Tutorial 8

Management control system

Exercise

1. 9-5 The four major behavioral considerations in MACS design are: (1)
embedding the organization’s ethical code of conduct into MACS
design, (2) using a mix of short- and long-term qualitative and
quantitative performance measures (or the balanced scorecard
approach), (3) empowering employees to be involved in decision
making and MACS design, and (4) developing an appropriate
incentive system to reward performance.

2. 9-8 Often managers are subject to intense pressures from their job
circumstances and from other influential organizational members to
suspend their ethical judgment in certain situations. These pressures
include the following:
 requests to tailor information to favor particular individuals or
groups
 pleas to falsify reports or test results
 solicitations for confidential information
 pressures to ignore a questionable or unethical practice

3.
9-10 An ethical control system is a system that promotes ethical decision
making in an organization. Key elements include the following:
 A statement of the organization’s values and code of ethics.
 A clear statement of the employee’s ethical responsibilities for
every job description and a specific review of the employee’s
ethical performance as part of every performance review.
 Adequate training to help employees identify ethical dilemmas
in practice and learn how to deal with the dilemmas.
 Compelling evidence that senior management expects
organization members to adhere to its code of ethics. This
means that management must provide a statement of the
 consequences of violating the organization’s code of ethics,
establish a means to deal with violations of the code of ethics,
provide visible support of ethical decision making, and provide
a private line of communication from employees directly to the
chief executive officer, chief operating officer, head of human
resource management or board of directors.
 Evidence that employees can make ethical decisions or report
violations of the organization’s stated ethics without fear of
reprisals from superiors, subordinates, or peers in the
organization.
 An ongoing internal audit of the efficacy f the organization’s
ethical control system.

4. 9-17 Quantitative, financial measures of performance in a

manufacturing organization include:
 cost per unit
 profit per unit
 return on investment
Quantitative, financial measures of performance in a service
organization include:
 cost of service
 profitability of service
 service revenue

9-18 Quantitative, non-financial measures of performance in a

manufacturing organization include:
 yield rate
 quality
 schedule adherence
 number of process problems
 defective rate
 on-time delivery
Quantitative, non-financial measures in a service organization include:
 number of customer complaints (in a restaurant)
 number of errors in processing claims (in an insurance
organization, for instance).
 number of repeat customers (for all service organizations)
  on-time flight arrival (in the airline industry)

5. 9-27 The three most common methods of setting a budget are: (1)
authoritative budgeting in which a superior tells subordinates what
their budget will be without requesting input from the subordinates,
(2) participative budgeting in which the setting of the budget is done
jointly between a superior and subordinates and (3) consultative
budgeting in which a superior asks subordinates for their ideas about
the budget but then determines the final budget alone.

6. 9-68 The four major behavioral considerations in MACS design are

(1) embedding the organization’s ethical code of conduct into MACS
design, (2) using a mix of short- and long-term qualitative and
quantitative performance measures (or the balanced scorecard
approach), (3) empowering employees to be involved in decision
making and MACS design, and (4) developing an appropriate
incentive system to reward performance.

(1) The MACS design should incorporate the principles of an

organization’s code of ethical conduct to guide and influence
behavior and decision making as people face ethical dilemmas
on the job. Often managers are subject to intense pressures from
their job circumstances and from other influential
organizational members to suspend their ethical judgment in
certain situations. The ethical framework embedded in system
design is extremely important because it will influence the
behavior of all users.

(2) The ways in which organizations and individuals measure

performance sends signals to all employees and stakeholders
about what the organization considers its priorities. If
organizations choose performance measures without careful
consideration, then behavior incongruent with the
organization’s goals can occur. The Balanced Scorecard
integrates an appropriate mix of short- and long-term financial
 and non-financial performance measures used across the
organization, and helps organizations grapple with their
intangible or intellectual assets. The Balanced Scorecard is a
systematic approach to performance measurement that
translates an organization’s strategy into clear objectives,
measures, and targets.

(3) Empowering employees in MACS design requires two essential

elements—allowing employees to participate in decision
making and ensuring employees understand the information
they are using and generating. Encouraging participation has a
two-fold benefit for organizations. First, research has suggested
that employees who participate in decision making evince
greater feelings of morale and job satisfaction, as well as
commitment to the decision. In many instances, these
heightened feelings translate into increased productivity as
employees begin to feel that they have some ownership and
control over what they do at work. Second, the organization is
able to gather information about improving jobs and processes
from the individuals who are closest to those jobs and
processes.

