Nature of MCS

‡ ‡
± ±

According to Anthony & Govindarajan MCS helps managers move an organization toward its strategic objectives 2 views about scope of MCS
1st strategy is developed and then MCS comes into picture Strategies emerge through experimentation and are influenced by the MCS

‡
± ±

Above issue actually depends on the environment in which the entity operates ±
If the environmental changes are predictable, strategy can be developed 1st If the environmental changes are rapid then experimentation and MCS¶s influence is there

‡ ‡

As compared to mechanical control systems, MCS are complex and judgmental The central control problem is of GOAL CONGRUENCE

1

Control Process in General
‡ Four basic elements ±
± Detector (actual measurement) ± Assessor (comparison with standard) ± Effector (alteration of behavior, if required) ± Communication network (transmission of information)

2

3 levels of controls
Point Strategy formulation Management control Task control 1. Nature of end product Goals, strategies & policies Least systematic Implementation of strategies Somewhat systematic Efficient and effective performance of individual tasks Most systematic

2. Degree of systematization 3. Time frame focus

Focuses on long-run

Focuses on medium-term

Focuses on short-run activities Uses current accurate data Control more important

4. Inputs

Rough estimations of future Planning more important

Mix of accurate data and forecasts Planning & control equally important

5. Importance of planning & control

3

Formal MCS
Goals & strategies Rules Other Information

Reward (feedback)

Yes Strategic Planning Budgeting
Responsibility Center performance

Report Actual v/s Plan

Was Performance Satisfactory?

No

Revise

Revise

Corrective action

Measurement Feedback Communication
4

MSSM - Formal & Informal MCS
‡ ‡ ‡ ‡ ‡ Management Style and Culture Infrastructure Rewards Coordination and integration Control Process

5

Management Control Systems ± Cybernetic Paradigm & control
Environment Decision maker Goals

Value premises Feedback Sensor Perception Factual premises Comparator

Behavior choice

Effector

Behavioral Repertoire

6

Cybernetic Paradigm & Control Process Elements of a control process

1. 2. 3. 4. 5. 6. 7. 8.

Set goals and performance measures Measure achievement Compare achievement with goals Compute variances Report variances Determine cause(s) of variances Take action to eliminate variances Follow-up to ensure goals are met
7

Attributes of good control system (MCS)
1. 2. 3. 4. 5. 6. A positive view of the control process Objectives should be expressed in measurable terms Objectives should have focus and should not be too many in numbers Controls should seek balance among various aspects No dual assignment of responsibility True control is achieved by comparing projected performance against the standard 7. Early warning predictors should be tracked 8. Use of sampling 9. Establish acceptable range of variation 10. Control by exception 11. Confirm severity of a problem; cause of the problem should be identified; results of the corrective action should be monitored 12. Developing a discerning view of control
8

Understanding strategies ± Concept of strategy
‡ Strategy describes the general direction in which an organization plans to move to attain its goals ‡ Strategy formulation ± Environmental analysis pointing out opportunities and threats, simultaneous internal analysis revealing strengths and weaknesses, matching core competencies with external opportunities and deciding a strategy
9

Understanding strategies ± Corporate and unit-level strategies
‡ Corporate strategy is concerned more with where to compete than how to compete; the latter is a matter of unit level strategy ‡ Classification into 3 types for corporate level
± Single industry ± Related diversification ± Unrelated diversification

‡ Research has shown that, on average, related diversified firms perform the best, single industry perform next best, and unrelated diversified firms do not perform well over the long run. This is because Corporate HQ, in the related diversified firm, has the ability to transfer core competencies from one business unit to another.
10

Understanding strategies ± Corporate level strategiessummary of 3 generic strategies
Type Single industry Related diversified Unrelated diversified

Pictorial representation

Features

Competes in only one industry

Sharing core competencies across businesses

Totally autonomous businesses in different markets

Examples

Wrigley, Ford Motor

P & G, Gillete

General Electric

11

Understanding strategies ± Unit-level strategies
‡ Business unit strategies depend on two interrelated aspects 1) its mission & 2)its competitive advantage ‡ There are a couple of famous models to fix the BU mission ‡ One is the BCG Model and the other one is the GE Planning Model ‡ These models basically try to match the industry and the unit in terms of opportunities/threats and strengths/weaknesses ‡ Control system designers need to know what is the BU mission but not necessarily why the BU has chosen that mission

