The best thought-out plans in the world aren't worth

the paper they're written on if you can't pull them

off.
Ralph S. Larsen
Chairman and CEO, Johnson & Johnson

BASIC CONCEPTS
1. Control
An organization must be controlled i.e. devices
that ensure that it goes where its leaders want it
to go must be operative.
Any control system has at least 4 elements:
1. A detector or sensor: it is a measuring device
that identifies what is actually happening in the
process being controlled.
2. An assessor: It is a device for determining the
significance of what is happening. Usually,
significance is assessed by comparing the
information on what is actually happening with
some standard or expectation of what should be
happening.
3. An effector: it is a device that alters behaviour
if the assessor indicates the need for doing so.
This device is often called feedback.
4. A communications network: it transmits
information between the detector and the
assessor, and between the assessor and the
effector.

Control
device

Detector. Information about

what is happening

Assessor, Comparison with

standard

Effector. Behaviour
alteration, if needed

Entity
being
controlled

2. Management
An organization consists of a group of people
who work together.
The organization has goals- that is, it wants to
accomplish certain results.
Management is the process whereby the
resources of man, machine and material are
integrated to accomplish these goals.
Therefore the role of management is to plan,
organize, integrate and interrelate organizational
activities and resources in order to achieve the
organizations objectives. This role is facilitated
through appropriate management ctrl systems
and processes.

 In
a
business
organization,
earning
a
satisfactory profit usually is an important goal.
The leader of the organization are its
management there is a hierarchy of managers,
with the CEO at the top, and business unit,
departmental, section
and other managers
below the CEO.
Depending on the size and complexity of the
organization, there may be several layers in the
hierarchy. Except for the CEO, each manager is
both a superior and a subordinate. Each
supervises
people
in
his
or
her
own
organizational unit and is a subordinate of the
manager to whom he or she reports. These
relationships usually are shown on the
organizational chart.
The CEO (or, in some organizations, a team of
senior managers) decides on strategies that are
expected to attain the organizations goals. If
the company is organized into business units,
business unit managers formulate strategies for
their units, subject to the approval of the CEO.
The management control process is the process
that managers use to assure that the members
of the organization implement these strategies.
Systems
A system is a prescribed way of carrying out an
activity or set of activities; usually the activities are
repeated. A system is characterized by a more or
less rhythmic, recurring, coordinated series of steps
that are intended to accomplish a specified purpose.
An important characteristic of systems is control.

Control centers on the prevention and correction of

deviations in a systems behaviour from those of
standards that have been specified at a given time.
In self- regulating systems, the key element for
control procedure is feed back. A comparison of
output values is made with the standards, and
information concerning the degree of deviation is fed
back to the other elements in the systems structure
so that preplanned activities may be changed if
necessary.
Systems can be closed or open.
The closed systems are also called informationtight systems i.e. information loop is closed and
the control mechanism has the capability to
affect the processor so that the desire output is
achieved.
Open systems do not have information-tight
control unit. Here the relationships among
elements of the system and between the system
and its environment are often not known. Open
systems characteristically strive to maintain a
dynamic balance. The open system receives
signals of changes in environment and adapts
itself in keeping with its character and goals.
An organization is a system of interrelated parts
working in conjunction with each other for
accomplishing its goals and those of the people
involved in it.
Management control system
A management control system is a system.

A system is an aggregate of machines and people

that work toward a common objective. A system can
be described as a series of steps or phases consisting
of an input phase, a processing phase, and an output
phase.
A control system adds measurement, analysis and
reporting phases to the system. Output is measured,
compared against a plan, analyzed if judged
significant, and then reported back to the
appropriate earlier phases of the system in the form
of positive or negative reinforcement.
In a management control system, data/information
is typically fed back to managers of the various
system phases. Responsible managers will then take
appropriate action based on the data/information
provided.
To help ensure that the data/information is of high
quality, the management control system must have
certain characteristics.
There
must
be
a
reliable
performance
measurement system.
Realistic standards should be planned and
maintained.
The standards should be consistently and
regularly
compared
with
performance
measurement data.
Any variances that exceed predetermined
thresholds
should
be
enthusiastically
investigated and reported to the people who

have responsibility and authority to make

appropriate and timely adjustments.
All adjustments should be controlled, especially
any adjustments that affect predetermined
standards and thresholds.
Many management actions are unsystematic. A
manager regularly encounters situations for which
the rules of the system are not well defined; the
manage then uses his or her best judgment in
acting. Many interactions between managers or
between a manager and a subordinate are of this
type. The appropriate response is determined by the
managers skill in dealing with people, not by a rule
specified by the system (although the system may
suggest the general nature of the appropriate
response). If all systems provided the correct action
for all situations, there would be no need for human
managers. This is the case in automated factory;
managers are needed only in the event of a system
failure.
Distinguishing
characteristics
of
control
systems in organizations.
Control systems in organizations operate on the
same basic framework as control systems in general.
The control process that managers use has the same
elements as those in the control systems in general:
detectors,
assessors,
effectors,
and
a
communications system.
Only difference is the involvement of people. Thus
control in an organization is much more complicated
than the control of an automated system.

The process of control in organizations involves

the following steps:
Information about the actual state of the
organization
is
compiled
by
people,
(detectors
report
what
is
actually
happening throughout the organisation)
it is compared(by people) with the desired
state ( the desired state is also decided by
people)

(assessors
compare
this
information with the desired state, which
is the implementation of strategies)
and if there is an significant difference, a
course of action is recommended (by people)
and action taken (by people) (effectors
take corrective action if there is a
significant difference between the actual
state and the desired state;)
This is why the process of control is more complex
than the automatic control system.
Three levels of management
An organisation is made of three distinct levels of
management:
1. Corporate
managementconsists
of
executives who are responsible for the
performance of the organisation as a whole. The
chairman or managing director and executives in
charge of specific functions such as finance,
marketing or personnel constitute the corporate
management.
2. Divisional
management:
consists
of
executives responsible for total performance of a
particular region or product division.

3.

Operating
management:
consists
of
executives changed with the management of
unit operations or are responsible for specific
operational tasks.

Three levels of decision-making

The following are the three levels of decision
making in an organisation:
1. Strategic thinking and planning takes place
at the institutional level. People involved at this
level are those who are concerned with general
company objectives of the company.
2. the
managerial level which focuses on
gathering, coordinating and allocating resources
for the organisation e.g. planning, budgeting,
capital expenditure decision making, etc.
3. The technical level involving the acquisition
and utilization of technical knowledge for
operational controls e.g. production scheduling,
inventory control. Etc.
Consistent with the three levels of management and
three levels of decision making, the total planning
and control system could be subdivide into 3
categories as shown in the figure below.

Strategic planning

Corporate
management

Management control

Operational control

Institutional level

Strategic planning

Divisional management

Managerial level

Management control

Operating
management

Technical level

Operational control

Three levels of management, three levels of decision-making and the corresponding

three activities of planning and control

Nature of management control systems

The aspects of control in an organization are:
1. Planning Process: The desired state or
standards against which performance is compared
is decided by the management. It is the
responsibility of the management to decide what
the organization plans to achieve in a given time
framework. This is Planning Process.
Planning and control are intricately linked
because in control, actual performance is
compared to planned performance.
2. Measurement of what is happening.
3. The next problem is how to decide whether the
difference in the desired state and actual state is
significant or not.
4. Then we have to decide what action needs to be
taken. Managers will have to seek various

alternatives of action and choose the one that is

likely to result in optimal decisions.
5. Follow-up: merely deciding what action needs
to be taken is not sufficient. There has to be
proper follow-up and therefore, another level of
control for the control system.
Hence, managers have to influence people in
regulating their behaviour for the desired action.
6. Coordination: in order to ensure that subparts
of an organization work in harmony, there has
to be proper coordinating mechanisms. So
control in organizations is needed to ensure
proper coordination among various departments.
Thus, a control system in and organization is
superimposed on smaller control systems in
every part of the organization. Problems of
control in organization are similar to problems of
interconnected ctrl systems.
Although the manage control process has the
same processes as other control processes, the
significant differences are:
1. The standard is not preset but is a result of
a conscious planning process. Unlike the
thermostat or body temperature systems, the
standard is not preset but is a result of a
conscious planning process. Management
decides what the organisation should be doing,
and part of the control process is a comparison
of actual accomplishments with these plans.
Thus, the control process in an organization
involves planning. In many situations, planning
and control can be viewed as tow separate

2.

activities.
Management
control,
however
involves both planning and control.
Management control is not automatic: like
control of an automobile, but unlike the
thermostat and body temperature systems, mgt
control is not automatic. Some of the detectors
(i.e. instruments for detecting what is happening
in the organization) are mechanical, but
important information is often detected through
the managers own eyes, ears, and other
senses.
Although there are routine ways of comparing
certain reports of what is actually happening
against some standard of what should be
happening, managers themselves must judge
whether the difference between actual and
standard performance is significant enough to
warrant action, and, if it is, what action to take.
Action taken to alter the organizations
behaviour involves human beings; in order to
effect change, a manager must interact with
another person.
Detectors are not just mechanical, managers
senses detect important information
Although there are routine ways of comparing
certain reports of what is actually happening
against some standard of what should be
happening, managers themselves must
judge
whether the difference between
actual and standard performance is
significant enough to warrant
action,

and, if it is, what action to take

Action taken to alter the organizations
behaviour involves human beings; in order to
effect change, a manager must interact with
another person.
Management control requires coordination
among individuals: an organization consists
of many separate parts, and management
control must ensure that the work of these pars
is in harmony with one another. This need does
not exist at all in the case of the thermostat,
and it exists only to a limited extent in the case
of the various organs that control body
temperature.
There is no clear-cut connection between
the observed need for action and the
behaviour that is required to obtain the
desired action: in the assessor function, a
manager may decide that costs are too high;
but there is no easy or automatic action, or
series of actions, that is guaranteed to bring
costs down to what the standard says they
should be. The term black box is used to
describe an operation whose exact nature
cannot be observed. A management control
system is an black box. We cannot know
what action a given manager will take
when a significant difference between
actual
and
expected
performance
is
assessed, or what (if any) action others
will take in response to the managers
signal.

3.

4.

5.

much control is self-control; control in an

organization does not come about solely, or
even primarily, as a consequence of actions that
are taken by an external regulating device like
the thermostat. Much control is self-control; i.e.
people act in the way they do, not necessarily
because they are given specific instructions by
their superior but, rather, because their own
judgment tell them what action is appropriate.

Boundaries of management control

Management control is one of several types of
planning and control activities that occur in an
organization.
It fits between strategy formulation and task control
in several respects.
Strategy formulation is the least systematic of
the three, task control is the most systematic,
and management control is in between.
Strategy formulation focuses on the long run,
task control focuses on short-run operating
activities, and management control is in
between.
Strategy formulation uses rough approximations
of the future, task control uses current accurate
data, and management control is in between.
Each activity involves both planning and control;
but the emphasis varies with the type of activity.
The planning process is much more important in
strategy formulation, the control process is
much more important in task control, and
planning and control are of approximately equal
importance in management control.

General relationships
control functions
Activity

among

planning

and

Nature of end product

Strategy
formulation

Goals, strategies and policies

Management
control

Implementation of strategies

Task control

Efficient and effective

performance of individual tasks

Management control
Management control is the process by which
managers
influence
other
members
of
the
organization to implement the organizations
strategies.
Management control is the process of evaluating,
monitoring and controlling the various sub-units of
the organization so that there is effective and
efficient allocation and utilization of resources in
achieving the predetermined goals.
Thus, the focus of management control is on the
managers of organisational sub-units and hence its
focus is on line managers responsible for the
performance of their departments.

Management control, therefore, is the control

exercised by the management over the
managers.
management control is exercised by evaluating
the performance of each responsibility centre
against planned performance.
Planned performance is decided in consultation with
the managers of responsibility centres, taking into
consideration the activities being managed by them
and the resources available to them in terms of men,
materials and money.
Planned performance is usually translated into
monetary terms, although physical achievements are
also planned for.
Managers are not only responsible for the
achievement of physical targets, but also for the
corresponding monetary values.
Thus, management control is generally built around
a
financial
structure.
Actual
and
planned
performance are compared at regular intervals so as
to identify resource gaps and, if need be, provide
managers with more resources or transfer resources
form on organisational unit to another. The end-oftheyear review may be too late to take corrective
action. The whole purpose of management control is
to decide on corrective action if there are substantial
deviations from the planned performance. The
management control system also provides
mechanisms for proper coordination and
integration of various organisational sub-units by
interrelating the tasks being performed and deciding
on the resource allocation. In the process of
management control conflicts are inherent between

managers for resource mobilization, allocation and

snatching. Thus there is intense interaction among
managers.
Aspects(nature and scope)
1. Management control activities
Management control involves a variety of activities.
These include:
1. planning what the organization should do,
2. coordinating the activities of several parts of the
organisation,
3. communicating information
4. evaluating information,
5. deciding what, if any, action should be taken,
and
6. Influencing people to change their behaviour.
Management control does not necessarily mean
that actions should correspond to a plan, such as a
budget because:
i. If the circumstances are now believed to be
different from the circumstances on which
stated plans were based on, at the time when
they were formulated, the planned actions may
no longer be appropriate.
ii. The purpose of mgt control is to ensure that
strategies are carried out so that the
organizations objectives are attained. If a
manager discovers a better way of operatingone that is more likely to achieve the
organizations goals than the actions stated in
the plan- then the management control system

should not prohibit him or her from operating in

that fashion.
2. Behavioral considerations
The mgt control process is systematic, but not
mechanical.
The
process involves interactions among
individuals. There is no mechanical way of
describing these interactions.
Managers have personal goals, and the central
control problem is goal congruence, that is,
to induce them to act so that when they seek
their personal goals, they help to attain the
organisations goals. Goal congruence means that
the goals of individual members of an
organisation should be, as far as feasible,
consistent with the goals of the organisation
itself.
See pg 93
Perfect goal congruence cannot be achieved.
Nevertheless, the system should go as far in this
direction as is feasible. The development of
optimum compensation plans and other incentives
are and important consideration in promoting goal
congruence.
3. Tool for Implementing Strategy.
Management control systems aid management in
moving an organization toward its strategic
objectives. Thus, management control focuses
primarily on strategy execution. Management
controls are only one of the tools managers use in
implementing desired strategies. Strategies get

implemented through management controls,

organization
structure,
human
resource
management, and culture. Organisation structure
specifies the roles, reporting relationships, and
responsibilities that shape decision making within
organisations . Human resource management
deals with selection, training, development,
evaluation, promotion, and firing of employees.
Human resource decisions should be consistent
with the chosen strategy and structure so that the
required knowledge and skills are developed.
Culture refers to the organizations set of common
beliefs, attitudes, and norms that explicitly or
implicitly guide managerial action.
4. Financial and non-financial emphasis
Management control systems encompass both
financial and non-financial performance measures.
The financial dimension focuses on the monetary
bottom line, which s net income, return on
equity, or some similar financial figure.
Virtually all organisational subunits also have nonfinancial objectives: product quality, market share,
customer satisfaction, on-time delivery, employee
morale, and so on.
6.Aid in developing new strategies
The primary role of management controls is to
help in the execution of chosen strategies. In
industries that are subject to very rapid
environmental changes management control
information can also provide the basis for
thinking about new strategies. This is referred to
as interactive control. Interactive control calls to
managements attention developments-either

troubles (e.g. Loss of market share; customer

complaints) or opportunities (eg. opening up of
a new market because of removal of certain
government regulations) that become the
basis for managers to adapt to a rapidly
changing environment by thinking about new
strategies. Interactive controls are not a
separate system they are an integral part of the
management
control
systems.
Some
management control information helps manager
think about new strategies. Interactive control
information usually, but not exclusively, tends to
be non-financial.
MANAGEMENT CONTROL PROCESS
Management control has 2 aspects:
1) System:
the
system
outlines
authority
relationships, autonomy delegation, relationship
among
various
organisational
sub-units,
parameters for performance evaluation, reward
and punishments for achievement and nonachievement of targets, and information flow
among various responsibility centers of the
organization.
2) Process:
the
processes
are
managerial
processes involved in establishing goals and
objectives,
performance
appraisal
of
responsibility centers, ensuring achievement of
targets and budgets by various organisational
sub-units, follow-up of remedial action plans,
implementation
of
decisions
taken
in
performance review meetings.