The second critical element of empowering employees is

ensuring that they understand the information they use and on
which they are evaluated. If employees at all levels understand
the organization’s performance measures and the way they are
computed, the employees can take actions that lead to superior
performance.

(4) MACS design involves choosing the most appropriate reward

systems to motivate desired behavior. Although intrinsic
rewards are sufficient to motivate some people to choose
behavior consistent with the organization’s goals, a system of
extrinsic rewards often provides additional motivation for
desirable behavior.

7. 9-73 (a) Preventive control: Preventive control is usually used in

situations where there is the possibility for the employee’s
actions to deliberately or accidentally cause damage, risk, or
 loss either to the employee or to the organization. In preventive
control, discretion in performing a task may be minimized
because of the precision required or the nature of the materials
involved. The examples chosen should indicate why preventive
control is appropriate and should clearly illustrate an approach
where the organization is designing the job to try to prevent
some undesired employee behavior.

(b) Monitoring: Monitoring involves inspecting the work or

observing the behavior of employees while they are performing
a task. Monitoring is most useful in settings similar to those
indicating preventive control. While preventive control focuses
on designing the job or the process to prevent the undesired
activity from happening, monitoring relies on random
observation to enforce the operating rules. Therefore, unlike the
preventive control situation, there is no attempt to design the
job to avoid the undesired behavior. The examples chosen
should reflect an appropriate setting for monitoring and should
demonstrate an understanding of the differences between
preventive control and monitoring.

(c) Results control: Results control is most useful in situations

where employees understand the organization’s objectives and
their contribution to those objectives, and employees deliver a
high component of skill, knowledge, or commitment to their
jobs. For results control to be effective, the organization must
clearly define its objectives, communicate them to appropriate
members, and design performance measures consistent with the
objectives. This method does not directly monitor or control the
tasks to be performed, often because it is difficult to measure
the components of what the employee delivers to the job. The
disadvantage of results control is that results can be affected by
circumstances beyond the employee’s control. Therefore,
results control is often conditioned by assessing performance
relative to a standard that reflects the circumstances the
employee faced. The examples chosen should reflect situations
where the employee contributes skill, knowledge, or motivation
to the job that cannot be directly assessed.
8. 9-79 (a) The motivation of the sales group is to understate their sales
estimates in order to increase their expected sales commission.

(b) The organization’s budgets will understate sales. If capacity is

planned based on understated sales, then capacity will be too low
and the organization will continuously be using overtime to meet
demand.

(c) The need is to develop a scheme that eliminates the motivation of

the sales force to understate their sales expectations. The idea
would be to decouple the sales estimates and the sales targets. One
approach would be to eliminate the sales commission—however,
this is likely not a choice that would be considered seriously.
Another possibility is to base sales estimates on historical trends.
The organization might undertake to link industry sales to
demographic or economic indicators in order to end the reliance on
sales force forecasts. Another approach would be to reward the
sales person for two things: (1) the accuracy of the estimate and (2)
the level of sales.

Tutorial 9-10

1. 8-1 The total-life-cycle costing approach is a comprehensive way for

managers to understand and manage costs through a product’s design,
development, manufacturing, marketing, distribution, maintenance,
service, and disposal stages. It refers to the process of managing all costs
along the value chain. Using this approach can lead to substantial cost
savings. By some estimates, 80-85% of a product’s total life costs are
 committed by decisions made in the RD&E stage, underscoring the
importance of managing all costs along the value chain.

2. 8-21 The benefits of using a total life cycle costing approach to product
costing include providing managers with the “big picture” of
managing costs over the research development and engineering;
manufacturing; and post-sale service and disposal cycles. Such a
perspective allows managers the opportunity to see how decisions
made in one stage affect costs throughout the entire product life cycle.
This perspective is not possible under the traditional product costing
approach. The total life cycle costing approach should therefore lead
to more cost-effective products and services.

3. 8-25 Target costing differs from traditional cost reduction methods

through the process by which costs are determined. Under traditional
cost reduction, after market research to determine customer
requirements and product specification, engineers and designers
determine product design, then the cost to produce the product. If the
estimated cost is too high, then it may be necessary to modify the
product design. The desired profit margin is found by subtracting the
estimated cost from the expected selling price.