12

Understanding strategies ± Business unit mission ± BCG Model
High High ³Star´ Hold ³Question mark´ Build Low High

Market growth rate

³Cash cow´ Harvest Low High Relative Market share

³Dog´ Divest Low Low
13

Understanding strategies ± Business unit mission ± GE Model
The Portfolio matrix & Recommended Business Strategies High Winners Invest Strongly Winners Invest Selectively
Profit producers

Winners Invest Selectively Avg bus Earn/ Protect Losers Harvest/ Divest Average Business strength

? Marks Dominate/ Delay/Divest Losers Harvest/ Divest Losers Harvest/ Divest Weak
14

Industry Attractiveness Average

Low

Earn/ Protect Strong

Understanding strategies ± Gaining competitive advantage
‡ 3 interrelated questions should be considered ±
± What is the industry structure? ± How should the BU exploit it? ± What will be the basis of the BU¶s competitive advantage?

‡ Michael Porter has suggested 2 analytical approaches to develop & sustain competitive advantage ±
Industry analysis & Value chain analysis

15

Understanding strategies ± Industry structure analysis ±
Porters 5 forces model
Threat of New Entrants

Suppliers Bargaining Power

Intensity of Industry Competition

Customers Bargaining power

Threat From Substitutes
16

Understanding strategies ± Industry structure analysis ±
Porters 5 forces model ‡ 3 observations with regard to industry analysis
± More powerful the 5 forces less profitable an industry is likely to be; conversely in high profitable industries these 5 forces are not strong ± Depending on relative strength of the 5 forces the strategic issues would emerge and would differ from industry to industry ± Understanding the nature of each force helps the firm to formulate effective strategies

17

Understanding strategies ±
Gaining competitive advantage ± Porters model

‡ The 5 force analysis is starting point to develop competitive advantage as it helps understanding external environment ‡ Response from the firm can be on two fronts ± low cost & differentiation ‡ A firm should strive to achieve cost leadership and/or product differentiation to gain competitive advantage
18

Understanding strategies ±
Gaining competitive advantage ± Porters model

Superior Cost-cumDifferentiation advantage Differentiation advantage

Relative Differentiation position

Low cost Advantage Inferior Superior

Stuck-inThe-middle

Inferior Relative Cost Position
19

Understanding strategies ±
Gaining competitive advantage ± Value chain analysis

‡ Value chain disaggregates the firm into its distinct strategic activities ‡ It is a complete set of activities involved in a product beginning with extraction of RM and ending with after sales service ‡ The VC framework is a method of breaking down the chain into specific activities in order to understand behavior of costs and sources of differentiation.
20

Understanding strategies ±
Gaining competitive advantage ± Value chain analysis
Product Development

Manufacturing

Marketing And Sales

Services/ Logistics

Support Activities : - Finance, Human Resources, IT

21

Understanding strategies ±
Gaining competitive advantage ± Value chain analysis
‡ For each value added activity, key questions are ±
1. Can we reduce costs in this activity, holding value (revenues)? 2. Can we increase value (revenues) in this activity holding costs constant? 3. Can we reduce assets in this activity holding costs and value (revenues) constant? 4. Most importantly can we do 1, 2 & 3 simultaneously?

‡

By systematically analyzing costs, revenues and assets in each activity, BU can achieve cost-cum-differentiation advantage.

22

Goal CongruenceMeaning
‡ ‡ Central purpose of a MCS is to ensure a high level of goal congruence In a goal congruent process actions people are led to take in accordance with their perceived self-interest are also in the best interest of the organization In evaluating any management control practice, 2 most important questions are ±
‡ ‡ What actions does it motivate people to take in their own selfinterest? Are these actions in the best interest of the organization?

‡

23

Goal CongruenceInfluencing factors
‡ INFORMAL FACTORS
‡ ‡ External
‡ ‡ ‡ ‡ ‡ Work ethic ± overall attitude of the working community Organization culture Management style Informal organization Perception and Communication

Internal

‡

FORMAL CONTROL SYSTEM
‡ ‡ MCS Rules ± Physical controls, Manuals, System safeguards etc
24

Goal congruenceFormal MCS
Goals & strategies Rules Other Information

Reward (feedback)

Yes Strategic Planning Budgeting
Responsibility Center performance

Report Actual v/s Plan

Was Performance Satisfactory?