The control system provides the necessary

feedback and other relevant information and thus
affects the quality of the decisions. The
effectiveness of the control process is dependent
on the quality of feedback received and the way it
is used by the senior management for
performance appraisal.
In hierarchical organizations with appropriate
decentralization of authority the control process
begins with a review of the past performance of
strategic business units and responsibility centers,
and negotiation of specific objectives and targets
for the next year. This is followed by a periodic
recording of actual results and reporting of actual
results
against
the
targets.
The
senior
management
reviews
the
performance
of
responsibility centres on the basis of this reported
information. During this process, areas where
improvement is necessary are identified and
reasons for shortfall are analysed. Then, remedial
actions are decided upon. In the next review
meeting, results of past corrective action together
with the current performance are analysed. This
process is carried through in each review meeting.
In the process of reviewing the performance,
specific targets may also get altered as a result of
negotiation with the senior management. Thus,
the management control process is primarily
managerial in nature, secondarily accountingoriented and involves behavioral issues related to
superior-subordinate relationships. While the
management must identify the objectives of

various sub-units and contributions expected from

managers, accountants should help in methods of
measuring and reporting results as they are
achieved.

Components of management control process

DS

ENVIRONMENT
R

SENSOR

FEEDBACK

AS

RA

CHOICE

Generation of
solutions
AS-measurement of actual state
DS-desired state as indicated in goals or standards
C-comparator, i.e. comparison of actual with standard
RA-initiation of remedial action

Distinctions between Strategic Planning,

Management Control and Operational Control
Basis
of Strategic
Management
Operational
distinction
planning
control
control
Level
of Top
Top management Supervisor
management
management and
middle
involved
with
little management are
involvement closely involved
of
middle
management
Time frame
Long range
Short
to Short
intermediate(1 to periods5 years)
day to day,

Goals
objectives

and Basic
objectives

Structuring
Activity patterns

Tangible
goals,
with in framework
of
overall
objectives
Relatively
Fairly
highly
unstructured structured
but
flexible
Irregular
Rhythmic, regular

Character
activity
Focal point

of Creative
persuasive
Entire
organisation
Reliability
of Reliability is
data generated subject
to
by the process high level of
of planning or doubt due to
control
uncertainties
involved

Administrative,
little initiative
All
operations,
line management
More
accurate
and reliable as it
relates to past or
current events or
events likely to
occur in the near
future.

The
estimates
used
are
impersonal
and neutral

Data
used
for
setting standards
against
which
performance
is
evaluated
is

weekly,
monthly)
Short-term
tangible
operating
unit
Quite rigid
pre
established
Highly
repetitive
Following
directions
Operating
unit
More
accurate
and
reliable as
it relates to
past
or
current
events or
events
likely
to
occur
in
the
near
future.

Scope of activity Total

Basis
decisions

of

Focus of activity

Measures
performance

of

Information/data External
used
information

personalised
Overall, consisting
of
related
subsystem.(Whole
operation of the
organisation)
Managerial
judgment
is
required and the
scope
of
quantitative
models is limited
Organizational
effectiveness
Human
considerations are
more
dominant.
Control is more
difficult

Operating
unit
(Specific
tasks)
Decision
rules
developed
to
decide
about
optimum
decisions
Efficiency

The system
is
more
important
then
the
human
element
becoz
system
makes the
decisions
not
managers
Both in physical Physical
terms
and terms
financial terms
Internally
Data
generated data
generated
on specific

tasks
or
activities

Control Environment:
THE
CONTROL
ENVIRONMENT
HAS
A
PERVASIVE structure that affects many business
process activities. It includes elements such as
managements integrity and ethical values, operating
philosophy and commitment to organizational
competence.
What is the Control Environment?
The control environment provides an atmosphere in
which people conduct their activities and carry out
their
control
responsibilities.
The
control
environment sets the tone of an organization by
influencing the control consciousness of its people. It
is the foundation for all other components of internal
control, providing discipline and structure. Control
environment factors include the integrity, ethical
values, and competence of the entity's people;
management's philosophy and operating style; the
way
management
assigns
authority
and
responsibility; the way management organizes and
develops its people; and the attention and direction
provided by the audit committee and board of
directors.

What
is
the
Environment?

objective

of

the

Control

The objective of the control environment is to

establish and promote a collective attitude toward
achieving effective internal control over the entity's
business.
Control
environment
factors
incorporate
management's attitude, awareness, and actions
concerning an organization's control environment.
The following
environment:

factors

constitute

the

control

A. Management's Philosophy and Operating

Style:
Management concern about internal controls and
the environment in which specific controls function.
Management approach to risk taking and
accounting policies.
Managements responsiveness to crisis situations in
both operating and financial areas.
The reliability and accuracy of information used by
Management to make business decisions.
Frequency of reorganization or replacement of
management staff or consultants.
Turnover of management personnel.
Managements ability to adapt to new or
untraditional roles required to meet the changing
needs of the organization.
Communication and feedback systems within the
organization.

 The organizations financial sustainability.

B. The Entity's Organizational Structure:
An understanding of organisation behaviour is
important for the proper perception of management
control system and processes. As the major focus of
the control system is on the performance evaluation
of the organisational sub-units, the control system
designer should also have an understanding of the
organisation structure. Structure refers to the way
the enterprise is organized so as to enable the total
task of the organisation to be performed in an
efficient and effective way. The organisational
structure is essentially the arrangement of its
subsystems with authority and responsibility relation.
Thus, it refers to whether the organisation is
centralized or decentralized or whether it emphasizes
line or staff.
The organizational structure should be appropriate
for the entity's size and complexity.
The structure should enable segregation of duties
for initiating and recording transactions and
maintaining custody over assets.
Delegation of responsibility and authority should be
appropriate, and the number of supervisors should
be adequate and accessible.
Policies and procedures should be established at
appropriate levels.
Organizational conflict of interest should not exist
Major forms of organisation structure
1. Functional organisation in which the tasks are
differentiated on the basis of each major function

such as marketing, production, etc. with each

manager responsible for the specified function;
2. divisional organisation in which differentiation is
on the basis of a product line or group of product
lines with the manager responsible for all the
functions related to such a product line or group of
product lines,
3. Matrix organisation in which there is 2-way
differentiation, namely according to functions and
according to projects, with both superimposed on
each other
4. Network structure aimed at closer interinstitutional coordination among a network of
agencies involved in implementing a programme or a
project.
C. Methods of Assigning Authority and
Responsibility:
The adequacy of the entity's policies regarding the
assignment of responsibility and the delegation of
authority for such matters as organizational goals
and objectives, operating functions, and regulatory
requirements.
Employee job descriptions should adequately
describe specific duties, responsibilities, reporting
relationships, and constraints.
D. Management's Monitoring of Performance:
Managements involvement
organization's performance.

in

reviewing

the

 Management control methods should be adequate

to investigate unusual or exceptional situations and
to take appropriate and timely corrective action.
Management's follow-up action should be timely
and appropriate in response to communications from
external parties, including complaints, notification of
errors in transactions with parties, and notification of
inappropriate employee behavior.
E. Human Resources Policies and Practices:
Human resources policies for hiring, retaining, and
rewarding capable people.
Standards and procedures for hiring, promoting,
transferring, retiring, and terminating personnel.
Training programs.
Written job descriptions and reference manuals.
The channels of communication for employees
reporting suspected improprieties.
Policies on employee supervision.
Whether Policies and procedures provide for
employee empowerment and encourage and support
risk
taking
and
initiatives
for
performance
improvement.
F. Budget Control:
Guidance material and instructions to provide
direction to those preparing the budget.
The budget review, approval, and revision process.
Management
concern
for reliable budget
information.
Management participation in directing and
reviewing the budget process.

 Management involvement in determining when,

how much, and for what purpose expenditures can
be made.
Comparison of actual expenditures periodically to
budgets.
G. Compliance with Laws and Regulations:
Awareness of Management of applicable laws and
regulations and potential problems.
A mechanism to inform management of the
existence of illegal acts.
Management reaction to identified instances of
noncompliance with laws and regulations.
Policies and procedures for complying with laws
and regulations.
Policies on such matters as acceptable business
practices, conflicts of interest, and codes of conduct.
H. Changing Conditions:
The mechanisms for identifying and communicating
events, activities, and conditions that affect
operations or financial reporting objectives.
Modification of Accounting and/or information
systems in response to changing conditions.
Consideration given to designing new or alternative
controls in response to changing conditions.
Managements responsiveness to changing
conditions.
Types of organisation and management control
system
the firms strategy has and important influence on its
organisation structure. The type of organisation

structure, in turn, has an influence on the design of

management
control
systems.
Although
organizations come in all sizes and shapes, their
structures can be grouped into three general
categories:
(1) A functional structure, in which each manager is
responsible for a specified function, such as
production or marketing;
(2) A business unit structure, in which each business
unit manager is responsible for most of the activities
of a business unit, which is a semi-independent part
of the company and
(3) A matrix structure, in which functional units have
dual responsibilities.

Concept of goals and strategies

Goals
Goals can be defined as broad statements of what
the organisation wants to achieve in the long run, or
on a permanent basis.
Goals are broad objectives.
Goals are fairly timeless statements.
Goals and objectives are properly defined. If they are
vague or ill-defined, it may not be possible to
measure the performance of the organisation.
The clarity of goals and objectives is quite often
more evident to the initial employers and promoters
of institutions. With expansion of activities and
joining of new member, goals and objectives as

perceived by participants tend to get diffused.

Different key managers may have different
perceptions about goals and objectives. It is because
of this that organisations insist on proper induction
of new entrants to the philosophy of the
organisation.
External pressures, sometimes political in nature,
may force an enterprise to alter its goals and
objectives, particularly in the case of public
institutions, unless effective steps are taken by the
top management of the enterprise to counteract
such pressures, the enterprises goals and objectives
will get diffused and even confused, and will
seriously affect the effectiveness of the organisation.
Besides achieving the broad goals and objectives,
the management also attempts to achieve super
ordinate goals.
Super ordinate (or shared) goals are the set of
values or aspirations that underscore what an
organisation stands for and believes in. they are the
overreaching purposes to which an organisation and
its members dedicate themselves.
Super ordinate goals are values that genuinely seek
congruence between the individual and the
organizations purposes and are higher order
objectives beyond the bottom-line goals of ROI,
market share, expenses and sales levels. The super
ordinate goals encompass the concepts of service to
society and therefore the organisations must
demonstrate that their products serve social needs
before society accepts them.

Strategies
Strategy is the route with alternatives for reaching
objectives and goals - Smith and Walsh
Strategy is an outline of the proposed path of
action of an enterprise.
It is futuristic and indicative of the direction of
growth on the basis of which the plan for growth is
formulated.
Since strategy pertains to the interface between the
enterprise and its environment, the important
determinants of strategy in relation to internal
environment are:
Corporate goals and objectives
Physical resources of the enterprise in terms of
technology, finance and personnel,
Policies and styles of the management
Determinants of strategy in relation to external
environment are:
Competition
Technology
Political stability
Socio-economic factors
Governmental controls and policies
Strategies are evolved in response to changes in the
environment in which the enterprise operates.
While some enterprises systematically scan the
environment to identify the threats or opportunities,
others do it on an as and when basis.

The strategy outlines the growth pattern of an

enterprise and strategic decisions therefore can be
viewed in terms of product-market combinations.
An enterprise can outline its growth on the basis of
i)
existing product markets
ii) existing product, new markets
iii) new product, existing market and
iv) new product, new markets.
Depending upon the choice it makes, there will be a
particular product market strategy. The 4 different
strategies will be:
1. Market
penetration strategy: the firm
attempt to increase the overall market share
without any change in the product itself or its
use. The firm therefore may have an objective of
stated increase in market share. The risk
element in this strategy is not very high because
the product is already accepted in the market.
The problem is to increase sales and hence
production.
2. Market development strategy: new markets
are explored for existing products are made
broad-spectrum. For this strategy constant
experimentation is needed to find out what
different needs can be served by the same
product.
Thus,
the
product
becomes
multipurpose. Here has to be substantial
investment in R& D for this. Since the product
would serve the diverse needs, the acceptance
of the product by varied customers may pose a
certain amount of risk.
3. Product development strategy: the aim of
this strategy is to innovate new products to

replace current ones. The key variable here is

marketing. Since new products are to cater to
the same market, choice of technology is
critical.
4. Diversification strategy: it involves decisions
about new products to cater to new markets.
The diversification strategy may include either
vertical integration or horizontal diversification.
A strategy can be evaluated by asking key
questions, such as:
1. is the strategy internally consistent?
2. Is the strategy consistent with environment?
3. Is the strategy appropriate in view of available
resources?
4. Does strategy involve an acceptable degree of
risk?
5. Does the strategy have an appropriate time
horizon?
6. is the strategy workable?
A strategy should be
consistent with the environment
Internally consistent with organisational goals
and objectives.
Formulated
keeping
in
view
resource
availability and risk-taking capabilities of the
management.
Since
implementation
of
strategy
involves
commitment of resources, the management should
determine the time frame over which a given
strategic choice will have its impact.
The most important aspect of a strategic choice is
to know whether the proposition is workable.

Once the organisation has defined its strategy for

the organisation as a whole and for each of its
strategic business units (SBU), it must elaborate
the strategies into policies with a view to
facilitating the achievement of goals and
objectives. The policies have to be consistent with
strategies. Through the process of policy
formulation, management coordinates the strategy
of each business unit so as to ensure that all
organisational units work in harmony to achieve
the goals. The policies are formulated in respect of
prices, products, personnel, finance, and research
and development. The policies act as constraints
on the sub-units, for instance a particular transfer
pricing policy will act as a constraint within which
the divisional manager would have to operate. As
the performance results of an organisational subunit are also determined by the managerial
policies, the designer of control systems should
have
a
clear
understanding
of
various
organisational policies.

