary terms. Second when a company faces a crises or when a new management takes over overhead costs are sometimes drastically reduced without any adverse consequences.Differences in budgeting perspective of engineered and discretionary expense centre Budget preparation The decision that management make about a discretionary expense budget are different from the decisions that it makes about the budget for an engineered expense center. It in no way measures the value of the output.  Incremental budgeting: Here the current level expenses in a discretionary expense center is taken as a starting points this amount is adjusted for inflation for anticipated changes in the workload of continuing tasks for special tasks and if the data are readily available for the cost of comparable work in similar units. First because managers of these centers typically want to provide more service they tend to request additional resources in the budgeting process and if they make a sufficiently strong case these request will be granted. management decides whether the proposed operating budget represent the cost of performing task efficiently for the coming period. Despite this limitation most budgeting in discretionary expense centers is incremental. For the latter. Time does not permit the more thorough analysis described in the next section. Management is not so much concerned with the magnitude of the task because this is largely determined by the actions of other responsibility centers. the manager has ‘lived within the budget ‘ however . One company may have a small headquarter staff another company of similar size and in the same industry may have a staff that is 10 time as large the management of both companies may be concerned that they made the correct decision on staff size but there is no objective way judging which decision was actually better manager are hired and paid to make such decision after such a drastic change the level of discretionary expenses generally has a similar pattern from one year to the next. Management has decided on certain policies that should govern the operation of the company.3. 22 . The term discretionary does not mean that management judgments are capricious or haphazard. This tendency is expressed in Parkinson’s second law: overhead costs tend to increase period.because by definition the budget does not purport to measure the optimum amount of spending we cannot say that living within the budget is efficient performance . They include administration and support units research and development organization and most marketing activities. There is ample evidence that not all this upward creep in cost is necessary. 4. such as the marketing departments’ ability to generate sales. In formulating the budget for a discretionary expense center.

By contrast costs in engineering expense center are expected to vary with short run changes in volume. technology.(1) should use customer?(2) what should the quality level be ?are we doing too much(3)should the function be performed in this way (4) how much should it cost? Cost variability: In discretionary expense center costs tend to vary with volume from one year to the next but they tend not to vary with short run fluctuation in volume within a given year. Some are process oriented. Some rely heavily on reports and certain formal documents. Style affects the management control process – how the CEO prefers to use the information. Such an analysis is often called a zero base review. Some are long-term oriented.2) Explain some factors which may influence top management style and the implication of the top management style on management control. In part this reflect the fact that volume changes do have an impact throughout the company even though their actual impact cannot be measures the . formal education. and experience in a given function. others emphasize a broader set of rewards. others are risk averse. The management control function in an organization is influenced by the style of senior management. others prefer conversations and informal contacts. or finance.Zero based review: An alternative approach is to make a thorough analysis of each discretionary expense center on a schedule that will cover all of them over a period of five year or so. and so on – which in turn affects how the control system actually operates. Differences in Management Styles Managers manage differently. Some emphasize monetary rewards. and the style of functional department managers affects the management control process in their functional areas. in part this reflect the fact that volume changes do have an impact throughout the company even though their actual impact cannot be measured in part this result from a management personnel and personnel related costs are by far the largest expense item in most discretionary expense center the annual budget for these center tend to be a constant percentage of budgeted sales volume.  Management style is influenced by the manager's background and personality. Basic question are raised. marketing. Personality characteristics include such variables as the manager's willingness to take risks and his or her tolerance for ambiguity. another new base is established. others are results oriented. others use trial and error. the style of the business unit manager affects the unit's management control process. The style of the chief executive officer affects the management control process in the entire organization. There is a likelihood that expenses will creep up gradually over the next five years and this is tolerated at the end of five years. conducts performance review meetings.  Implications for Management Control The various dimensions of management style significantly influence the operation of the control systems.   Q. Some are analytical. two CEOs with different styles would use these reports very differently to manage the business units. others are short-term oriented. Some are risk takers. Background includes things like age. That analysis provides a new base. 23 . Similarly. such as manufacturing. Even if the same reports with the same set of data go with the same frequency to the CEO.  In contrast with incremental budgeting which takes the current level of spending as the starting point this more intensive review attempts to build up de now the resources that actually are needed by the activity.

24 . when CEOs change. In fact.even if the formal structure does not change under a new CEO. subordinates typically infer what the new CEO really wants based on how he or she interacts during the management control process.

judging the relevance and importance of what they learn partly on their appraisal of the other person.  Managers' attitudes toward formal reports affect the amount of detail they want. Designers of management control systems need to identify these preferences and accommodate them. It is a factor of how these formal devices are used. rules. and the actual control reflects the style of the manager's superior. Other managers are "people oriented". they look at a few numbers. or procedures. The manager of a routine production responsibility center can be controlled relatively tightly or loosely. Managers differ on how much importance they attach to formal budgets and reports as well as informal conversations and other personal contacts. If the manager recognizes this incongruity and adapts his or her style accordingly. The degree of looseness tends to increase at successively higher levels in the organization hierarchy: higher-level managers typically tend to pay less attention to details and more to overall results. If. If a new senior manager with a different style takes over. they want a large flow of quantitative information. the system tends to change correspondingly. The style of the CEO has a profound impact on management control. Some managers are "numbers oriented". and they spend much time analyzing this information and deriving tentative conclusions from it.Personal versus Impersonal Controls Presence of personal versus impersonal controls in organizations is an aspect of managerial style. the degree of tightness or looseness often is not revealed by the content of the forms or aspects of the formal control documents. the frequency of these reports. and even their preference for graphs rather than tables of numbers. 25 . the problem disappears. the organization will experience performance problems. They visit various locations and spend time talking with both supervisors and staff to get a sense of how well things are going. It might happen that the manager's style is not a good fit with the organization's management control requirements. and whether they want numerical reports supplemented with written comments. The solution in this case might be to change the manager. Thus. but they usually arrive at their conclusions by talking with people. the manager is unwilling or unable to change. however.  Tight versus Loose Controls A manager's style affects the degree of tight versus loose control in any situation.

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 $55000 .this is the same amount as the amount it would pay unit x if the transfer price is less than 5000 units say 4000unoits. a profit allowance based on a return on investment on variable assets would be added to the standard variable cost for each unit sold. rather. The difference is their transfer prices were for not using a portion of unit X capacity that it has reserved. In particular the transfer price should be designed so that it accomplishes the following objective: It should provide each segment with the relevant information required to determine the optimum tradeoff between company cost and revenues It should induce goal congruent decisions that is the system should be so designed that decision improve business unit to earn more profit It should help measure the economic performance of the individual profit center Two step pricing: First. It would be appropriate under some circumstance to divide the investment into variable and fixed component.   26 . One or both of these components should include a profit margin. In the example we calculated the profit allowance as a fixed monthly amount. and transferring fixed cost and profit on a lump sum basis under this method the transfer price for product A would be 5$ for each unit that unit Y purchases plus $20000 per month for fixed cost. 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.unit y would pay $50000 under the two step methods compared with the $44000 it would pay if the transfer price were $11 per unit. Q. The transfer price is not primarily an accounting tool. and unit Y will make the correct short term marketing decisions. The return on investment that unit X earns on competitive product is calculated and multiplied by the investment assigned to the product.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. Note that under two step method the company variable cost for product A is identifiable to unit Y variable cost for the product. 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 two step pricing method correct this problem by transferring variable cost on a per unit basis. it is a behavioral tool that motivates manager to make the right decisions.3) Explain advantages and disadvantages of two step transfer pricing and profit sharing methods Transfer pricing: If two or more profit center is jointly responsible for product development manufacturing and marketing each should share in the revenue that is generated when the product is finally sold. Then.

 Profit sharing: If the two step pricing system just described is not feasible. the business units share the contribution earned which is selling price minus the variable manufacturing and marketing costs. time consuming and work against basic reason for decentralization namely autonomy of the business units mangers. In general. 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. 27 . Which is costly. 2. This system operates somewhat as follows. Manufacturing units may perceive this situation to be unfair  Two set of price: in this method. First. Also. there can be arguments over the way contribution is divided between the two profit centers. it is better for the headquarter to be aware of the conflict arising out of transfer prices because such conflict may signal problem in either the organizational structure or In other management systems. senior management must be aware of this situation in approved budget for the business units and in subsequent evaluation of performance against these budget. this system create an illusion feeling that business units are making money while in fact the overall company might be losing after taking account of the debits to headquarter. There are several practical problems in implementing such profit sharing system. 1. The difference is changed to a headquarter account and eliminated when the business unit statement are consolidated. this method accomplished the purpose of making the marketing unit’s interest congruent with the companies. After the product is sold. Second. a profit sharing system might be used to ensure congruence of business unit interest with company interest. however the sum of the business unit profit is greater than overall company profits. Under the two sets of prices method these conflicts are smoothed over thereby not alerting senior management to these problems. arbitrarily divided up the profit between units does not give valid information on the profitability of each segment of the organization. the manufacturing unit’s revenue is credited at the outside sales price. Further this system might motivate business unit to concentrate more on internal transfers at the expense of outside sales  The fact that the conflict between the business units would be lessened under this system could be viewed as a weakness. The product is transferred to the marketing unit at standard variable cost. Sometime. this transfer pricing method is sometimes used when there are frequent conflict between the buying and selling units that cannot be resolved by one of the other method both the buying and selling  There are several disadvantages to the system of having two set of transaction prices. and the buying unit is charged the total standard costs. Third since the contribution is not allocated until after the sale has been made the manufacturing units contribution depends upon the marketing unit’s ability to sell and on the actual selling price.

it is usually not possible for management to evaluate the efficiency of the R&D effort because of its technical nature. 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. The research managers typically want to build the best research organization that money can buy.4) Discuss special challenges faced in controlling R & D activities and possible management initiatives Type of financial control: The financial control exercised in a discretionary expense center is quite different from that in engineered center the latter attempts to minimize operating cost by setting a standard and reporting actual costs against this standards. new products. If these two types of responsibility center are carefully distinguished management may treat the performance report for the discretionary expense center 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. even though this is more expensive than the company can afford. Nevertheless. The goal congruence problem in R&D center is similar to that in administrative centers. which are also discretionary expense center is difficult for the following at least a semi tangible output reasons. by luck result in a bonanza. Costs are controlled primarily by deciding what task should be undertaken and what level of effort is appropriate for each. A complete product of an R&D group may require several year of effort. Thus in a discretionary expense center financial control is primary exercised at the planning stage before the amount are incurred. R&D usually has at least a semi tangible output in patent. Q. whereas a mediocre effort may. Measurement of performance: The primary job of the manager of a discretionary expense center is to accomplish the desired output spending an amount that is on budget is satisfactory. As contrasted with administrative activities. Even if the value of the output can be calculated. A brilliant effort may come up against an insuperable obstacle. 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. Even if an output can be identified a reliable estimate of its value often cannot be made. the relationship of these outputs to inputs is difficult to measure and appraise. 28 .    Control problems: The control of R & D centers. Results are difficult to measure quantitatively. consequently input as stated in an annual budget may be unrelated to outputs. 2. 1. or new processes. This is in contrast with the report in an engineered expense center which helps higher management to evaluate the manger efficiency.

3.

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 long term investment not as an activity that varies with short run corporate profitability.

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.

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 Q.5) Explain problems faced in pricing corporate services provided to business units
organized as Profit Centers Services are intangible in nature. This characteristic of services makes it difficult for pricing. Charging business units for services furnished by corporate staff units becomes challenging work due to intangibility of services. While pricing corporate services, we exclude the cost of central service staff units over which business units have no control (e.g., central accounting, public relations, and administration). If these costs are charged at all, they are allocated, and the allocations do not include a profit component. The allocations are not transfer prices.  We need to consider two types of transfers: For central services that the receiving unit must accept but can at least partially control the amount used. For central services that the business unit can decide whether or not to use.

O
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Business units may be required to use company staffs for services such as information technology and research and development. In these situations, the business unit manager cannot control the efficiency with which these activities are performed but can control the amount of the service received. There are three schools of thought about such services. One school holds that a business unit should pay the standard variable cost of the discretionary services. If it pays less than this, it will be motivated to use more of the service than is economically justified. On the other hand, if business unit managers are required to pay more than the variable cost, they might not elect to use certain services that senior management believes worthwhile from the company's viewpoint. This possibility is most likely when senior management introduces a new service, such as a new project analysis program. The low price is analogous to the introductory price that companies sometimes use for new products. A second school of thought advocates a price equal to the standard variable cost plus a fair share of the standard fixed costs-that is, the full cost. Proponents argue that if the business units do not believe the services are worth at least this amount, something is wrong with either the quality or the efficiency of the service unit. Full cost represents the company's long run costs, and this is the amount that should be paid. A third school advocates a price that is equivalent to the market price, or to standard full cost plus a profit margin. The market price would be used if available (e.g., costs charged by a computer service bureau); if not, the price would be full cost plus a return on investment. The rationale for this position is that the capital employed by service units should earn a return just as the capital employed by manufacturing units does. Also, the business units would incur the investment if they provided their own service. Optional Use of Services In some cases, management may decide that business units can choose whether to use central service units. Business units may procure the service from outside, develop their own capability, or choose not to use the service at all. This type of arrangement is most often found for such activities as information technology, internal consulting groups, and maintenance work. These service centers are independent; they must stand on their own feet. If the internal services are not competitive with outside providers, the scope of their activity will be contracted or their services may be outsourced completely.

For example, Commodore Business Machines outsourced one of its central service activities-customer service-to Federal Express. James Reeder, Commodore's vice president of customer satisfaction, said, "At

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that time we didn't have the greatest reputation for customer service and satisfaction. But this was FedEx's specialty, handling more than 300,000 calls for service each day. Commodore arranged for FedEx to handle the entire telephone customer service operation from FedEx's hub in Memphis.

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In this situation.92.00.000 24.com while being able to focus on the growth of its bricks and mortar business.000 20.000 Unit) 20 Actual (Rs.00. 120 per unit by mutual agreement.00. A would require for this additional activity. compare Actual Vs Budgetred Performance b) Its implications for Management Control? Solution: a) Particulars Budgeted Budgeted (Rs. Material Cost of Rs.After losing $29 million online the previous year.40.4 lacs) and Rs. Borders Group turned to rival Amazon.000 4.60. Their transfer prices should be based on the same considerations as those governing other transfer prices. A was able to reduce material consumption by 5% but its budgeted investment overshot by 10%. Per Unit) 20 Actual (Total in Rs. business unit managers control both the amount and the efficiency of the central services.09. Borders get to maintain an Internet sales channel and gains the operational effectiveness provided by Amazon.00.20 lacs that Div.000 For 19.200 119. Also the sales have decreased by 400 units.20 (lumpsum Rs. 32 .000 4.600 Units 60 20 100 120 20 20 12.17.000 20.000 20% 57 11.) 3.com to manage its online sales.000 22. Div. 20. Therefore we can say that additional investment has not achieved any positive results.) For 20. B from Div.000 Direct and Variable Labour Cost Material Cost Fixed Overheads Total Cost Transfer Price Profit Investment ROI = Profit/Investment Units 4. A was 19.86 23.200 4.000 20% Despite of increase in investment by 10%. During the year.00. a) As Financial controller of Div.00.600 units. Fixed overheads of Rs. Per (Total in Rs.000 units of a components which goes into the final product made by Div. A. 20.000 19.00. (Numerical) MCS – 2004 Division B of Shayana company contracted to buy from Div.49.00. A. Under these conditions. The transfer price for this internal transaction was set at Rs. actual off take of Div. This comprises of (per unit) Direct and Variable labour cost of Rs.200 4. B.00. these central groups are profit centers. there is negligible difference in transfer price.

MCS – 2007 Two Divisions A and B of Satyam Enterprises operate as Profit centers. Division A normally purchases annually 10,000 nos. of required components from Div. B; which has recently informed Div. A that it will increase selling price per unit to Rs.1,100. Div. A decided to purchase the components from open market available at Rs. 1000 per unit. Naturally, Div. B is not happy and justified its decision to increase price due to inflation and added that overall company profitability will reduce and the decision will lead to excess capacity in Div. B, whose variable and fixed costs per unit are respectively Rs. 950 and Rs. 1,100. a) Assuming that no alternate use exists for excess capacity in Div. B, will company as a whole benefit if div A buys from the market. b) If the market price reduces by Rs. 80 per unit. What would be the effect on the company (assuming Div. B still has excess capacity) if A buys from the market c) If excess capacity of Div. B could be used for alternative sales at yearly cost savings of Rs. 14.5 lacs, should Div. A purchase from outside? Justify your answers with figures. Solution a) Option A ( Div A buys from outside) Total Purchase Cost = 10,000 Units * Rs. 1000 = Rs. 1,00,00,000 Total outlay if transferred inside = 10,000 Units * Rs. 950 = Rs. 95,00,000 Since total outlay if transferred inside is lesser than total purchase cost if bought from outside, relevant cost is the lesser one i.e. Rs. 95,00,000 and overall benefit for the company would be Rs. 5,00,000 b) Option B ( if the market price is reduced by Rs. 80 per unit and A buys from the market) Total Purchase Cost = 10,000 Units * Rs. 920 = Rs. 92,00,000 Total outlay if transferred inside = 10,000 Units * Rs. 950 = Rs. 95,00,000 Since total purchase cost is lesser than the total outlay if transferred inside, relevant cost is the lesser one i.e. 92,00,000 and overall benefit for the company would be Rs. 3,00,000 c) Option C ( if excess capacity of Div B could be used for alternative sales at yearly cost savings of Rs 14.5 lacs, should Div A purchase from outside) Total Purchase Cost = 10,000 Units * Rs. 1,000 = Rs. 1,00,00,000 Total outlay if transferred inside = 10,000 Units * Rs. 950 = Rs. 95,00,000 Total opportunity cost if transferred inside = Rs. 14,50,000 Total relevant cost becomes Rs. 1,00,00,000 If Div A purchase from outside, overall benefit for the company would be Rs. 9,50,000. Therefore, Div A should purchase from outside. Particulars Total Purchase Cost Total outlay if transferred inside Total opportunity cost if transferred inside Total relevant cost Net advantage/disadvantage to company as a whole if it buys from inside Option A Amount 1,00,00,000 95,00,000 95,00,000 5,00,000 Option B Amount 92,00,000 95,00,000 92,00,000 (3,00,000) Option C Amount 1,00,00,000 95,00,000 14,50,000 1,00,00,000 (9,50,000)

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SET.4
Q.1) Explain the concept of ROI. What are its advantages? Many experts regard EVA as a concept is superior to ROI and yet in certain cases, EVA does not do justice to the evaluation of investment centre. Explain this phenomenon with illustration.

Q.2) What are the different methods to evaluate the performance of an investment centre? Discuss the merits and demerits of each? Which method would you recommend?

Q.3) What are the objectives of Transfer Pricing? What is ideal transfer price in the situations of Limited Market Shortage of Capacity in the industry

Q.4) When do you use Cost Based Transfer Pricing? - Transfer Pricing is not an accounting tool” comment with illustration. - Market Price is ideal transfer price even in limited markets. Comments.

Q.5 ) Aparna Company Manufacturers (MCS-2004) Numerical

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Q.1) A)Explain the concept of ROI. What are its advantages? Return on investment (ROI) is the ratio of profit before tax to the gross investment. ROI is calculated with the help of the following formula: ROI = (Pre-Tax Profit/Sales) X (Sales/Net Assets) or (Pre-Tax Profits/Net Assets) The numerator is profit before tax as reported in the P&L account. The profit should include only the profits arising out of the normal activities of the division. Unusual items of receipts and expenses should be excluded from the profit figure. One should also ignore windfalls and income from investments not related to the operations of the division. Tax is excluded from the numerator because the marginal of the SBU is not responsible for or in control of the tax paid. Capital employed can be ascertained from the balance sheet by including fixed and current assets. Assets not currently put to divisional use should be excluded from the investment base. One also needs to exclude their relative earnings if any. The company should also exclude intangible assets like goodwill, deferred revenue expenses, preliminary expenses, etc. ROI can be improved by: Increasing the profit margin on sales. Increasing the capital turnover Increasing both profit margin and capital turnover. Reducing cost as that adds to the total earnings of the firm. Increasing the profits by expanding present operations or developing new product line, increasing market share, etc. Diversifying, introducing productivity imporevement measures, expansion, replacement of old equipments Advantages of ROI ROI relates return to the level of investment and not sales as the rate of return is more realistic. ROI can be decomposed into other variables as shown. These variables have tremendous analytical value. ROI is an effective tool for inter-firm comparison.