No

Revise

Revise

Corrective action

Measurement Feedback Communication
25

Types of organizations ± A. Functional organization
CEO Staff

Manufacturing Manager

Marketing Manager

Staff

Staff

Manager Plant 1

Manager Plant 2

Manager Plant 3

Manager Region A

Manager Region B

Manager Region C

26

Types of organizations ± B. Business unit organization
CEO Staff

Manager BU X

Manager BU Y

Manager BU Z

Staff

Staff

Staff

Plant Manager

Marketing Manager

Plant Manager

Marketing Manager

Plant Manager

Marketing Manager

27

Types of organizations ± C. Matrix organization
Chief Executive Officer

Staff

Function A Manager

Project X Manager

Function B Manager

Project Y Manager

Function C Manager

Project Z Manager

28

Organization Structure & implications for system design
‡ Designers might be tempted to recommend the BU structure because of the apparently clear-cut profit responsibility. However they should not forget other considerations. The system designer must always fit the system to the organization rather than the other way around

‡

29

Functions of the Controller
‡ ‡ ‡ ‡ ‡ ‡ Design and operate information and control systems Preparing financial statements and reports Preparing and analyzing performance reports Compiling the annual operating plan (budget) Supervising internal audit and accounting control procedures Developing subordinates

30

Nature of Controllers role
‡ Relation to line organization
‡ ‡ ‡ ‡ ‡ Controllership is a staff function Controller designs system, use is done by line managers Decisions made by controllers are primarily those that implement policies decided by line management Controllers play important role in preparation of strategic plans and budgets. They are also called to scrutinize reports prepared by line managers
31

Nature of Controllers role
The BU Controller ± 2 possible relationships CC CC

BUM

BUM

BUC

BUC
32

CC ± Corporate Controller, BUM - Business unit manager & BUC ± Business unit controller

Responsibility Centers - Basic
‡ Responsibility Centers (RC) constitute the structure of a control system and the assignment of responsibility to organizational units must reflect the organizations strategy. RC is an organization unit that is headed by a manager who is responsible for its activities RC exists to accomplish some purpose that are called as its objectives

‡ ‡

33

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

Inputs Work Resources used Measured by ³cost´

Outputs Goods or services

‡

Management is responsible for ensuring the optimum relationship between inputs and outputs
34

Responsibility Centers ± Measuring inputs and outputs
‡ ‡ Cost is a monetary measure of the amount of resources used by a RC It is much easier to measure the cost of input than to calculate the value of outputs. For example, a college can easily measure how many students have passed but it is difficult to measure how much education each of them acquired

35

Responsibility Centers ± Measuring inputs and outputs ± Efficiency and Effectiveness
‡ ‡ ‡ ‡ ‡ Efficiency and effectiveness are the 2 performance measurement criteria for RC Efficiency is a ratio of input to output (doing things right) Effectiveness is determined by the relationship between a RC¶s output and its objectives (doing right things) These 2 e¶s are not mutually exclusive; each RC has to be efficient and effective as well Profit as a measure of performance measures both efficiency and effectiveness because profit is the major objective (effectiveness) and it is also the difference between output and input (efficiency)

36

Responsibility Centers - Types
Optimal relationship Can be established Outputs Work (physical)

Inputs (monetary value)

Example ± Manufacturing Function

Above is the relationship between input and output in case of An ENGINEERED EXPENSE CENTER Characteristics : - 1. Input can be measured in monetary terms 2. Output can be measured in physical terms 3. Optimum relationship between amount of input for one unit of output can be established

37

Responsibility Centers - Types
Optimal relationship cant be established Outputs Work (physical)

Inputs (monetary value)

Example ± R & D Function

Above is the relationship between input and output in case of An DISCRETIONARY EXPENSE CENTER

38

Responsibility Centers - Types
Inputs not related to outputs Outputs Work (monetary value)

Inputs (monetary value only for costs directly incurred)

Example ± Marketing Function

Above is the relationship between input and output in case of a REVENUE CENTER

39

Responsibility Centers - Types
Inputs are related to outputs Outputs Work (monetary value)