Behavioral considerations
Decision making process has 2 types of aspects (i)
technical aspect and (ii) behavioral aspect.
Technical aspects focus on technical details of data
processing
or
external
financial
reporting,
emphasizing compliance with legal requirements or

detections of frauds. management control system is

also concerned with inducing the human beings in an
organisation to take those actions that will help
attain the organisational goals. The important
behavioral considerations which should be taken care
of while designing a management control system are
as follows:
1. top management goals and sub goals
2. working with constraints
3. internal control
4. cost benefit considerations
5. goal congruence
6. managerial effort
7. management motivation
8. fairness and objectivity
1.top mgt goals and sub goals
The starting point for judging a system is the
specification of top mgt goals. Some mgt s will set a
single goal such as the maximization of profit over
the long run. This may be a vague goal for most
subordinates. Consequently, most organisations
specify multiple goals and accompany them with
some form of measurement
for evaluating
performance. Top mgts sub goals are frequently
called by other names, such as key-result areas,
critical success factors, key variables, or critical
variables.
Some important goals of a business are as follows:
(a) profitability
(b) market position
(c) productivity
(d) product leadership

(e)
(f)
(g)
(h)

personnel development
employee attitudes
public responsibility
balance between short-range and longrange goals

Profitability is usually measured in terms of a single

years results. The thrust of the other goals is to
offset the inclination of mangers to maximize short
run profits to the detriment of long-run profits.
Over emphasis on any single goal, be it short-run
profits or some other goals, seldom promotes longrun profitability. Balancing the various goals is an
important part of mgt control.
2.working within constraints
Management control system should be designed to
suit specific conditions. The latter are defined here as
the way top mgt has arranged the lines of
responsibility within and entity. For example, one
company may be organized primarily by functions
such as manufacturing and sales; another company
by divisions bearing profits responsibility such as the
eastern and western division; and other companies
by some hybrid arrangement.
The designer of management control system should
ordinarily consider the following:
(i) Top- mgt goals
(iii)
sub goals or key-result areas
(iv)
trade-offs among the goals in items 1
and 2
(v)
organization structure
(vi)
systems design in light of the foregoing

3.internal control
An internal control system consists of method and
procedures that are concerned with the authorization
of transactions, safeguarding of assets, and accuracy
of the financial records. Both manager and
accountants are responsible for developing and
evaluating internal control systems.
An internal control system has 3 goals:
(i)To prevent errors and irregularities by a system of
authorization for transactions, accurate recording of
transactions, and safeguarding of assets.
(ii) to detect errors and irregularities by reconciling
accounting recording with independently kept
records and physical counts and reviewing accounts
for possible write-downs of values.
(iii) To promote operating efficiency by examining
policies and procedures for possible improvements.
A management control system encompasses
administrative controls (such as budgets for planning
and controlling operations) and accounting controls
(such as the common internal control procedure of
separating the duties of the person who counts cash
form the duties of the person who has access to the
accounts receivable records.) top mgt has the
ultimate responsibility for both administrative and
accounting controls.
4.cost Benefit considerations
the choice of a system should be governed by
weighing the collective costs and benefits, give the

circumstances of the specific organization.

benefits are often difficult to measure.
5.goal congruence

The

goal congruence exists when individuals and groups

aim at the goals desired by top mgt. goal congruence
is achieved as managers, when working in their won
perceived best interests, make decisions that
harmonize with the overall objectives of top mgt. the
challenge is to specify segment goals (or behaviors)
that induce (or at least do not discourage) decisions
that would achieve top-mgt goals.
6.managerial efforts
Managerial effort is defined here as exertion toward
a goal. It includes all conscious actins (such as
watching or thinking) that result in more efficiency
and effectiveness. Managerial effort is a matter of
degree; it is maximized when individuals and groups
strive toward their goals.
Goal congruence can exist with little accompanying
effort, and vice versa. Performance evaluation is a
widely used means of improving congruence and
effort because most individuals tend to perform
better when they accept such feedback.
7.management motivations
Motivation has been defined as aiming for some
selected goal (goal congruence) together with the
resulting drive (managerial effort) that influences
action toward that goal.
8.fairness or objectivity

Managerial effort and motivation, among other

things, depend largely on the degree of fairness, or
objectivity built into the performance measurement
and evaluation. Experience show that people resent
evaluation which they consider unfair or subjective
or vague rather than evaluation per se. thus,
reasonably objective measures of performance
should merit special attention of the management
control system designers.
Goal congruence
Management control systems influence human
behaviour.
The systems should influence behaviors in a goal
congruent manner.
Goal congruence is affected both by informal
processes and also by formal systems. Some of the
informal factors are external to the organisation and
some are internal.
Control is also attained by two types of formal
devices
1. rules, broadly defined;
2. a systematic way of planning and controlling.
Senior management wants the organisation to
attain the organisations goals. However, the
members of the organisation have their won
personal goals, and these are not entirely
consistent with the goals of the organisation. The
actions of individual members of the organisation
are directed towards achieving their personal
goals. The central purpose of a management

control systems, therefore, is to assure, so far as

is feasible, goal congruence.
Goal congruence in a process means that actions it
leads people to take in accordance with their
perceived self-interest are also in the best interest
of the organisation.
Perfect congruence between individual goals and
organisational goals does not exist. One obvious
reason is that individual participants usually want
as much compensation as they can get; whereas,
from the organizations viewpoint, there is an
upper limit to salaries beyond which profits would
be adversely and unnecessarily affected. As a
minimum, however; the management control
systems should not encourage individuals to act
against the best interests of the organisation.
For example, if the system signals that the
emphasis should be only on reducing costs, and if
a manager responds by reducing costs at the
expense of adequate quality or by reducing costs
that he or she controls by causing a more than
offsetting increase in cots in other parts of the
organisation, then the manager has been
motivated, but in the wrong direction.
Two questions are important in evaluating any mgt
control practice:
1. What actions does it motivate people to take for
their self-interest?
2. Are these actions in the best interest of the
organisation?

Informal factors that influence goal congruence

(control environment)
I.
external factors
External factors are norms of desirable
behaviour that exist in the society of which the
organisation is a part. They are of the referred
to as the work ethic. They are manifest in
employees loyalty to the organisation, their
diligence, their spirit, and their pride in doing a
good job (as contrasted with merely putting in
time). Some of these attitudes are local: they
are specific to the city or region in which the
organisation does its work. In encouraging
companies to locate in their city or state,
chambers of commerce or other promotional
organisations often claim that their locality has a
loyal, diligent work force. Others are industryspecific, still others are national; some countries
have a reputation for excellent work ethics. Eg.
Japan, South Korea, Hong Kong, and other East
Asian countries.
II. Internal factors
1. Organizations culture or climate
Organisation culture refers to the set of common
beliefs, attitudes, norms, relationships and
assumptions that are explicitly or implicitly
accepted
and
evidence
throughout
the
organisation.
Kenneth R. Andrews-Climate is used to
designate the quality of the internal environment
that conditions the quality of cooperation, the
development of individuals, the extent of

members
dedication
or
commitment
to
organisational purpose, and the efficiency with
which that purpose is translated into results.
Climate is the atmosphere in which individuals
help, judge, reward, constrain, and find out about
each other. It influences morale- the attitude of
the individual toward his or her work and his or
her environment.
Certain practices are rituals, and others are
taboos.
Culture exists unchanged for many years. There is
resistance to any attempts to change the culture.
Culture is influenced by:
1. Personality and policies of the CEO (and by
those of lower-level managers w.r.t the part of
the organisation that they manage.)
2. The rules and norms accepted by the union (if
the organisation is unionized)
2. Management style
Management style, in particular, the attitude of a
managers superior toward control has greatest
impact on mgt control.
Some managers are charismatic and outgoing
Some are less ebullient
Some rely on mgt by waling around
Others rely more heavily on written reports
3.the informal organisation
The relationships that constitute the informal
organisation are important in understanding the
realities of the mgt control process
4.Perception and communication

Operating managers must know what these goals

are and what actions they are supposed to take in
order to achieve them. They receive information
about what they are supposed to do through
various channels like budgets and other formal
documents, conversations and other informal
means. This information often is not a clear
message about what senior mgt wants done.
Moreover, the messages received through various
information channels may conflict with one
another, or manger may interpret them in
different ways.
Many erroneous perceptions arise from functional
fixation-that is, the tendency of people to
interpret the meaning of words and phrase
according to accustomed definitions, even though
these definitions have become obsolete or are not
applicable to the current situation. Greater
emphasis in mgt control reports on a standard
terminology is one way to reduce the impact of
functional fixation.
5.cooperation and conflict
The lines in the organisation chart imply that the
way organisational goals are attained is that senior
mgt makes a decision and communicates that
decision down through the organisational hierarchy
to managers at lower levels of the organisation,
who then implement it. This implication ignores
the personal goals of individuals, and it is not the
way an organisation actually function.

Many actions that a manager may what to take in

order to achieve personal goals may have and
adverse effect on other managers and on overall
profitability .eg. managers may argue about which
of them is to obtain the use of limited production
capacity or other scarce resources, or about
potential customers that several managers want to
solicit, unless the management control system
provides
instruction
in
advance.
The
management control system must help to
maintain the appropriate balance between conflict
and cooperation within the organisation. this is
because some conflict is desirable. A certain
amount of cooperation is also obviously essential;
but if undue emphasis is placed on developing
cooperative attitudes, the most able participants
will be denied the opportunity of using their talents
fully.
The formal control system
These can be classified into two types:
1.rules
2.the management control system

1.Rules
Rules refer to all types of formal instructions and
controls. They include standing instructions,
practices, job descriptions, standard operating
procedures, manuals, and codes of ethics.
Rules are in force indefinitely.
They are changed infrequently.

 They may relate to matter that range from the

most trivial to the most important.
Some rules are guides and organisation
members are permitted to depart from them
either is specified circumstances or if departure
is in the organizations best interests.
Some rules should never be broken
Some rules are prohibitions against unethical,
illegal, or other undesirable actions.
Some are positive requirements that certain
actions be taken
Types of rules are
i.
physical controls
ii. manuals
iii. system safeguards
iv. task control systems

Responsibility Centres
A responsibility centre can be defined as an
organisation unit headed by a responsible
executive.
It represents a set of activities assigned to a
manager or a group of managers.
A small collection of machines may be responsibility
centre for a production supervisor, a full department
for the department head and the centre organisation
for the managing director.

The size of a responsibility centre will be determined

by the nature of the task, technology, people and the
level in organisation hierarchy. From the point of
view of the top mgt, a division, which is a
significantly large unit, is a responsibility centre.
From the point of view of divisional mgt, the
marketing department of the division is a
responsibility centre and from the point of view of
the marketing manager, the sales distribution and
advertising departments are responsibility centres.
A responsibility center exists to accomplish one or
more purposes; these purposes are its objectives.
The company as a whole has goals, and senior
management has decided on a set of strategies to
accomplish
these
goals.
The
objectives
of
responsibility centres are to help implement these
strategies. Because the organisation is the sum of its
responsibility centers, if the strategies are sound,
and if each responsibility center meets its objectives,
the whole organisation should achieve its goal.
Responsibility centre is a sub system which has
both inputs and outputs.
Its inputs may include physical quantities of
materials, manpower and various services, working
capital and fixed assets.
It works with these resources.
As a result of this work, the responsibility centre
produces output. These can be goods or services
which either go to other responsibility centres within
the organisation or sold to customers in the outside
world.

Inputs
Resources used,
measured by cost

Outputs
Work

Goods or services

Capital

Management is responsible for obtaining the

optimum relationship between inputs and outputs. In
some situations the relationship is causal and direct
eg. In production department the inputs become a
physical part of the finished goods output. In many
situations, however, inputs are not directly related to
outputs eg. Advertising expense and R & D
expenditure.
Types of responsibility centres
1. revenue centres
2. expense centres
3. profit centres
4. investment centres
in revenues centres, only outputs are measured in
monetary terms; in expense centers, only inputs are
measured; in profit centers, both revenues and
expenses are measured and in investment centers,
the relationship between profits and investment is
measured.

1.Revenue centers

in a revenue center, outputs are measured in

monetary terms, but no formal attempt is made to
relate inputs (I.e. expenses or costs) to outputs.
Revenue centers are, marketing organisations that
do not have profit responsibility. Actual sales or
orders booked are measured against budgets or
quotas. Each revenue center is also an expense
center in that the revenue center manager is held
accountable for the expenses incurred directly
within the unit. The primary measurement,
however, is revenue. Revenue centers are not
charged for the cost of the goods that they
market. Consequently, they are not profit centers.
Revenue centers do not typically have authority to
set selling prices.
2.Expense centers
Expense centers are responsibility centers for which
inputs, or expenses are measured in monetary
terms, but for which outputs are not measured in
monetary terms. There are 2 general types:
Engineered expense centers: are expense centers
in which all or most costs are engineered costs.
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. Const incurred in a factory for direct
labour, direct material, components, supplies, and
utilities are examples.
Discretionary expense centers: are expense
centers in which all, or most, costs are discretionary.
Discretionary costs/managed costs are those for
which no such engineered estimate is feasible the

amount of costs incurred depends on managements

judgment about the amount that is appropriate
under the circumstances.
3.Profit centers
It is a responsibility center is measured in terms of
profit, which is the difference between the revenues
and expenses. 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.
A typical example of a profit center is a division of
the company that produces and markets different
products. The manager of this division will be
responsible for the setting up of production policies
and the price as also marketing strategies. Even
though the division manager may propose the
investments in the division the decisions are usually
made by the top mgt
Advantages of profit centers
(i) The speed of operation decisions may be
increase because many decisions do not have to be
referred to corporate headquarters.
(ii) Quality of many decisions is improved
(iii) Headquarter management is relieved of day-today decisions and can concentrate on broader issues.
(iv) Profit consciousness may be enhanced
(v) Measurement of performance is broadened.
(vi)Managers are freer to use their imagination and
initiative.
(vii) It provides a training ground for general
management.
Disadvantages of profit centers

(i) Top mgt may lose some control

(ii) Lack of competent general managers
(iii)
Disadvantageous
competition
between
organisation units.
(iv) Friction can increase
(v) Too much emphasis on short-run profitability.
(vi)
No completely satisfactory system for
ensuring that each profit center, by
optimizing its own profits, will optimize
company profits.
(vii) The quality of some of the decisions
may be reduced.
(viii) Additional costs
4.Investment centers:
it is a responsibility centre whose performance is
evaluated in terms of profit and assets employed
in earning the profit. Since different divisions have
different investment bases, it is difficult for the top
management to compare the profit performance of
one division with another division, unless it
considers the investment base in each division.
The comparison of absolute profits may not yield
meaningful results because of different amounts of
resources used by each division. The investment
base is measured by net assets which consist of
net fixed assets plus net current assets. This
corresponds to the sum of shareholders equity
plus reserves and surplus plus long-term loans in
the balance sheet of a company. Thus in the case
of divisions, the figure of net assets can be
conceived as corporate equity in the division.
There are 2 ways in which assets employed can

be related to profits, namely:

i)

Return on investment: The return on

investment is calculated by dividing the
profits by the amount of investment i.e.
assets employed. It is a ratio.

ii)

Residual income: it is an absolute amount.

It is calculated by deducting an interest
charge from the profits. The interest charge
is obtained by multiplying the net assets by
a predetermined interest rate.

The concept of return on investment (ROI) is

more widely used than residual income as
managers by training are more accustomed to
look at ratios. Further, ROI data is generally
available for other companies or industries and
can be used as a basis of comparison. The
residual income concept cannot be used for
comparison.

TRANSFER PRICING

Large organisations are divided into a number of

divisions to facilitate managerial control. The
problem of transfer pricing arises when one division

of the organisation transfers its output to another

division as an input.
A transfer price is the price one segment
(subunit, department, division etc.) of an
organisation charges for a product or service
supplied to another segment of the same
organisation.
The transfer from one segment to another is only an
internal transfer and not a sale.
Transfer pricing is needed to monitor the flow of
goods and services among the divisions of a
company and to facilitate divisional performance
measurement. The main use of transfer pricing is to
measure the notional sales of one division to another
division. Thus the transfer prices used in the
organisation will have a significant effect on the
performance evaluation of the various divisions. This
requires that the system of transfer pricing should be
objective and equitable.
Transfer pricing becomes necessary when there are
internal transfers of goods or services and it is
required to appraise the separate performances of
the divisions or departments involved.
Transfer pricing is the process of determining
the price at which goods are transferred from
one profit center to another profit center within
the same company.
If profit centers are to be used, transfer prices
become necessary in order to determine the
separate performances of both the buying and
selling profit centers. If transfer prices are set too
high, the selling center will be favored whereas if set

too low the buying center will receive an

unwarranted proportion of the profits.
Objectives that transfer prices should meet
(a) Goal congruence: the prices should be set so
that the divisional mgt desire to maximize divisional
earnings is consistent with the objectives of the
company as a whole. The transfer prices should not
encourage sub-optimal decision-making. The system
should be so designed that decisions that improve
business unit profits will also improve company
profits.
(b) Performance appraisal: the prices should
enable reliable assessments to be made of divisional
performance. The prices form part of information,
which should:
1 Guide decision making
2 Appraise managerial performance
3 Evaluate the contribution made by the division
to overall company profits.
4 Assess the worth of the division as an economic
unit.
The transfer prices should be designed such that
they help in measuring the economic performance
(c) Divisional autonomy: the prices should seek
to maintain the maximum divisional autonomy so
that the benefits of decentralization (motivation,
better
decision-making,
initiatives,
etc.)
are
maintained. The profits of one division should not be
dependent on the actions of other divisions.
(d) Simple and easy: the system should be simple
to understand and easy to administer.