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This is far from being completely satisfactory because actual savings or revenues from a fixed asset acquisition may not be identifiable. Explain this phenomenon with as illustration. EVA does solve the problem created by differing profit potentials. and they control fixed assets by separate devices. Nevertheless. Once the investment has been made. production interruptions or lost customer business can result from the stockouts. a business unit can increase its EVA by taking actions contrary to the interests of the company.Question 1 (b): Many experts regard EVA as a concept superior to ROI and yet in certain cases. and the risk of obsolescence is increased. and others when they are expensed. not only because some action may be appropriate with respect to the person responsible for the mistakes but also because safeguards to prevent a recurrence may be appropriate. Controllable assets are. the unit with the relatively larger marketing operations will tend to have the highest EVA. In view of all these problems. will be motivated to increase investments if the rate of return from a potential investment exceeds the required rate prescribed by the measurement system. if a new machine produces a variety of products. to obtain the maximum long-run cash flow from the capital investments the business unit manager controls and to add capital investments only when they will provide a net return in excess of the company's cost of funding that investment. as shown in Exhibit 7-3. dealer organization. These companies make an interest charge for controllable assets only. In particular. unnecessary capital is tied up. Illustration 36 . and this is rarely done in practice. the capital investment analysis procedure is of primary importance in investment control. if inventories are too high. and. EVA will be temporarily depressed by new investments because of the high net book value in the early years. if inventories are too low. it does not solve the problem of accounting for fixed assets discussed above unless annuity depreciation is also used. If gross book value is used. If these decisions are wrong. EVA does not solve all the problems of measuring profitability in an investment center. Although the purchase cost of fixed assets is ordinarily capitalized. This acts both to motivate business unit management properly and also to measure the real cost of resources committed to these items. If net book value is used. Moreover. materialized. it is largely a sunk cost and should not influence future decisions. receivables. This situation applies especially in marketing units. some companies. some companies have decided to exclude fixed assets from the investment base. the cost accounting system usually will not identify the savings attributable to each product. some assets may be undervalued when they are capitalized. regardless of profitability. such as Quaker Oats. To focus attention on these important controllable items. For example. serious consequences can occur-quickly. namely. then. and office furniture and equipment. management wants to know when capital investment decisions have been made incorrectly. In these units the investment amount may be limited to inventories. receivables and inventory. Investment decisions. are controlled at the point where these decisions are made. new product development. Furthermore. For example. a substantial amount of investment in start-up costs. Consequently. 17 include a capital charge for the items as an element of cost in the business unit income statement. EVA does not do justice to the evaluation of investment center. The argument for evaluating profits and capital investments separately is that this often is consistent with what senior management wants the business unit manager to accomplish. Investments in fixed assets are controlled by the capital budgeting process before the fact and by post completion audits to determine whether the anticipated cash flows. whereas. Business unit management can make day-to-day decisions that affect the level of these assets. When a group of units with varying degrees of marketing responsibility are ranked. essentially. and so forth may be written off as expenses. therefore. All business units. EVA will increase simply due to the passage of time. in fact. not appear in the investment base.

Return on investment (ROI): The rate of return on investment is determined by dividing net profit or income by the capital employed or investment made to achieve that profit. the profit margin and the investment turnover in any of the following ways: Increasing the profit margin Increasing the investment turnover Increasing both profit margin and investment turnover Capital employed is taken to be the total of shareholders funds.Q. 37 . loans etc The profit figure used is in calculating ROI is usually taken from the profit and loss account. ROI = Profit / Invested capital * 100 ROI consists of two components viz. Profit margin Investment turnover ROI = Net profit / Investment = (Net profit / Sales) * (Sales / Investment in assets) It will be seen from the above formula that ROI can be improved by increasing one or both of its components viz.2 Soln What are the different methods to evaluate the performance of an investment centre? Discuss the merits and demerits of each? Which method would you recommend? The following techniques are useful in evaluating the performance of an investment centre: 1. profit arising out of the normal activities of the company should only be taken.

Residual income is profit minus notional interest charge on capital employed. Most likely the rate would improve in course of time when the initial difficulties are overcome. emphasis is placed on marginal profit amount above the cost of capital rather than on the rate itself. The book value of assets decline due to depreciation. Demerits: ROI analysis is not very suitable for short-term projects and performances. 38 . It has been argued that a more suitable measure of performance for investment centres.Capital employed for the company as a whole can be arrived at as follows: Share capital of the company Reserves and surplus Loans (secured/unsecured) xxx -----xxx Less: a. This encourages managers to obtain assets that will provide a satisfactory return on investment and to dispose off assets that are not providing an acceptable return. In other words. Residual income: Residual income can be defined as the operating profit (or income) of the company less the imputed interest on the assets used by the company. Investment outside the business b. Residual income is affected by the size of the organization and therefore will not provide a basis for evaluation of organizational performance. This is probably the main reason why the management continues to make use of ROI which is relative measure. the investment base will continuously decrease in value. Not all projects start off with positive or sufficiently large positive profits in the early years of a project to produce a positive increment to residual income. Debit balance of P & L A/c xxx xxx xxx xxx ------xxxx xxx xxx Merits: Return on investment analysis provides a strong incentive for optimum utilization of the assets of the company. Because when RI is adopted for evaluation purposes. which could encourage managers to be more willing to undertake marginally profitable projects. is residual income. 2. In selecting amongst alternative long-term investment proposals. ROI provides a suitable measure for assessment of profitability of each proposal. In the initial stages a new investment may yield a small ROI which may mislead the management. interest on the capital invested in the company is treated as a cost and any surplus is the residual income. causing the rate of return to increase. Preliminary expenses c. We recommend RI as a method of evaluating performance of an investment centre.

By contrast. The system should be simple to understand and easy to administer. because low bidders can expect to get some of the business. It should help measure the economic performance of the individual profit centers. market prices that are applicable to relatively small purchases are not valid in this case. This can be done by calculating the cost of the difference in design and other conditions of sale between the competitive products and the proprietary products. The person/group would then make a sourcing decision on the basis of the company’s best interests.Q. Some companies allow either buying profit center to appeal a sourcing decision to a central person or committee. For example. If the buying profit center purchases similar products from the outside market. it may be possible to replicate competitive prices for its proprietary products.e.3 Solution What are the objectives of Transfer Pricing? Transfer price if designed appropriately has the following objectives: It should provide each segment with the relevant information required to determine the optimum trade-off between company costs and revenues. it is often possible to replicate a competitive price on the basis of the outside price. The company then puts all of the products out to bid. However. If the production profit center sells similar products in outside markets. Shortage of Capacity in the industry In this case. 39 . Even in case of limited market the transfer price that is ideal or satisfies the requirement of a profit center system is the competitive price.It should induce goal congruent decisions-i. they can be used to establish transfer prices. In other words. it will soon find that either no one bids or that the bids are of questionable value. if a company requests bids solely to obtain a competitive price and does not award the contracts to the low bidder. 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. This generally can be done only if the low bidder has a reasonable chance of obtaining the business. The company obtains valid bids. They are as follows: If published market prices are available. the system should be so designed that decisions that improve business unit profits will also improve company profits. the profit center is appealing only the sourcing decision. In every case the transfer price would be the competitive price. the output of the buying profit center is constrained and again company profits may not be optimum. 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. In this scenario a buying profit center could appeal a selling profit center’s decision to sell outside. What is ideal transfer price in the situations of Limited Market Shortage of Capacity in the industry The ideal transfer price in the situations of Limited Market By limited market it means that the markets for buying and selling profit centers may be limited. One company accomplishes this by buying about one-half of a particular group of products outside the company and one-half inside the company. Market prices are set by bids. but selects one-half to stay inside.

there is a need to provide an incentive to set tight standards and to improve standards. there also are two decisions: What is the profit markup to be based? The simplest and most widely used base is percentage of costs. new facilities designed to reduce prices could actually increase costs because old assets are undervalued What is the level of profit allowed? The second problem with the profit allowance is the amount of the profit. A conceptually better base is a percentage of investment. rarely used in practice. however. If this base is used. no account is taken of capital required. The conceptual solution is to base the profit allowance on the investment required to meet the volume needed by the buying profit centers. Transfer prices may be set up on the basis of cost plus a profit. The profit markup: In calculating the profit markup. The investment would be calculated at a “standard” level. This solution is complicated and. If the standard costs are used. with fixed assets and inventories at current replacement costs. the market price is the best transfer price. When do you use Cost Based Transfer Pricing? We use cost-based transfer pricing if there is no way of approximating valid competitive price. Actual costs should not be used because production inefficiencies will then be passed on to the buying profit center. therefore. If the market price can be approximated. Two aspects need to be considered for cost-based transfer pricing: The cost basis: The usual basis is the standard cost.Even if there are constraints on sourcing. 40 . even though such transfer prices may be complex to calculate and the results less satisfactory than a market-based price. But there may be a major practical problem in calculating the investment applicable to a given product. it is ideal transfer price. If the historical cost of the fixed assets is used.

The principle states that the transfer price would be arrived at on the basis as if the two . it would be advisable to show lower profits in Country B and higher profits in Country A. Organisation for Economic Cooperation and Development issued some guidelines in 1995. The company had incurred an R&D cost that was included in the price. the group can adjust the transfer price in such a way that the profits in Country A increase and that in Country B get reduced. 1. But if companies set unrealistic transfer price to minimize their tax liabilities and the same is spotted by the tax authority. The company had falsely inflated freight charges by 40-60% to reduce the profits.Gross Margin Method where a gross margin is established and applied to the seller's manufacturing cost. There have been instances where companies have fixed unrealistic transfer prices. as transfer prices on import of cars and trucks were too high. For this they enter into agreements whereby tax is paid on specific transactions in one country only. Interestingly the Japanese tax authorities took a different view and returned the double tax. For example the tax rate in Country A is 20% and is 50% in Country B. While the tax authorities in UK accepted the price. For this. They evolved what came to be known as the arm's length price. The reverse will be true if the Division in Country A acquires goods from the Division in Country B. The company's lawyers argued the case before the Commission on two grounds viz. There is also a temptation to set up marketing subsidiaries in countries with low tax rates and transfer products to them at a relatively low transfer price. The manipulation helped the company to hide tax to the tune of 237 million dollars. With a view to avoid such cases from recurring. For this the group should fix a very high transfer price if the Division in Country A provides goods to the Division in Country B. These arguments did not go well with the Commission and the company was fined 1. the tax authorities monitor transfer prices closely in an attempt to collect the full amount of tax due. The next year Nissan was made to pay 106 million dollars in unpaid tax in the USA because the authorities felt that part of their US marketing profits were being transferred to Japan. In the larger interest of the group. The price is determined through: Comparable Price Method where the price is fixed on the basis of prices of similar products or an approximation to one. manipulating the transfer prices between the subsidiaries can scale down the overall tax bill of the group. The first case relates to Hoffman La Roche that imported two drugs Librium and Valium into UK at prices of 437 pounds and 979 pounds per kilo respectively. These guidelines aim at encouraging world trade. 41 . companies are independent and unrelated.85 million pounds for the manipulative practices adopted while fixing the transfer price. While companies indulge in all types of activities to lower their tax liability. the Monopolies Commission did not accept the company's argument. The second case is of Nissan. Transfer price is viewed as a major international tax issue. This will maximize the profits in Country A and minimize the profits in Country B.4 (a) solution “Transfer Pricing is not an accounting tool” comment with an illustration If a group has subsidiaries that operate in different countries with different tax rates. The price was not set on cost but on what the market would bear and 2.Q. then the company is forced to pay tax in both countries leading to double taxation. since the same drugs were available from an Italian firm for 9 pounds and 28 pounds per kilo.

For example.So we see from the above arguments that market price is ideal transfer price even in limited markets 42 . This generally can be done only if the low bidder has a reasonable chance of obtaining the business. Other countries are also in the process of evolving tight norms for the same. it is often possible to replicate a competitive price on the basis of the outside price. 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. they can be used to establish transfer prices. but selects one-half to stay inside. So the onus of proving the price has been put on the taxpayer who is required to produce supporting documents. it may be possible to replicate competitive prices for its proprietary products. 3. If published market prices are available.In spite of all these efforts. By contrast. However. If the taxpayer fails to do this he is required to pay heavy penalty.If the buying profit center purchases similar products from the outside market. 2. They are as follows: 1. Q. For example. The company then puts all of the products out to bid.Market prices are set by bids. market prices that are applicable to relatively small purchases are not valid in this case. failure to provide documentary evidence results in a 40% penalty on the arm's length price. Even in case of limited market the transfer price that is ideal or satisfies the requirement of a profit center system is the competitive price. in USA. This can be done by calculating the cost of the difference in design and other conditions of sale between the competitive products and the proprietary products. if a company requests bids solely to obtain a competitive price and does not award the contracts to the low bidder. 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.4. One company accomplishes this by buying about one-half of a particular group of products outside the company and one-half inside the company. 4. Comments By limited market it means that the markets for buying and selling profit centers may be limited.If the production profit center sells similar products in outside markets. it will soon find that either no one bids or that the bids are of questionable value. it has to be admitted that setting a fair transfer price is not easy. The company obtains valid bids. Countries across the globe also allow the taxpayer to enter into an Advance Pricing Agreement whereby dispute can be avoided and so also the costly penalty of double taxation and penalty.( b) Solution Market Price is ideal transfer price even in limited markets. In UK the penalty is to the tune of 100% of any tax adjustment. because low bidders can expect to get some of the business.

Intra company transactions rule: standard cost plus a 10 percent return on fixed assets and inventory. Product C could become uncompetitive since upstream margins are added.000 1. Standard Cost per Unit Product A Product B Product C *Purchase of outside material Direct.Q.000 43 .00.60. to be paid by the buying division.000 40. Comment. (20 * 2 lac units) 80.) *Fixed overhead per unit.e.000 + 10% on (FA + Inventory) i. Answer (a): Standard Cost of Product A Outside material (40 * 2 lac units) Direct Labour (20 * 2 lac units) Variable O.) 40 20 60 40 20 60 40 20 6 lacs 3. B and Standard Cost of Product C.) 14 lacs 3 lacs 9 lacs 6 lacs (Units) 2 lacs 2 lacs (a) (b) Determine from above data.) Average Inventory Net Fixed Assets Standard Production (Rs.2 lacs 2 lacs 20 Variable overhead 20 60 (Rs.00.00. which then is sold to third division to be used as part of its Product C (sold to outside market). 10% on 20 lacs 2. transfer prices for Products A.5 solution Division of Aparna Company manufactures Product A. which is sold to another division as a component of its product B.) (Rs.00.62.000 40. (Rs.) 20 (Rs. Labour (Rs.00.H.00.000 1.

H.000 Transfer Price for Product A = 2.20.000 = 100.00.00.00.20.00.00.000 Standard Cost of Product B Outside material (60 * 2 lac units) Direct Labour (20 * 2 lac units) Variable O.000 40.20.00.000 Standard Cost of Product C Outside material (20 * 2 lac units) Direct Labour (40 * 2 lac units) Variable O.000 80.6 2.00.01.01.00. (40 * 2 lac units) Fixed O.000 2.00.000 + 10% on (FA + Inventory) i.00.000 44 . 10% on 12 lacs 1.00.20.000 = 81 2.000 40.H.000 20.62.Transfer Price for Product A = 1. (20 * 2 lac units) 1.00.H.000 80.000 2.00.000 40. (20 * 2 lac units) 2.e.20.

So if the quality of product C is better than its competitors than only it can survive in this competitive market. as its price will normally be high compared to products of similar category. This may do well to the product by making higher revenues and capturing the market share. Another strategy for the company is to cut the margins added by Products A and B. it suffers a disadvantage from its competitors as far as pricing is concerned. are added. and then come out with Product C with a lower price tag on it. So it might become uncompetitive. 45 . But in the long run. So when it is sold to outside market. margins of Product A. which in turn become an input to Product C. and Product B. which become an input to Product B.(b): While arriving at the cost of Product C. customers will distinguish between a good product and a bad product and the one with the best quality will survive.

they ensure that individual actions taken to achieve personal goals also help to achieve the organization's goals." In a goal congruent process. Other attitudes and norms are industry-specific. 46 . is to ensure a high level of what is called "goal congruence. These norms include a set of attitudes. and they are not necessarily consistent with those of the organization. their spirit. often collectively referred to as the work ethic. which is manifested in employees' loyalty to the organization. chambers of commerce and other promotional organizations often claim that their locality has a loyal. Senior management wants the organization to attain the organization's goals. some countries. that is. Management control systems influence human behavior. specific to the city or region in which the organization does its work. Good management control systems influence behavior in a goal congruent manner. The concept of goal congruence. Still others are national.5 Q. In the informal forces both internal and external factors play a key role. diligent workforce.SET . and their pride in doing a good job (rather than just putting in time). have a reputation for excellent work ethics. The central purpose of a management control system. then. Ans. Some of these attitudes are local that is. the actions people are led to take in accordance with their perceived self interest are also in the best interest of the organization.1) Describe and illustrate significance of human behavior patterns in management control system. describing how it is affected both by informal actions and by formal systems. their diligence. But the individual members of the organization have their own personal goals. In encouraging companies to locate in their city or state. External Factors External factors are norms of desirable behavior that exist in the society of which the organization is a part. The significance of human behavior patterns in management control system can be explained with the help of Informal Factors that influence Goal Congruence. such as Japan and Singapore.

and the larger and more mature the organization. 47 . Cultural norms are extremely important since they explain why two organizations with identical formal management control systems. Usually. and by those of lower-level managers with respect to the areas they control. Certain practices become rituals. Management Style  The internal factor that probably has the strongest impact on management control is management style. shared values. subordinates' attitudes reflect what they perceive their superiors' attitudes to be.Internal Factors Culture  The most important internal factor is the organization's own culture-the common beliefs. the greater the resistance is. although no one may remember why. may vary in terms of actual control. If the organization is unionized. Some are charismatic and outgoing. Some spend much time looking and talking to people (management by walking around)." Others are taboo ("we just don't do that here"). A company's culture usually exists unchanged for many years. Managers come in all shapes and sizes. Organizational culture is also influenced strongly by the personality and policies of the CEO. others rely more heavily on written reports. others are less ebullient. and their superiors' attitudes ultimately stem from the CEO. carried on almost automatically because "this is the way things are done here. norms of behavior and assumptions that are implicitly and explicitly manifested throughout the organization. the rules and norms accepted by the union also have a major influence on the organization's culture. Attempts to change practices almost always meet with resistance.

the headquarters staff. The informal factors discussed above have a major influence on the effectiveness of an organization’s management control. with all these other communication sources available. and people who are simply friends and acquaintances. this is especially likely to occur when the production manager is evaluated on production efficiency rather than on overall performance. as well as with other managers. 48 .g. it is not always clear what senior management wants done. The other major influence is the formal systems. They receive this information through various channels. An organization is a complicated entity. the production manager of Division A actually communicates with many other people in the organization. that the production manager of Division A reports to the general manager of Division A. might reduce future profitability. For example. the official authority and responsibilities-of each manager... and the actions that should be taken by anyone part to further the common goals cannot be stated with absolute clarity even in the best of circumstances. although increasing current profits.  Perception and Communication In working toward the goals of the organization. The realities of the management control process cannot be understood without recognizing the importance of the relationships that constitute the informal organization. or be subject to differing interpretations. the production manager. The chart may show. the budget mechanism may convey the impression that managers are supposed to aim for the highest profits possible in a given year. operating managers must know what these goals are and what actions they are supposed to take in order to achieve them. These systems can be classified into two types: (1) the management control system itself and (2) rules. Moreover. In extreme situations. Despite this range of channels. conversations). the messages received from different sources may conflict with one another.g. both formal (e. whereas senior management does not actually want them to skimp on maintenance or employee training since such actions. budgets and other official documents) and informal (e. which are described in this section. for example. may not pay adequate attention to messages received from the general manager. But in the course of fulfilling his or her responsibilities. support units. The Informal Organization The lines on an organization chart depict the formal relationships-that is.

for example. how much discretion should be allowed. Some specific types of rules are listed below: Physical Controls Security guards. Manuals Much judgment is involved in deciding which rules should be written into a manual. Some rules are positive requirements that certain actions be taken (e. and organizations with geographically dispersed units performing similar functions (such as fast-food restaurant chains) have more than do single-site organizations   49 . and a host of other considerations. Rules range from the most trivial (e. standard operating procedures. illegal. Finally. or a rule that airline pilots must never take off without permission from the air traffic controller. and other physical controls may be part of the control structure. that is. including: standing instructions. and ethical guidelines.g. either under specified circumstances or when their own best judgment indicates that a departure would be in the best interests of the organization. which should be considered to be guidelines rather than fiats. and indeed expected. capital expenditures of over $5 million must be approved by the board' of directors). fire drills at prescribed intervals). to depart from them.g.g. large organizations have more manuals and rules than small ones. centralized organizations have more than decentralized ones.The Formal Control System Rules We use the word rules as shorthand for all types of formal instructions and controls. manuals. or other undesirable actions. there are rules that should never be broken under any circumstances: a rule prohibiting the payment of bribes. Manuals in bureaucratic organizations are more detailed than are those in other organizations.. organization members are permitted. computer passwords. paper clips will be issued only on the basis of a signed requisition) to the most important):e. job descriptions.. Others are prohibitions against unethical. locked storerooms. vaults.. Some rules are guides. television surveillance.

and to prevent (or at least minimize) fraud of every sort. System Safeguards Various safeguards are built into the information processing system to ensure that the information flowing through the system is accurate. requiring signatures and other evidence that a transaction has been authorized. the automated system itself provides the control. Many of these tasks are controlled by rules. These include: crosschecking totals with details. separating duties. 50 . counting cash and other portable assets frequently.  Task Control Systems Task control is the process of assuring that specific tasks are carried out efficiently and effectively. If a task is automated. and a number of other procedures described in texts on auditing.