Inputs (monetary value)

Example ± BU

Above is the relationship between input and output in case of a PROFIT CENTER

40

Responsibility Centers - Types
Profits are related to capital employed Outputs Capital employed (monetary value)

Inputs (monetary value)

Example ± BU

Above is the relationship between input and output in case of an INVESTMENT CENTER

41

Responsibility centers ± difference between
engineered & discretionary expense center
Point Nature of expenditure Engineered EC Engineered costs are those for which standards can be easily established Optimal relationship can be established Manufacturing function Budget represents unit cost of performing task efficiently Difference between budget and actual is a measure of efficiency (since input and output optimum relationship can be established) Being ³within budget´ is important Discretionary EC Discretionary costs are those for which standards cant be easily established Optimal relationship cant be established Service function Budget determined by the magnitude of the job to be done Difference between budget & actual is not a measure of efficiency (since input and output optimum relationship cant be established) Doing the task is more important (doesn¶t mean that budget is not to be adhered; emphasis differs) More at planning stage 42

I/p - o/p relationship

Application Budget preparation Budgetary control

Financial control

During performance

Responsibility centers ± difference between
Profit center & revenue center
Point Meaning Profit Center A responsibility center that is responsible for both revenues and expenses is profit center. Optimal relationship is established between value of output (revenue) and value of input (expense) Business units Maximizing profit by controlling both revenue and expenses Revenue Center A responsibility center that is responsible for revenues but not for the expenses is revenue center. Optimal relationship cant be established between value of output (revenue) and value of input (expense) Marketing offices Maximizing revenue

I/p - o/p relationship

Application Goal

43

Responsibility Centers ±
General control characteristics of Discretionary EC¶s

‡ ‡ ‡ ‡ ‡ ‡ ‡ ‡

Budget preparation ± based on the magnitude of the task to be done Tasks divided into 2 ± continuing and special MBO technique used Incremental Budgeting ZBB review Cost variability ± not in short run Type of Financial control ± planning important Measurement of performance ± Doing the planned work is important
44

Responsibility Centers ±
Administrative and Support Centers ± control problems & budget preparation

‡

2 important reasons for control problems
‡ ‡ Difficulty in measuring output Lack of goal congruence Section covering costs of ³being in business´ Discretionary activities Justification for proposed increases in budget

‡

Budget preparation
‡ ‡ ‡

45

Responsibility Centers ±
R&D centers±control problems, budget preparation & performance measurement ‡ 2 important reasons for control problems ‡ Difficulty in relating results to output ‡ Lack of goal congruence Budget preparation ‡ One should understand R & D continuum ‡ Basic research ± applied research ± development ± production engineering ± testing ‡ No scientific way of determining R & D budget ‡ Some companies use % of revenue for R&D budget ‡ For basic research, budget can be a lump-sum amount ‡ For testing, number of testing can be a budget base Performance measurement ‡ Monthly/quarterly reports on budgeted and actual expense ‡ 2 types of financial reports ± one reporting total R & D expense, the other reporting it separately for each RC ‡ Effectiveness of research is informed though progress reports ( these are not financial reports)
46

‡

‡

Responsibility Centers ±
Marketing Centers ± activities and related controls

‡

Logistic Activities
‡ These RCs are similar to expense centers in manufacturing plants and can be safely called as engineered expense centers
‡ ‡ Measuring output is easy, evaluating effectiveness is difficult because of influence of ³other´ factors on sales Marketing expenses are often budgeted at % of sales not because sales volume cause marketing expenses but because it gives larger affordability ³Order-getting costs´ are that way discretionary and controls cannot be easily standardized
47

‡

Marketing activities ± control problems

‡

Responsibility Centers ± Profit Centers
‡ 2 conditions for delegating profit responsibility
‡ ‡ Access to relevant information needed for decision making Measurement of effectiveness of the trade-offs made by managers should be possible

48

Responsibility Centers ± Profit Centers
‡ Advantages of profit centers
‡ ‡ ‡ ‡ ‡ ‡ ‡ ‡ Improved quality of decisions Quick decisions HQ relieved from day-to-day decision making Effective use of imagination and initiative Training ground for managers Enhanced profit consciousness Information on profitability of individual units They respond well to improvement initiatives since their output is so readily measurable
49