(e)the transfer price should provide each segment

with the relevant information required to determine
the optimum trade-off between company costs and
revenues.
Fundamental principles for transfer price
The fundamental principle is that he transfer
price should be similar to the price that would
be charged if the product were sold to outside
customers or purchase from outside vendors.
When profit centers of accompany by from and sell
to one another, 2 decisions must be made
periodically for each product that is being produced
by one business unit and sold to another:
5. Should the company produce the product inside
the company or purchase it form and outside
vendor? This is the sourcing decision.
6. If produced inside, at what price should the
product be transferred between profit centers?
This is the transfer price decision.
Transfer price systems can range from the very
simple to the extremely complex, depending on the
nature of the business.
Ideal situation
A transfer price will induce goal congruence if all the
conditions listed below exist.
1. Competent people: ideally, managers should
be interested in the long run as well as the
short-run performances of their responsibility
centers. Staff people involved in negotiation and

2.

3.

4.

arbitration of transfer process also must be

competent.
Good atmosphere: managers must regard
profitability as measured in their income
statement as an important goal and as a
significant consideration in the judgment of their
performance. They should perceive that the
transfer prices are just.
a market price. : The ideal transfer price is
based on a well-established, normal market
price for the identical product being transferredthat is, a market price reflecting the same
conditions (quantity, delivery time, and the like)
as the product to which the transfer price
applies. The market price may be adjusted
downward to reflect savings accruing to the
selling unit form dealing inside the company.
Freedom to source: alternatives should exist,
and managers should be permitted to choose
the alternative that is in their own best interest.
The buying manger should be free to buy from
the outside, and the selling manger should be
free to sell outside. If the selling profit center
can sell all of its products, either to insiders or
to outsiders, and as long as the buying center
can obtain all of its requirements form either
outsiders or insiders, this method is optimum.
The market price represents the opportunity
cost to the seller of selling the product inside.
Form a company point of view, therefore, the
relevant cost of the product is the market price
because that is the amount of cash that has
been forgone by selling inside. The transfer price

5.

6.

represents the opportunity cost to the company.

Full flow of information: managers must
know the available alternatives and the relevant
costs and revenues of each.
Negotiation: there must be a smoothly
working mechanism for negotiating contracts
between business units.

If all the above conditions are present, a transfer

price system based on market prices would fulfill all
of the objectives stated above, with no need for
central administration.
Less than ideal conditions
1. Constraints on sourcing: ideally the buying
manager should be given freedom to make
sourcing decisions if the profit centre is to
operate in an entrepreneurial manner. Similarly,
the selling manager should be free to sell
products in the most advantageous market.
However, in real life, freedom to source either
might not be feasible or, even if it is feasible,
might be constrained by corporate policy.
2. Limited
markets:
in many companies,
markets for the buying or selling profit centers
may be limited. There are several reasons for
this.
i)
ii)

the existence of internal capacity might limit

the development of external sale
if a company has made significant investment
in facilities, it is unlikely to use outside source
even though outside capacity exists, unless

the outside selling price approaches the

companys variable cost, which is not usual.
iii) If a company is the sole producer of a
differentiated product, no outside capacity
exists.
Even in the case of limited markets, the transfer
price that best satisfies the requirement of a profit
centre is the competitive price. How does a
company find out what the competitive price is, if
it does not buy or sell the product in an outside
market? The ways are:
a)if published market prices are available, they
can be used to establish transfer prices.
b)Market prices may be set by bids
c) If the production profit centre sells similar
products in outside markets, it is of tern possible
to replicate a competitive price on the basis of
the outside price
d)If the buying profit centre purchases similar
products from the outside market, it may be
possible to replicate competitive prices for its
proprietary products
In some companies, given the option, buying profit
centres prefer to deal with an outside source for the
following reasons:
i)
service: outside sources may be perceived to
provide better service
ii)
Internal rivalry that sometimes exists in
divisionalized
companies.
For
whatever
reason, management should be aware of the
strong political overtones that sometimes
occur in transfer price negotiations. There is
no guarantee that a profit center will

voluntarily buy from the inside source when

excess capacity exists.
Thus, even if there are constraints on sourcing, the
market price is the best transfer price. If the market
price exists or can be approximated, use it. However,
if there is no way of approximating valid competitive
prices, the other option is to develop cost-based
transfer prices.
Methods of transfer pricing
the methods of transfer pricing can be divided into 4
categories:
a)market based pricing
b)cost based pricing
c) negotiated pricing
d)opportunity cost transfer pricing
1. Market based transfer pricing
Where a market exists outside the firm for the
intermediate product and where the market is
competitive (i.e. the firm is a price taker) then the
use of market price as the transfer price between
divisions would generally lead to optimal decision
making. Such a price would meet al of the objectives
of a transfer price i.e.
- achieve goal congruence
- realistic performance evaluation
- maintain autonomy of the divisions
Where significant external buying and selling costs
exist then a transfer may be set somewhat lower
than market price to reflect the cost savings from
internal transfers. The circumstances may lead to

negotiated market prices where the total cost

savings are apportioned between the buying and
selling divisions. In such circumstances an arbitration
procedure may be required but too much central
intervention of this nature could undermine the
autonomy of the divisions.
Where appropriate market price exists then their use
represents a feasible ideal. However the following
difficulties may arise in applying the concept:
a)no market for the intermediate product or
service being considered
b)Though market exists, difficulty in obtaining a
competitive price. (price is only strictly
comparable when all features are identicalquality, delivery, finish, and so on.
c) Market exists but is not perfectly competitive
i.e . the market is affected by the pricing
decision of divisional managers.
d)Market prices that are available may be
considered unrepresentative eg. there may be
considerable excess capacity in the intermediate
market that current quotations are well below
long run average price. In such circumstances
eth use of either the current, abnormally low
price or the long run normal price may lead to
sub-optimal decision making on the part of the
supplying divisional management or to loss of
motivation and autonomy of the purchasing
division.
Adjusted market price: inter-divisional transfers
in most situations cannot replicate a competitive
market situation. A division may have the
advantage or disadvantage of being a captive

buyer or captive supplier. Capacities may be

related which are different from the economically
competitive capacities to take advantage of the
synergies of integration or to remove the
uncertainties attached with the supply of critical
items by outside parties, etc. these and many
other factors may be considered while fixing the
transfer prices. They will thus justify the setting of
transfer prices based on adjusted market price.
The extent of adjustment to market price will still
have to be decided.
2. Cost based pricing
Cost based transfer pricing systems are commonly
used because the conditions for setting ideal market
prices frequently do not exist; eg. there may be no
intermediate market or the market which does exist
may be imperfect.
Providing that the required information is available, a
decision rule that would lead to optimal decisions for
the firm as a whole, would be to transfer at
marginal cost up to the point of transfer, plus
any opportunity cost to the firm as a whole.
Limitations:
i) Even assuming that variable outlay costs as
conventionally recorded in accounting systems,
are a reasonable approximation of economic
marginal costs the imposition of such a rule
would undermine the concept of profit centres in
that the profitability of divisions required to
transfer at marginal cost could not be appraised
and
ii) The autonomy of divisions would be affected.

iii) The cost may include inefficiencies of the selling

division which would thus be passed on to the
buying division. Accordingly, standard cost,
rather than actual costs should be used as the
basis of the transfer price in order not to burden
the buying department with the inefficiencies of
the supplying department.
The 2 main cost derived methods are those based on
full cost and variable cost.
I) full cost transfer pricing
this method, and the variant which is full costs plus a
profit markup, has the disadvantage that suboptimal decision making may occur particularly when
there is idle capacity within the firm.
The full cost (or cost plus) is likely to be treated by
the buying division as an input variable cost so that
external selling price decisions , if based on cost may
not be set at levels which are optimal as far as the
firm as a whole is concerned.
Limitations of full cost transfer pricing
a)The calculated cost is only accurate at one level
of output.
b)The validity of any pricing decision base on past
costs is questionable
c) When transfers are made at full cost plus a
profit
markup
the
selling
division
is
automatically given a certain level of profit
rendering
genuine
performance
appraisal
difficult

d)When the selling division is inefficient or working

at low volume the costs may be unacceptably
high as far as the buying division is concerned.
II) Variable cost transfer pricing
Here transfers are made at the (standard) variable
costs up to the point of transfer. Assuming that the
variable cost is a good approximation of economic
marginal cost then this system would enable
decisions to be made which would be in the interest
of the firm as a whole.
However, variable cost based prices will result in a
loss for the selling division so performance appraisal
becomes meaning less and motivation will be
reduced.
Sub-optimal decision making may be minimized by
the following:
(1.) Two step pricing: a transfer price is
established that includes 2 charges:
i) a charge is made for each unit sold that is equal to
the standard variable cost of production.
ii) a periodic (usually monthly) charge is made that
is equal to the fixed costs associated with the
facilities reserved for the buying unit.
One or both of these components should include a
profit margin.
(2.) Profit sharing: a profit sharing system might
be used to ensure congruence of business unit
interest with company interest. This operates as
follows:
I) the product is transferred to the marketing unit at
standard variable cost.

II) After the product is sold, the business units share

the contribution earned, which is the selling price
minus the variable manufacturing and marketing
costs.
This method of pricing may be appropriate if the
demand for the manufactured product is not steady
enough to warrant the permanent assignment of
facilities, as in the 2-step method. In general, this
method accomplishes the purpose of making the
marketing units interest congruent with the
companys. This dual transfer price approach has an
apparent fairness in that credit for profits earned and
shared between divisions but performance appraisal
based on arbitrarily apportioned profit shares has
obvious shortcomings and administrative difficulties.

The problems in implementing a profit sharing

system are:
i) There can be arguments over the way contribution
is divided between the two profit centers. Senior
management might have to intervene to settle these
disputes which is costly, time consuming, and works
against a basic reason for decentralization, namely,
autonomy of business unit managers
ii) Arbitrarily dividing up the profits between units
does not give valid information on the profitability of
each segment of the organization.
Since the contribution is not allocated until after the
sale has been made, the manufacturing units
contribution depends on the marketing units ability

to sell and on the actual selling price. Manufacturing

units may perceive this situation to be unfair.
a variable cost based transfer price so that and, as a
separate exercise, credit the supply division with a
share of the overall profit which eventually results
from the transferred item.
3. Negotiated transfer pricing
Transfer price could be set by negotiation between
the buying and selling divisions. This would be
appropriate if it can be assumed that such
negotiations would result in decisions which were in
the interest of the firm as a whole and which were
acceptable to the parties concerned.
A company could establish a formal mechanism
whereby representatives from the buying and selling
units meet periodically to decide on outside selling
prices and on the sharing of profits for products
having significant amounts of upstream fixed costs
and profit. This mechanism is workable only if the
review process is limited to decisions that involve a
significant amount of business to at least one of the
profit centers; otherwise, the value of these
negotiations may not be worth the effort.
Limitations of negotiated transfer pricing
1.its unlikely that the parties concerned have equal
bargaining power
2.protracted negotiations may be time consuming
and divert mgt energies away from their primary
tasks
3.Disagreements which are all too likely, will require
some form of arbitration by central mgt which

itself undermines the autonomy of divisions and

may cause resentment. It must be remembered
that the objectives of divisionalisation is to
enhance the overall efficiency of the organisation
so that care must be taken not to nullify any
benefits through inter-divisional wrangling over
transfer prices.
4.opportunity cost transfer pricing
In several cases there are situations where the
pricing of inter-divisional transfers based on market
price or its variants becomes difficult because of the
lack of existence of reasonable market for such
intermediates.
This may also be the case where the supplier division
is a monopoly producer or the user division is a
monopoly consumer.
In such circumstances the transfer price is set by the
central mgt. an ideal option for the central mgt will
be to set the price at a level which equals the
opportunity cost of the supplier division and the user
division.
Both divisions under these circumstances will be
encouraged to produce and consume that quantity
which is optimal from the point of view of the
company as a whole.
If the user division fails to provide adequate orders
from the supply division the amount of contribution
in respect of the production foregone due to lack of
orders should be charged from such division.

BUDGET
A budget is a plan expressed in quantitative, usually
monetary term, covering a specific period of time,
usually one year. In other words a budget is a
systematic plan for the utilization of manpower and
material resources.
In a business organization, a budget represents an
estimate of future costs and revenues. Budgets may
be divided into two basic classes: Capital Budgets
and Operating Budgets. Capital budgets are directed
towards proposed expenditures for new projects and
often require special financing. The operating
budgets are directed towards achieving short-term
operational goals of the organization, for instance,
production or profit goals in a business firm.
Operating budgets may be sub-divided into various
departmental of functional budgets.
The main characteristics of a budget are:
1. It is prepared in advance and is derived from the
long-term strategy of the organization.
2. It relates to future period for which objectives or
goals have already been laid down.
It is expressed in quantitative form, physical or
monetary units, or both.
Different types of budgets are prepared for different
purposed e.g. Sales Budget, Production Budget,
Administrative
Expense
Budget,
Raw-material
Budget etc. All these sectional budgets are

afterwards integrated into a master budget, which

represents an overall plan of the organization.
ADVANTAGES OF BUDGETS
A budget helps us in the following ways:
1. It brings about efficiency and improvement in the
working of the organization.
2. It is a way of communicating the plans to various
units of the organization. By establishing the
divisional, departmental, sectional budgets, exact
responsibilities are assigned. It thus minimizes the
possibilities of buck passing if the budget figures are
not met. 3. It is a way or motivating managers to
achieve the goals set for the units.
4. It serves as a benchmark for controlling on-going
operations.
5. It helps in developing a team spirit where
participation in budgeting is encouraged.
6. It helps in reducing wastage and losses by
revealing them in time for corrective action.
7. It serves as a basis
performance of managers.

for

evaluating

the

8. It serves as a means of educating the managers.

BUDGETARY CONTROL
No system of planning can be successful without
having an effective and efficient system of control.

Budgeting is closely connected with control. The

exercise of control in the organization with the help
of budgets is known as budgetary control. The
process of budgetary control includes:
1.
Preparation
of
various
budgets.
2. Continuous comparison of actual performance with
budgetary
performance.
3. Revision of budgets in the light of changed
circumstances.
A system of budgetary control should not become
rigid. There should be enough scope of flexibility to
provide for individual initiative and drive. Budgetary
control is an important device for making the
organization. More efficient on all fronts. It is an
important tool for controlling costs and achieving the
overall objectives.
INSTALLING
SYSTEM

BUDGETARY

CONTROL

Having understood the meaning and significance of

budgetary control in an organization, it will be useful
for you to know how a budgetary control system can
be installed in the organization. This requires, first of
all, finding answers to the following questions in the
context of an organization:

What
is
likely
to
happen?
What can the objectives to be achieved?
What are the constraints and to what extent their
effects
can
be
minimized?
Having found answers to the above questions, the

following steps may be taken for installing an

effective system of budgetary control in an
organization.
Organization for Budgeting:
The setting up of a definite plan of organization is
the first step towards installing budgetary control
system in an organization a budget manual should
be prepared giving details of the powers, duties,
responsibilities and areas of operation of each
executive in the organization.
1. Budget Manual: "A document which setout, inter
alias, the responsibilities of the persons engaged in,
the routine of, and the forms and records required
for, budgetary control."
2. Web for obtaining the necessary approval of
budgets, the authority of granting approval should
be stated in explicit terms. Whether one, two or
more signatures are to be required on each
document should also be clearly stated.
3. Timetable for all stages of budgeting.
4. Reports, statements, forms and other records to
be maintained.
5. The accounts classification to be employed. It is
necessary that the framework within which the costs,
revenues and other financial amount are classified
must be identical both in accounts and the budget
department.

There are many advantages attached to the use of

budget manual. It is a formal record defining the
functions and responsibilities of each executive.
The methods and procedures of budgetary control
are standardized. There is synchronization of the
efforts of all which result in maximization of the
profits of the organization.
The
responsibility
for
preparation
and
implementation of the budgets may be fixed as
under:
Budget Controller
Although the chief executive is finally responsible for
the budget programme, it is better if a large part of
the supervisory responsibility is delegated to an
official designated as Budget Controller or Budget
Director. Such a person should have knowledge of
the technical details of the business and should
report directly to the president or the Chief Executive
of the organization. Fixation of the budget period
Budget period mean the period for which a budget is
prepared and employed. The budget period depends
upon the nature of the business and the control
techniques. For example, a seasonal industry will
budget for each season while an industry requiring
long periods to complete work will budget for four,
five or even larger number of year. However, it is
necessary of control purposes to prepare budgets
both for long as well as short periods.