Target costing begins in approximately the same way with market

research to determine customer requirements and product
specification. From this point on, procedures are quite different. The
next step under target costing is to determine the target selling price
and target product volume. Then the target profit margin is
determined. The target cost is the difference between the target selling
price and target profit margin. Target costing focuses on achieving the
target cost. Product cost is not important in product design under
traditional cost-reduction methods, which focus on cost reduction at
the manufacturing stage. In contrast, target costing focuses on cost
reduction at the RD&E stage. Target costing uses the total life cycle
concept to focus on cost of ownership over the product’s life. In
addition, target costing involves cross-functional teams and close
relationships with suppliers.
3. 8-30 The target costing relationship is expressed in the following
equation form: C  S  P , where C is the target cost, S is the target
selling price, and P is the target profit margin. This equation differs
from the other two types of traditional equations relating to cost
reduction in the following ways. The first traditional cost reduction
method is expressed as follows: P  S  C . The desired profit margin,
P, is found by subtracting the estimated cost, C, from the expected
selling price, S. The second traditional approach, known as the cost-
plus method, expresses the relationship among variables as S  C  P .
Under cost-plus, an expected profit margin is added to the expected
product cost. Price is simply the result of the sum of these two variables.
Unlike the traditional approaches, target costing focuses on achieving a
particular cost target.
4.
8-36 The traditional focus of cost management has been only on
manufacturing processes. Under this approach, pre-manufacturing
costs, such as research and development, and post-manufacturing
costs, such as service, are considered period costs, and companies
expense them in the period incurred. Thus, these costs are in no way
linked to individual products. Traditional accounting procedures and
the way that many organizations have been separated by department
or function (e.g., design engineering, manufacturing, marketing,
logistics, installation and postal service), often lead managers to focus
myopically on their own department’s costs. In particular, for the
manufacturing function, defining product costs as those solely related
to the manufacturing process ignores many costs associated with the
entire life cycle cost of a product.

Understanding the total life cycle costs (TLCC) of a product or

service, or the product costs incurred before, during, and after the
manufacturing cycle is critical, as decision makers can more
completely analyze and understand what creates product costs. For
example, if a company can reduce a product’s design and
development costs at the pre-manufacturing stage, it also is possible to
reduce all other subsequent product-related (downstream) costs such
as manufacturing and service-related costs. A TLCC system provides
information for managers to understand and manage costs through a
product’s design, development, manufacturing, marketing,
distribution, maintenance, service, and disposal stages. The total life
approach is also known as managing costs “from the cradle to the
grave.”

5. 8-40 Some studies of target costing in Japan indicate that there are
potential problems in implementing the system, especially if
focusing on meeting the target cost diverts attention away from other
elements of overall company goals. These potential problems include
the following:

(1) Senior executives and workers may reject target costing.

Education about the benefits of target costing should be
provided in order to gain top management commitment to target
costing, and top management commitment should be
 communicated to employees involved in the target costing
process.

(2) Conflicts can arise between various parties involved in the

target costing process. First, companies can put excessive
pressure on subcontractors/suppliers to conform to the schedule
and to reduce their costs. This can lead to alienation and/or
failure of the subcontractor. Second, design engineers become
very upset when other parts of the organization are not as cost
conscious as they are. Since they work very hard to squeeze
pennies out of the cost of a product, they think that other parts
of the organization (administration, marketing, distribution)
should also be as cost conscious. Often this is not the case.

To overcome this problem, pressure can be reduced on

subcontractors/suppliers by giving them reasonable grace
periods over which cost reduction must occur. Simply
demanding cost reduction immediately will exacerbate the
conflict. The issue of design engineers also can be addressed by
making other parts of the organization as cost conscious.
Adopting a total-life-cycle costing approach and using cross-
functional teams will help the organization to this end.

(3) Employees in many Japanese companies working under target

costing goals experience burnout due to the pressure to meet the
target cost. Burnout is particularly evident for design engineers.