Responsibility Centers ± Profit Centers
‡ Difficulties with profit centers
‡ ‡ ‡ ‡ ‡ ‡ ‡ Loss of control Reduced quality of decisions Increased friction amongst units and HQ In-house competition may get substituted for cooperation Additional costs Non-availability of competent GMs Too much emphasis on short-run profitability
50

Responsibility Centers ± Profit Centers
‡ ‡ Measurement of performance ± Management performance and economic performance Measures of economic performance ± measures of profitability
‡ ‡ ‡ ‡ ‡ Contribution margin Direct profit Controllable profit PBT PAT

51

Responsibility Centers ± Investment centers
‡ Difficulties in measuring assets employed
‡ ‡ ‡ ‡ ‡ ‡ ‡ ‡ Cash- actual cash held at HQ much less than that would have been required as an independent company Receivables ± whether to include at SP or COGS? Inventories ± how to deal with creditors? Working Capital in general ± treatment of current liabilities ± 2 extreme treatments Fixed Assets ± which value to consider? Problems with depreciation Leased assets ± preference for leased assets over owned assets so as to reduce capital charge Idle assets ± exclusion from computation of assets employed Intangible assets ± Capitalization of items like R & D and its repercussion on EVA ± if capitalized, very less incentive to cut such expenditure as it would only reduce a part of if by way of capital charge

52

Responsibility centers ± Performance
measures of an Investment center ± ROI v/s EVA
Point Meaning RoI RoI is the comparison of the income generated with the assets employed. RoI is a ratio. Numerator is income and denominator is assets employed. Conceptually EVA is superior than RoI As per one survey carried by Vijay Govindarajan of Fortune 1000 companies, RoI is more popular than EVA RoI is comparatively easy to calculate EVA EVA is the residual profit after taking into account the capital charge. EVA is a value. It is found out by subtracting capital charge from Profit after Tax. Conceptually EVA is superior than RoI As per one survey carried by Vijay Govindarajan of Fortune 1000 companies, RoI is more popular than EVA EVA is a bit difficult to calculate given the problems with calculating the capital 53 charge

Calculation

Superiority Popularity

Simplicity of calculation

Responsibility centers ±
Performance measures of an Investment center ± RoI

‡ Advantages of RoI
± It is a comprehensive measure ± anything that affects the financial statements affect the RoI. ± Simple to calculate, easy to understand and meaningful in an absolute sense ± It is a common denominator that may be applied to any organizational unit responsible for profitability regardless of size or type of business

54

Responsibility centers ±
Performance measures of an Investment center ± Superiority of EVA over RoI

‡ 4 points
± EVA offer same profit objective for comparable investments, unlike RoI which may make a manager reluctant to accept lower RoI (20%) opportunities than the current RoI (30%) levels despite being more than CoC (10%). RoI creates a bias towards little or no expansion in high-profit business units while at the same time low-profit units are making investments at rates of returns well below those rejected by high-profit units

.

± Units can increase RoI by actually decreasing its overall profits. This thing will not happen if EVA is measured. ± Different interest rates can be used for different types of assets. For more riskier assets, higher rates of costs of capital can be used. With RoI this is not possible. ± EVA as compared to RoI has a stronger positive correlation with changes in a company¶s market value. To induce managers at the BU level to enhance shareholders value, managers can be told to create and grow EVA.

55

Strategic Planning Process
1. Reviewing and updating the strategic plan from last year 2. Deciding on assumptions and guidelines 3. First iteration of the new strategic plan 4. Analysis 5. Second iteration of the new strategic plan 6. Final review and approval

56

Budgetary control ±
Budget preparation process
‡ Organization
‡ Budget Department ‡ Budget Committee

‡ ‡ ‡ ‡ ‡

Issuance of guidelines Initial budget proposal Negotiation Review and approval Budget revisions
‡ Procedures that provide for systematic updation ‡ Procedures that allow revisions under special circumstances

57

Budgetary control ±
Types of budgets & importance
± Types
‡ ‡ ‡ ‡ Fixed and flexible budgets Functional budgets Incremental & Zero Base budgets Annual, quarterly, monthly and weekly budgets