If the organization shows net losses it may show the NPO facing risk of bankruptcy. On the financial front. Hence non availability of clear-cut performance yardstick makes the problem of control worst. The more stress expected on allocation of scare resources. 3. Absent of profit performance measure leads to problems in assessing the efficiency of the organization. The nature of the contributed capital is beyond control of the management and therefore management concentrates on controlling the operating assets/investments. which entitles the organization to reap the interest on it keeping the principal amount intact. Governance: Usually NPO are managed by trusts. a) Concept of profit centre in NPO By law NPO are allowed to make profit but are restrained from distributing it to owners and management This way they are non profit making organizations (from the owner's point of view). who exercise less control on operational matters. 4. Implications of differentiated strategies on controls. 2. Operating Assets represents the resources used for running day to day activities. Characteristics: 1. If the organization shows large net income it may be because that NPO may not be providing the services to the extent possible/ expected. Second kind of contribution could be in the form of monetary assistance. Such organizations include religious. and enhancing the service base. 5. Management control in matrix structures c. charitable and educational trusts. These characteristics pose difficulty in pricing of the product/services . But one can make the things easier by concentrating on adherence to costs budgets. Hence performance control is less demanding from owners' point of view and difficult from the point of view of management.what could be appropriate price? Usually it is set at total/full cost. Fund accounting: NPO need to keep two types of financial statements one set for contributed capital and another for operating capital. but a sense of control can be built among the managers by way of using budgets for various activities and expenses. grants etc so also they attract special control from these assisting institutes. they enjoy many concessions from the government such as taxes. NPO's have contributed capital Plant: NPOs do not have shareholder as its stakeholder. Prime goal of management control systems in such organization is enhancing the service spread first and if possible then cost control rather and than operating efficiency.2) Write short notes on a. Though not stricter control. subsidies. 51 . Concept of profit centre in non-profit organization b. Ans. Non profit basis makes performance evaluation quite impossible. And the contributed assets are not allowed to mix up with the operating assets. The capital contribution to the business comes by way of contributions to assets such as building and equipments.Q.

52 .

it poses problems of casting the individual responsibility. efficiency and effectiveness but simultaneously it may pose problems such as added complexity in control function. This form of organization is very complex. assignment of responsibility and authority etc. account supervisors are shifted from one account to another on periodic basis. Though they offer economies of using scares functional staff. Matrix structure offers advantages such as faster decision making process. Usually in an advertisement agency. However taking in to consideration the time lag of result realization in such services is quite large. This does not mean a control system designer should insist on abandoning the rotation system of the executives. And this may pose problem of performance assessment of a particular executive. One has to mold and remold the management control system to suit the given organization structure A citation by Anthony is worth noting in this regard.b) Management control in matrix structures Matrix organizational structure assigns multiple responsibilities to the functional heads. 53 . from the point of view of management control system. Evaluation of performance of such organizational entities is very difficult. this practice allows the agency to look at the account from the perspectives of different executives. At the end we must not forget that the management control system is for the organization and not the organization exists for management control system.

This implies that as firms become more diversified. several of them could be pursued fruit. The horizontal dimension might be incorporated into the strategic planning process in a number of different ways.  Strategic planning: given the low level of interdependencies. the activities of the company's various business units. Third. conglomerates tend to use vertical strategic planning systems-that is. or experience in. there are low levels of interdependence among the business units of unrelated diversified firms. If so. These methods are not mutually exclusive. Communication channels and transfer of competencies across business units. strategic plans of individual business units could have an interdependence section. a group executive might be given the responsibility to develop a strategic plan for the group as a whole that explicitly identifies synergies across individual business units within the group. in which the general manager of the business unit identifies the focal linkages with other business units and how those linkages will be exploited. corporate-level managers for highly diversified firms cannot expect to control the different businesses on the basis of intimate knowledge of their activities. and performance evaluation tends to be carried out at arm's length. business units prepare strategic plans & submit to senior management to review & approve. corporate-level managers may not have significant knowledge of. strategic plans of individual business units could be circulated to managers of similar business units to critique and review. the corporate office could require joint strategic plans for interdependent business units. it may be desirable to change the balance in control systems from an emphasis on fostering cooperation to an emphasis on encouraging entrepreneurial spirit. Single-industry and related diversified firms possess corporatewide core competencies (on which the strategies of most of the business units are based. Finally. are critical in such firms. In fact. Second. In contrast. First.c) Implications of differentiated strategies on controls Different corporate strategies imply the following differences in the context in which control systems need to be designed: As firms become more diversified. fully at the same time. 54 . therefore.

This lessens the need to rely as heavily on the budgeting system as the tool of control. they may base a larger portion of the bonus on quantitative. the incentive bonus of the 'business unit managers tend to be determined primarily by the profitabi1ity of that unit.the overall corporation). the greater the possibility of interunit conflict. in a single-industry or a related diversified firm. synergies may be important. such as X percent bonus on actual economic value added (EVA) in excess of budgeted EVA. rather than the profitability of the firm~ Its purpose is to motivate managers to act as though the business unit were their own company. On the other hand. Budgeting: The chief executives of single-industry firms may be able to control the operations of subordinates through informal and personally oriented mechanisms. However. in a conglomerate it is nearly impossible for the chief executive to rely on informal interpersonal interactions as a control tool. In contrast. These formula-based bonus plans are employed because senior management typically is not familiar with what goes on in a variety of disparate businesses. This implies the following budgeting system characteristics in a conglomerate. and business units may not be given the freedom to make sourcing decisions. Therefore. In many related diversified firms. On the other hand. such as frequent personal interactions. formula-based plans that are tied strictly to financial performance criteria could be counterproductive. for companies with highly interdependent business units. The usual transfer pricing policy in a conglomerate is to give sourcing flexibility to business units and use arm's-length market prices.  Incentive Compensation: The incentive compensation policy tends to differ across corporate strategies in the following ways-  Use of formulas: Conglomerates. that is. Business unit managers have somewhat greater influence in developing their budgets since they. single-industry and related diversified firms tend to base the incentive bonus of a business unit manager on both the performance of that unit and the performance of a larger organizational unit (such as the product group to which the business unit belongs or perhaps even . Senior managers of single-industry and related diversified firms tend to base a larger fraction of the business unit managers’ bonus on subjective factors. When business units are interdependent. the more the incentive bonus of general managers emphasizes the separate performance of each unit.  Transfer Pricing: Transfers of goods and services between business units are more frequent in single-industry and related diversified firms than in conglomerates. are more likely to use formulas to determine business unit managers' bonuses. not the corporate office. greater degrees of interrelationships imply that one unit's performance can be affected by the decisions and actions of other units. in general. possess most of the information about their respective product/market environments. much of the communication and control has to be achieved through the formal budgeting stem. Greater emphasis is often placed on meeting the budget since the chief executive has no other informal controls available. basing the bonus of general managers 55 . financial measures.  Profitability measures: In the case of unrelated diversified firms.

or harvest. product technology. a build mission signifies additional capital investment (greater dependence on capital markets). Such factors as manufacturing process. Management control systems can be systematically varied to help motivate the man ager often require systematically different management control systems. whereas harvest strategies typically are undertaken in the mature decline stage of the product life cycle. and divest. relations with suppliers. Typically business units choose from four missions: build. The business unit has two generic ways to compete and develop a sustainable competitive advantage: low cost and differentiation.battle for market share is a zerosum game. Because the total market share of all firms in an industry is 100 percent. hold. thereby increasing managers' motivation to exploit interdependencies rather than their individual results.Build business units are often in new and evolving industries.The strategy of a business unit depends on two interrelated aspects: (1) Its mission ("What are its overall objectives?") and (2) its competitive advantage. and so on. there should be congruence between the mission chosen and the types of controls used. harvest. The mission of the business unit influences the uncertainties that general managers face and the short-term versus long-term trade-offs they make. build managers are 56 . they tailor the approach to each business unit's strategy. uniform approach to controlling their business units. different missions  Mission and Uncertainty "Build" units tend to face greater environmental uncertainty than "harvest" units for several reasons: Build strategies typically are undertaken in the growth stage of the product life cycle. a build strategy puts a business unit in greater conflict with its competitors than does a harvest strategy. For instance. and distribution channels. buyers. ("How should the business unit compete in its industry to accomplish its mission?"). increase in production volume (greater dependence on raw material suppliers and labor markets). build managers tend to experience greater dependencies on external individuals and organizations than do harvest managers. Thus. to cope effectively with uncertainty and make appropriate short-term versus long term trade-offs. with "pure build" at one end and "pure harvest" at the other end. market demand. expansion of capacity (greater dependence on the technological environment). thus.  Business Unit Strategy: Diversified corporations segment themselves into business units and typically assign different strategies to the individual business units. Competitors' actions are likely to be unpredictable. number of competitors. and this contributes to the uncertainty that build business units face. The greater the external dependencies a business unit faces. To implement the strategy effectively. increase in market share (greater dependence on customers and competitors). Many chief executive officers of multi business organizations do not adopt a standardized. hold. the . the greater the uncertainty it confronts. An objective of a build business unit is to increase market share. On both the input side and the output side. thus. and competitive structure change more rapidly and are more unpredictable in the growth stage than in the mature/decline stage.  Mission The mission for existing business units could be either build. instead. These missions constitute a continuum.more on the overall corporate performance is likely to encourage greater interunit cooperation.

as compared with harvest. (b) major R&D expenditures (to introduce new products). This also contributes to the greater uncertainty that managers of build units face in dealing with external constituencies. senior management may set a relatively low discount rate. on the other hand. many decisions that a build unit manager makes. thereby motivating build managers to forward more investment ideas to corporate office. and favorable or unfavorable performance. However. In screening capital investments and allocating resources. depends on the strategic context of the business unit under evaluation. there may be no strategic planning process at all or only a broad-brush strategic plan. 57 . is positioned on the growth stage of the product life cycle. but they depress short-term profits. some strategic planning of the harvest business units may be necessary because the company's overall strategic plan must encompass all of its businesses to effectively balance cash flows. on the other hand. the required earnings rate for such a business unit may be relatively high to motivate the manager to search for project with truly exceptional returns. Because harvest units tend to experience stable environments with predictable products. nor does an unfavorable variance imply unfavorable performance. If the environment is stable. Since the corporate office wants to take advantage of the opportunities in a growing market. Thus. The share-building strategy includes (a) price 'cutting. the system may be more quantitative and financial for harvest units. Nevertheless. Hence. competitors. today may not result in profits until some future period. Thus. and this usually requll1 longer-range view of planning than is possible in the annual budget. A harvest strategy. The required information used to evaluate investments from harvest units is primarily financial. the strategic planning process is more critical and more important for build.  Mission and Time Span The choice of build versus harvest strategies has implications for shortterm versus long-term profit trade-offs. technologies. nonfinancial data are more important. Given the product/market uncertainties. financial analysis of some projects from build units may be unreliable. The link between a favorable or unfavorable variance. A harvest business unit operates in a mature industry and does not offer tremendous new investment possibilities. concentrates on maximizing short-term profits. a favorable variance does not necessarily imply favorable performance. the strategic planning process is especially important management needs to think about how to cope with the uncertainties. however.likely to have less experience in their industries. and customers).  Strategic Planning When the environment is uncertain. A build unit. on the one hand. For such projects.  Budgeting The calculational aspects of variance analysis comparing actual results with the budget identify variances as either favorable or unfavorable. discounted cash flow PCF) analysis often can be used more confidently. business units. and (c) major market development expenditures. These actions are aimed at establishing market leadership.

g. As to the second question. and return on investment). they should have a higher percentage of their remuneration in the form of an incentive bonus. EVA. similarly. etc. Some performance criteria (cost control. with differential weights for each criterion depending on the business unit's mission. annual. cash flow from operations. and people development) focus on long-term profitability.As already noted. 4.. a manager's bonus might be a strict formula-based plan. it may not be appropriate to use a single.in contrast with harvest managers. 58 . profit. whereas other performance criteria (market share. How much reliance should be placed on subjective judgments in deciding on the bonus amount? How frequently (semiannual.g. product development) should be used when deciding the general manager's incentive bonus awards? If multiple performance measures are employed. At the other extreme. What should the size of incentive bonus payments be relative to the general manager's base salary? Should the incentive bonus payments have upper limits? 2. Alternatively. should concentrate more on the long run.to take greater risks. how should they be weighted? 3. A better idea would be louse multiple performance criteria. the greater the proportion of the general manager's compensation in bonus compared to salary (the "risk/return" principle). with the bonus tied to performance on quantifiable criteria (e. uniform financial criterion. Considering the relative differences in time horizons of build and harvest managers. incentive bonus amounts might also be based on a combination of formula-based and subjective approaches.. Thus. biennial. What measures of performance (e. X percent bonus on actual profits in excess of budgeted profits). new product development. build managers. a manager's incentive bonus amounts might be based solely on the superior's subjective judgment or discretion. linking incentive bonus to short-term criteria tends to promote a short-term focus on the part of the general manager and. new-product development. 1. many firms use the principle that the riskier the strategy. the following questions need to be resolved: 1. and people development) is harder to measure objectively than is performance along most short-run criteria (operating profits. behaviour ls influenced by the desire to optimize performance with respect to those criteria. so they typically are evaluated more subjectively than are harvest managers. They maintain that because managers in charge of more uncertain task situations should be willing. operating profits. market share. Thus. sales volume. linking incentive bonus to long-term criteria is likely to promote long-term focus. "build" managers are more likely than "harvest" managers to rely on bonuses. to evaluate the performance of every business unit. and cash flow from operations) focus more on short-term results. market development. such as operating profits. Performance on most long-term criteria (market development. Incentive Compensation Syste In designing an incentive compensation package for business unit managers. At one extreme. when rewards are tied to certain performance criteria.) should incentive awards be made? With respect to the first question. The third question asks how much subjective judgment should affect bonus amounts.

the demand for differentiated products is typically more difficult to predict than the demand for commodities. is likely to engage in greater product innovation. increases uncertainty of a business unit's task environment for three reasons. with primary emphasis on cost reduction. 1. Product innovation is more critical for differentiation business units than for low cost business units. 3.  Competitive Advantage A business unit can choose to compete. Differentiation business units on the other hand tend to have a broader set of products to create uniqueness. Choosing a differentiation 'approach. 59 . typically prefers to keep its product offerings stable over time. rather than a low-cost approach. Either as a differentiated player or as a low-cost player. A low cost business unit typically tend to have narrow product lines to minimize the inventory carry costs as well as to benefit from scale economies. a differentiation business unit. the frequency of bonus awards does influence the time horizon of managers.As to the final question. 2. Low cost business units typically produce no-frill commodity products& these products succeed primarily because they have lower prices than competing products. More frequent bonus awards encourage managers to concentrate on short-term performance since they have the effect of motivating managers to focus on those facets of the business they can affect in the short run. with its primary focus on uniqueness & exclusivity. Since the customer perception is difficult to learn about. This is partly because a low-cost business unit. & since customer loyalty is subject to change resulting from actions of competitors or other reasons. However product differentiation business units succeed if customers perceive that the products have advantages over competing products.

the actual cash balances at the business unit level tend to be much smaller than would be required if the business unit were an independent company. if followed. One reason to include cash at a higher amount than the balance carried by a business unit is that the higher amount is necessary to allow comparisons to outside companies. in respect of following assets d. Consequently. in performance measurement of investment centres are likely to induce goal congruence. the focus is on profit as measured by the difference between revenues and expenses. We refer to the latter group of responsibility centers as investment centers. Du Pont was reported to use two months' costs of sales minus depreciation. 60 . what practices will induce business unit managers to use their assets most efficiently and to acquire the proper amount and kind of new assets? Presumably. In other business units. Business unit cash balances may well be only the "float" between daily receipts and daily disbursements. Some companies omit cash from the investment base. business unit managers will try to improve their performance as measured in this way. Measuring Assets Employed In deciding what investment base to use to evaluate investment center managers. headquarters asks two questions: First. Second. profit is compared with the assets employed in earning it. These companies reason that the amount of cash approximates the current liabilities.Q. If only the actual cash were shown: by internal units would appear abnormally high and might mislead senior management. In some business units. General Motors was reported to use 4. what practices best measure the performance of the unit as an economic entity?  Cash Most companies control cash centrally because central control permits use of a smaller cash balance than would be the case if each business unit held the cash balances it needed to weather the unevenness of its cash inflows and outflows.3) Which management control practices. For example. the sum of accounts receivable and inventories will approximate the working capital. if this is so. when their profits are related to assets employed. \Senior management wants the actions that they take toward this end to be in the best interest of the whole corporation.5 percent of annual sales. (i) Cash (ii) Receivables (iii) Inventories Ans. (i) Idle (ii) Intangible (iii) Leased e. Many companies therefore use a formula to calculate the cash to be included in the investment base.

For e. On the other hand. If the business unit can influence the payment period allowed by vendors. by establishing credit terms by approving individual credit accounts and credit limits.g. In times of high interest rates or credit stringency. as is typically the case with goods that require a long manufacturing period. with manufacturing periods a year or greater. receivables may be calculated on a formula basis. delaying payments unduly to reduce net current assets may not be in the company's best interest since this may hurt its credit rating. 30 days' sales where payment is made 30 days after the shipment of goods. these payments either are subtracted from the gross inventory amounts or reported as liabilities. managers might be encouraged to consider forgoing the cash discount to have. and. receivable included at the actual end-. in effect.  Inventories Inventories ordinarily are treated in a manner similar to receivables –that is they are often recorded at end-of-period amounts even though intraperiod averages would be preferable conceptually. it is possible to argue that the business unit could reinvest the money collected from accounts receivable. and these same costs should be used to measure cost of sales on the business unit income statement If work-in-process inventory is financed by advance payments or by progress payments from the customer. receivables at the book amount. not only indirectly by their ability to generate sales. Whether to include accounts receivable at selling prices or at cost of goods sold is debatable. The usual practice is to take the simpler alternative-that is. a different valuation method usually is used for business unit profit reporting because LIFO inventory balances tend to be unrealistically low in periods of inflation. In the interest of simplicity. and directly. 61 . which is the selling price less an allowance for bad debts.of-period balances. This formula should be consistent with the normal payment period-for example. additional financing provided by vendors. although the average of intraperiod balances is conceptually a better measure of the am should be related to profits. inventories should be valued at standard or average costs. One could argue that the business unit's real investment in accounts receivable is only the cost of goods sold and that a satisfactory return on this investment is probably enough. On the other hand. at zero cost to the business unit. Some companies subtract accounts payable from inventory on the grounds that accounts payable represent financing of part of the inventory by vendors. The corporate capital required for inventories is only the difference between the gross inventory amount and accounts payable. accounts receivable should be included at selling prices. In these circumstances. and by the collecting overdue amount. then including accounts payable in the calculation encourages the manager to seek the most favorable terms. Receivables Business unit managers can influence the level of receivables. Boeing received progress payments for its airplanes and recorded them as liabilities. If the business unit does not control credits and collections. therefore. If the company uses LIFO (last in first out) for financial accounting purposes.

The purpose of this permission is to encourage business unit managers to release underutilized assets to units that may have better use for them.e.) Many leases are financing arrangements-that is. 62 . Financial leases (i. Financing decisions usually are made by corporate headquarters. (Here.. if the fixed assets cannot be used by other units. If there is no alternative use for the equipment. the impact of income taxes must also be taken into account. Nevertheless. this generalization oversimplifies because. economic valued added would increase because the higher cost would be more than offset by the decrease in the capital charge. the business unit's income before taxes would decrease because the new rental expense would be higher than the depreciation charge that was eliminated. any contribution from this equipment will improve company profits. as elsewhere.000. business unit managers are induced to lease. For these reasons. and then leased back the assets at a rental rate of $60. long-term leases equivalent to the present value of the stream of lease charges) are similar to debt and are so reported on the balance sheet. it could encourage the business unit manager to idle partially utilized assets that are not earning a return equal to the business unit's profit objective. the business unit may be permitted to exclude them from the investment base if it classifies them as available. in the real world. As Exhibit 2 (see page 21) shows. However. Because of this. rather than own. assets whenever the interest charge that is built into the rental cost is less than the capital charge that is applied to the business unit's investment base.  Idle Assets If a business unit has idle asset that can be used by other units.000 per year. they provide an alternative way of getting to use assets that otherwise would be acquired by funds obtained from debt and equity financing. Leased Assets Suppose the business unit whose financial statements are shown in Exhibit 1 (see page 21) sold its fixed assets for their book value of $300. returned the proceeds of the sale to corporate headquarters. permitting the business unit manager to remove them from the investment base could result in dysfunctional actions For example. restrictions usually are placed on the business unit manager's freedom to lease assets.

Exhibit 1 Exhibit 2 63 . By accounting for these assets as long-term investments. the capital charge is thus reduced only by one dollar times the cost of capital. each dollar cut will reduce the assets employed by a dollar. if R&D expenditures are expensed immediately.. which has a much smaller positive impact on economic valued added. the business unit manager will gain less short-term benefit from reducing out lays on such item. pharmaceutical firms such as Novartis spend huge amounts on developing new products). There are advantages to capitalizing intangible assets such as R&D and marketing and then amortizing them over a selected life. Intangible Assets Some companies tend to be R&D intensive (e. consumer products firms such as Unilever spend huge amounts on advertising). others tend to be marketing intensive (e. For instance. On the other hand.g.. if R&D costs are capitalized.g. each dollar of R&D cut would be a dollar more in pretax profits. This method should change how the business unit manager views these expenditures.