This issue can be addressed by making target-costing goals

tight, but attainable. Often organizations make the mistake of
setting impossible goals. Design engineers also often fear that if
they make the target, in the next period, the target will be
“ratcheted up” and made even more difficult to achieve. Thus,
they may consciously try to make sure that they do not achieve
the target unless their jobs rest on it. The organization has to be
careful not to burn out employees, and design engineers in
particular, as they are extremely valuable to the organization.
Burnout is probably the biggest issue related to the success or
failure of target costing in Japan.
 (4) While the target cost may be met, there may be increased
development time because of repeated value engineering cycles
to reduce costs, which ultimately can lead to the product being
late getting to market. For some types of products, being six
months late to market may be far more costly than having small
cost overruns.
This is a very serious problem for the organization. Clearly,
there is a tradeoff between continuing to reduce target costs and
being very late to market. However, on average, many months
of lost sales will have a much more detrimental effect on the
organization than whether target costs are met. Thus, the
organization has to take a reasonable approach to target costing
and not lose sight of the ultimate goal of selling the product and
increasing market share. Time limits can be put in place for the
length of time allowed to develop or introduce new products.
6. 8-41 There are some similarities between traditional cost reduction and
target costing, but the differences are more striking. Both the traditional
costing method and target costing begin with market research into
customer requirements followed by product specification. Under
traditional cost reduction, companies engage in product design and
engineering, and obtain prices from suppliers. Product cost at this
stage is not a significant factor for product design. After the engineers
and designers have determined product design, they estimate product cost
and if the estimated cost is too high, then product design may have to
change. The desired profit margin is found by subtracting the estimated
cost from the expected selling price. Profit margin is the result of the
difference between the expected selling price and the estimated
production cost. Under another traditional method, cost-plus, the
expected profit margin is added to the expected product cost and selling
price is the result of the sum of these two variables.

Under target costing, after market research to determine customer

requirements and product specification, the process is quite different.
The next step, determining a target selling price and target product
volume, depends on the company’s perceived value of the product to
the customer. The target profit margin results from a long-run profit
analysis, often based on return on sales (net income/sales). The target
cost is the difference between the target selling price and the target
profit margin.
 Once the target cost is set, the company must determine target costs
for each component. The value engineering process includes
examination of each component of a product to determine whether it
is possible to reduce costs while maintaining functionality and
performance. In some cases, product design might change, materials
used in production might need replacing, or manufacturing processes
might require being redesigned. Suppliers also play a critical role in
making target costing work. If manufacturers with market power
decide that there is a need to reduce the cost of specific components,
they will pressure suppliers to find ways to reduce costs.

7. 7-14 Kaizen costing is a system that supports lean production

systems. Its goals are:
 to achieve cost reduction during the manufacturing stage of a
product;
 to ensure that a product meets or exceeds customer requirements
for quality, functionality, and prices in order to effectively
compete.
 to ensure that actual production costs are less than the cost base
(i.e. a predetermined cost that is equal to the actual cost of the
product in the previous year)
 to give workers the responsibility and control to improve
processes and reduce costs.

8. 7-17 Benchmarking is a process in which organizations gather

information concerning the best practices of others in order to meet or
exceed the benchmark. Products, functions, processes, and strategies all
can be benchmarked. Benchmarking is highly effective because
organizations save time and money by avoiding mistakes that other
organizations have made or by not reinventing a process or method that
other companies have already developed and tested.

9. 7-19 The three broad classes of information on which firms

interested in benchmarking can focus are: (1) product—any type of
product or service, (2) functions or process—all types of
organizational activities from R&D, manufacturing to service, and (3)
strategic—the variables on which the organization chooses to compete
such as cost, quality, etc. Variables related to the design and
 functioning of the management accounting system fall under the
strategic category.

10. 7-47 (a) The biggest problem with Kaizen costing is similar to the one
that faces target costing, and that is the system places enormous
pressure on employees to reduce every conceivable cost. The
results of this pressure are internal conflicts among various parties
and a great deal of employee burnout. Another concern has been
that Kaizen costing leads to incremental rather than radical process
improvements. This can cause myopia as management tends to
focus on the details rather than the overall system.