‡ Importance
± It translates the strategic plan into an annual operating plan with reasonable details ± It provides a basis for translating the strategic decisions into actions during the forthcoming year ± It provides a good basis for controlling the actuals. Variances can be analyzed and corrective actions can be taken. ± It relieves the top management from day-to-day intervention and botheration as it can look only into activities that are outside the budget

58

Budgetary control ±
Zero based budgeting
‡ In contrast to incremental budgeting, ZBB starts the budget from the scratch (de novo) ‡ Managers are required to justify the items with proper bases ‡ Thus ZBB is an intensive review of the budgetary allocations ‡ Certain basic questions are asked like ± should the activity under review be performed at all? What should the quality level be? ‡ It is a good way of doing budgeting and can eliminate a lot of waste. However it demands some time and energy.

59

Transfer Pricing - basics
‡ If 2 or more profit centers are jointly responsible for developing, manufacturing and marketing of a product they should share the revenue when the product is finally sold. The transfer price is the mechanism for distributing this revenue. ‡ Objective of TP ±
‡ To provide each BU with information to determine optimum tradeoffs between company costs and revenues ‡ To induce goal congruent decisions ‡ To measure economic performance of BU¶s ‡ It should be simple to understand and easy to administer

60

Transfer Pricing - methods
‡ Fundamental principle is that the TP should be similar to the price that would have been if the product was sold in outside market. ‡ Methods ±
‡ Cost based
‡ Standard Costs plus markup ‡ Two-step pricing ‡ Instead of building the fixed cost and profit element on a unit level as a part of the TP, the same is charged to the transferee unit on a periodical basis ‡ Thus the two-step pricing would mean ± the first step to charge the variable cost as the TP and in the second step a lump-sum charging of the fixed cost and the profit. ‡ This method helps the transferee division to make appropriate short-term marketing decisions

61

Transfer Pricing - methods
‡ Methods ±
‡ Cost based
‡ Profit sharing ± this operates as under ± 1. Product is transferred to marketing division at standard variable cost 2. After the product is sold the BU share the contribution earned which is the SP minus the variable manufacturing and marketing cost.

‡ ‡

Market price based Negotiated price

62

Transfer Pricing - methods
Comparative usage of the TP methods by fortune 1000 Companies as per survey by Vijay Govindarajan

17%

Cost based Market Price 52%

31%

Negotiated price/other

63

Transfer Pricing - methods
‡ Methods ±
‡ Dual Pricing (2 sets of prices)
‡ ‡ ‡ ‡ Crediting transferor with outside sales price But charging the transferee with total standard costs Difference to be charged to a HQ account that will get eliminated at the time of consolidation This method is used when there are conflicts between the transferor and transferee division and any other method is not working

64

Performance Measurement ± Balanced Score Card
‡ ‡ Developed by Kaplan and Norton Provides a mechanism for linking strategy to action ± creates awareness of the KRA¶s
‡ Translates strategy into measurable parameters

‡ ‡

A comprehensive measure of performance Four perspectives to measure performance
‡ ‡ ‡ ‡ Customer Internal Innovation and learning Financial

‡

For each of this perspective appropriate performance measures should be developed
65

Performance Measurement ± Balanced
Score Card ± Difference between financial and non-financial measures
Point Meaning Financial measures These are performance measures that are expressed in terms of financial parameters Return on Investment, EVA, Profit Margin etc These measures can be quite accurately measured Since these measures are easily quantifiable and comparable, practically they are widely applied Non-financial measures These are performance measures that are not expressed in terms of financial parameters Customer satisfaction, Employee Morale etc It is quite difficult to measure and quantify these measures Since these measures are not easily quantifiable and comparable, practically they are not that widely applied. However with the advent of BSC these measures are also getting importance.
66

Examples

Degree of accuracy in measurement Degree of attention

Activity Based Costing (ABC)Nature, Benefits
‡ ABC tries to allocate costs on rational basis instead of ad-hoc basis like labor hours and machine hours or percentage of labor cost/material cost ‡ Cost drivers are identified. These are real causes of cost incurrence. For example in purchasing activity, number of purchase orders is the cost driver ± it causes costs to happen in the purchase department ‡ The concept is quite useful given the fact that these days OHs are significant elements of costs and the number of products produced by a firm have increased. ABC gives more accurate costing of the products as compared to traditional methods. ‡ Information provided by ABC can be used in policies relating to: ± ± ± ± ± Full-line versus focused product line Product pricing Make or buy decision Product mix decisions Elimination of non-value-added activities etc