Budget Procedures
Having established the budget organization and fixed
the budget period, the actual work or budgetary
control can be taken upon the following pattern:
STEPS IN BUDGETARY CONTROL
1.
Organization
2. Budget manual + Theory

for

budgeting

"A document which sets out, inter alias, the

responsibilities of the persons engaged in, the
routine of and forms and records required for
budgetary control."
The budget manual is a written document or booklet
that
specifies
the
objectives
of
budgeting
organization and procedures. Following are some of
the important matters covered in a budget manual:
1. A statement regarding the objectives of the
organization and how they can be achieved through
budgetary
control.
2. A statement regarding the functions and
responsibilities of each Executive by designation both
regarding preparation and execution of budgets.
3. Procedures to be followed for obtaining the
necessary
approval
of
budgets.
4. The authority of granting approval should be
stated
in
explicit
terms.
5. Whether one, two or more signatures are to be
required
on
each
document
6.
Should
also
be
clearly
stated.

7. Timetable for all stages of budgeting.

8. Reports, statements, forms and other records to
be
maintained.
9. The accounts classification to be employed. It is
necessary that the framework within which the
costs, revenues and other financial amount are
classified must be identical both in accounts and the
budget departments.
There are many advantages attached to the use of
budget manual. It is a formal record defining the
functions and responsibilities of each executive.
The methods and procedures of budgetary control
are
standardized.
There is synchronization of the efforts of all which
result in maximization of the profits of the
organization.
Making a forecast
Consideration
of
alternative
combination
of
forecasts:
Alternative combinations of forecasts are considered
with a view to contain the most efficient overall plan
so as to maximize profits. When the optimum -profit
combination of forecasts is selected, the forecasts
should be regarded as being finalized.
Sales budget
Past sales figures and trend. The record of previous
experience forms the most reliable guide as to future
sales as the past performance is related to actual
business conditions. However the other factors such

as seasonal fluctuations, growth of market, trade

cycles etc., should not be lost sight of salesmen's
estimates. Salesmen are in a position to estimate the
potential demand of the customers more accurately
because they come in direct contact with the
customers. However, proper discount should be
made for over-optimistic or too conservative
estimates of the salesmen depending upon their
temperament.
Plant Capacity. It should be the endeavor of the
business to ensure proper utilization of plant facilities
and that the sale budget provides an economic and
balanced production on the factory.
General trade prospects. The general trade prospects
considerable affect the sales. Valuable information
can be gathered in this connection from trade papers
and magazines.
Orders on hand. In case of industries where
production is quite a lengthy process, orders on hand
also have a considerable influence in the amount of
sales.
Proposed expansion of discontinuance of products. It
is affects sales and therefore, it should also be
considered.
Seasonal fluctuations. Past experience will be the
best guide in this respect. However, efforts should be
made to minimize the effects of seasonal fluctuations
by giving special concessions or off-season discounts
thus increasing the volume of sales.

Potential market. Market research should be carried

out for ascertaining the potential market, for the
company's products. Such an estimate on the basis
of expected population growth, purchasing power of
consumers and buying habits of the people.
Availability of material and supply. Adequate supply
of raw materials and other supplies must be ensured
before drafting the sales programme.
Financial aspect. Expansion of sales usually require
increase in capital outlay also, therefore, sales
budget must be kept within the bounds of financial
capacity.
Other factors:
a. The nature and degree of competition within the
industry;
b.
Cost
of
distributing
goods;
c. Governments controls, rules and regulations
related
to
the
industry;
d. Political situation - national and international as it
may have an influence upon the market.
The sales manager, after taking into consideration all
these factors, will prepare the sales budget in terms
if quantities and money, distinguishing between
products, periods and areas of sale.

TYPES OF BUDGETS -The following are the main types of

budgets :

Lump Sum
Typically, lump sum budgeting involves the allocation by the
librarys parent organizations upper-level management of a lump
sum of budget resources to the library. Since the lump sum
method lacks specific ties to corporate goals and objectives, many
library managers prefer other types of budgets. However, lumpsum budgets can be perceived as representing a high-level of
flexibility and control within the library itself.

Once the lump-

sum is allocated, the library management proceeds with lowerlevel allocations among library programs and services.
Formula Budget
When a special library is funded through the formula budget,
the budget allocation is typically tied to a numeric value such as
full-time-equivalencies (FTEs), i.e., number of FTEs registered
students multiplied by a fixed dollar amount yields the budget for
the library. This method is fraught with weaknesses; primarily, the
budget total is calculated at a late point in time and intrudes on

advance planning especially for purchases and staffing increases

within the library. Another weakness results from the formula
budgets lack of identification with the parent organizations goals
and objectives. Another weakness emanates from the unpredictable
nature of the budget since the formula is based on variables outside
the influence or control of the special library.
Line-Item Budget
The line-item budget represents the most commonly used
budgeting method for special libraries (Warner 9). In a line-item
budget, each category of activity is afforded its separate
appearance. Line-item budgets facilitate low levels of detail for
both planning and cost control purposes. Often, the accounting
function of the parent organization develops accounts and subaccounts on a company-wide basis. In that case, the library uses
the company accounting scheme.
Among the advantages of line-item budgets are ease of
preparation, use as detailed planning vehicle and utility as a means

of comparing performance from one fiscal period to another fiscal

period.
Warner provides a model to illustrate the simplicity and
utility of the line-item budget:
LINE-ITEM BUDGET
Last year This
year
Salaries
Materials
Etc.
Etc.
Miscellaneous
TOTAL

Next
year

Problems identified by Warner include the difficulty of

relating the line budget to the goals of the parent organization, the
line-item budgets propensity for perpetuating a line, i.e., once a
line, always a line, the tendency of the Miscellaneous line to grow
unwieldy as technologies and their costs evolve, and the reality
that comparing this year to last year is more complex and
represents variables unaccounted for within the line-item budget
(Warner 10).

Program Budget
By its nature, a program budget focuses on the services the
library provides to its clients. Therefore, the program budget more
readily relates to overall organizational goals and objectives. Its
attractiveness is further enhanced by its usefulness when
establishing priority for library programs relative to the parent
organization.
The program budget development is typically an extension of
the line-item budget development method. Robinson and Robinson
explain that each program in the program budget appears
separately and is broken out in categories similar to the line-item
budget (Robinson and Robinson 426).

Warner provides the

following model:
PROGRAM BUDGET
Program
#1
Salaries
Materials
Etc.
Etc.
Miscellaneous
TOTALS

Program
#2

Program
#3

TOTALS

100%
As the model demonstrates, the program budget facilitates

comparative analyses among the librarys multiple programs.

Others maintain that a program budget produces a document that is
easily understood and demonstrates a willingness to make best use
of limited resources by minimizing conflict and overlap among
projects (Asantewa 15). A disadvantage associated with the
program budget emerges when the adoption of the program budget
method forces special library staff members to think along
program lines in contrast to the comfort-zone associated with
previous budgeting methods. Warner notes that some people can
become defensive when required to analyze, report and justify
how they spend their time.
Performance Budget
Performance budgets share characteristics with program
budgets, but performance budgets focus primarily on what library
staff members do or what functions they perform in the librarys

service complement. Tasks rather than programs are highlighted.

Among the functions displayed within a performance budget are
technical services (i.e., cataloging, materials processing); planning
(budgeting,

automation,

employee

selection,

interviewing,

development; patron contact (circulation desk, email & telephone

contacts).
Warner provides this model for the Performance Budget or
Function Budget:
PERFORMANCE BUDGET, FUNCTION BUDGET
Function Function Function TOTALS
#1
#2
#3
Salaries
Materials
Etc.
Etc.
Miscellaneous
TOTALS
%
100%
Warner identifies the performance budgets strength as
providing an instrument for monitoring staff members and for
developing unit costs. The primary disadvantage associated with

performance budgets is the emphasis on quantity, not quality, of

the activity being monitored .
Zero-Based Budget
Zero-based budgeting shifts the emphasis from comparing
present performance and/or programs to the past or to the current
activity. Rather, zero-based budgeting requires that a clean slate
be the starting point for budget development. Therefore, the
emphasis is on what will happen in the future that corresponds to
the goals and objectives of the parent organization. This from
scratch approach is viewed as an appropriate instrument to rank
library programs by cost/importance to organizational goals and to
identify and eliminate programs that provide minimal value-added
(Zach 22)Once the value enhancing activities are identified, then
the attendant costs are developed. Accompanying zero-based
budgeting is the concept of decision packages, a method used to
examine each proposed program and rank its merits vis a vis the
parent organizations goals and objectives. Once the top-ranking

programs are identified, a program budget model is typically used

to construct the resource details.
Advantages associated with zero-based budgeting include its
focus on identifying programs that will further the companys
goals for the future. Reliance on the way weve always done
things violates the basic premise of zero-based budgeting. Most
zero-based budgeting advocates maintain that the method promotes
innovation, effectiveness and efficiency.
The downside of zero-based budgeting relates to its timeconsuming nature. Starting at zero implies that all aspects of the
librarys operation will undergo examination and justification.
Most special libraries indicate that zero-based budgeting also
intrudes on day-to-day operational activities such as journal
subscription renewals and standing orders
Sales budget - Whether you sell widgets or
washing machines, your sales budget is ground zero
for the rest of your operating budget. Overestimate
your sales budget, and youll likely spend too much
money. If you underestimate your sales budget, youll
risk losing customers to insufficient inventories or

poor customer service. Either way, your company will

have problems.

Production budget - The cost of generating or

producing the goods and services you offer are
included in your production budget. That usually
means raw materials, payroll, equipment and
overhead expenses. The latter is the cost of things
not directly associated with the development of your
product or service - items such as rent, utilities,
insurance, marketing, and accounting expenses. In
other words, if you brew beer, your production budget
for beer should include brewing ingredients,
packaging materials, your brewery staffs salary and
benefits, the cost of the bottles youll keep the beer
in, and other related items.

Operating expenses budget - Operating

expenses are really an offshoot of your production
budget. It includes the items in your production
budget and breaks them down by department-human resources, advertising and marketing,
research and development, manufacturing, sales,
and so on. The larger your company gets, the more
the need for a good operating expenses budget.

Budgeting income statement - Your budgeting

income statement is comprised of your sales,
production, and operating expenses budget. You
cant complete your budget income statement until
you have those budgets in order. Your income
statement enables you to check your revenues and
expenses to ensure you have enough money to keep
going.

Cash budget - If you take your companys

income earned and subtract your expenses, the
number you have left is your cash. In other words,

this is the difference between writing those bottomline numbers in black ink or red.
Your cash budget will help you figure out what to do with
the cash you have in hand. To go back to that brewery
analogy, you may use the money to research a new brand
of ale, hire a master brewer to make it, or hire a public
relations agency to tout it at local restaurants and bars.
Cash can also be squirreled away for unexpected needs.
And every business has unexpected needs.
Work the income/outflow pipeline to your advantage when
youre building your business budget. For money owed to
your firm, insist on payment as quickly as possible. Thirty
days is obviously more preferable to 60 or 90 days. Every
time you extend payment terms, youre costing your
company money. Conversely, for money you owe, hang
on the payment for as long as possible to retain control
over your companys finances. Electronic banking is a
great way to control your outgoing business expenditures
on the timeline that works best for you.
The operating budget the municipalitys operating
budget lists the planned operating expenditure (costs)
and income, for the delivery of all services to the
community.
Operating expenditure is the cost of goods and services
from which there will be short-term benefit - that is, the
services will be used up in less than one year.
For example, the payment of staff salaries results in a
short-term benefit as salaried employees are paid
monthly for one month's work. They could resign, next
month, and the municipality would not have the benefit
of their skills anymore. Examples of operating costs are

salaries, wages, repairs and maintenance, telephones,

petrol, stationery.
Operating income is the amount received for services
delivered for a short-term period. For example,
ratepayers pay rates monthly or annually as payment to
their municipality for receiving municipal services.
Examples of operating income are property rates,
service charges, investment interest, and traffic fines.
The capital budget - The capital budget puts money
aside, for planned expenditure on long-term purchases
and big investments such as land, buildings, motor
vehicles, equipment and office furniture that will be a
municipal asset for more than a year - probably for
many years to come.
A municipality's capital budget will list the estimated
costs of all items of a capital nature such as the
construction of roads, buildings and purchase of
vehicles that are planned in that budget year.
The difference between the operating and
capital budgets
A useful way for to look at the difference between
operating and capital expenditure is to think about the
purchase of a car. The purchase of a car is capital as the
expected life of the motor vehicle is much more than
one year. The cost of fuel and repairs only provide
short-term benefit (less than a year) and therefore is
operating expenditure.
The capital budget and operating budget have to be
prepared and discussed together. This is important
because planned expenditure that is included in the

municipalitys capital budget will impact on the

operating costs and income needed to "operate" the
municipalitys assets, efficiently.
This link between capital and operating budgets can be
explained by using the car example again. If you decide
to buy a car, in addition to including funds for this in
your capital budget, you are going to have to include
money in the operating budget for tyres, drivers wages,
petrol, service and other operating expenses.
The increase in operating expenditure needs to be
considered when making a decision on whether or not
to buy a new car. If fuel, tyres, repairs and wages costs
cannot be included in the operating budget because of
insufficient funds to pay for them, then the municipality
should not buy the car!
Behavioral aspects of budgets
One of the purposes of a management control
system is to encourage the manager to be effective
and efficient in attaining the goals of the
organization. Some motivational considerations in
the preparation of operating budgets are described
below:
1. Participation in the budgetary process
Budget processes are either top down or bottom
up.
1. Top down budgeting: With top down budgeting,
senior management sets the budget for the lower
levels. The top down approach rarely works,
however. It leads to a lack of commitment on the
part of budgetees; this endangers the plans success.

2. bottom up budgeting: With bottom up

budgeting, lower-level managers participate in
setting the budget targets.
Bottom up budgeting is most likely to generate
commitment to meeting the budgeted objectives;
however, unless carefully controlled, it may result in
objectives that are too easy or in objectives that may
not match the companys over-all objectives.
Actually, an effective budget preparation process
blends the 2 approaches. Budgetees prepare the first
draft of the budget for their area of responsibility
which is bottom up; but they do so within
guidelines established at higher levels, which is top
down. Senior managers review and critique these
proposed budgets.
Research has shown that budget participation (i.e., a
process in which the budgetee is both involved in
and has influence over the setting of budget
amounts) has positive effects on managerial
motivation for 2 reasons:
I) There is likely to be greater acceptance of
budget goals if they are perceived as being
under personal control, rather than being
imposed externally. This leads to higher
personal commitment to achieve the goals.
II) Participative budgeting results in effective
information exchanges. The approved budget
amounts benefit form the expertise and personal
knowledge of the budgetees, who are closest to
the
product/market
environment.
Further,
budgetees, have a clearer understanding of their

jobs through interactions with superiors during

the review and approval phase.
Participative budgeting is especially beneficial for
responsibility
centers
operating
in
uncertain
environments because managers in charge of such
responsibility centers are likely to have the best
information regarding the variables that affect their
revenues and expenses.

2. Degree of budget target difficulty

The ideal budget is one that is challenging but
attainable. There are several reason why senior
management approves achievable budgets for
business units:
If the budgeted target is too difficult, managers
are motivated to take short-term actions that may
not be in the long-term interests of the company.
Attainable profit targets are a way of minimizing
these dysfunctional actions.
Achievable budget targets reduce the motivation
for managers to engage in data manipulation (e.g.
inadequate provision for warranty claims, bad
debts, inventory obsolescence, and the like) to
meet the budget.
If business unit profit budgets represent
achievable targets, senior management can, in
turn, divulge a profit target to security analysts,
shareholders, and other external constituencies
with a reasonable expectation of being correct.
A profit budget that is very difficult to attain
usually implies an overly optimistic sales target.