Depreciation Less. Net Profit for M. Investment for: M = 0 + 200 = 200 P = 200 + 1000 = 1200 C = 200 + 500 = 700 Now. Investment = Fixed assets + Net working Capital (We assume Current Assets as the Net Working Capital as there are no Current Liabilities given in the question) Therefore.Operating Expenses M 400 (NIL) (200) P 400 (100) (100) C 400 (50) (150) 64 .Q. (2004) We know that formula for Return on Investment is: ROI = NET PROFIT INVESTMENT Now.4) NUMERICAL – ANANYA Ltd. P and C: Particulars Profit before Depreciation & Operating Expenses Less.

the ROI is higher. So going ahead if the operating expenses for div P & C remains at the same level. but the operating expenses are much higher for these division. ROI for: M = 200 = 100 % 200 P = 200 = 16. any further increase in op exp is likely to drag the ROI down Since the asset is depreciated for10 years as per SLM method.57 % 700 Since there are no fixed assets in marketing division. 65 . Hence.67 % 1200 C = 200 = 28. Even the rate of increase in ROI for Div P would be higher since the asset of a higher value is depreciated than the Div C. the depreciation rate is 10 %.TOTAL 200 200 200 Therefore. reduction in the value of an asset due to depreciation is likely to have a positive impact on ROI.

organization charts. it can not do so on account of non availability of personnel. 66 . Example 2– The marketing department has planned an impressive advertising campaign.6 Q. and job descriptions. But they must come together as far as Company’s Goal is concerned (there action must speak Co’s language.SET.1) What do you understand by Goal Congruence? What are the informal factors that influence goal congruence? Ans: This term is used when the same goals are shared by top managers and their subordinates. This is one of the many criteria used to judge the performance of an accounting system.) Goal Congruence Example 1– The HR manager has devised a HR training program to enhance the skills of its sales personnel.Meaning Individuals work in different hierarchies and handle different responsibilities & may have different goals. with an objective to enhance their productivity But if company is in strategic need of attaining a certain sales volume in a given quarter.  Goal Congruence. The goals of the company should be the same as the goals of the individual business segments. Corporate goals can be communicated by budgets. • Whether his actions are leading to scoring of points on the organization’s score card too? if it is so then only one can say the organization is marching towards a common goal.e. which promises good returns. The system can achieve its goal more effectively and perform better when organizational goals can be well aligned with the personal and group goals of subordinates and superiors. While doing so he just overlooked the financial interest of the company. • After completing the given activity in more efficient manner the concerned manager scores the point/s on his score card. higher investment in current assets. But at what cost? Building up the high inventory i. But say due to cash crunch Company’s current financial position may not let to lose the strings Example 3 – Production Manager may get a good applause for reducing cycle time.

In a goal congruence process.e. Competent units that were once cooperating as functional units may now compete with one another dis advantageously. causing a possible dysfunction. maintenance. An increase in one manager’s 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. Relying on control reports is not as effective as personal knowledge of an operation. the profit center manager may skip on R&D. In the desire to report high current profits.Every individual working in an organization has got his own motive to do the work. shared values. How could such a situation be resolved? Define role of controller which suits your suggestion. training. based on their own motivations. the actions the people are led to take in accordance with their perceived self interest are also in the best interest of the organization i. Goal congruence ensures that the action of manager taken in their best interest is also in the best interest of the organization. In these circumstances. With profit center. Mgt. This tendency is especially prevalent when the turnover of profit center managers is relatively high. There may be too much emphasis on short run profitability at the expense of long run profitability. And it is always not necessarily consistent with the Co’s goal. Instead of personal direction senior management must rely to a considerable extent on management control reports. Style – Informal/Formal The Communication Channels Perception and Communication – e. To the extent the decision are decentralized top management may lose some control. 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. 67 . Individuals act in their own interest.g. work ethics of the society Internal factors – (Factors within the organization) • • • • • Culture-Common beliefs.  Organizations with Business Divisions (Profit Centre) format have observed that Divisional Controllers experience divided loyalty in carrying out their functions. norms of behavior & assumptions Implicitly accepted and explicitly built into. Budget (meaning) strict profit. manager may have good reason to believe that their action may not affect profitability until after they have moved to other job. Informal factors that influence goal congruence: Informal Factors – External factors – set of attitudes of the society. top management must change its approach to control.

will optimize company profits. 68 . In the case of a bank the branch performing a service may be given explicit credit for that service even though the customer account is maintained in another branch. The effectiveness of a business units organization is largely dependent on how well these trade off are made.There is no complete satisfactory system for ensuring that each profit center by optimizing its own profit . If headquarter management is more capable or has better information then the average profit center manager the quality of some of the decision may be reduced. They for example. Robert Morris associates annual statement studies. Consequently business unit structure represents trade off between business unit autonomy and corporate constraint. There are some situations in which two or more profit centers participate in the sales effort that results in a sale. Role of controller • It should publish procedure and forms for the preparation of the budget. As a practical matter however such autonomy is not feasible. Revenues: choosing the appropriate revenue recognition method is important. and marketing resources. Many companies have not given much attention to the solution of these common revenue problems. Business units as profit centers: Business units are usually set up at profit centers. ideally. Business unit managers tend to control product development. In addition. Trade associations publish data for the companies in their industries. issues related to common revenues may need to be considered. at the time an order is shipped. Data for individual companies are available from the securities and exchange commission for about key business ratios. and Forbes. However as pointed out in the next section a business unit manager authority may be constrained such constrained should be incorporated in designing and operating profit center. may credit the business unit that takes an order for a product handled by the another unit with the equivalent of a brokerage commission or a finder fee. Divisionalization may cause additional cost because it may require additional management staff personnel and recordkeeping and may lead to redundant at each profit center. Also senior management authority that a board of director gives to the chief executive. each should be given appropriate credit for its part in this transaction. They are in a position to influence revenue and cost and as such can be held accountable for the bottom line. business week. The performance of a profit center is appraised by comparing actual results for one or more orf these measures with budgeting amounts. Constraint on business unit authority To realize fully the advantage of the profit center concept the business unit manger would have to be as autonomous as the president of the independent company. and annual survey published in fortune. Inc. data on competitors and the industry provide a good cross check on the appropriate of the budget. They take the position that the identification of price responsibility for revenue generation is too complicated to be practical and that sale personnel must recognize they are working not only for their own profit center but also for the overall good of the company. manufacturing. or at the time cash is received? In addition to that decision. standard & poor computer services. Should revenue be recognized at the time as order is received. If a company were divided into completely independent units the organization would be giving up the advantage of size and synergism.

• • • • It should provide assistance to budgetees in the preparation of their budget. It should coordinate the work of budget departments in lower echelons It should analyze reported performance against budget. interprets the result. It should administer the process of making budget revision during the year. and prepares summary report for senior management. 69 .

A firm’s strategy has a major influence on its structure. reduce costs and wants to be in a position to customize products as per the demands of the customer. strengthen marketing and be in a position to produce and meet unexpected and unusual customer demands. profitability. They are responsible for planning and co-coordinating the work of the separate functions. The company aims to strengthen marketing. growth and profits. as well as approving budgets and judging the performance of business unit managers. which has impacted its profitability. established its own facilities in India over 75 years ago and enjoyed an excellent record-high market share for its diverse range of shoes. Thus an important advantage of the functional structure is efficiency. setting their compensation. it is seen as a production oriented company. A major disadvantage of this structure is that there is no unambiguous way of determining the effectiveness of the separate functional managers because each function contributes jointly to the organization’s final output. there is no way of determining how much of the profit was earned respectively by the several production departments. The business managers act almost as if their units are separate companies. Pressure from cheap Chinese shoes and also premium shoes like Nike has made the company think< of organizational restructuring and introducing Comensurate Control System to regain its position. vis-à-vis a general purpose manager who lacks the specialized knowledge. SSC wants to adopt measures to reduce costs. A skilled marketing and production manager would be able to make better decisions in their respective fields. the actions people are led to take in accordance with their perceived self-interest are also in the best interest of the organization. SC markets its products through company owned shops and its own personnel. Since 2001. This is a valid criterion because profit reflects the activities of both marketing and production. The type of structure in turn influences the design of the organization’s management control systems. Therefore. The benefits of the re-organization would be that the business unit or the division would be responsible for all the functions involved in producing and marketing a specified product line. Also it needs to be seen that the company outsources about 30% of its products. Though business unit managers exercise broad authority over their units. Headquarters are responsible for obtaining funds for the company as a whole and allocating it to the business unit. Although SSC outsources. headquarters reserves certain key prerogatives. A major advantage of the Business unit structure of organization is that because it is close to the market for its products than the headquarters. He would also be able to supervise workers in the same function better than the generalist would. Their performance is measured by the profitability of the business unit. market share are slipping. Sundaram needs to re-organize its organization structure which is functional to a Business Unit form of organization. 30% of products. Sundaram Shoe Company’s (SSC) organization structure is functional which involves the notion of a manager who brings specialized knowledge to bear on decisions related to a specific function. Sundaram Shoe Company(SSC). Thus. Define Performance Metric? In a goal congruent process. How should the company reorganize to achieve Goal Congruence. Sundaram Shoe Company which was a market leader for a period of over 75 years has been losing market share. Organization structure is functional. its manager may make sounder production and marketing decisions than headquarters 70 . Part of a multinational group.

customer requirements.might and the unit as a whole reacts to new threats or opportunities quickly. Profitability (could be at the company.) SUPPLIERS 1. Cost performance (could be productivity measures. they assess your overall performance in the areas you are measuring. Associate satisfaction 71 . Performance Metrics are high-level measures what you are doing. product line. They are external in nature and are most closely tied to outputs. Performance of suppliers against your requirements FINANCIAL 1. or individual level) Market share growth and other standard financial measures EMPLOYEE 1. 2. Cycle times Product and service quality 3. Customer Satisfaction PERFORMANCE OF INTERNAL WORK PROCESSES 1. and business needs for the process. 2. inventory. The performance measurement system should cover the following areas at a minimum: CUSTOMERS 1. that is. etc. Performance against customer requirements 2. This re-organization would help in achieving goal congruence in the organization.

lakhs) and comment on divisional performance.Ananaya & Company comprises of five divisions A.25% D = 110/1200*100 = 9.25% B = 220/2000*100 = 11% C = 100/1600*100 = 6. B. Solution: Working Note: Return on Assets = Profit * 100 Total Assets A = 300/960*100 = 31.* Capital Employed) In this case.A. 72 . However. C.fixed assets should be 5% and 10% respectively.C.17% E = 180/1000*100 = 18% Economic Value Added (EVA) = Profit – (W.C. Compute and tabulate both return on assets and EVA on the basis of following information (Rs. metric is return on assets. Division Profit Fixed Assets Current Assets -- A B 220 300 800 400 160 ---1600 C ________ D E 100 600 1000 110 400 800 180 200 800 Controller feels corporate finance rates on current assets and . the controller has suggested management to switch over to economic value added (EVA) as the criterion rather than return on assets. D and E and the present performance.

05*1000) = -10 lakhs D = 110 – (0.25% 9.) (Rs.05*800) = 30 lakhs E = 180 – (0.O.C. on Fixed Assets * Total Fixed Assets) + (W.10*600) + (0.00% 212 100 -10 30 120 73 .A.25% 11.) Economic Value Added (E. lakhs) A B C D E 31.C.17% 18.V.10*400) + (0.10*800) + (0.A.C.05*1600) = 100 lakhs C = 100 – (0. on Current Assets * Total Current Assets) A = 300 – (0.05*800) = 120 lakhs Summary Division Return on Assets (R.A.00% 6.10*400) + (0.10*200) + (0.EVA = Profit – (W.05*160) = 212 lakhs B = 220 – (0.A.C.

V. It appears from the above analysis that division A has performed the best among the five divisions.V. The above reason holds true for the poor performance of divisions C and D as can be seen that they have a huge amount invested in current assets which does not indicate good signs about their operational efficiency. as well as E. Also. but the major problem with this division is that it has a terrible working capital management. 5. 74 .A. The reason why division A has performed the best is that it has the best working capital management that can be reflected in the total amount invested in current assets and which is the least among the five divisions.A. 4.O. A company which is into an expansion and overall growth mode primarily invests into fixed assets and this is also one of the major reasons why the performance of division A is the best amongst all. 2. as well as E.Comments: 1. 3. Though division C has also invested a huge amount in fixed assets the advantage is offset due to the fact that it perhaps has a larger investment in current assets. Division B is a better performer than divisions C and D in terms of R. Division E is the second best both in terms of R.A. 10.O. 8. 6. 9. Though division E has the same amount invested in current assets as that of division D and perhaps a lesser amount invested in fixed assets its profitability is much better and hence it has delivered a better performance. 7. Its current assets are the highest and this reflects that it has huge sums of money held up either in debtors or inventory or rather it is holding a large amount of cash which is not a good sign.A. it can be clearly noticed that divisions C and D seem to be in trouble. Division A has performed the best when seen in terms of return on assets and economic value added.

The quality of education is so difficult to measure that few educational organizations have a formal quality control system. the costs of many service organizations are essentially fixed in the short run. However because units differ in the mix of services they provide. but customer satisfaction depends to a considerable extent on the way it is served. It must try to minimize its unused capacity. Multi-Unit Organizations:  Some service organizations operate many units in various locations. Most service companies are labor intensive and cannot do this. Difficulty in Controlling Quality:  A manufacturing company can inspect its products before they are shipped to the consumer. and high performers and low performers can be identified. In the short run. and in other ways. physicians. 75 . and other professional organizations are reluctant to layoff professional personnel in times of low sales volume because of the effect on morale and the costs of rehiring and training. and this increases costs. auto rental companies. Some of the units are owned. and other professionals that are not used today are gone forever. These organizations are fast-food restaurant chains. which is a buffer that dampens the impact on production activity of fluctuations in sales volume. A law firm expands by adding partners and new support personnel. and then the judgments are often subjective. The airplane seat. Accounting firms. A service company cannot judge product quality until the moment the service is rendered. Restaurant management can examine the food in the kitchen. Services cannot be stored. law firms. color. a service company cannot do so.SET . and so on). Hospitals do add expensive equipment. Moreover. care must be taken in making such comparisons. Labor Intensive:  Manufacturing companies add equipment and automate production lines. each unit relatively small. gasoline service stations. and their quality can be measured visually or with instruments (tolerances. and many others. The information for each unit can be compared with system wide or regional averages. purity. or the hours of lawyers. weight. hotel room. The similarity of the separate units provides a common basis for analyzing budgets and evaluating performance not available to the manufacturing company. although a manufacturing company can earn revenue in the future from products that are on hand today. hospital operating room. a hotel cannot reduce its costs substantially by closing off some of its rooms. but mostly to provide better treatment. others operate under a franchise. in the resources that they use. thereby replacing labor and reducing costs. Thus.7 Q: 1) (A) Describe the factors which impact service organization Ans: Factors which impact service organization:  Absence of Inventory Buffer: Goods can be held as inventory. scientists.

In many organizations.date. or gallons. In part. We can measure the number of patients a physician treats in a day. In part. Many professionals prefer to work independently. senior partners in an accounting firm participate actively in audit engagements. which doesn't appear on its balance sheet. Output and Input Measurement:  The output of a professional organization cannot be measured in physical terms. re. it reflects economies of scale in using the efforts of a central personnel staff and units responsible for keeping the organization up to.Q:1) (B) Explain special characteristics of professional organization which would have a bearing on their control system. it leads to inadequate cost control. at most. Professionals tend to give inadequate weight to the financial implications of their decisions. Their financial goal is to provide adequate compensation to the professionals. Output is the effectiveness of the lawyer's work. 76 . but this is a measure of input. a related goal is to increase their size. and even classify these visits by type of complaint. Education for most professions does not include education in management. professionals tend to look down on managers. Return on assets employed. therefore. At most. We can measure the number of hours a lawyer spends on a case. and this is not measured by the number of pages in a brief or the number of hours in the courtroom. senior partners in law firms have clients. such as units. is essentially meaningless in such organizations. but quite naturally stresses the skills of the profession. Large public accounting firms need to have enough local offices to enable them to audit clients who have facilities located throughout the world. what is measured is the physician's efficiency in treating patients. but these monetary amounts.  Professionals: Professional organizations are labor intensive. rather than as part of a team. which is of some use in identifying slackers and hard workers. not to their quality (although poor quality is reflected in reduced revenues in the long run). Ans: Special Characteristics of Professional Organization:  Goals: A dominant goal of a manufacturing company is to earn a satisfactory profit. they want to do the best job they can. relate to the quantity of services rendered. not output. but this is by no means equivalent to measuring the amount or quality of service the physician has provided. for this and other reasons. This attitude affects the attitude of support staffs and nonprofessionals in the organization. Professionals who are also managers tend to work only part time on management activities. this reflects the natural tendency to associate success with large size. its principal asset is the skill of its professional staff. and the labor is of a special type. specifically a satisfactory return on assets employed. Revenues earned is one measure of output in some professional organizations. A professional organization has relatively few tangible assets.I regardless of its cost. rather than management. tons.

although in using these standards. In this situation. it takes the form of personal contacts. the professional who is responsible for obtaining the engagement may not be personally involved in carrying it out. a regular comparison of performance against budget. perhaps as a percentage of the project's revenue. usually by professionals who spend much of their time in production work-that is. unusual circumstances that affect a specific job must be taken into account. No two consulting jobs or research and development projects are quite the same. to set reasonable standards for task performance. Marketing is an essential activity in almost all organizations. The development of standards for such tasks may be worthwhile. Senior management in such organizations can personally observe what is going on and personally motivate employees. the profession's ethical code limits the amount and character of overt marketing efforts by professionals (although these restrictions have been relaxed in recent years). speeches. articles. such as law. and so on. or from the reputation of one of the firm's professionals as an outgrowth of speeches or articles. these marketing contributions were rewarded subjectively. sales contracts. Until fairly recently. and certain medical and surgical procedures. professional organizations are relatively small and operate at a single location. These marketing activities are conducted by professionals. and to judge how satisfactory the performance was.that is. even a small organization needs a budget. it is difficult to assign appropriate credit to the person responsible for "selling" a new customer. the taking of a physical inventory by an auditor. deeds. In a consulting firm. working for clients. and similar documents. medicine. for example. Moreover. If it can't be conducted openly. and accounting. the work done by many professionals is non repetitive. Thus. a new engagement may result from a conversation between a member of the firm and an acquaintance in a company. conversations on the golf course. such as some law firms and accounting firms. they were taken into account in promotion and compensation decisions.  Marketing: In a manufacturing company there is a clear dividing line between marketing activities and production activities. Some organizations now give explicit credit. Such a clean separation does not exist in most professional organizations. 77 . however. This makes it difficult to plan the time required for a task. only senior management is concerned with both. Some tasks are essentially repetitive: the drafting of simple wills.Furthermore. if the person who "sold" the project can be identified. and a way of relating compensation to performance. with profit centers and formal performance reports. Small Size:  With a few exceptions. there is less need for a sophisticated management control system. Nevertheless. In some.

(4) income before income taxes. All responsibility centers fit into a continuum ranging from those that clearly should be profit centers to those that clearly should not. A major step in creating profit centers is to determine the lowest point in an organization where these two conditions prevail. the income remaining after all costs. (3) controllable profit. which focuses on how well the profit center is doing as an economic entity. however.. The performance of the profit center manager. may be evaluated by five different measures of profitability: (1) contribution margin. including a fair share of the corporate overhead. while the economic performance report may indicate that because of economic and competitive conditions in its area the store is a losing proposition and should be closed. the management performance report for a branch store may show that the store's manager is doing an excellent job under the circumstances. This measure is used for planning. Before it is safe to delegate such a trade-off decision to a lower-level manager. For example. the system should be designed to measure management performance routinely. or (5) net income 78 . Ways to Measure Performance:  There are two types of profitability measurements used in evaluating a profit center. two conditions should exist. just as there are in evaluating an organization as a whole. there is no clear line of demarcation. Ans: 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. Second. • • The manager should have access to the relevant information needed for making such a decision. Management must decide whether the advantages of giving profit responsibility offset the disadvantages. which focuses on how well the manager is doing. Types of Profitability Measures  A profit center's economic performance is always measured by net income (i. while the economic report is prepared only on those occasions when economic decisions must be made.e. considerations relating to management performance measurement have first priority in systems design-that is. The messages conveyed by these two measures may be quite different from each other. . and controlling the profit center's day-to-day activities and as a device for providing the proper motivation for its manager.Q:2) 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. Additional advertising expense is an example. Because the management report is used frequently. there is the measure of management performance. Such decisions are said to involve expense/revenue trade-offs. The necessary information for both purposes usually cannot be obtained from a single set of data. there is the measure of economic performance. There should be some way to measure the effectiveness of the trade-offs the manager has made. coordinating. First. have been allocated to the profit center). As with all management control system design choices. with economic information being derived from these performance reports as well as from other sources. (2) direct profit. which are discussed below.

are not included in this calculation. Second.(1) Contribution Margin: Contribution margin reflects the spread between revenue and variable expenses. First. Allocating corporate overhead costs to profit centers increases the likelihood that profit center manager§ will question these costs. when managers know that their respective centers will not show a profit unless all-costs. cannot be changed in the short run. (Some companies have actually been known to sell their corporate jets because of complaints from profit center managers about the cost of these expensive items. The problem with this argument is that its premises are inaccurate. the profit center manager is still responsible for controlling employees' efficiency and productivity. at least to a degree. The principal argument in favor of using it to measure the performance of profit center managers is that since fixed expenses are beyond their control. First. Expenses incurred at headquarters. they are motivated to make optimum long-term 79 . are recovered. including the allocated share of corporate overhead. If these costs are included in the measurement system. 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. Further. There are. these managers should not be held accountable for them. and some are entirely controllable. There are two arguments against such allocations. 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. however. A focus on the contribution margin tends to direct attention away from this responsibility. the performance of each profit center will become more realistic and more readily comparable to the performance of competitors who pay for similar services. (4) Income before Taxes: In this measure. Finally. regardless of whether or not these items are within the profit center manager's control. three arguments in favor of incorporating a portion of corporate overhead into the profit centers' performance reports. accounting. even if an expense. It incorporates all expenses either incurred by or directly traceable to the profit center. however. by the business unit manager-information technology services. it may be difficult to allocate corporate staff services in a manner that would properly reflect the amount of costs incurred by each profit center. thus serving to keep head office spending in check. that is. since the costs incurred by corporate staff departments such as finance. profit will be what remains after the deduction of all expenses that may be influenced by the profit center manager. senior management wants the profit center to keep these discretionary expenses in line with amounts agreed on in the budget formulation process. all corporate overhead is allocated to profit centers based on the relative amount of expense each profit center incurs. managers should focus their attention on maximizing contribution. almost all fixed expenses are at least partially controllable by the manager. Presumably. The former category includes expenses that are controllable. for example. such as administrative salaries.) Second. Many expense items are discretionary. in fact. A weakness of the direct profit measure is that it does not recognize the motivational benefit of charging headquarters costs. and human resource management are not controllable by profit center managers. they can be changed at the discretion of the profit center manager. (2) Direct Profit: This measure reflects a profit center's contribution to the general overhead and profit of the corporation. (3) Controllable Profit: Headquarters expenses can be divided into two categories: controllable and non controllable.