(b) To address the first problem, some Japanese automobile

companies use a grace period in manufacturing just before a
new model is introduced. This period, called a cost sustainment
period, provides employees with the opportunity to learn any
new procedures before the company imposes Kaizen and target
costs on them. Another solution relates to the kinds of penalties
that employees face as a result of not attaining cost targets. In
Japan, for those employees with lifetime employment, there is
virtually no chance of losing one’s job, however, there are
“social penalties” such as loss of face, letting down the
company, etc., associated with not achieving targets. In the
United States the threat of job loss is much more salient. The
last thing that U.S. managers would want to do is to threaten
job loss to those who did not achieve targets. This would
simply exacerbate the problem. In the final analysis, Kaizen
costing has to be understood as a tool for change, but not as a
hammer. With respect to the second problem above,
management needs to focus on the overall production process
as well as the details.
 Tutorial 11

1. 2-8 Once the company’s vision, mission, and strategy have been
established, the senior management team selects performance
measurements to provide the needed specificity that makes vision,
mission, and strategy statements actionable for all employees.
Companies generally start their Balanced Scorecard project by
building a strategy map that contains the word statements of their
strategic objectives in the four perspectives and the linkages among
them. The process of building a Balanced Scorecard should start with
word statements, called objectives that describe what the company is
attempting to accomplish. Objectives concisely express actions and
may express the means and the desired results. An example of an
objective for the financial perspective might be to increase revenues
through expanded sales to existing customers. Measures describe how
success in achieving an objective will be determined. A measure
should be specific in order to provide clear focus for the objective. An
example of a measure for the objective above might be to measure the
percent increase in sales to existing customers each month. Targets
establish the level of performance or rate of improvement required for
a given measure. For example, a target could be a two percent
increase in sales each month to existing customers.

2. 2-16 The Balanced Scorecard is helpful in identifying critical

processes because it forces the company to determine the means by
which it will produce and deliver the value propositions for customers
and achieve the productivity improvements for the financial
objectives. Furthermore, the Balanced Scorecard includes objectives
and measures to evaluate performance on these critical processes.

3. 2-28 Because financial success is not their primary objective,

nonprofit and government organizations (NPGOs) cannot use the
standard architecture of the Balanced Scorecard strategy map where
financial objectives are the ultimate, high-level outcomes to be
achieved. NPGOs generally place an objective related to their social
impact and mission, such as reducing poverty, school dropout rates,
incidence or consequences from particular diseases, or eliminating
 discrimination, at the top of their scorecard and strategy map. A
nonprofit or public sector agency’s mission represents the
accountability between it and society, as well as the rationale for its
existence and ongoing support.

4. 2-30 Wal-Mart is a company that uses the “best buy” or lowest total
cost value proposition. The objectives of this value proposition
emphasize attractive prices, excellent and consistent quality for the
product attributes offered, good selection, and ease of purchase.
Possible measures for Wal-Mart include the following:
(1) Financial: Return on investment, profit, change in yearly profit,
cost of purchasing items, inventory turnover.
(2) Customer: Market share, customer satisfaction in targeted
segments such as price-sensitive customers, customer satisfaction
and/or market share for Wal-Mart branded products, stockout
rates, price indexes compared to competitors, return rates due to
defective products.
(3) Process: Cost of purchasing as a percentage of total purchase
price, lead time for suppliers to replenish customer purchases,
distribution cost per unit, supplier defect rates, percent suppliers
that operate automatically for continuous replenishment, checkout
speed.
(4) Learning and growth: Employee satisfaction measured by a
survey, employee retention, percent of suppliers linked
electronically to point of sale terminals, number of employee
suggestions for cost reduction or improved customer service,
employee culture survey for continuous improvement.

5. 2-39 The Balanced Scorecard is both a performance measurement

system and a management system. The Balanced Scorecard was
originally developed to improve performance measurement by
incorporating nonfinancial drivers of performance, in addition to the
usual financial performance measures. Once the basic system was in
place, managers realized that measurement not only has consequences
for reporting on the past, but also creates focus for the future. The
Balanced Scorecard helps communicate the strategy, including
objectives, measures, and targets, to all organizational units and
employees, thus serving also as a management system.
 Tutorial 12

Marking Scheme

2-1 Companies use performance measurement systems to perform

multiple roles. These roles are:
 communicating the company’s strategic objectives

 motivating employees to help the company achieve its strategic

objectives

 evaluating the performance of managers, employees, and

operating units

 helping managers allocate resources to the most productive and

profitable opportunities

 providing feedback on whether the company is making progress

in improving processes and meeting the expectations of
customers and shareholders.