This may lead to an over commitment of resources

to gear up for the higher sales activity. It is
administratively and politically awkward to
downsize operations. If the actual sales levels do
not reach the optimistic targets.
When business unit managers are able to meet
and exceed their targets, there is a winning
atmosphere and positive attitude within the
company.
Limitation: the business unit managers may not
put forth satisfactory effort once the budget is met.
This may be overcome by providing bonus payments
for actual performance that exceeds the budget.
3. Senior management involvement
This is necessary for any budget system to be
effective in motivating budgetees.
Management must participate in the review and
approval of the budgets otherwise some managers
will submit easily attained budgets or budgets that
contain
excessive
allowances
for
possible
contingencies.
Management must also follow up on budget results.
If there is no top management feedback, with
respect to budget results, the budget system will not
be effective in motivating the budgetee.
4. The budget department
It has a particularly difficult behavioral problem.
It must analyze the budgets in detail, and it must be
certain that budgets are prepared properly and that
the information is accurate.
To accomplish these tasks, the budget department
sometimes must act in ways that line managers

perceive as threatening or hostile eg. ensuring that

the budget does not contain excessive allowances or
disclosing the fact that the explanation of budget
variances provided by the budgetee hide or minimize
a potentially serious situation.
To perform their function effectively, the members of
the budget department must have a reputation for
impartiality and fairness. If they do not have his
reputation, it becomes difficult, if not impossible, for
them to perform the tasks necessary to maintain an
effective budgetary control system. The members of
the budget department should, of course, also have
the personal skills required to deal effectively with
people.

ANALYSIS OF VARIANCES
The object of standard costing is to exercise cost
control and cost reduction. The performance targets with actual
performance will enable a control system. The management by
exception is possible under standard costing. Cost reduction is
possible through the efficiency in use of material and labour. The
deviations between standard costs, profits or sales and actual costs,
profits or sales respectively will be known as variances. The
variances may be favourable and unfavourable. If actual cost is
less than the standard cost and actual profit and sales are more than

the standard profits and sales, the variances will be favourable. On

the contrary if actual cost is more than the standard cost and actual
profit and sales are less than the standard profit and sales, the
variances will be unfavourable. The variances are related to
efficiency. If variances are favourable, it will show efficiency and
if variances are unfavourable it will show inefficiency.
The variances may be categorized as controllable and
uncontrollable. If a variance can be regarded as a responsibility of
a particular person it will be known as controllable variance. In
case the variances are not in the control of persons then these will
be called uncontrollable variances.

A distinction between

controllable and uncontrollable variances will be essential for

fixing responsibility.
How To Calculate Variance :
Estimate to Planned. This is the difference between what
we quoted and how we actually planned to do the work. I
look at what has changed and why. It may be that there are
new processes, vendors, materials, technology, laws, etc. If
the variances are significant, I search for alternatives before
work commences whenever possible. If alternatives are not
possible, then I learn from the situation and communicate
what not to do for subsequent work. You may wonder why
there is a difference between planned and estimated. This is

due to situations where projects are quoted based on best

guesses and black magic. In other words, the quote is
created without formal detailed planning often by a group
who will not actually do the work. As you can imagine, it is
advantageous to keep the quoting and planning teams in
synch over time.
Planned to Actual. This variance looks at the difference
between how work is planned and how it actually is
executed. By comparing planned to actual, we can see how
the work changed once in progress. There may be changes
brought on by the project team, by the customer, by vendors
or by a change in the environment, such as new regulations.
Regardless, the changes need to be analyzed so issues can
be identified and mitigation strategies can be developed to
protect future work.
Estimate to Actual. Here, we compare what we quoted to
what we actually did. This is a crucial comparison. If jobs are
estimated in a manner that operations cannot support, then
there are substantial risks including profit losses and even
project failures. Again, by analyzing the numbers, we can
determine what changed, why and then take corrective
action. For subsequent work, we may need to change
vendors, processes, materials, contractual stipulations, etc.
Alternatively, unplanned customer change requests may be
fully billable, in which case we need to identify those
changes as such and invoice accordingly. It is very important
to point out that some of the most financially successful
groups I have worked with are very adept at writing detailed
quotes, assembling solid plans and then capturing customer
change requests and billing for them.
Why do we do this?

In short, we want to do variance analysis in order to learn.

One of the easiest and most objective ways to see that
things need to change is to watch the financials and ask
questions. Don't get me wrong: You cannot and should not
base important decisions solely on financial data.
You must use the data as a basis to understand areas for
further analysis. For example, if a bandsaw is a bottleneck,
then go to the department and ask why. The reasons for the
variance may range from the normal operator being out sick,
to a worn blade, to there not being enough crewing and a
great deal of overtime being incurred. Use the numbers to
highlight areas to investigate, but do not make decisions
without first investigating further.

CLASSIFICATION OF VARIANCES
1. Direct Material Variances
2. Direct Labour Variances
3. Overheads Cost Variances
4. Sales or profit Variances.
1. Direct Material Variances
Material Cost Variance

Material Price Variance

Material Usage Variance

Material Mix
Variance

Material Yield
Variance

(a)Material Cost Variance

(b)
Material Price Variance
(c)Material Usage Variance
(d)
Material Mix Variance
(e)Material Yield Variance.
Material Cost Variance = Material Price Variance +
Material Usage Variance
Material Usage Variance = Material Mix Variance +
Material Yield Variance
Material Cost Variance = Material Price Variance +
Material Mix Variance + Material Yield Variance

1. Material Cost Variance = Standard Material Cost Actual

Material Cost
2. Material Price Variance = Actual Quantiy (Standard price
Actual price)
3.Material Usage Variance = Standard Price (Standard
Quantity Actual Quantity)

4. Material Mix Variance.

I. When Actual Weight and Standard Weight of Mix are Equal
In this case the formula for calculating mix variance is:
Standard cost of standard mix Standard cost of actual mix.
(Standard Price Standard Quantity) (Standard Price
Actual Quantity)
or
Standard unit cost (Standard Quantity Actual Quantity).
In case standard quantity is revised due to shortage of one material, the formula will be:
Standard unit cost (Revised Standard Quantity).

II. When Actual Wright and Standard Weight of Mix are

Different

When quantities of actual material mix and standard material mix

are different, the formula will be:
Total Weight of Actual mix
Standard Cost of Standard mix

- Standard cost of actual mix)

Total Weight of Standard mix

In case the standard is revised due to the shortage of one material

then revised standard will be used instead of standard, the formula
will become:

Total Weight of Actual mix

Standard cost of revised Standard mix -(Standard cost of Actual mix)
Total Weight of revised Standard mix

(a)Materials Yield Variance.

Material Yield variance is calculated with the following formula:
Standard Rate (Actual Yield Standard yield)
Standard Cost of Standard mix
Standard Rate =
Net Standard output i.e., Gross output Standard loss

2. DIRECT LABOUR VARIANCES

Labour Variance can be discussed as follows:
(a) Labour Cost Variance
(b)Labour Rate of Pay or Wage Rate Variance
(c) Labour Efficiency or Labour Time Variance
(d)Idle Time Variance
(e) Labour mix or Gang Composition Variance

Labour Cost Variance = Standard Labour Cost Actual Labour Cost = Standard time Standard
Wage Rate) (Actual time Actual Wage Rate)

Labour Rate of Pay Variance = Actual time (Standard Rate Actual Rate)

Labour Efficiency variance = Standard Wage Rate (Standard Time Actual Time)

Idle Time Variance Idle Hours Standard Rate

(e) Labour Mix or Gang Composition Variance:

(a)When standard and actual times of the labour mix are same.
In this case the variance is calculated as follows:
Labour Mix Variance = Standard Cost of Standard Labour Mix
Standard Cost of Actual
Labour Mix.
Due to the non-availability of one grade of labour, there may be a
change in standard labour mix, then revised standard will be used
for standard mix. The formula will be:

Labour Mix Variance = Standard cost of Revised Standard Labour Mix Standard Cost of Actual Labour Mix.

(ii) When Standard and actual time of Labour mix are different:
In this case the variance will be calculated as follows:
Total Time of Actual Labour Mix
Total Time of Standard Labour Mix

Standard cost of Standard Labour Mix - (Standard Cost of Actual

Labour Mix

As in the earlier case, if labour composition is revised because of

non-availability of one grade of labour then revised standard mix
will be used instead mix and the formula will become:

Total Time of Actual Labour Mix

Standard cost of Revised Labour Mix
Total Time of Standard Labour Mix

- (Standard Cost of Actual

Labour Mix

3.OVERHEAD VARIANCE :
A VARIABLE OVERHEAD VARIANCE :
SOCAOC
SOC (per hour ) SH for AOT*SOR per H
(per out put ) AOT *SOR per unit
B. FIXED OVERHEAD VARIANCE :
( SH for AOT *SFOR ) *AFO

4. SALES VARIANCE
A:BASED ON SALES MARGIN
a) TSMV - SM-AM
b)SMQV - (S prop. For Asale*Bud. Q )* SP
c) SMPV -(SMPU-AMPU ) *AQ
d) SMVol. V (Bud. Units Aq. Units )*SM PU
e)SM Mix V (Aq.*ST. Prop. Of Ac.. Sale )*SP

B BASED ON SALES VALUE (SV)

a) SVV -Bud.S-Aq. S
b) SPV - (AP-SP )* Aq.
c) S Vol. V (STQ of s-Aq. of S )*St P
d) SQV- Bud.Sales Rev st S
e) SMV (SM/Rev.Mof AQ Sold AM )*St. P

PERFORMANCE ANALYSIS AND MEASUREMENT

Performance measurement systems
These have the goal of strategy implementation.
In setting up a PMS, senior management selects
a series of measures that best represent the
companys strategy.
These measures can be seen as current and
future critical success factors.
If these factors are improved, then the company
has implemented its strategy.
The success of the strategy depends on the
strategy itself.
A PMS is simply a mechanism for improving the
likelihood of the organization successfully
implementing a strategy.

Analysis of financial performance occupies an

important place in the duty profile of a manager. The
purpose of such analysis is to identify the strong and
weak points of business organizations and to make
appropriate strategies and plans to keep the
business organisation in good position.
The performance of business can be measured by
comparing actual financial performance compared
with budgeted financial performance. This is one
type of performance measurement. But financial
performance although important, is only one aspect
of what an organizations performance is.
Financial measures of corporate success, profit and
revenue show the results of past decisions the
company has taken. Because businesses have been
using profit and revenue measures for a long time,
these measures have become quite sophisticated.
Over the past few years, though, there has been an
increasing demand for measuring non-financial
results with the same level of sophistication. As a
result many companies are turning to PMS as a way
to link strategy to action.
Even in the past, companies had used financial and
non-financial measures. However companies tended
to use non financial measures usually at lower levels
in the organization for task control, and used
financial measures at higher organizational levels for
management control. An objective PMS uses a blend
of financial and non financial measurements at all
levels in the organization.
An example of a performance measurement
system is the balanced scorecard approach.

The Balanced Scorecard

The balanced scorecard is and example of a
performance measurement system. It fosters a
balance between otherwise disparate strategic
measures in an effort to achieve goal congruence,
thus encouraging employees to act in the best
interest of the organization. It is a tool for focusing
the organization, improving communication, setting
organizational objectives, and providing feedback on
strategy.
Every measure on a balanced scorecard addresses
and aspect of a companys strategy. In creating the
balanced scorecard, executives must choose a set of
me
What is the Balanced Scorecard?
In 1992, Robert S. Kaplan and David Norton
introduced the balanced scorecard (BSC), a
concept for measuring a company's activities in
terms of its vision and strategies, to give managers a
comprehensive view of the performance of a
business. The key new element is focusing not only
on financial outcomes but also on the human issues
that drive those outcomes, so that organizations
focus on the future and act in their long-term best
interest. The strategic management system forces
managers to focus on the important performance
metrics that drive success. It balances a financial
perspective with customer, process, and employee

perspectives. Measures are often indicators of future

performance.
Implementing the scorecard typically includes four
processes:
1. Translating the vision into operational goals;
2. Communicate the vision and link it to individual
performance;
3. Business planning;
4. Feedback and learning and adjusting the
strategy accordingly

The balanced scorecard is a management system

(not only a measurement system) that enables
organizations to clarify their vision and strategy and
translate them into action. It provides feedback
around both the internal business processes and
external outcomes in order to continuously improve
strategic performance and results. When fully
deployed, the balanced scorecard transforms
strategic planning from an academic exercise into
the nerve center of an enterprise.
Kaplan and Norton describe the innovation of the
balanced scorecard as follows:
"The balanced scorecard retains traditional financial
measures. But financial measures tell the story of
past events, an adequate story for industrial age
companies for which investments in long-term
capabilities and customer relationships were not

critical for success. These financial measures are

inadequate, however, for guiding and evaluating the
journey that information age companies must make
to create future value through investment in
customers,
suppliers,
employees,
processes,
technology, and innovation."
A

Comprehensive
Performance

View

of

Business

Balanced Scorecard is a method and a tool which

includes:

a strategy map where strategic objectives are

placed over four perspectives in order to clarify
the strategy and the cause and effect
relationships that exists among them.
strategic objectives which are smaller parts of
the strategy interlinked by cause and effect
relationships in the strategy map.
measures directly reflecting strategy. Their
prime purpose is to measure that the desired
change or development defined by strategic
objectives actually takes place.
strategic initiatives that constitute the actual
change as described by strategic objectives

The balanced scorecard suggests that we view the

organization from four perspectives, and to develop
metrics, collect data and analyze it relative to each

of these perspectives. The scorecard drives

implementation of strategy using perspectives which
generally include:
1. The Learning and Growth Perspective
2. The Business Process Perspective
3. The Customer Perspective
4. The Financial Perspective

1. The Learning and Growth Perspective

Learning and Growth Perspective refers to
measures describing the company's learning curve -for example, number of employee suggestions or
total hours spent on staff training.

This perspective includes employee training and

corporate cultural attitudes related to both individual
and corporate self-improvement. In a knowledgeworker organization, people -- the only repository of
knowledge -- are the main resource. In the current
climate of rapid technological change, it is becoming
necessary for knowledge workers to be in a
continuous learning mode. Government agencies
often find themselves unable to hire new technical
workers, and at the same time there is a decline in
training of existing employees. This is a leading
indicator of 'brain drain' that must be reversed.
Metrics can be put into place to guide managers in
focusing training funds where they can help the
most. In any case, learning and growth constitute
the essential foundation for success of any
knowledge-worker organization.
Kaplan and Norton emphasize that 'learning' is more
than 'training'; it also includes things like mentors
and tutors within the organization, as well as that
ease of communication among workers that allows
them to readily get help on a problem when it is
needed. It also includes technological tools; what the
Baldrige criteria call "high performance work
systems." One of these, the Intranet
2. The Business Process Perspective
Business Process Perspective refers to measures
reflecting the performance of key business
processes, for example the time spent prospecting,
number of units that required rework or process
cost.

This perspective refers to internal business

processes. Metrics based on this perspective allow
the managers to know how well their business is
running, and whether its products and services
conform to customer requirements (the mission).
These metrics have to be carefully designed by those
who know these processes most intimately; with our
unique missions these are not something that can be
developed by outside consultants.
In addition to the strategic management process,
two kinds of business processes may be identified:
a) mission-oriented processes, and b) support
processes. Mission-oriented processes are the special
functions of government offices, and many unique
problems are encountered in these processes. The
support processes are more repetitive in nature and
hence easier to measure and benchmark using
generic metrics.
3. The Customer Perspective
Customer Perspective refers to measures having a
direct impact on customers, for example time taken
to process a phone call, results of customer surveys,
number of complaints or competitive rankings.
Recent management philosophy has shown an
increasing realization of the importance of customer
focus and customer satisfaction in any business.
These are leading indicators: if customers are not
satisfied, they will eventually find other suppliers
that will meet their needs. Poor performance from
this perspective is thus a leading indicator of future

decline, even though the current financial picture

may look good.
In developing metrics for satisfaction, customers
should be analyzed in terms of kinds of customers
and the kinds of processes for which we are
providing a product or service to those customer
groups.
4. The Financial Perspective
Financial Perspective refers to measures
reflecting financial performance, for example
number of debtors, cash flow or return on
investment. The financial performance of an
organization is fundamental to its success. Even
non-profit organizations must make the books
balance. Financial figures suffer from two major
drawbacks:
o

They are historical. Whilst they tell us what

has happened to the organization they may
not tell us what is currently happening, or
be a good indicator of future performance.
It is common for the current market value
of an organization to exceed the market
value of its assets. Tobin's-q measures the
ratio of the value of a company's assets to
its market value. The excess value can be
thought of as intangible assets. These
figures are not measured by normal
financial reporting.