In other cases. it may be desirable to allocate income tax expenses to profit centers not only to measure their economic profitability but also to motivate managers to minimize tax liability. are freer to use their imagination and initiative. profit centers are particularly responsive to pressures to improve their competitive performance. this item should be calculated on the basis of budgeted.). . product mix. and upper management gains the opportunity to evaluate their potential for higher-level jobs. rather than actual. Because their output is so readily measured. in which case there would be no advantage in incorporating income taxes. Instead. (5) Net Income: Here. There are two principal arguments against using this measure: (1) after tax income is often a constant percentage of the pretax income. it is not appropriate to judge profit center managers on the consequences of these decisions. . 80 . • Profit centers provide top management with ready-made information on the profitability of the company's individual components. For example. . (A manager responsible for marketing activities. In these situations. such variances would appear in the reports of the responsibility center that actually incurred these costs.marketing decisions as to pricing. relieved of day-to-day decision making. and so forth. Merits: • • The quality of decisions may improve because they are being made by managers closest to the point of decision. for example.Because profit centers are similar to independent companies. whereas a manager responsible for profits will be motivated to make promotion expenditures that increase profits. foreign subsidiaries or business units with foreign operations may have different effective income tax rates. and their use of other generally accepted accounting procedures to distinguish gross income from taxable income. profit centers may influence income taxes through their installment credit policies. • Managers. that will ultimately benefit (and even ensure the viability of) the company as a whole. If profit centers are to be charged for a portion of corporate overhead. they provide an excellent training ground for general management. companies measure the performance of domestic profit centers according to the bottom line. and (2) since many of the decisions that affect income taxes are made at headquarters. in which the effective income tax rate does vary among profit centers. There are situations. • Profit consciousness is enhanced since managers who are responsible' for profits will constantly seek ways to increase them. the amount of net income after income tax. costs. This ensures that profit center 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. Headquarters management. however. can concentrate on broader issues. Their managers gain experience in managing all functional areas. will tend to authorize promotion expenditures that increase sales. in which case the "budget" and "actual" columns in the profit center's performance report will show identical amounts for this particular item. their decisions on acquiring or disposing of equipment. subject to fewer corporate restraints. The speed of operating decisions may be increased since they do not have to be referred to corporate headquarters.

harvest. would be better off used in another unit. While these models differ in the methodologies they use to develop the most appropriate missions for the various business units. Friction may increase because of arguments over the appropriate transfer price. and record keeping required. that is. they have the same set of missions from which to choose: build. the components of which differ as to their risk/reward characteristics just as the components of an investment portfolio differ. 81 . If headquarters management is more capable or better informed than the average profit center manager. In such situations. identified by their mission. from the overall company standpoint. Together.Demerits: • • • Decentralized decision making will force top management to rely more on management control reports than on personal knowledge of an operation. and the credit for revenues that were formerly generated jointly by two or more business units working together. entailing some loss of control. These models suggest that a firm has business units in several categories. the assignment of common costs. • Divisionalization may impose additional costs because of the additional management. staff personnel. make decisions regarding the use of the cash generated from some business units to finance growth in other business units. and may lead to task redundancies at each profit center. may hoard personnel or equipment that. Of the many planning models. hold. or may make production decisions that have undesirable cost consequences for other units. and divest. Q:3) what are different types of Strategic Missions at SBU level? How do these missions affect Strategic Planning process and Budgeting at SBU Level? Different Types of Strategic Missions: Business Unit Mission: In a diversified firm one of the important tasks of senior management is resource deployment. the several units make up a portfolio. the quality of decisions made at the unit level may be reduced. two of the most widely used are Boston Consulting Group's two-by-two growthshare matrix and General Electric Company/McKinsey & Company's three-by-three industry attractiveness-business strength matrix. • Organization units that once cooperated as functional units may now be in competition with one another. An increase in profits for one manager may mean a decrease for another. the appropriate strategies for each category differ. a manager may fail to refer sales leads to another business unit better qualified to pursue them. Several planning models have been developed to help corporate level managers of diversified firms to effectively allocate resources. Both the corporate 'office and the business unit general manager are involved in identifying the missions of individual business units.

number and diversity of competitors. buyer's switching costs. American Brands' tobacco products. and exit barriers. impact of the business unit's product on buyer's product quality/ performance. buyer's ability to integrate backward. Three interrelated questions have to be considered in developing the business unit's competitive= advantage. The bargaining power of customers. First. and significance of the business unit's volume to buyers. General Electric's and Sylvania's light bulbs)  Divest: This mission indicates a decision to withdraw from the business either through a process of slow liquidation or outright sale. the most significant predictor of firm performance. 82 . supplier's ability to integrate forward. they are not cook books. product differentiability. presence of substitute inputs. Factors affecting supplier power are number of suppliers. even at the expense of market share (e. Factors affecting substitute threat are relative price/performance of substitutes. intermittent overcapacity.g. by far. buyer's switching costs.  Business Unit Competitive Advantage: Every business unit should develop a competitive advantage in order to accomplish its mission. 3. the structure of an industry should be analyzed in terms of the collective strength of five competitive forces.: IBM's mainframe computers). even at the expense of shortterm earnings and cash flow (e. The bargaining power of suppliers. While the planning models can aid in the formulation of missions. level of fixed costs. According to Porter. A business unit's position on a planning grid should not be the sole basis for deciding its mission. how should the business unit exploit the industry's structure? Third. Factors affecting direct rivalry are industry growth.g. Build: This mission implies an objective of increased market share.  Hold: This strategic mission is geared to the protection of the business unit's market share and competitive position (e.g. 1. and importance of the business unit's volume to suppliers. The intensity of rivalry among existing competitors. Black and Decker's handheld electric tools). impact of the business unit's product on buyer's total costs. 4. Factors affecting buyer power are number of buyers. 2. Merck's bio-technology. and buyer's propensity to substitute. what is the structure of the industry in which the business unit operates? Second..  Harvest: This mission has the objective of maximizing short-term earnings and cash flow. Studies have shown that average industry profitability is.. Threat from substitutes. what will be the basis of the business unit's competitive advantage?  Industry Analysis: Research has highlighted the important role industry conditions play in the performance of individual firms.

. Wal-Mart in discount retailing.  Low Cost: Cost leadership can be achieved through such approaches as economies of scale in production. 2. the business unit should link with the supplier group for which it has the best competitive advantage. the five forces are strong (e. expected retaliation from existing firms. product design and product features (Hewlett-Packard in electronics). Lincoln Electric in arc welding equipment. the key strategic issues facing the business unit will differ from one industry to another. and government policy.5.g. In industries where average profitability is high (such as soft drinks and pharmaceuticals). entry barriers are high). access to distribution channels. superior customer service (Nordstrom in retailing).g. Porter claims that the business unit has two generic ways of responding to the opportunities in the external environment and developing a sustainable competitive advantage: low cost and differentiation. Hyundai in automobiles. With this understanding. Texas Instruments in consumer electronics. the five forces are weak (e. Emerson Electric in electric motors. or advertising). We make three observations with regard to the industry analysis:  1. 83 . in the soft drink industry. the less profitable an industry is likely to be. Supplier selection (a strategic issue) is aided by the analysis of the relative power of several supplier groups. tight cost control. Other examples of firms following a differentiation strategy include BMW in automobiles. In industries where the average profitability is low (such as steel and coal). and technology (Cisco in communications infrastructure). Mont Blanc in pens. technological complexity of product or process. product differentiation. and cost minimization (in such areas as research and development. analyzing the relative bargaining power of several buyer groups will facilitate selection of target customer segments. Similarly. Depending on the relative strength of the five forces. dealer network (Caterpillar Tractors in construction equipment). Stouffer's in frozen foods. 3. economies of scale. Understanding the nature of each force helps the firm to formulate effective strategies. experience curve effects. Dell in computers. Black and Decker in machine tools. The threat of new entry.  Differentiation: The primary focus of this strategy is to differentiate the product offering of the business unit. and Rolex in wristwatches. creating something that is perceived by customers as being unique. Some firms following this strategy include Charles Schwab in discount brokerage. Generic Competitive Advantage:  The five-force analysis is the starting point for developing a competitive advantage since it helps to identify the opportunities and threats in the external environment. and BIC in pens. threat from substitutes is high). Approaches to product differentiation include brand loyalty (Coca-Cola and Pepsi Cola in soft drinks).. Nucor in steel. service. Factors affecting entry barriers are capital requirements. The more powerful the five forces are. Neiman-Marcus in retailing. sales force. in the steel industry.

decided to detailed expense control system including responsibility budgets for overhead expense items at each factory. Engineered expense centers  Engineered expense centers are usually found a manufacturing operations. Controller developed a standard for each overhead expense item (relating expense to volume of activity). From historical data. This label relate to two types of cost. All figures are in Rs. It is experiencing crisis. Item Management Supervision Indirect labour Idle time Materials.04 Budgeted at actual volume 720 11322 361 3096 13909 21040 2103. and payroll sections in the controller department. distribution. or both. Discretionary costs (also called managed costs) are those for which not such engineered estimate is feasible. Engineered costs are those for which the “right” or “proper” amount can be estimated with reasonable reliability for example. accounts payable. In an engineered expense center. differentiation. Value Chain Analysis: Business units can develop competitive advantage based on low cost. accounts receivable.) Standard at nominal volume 720 12706 420 3600 14840 21040 2133.3 (A) Explain with justification which of the two (1) or (2) is more meaningful for expense control. 000. These engineered expense centers are usually located within departments that are discretionary expense centers. Q:4) Pritam Engineering manufacturers (MCS-2005) Numerical Pritam Engineering manufacturing variety of metal product at many factories. (B) Can the supervisor be held responsible for all overhead expenses included? Why/why not? Ans. Warehousing. therefore. personnel records and the cafeteria in the human resources department. direct material. The difference between the theoretical and the actual cost represents the efficiency of the expense center being measure. supplies. the costs incurred depend on managements judgment as to the appropriate amount under the circumstances. In discretionary expense centers. trucking. output multiplied by the standard cost of each unit produced measures what the finished product should have cost. a factory’s costs for direct labor. shareholder records in the corporate secretary department. Management has. as may certain responsibility centers within administrative and support department for instance. Currently. and utilities. The most attractive competitive position is to achieve cost-cum-differentiation. 84 .39 actual 582 12552 711 3114 17329 21218 2413. Tools Maintenance. Such units perform repetitive tasks for which standard costs can be developed. scrap Allocated expenses Total per ton (Rs.2005 given to concerned Production Supervisor for comments is tabulated. and similar units within the marketing organization may also be engineered expense centers. components. and the company motor pool. Summarized expenses for November. (A) There is two general types of expense centers: engineered and discretionary.

public relations. while another company of similar size and in the same industry may have a staff 10 times as large. Even in highly automated production departments. Discretionary expense centers  Discretionary expense centers include administrative and support units (e. There are few. But it does not imply that valid engineered estimates can be made for each and every cost item. Moreover. Therefore. their performance reviews should include an appraisal of how well they carry out these responsibilities. Rather it reflects management’s decisions regarding certain policies: whether to match or exceed the marketing efforts of competitors. responsibility centers in which all cost items are engineered. the type and level of production are prescribed. The output of these centers cannot be measured in monetary terms. but there is no objective way to judge which (if either) is right. So that manufacturing costs are not minimized at the expense of quality. There for standard (1) is more meaningful for expenses control. research and development operations. and specific quality standards are set. human resources). we can easily estimate “proper” or “right” amount with responsible reliability. The senior managers of each company may each be convinced that their respective decisions on staff size are correct. managers of engineered expense centers may be responsible for activities such as training and employee development that are not related to current production. legal. and most marketing activities. One company may have a small headquarters staff. accounting. 85 . and a host of other activities. public relations. and the appropriate amounts to spend for R&D. both decisions may be equally good under the circumstances. The term discretionary does into imply that managements judgment as to optimum cost is capricious or haphazard. financial planning.We emphasize that engineered expense centers have other important tasks not measured by cost alone. Thus the term engineered expense center refers to responsibility centers in which engineered costs predominate. their supervisors are responsible for the quality of the products and volume of production as well as for efficiency.g. if any. industrial relations. As far as above stated over heads are concern. the level of services the company should provide to its customers. with the differences’ in size reflecting other underlying deference’s in the two companies. the use of indirect labor and various services can vary with management’s discretion.

(B) A responsibility center is an organization unit that is headed by a manager who is responsible for its activities. each of which is represented by a box on the organization chart. Materials. the entire company is a responsibility center. tools. work shift.Ans. a company is a collection of responsibility centers. and other small organization units. maintenance. From the standpoint of senior management and and the board of directors. Departments or business units comprising several of these smaller units are higher in the hierarchy. scrape and Management supervision by proper supervising supervisor can control the listed overhead expenses. In a sense. 86 . These responsibility centers form a hierarchy. though the term is usually used to refer to units within the company and there for Supervisor is responsible for the uses of the Above stated Resources (over heads) like Indirect labor. At the lowest level are the centers of the sections. idle time.

they exist. the whole company is responsibility center although the term is usually used to refer to unit within the company. In the first case. There are some significant advantages to classifying simple. Because the cost centre has a negative impact on profit (at least on the surface) it is a likely target for rollbacks and layoffs when budgets are cut. And from the stand point of senior management and the board of directors. Types of Responsibility Centers Cost Center Cost centers are divisions that add to the cost of the organization. for example. if the strategies are sound and if each responsibility center meets its objectives the whole organization should achieve its goals. and a variety of services. nevertheless. outputs are difficult to measure. metrics such as average handle time. or investment centers. a company is a collection of responsibility centers. since cost is easy to measure. At a higher level are departments or business units that consist of several of these smaller units plus staff and management people these larger units are also responsibility center. such as human resources. In a contact centre. Responsibility centers: A responsibility center is an organization unit that is headed by a manager who is responsible for its activities. Its work with these resources and it usually require working capital. accounting. the outputs are goods. Each of which is represented by box on the on the organization are responsibility centers for section work shifts or other small organization units. Because the organization is the sum of its responsibility centers. Business metrics are sometimes employed to quantify the benefits of a cost centre and relate costs and benefits to those of the organization as a whole. and other asset to do this work. if the strategies are sound and if each responsibility center. equipment. Typical examples include Research and Development. Marketing and Customer service. are typically driven by cost considerations. For many responsibility centers. Companies may choose to classify business units as cost centers. the product are inputs to the other responsibility center in the latter case. The company as a whole has goals. especially staff units. However. service level and cost per call are used in conjunction with other calculations to justify current or improved funding. and this underfunding may result in adverse consequences for the company as a whole (reduced sales because of bad customer service experiences. A responsibility center uses inputs. The products produced by a responsibility center or to the outside marketplace. The objectives of responsibility centers are to help implement these strategies. In a sense. profit centers. Financial investments in new equipment.SET 8 1. What is a responsibility centre? List and explain different types of Responsibility Centers with sketches. they are output s of the whole organization. the output s are services. In staff units. As a result of this work the responsibility center produces output which is classified either as goods if they are tangible or as services if they are intangible. Every responsibility center has output that is it does something. In a production plant. straightforward divisions as cost centers. but only indirectly add to the profit of the company. Nature of responsibility centers A responsibility center exist one or more purpose are its objectives. Operational decisions in a contact centre. transportation. and administration. for example. cost centers create incentives for managers to underfund their units in order to benefit themselves. 87 . engineering. and senior management has decided on a set of strategies to accomplish these goals. technology and staff are often difficult to justify to management because indirect profitability is hard to translate to bottom-line figures. for example).

That is. The Vice President (Investments) of a mutual funds company may be in charge of an Investment Centre. both manufacturing and marketing. The manager of an investment centre is required to earn a satisfactory return. 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. when the output is meant for outsiders. asset employed in his responsibility centre. the revenue is realized when the sales are made. On account of these difficulties. the term investment centre is not widely used. expenses and the amounts invested in the centre’s assets. Measurement of assets employed poses many problems. is termed as a profit centre. He also formulates the credit policy. Thus. For instance. In practice. Whether such assets should be included in the figure of assets employed of the responsibility centre and if included. then the revenue will be measured from the price charged from customers. which have independent divisions. Although such transfers do not increase the Company’s assets. In the Investment Centre. at how much value. as in a ratio of income to the value of the capital employed. The investment centre manager has control over revenues. 88 . when its manager is responsible for costs and revenues as well as for the investment in assets used by his centre. they help in management control process. Such transfers will give some profit to that responsibility centre. Its success is measured not only by its income but also by relating that income to its invested capital. a profit centre can exist in nonprofits organizations (though it might not be referred to as such) when a responsibility centre receives revenues for its services.Profit Center A responsibility centre is called a profit centre when the manager is held responsible for both costs (inputs) and revenues (outputs) and thus for profit. but may or may not be assigned responsibility for the capital investment. and the inventory policy. investment centers are generally used only for relatively large units. Despite the name. A responsibility centre is called an investment centre. Some of the assets are in the physical possession of the responsibility centre while for some assets it may depend upon other responsibility centers or the Head Office of the company. which has a direct influence on debt collection. whose performance is measured in terms of both . in case of a process industry. It becomes difficult to determine the amount of assets employed in a particular responsibility centre. The output of a responsibility centre may either be meant for internal consumption or for outside customers. the term profit centre is used indiscriminately to describe centers that are always assigned responsibility for revenues and expenses. then management takes a decision whether to treat the centre as profit centre or not. He is responsible for maintaining a satisfactory return on investment i. return on investment (ROI) is used as the performance evaluation criterion in an investment centre. This is particularly true of cash or heavy plant and equipment. A profit centre is a big segment of activity for which both revenues and costs are accumulated: A centre. any responsibility centre can be turned into a profit centre by determining a selling price for its outputs. In the latter case. is a difficult question. the manager in charge is held responsible for the proper utilization of assets. for their individual products. Instead. In fact. If the output is meant for other responsibility centre. which determines the investment in inventory. He is expected to earn a satisfactory return on the assets employed in his responsibility centre.e. Investment Centre An investment centre goes a step further than a profit centre does.the expense it incurs and revenue it earns. the output of one process may be transferred to another process at a profit by taking into account the market price.

district and sub district.2. Goals defined for each area of responsibility should be attainable with efficient and effective performance. the variances are conveyed to the top management. The actual performance is communicated to the managers concerned. The manager of responsibility centre should know as what is expected of him . state.SCERT. 4. over which they can exercise a significant degree of direct control. implementation and monitoring of all quality related interventions. The personal factor in Responsibility Accounting is most important. so that he may be able to give full information about his department. Process of evaluation of Responsibility Center. these groups would need to be constituted at various operational levels. State level . experts and eminent educationists. but its success depends upon the initiative and the will of the workers to execute it Example of Responsibility Center The Sarva Shiksha Abhiyan emphasizes quality improvement in elementary education for which it deems necessary that resource groups and responsibility centers from national to sub-district levels are identified. The targets or budgets of each responsibility centre are set in consultation with the manager of responsibility centre. Their major role would be to advise and assist at various levels in curriculum development. namely . Each responsibility centre is put under the charge of a responsibility manager. The responsibility and authority of each centre should be well defined. Managers are charged with the items and responsibility. 1. The following could be involved in the groups: National level . These groups would oversee the policy. planning. Explain the process of evaluation of Responsibility Center from one stage to another with the help of illustration-cum-experiences of the corporate. SIEMAT. experts and eminent educationists. The purpose of all these steps is to assign responsibility to different individuals so that their performance is improved and costs are controlled.national.NCERT. In order to facilitate a decentralized mode of education. Universities. NGOs. teacher education/training and activities related to classroom transaction. The names of persons responsible for the variances are also conveyed so that responsibility may be fixed.each centre should have a clear set of goals. If it falls short of the standards. 3. 89 . NGOs. IASEs/CTEs. pedagogical improvement. 2. The organization is divided into various responsibility centers. NIEPA. Universities. The management may prepare the best plan or the budget and put up before its staff. 5.