67

Activity Based Costing (ABC)comparison with traditional costing
Point Key concepts Basis of OH allocation Traditional Costing Cost Center, basis of allocation Machine Hour, Labor Hour etc ABC Activity, cost driver Based on actual consumption of resource measured through different cost drivers More accurate product costing Relatively difficult to use More number of products; OH cost relatively high

Accuracy in costs Simplicity Suitability

Less accurate product costing Relatively simple to use Lesser number of products; OH cost relatively less

68

MCS in service sector
‡ Characteristics of service organizations in general
‡ ‡ ‡ ‡ Absence of inventory buffer Difficulty in controlling quality Labor intensive Multi-unit organizations

± The above characteristics peculiar to service sector are the causes of differences in the nature of MCS that is used in the Manufacturing Sector
69

MCS in service sector ±
Professional service organizations ‡ Special Characteristics
‡ ‡ ‡ ‡ ‡ Goals Professionals Output and input measurement Small size Marketing Pricing Profit Centers and TP Strategic planning and budgeting Control of operations Performance measurement and appraisal
70

‡

MCS
‡ ‡ ‡ ‡ ‡

MCS in service sector ±
Financial service organizations

‡

Special Characteristics
‡ ‡ ‡ ‡ Monetary assets Time period for transactions Risk and reward Technology General principles of MCS apply but they need to be adapted to the above mentioned special characteristics

‡

MCS
‡

71

MCS in service sector ±
Health Care Organizations
‡ Special Characteristics
‡ ‡ ‡ ‡ ‡ Difficult social problem Change in mix of providers Third-party payers Professionals Importance of quality control General principles of MCS apply Because of high cost of equipments, strategic planning process is important Annual budget preparation is conventional Huge quantity of information are available quickly for controlling of operating activities Financial performance is analyzed by comparison of revenues and expenses with budgets
72

‡

MCS
‡ ‡ ‡ ‡ ‡

MCS in service sector ±
Nonprofit Organizations

‡

Special Characteristics
‡ ‡ ‡ ‡ Absence of the profit measure Contributed Capital Fund Accounting Governance Product pricing Strategic planning and budget preparation Operation and evaluation
73

‡

MCS
‡ ‡ ‡

Auditing as a control tool
‡ ‡ Auditing is a control tool that ensures through checking, verification of documents and evidence that the plans/policies of the management are implemented as desired Many big organizations have a special internal audit department that carries internal audit to see to it that the internal controls and checks as set by the management are being adhered to There are different types of audits like financial audit, internal audit, cost audit, management audit etc. Purpose of these audits are different. An audit system makes the staff more vigilant. Audits like concurrent audit in banks actually act a continuous control system. Findings from an audit can help strengthen future controls.

‡

‡

74

Auditing as a control tool ± Different
types
Point Purpose Financial To verify trueness and fairness of financial statements Cost To check that the cost accounting plan is adhered to Internal To check that the internal checks and controls are being observed Management To investigate into specific issues or check effectiveness of corporate planning Not necessarily CA By Management

Auditor Appointment

Qualified CA By shareholders

Qualified ICWA By Government & Management Ordered by the Central Govt. Otherwise not mandatory.

Not necessarily CA By Board of Directors Usually optional.

Nature

Mandatory as per statute. Also known as statutory audit. Compliance of Accounting Standards in preparation and

Optional.

Emphasis

Efficient use of Propriety/judiciou resources, sness of control over costs decisions, detection of

Effectiveness of management 75 functions

Management Audit
‡ ‡ Management Audit as the name suggests is the audit of the management itself, that is, the management auditor judges the effectiveness of the functions performed by the management. The Management Auditor will check the planning, decision making, controlling and other such functions performed by the management. Management Auditor generally is a senior person with good allround knowledge and experience. He uses tools like questionnaire to gather audit evidence. If used properly Management Audit can be a good control tool to provide feedback to the management about its own effectiveness.

‡ ‡ ‡

76

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