Kaplan and Norton do not disregard the traditional

need for financial data. Timely and accurate funding
data will always be a priority, and managers will do
whatever necessary to provide it. In fact, often there
is more than enough handling and processing of
financial data. With the implementation of a
corporate database, it is hoped that more of the
processing can be centralized and automated. But
the point is that the current emphasis on financials
leads to the "unbalanced" situation with regard to
other perspectives.
There is perhaps a need to include additional
financial-related data, such as risk assessment and
cost-benefit data, in this category.
Specific measures are chosen based on the
organization's goals. Typically organizations "get
what they measure" so care in creating measures
and
revisiting
the
measures
regularly
is
recommended by most practitioners.
The method helps separate creation of strategy from
strategy implementation, which can push power
downwards while making the leaders' jobs easier. It
can also help detect correlation between activities.
For example, the process objective of implementing
a new telephone system can help the customer
objective of reducing response time to telephone
calls, leading to increased sales from repeat
business.

The

Balanced Scorecard
Based Management

and

Measurement-

The balanced scorecard methodology builds on some

key concepts of previous management ideas such as
Total
Quality
Management
(TQM),
including
customer-defined quality, continuous improvement,
employee empowerment, and -- primarily -measurement-based management and feedback.
Double-Loop Feedback
In traditional industrial activity, "quality control" and
"zero defects" were the watchwords. In order to
shield the customer from receiving poor quality
products, aggressive efforts were focused on
inspection and testing at the end of the production
line. The problem with this approach -- as pointed
out by Deming -- is that the true causes of defects
could never be identified, and there would always be
inefficiencies due to the rejection of defects. What
Deming saw was that variation is created at every
step in a production process, and the causes of
variation need to be identified and fixed. If this can
be done, then there is a way to reduce the defects
and improve product quality indefinitely. To establish
such a process, Deming emphasized that all business
processes should be part of a system with feedback
loops. The feedback data should be examined by

managers to determine the causes of variation,

what are the processes with significant problems,
and then they can focus attention on fixing that
subset of processes.
The balanced scorecard incorporates feedback
around internal business process outputs, as in TQM,
but also adds a feedback loop around the outcomes
of business strategies. This creates a "double-loop
feedback" process in the balanced scorecard.

Outcome Metrics
You can't improve what you can't measure. So
metrics must be developed based on the priorities of
the strategic plan, which provides the key business
drivers and criteria for metrics that managers most
desire to watch. Processes are then designed to
collect information relevant to these metrics and
reduce it to numerical form for storage, display, and
analysis. Decision makers examine the outcomes of
various measured processes and strategies and track
the results to guide the company and provide
feedback.
So the value of metrics is in their ability to provide a
factual basis for defining:

Strategic feedback to show the present status of

the organization from many perspectives for
decision makers

Diagnostic feedback into various processes to

guide improvements on a continuous basis
Trends in performance over time as the metrics
are tracked
Feedback around the measurement methods
themselves, and which metrics should be
tracked
Quantitative inputs to forecasting methods and
models for decision support systems

Management by Fact
The goal of making measurements is to permit
managers to see their company more clearly -- from
many perspectives -- and hence to make wiser longterm decisions. The Baldrige Criteria (1997) booklet
reiterates this concept of fact-based management:
"Modern businesses depend upon measurement and
analysis of performance. Measurements must derive
from the company's strategy and provide critical
data and information about key processes, outputs
and results. Data and information needed for
performance measurement and improvement are of
many types, including: customer, product and
service
performance,
operations,
market,
competitive
comparisons,
supplier,
employeerelated, and cost and financial. Analysis entails using
data to determine trends, projections, and cause and
effect -- that might not be evident without analysis.
Data and analysis support a variety of company
purposes, such as planning, reviewing company
performance, improving operations, and comparing

company performance with competitors' or with 'best

practices' benchmarks."
"A major consideration in performance improvement
involves the creation and use of performance
measures or indicators. Performance measures or
indicators are measurable characteristics of products,
services, processes, and operations the company
uses to track and improve performance. The
measures or indicators should be selected to best
represent the factors that lead to improved
customer, operational, and financial performance. A
comprehensive set of measures or indicators tied to
customer
and/or
company
performance
requirements represents a clear basis for aligning all
activities with the company's goals. Through the
analysis of data from the tracking processes, the
measures or indicators themselves may be evaluated
and changed to better support such goals."

Actual Usage of the Balanced Scorecard

Kaplan and Norton found that companies are using
the scorecard to:

Clarify and update budgets

Identify and align strategic initiatives
Conduct periodic performance reviews to learn
about and improve strategy

In 1997, Kurtzman found that 64% of the companies

questioned were measuring performance from a

number of perspectives in a similar way to the

balanced scorecard.
Balanced scorecards have been implemented by
government agencies, military units, corporate units
and corporations as a whole, nonprofits, and schools;
many sample scorecards can be found via Web
searches, though adapting one organization's
scorecard to another is generally not advised by
theorists, who believe that much of the benefit of the
scorecard comes from the implementation method.

Return on Investment

Definition: Return on Investment (abbreviated ROI) is a measure

of a company's ability to use its assets to generate additional value
for shareholders. It is calculated as Net Profit divided by Net
Worth, and expressed as a percentage.
Examples: Our target for this fiscal year is to increase our Return
on our Investment to 37%.
A performance measure used to evaluate the efficiency of
an investment or to compare the efficiency of a number of
different investments. To calculate ROI, the benefit (return)
of an investment is divided by the cost of the investment; the
result is expressed as a percentage or a ratio.

Return on investment is a very popular metric because of its

versatility and simplicity. That is, if an investment does not
have have a positive ROI, or if there are other opportunities
with a higher ROI, then the investment should be not be
undertaken.
Keep in mind that the calculation for return on
investment can be modified to suit the situation -it all
depends on what you include as returns and costs. The term
in the broadest sense just attempts to measure the
profitability of an investment and, as such, there is no one
"right" calculation. For example, a marketer may compare
two different products by dividing the revenue that each
product has generated by its respective expenses. A
financial analyst, however, may compare the same two
products using an entirely different ROI calculation, perhaps
by dividing the net income of an investment by the total
value of all resources that have been employed to make and
sell
the
product.
This flexibility has a downside, as ROI calculations can be
easily manipulated to suit the user's purposes, and the result
can be expressed in many different ways. When using this
metric, make sure you understand what inputs are being
used.

The degree to which Return On Investment (ROI) overstates the economic

value depends on at least 5 factors:
1. length of project life (the longer, the bigger the overstatement)

2. capitalization policy (the smaller the fraction of total investment capitalized

in the books, the greater will be the overstatement)
3. The rate at which depreciation is taken on the books (depreciation rates
faster than straight-line basis will result in a higher ROI)
4. The lag between investment outlays and the recoupment of these outlays
from cash inflows (the greater the time lag, the greater the degree of
overstatement)
5. the growth rate of new investment (faster growing companies will have
lower Return On Investment )

Economic Value Added (EVA) is often defined as the value of an

activity that is left over after subtracting from it the cost of
executing that activity and the cost of having lost the opportunity
of investing consumed resources in an alternative activity. In
business terms, one could calculate EVA as Income from
Operations - rate of interest in sovereign debt, if sovereign debt can
be considered an alternative opportunity to invest working capital
and equity. The concept of economic profits is closely linked to
EVA. However, Economic Profit is not adjusted.
The underlying concept was first introduced by Eugen
Schmalenbach, and the current theory was formulated by Joel M.
Stern.

Calculating EVA
In the field of corporate finance, economic value added is a way to
determine the value created, above the required return, for the
shareholders of a company.

The basic formula is:

where
, called the return on capital employed (ROCE)
is the firm's return on capital, NOPAT is the Net Operating Profit
After Tax, c is the Weighted Average Cost of Capital (WACC) and
K is capital employed.
Shareholders of the company will receive a positive value added
when the return from the equity employed in the business
operations is greater than the cost of that capital.

Management control in service organisations

The type of control which would be suitable for a

particular firm depends upon the nature and
complexities of its operations. A suitable control
system has to be designed to suit the specific
requirements of a particular firm.
Service organisations are those organisations that
provide intangible services.
Service organisations include hotels, restaurants,
and other lodging and eating establishments;
barbershops, beauty parlors and other personal
service; repair services; motion picture, television
and other amusement and recreation services; legal
services;
and
accounting,
engineering,
research/development,
architecture
and
other
professional service organisations.
Characteristics of service organisations
1. Absence of inventory: services cannot be stored.
If the services available today are not sold today,
the revenue from these services is lost forever. In
addition the resources available for sale in many
service organisations are essentially fixed in the
short run.
A key variable in most service organisations
therefore is the extent to which current capacity is
matched with demand. Organisations attempt this
matching in 2 ways:
i) They try to stimulate demand in off-peak
periods by marketing efforts and price
concessions. Airlines and resort hotels offer

2.

3.

4.

low rates in off-seasons; utilities offer low

rates on slack periods during a day.
ii) if feasible, they adjust the size of the work
force to the anticipated demand, by such
measures as scheduling training activities in
slack periods and compensating for long hours
in busy periods with time off later.
Labour intensive: service organisations tend to
be labour intensive. It is difficult to control the
work of a labour-intensive organisation than that
of an operation whose workflow is paced or
dominated
by
machinery.
Manufacturing
companies
add
equipment
and
automate
production lines that replace labour and reduce
costs. Most service companies cannot do this.
Hospitals do add expensive equipment; but most
of these provide better treatment, and they
increase, rather than reduce costs.
Quantity measurement: it is not easy to
measure the quantity of many services. For many
services, the amount rendered can be measured
only in the crudest terms, if at all it can be
measured.
Quality measurement: the quality of a service
cannot be inspected in advance (as in the case of
tangible goods). At best, it can be inspected during
the time that the service is being rendered to the
client. Judgments as to the adequacy of the quality
of most services are subjective; measuring
instruments and objective quality standards do not
exist. A public accounting firm can measure the
number of hours spent on an audit, but not the

thoroughness of the work done during those

hours.
5.

Historical development: cost accounting started

in manufacturing companies because of the
necessity for valuing work-in-process and finished
goods inventories for financial statement purposes.
These amounts provided raw data that was easily
adapted to use, first for setting selling process and
then for other management problems. Standard
cost systems, the separation of fixed and variable
costs, and the analysis of variances and the
foundation of actual cost systems, and the fact
that managers in manufacturing companies were
accustomed to using cost information facilitated
the general adoption of these techniques. Until the
last few decades, most books on cost accounting
and related subjects dealt only with manufacturing
companies.

6.

Size:
with some notable exceptions, service
organisations are relatively small and operate in a
single location. Top management in such
organisations can personally observe what is going
on and personally motivate employees. Thus,
there is less need for a sophisticated management
control system, with profit centres and heavy
reliance on formal reports of performance.
(Nevertheless, even a small organisation needs a
budget,
a
regular
comparison
of
actual
performance against a budget, and the other
essential ingredients of a management control
system.

7.

multi
unit
organizations:
some
service
organizations operate many units in different
locations, each of which is relatively small. These
include fast food restaurant chains, auto rental
companies, gasoline service stations, and many
others. Some of the units are owned; others
operate under a franchise. The similarity of these
separate units provides a basis for analyzing
budgets and evaluating performance that is not
present in the usual manufacturing company. The
information for each unit can be compared with
system wide or regional averages, and high
performers and low performers can be identified.
Because units differ in the mix of services they
provide, in the resources that they use, and in
other ways, care must be taken in making such
comparisons.

Implications for Management Control System in

service organisations
There are some differences between management
control system in service organisations and those in
manufacturing organisations. There are differences
in degree, rather than in kind, however. The
essential features are the same in both types of
organisations. In both, planning is done in terms of
programs and responsibility centers, including profit
centers and investment centers for organisation units
that meet the criteria. The management control
process in both organisations involves the steps of
programming, budgeting, the measurement of
performance, and the appraisal of that performance.

Because of their relatively recent development,

systems currently found in service organisations tend
to be less advanced than those in manufacturing
organisations. Because of the difficulty of measuring
both the quantity and the quality of output,
judgments about both the efficiency and the
effectiveness of performance are more subjective
than is the case when output consists of physical
goods, which means that there is more room for
legitimate differences of opinion about performance.
Managers are coming to recognize that performance
is not easy to measure; this suggests that a search
for better tools for improving its measurement is
likely to be eminently worthwhile.

Modern control methods

JIT
TQM
DSS
Just in time (JIT)
Just in time mcs tries to ensure that there are no
zero inventories, and goods are produced or ordered
only when they are needed. Hence the name, justin-time. In actual practice zero inventories may not
be possible but the term JUST-IN-TIME states the
direction in which lot size should be headed.
Just In Time (JIT) is an inventory strategy
implemented to improve the return on investment
by reducing in-process inventory and its
associated costs.
The process is driven by a series of signals, or
Kanban that tell production processes to make the
next part. Kanban are usually simple visual signals,
such as the presence or absence of a part on a shelf.
When implemented correctly, JUST-IN-TIME can lead
to dramatic improvements in a manufacturing
organization's return on investment, quality, and
efficiency.
New stock is ordered when stock reaches the reorder level. This saves warehouse space and costs.
Drawback of the just-in-time system: The reorder level is determined by historical demand. If
demand rises above the historical average planning

duration demand, the firm could deplete inventory

and cause customer service issues. To meet a 95%
service rate a firm must carry about 2 standard
deviations of demand in safety stock.
History
The technique was first used by the Ford Motor
Company. The technique was subsequently adopted
and publicised by Toyota Motor Corporation of Japan
as
part
of
its
Toyota
Production
System
(TPS).Japanese corporations cannot afford large
amounts of land to warehouse finished products and
parts.
Philosophy
The just-in-time inventory system is all about
having the right material, at the right time, at
the right place, and in the exact amount.
The ideas in this philosophy come from many
different disciplines including; statistics, industrial
engineering, production management and behavioral
science.
In the just-in-time inventory philosophy there are
views with respect to how inventory is looked upon,
what it says about the management within the
company, and the main principle behind JUST-INTIME.
1. Inventory is seen as incurring costs instead of
adding value, contrary to traditional thinking. Under
the philosophy, businesses are encouraged to

eliminate inventory that doesnt add value to the

product.
2. It sees inventory as a sign of sub par
management as it is simply there to hide problems
within the production system. These problems
include backups at work centres, lack of flexibility for
employees and equipment, and inadequate capacity
among other things.
Salient features of just-in-time
1. Reduce buffer inventory: buffer inventory
exists partly because a manufacturing workstation
may breakdown and partly due to uncertain supply
from suppliers. When these events happen,
production in following workstation is disrupted
unless there is an inventory on which they can draw.
The amount of buffer inventory can be reduced if
steps are taken to minimize machine breakdown and
improve product quality. The purpose of just-in-time
is to ensure that every workstation produces and
delivers to the next workstation the right items in
the right quantity at the right time; if this purpose is
achieved there would be no need for buffer
inventory.
2. Decrease Set-up costs: with computer
controlled machine tools, set up involves simply
inserting a new computer program into a machine.
Thus, after the computer program has been created,
the cost of setting up for all succeeding lots becomes
trivial.
3. Decrease procurement costs: just-in-time also
aims at decreasing procurement costs. Traditionally,

procurement involved issuing requests for bids form

many vendors, analyzing bids, placing an order with
the best (usually the cheapest) vendor, and receiving
and inspecting the incoming goods. As per the justin-time philosophy companies now reduce the cost of
each
of
these
components
by
establishing
relationships with one or two vendors for each item.
4. Relation with customers: just-in-time also aims
at
establishing
permanent
relationships
with
customers
for
automatic
ordering.
Some
manufacturers have systems in which their
salespersons automatically place orders from
retailers or other customers on the basis of preset
formulas that determine reorder time and quantities;
this reduces the customers ordering costs and also
cements a relationship between the customers and
the manufacturer.
Implications for management control
1.
Work-in-process
inventory
becomes
so
insignificant that it is disregarded. The only
inventories are for raw materials and finished goods.
2. There is reduction in record keeping because
job-cost system is transformed into a processcost system with only one cost center
elimination of the tedious task of calculating
equivalent production, which is necessary to
find work-in-process inventory amounts when
the inventory consists of partially completed
products.
3. a just-in-time system focuses management
attention on time in addition to the traditional focus

on cost. a reduction in cycle time can lead to a

reduction in cost.
Effects
1. A huge amount of cash released as in-process
inventory is built out and sold.
2. The response time of the factory falls, resulting in
improved customer satisfaction.
3. Products may be built to order; completely
eliminating the risk they will not be sold. This
dramatically improves the company's return on
equity by eliminating a major source of risk.
4. Dramatic improvement in product quality
5. In the commercial sector, it eliminates one or all
of the warehouses in the link between a factory and
a retail establishment.