Their inputs can be measured in monetary terms. 3.Their output can be measured in physical terms. Briefly define Discretionary Expense Center. Engineered Expense Center. representatives from CRCs. the management of both companies may be concerned that they made the correct decision on staff size but there is no objective way judging which decision was actually better manager are hired and paid to make such decision. NGOs. Management has decided on certain policies that should govern the operation of the company. We emphasize that engineered expense centers have other important tasks not measured by cast alone. .DIETs. After such a drastic change the level of discretionary expenses generally has a similar pattern from one year to the next. They include administration and support units research and development organization and most marketing activities. Discretionary expense center: The output of discretionary expenses center cannot be measured in monitory terms. the level of service that the company provides to the customer. Even in highly automated production department the amount of indirect labor and of various services used can vary with management discretion. higher educational institutions. trucking and similar units in the marketing organization also may be engineered expense center and so many certain responsibility center within administrative and support department. Engineered expense center usually are found in manufacturing operations. The appropriate amount of spending for R & D. Such units perform repetitive task for which standard cost can be developed. Moreover manager of engineered expense center may be responsible for activities such a training that are not related to current production judgment about their performance should include an appraisal of how well they carry out these responsibilities. Profit Centre and Investment Centre? How is budget prepared in Discretionary Expenses Centre? Engineered expense centers: Engineered expense center have the following characteristics: . innovative teachers from the districts. distribution. When this cost is compared to actual costs. The difference 90 . the term engineered costs center refers to responsibility center in which engineered cost predominate but in does not imply that valid engineering estimates can be made for each and every cost item. Therefore the type and amount of production is prescribed and specific quality standards are set so that manufacturing costs are not minimized at the expense of quality. . the difference between the two represents the efficiency of the organization unit being measured. One company may have a small headquarter staff another company of similar size and in the same industry may have a staff that is 10 times as large. Sub-district .BRC/BEO. representatives from DPEP District Resource Group. The term discretionary does not mean that management judgment is capricious or haphazard. The effectiveness of this aspect of performance should be controlled. Warehousing. financial planning public relation and many other activities.The optimal dollar amount of input required to produce one unit of output can be established. In an engineered expense center the output multiplied by the standard cost of each unit produced represents what the finished product should have cost. For example expenses center supervisor are responsible for the quality of good and for the volume of production in addition to their responsibility for cost efficiency. innovative teachers. There are few if any responsibility center in which all cost items are engineered. Thus. Whether to match exceed or spend less than the marketing effort of its competitor. Examples are accounts receivable account payable and payroll section in the controller department personnel record and cafeteria in the human resource department shareholder record in the corporate secretary department and the company motor pool.District level .

such as the marketing departments ability to generate sales. if actual expense do not exceed the budget amount. It in no way measures the value of the output. The Vice President (Investments) of a mutual funds company may be in charge of an Investment Centre. Such transfers will give some profit to that responsibility centre. The manager of an investment centre is required to earn a satisfactory return. Although such transfers do not increase the Company’s assets. He is expected to earn a satisfactory return on the assets employed in his responsibility centre. management is not so much concerned with the magnitude of the task because this is largely determined by the actions of other responsibility centers. the manager in charge is held responsible for the proper utilization of assets. That is. The investment centre manager has control over revenues. in case of a process industry. when its manager is responsible for costs and revenues as well as for the investment in assets used by his centre. the manager has ‘lived within the budget ‘ however . In the latter case. which has a direct influence on debt collection. The output of a responsibility centre may either be meant for internal consumption or for outside customers.because by definition the budget does not purport to measure the optimum amount of spending we cannot say that living within the budgeted is efficient performance. In formulating the budget for a discretionary expense center. as in a ratio of income to the value of the capital employed. the term investment centre is not widely used. Thus. and the inventory policy. they help in management control process. Investment Centre An investment centre goes a step further than a profit centre does. the term profit centre is used indiscriminately to describe centers that are always assigned responsibility for revenues and expenses. For instance. then the revenue will be measured from the price charged from customers. Special tasks are one shot project for example developing and installing a profit budgeting system in a newly acquired division. In the Investment Centre. A profit centre is a big segment of activity for which both revenues and costs are accumulated: A centre.the expense it incurs and revenue it earns.e. He is responsible for maintaining a satisfactory return on investment i. whose performance is measured in terms of both . is termed as a profit centre.between budgeted and actual expense is not a measure of efficiency in a discretionary expense center it is simply the difference between the budgeted input and the actual input. the output of one process may be transferred to another process at a profit by taking into account the market price. then management takes a decision whether to treat the centre as profit centre or not. The decision that management make about a discretionary expense budget are different from the decisions that it makes about the budget for an engineered expense center. expenses and the amounts invested in the centre’s assets. when the output is meant for outsiders. a profit centre can exist in nonprofits organizations (though it might not be referred to as such) when a responsibility centre receives revenues for its services. which determines the investment in inventory. however management principal task is to decide on the magnitude of the job that should be done. asset employed in his responsibility centre. 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. return on investment (ROI) is used as the performance evaluation criterion in an investment centre. There are two different approach to planning for the discretionary expense center increment budgeting and zero based review. Continuing task are those that continue from year to year for example financial statement preparation by the controller’s office. any responsibility centre can be turned into a profit centre by determining a selling price for its outputs. Management by objective is a formal process in which a budget purposes to accomplish specific tasks and state a mean for measuring whether these tasks have been accomplished. For the latter management decides whether the proposed operating budget represent the cost of performing task efficiently for the coming period. In fact. A responsibility centre is called an investment centre. but may or may not be assigned responsibility for the capital investment. In practice. 91 . the revenue is realized when the sales are made. These tasks can be divided generally into two types continuing and special. Its success is measured not only by its income but also by relating that income to its invested capital. Budget Preparation. The technique management by objective is often used in preparing the budget for a discretionary expense center. He also formulates the credit policy. If the output is meant for other responsibility centre. Profit Center A responsibility centre is called a profit centre when the manager is held responsible for both costs (inputs) and revenues (outputs) and thus for profit. Instead. Despite the name.

An increase in profits for one manager may mean a decrease for another. Organization units that once cooperated as functional units may now be in competition with one another. and marketing resources. the profit center manager may skimp on R&D. Constraints on Business Unit Authority To realize fully the benefits of the profit center concept. managers may have good reason to believe that their actions may not affect profitability until after they have moved to other jobs. the organization would lose the advantages of size and synergy. and may lead to task redundancies at each profit center. Furthermore in delegating to business unit management all the authority that the board of directors has given to the CEO. One of the main problems occurs when business units must deal with one another. the quality of decisions made at the unit level way be reduced. and (3) The procurement or sourcing decision (how to obtain or manufacture the goods or services). and the credit for revenues that were formerly generated jointly by two or more business units working together. would be better off used in another unit. or may make production decisions that have undesirable cost consequences for other units. As a practical matter. In the desire to report high current profits. where. In these circumstances. and marketing decisions for a single product line are split among two or 92 . These managers are in a position to influence revenues and costs and as such can be held accountable for the "bottom line. The effectiveness of a business unit organization is largely dependent on how well these trade-offs are made. if the production. entailing some loss of control. as pointed out in the next section. In general. If headquarters management is mere capable or better informed than the average profit center manager. This tendency is especially prevalent when the turnover of profit center managers is relatively high. the assignment of common costs. the more difficult it becomes to assign responsibility to a single profit center for all three activities in a given product line. business unit structures represent trade-offs between business unit autonomy and corporate constraints. and record keeping required. the greater the degree of integration within a company. and for how much are these goods or services to be sold?). training programs. which ought to be reflected in a profit center's design and operation. there is usually no difficulty in assigning profit responsibility and measuring performance. Constraints from Other Business Units.SET . manufacturing. or maintenance." However. Divisionalization may impose additional costs because of the additional management. In such situation a manager may fail to refer sales leads to another business unit better qualified to pursue them. If a business unit manager controls all three activities. Describe inherent difficulties creation of profit centres may cause and advantages possible? Under which situation creation of profit centre is not advisable. a business unit manager's authority may be constrained in various ways. standpoint. procurement. Friction may increase because of arguments over the appropriate transfer price. Under which situation creation of profit centre is not advisable Decentralized decision making will force top management to rely more on management control reports than on personal knowledge of an operation. however. Q2. It is useful to think of managing a profit center in terms of control over three types of decisions: (1) The product decision (what goods or services to make and sell).9 Q1. such autonomy is not feasible. If a company were divided into completely independent units. staff personnel. senior management would be abdicating its own responsibility. that is.What are the challenges faced in pricing corporate services provided to Business Units “profit centers?” operating as Business Units as Profit Centers Most business units are created as profit centers since managers in charge of such units typically control product development. from the overall company’s. There is no completely satisfactory system for ensuring that optimizing the profits of each individual profit center will optimize the profits of the company as a whole. (2) The marketing decision (how. There may be too much emphasis on short-run profitability at the expense of long-run profitability.Competent general managers may not exist in a functional organization because there may not have been sufficient opportunities for them to develop general management competence. may hoard personnel or equipment that. Consequently. the business unit manager would have to be as autonomous as the president of an independent company.

Increases staff motivation by providing greater initiative and responsibility in decision-making. 4. Increases communication and coordination within the organization. By contrast. It would be more technically correct to refer to this practice as "active-balanced budgeting". 5. 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. Identifies and eliminates wasteful and obsolete operations. 7. 2. Forces cost centers to identify their mission and their relationship to overall goals.[1] Zero-based budgeting requires the budget request be justified in complete detail by each division manager starting from the zero-base.more business units. Municipal planning departments are exempt from this budgeting practice. No reference is made to the previous level of expenditure. the maintenance of the proper corporate image may require constraints on the quality of products or on public relations activities. as it is based on needs and benefits. and (3) Those resulting from the economies of centralization. and then adjusting some part of the budget downward for every other part that needs to be adjusted upward. 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. Corporate management . Disadvantages of Zero-Based Budgeting: 93 . Most companies retain certain decisions.also imposes other constraints. Consequently. and it must refrain from operating beyond its charter. (2) Those resulting because uniformity is required. Companies impose some constraints on business units because of the necessity for Uniformity. Each business unit has a "charter" that specifies the marketing and/or production activities that it is permitted to undertake. at the corporate level. 8. The term "zero-based budgeting" is sometimes used in personal finance to describe the practice of budgeting every dollar of income received. Drives managers to find cost effective ways to improve operations. Identifies opportunities for outsourcing. Zero Based Budgeting Internal Control\ Zero Based Budgeting: Zero-based budgeting is a technique of planning and decision-making which reverses the working process of traditional budgeting. Advantages of Zero-Based Budgeting: 1. Also. Business units must compete with one another for a share of the available funds. even though it sees profit opportunities in doing so. 6. 3. especially financial decisions. Thus. In traditional incremental budgeting. one of the major constraints on business units results from corporate control over new investments. rather than only increases. The zero-base is indifferent to whether the total budget is increasing or decreasing.3) Write Short Notes on 1. at least for domestic activities. a business unit could find its expansion plans thwarted because another unit has convinced senior management that it has a more Attractive program. 2. Q. every department function is reviewed comprehensively and all expenditures must be approved. 10. Detects inflated budgets. in zero-based budgeting. Useful for service departments where the output is difficult to identify. Efficient allocation of resources. 9. departmental managers justify only increases over the previous year budget and what has been already spent is automatically sanctioned.

both physical (e.. designed to help the organization accomplish specific goals or objectives. Rights & Obligations: Assets represent the rights of the company.g. in financial auditing. The specific target used to determine whether a control is operating effectively is called the control objective. Necessary to train managers. Existence (Validity): Only valid or authorized transactions are processed (i.. At the organizational level.g. Any manager that exaggerates skews the results Internal Control: Internal control is defined as a process affected by an organization's structure.. Honesty of the managers must be reliable and uniform. and measured. Control objectives fall under several detailed categories. as of a given date.e. 3. 5. Forced to justify every detail related to expenditure. how to ensure the organization's payments to third parties are for valid services rendered. reputation or intellectual property such as trademarks). Objective categorization Internal control activities are designed to provide reasonable assurance that particular objectives are achieved. Zero-based budgeting must be clearly understood by managers at various levels to be successfully implemented. leading to more predictable outcomes Describing Internal Controls: Internal controls may be described in terms of: a) the objective they pertain to. Completeness: All transactions are processed that should be (i. 3. 5. The R&D department is threatened whereas the production department benefits. people and management information systems.e. and compliance with laws and regulations.g. 7.1. and liabilities its obligations. monitored. It plays an important role in preventing and detecting fraud and protecting the organization's resources. and b) the nature of the control activity itself. no invalid transactions) Occurrence (Cutoff): Transactions occurred during the correct period or were processed timely. or related progress understood. Presentation & Disclosure (Classification): Components of financial statements (or other reporting) are properly classified (by type or account) and described. they relate to particular financial statement assertions. 6..[5] but broader frameworks are helpful to also capture operational and compliance aspects: 1. Reasonableness-transactions or results appear reasonable relative to other data or trends. In a large organization. 4. timely feedback on the achievement of operational or strategic goals. Difficult to define decision units and decision packages.. machinery and property) and intangible (e. 2. 4. internal control objectives relate to the reliability of financial reporting. 2. as it is time-consuming and exhaustive. Activity categorization 94 .[1] It is a means by which an organization's resources are directed. work and authority flows. 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. internal control refers to the actions taken to achieve a specific objective (e. no omissions) Valuation: Transactions are calculated using an appropriate methodology or are computationally accurate. Difficult to administer and communicate the budgeting because more managers are involved in the process. At the specific transaction level.) Internal control procedures reduce process variation.

review of particular transactions by an appropriate person. Authorization of transactions . locks. metrics. custody.Control activities may also be described by the type or nature of activity. to protect property. periodic and regular operational reviews. These include (but are not limited to): • • • • • • • Segregation of duties . and other key performance indicators (KPIs).observation or review of ongoing operational activity. 95 . physical barriers. and record keeping roles to limit risk of fraud or error by one person. to ensure access restricted to authorized personnel. Supervision or monitoring of operations .separating authorization.usage of cameras.maintaining documentation to substantiate transactions. IT Security . etc. access logs.usage of passwords. Physical safeguards . etc. Retention of records . Analysis of results.

Transaction and economic exposures. (c) Exchange Control Restrictions: Every country has foreign exchange control regulations. It is seen that the impact of tariffs on the profitability of foreign operations is generally the reverse of the incidence of income taxes in transfer pricing. (d) Income Tax Regulations: The rates of income tax vary from country to country. Evaluation of the subsidiary as a basis for a decision to locate operations in a country or to relocate operations from a country should reflect the consequences of translation. it would reduce the profits of the joint venture and as a result reduce the foreign partner's share of profits. Transaction effects are best handled through centralized coordination of the MNE's overall hedging needs. It is therefore advisable that companies must compute the net effect of these factors while determining transfer prices. This is likely to be cheaper and simpler. These include: (a) Fair Price: This is an important factor one needs to consider while determining the transfer price for foreign operations. In designing performance evaluation systems for acquired Veena company. The subsidiary manager should be held responsible for the dependence effects of exchange rates resulting from economic exposure. as this company would generally provide inputs to HUL.and Duties: No country likes high imports. the parent company should fix a higher transfer price for all transfers to countries with high income tax rates. and it prevents the subsidiary manager from becoming a foreign exchange rate forecaster and speculator. Hindustan Lever. This approach would enable the parent company to minimize taxes in such countries. This results in high income taxes in that country. in addition to the criteria used in domestic operations for the determination of transfer price..) What changes in the control system would you expect and why? Since Veena is a small multiproduct company it would require changes in control system which would be related to transfer pricing a. In order to restrict imports countries impose restrictions such as quantitative restrictions. the profit arising in that country would be high. a small multiproduct company is taken over by a multinational company ( e. To accommodate the foreign subsidiary the parent company may have a lower transfer price so that the subsidiary is able to import a larger quantity of required goods. although a lower tariff may be levied if the import value is lower. The simplest way to achieve this objective is to compare budgets and actual results using the same metric and isolate inflation-related effects through variance analysis. 96 . are involved. Companies that enter into joint ventures must ensure that the transfer price charged is fair. (e) Desire to accumulate funds: A company that wishes to accumulate funds in a particular country may fix the transfer prices in such a manner that it facilitates shifting of funds into that country.HUL could use the following guidelines Subsidiary managers should not be held responsible for translation effects. Where government rules and regulations regarding transfer prices are lenient. Ltd. As such a low transfer price would lead to low import duties on transfer. (I) Tariffs. It is pointless for managers to worry about the appropriate metric. Thus the domestic operations generally involve transfer of goods and services only In view of this difference many other considerations. These regulations impose a limit on the amount of foreign exchange available for the import of certain goods.Q4 .g.Veena Pvt. high duties and tariffs and banning import of products. This helps the parent company to reduce its taxes on a global basis. If such companies charge a higher transfer price. (b) Government Regulations: All countries have a regulatory framework under which business units operate. The general practice is to charge import duties as a percentage of the value of products imported. The MNE should choose whatever metric is more convenient. To overcome this difference the transfer price should be so fixed that countries with low tax rates show profits while others end up with a loss.

Output and Input Measurement The output of a professional organization cannot be measured in physical terms. at most. Revenues earned is one measure of output in some professional organizations. specifically a satisfactory return on assets employed. deeds. how should work done on evenings and weekends be counted? (Professionals are "exempt" employees-that is. tons. and even classify these visits by type of complaint. this reflects the natural tendency to associate success with large size. Output is the effectiveness of the lawyer's work. rather than as part of a team. professionals tend to look down on managers. and professors. Some tasks are essentially repetitive: the drafting of simple wills. not to their quality (although poor quality is reflected in reduced revenues in the long run). and this complicates the task of measuring performance. which is of some use in identifying slackers and hard workers. and similar documents. No two consulting jobs or research and development projects are quite the same. and certain medical and surgical procedures. and the labor is of a special type. rather than management. notably scientists. Their financial goal is to provide adequate compensation to the professionals. Professionals Professional organizations are labor intensive. Some professionals. going to meetings. for this and other reasons. This attitude affects the attitude of support staffs and nonprofessionals in the organization. We can measure the number of hours a lawyer spends on a case. it leads to inadequate cost control. therefore. or gallons. such as units. not output. and this is not measured by the number of pages in a brief or the number of hours in the courtroom. but these monetary amounts. Nevertheless.1) What are the Special Characteristics of Professional Service Organization? Answer: Goals A dominant goal of a manufacturing company is to earn a satisfactory profit. Many professionals prefer to work independently. Professionals tend to give inadequate weight to the financial implications of their decisions. what is measured is tl1e physician's efficiency in treating patients. At most. regardless of its cost. If the normal work week is 40 hours. engineers. In many organizations.SET 10 Q. out this is a measure of input.) How to account for time spent reading literature. This makes it difficult to plan the time required for a task. they want to do the best job they can. sales contracts. Professionals who are also managers tend to work only part time on management activities. its principal asset is the skill of its professional staff. and otherwise keeping up-to-date? 97 . senior partners in an accounting firm participate actively in audit engagements. This reluctance seems to have its roots in tradition. We can measure the number of patients a physician Teats in a day. Education for most professions does not include education in management. A professional organization has relatively few tangible assets. they are not subject to government requirements of overtime payments. it reflects economies of scale in using the efforts of a central personnel staff and units responsible for keeping the organization up-to-date. the work done by many professionals is non repetitive. senior partners in law firms have clients. a related goal is to increase their size. is essentially meaningless in such organizations. In part. the taking of a physical inventory by an auditor. are reluctant to keep track of how they spend their time. usual circumstances that affect a specific job must be taken into account. Furthermore. although in using these standards. but quite naturally stresses the skills of the profession. and to judge how satisfactory the performance was. Return on assets employed. difficult problems arise in deciding how time should be charged to clients. to set reasonable standards for task performance. which 'doesn't appear on its balance sheet. Large public accounting firms need to have enough local offices to enable them to audit clients who have facilities located throughout the world. it can be overcome if senior management is willing to put appropriate emphasis on the necessity of accurate time reporting. usually. relate to the quantity of services rendered. The development of standards for such tasks may be worthwhile. but this is by no means equivalent to measuring the amount or quality of service the physician has provided. should a job be charged for 1140th of a week's compensation for each hour spent on it? If so. In part.

and accounting. peers. Judgments made by superiors are the most common. Some systems require numerical ratings of specified attributes of performance and provide for a weighted average of these ratings. the appraisal must be made currently. Some organizations now give explicit credit. working for clients. and clients. Marketing is an essential activity in almost all organizations. internal audit procedures are used to control quality. For these. the professional who is responsible for obtaining the engagement may not be personally involved in carrying it out. and its appraisal must be largely subjective. " Appraisals by a professional's peers. and in most circumstances the assessment of performance is finally a matter of human judgment by superiors. however. The budget can be used as the basis for measuring cost performance. self. articles. or by subordinates. only senior management is concerned with both. a regular comparison of performance against budget. or a bond indenture has a flaw. it takes the form of personal contacts.Small Size With a few exceptions. the report of an audit is reviewed by a partner other than the one who is responsible for it. Such financial measures are relatively unimportant in assessing a professional's contribution to the firm's. and the actual time taken can be compared with the planned time. If it can't be conducted openly. they were taken into account in promotion and compensation decisions. In a matrix organization. In some organizations. perhaps as a percentage of the project's revenue. a new control system actually works well. profitability. with profit centers and formal performance reports. Senior management in such organization can personally observe what is going on and personally motivate employees. at the extremes the performance of professionals is easy to judge. for example. even a small organization needs a budget. Nevertheless. it cannot wait until one learns whether a new building is well designed. individuals may be asked to make a self-appraisal. to these numerical ratings. Appraisal of the large percentage of professionals who are within the extremes is much more difficult. subject to appropriate qualifications. usually by professionals who spend much of their time in production work-that is. How do we evaluate the Performance Appraisal? As noted earlier in regard to teachers. How is Marketing done in them? In a manufacturing company there is a clear dividing line between marketing activities and production activities. and a way of relating compensation to performance. both the project leader and the head of the functional unit that is the professional's organizational "home" judge performance. Until fairly recently. such as law. of course. there is less need for a sophisticated management control system. the accuracy of a surgeon's diagnosis can be verified by an examination of the tissue that was removed. in part. professional organizations increasingly use formal systems to collect performance appraisals as a basis for personnel decisions and for discussion with the professional. although such expressions may not always be readily forthcoming. and the work of the whole firm is "peer reviewed" by another firm. Furthermore. such as some law firms and accounting firms. The professional's major contribution is related to quantity and above all quality of work. the profession's ethical code limits the amount and character of overt marketing efforts by professionals (although these restrictions have been relaxed in recent years). a new engagement may result from a conversation between a member of the firm and an acquaintance in a company. subordinates. conversations on the golf course. if the person who "sold" the project can be identified. In this situation. Compensation may be tied. Budgeting and control of discretionary expenses are as important in a professional firm as in a manufacturing company. medicine. however. These marketing activities are conducted by professionals. 98 . In a consulting firm. Expressions of satisfaction or dissatisfaction from clients are also an important basis for judging performance. Thus. For some professions. Moreover. In some. and the doctors' skill can be measured by the success ratio of operations. In some professions. professional organizations are relatively small and operate at a single location. speeches. These measures are. Such a clean separation does not exist in most professional organizations. these marketing contributions were rewarded subjectively-that is. it is difficult to assign appropriate credit to the person responsible for "selling" a new customer. and so on. or from the reputation of one of the professionals as an outgrowth of speeches or articles. are sometimes part of a formal control system. In many accounting firms. objective measures of performance are sometimes unavailable: The recommendations of an investment analyst can be compared with actual market behavior of the securities. The proposed design of a building may be reviewed by architects who are not actively involved in the project.