2-5 A company can enhance its intangible assets through the following
actions:
 upgrading the skills and motivation of employees

 expanding the data captured and shared about processes,

customers, and suppliers

 accelerating new products through the research and

development pipeline

 improving the quality and speed of production, distribution and

service processes

 enhancing trusted relationships with profitable customers and

low-cost suppliers.
1 The four perspectives of the balanced scorecard are:

– Financial – how do we optimally serve our shareholders’ interests?

– Customer – how should we present ourselves to our customers?

– Internal business process – what processes are critical to achieving our customer and
shareholder goals and how can we optimise these?

– Learning and growth – how do we maintain our ability to change and grow?

The new strategy addresses these perspectives in different ways. Ultimately all of the
perspectives will have financial effects whether in the short or long term interests of our
shareholders.

Focus on key customers – this directly addresses the customer perspective and will
require the collection of the profiles and needs of these customers in order to generate
market growth and so improve our financial position. Suitable performance measurement
would segment our market (for example, by customer age or gender) and identify our
changing market share within each segment. Ensuring we meet key customer needs –
again addresses the customer perspective but will also impact on the products/services
that Berjaya offers and so affect the process perspective. Suitable performance measures
from the customer perspective would be levels of repeat business and customer
satisfaction and from the process perspective, Berjaya will measure its product range and
quality. Range would be measured against competitors while quality could be measured
subjectively against competitors or internally by level of customer complaints or returns,
Cost cutting – this connects to the process perspective as it seeks to focus the business on
value added activities. Suitable performance measures would be efficiency savings
generated by removing or reducing unnecessary processes/products. Berjaya could
possibly look to simplify its supply chain by cutting the number of suppliers with which
it deals. Amend current processes to meet the new focus – clearly, this takes the process
perspective and measurement of this objective will be by way of the achievement of goals
in a specific change programme to assist the other objectives. Programme of sustainable
development – this objective looks to the future and this is the learning and growth
perspective. Suitable measures for this area would include the company’s carbon
footprint (its CO2 output), the efficiency of energy use of the business and the level of
packaging waste generated.

2 (a) Berjaya’s financial performance

The year on year performance of Berjaya has declined with earnings per share falling by
23%. Normally, this would imply that the company would be heavily out of favour with
investors. However, the share price seems to have held up with a decline of only 15%
compared to a fall in the sector of 22% and the market as a whole of 35%. The sector
comparison is the more relevant to the performance of Berjaya’s management as the main
market index will contain data from manufacturing,financial and other industries.
Shareholders will be encouraged by the implication that the market views Berjaya as one
of the better future prospects for investment.

This view is substantiated by the positive EVA for 2010 (RM110m) which Berjaya
generated. EVA has fallen by 64% from 2009 but it has remained positive and so the
company continues to create value for its shareholders even in the poor economic
environment.

(b) Evaluating the financial metrics

The indicators each have strengths and weaknesses. EVA is a widely used indicator
which aims to capture the increase in shareholder wealth that the company generates. It
uses amended traditional profit based information in order to approximate the net present
value method of appraising an investment. Thus, EVA provides a clear focus on the
major objective of most commercial entities. However, its calculation requires a large
number of adjustments to the traditional accounting figures, for example the need to
calculate the economic rather than accounting depreciation, the need to distinguish
between cash flow and accruals and to distinguish between expense and investment. This
makes the method less easily understood than the two other measures currently used by
Berjaya.

EPS growth is important to shareholders as it relates to dividend growth which is a

fundamental variable used in the calculation of share value (Dividend valuation method).
It is a widely used measure by equity analysts and so is a key driver of share prices.
However, it is based on accounting profit and only captures year on year change and so
can be subject to short-term manipulation if the trend over a number of years is not
considered.

Share price performance reflects the capital performance of an investment but tends to be
volatile and subject to significant fluctuations outside of the control of management. It
will be the figure that most shareholders turn to in order to get a quick impression of their
investment performance but it can lead to judgements being formed on the basis of that
short-term volatility which are more appropriate for speculators rather than investors. .
The use of an average share price in this instance should help to ameliorate such
problems but the averaging method and time-period should be further investigated.

The impact of these metrics on management is intended to focus their activities on

improvement of financial performance for shareholders. The danger of EPS growth and
share price is that these may be manipulated in the short-term in order to demonstrate
improvement but at the risk of impairing long-term performance. EVA partially tackles
this issue through its use of adjusted accounting figures (e.g. depreciation) but suffers
from lack of clarity in its calculation compared to these other metrics.