Benefits
1.

2.

Set up times are significantly reduced in

the warehouse. Cutting down the set up time
to be more productive will allow the company to
improve their profits, to look more efficient and
focus time spend on other areas that may need
improvement.
The flows of goods from warehouse to
shelves are improved. Having employees

focused on specific areas of the system will allow

them to process goods faster instead of having
them vulnerable to fatigue from doing too many
jobs at once and simplifies the tasks at hand.
3.Employees who possess multi-skills are
utilized more
4.
5. efficiently. Having employees trained to work
on different parts of the inventory cycle system
will allow companies to use workers in situations
where they are needed when there is a shortage
of workers and a high demand for a particular
product.
6. Better
consistency of scheduling and
consistency of employee work hours. If
there is no demand for a product at the time,
workers dont have to be working. This can save
the company money by not having to pay
workers for a job not completed or could have
them focus on other jobs around the warehouse
that would not necessarily be done on a normal
day.
7. Increased
emphasis
on
supplier
relationships. No company wants a break in
their inventory system that would create a
shortage of supplies while not having inventory
sit on shelves. Having a trusting supplier
relationship means that you can rely on goods
being there when you need them in order to
satisfy the company and keep the company
name in good standing with the public.
8. Supplies continue around the clock keeping
workers productive and businesses focused

on turnover. Having management focused on

meeting deadlines will make employees work
hard to meet the company goals to see benefits
in terms of job satisfaction, promotion or even
higher pay.
Problems

1. The major problem with Just In Time operation is

that it leaves the supplier and downstream
consumers open to supply shocks.
2. just-in-time requires
a business to resupply
frequently instead of holding excess stocks. In
practice JIT works well for many businesses, but it is
not appropriate if ordering cost per order is not
small.
3.Any delay in delivery means that additional 'safety
stocks' need to be held if a stock out is to be
rendered very unlikely.

Total Quality Management

Total
Quality
Management
management strategy aimed at em

(TQM)

is

bedding awareness of quality in all organizational

processes.

TQM has been widely used in manufacturing,

education, government, and service industries, as
well as NASA space and science programs.
Total Quality provides an umbrella under which
everyone in the organization can strive and create
customer
satisfaction.
TQ is a people focused management system that
aims at continual increase in customer satisfaction at
continually lower real costs.
Definition
As defined by ISO:
"TQM is a management approach for an
organization, centered on quality, based on
the participation of all its members and
aiming at long-term success through
customer satisfaction, and benefits to all
members of the organization and to
society."
In Japanese, TQM comprises four process steps,
namely:
1.

2.

3.

Kaizen Focuses on Continuous Process

Improvement, to make processes visible,
repeatable and measurable.
Atarimae Hinshitsu The idea that things will
work as they are supposed to (e.g. a pen will
write.).
KanseiKansei Examining the way the user
applies the product

4. leads to improvement in the product itself.

5. Miryokuteki Hinshitsu The idea that things
should have an aesthetic quality which is
different from "atarimae hinshitsu" (e.g. a pen
will write in a way that is pleasing to the writer.)
TQM requires that the company maintain this
quality standard in all aspects of its business.
This requires ensuring that things are done
right the first time and that defects and waste
are eliminated from operations.
Origins
"Total Quality Control" was the key concept of
Armand Feigenbaums 1951 book, Quality Control:
Principles, Practice, and Administration, a book that
was subsequently released in 1961 under the title,
Total Quality Control .
Joseph Juran, Philip B. Crosby, and Kaoru Ishikawa
also contributed to the body of knowledge now
known as TQM.
The American Society for Quality says that the term
Total Quality Management was first used by the U.S.
Naval Air Systems Command "to describe its
Japanese-style management approach to quality
improvement."
TQM approach can be summarized below under three
headings: responsibility for quality, product design,
and relation with suppliers.
1.Responsibility for quality

The traditional view was that quality problems start

on the factory floor, that workers were primarily
responsible for poor quality, and that the best way to
control quality, therefore, was to inspect quality into
the final product. This required a large quality
control department. The total quality control view is
that responsibility for quality should be shared by
everyone in the organization; in fact most of the
problems arise before the product reaches the
factory floor. Under total quality management, the
philosophy is to build quality into the product
rather than inspect quality of the product. Errors in
design, raw material procurement, and so on should
be detected at the source. Workers should be held
responsible for their own work and should not pass a
defective unit on to the next work station; thus, the
worke
rs are their own inspectors. Instead of inspecting
product quality at the end of production, the quality
control staff should monitor the production process
and enable workers to make the product right the
first time.
2.

Product design: studies have shown that many

quality problems originate with the design or the
product. Some designers pay inadequate
attention to the manufacturability of the
product. Others include pars that are unique to
the product, whereas pars that are common to
several products would be satisfactory and are
available at lower cost; or they design more
separate parts than are necessary, which gives

inadequate recognition to the cost involved in

setting up machines for each part. Under total
quality control, there has been an effort to
have the designers work closely with production
engineers
who
are
familiar
with
the
manufacturing problems.

Designing for manufacturability is one aspect of

design. The other aspect of design is designing
for marketablility, that is, the quality of a
product should be what the customer wants, not
more. Thus there should be close cooperation
between designers and marketing people.
3.

Relation
with
suppliers:
total
quality
management involves a change in the traditional
relationship with suppliers. Instead of awarding
contracts to several suppliers, based primarily
on which one bid the lowest price, there are only
one or two suppliers for a given item; they are
selected on the basis of quality and on-time
delivery as well as on, price. Long term
relationships are established with them.

Implications for management control

Companies collect non-financial information about
quality, including the number of defective units
delivered by each supplier, number and frequency of
late deliveries, number of parts in a product,
percentage of common versus unique parts in a
product, percentage yields, first-pass yields (i.e.

percentage of units furnished without rework), scrap,

rework, machine breakdowns, number and frequency
of times that production and delivery schedules were
not met, number of employee suggestions, number
of
customer
complaints,
level
of
customer
satisfaction (obtained by questionnaire surveys),
warranty claims, field service expenses, number and
frequency of product returns, and so
on.
There are 2 major advantages with these nonfinancial measures:
(1) most of them can be reported almost on a
daily basis, and
(2) Corrective actions can be taken almost
immediately.
Thus reporting performance on non-financial
measures is essential to provide continuous feedback
to managers and workers in their pursuit for better
quality

Decision support system

Decision support systems are a class of computerbased information systems including knowledge

based systems
activities.

that

support

decision

making

A DSS is a computerized system for helping make

decisions.

A decision is a choice between alternatives based on

estimates of the values of those alternatives.
Supporting a decision means helping people working
alone or in a group gather intelligence, generate
alternatives and make choices. Supporting the choice
making process involves supporting the estimation,
the evaluation and/or the comparison of alternatives.
In practice, references to DSS are usually references
to computer applications that perform such a
supporting role.
Decision support systems are end-user computing
systems. Decision support systems tend to be used
in planning, modeling, analyzing alternatives and
decision making. They generally operate through
terminals operated by the user who interacts with
the computer system.
Decision support systems are especially useful for
semi-structured proble

ms where problem solving is improved by interaction

between the manager and the computer system. The
emphasis is on small, simple models which can easily
be understood and used by the manager rather than
complex integrated systems which need information
specialists to operate them.

Definitions

Finlay (1994) and others define a DSS rather

broadly as "a computer-based system that aids
the process of decision making"
Turban (1995) defines it more specifically as
"an
interactive,
flexible,
and
adaptable
computer-based information system, especially
developed for supporting the solution of a nonstructured management problem for improved
decision making. It utilizes data, provides an
easy-to-use interface, and allows for the
decision maker's own insights."
Keen and Scott Morton (1978), "DSS are
computer-based
support
for
management
decision makers who are dealing with semistructured problems"
Sprague and Carlson (1982), DSS are
"interactive computer-based systems that help
decision makers utilize data and models to solve
unstructured problems."
Power (1997), the term decision support
system remains a useful and inclusive term for

many types of information systems that support

decision making.
A brief history
According to Keen and Scott Morton (1978), the
concept of decision support has evolved from two
main areas of research:
1. The theoretical studies of organizational decision
making done at the Carnegie Institute of Technology
during the late 1950s and early 1960s, and
2. The technical work on interactive computer
systems mainly carried out at the Massachusetts
Institute of Technology in the 1960s.

Characteristics of decision support systems

1. a user with unstructured or semi structured
problems
2. one or more corporate databases
3. one or more user data bases
4. a set of quantitative models stored in a model
base
5. a dialogue capability
a primary ingredient in a decision support system is
the users ability to simulate a business situation

over and over using different parameters and

solution values i.e. to perform what- if analysis.
Decision support systems

Computer data
base

Online
terminal

Dialogue system using

a planning language

User data base

DSS model base

Criteria for application of decision support

system
1. there should be a large database
2. There should be large amount of computation or
data manipulation required.
3. complex inter-relationships

4. Analysis by stages- where the problem is an

iterative one with stages for re-examination and
re-assessment.
5. judgment required
6. communication- where several people are
involved in the problem solving process, each
contributing some special expertise, then the
coordinating power of the computer can be of
assistance

Thus, decision support systems are inappropriate for

unstructured
problems
and
unnecessary
for
completely structured problems because these can
be dealt with wholly by the computer and
man/machine interaction is unnecessary;
In outline decision support system require a
database, the software to handle the database and
decision support programme including, for example,
modeling, spread sheet and analysis packages,
expert systems and so on.
Implications for management control
DSSs may reduce the need for certain types of
managers- that is, thy may convert management
control activities into task control activities. They
may also permit managers to spend a larger fraction
of their time on other problems.
A DSS is a double-edged sword insofar as its use is
concerned:

1. It can increase the quality of decisions and reduce

(or, in some cases, eliminate) the time required to
make them.
2. They permit many types of decisions to be made
by the computer or by lower level personnel and
thus, reduce the level of expertise required and, in
some cases eliminate jobs entirely.

Decision support systems belong to an environment

with multidisciplinary foundations, including (but not
exclusively) database research, artificial intelligence,
human-computer interaction, simulation methods,
software engineering, and telecommunications.
Httenschwiler (1999) differentiates
active, and cooperative DSS.

passive,

A passive DSS is a system that aids the

process of decision making, but that cannot
bring out explicit decision suggestions or
solutions.
An active DSS can bring out such decision
suggestions or solutions.
A cooperative DSS allows the decision maker
(or its advisor) to modify, complete, or refine
the decision suggestions provided by the
system, before sending them back to the system
for validation. The system again improves,
completes, and refines the suggestions of the

decision maker and sends them back to her for

validation. The whole process then starts again,
until a consolidated solution is generated.
Using the mode of assistance as the criterion, Power
(2002) differentiates communication-driven DSS,
data-driven DSS, document-driven DSS, knowledgedriven DSS, and model-driven DSS.

A model-driven DSS emphasizes access to and

manipulation
of
a
statistical,
financial,
optimization, or simulation model. Model-driven
DSS use data and parameters provided by users
to assist decision makers in analyzing a
situation; they are not necessarily data
intensive. Dicodess is an example of an open
source model-driven DSS generator (Gachet
2004).
A communication-driven DSS supports more
than one person working on a shared task;
examples include integrated tools like Microsoft's
NetMeeting or Groove (Stanhope 2002).
A data-driven DSS or data-oriented DSS
emphasizes access to and manipulation of a
time series of internal company data and,
sometimes, external data.
A document-driven DSS manages, retrieves
and manipulates unstructured information in a
variety of electronic formats.
A knowledge-driven DSS provides specialized
problem solving expertise stored as facts, rules,
procedures, or in similar structures.

Using scope as the criterion, Power (1997)

differentiates enterprise-wide DSS and desktop DSS.
An enterprise-wide DSS is linked to large data
warehouses and serves many managers in the
company.
A desktop, single-user DSS is a small system that
runs on an individual manager's PC.
Architectures
Sprague and Carlson (1982)
fundamental components of DSS:

identify

three

(a) the database management system (DBMS),

the Data Management Component stores information
(which can be further subdivided into that derived
from an organization's traditional data repositories,
from external sources such as the Internet, or from
the personal insights and experiences of individual
users);
(b) the model-base management system
(MBMS), the Model Management Component
handles representations of events, facts, or
situations (using various kinds of models, two
examples being optimization models and goalseeking models); and
(c) the dialog generation and management system
(DGMS). the User Interface Management Component
is of course the component that allows a user to
interact with the system.

According to Power (2002), DSS has four major

components:
(a) The user interface,
(b) The database,
(c) The model and analytical tools, and
(d) The DSS architecture and network.
Httenschwiler (1999) identifies five components
of DSS:
(a) Users with different roles or functions in the
decision making process (decision maker, advisors,
domain experts, system experts, data collectors),
(b) A specific and definable decision context,
(c) A target system describing the majority of the
preferences,
(d) a knowledge base made of external data sources,
knowledge databases, working databases, data
warehouses and meta-databases, mathematical
models and methods, procedures, inference and
search engines, administrative programs, and
reporting systems, and
(e) A working environment for the preparation,
analysis, and documentation of decision alternatives.
Marakas
(1999)
proposes
a
architecture made of five distinct parts:

generalized

(a) The data management system,

(b) The model management system,
(c) The knowledge engine,
(d) The user interface, and
(e) The user(s).
Classification of DSS applications
Holsapple and Whinston (1996) classify DSS into the
following six frameworks:

Text-oriented DSS,
Database-oriented DSS,
Spreadsheet-oriented DSS,
Solver-oriented DSS,
Rule-oriented DSS, and
Compound DSS.

The support given by DSS can be separated into

three distinct. interrelated categories (Hackathorn
and Keen, 1981): Personal Support, Group Support
and Organizational Support.
Additionally, the build up of a DSS is also classified
into a few characteristics.
1) Inputs: this is used so the DSS can have factors,
numbers, and characteristics to analyze.
2) User knowledge and expertise: This allows the
system to decide how much it is relied on, and

exactly what inputs must be analyzed with or without

the user.
3) Outputs: This is used so the user of the system
can analyze the decisions that may be made and
then potentially
4) make a decision: This decision making is made
by the DSS, however, it is ultimately made by the
user in order to decide on which criteria it should
use.
DSSs which perform selected cognitive decisionmaking functions and are based on artificial
intelligence or intelligent agents technologies are
called Intelligent Decision Support Systems (IDSS)
Applications
1. Clinical decision support system for medical
diagnosis.
2. A bank loan officer verifying the credit of a loan
applicant.
3. An engineering firm that has bids on several
projects and wants to know if they can be
competitive with their costs.
4. DSS is extensively used in business and
management. Executive dashboards and other
business performance software allow faster decision
making, identification of negative trends, and better
allocation of business resources.

5. in agricultural production,
sustainable development.

marketing

for

6. Decrease the incidence of derailments: A specific

example concerns the Canadian National Railway
system, which tests its equipment on a regular basis
using a decision support system. A problem faced by
any railroad is worn-out or defective rails, which can
result in hundreds of derailments per year. Under a
DSS, CN managed to decrease the incidence of
derailments at the same time other companies were
experiencing an increase.
7. A DSS can be designed to help make decisions on
the stock market, or deciding which area or segment
to market a product toward.