Board members have no clear impression of how they are performing as members of a governing Board. funders. the most important reasons to measure performance are to improve effectiveness and to acquire information that will allow the organization to drive its agenda forward. discussing and debating topics to make wise decisions. because acceptance must come from senior management. on average.” Performance evaluation of nonprofit organization For any organization. as defined by law. To do performance assessment effectively. or for the benefit of. of course. If the motivation for doing evaluation remains outside an organization. staff. developing the members into well-trained and resourced members. or directors. it prohibits only the distribution of profits.2) What is a Non . This definition does not prohibit an organization from earning a profit. for services rendered and for goods supplied. A nonprofit organization needs to earn a modest profit. the evaluation will have limited impact. is an organization that cannot distribute assets or income to. 99 . Probably the biggest problem with Board self-evaluation is that it does not occur frequently enough.  Board self-evaluation Members of the Board of Directors should regularly evaluate the quality of their activities on a regular basis. and supervising the CEO. compensate its employees. and board members alike. including officers and members. an organization must commit to adopting a culture of measurement. The organization can.Q. can adversely affect the entire organization. Activities might include staffing the Board with new members. As a result. Poor Board operations. to provide funds for working capital and for possible “rainy days. its members. officers. when undetected.Profit Organization? How is the performance of this organization evaluated? Answer: Introduction A nonprofit organization.

It can also be the result of improper training about evaluation. Leaders sometimes do not recognize the ongoing activities of management to actually include organizational evaluations – but they do. both processes can be ineffective because they do not focus on improving the quality of operations in the workplace. goals or outcomes. useful evaluation information is not provided to the strategic and program planning processes. Experienced leaders have learned that continued problems in performance are not always the result of a poor work ethic – the recurring problems may be the result of larger. leaders do not realize that they have the responsibility to verify to the public that the nonprofit is indeed making a positive impact in the community. stress and low morale. particularly because donors demand them to ensure that their investments are making a difference in their communities. or at all. Consequently.  Organizational evaluation Ongoing evaluation of the entire organization is a major responsibility of all leaders in the organization. the entire organization is adversely effected. 100 . problems in these processes can be the result of any type of ineffective planning. functions and projects. Continued problems in individual performance often are the results of poor strategic planning. An ineffective program evaluation process often is the result of poor program planning – programs should be designed so they can be evaluated. those evaluations usually are not done systematically. When strategic and program planning are done poorly. which evaluate the quality of an individual’s performance in their position in the organization. program planning and staff development. Sometimes.  Program evaluation Program evaluations have become much more common. If overall planning is not done effectively. more systemic problems in the organizations. The activities of organizational evaluation occur every day. development and operating activities. As a result. there is little feedback to the strategic and program planning activities. Because these cross-functional processes span so many areas of the organization. individuals can experience continued frustration. such as programs. When program evaluations are not performed well.  Evaluation of cross-functional processes Cross-functional processes are those that span several systems. Ideally. However. Program evaluations are typically focused on the quality of the program’s process. those appraisals reference the individual’s written job description and performance goals to assess the quality of the individual’s progress toward achieving the desired results described in those documents. Common examples of major processes include information technology systems and quality management of services. Staff and volunteer (individual) performance evaluation Most of us are familiar with employee performance appraisals. resulting in their poor overall performance.

The management might have identified the flaws in the previous controls and systems of the company because of which the company might not be so effective and efficient. Currently. But. your core business tends to get neglected mainily due to excesive diversification. As. examined the old TV (valued at Rs 3500 by TV trade magazine) and felt that she could get Rs 5000 for that TV offer repairing cabinet. Black and White. As. 101 . that is why there will be some significant changes in the management control and systems and procedures if there is further scope for improvement. As. Sometimes.5 times SG and 1. Market price are arrived at after marking up cost by 3. also sells old TV exchanged (under scheme) by customer while purchasing new TV .4 times SP. most of its managers will be the same. So. Now there will be less red tapism and managers can take more risk. it may be a strategic decision by the promoters and directors of the company to sell one of its divisions. they can take necessary steps to overcome the flaws and improve the management control and systems. might not be major changes in management control and systems. They have a better understanding about the business dynamics and environment in which the firm operates. we Pritam International is a well diversified company. in one particular instance a new TV was sold for 14150(financed by cash rs2000. Explain what significant changes in systems and control procedures can be expected? Why? Answer: As. As. they are not answerable to their superiors. in unrelated lines of business. excessive diversification is ominous especially. resulting and servicing for which she would use services of SP and SG price chargeable to BTV by SP and SG are at market rates Rs235 for parts by SP and Rs 470 for services by SG. There. The managers will manage the firm in their own style. they have been associated with the company over aperiod of time. they are answerable to their stake-holders. the division is being sold to its own company managers.SP RS 32 .BTV Rs 665.exchange price for old TV agreed by CTV manager ) cost of new TV was Rs 11420. spare parts(SP) and servicing (SG) each headed by manager BTV in addition to BVTV sales. Sometimes. Q. the management is completely in their hands and that too with full autonomy. Bank loan 7350and Rs 4800. BTV pays a service commission of Rs 250 per TV sold . excessive diversification and that too in unrelated lines of business causes failure in the business operations. As.SG Rs 114. As.overhead fixed per sale are CTV Rs 835.Q. this may be impacting their core business.4) 2005 A TV dealership Veena Television (VT) is organized into four profit centers. As. there may be no advantage of operating synergy. As. So. Neither through: I) Sharing common resources nor II) Sharing common core competencies Therefore.Shivangi Manager of BTV. colour TV. One of the major reason for failures of many Mergers and Diversification is excessive diversification. sells one of its divisions to a group of its own company managers.3) A Well Diversified company – Pritam International Ltd. they will have more autonomy to take decisions independently after acquisition.

5000-5505= (-505) 102 . believed that she could sell the trade in at $5000  Other Cost: Rs235 for parts by SP and Rs 470 for services by SG When trade-in is recorded @ $4800 4800+470+235=5505. Shivangi of BTV Dept.Compute the profitability of the transaction assuming sales commission of $250 for the trade in on a selling price of $5000    Compute at market price At cost price Gross and net profit each SOLUTION:  SP of New TV by CTV = $14150.   Original cost= $11420 ($14150= $2000 cash down payment + $4800 trade in allowance + $7350 bank loan)  Guide Book Value =$3500  Ms.

Particulars Sales Selling commission Gross profit Overhead Servicing Net profit before common exp New TV 14150 0 2730 835 0 1895 OLD TV 5000 250 -505 665 470 -1640 Service 470 0 470 114 0 591 Parts 235 0 235 32 0 123 103 .

If the trade-in is recorded @ $3500 Particulars Sales Selling commission Gross profit Overhead Servicing New TV 14150 0 2730 835 0 OLD TV 5000 250 1045 665 470 Service 470 0 470 114 0 Parts 235 0 235 32 0 Net profit before common exp 1895 -340 356 123 104 .

The perspectives focused on the achievements of the firm in four areas: namely the financial. the scorecard will require a mix of lagging and leading (forward looking) measures.e. Strategy Formulation and Task Control Management Control and Task Control Q.1)Why Balance Score Card is considered superior to other methods of Performance Appraisal? Prepare Balance Score Card for any organization you are familiar with. Financial measures tend to be lagged and consequently. as the measures for each of the four perspectives are drawn from this strategy. lean production/service systems in many firms has strengthened the requirement for performance measurement systems to become more broadly based.SET 11 (Q. According to Kaplan and Norton.1)Why Balance Score Card is considered superior to other methods of Performance Appraisal? Prepare Balance Score Card for any organization you are familiar with. 2) Soniya company ( MCS-2006) Numerical 3) Sonali Enterprises (MCS-2006) Numerical 4) Discuss and illustrate differences and similarities between a. historic) view of performance. The firm’s strategy underlies the whole scorecard. were considered sufficient to track the key drivers of both current and future financial performance of the firm. These measures suffer from a number of serious drawbacks in that they take a short-term. the Balanced Scorecard provides a better assessment of performance as it "enables companies to track financial results while simultaneously monitoring progress in building the capabilities and acquiring the intangible assets they need for future growth". lagged (i. The original scorecard designed by Kaplan and Norton contained four key groupings of performance measures.. financial measures of performance. incorporating both non-financial and external measures of performance. the measures chosen 105 . ANSWER: What is the Balanced Scorecard? The rationale for the development of the Balanced Scorecard was a growing dissatisfaction with traditional. The shift towards flexible. To obtain a satisfactory overview of performance. internal business process and innovation/learning perspectives. called ‘perspectives’ by Kaplan and Norton. b. The four perspectives can be represented as an interlinked hierarchy. customer. These four groupings.

internal/external and leading /lagging information on firm performance in a coherent fashion. Building on the Balanced Scorecard’s use as a strategic management tool. Traditional methods of investment appraisal such as discounted cash flow do not cope well with investments which generate indirect rather than direct financial returns. In this role. Apart from the communication and co-ordination roles of the Balanced Scorecard in strategic implementation. the Balanced Scorecard can be used to link strategy to specific critical success factors in the customer. In this role. internal business process and growth/learning perspectives. Thus the challenge in designing a Balanced Scorecard is to choose driver measures which lead changes in the outcome measures in the non-financial perspectives and which ultimately drive the financial measures. Later it was realised that the Balanced Scorecard could play a pivotal role in the strategic management process. it can assist in the communication of the chosen strategy. Because the Balanced Scorecard requires management to clarify and obtain consensus on the strategic objectives of the firm. consequently aligning the efforts both of individuals and of departments. Examples of these include investments which enhance the future ‘flexibility’ of a firm or investments in the firm’s infrastructure. In general. Effective implementation of a Balanced Scorecard project will generally involve the development of a series of hierarchical (cascaded) scorecards. outcome measures tend to be lagged. as it can help clarify the objectives and the critical success factors for the newly formed teams. a scorecard can be developed for each manager (or perhaps even for each individual member of staff) which links the objectives on each perspective for that manager back to the objectives for each perspective outlined in the scorecard for the department and finally. current market share is the result of past decisions and consequently is a lagging measure. many firms have migrated away from a traditional hierarchical structure to a flatter. Given the overall corporate scorecard. firm and managerial performance is assessed by comparing actual attainment on each measure with the target set for that measure. team-based organisational structure. Once the firm’s objectives have been agreed and the appropriate outcome and driver measures chosen for each of the perspectives. Originally the Balanced Scorecard was seen as a useful tool for performance measurement. it has been suggested that the Balanced Scorecard can play a role in the investment appraisal process(5). Objective Measure Target Actual Benefits from adopting the Balanced Scorecard There are several benefits from implementing a Balanced Scorecard. Within each department. In recent years. such as an enhanced management 106 . supporting scorecards can be developed for each department within the firm. back to the objectives listed in the firm’s overall scorecard. the Balanced Scorecard was seen as integrating financial/non-financial. By setting both short and longterm targets for driver and outcome measures and by comparing actual attainment against target. The Balanced Scorecard could be used to assist in corporate restructuring.for the other perspectives will need to include leading measures. feedback is obtained on how well the strategy is being implemented and on whether the strategy is working. The Balanced Scorecard can support such changes. for example. there is a clear link between the Balanced Scorecard and management by objectives (MBO).

2) 107 . Balance Score Card of Credit Card Company Q .information system. An index score would be calculated for each investment opportunity and projects would then be ranked and selected based on this score. This could be achieved by using a weighting system developed from a firm’s Balanced Scorecard measures to evaluate new projects. The Balanced Scorecard can assist management’s investment appraisal decisions as it provides managers with a mechanism to incorporate the strategic aspects of the investment into the appraisal process.

000/ 96.6% Turnover of Investment = Sales * 100 Investment Turnover of Investment for Division ‘A’ = 40.00. Return on Investment for both divisions is 20%.000 = 3 times As Return on investment for both Divisions A and B is 20%. Details are given below:Particulars Divisional sales Divisional Investment Profit Div A 4000000 2000000 400000 Div B 9600000 3200000 640000 Analyse and comment on divisional performance of each.000/20.000 = 2 times Turnover of Investment for Division ‘B’ = 96.00.000 /40.00.40. 108 .000/32.00.000 *100 = 10% Profit Margin for Division ‘B’ = 6.00.00.Soniya Company has two Divisions: A & B. ANSWER As Profit Margin = Profit *100 Sales Profit Margin for Division ‘A’= 4.00.000 *100 = 6.

1000 p.1100. 1100. should Div A purchase from outside? Justify your answers with figures 109 . 3. it can be improved by increased sales or reducing investment. So it can become profitable organisation by improving Profit Margin. so it has more profitability but inspite of it. 2. 950 and Rs. 14. If the market price reduces by Rs. division ‘A’ has lower turnover of investment that its assets management is bad than Division ‘B’.u. Division ‘B’ – Needs to improve profit margin by increasing sales and reduce variable cost and sales at same price or by reducing salesprice and increase the volume of sales so that its profit would improve. Div A normally purchases annually 10000 nos. of required components from Div B. 1.u to Rs.u Div B is not happy and justified its decision to increase price due to inflation and added that the overall company profitability will reduce and decision will lead to excess capacity in Div B. Div A decided to purchase the components from open market available at Rs. Assuming that no alternate use exists for excess capacity in Div B.COMMENTS:Division ‘A’ – Although ‘A’ has more profit margin than Division ‘B’ that is 10% as compared to 6.3) Numerical 2006 Two divisions A and B of sonali enterprises operate Profit centers. If excess capacity of Div B could be use for alternative sales at yearly costs savings of Rs. will company benefit as a whole if Div A buys from the market. which has recently informed Div A that it will increase selling price p.6% of ‘B’.u. whose V. are Rs. As it has good assets management shown by its turnoverof Division ‘B’ that is 3 times which is better than Division ‘A’. What would be the effect on the company (assuming Div B has still excess capacity) if A buys from market. Q.5 lacs.80 p.C and Fixed cost p.

ANSWER: Dision ‘A’ action BUY OUTSIDE (Rs.00.) (Rs. (1000-80) = 920 110 .000 The Company As A Whole The Company as a whole will benefit if Division ‘A’ buys inside from Division ‘B’.80 p.000 9.000 Net Cash Outflow To 10.000 9.20.000 Net Cash Outflow To 9.) BUY INSIDE Total Purchase Cost Total Outlay Cost 9. 1) If the market price reduces by Rs.50.50.) (Rs.u Division ‘A’ action BUY OUTSIDE (Rs.00.50.) BUY INSIDE Total Purchase Cost Total Outlay Cost 10.000 Nil Nil 9.000 The Company As A Whole The Company as a whole benefit if ‘A’ buys from outside supplier at Rs.20.50.000 Nil Nil 9.

14.5 lakhs Division ‘A’ action BUY OUTSIDE (Rs.) (Rs.50.45.000 Nil Nil 9.000 The Company As A Whole Yes.55. without cloud of doubt Company should purchase from outside.If excess capacity of Div B could be use for alternative sales at yearly costs savings of Rs.000 Revenue From Using 1.00.) BUY INSIDE Total Purchase Cost Total Outlay Cost 10.50. 9.000 111 .000 These Facilities Net Cash Outflow To 8.

more internal and external and predictive. analytical Relatively difficult Lead to desired result Line and top management Large Administrative. definite pattern. persuasive d) Structure e) Communication information f) Purpose of estimates g) Persons involved h) No. more accurate. each Rhythmic. Unstructured and irregular.Q.4)Discuss and illustrate differences and similarities between . more Integrated. less historical. of persons involved i) Mental activity j) Planning and control k) Time horizon l) End result m) Appraisal of job done Planning dominant but some Emphasis on both planning and control control Tends to be long Policies and precedents Extremely difficult Tends to be short Action within policies laid Less difficult 112 .Strategy Formulation and Management Control .Management Control and Task Control ANSWER Some Distinction between Strategy Formulation and management Control Characteristics a) Focus of plan b) Complexities c) Nature of information Strategy Formulation On one aspect at a time Many variables hence complex Management Control On entire organisation Less complex Tailor-made for the issue. set problem being different procedure of Relatively simple Show expected results Staff and top management Small Creative. accurate.

113 . makes control easier. more internal and specific.b) Some Distinction between Management Control and Task Control Characteristics a) Focus of plan b) Nature of information Task Control Single task or transaction Management control On entire organisation Tailor-made to operation.Control is more objective standard against difficult due to subjective which actuals can be compared consideration. more accurate real time Supervisors Line and top management c) Persons involved d) Mental activity Follow directives or none as in Administrative. often non. persuasive case of machines or set objectives Day to day Tends to be short e) Time horizon f) Type of cost EngineeredExistence of Discretionary. Integrated. historical.financial.

will the manager be interested in accepting the market offer? Solution: Particulars Amount (Rs.60/unit. 114 . So.1 Girish Engineering Ltd.10/unit if it accepts the market offer whereas its target profit margin is Rs. it would suffer a loss of Rs. (Numerical) (MCS-2006) (1) On the basis of costing. division X would not accept the market offer./unit) Amount (Rs./unit) Cost of critical component for 220 division X Cost of other material Fixed & processing costs Total cost for division X Selling price of final product Net loss for division X Desired profit for division X 500 290 1010 1000 10 60 Thus on the basis of full actual cost incurred by division X.SET 12 Q.

80 Contribution per month = Rs.u. i. total Variable cost per month for division Y = 11 lakh – 6 lakh = Rs.2. p.u. Rs. is assigned by division Y to division X but it does not imply that a special investment of Rs. 115 . So. is made by division Y exclusively to produce the component required by division X. = 400000/5000 = Rs.100 • An annual investment of Rs2.24 lakh p. for division Y = 500000/5000 = Rs.(2) Is this offer beneficial to the company as a whole? Justify with figures. Lakh) 50 (5000 units * Rs.a.a.4 lakh per month Fixed cost p. = Rs.1000/unit) Material bought by division X 25 (5000 units * Rs. Solution: Particulars Cash inflow (a) Cash outlay: Variable cost for division Y 5 (Working note) Amount (Rs.2 lakh per month Fixed cost assigned to division X = Rs.6 lakh Total sales value for division Y = 220 * 5000 = Rs. Therefore. cash outflow associated with this investment is not relevant for the above concerned decision regarding accept the market offer.500/unit) from outside Total cash outlay (b) Net cash inflow to Company as a whole [(a). Lakh) Amount (Rs.4 Cr.20 lakh.4 Cr.4 Cr. the Company as an entity would receive cash inflow of Rs.e.11 lakh per month So.2.5 lakh Variable cost p. Working notes:• Variable cost for division Y: Desired RoI =10% of Rs.(b)] 30 20 Thus. the offer is beneficial to the company as a whole.

(desired profit margin). divisions X & Y can negotiate a transfer price by taking into account full actual variable cost (Rs.) & half of fixed costs incurred by division Y that is assigned to division X (Rs. Also. Solution: Currently.60 p.u. division X’s total costs would turn out to Rs. is following 2 step transfer pricing method wherein the selling division charges actual variable cost along with profit mark-up & separately allocates a particular amount of fixed costs per month to the buying division. Girish Engineering Ltd. division X. 116 . for division Y would be Rs. division Y prevents shifting of any operational inefficiencies from selling division to buying division i.u. Thus.250000 resulting in RoI of 12.e.940 (500 + 290 + 150) & would earn a profit margin of Rs.) & add a mark-up of say Rs.5% (250000/2000000) which is more than the desired RoI of 10%.10/unit. contribution p. this method of transfer pricing is not feasible as division X would suffer loss if it accepts the market offer under this scenario. In this case.u. So.50 (150 – 100).40 p.e. how should the company organize its transfer pricing mechanism? Illustrate.(3) If yes.u. total contribution for division Y would be Rs. which would unnecessarily increase the costs for division X and thereby eat up its profit margin. Taking into consideration only half of the fixed costs of selling division i. However. in the case of division X (buying division) & division Y (selling division).100 p.

Solution: i) Profitability statement of Division A:- Particulars Selling price p.) p. (Numerical) (MCS-2007) (a) Define profit in this case and prepare a statement for both divisions and overall company.35)] iii) Profitability statement of Company as a whole:- Expected sales 2000 3000 Net profit of division A Net profit of Division B Total Net profit (Rs. of units) 2000 48000 3000 72000 6000 144000 Total Fixed cost Net profit (Rs.2 Suresh Ltd. of contribution cost (Rs.) 60000 (12000) 60000 12000 60000 84000 ii) Profitability statement of Division B:- Selling p.u.) (Rs.u. Total Contribution Expected Total Total Fixed Net profit variable cost p.) (Rs.7) + Transfer price of intermediate product (Rs. (Rs.) 35 11 24 Contribution p. 24 24 24 Expected sales Total contribution (no.u.u.u. Contribution p. Amount(Rs.u.u. Variable Cost p.Q.) (Rs.) (12000) 6000 (6000) 12000 24000 36000 117 . = Variable cost p.u. units) 90 42 48 2000 96000 90000 6000 80 42 38 3000 114000 90000 24000 50 42 8 6000 48000 90000 (42000) [Note: Total Variable cost p.u. sales (no.

6000 84000 (42000) 42000 118 .

it would suffer a loss of Rs. 119 . of Rs. Comment on why the latter price is unlikely to be selected by division B.u. However. Division B would not select Selling price p.50.50 in order to maximize Company’s profit.(b) State the selling price which maximizes profits for division B and company as a whole. selling price p.u.50 maximizes profit for the Company as a whole. of Rs. of Rs. Solution: As per the calculation in part (a). if Division B opts for selling price p.80 maximizes profit for division B whereas selling price p. Therefore.u. of Rs.u.42000.

. "Profitability" refers to profits in the long run. One of management's responsibilities is to arrive at the right balance between the two main sources of financing: debt and equity. Economic Goals Shareholder's value. Earning per share and Market value. which consists of proceeds from the issuance of stock. But market value is not an accurate measure of the worth of shareholders' investments. such value can be obtained only when the share is traded in the stock exchange.. Besides. Profitability In a business. by borrowing. plus retained earnings. however. but this method does not draw attention to the two principal components: profit margin and investment turnover. The shareholders' investment (i. 120 .e. Ford Motor Company. community and so on. but not too much. "A reasonable profit is right. which is not a desirable goal. with resulting surprisingly enormous benefit to ourselves" Other goals such as adding new products. For many purposes.. it is an artificial being with no mind or decision-making ability of its own. and they are usually ratified by the board of directors. Many current expenditure (e. Wal-Mart. creditors. methods of providing service.Q. and Sam Walton. all relate to maximizing shareholder's value.3 Explain different organizational goals. a corporation does not have goals. but there are other stakeholders in the business also such as customers. that is. the source of financing is not relevant.g. Comment on goal of shareholder value maximization in particular. So. every organization has its share of responsibility towards the local community where it is situated. equity) is the amount of financing that was not obtained by debt. Goals Although we often refer to the goals of a corporation. Again. In the basic form of this equation. Return on investment can be found by simply dividing profit (i. Social Goals However.e. Sloan. It is interesting to note that Henry Ford's operating philosophy was 'satisfactory profit'. Of course. and the public at large. it has been my policy to force the price of the car down as fast as production would permit and give the benefit to the user and laborers. personnel involved in rendering service and the nature of the service in details can. rather than in the current quarter or year. not 'maximum profit'. because what is 'maximum' is difficult to determine. "investment" refers to the shareholders' investment. George Eastman. Eastman Kodak. amounts spent on advertising or research and development) reduce current profits but increase profits over time. "investment" thus means the total of debt capital and equity capital. Alfred P. General Motors Corporation. Although optimizing shareholder value may be one goal. employees. Examples are Henry Ford. It is very difficult to incorporate in Management Control System such goals as taking pride in an organization which cares for the society and renders service to the public. be mentioned through an appropriate system. or product-line or new business actually indicate normal organizational growth. He said. In many corporations. profitability is usually the most important goal. shareholder value is usually equated with the market value of the company's stock. the goals originally set by the founder persist for generations. Corporate goals are determined by the chief executive officer (CEO) of the corporation. any concrete structural programme indicating its operational expenses. revenues minus expenses) by investment. Walt Disney Company. with the advice of other members of senior management. Walt Disney.

Some CEOs stress only part of the profitability equation. Jack Welch, former CEO of General Electric Company, explicitly focused on revenue; he stated that General Electric should not be in any business in which its sales revenues were not the largest or the second largest of any company in that business. This does not imply that Welch neglected the other components of the equation; rather, it suggests that in his mind there was a close correlation between market share and return on investment. Other CEOs, however, emphasize revenues for a different reason: For them, company size is a goal. Such a priority can lead to problems. If expenses are too high, the profit margin will not give shareholders a good return on their investment. Even if the profit margin is satisfactory, the organization may still not earn a good return if the investment is too large. Some CEOs focus on profit either as a monetary amount or as a percentage of revenue. This focus does not recognize the simple fact that if additional profits are obtained by a greater than proportional increase in investment, each dollar of investment has earned less. Maximizing Shareholder Value In the 1980s and 1990s the term shareholder value appeared frequently in the business literature. This concept is that the appropriate goal of a for-profit corporation is to maximize shareholder value. Although the meaning of this term was not always clear, it probably refers to the market price of the corporation's stock. We believe, however, that achieving satisfactory profit is a better way of stating a corporation's goal, for two reasons. First, "maximizing" implies that there is a way of finding the maximum amount that a company can earn. This is not the case. In deciding between two courses of action, management usually selects the one it believes will increase profitability the most. But management rarely, if ever, identifies all the possible alternatives and their respective effects on profitability. Furthermore, profit maximization requires that marginal costs and a demand curve be calculated, and managers usually do not know what these are. If maximization were the goal, managers would spend every working hour (and many sleepless nights) thinking about endless alternatives for increasing profitability; life is generally considered to be too short to warrant such an effort. Second, although optimizing shareholder value may be a major goal, it is by no means the only goal for most organizations. Certainly a business that does not earn a profit at least equal to its cost of capital is not doing its job; unless it does so, it cannot discharge any other responsibilities. But economic performance is not the sole responsibility of a business, nor is shareholder value. Most managers want to behave ethically, and most feel an obligation to other stakeholders in the organization in addition to shareholders. Example: Henry Ford's operating philosophy was satisfactory profit, not maximum profit. He wrote let me say right here that I do not believe that we should make such an awful profit on our cars. A reasonable profit is right, but not too much. So it has been my policy to force the price of the car down as fast as production would permit, and give the benefits to the users and laborers-with resulting surprisingly enormous benefits to ourselves. By rejecting the maximization concept, we do not mean to question the validity of certain obvious principles. A course of action that decreases expenses without affecting another element, such as market share, is sound. So is a course of action that increases expenses with a greater than proportional increase in revenues, such as expanding the advertising budget. So, too, are actions that increase profit with a less than proportional increase in shareholder investment (or, of course, with no such increase at all), such as purchasing a cost-saving machine. These principles assume, in all cases, that the course of action is ethical and consistent with the corporation's other goals. An organization's pursuit of profitability is affected by management's willingness to take risks. The degree of risk-taking varies with the personalities of individual managers. Nevertheless there is always an upper limit; some organizations explicitly state that management's primary responsibility is to preserve the company's assets, with profitability considered a secondary goal. The Asian .financial crisis during 19961998 is traceable, in large part, to the fact that banks in Asia's emerging markets made what appeared to be highly profitable loans without paying adequate attention to the level of risk involved.

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Multiple Stakeholder Approach Organizations participate in three markets: the capital market, the product market, and the factor market. A firm raises funds in the capital market, and the public stockholders are therefore an important constituency. The firm sells its goods and services in the product market, and customers form a key constituency. It competes for resources such as human capital and raw materials in the factor market and the prime constituencies are the company's employees and suppliers and the various communities in which the resources and the company's operations are located. The firm has a responsibility to all these multiple stakeholders-shareholders, customers, employees, suppliers, and communities. Ideally, its management control system should identify the goals for each of these groups and develop scorecards to track performance. Example: In 2005, the Acer Group, headquartered in Taiwan, was one of the largest computer companies The Company subscribed to the multiple stakeholder approach and managed its internal operations to satisfy the needs of several constituencies. To quote Stan 'Shih,-the founder, "The customer is number 1, the employee is number 2, the shareholder is number 3. I keep this message consistent with all my colleagues. I even consider the company's banks, suppliers, and others we do business with are our stakeholders; even society is stakeholder. I do my best to run the company that way." Lincoln Electric Company is well known for its philosophy that employee satisfaction was more important than shareholder value. James Lincoln wrote: "The last group to be considered is the stockholders who own stock because they think it will be more profitable than investing more in any other way. The absentee stockholder is not' of any value to the customer or to the worker, since he has no knowledge of nor interest in the company other than greater dividends and advance in the price of his stock." Donald F. Hastings, chairman and chief executive officer, emphasized that this was still the company's philosophy in 1996.

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Q.4 Explain and illustrate with one example differences between 3 forms of internal audit- Financial, Operational & Management. Financial AuditFinancial 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". Institute of Internal Auditor: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 developed within 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. Objectives of 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. budgetary control system, if any scope and performance of internal audit, if any, suggestions for improvements in performance, if any, and improved inventory policies. The opinion expressed by the auditors shall be based on verified data, reference to ich shall also be made here and, if practicable, included after the company has been forded on opportunity to comment on them.

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Management Audit It is a complex task closely related with the process of management. such as division or department and its plans. It is highly result oriented. Its aim is to identify existing and potential management weaknesses within an organization and to recommend ways to rectify these weaknesses. It is a tool for the evaluation of methods and performance in all the areas of the enterprise. review and appraisal of various policies and actions of management on the basis of certain norms/standards. management procedures towards the achievement of enterprise goals. thus facilitating the most effective relationship with the outside world and the most efficient and smooth running internally. objectives. Definition: It's a comprehensive and constructive examination of an organization. review and appraisal of the various policies and actions of the management. Leslie Howard It is an audit performed with the object of examining the efficacy of the institution/control systems. William P. Leonard It's an investigation of a business from the higher level downwards in order to ascertain whether sound management prevails throughout. Chartered Institute of Management Accountants London Thus it can be seen that management audit is an examination. It goes beyond conventional audit and audits the efficacy of the management itself. Churchill & Cyert It is an objective and independent appraisal of the effectiveness of managers and the effectiveness of the corporate structure in the achievement of company objectives and policies. It requires inter/multi-disciplinary approach as it involves examination. . 124 . institution or branch of government or of any components thereof. its means of operations and its use of human and physical facilities. It undertakes comprehensive and critical review of all organizational activities with wider perspective. the structure of a company.

They need to have through knowledge of the management science and they should be acquainted with the salient features of various functional areas. The audit starts right at the top level of the management. The audit has to study the decision-making system of the organization and also the level of autonomy granted to the managers at different levels of the organization. 10. and the operation research specialists. They therefore have to be properly trained in this aspect. 6. It aims to achieve the efficiency of management and assess the strength and weaknesses of the organization structure. accountants. Ascertain objectives of the organization are properly communicated and understood at all levels. Conducting Management Audit Management audit requires an interdisciplinary approach since it involves a review of all aspects of management functions. 4. The team may consist of management experts. 8. 13. To ascertain the provision of proper control at different levels. To reveal defects or irregularities in any of the elements examined and to indicate what improvements are possible to obtain the best results of the operations of the company. the industry experts and even social scientists. 9. To suggest to the management the ways and means to achieve the objectives if the management of the organization itself lacks the knowledge of efficient management. 3. It studies the managerial performance at all the levels of management. The auditor must apprise managerial performance at all levels of the organization. the entire emphasis is on macro-aspect. 2. their effectiveness in accomplishing management goals. To ascertain the provision of proper control at different levels. their effectiveness I in accomplishing management goals. 7. 5. To assist the management to achieve the most efficient administration of its operations. One of the most important things that the audit must study is that the mangers at various levels use the authority. the individual transactions being125 . It has to be conducted by a team of experts because this requires 3 varieties of skills. To help the management at all levels in the effective and efficient discharge of their duties and responsibilities. The auditors must have analytical mind and ability to look at a management function form the point of view of the organization as a whole. To assist the management to achieve the most efficient administration of its operations. Ascertain objectives of the organization are properly communicated and understood at all levels.Objectives: 1. To suggest to the management the ways and means to achieve the objectives if the management of the organization itself lacks the knowledge of efficient management. Under financial audit. It aims to achieve the efficiency of management and assess the strength and weaknesses of the organization structure. The authority and responsibility given at the different levels of the management. its management team and its corporate culture. 12. its management team and its corporate culture. which one individual may not possess. 11. To reveal defects or irregularities in any of the elements examined and to indicate what improvements are possible to obtain the best results of the operations of the company.

The auditor reports to the owner.oriented. There is legal compulsion as regards management Financial audit is compulsory in the case of certain audit. The management auditor reports on performance of the management during a particular period and suggest ways to remedy the deficiencies. it serves interest of shareholders. Financial audit is not concerned with ~ avoidance of profiteering motive. policies etc. i. It reviews the procedure and internal checks. Examination of the performance of the management is beyond his scope Management Audit It is concerned with the review of the past Performance to ascertain whether it is in tune with the objectives. policies and procedures of the enterprise. It indicates the financial position and over~ performance of the business. and scrutinizes individual transactions for the purpose of verification. It is conducted under Sections 224 . of Profit and Loss Account and Balance Sheet.scrutinized for check of the aggregates. regardless of its performance in various segments. Financial Audit It is concerned with financial aspects of business transactions of the year under audit The auditor examines the past financial records to report his opinion on the truth and fairness of the representations made in the financial statements. Financial audit is applicable to all classes of companies and industries irrespective of size and Dan of operations. including modification of objectives. enterprises such as companies. It is concerned with examination of transactions recorded in the books of account.232 of the Companies Act 1956. Financial audit is organization . Past year '(Financial) transactions are No limit as to the period to be covered Covered Enterprises such as companies. trust and societies etc. The auditor reports to the management shareholders in the Case of a company 126 . Instead of serving the interest of the management and the Government.e. trust and societies etc.

Q. personality and social background joins a company like Britannia Industries or Reliance. Naturally. Yet. The formal communication system involves strategic plan.5 Explain briefly various stages of management control process citing salient features of each. Accounts Manager carried out the instructions so given. While visiting the Corporate Office for attending a Training Course. appoints him and makes him aware of what the company expects of him. Thus. These communications aim towards attaining the organization's goals. he should inform his General Manager. experience. 127 . Added to these factors is the existence of an informal organization within the structured formal organization. a young manager with good education. moving away from superior/subordinate relationship.2) reports to the General Manager of the Plant. expertise. verbally or even by facial expression. on the other hand. It is quite apparent that perfect congruence between the goals of the individual and the organization individual's goals and the organization's goals can never happen. The young manager sets his goals of gaining rich experience for his career progress besides adequate compensation packages. Informal communication. the actions depend on the perception of the individual managers. Management control process involves communication of information to the managers at various levels of hierarchy and their interactions arising out of them. The latter communicates some important matter to him verbally and wants action thereon. the main purpose of a management control system is to assure goal congruence between the interest of the individual and the organization as far as practicable. But individual managers have their personal goals also. relates to some external factors-work ethics. However. such relations depend on the personal capabilities of the manager such as education. For example. all the communication of information may be either formal or informal. his actions will be directed towards achieving his own objectives and goals while serving the company. The company finds him fit for the position as per job specifications. experience. standards and reports whereas the informal communication is made through letters and memos. However. Formal communications are all documented and addressed to the responsible managers for their information and actions. Accounts Manager of Nasik Plant (see the organization chart in the diagram 3. Informality refers to the relaxation of sharp differentiation and explicit description of behavior as indicated in the hierarchy and thereby. he meets other colleagues. Management control systems Formal and Informal Communication As mentioned earlier. if necessary. management style and culture. and he mayor may not report to the General Manager. For example. As per the organization chart. parallel officers and even the Finance Director. budgets. his self-interest and the best interest of the organization are apparently in conflict. but it depends on his own perception of the situation. But the best results can be achieved by perfectly matching the two interests and this is called 'goal congruence'. trust and cooperation.

but the parent organization's telephone number was located. the development of individuals. Work culture generally differs because of the life style and the attitude towards the work. the attitude ultimately stems from the temperament of the Chief Executive. the culture remains unchanged as long as the Chief Executive remains in position. But the existence of a good culture can be felt from the behavior of the members of the organization. but the attitude and treatment of that member of organization speak volumes about their excellent culture. 128 . Such a situation was unthinkable in Jessop & Co. W. However. That is why R.Work Ethics. when he attended Christmas lunch. He kept us amused with various stories of his recent tour abroad and recited Urdu 'shairies'. His visit was arranged through non other than the Director of the company himself. Emerson said "an institute is the lengthened shadow of a man". the culture remains unchanged and the traditions are maintained. if higher positions are filled in through promotion of internal executives. unless the new Chief follows the footsteps of his predecessor and maintains it. Once the writer landed up with his family at Hyderabad in the early morning to discover that nobody had come to receive them at the station. Management Style and Culture External factors like work ethics vary from place to place. His unit being new. who controls the entire organization. Climate is the atmosphere in which individuals work help. When an executive of the parent company was contacted. When a new executive replaces him. Correa. but cultural norms are extremely important. W. Culture differs between the organizations. entertain with coffee and then put up in a Hotel. the most important internal factor is the organization's culture and climate. Management control systems Climate is used to designate the quality of the internal environment that conditions the quality of cooperation. his table was shared by none other than the General Sales Manager Dr. Again. The writer joined Union Carbide as an Assistant just three days before Christmas Eve. They are not written like formal communication. Time has more value at Mumbai as compared to Kolkata. The culture refers to the set of common beliefs. where people take things easily and leisurely. The other important internal factor which influences management control system is management stylethat is the attitude of the superior to his subordinates and the latter's reaction through their perception of the attitude of their superiors. attitudes. In any organization.. even sharing jokes. judge. Generally.R. there is likelihood of some change in the culture. constrain and find out about each other. telephone directory did not include any number of his unit. people of Mumbai lead very fast life. Japanese and Korean people have reputation for their excellent work culture. It influences moral-the attitude of the individual towards his/her work and environment. Therefore. where sharp differences were maintained at every level of hierarchy. relationships and assumptions that are explicitly or implicitly accepted and evidenced throughout the organization. and reward. he immediately sent an officer of the company with a car to pick us up to their Guest House. organization work culture depends on the general behavior of the people in the society where the organization situates. the extent of members' dedication or commitment to organizational purpose and the efficiency with which that purpose is translated into results. On the very second day. norms. What subsequently happened is a different matter. For example.

quarterly. then the latter is revised to give effect to the changed position. (d) Reporting Actual performance is analyzed. During a very critical period in an organization. If such action requires to be included in the budget.Importance of Informal Communication An organization indulges in informal control process when encountering non-routine decision-making or when seeking new information to increase understanding of some problem areas. indicating variances and highlighting areas of weaknesses. A strategic plan is prepared in order to implement the strategies. after carefully considering opportunities and threats in the external environment as well as the strengths and weaknesses in the internal environment. and 'manuals'. besides budget. then the plan itself can be revised and a new basis of control may be established. If the performance is satisfactory. the writer found that the Chief Executive used to call managers informally at his residence or club to extract information in a relaxed manner rather than in a tense situation prevailing in the factory. half yearly. (c) Operations and Measurement Responsibility centers operate within the framework of the budget. established standards. The system has the following four components: (a) Strategic plan and programme (b) Budgeting (c) Operations and measurement in responsibility centers (d) Reporting (a) Strategic Plan and Programme The foundation of management control process lies in the organization's goals and its strategies for attaining these goals. They also classify the data by programmes as well as by responsibility centers for performance measurement. If required. Thus. If the same is unsatisfactory feedback communication is sent to the responsibility centre concerned for corrective action. The aforesaid formal control process has been presented in the following diagram: 129 . the responsibility centers are also guided by a large number of rules. Formal Control Process Formal communication system is structured as per the 'hierarchy outlined in the organization chart. measured and reported against plan. Thus. (b) Budgeting The strategic plan is converted to an annual budget incorporating planned expenditure and revenues for individual responsibility centers. and annually. say monthly. a strategic plan and programme is prepared as a guideline to budgeting. Expenses and revenues are marked for each responsibility centre period wise. They record the resources actually used and revenue earned. practices and operating procedures embodied in 'rules'. feedback information is sent to the responsibility centre concerned for praise or reward. standing instructions.

130 .

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