Workings:

(W1) 2009 2010

Economic value added (EVA) RM306m RM110m (down 64%)

(W2) 2009 2010

EPS (profit for year/av no of shares) 0.221 0.170 (down 23%)

(W3)

Stock market information 2009 2010

Main market index 1,115.2 724.9 (down 30%)

Retailing sector index 2,450.7 1,911.5 (down 22%)

Berjaya Stores share price RM2.45 RM2.08 (down 15%)

3 To: Board of Berjaya Stores

From: XYZ Accountant

Date: Today

Subject: Benchmarking performance

This report describes the benefits and problems associated with benchmarking the
company’s performance. Then, the performance of Berjaya and its two main competitors
is calculated and evaluated.

(a) Benchmarking methods

Benchmarking is a business improvement technique. There are different types of

benchmarking. Internal benchmarking is where similar operations in different parts of the
company under consideration are compared with each other and also with an internally
generated target. External benchmarking is where the company’s results are compared to
those of other companies.

There are different types of external benchmarking: one where competitors are used as
comparators and another where a company with similar operations (eg warehousing),
which is not a direct competitor, is compared. The aim of benchmarking is to identify
where best practice lies and then to analyse what constitutes the best operational practice
so this can be implemented across the business.

The main advantages and disadvantages concern the availability of benchmark

information and its applicability to the business.Internal comparison between regions in
Berjaya will be easy but may not yield dramatic improvements as the regions are
probably already in relatively close contact. Any improvements identified from this
exercise should be easily applicable as the systems will be broadly the same.

External benchmarking in this case means comparison to competitors where the

possibility of radical new ideas is greater but the difficulty will lie in obtaining
sufficiently detailed information to identify the best practice business process. Of course,
it will be difficult to negotiate an information sharing arrangement with a competitor due
to the commercially sensitive data being exchanged. However, there exist some
government schemes which require subscriber companies to supply data and then provide
them with anonymised industry data in return.

It would be easier to obtain information from a company which is not in direct

competition with Berjaya but which has similar functions such as purchasing and
warehousing. However, there are likely to be more significant differences in the
objectives and functions of the activities being compared and so it may be harder to apply
the lessons from the competitor to Berjaya’s operations. Data has not been supplied to
allow this analysis in this case. Berjaya could seek out companies which have industry
awards in these functional areas and then negotiate an information sharing agreement.

(b) Berjaya’s performance benchmarked

Comparing Berjaya to its competitors, it is clear that Berjaya has done well to increase its
total revenues but this has come at the cost of a significant fall in profit compared to BS
Stores. Berjaya should look into its pricing policy as it may have been buying sales by
offering heavy discounts and these may not be sustainable in the long term. The CS
Stores drop in profit is greatest of all but this may be explained by problems in the range
or quality of its products. CS Stores opened 19 new stores in the period but there has been
an overall fall in revenue of 4.9%. Berjaya should analyse CS offering to its customers in
order to avoid making the same mistakes. BS has increased profitability and this seems
due to a reduction in suppliers and presumably the overhead costs of managing those
relationships. Berjaya should examine BS Stores sourcing policy to see if it can simplify
its supply chain in a similar manner.

In terms of market share in food, Berjaya has maintained its position against slight falls in
its competitors. In clothing, all the companies have made gains and this may indicate a
trend to consolidation or failure of smaller stores of which Berjaya may be able to take
further advantage.
In revenue per shop, Berjaya has outperformed its competitors, however, this may be due
to Berjaya having a larger average store. This question could be answered by finding out
the average store area for the three companies. Regionally, the C area stands out with
poor revenue per shop and it has an unusual mix of food and clothing compared to the
other regions where clothing predominates. Further work will be needed to identify if this
is due to a different range being offered by managers or if there are regional variations in
customer preferences.

Conclusion

In conclusion, Berjaya appears to be performing well with increased market share during
the decline. The company must guard against the danger of eroding margins too far.

Indicative Marking Schedule

1. 1 mark per explanation of each perspective, up to 3.(3*4=12m)

1 mark for comments discussing each of the performance measures including the link to
the new objectives, up to 4.

Total: 16 marks

2 (a) Comments: 2 mark per point on EPS and share price (together) and EVA including
the calculation of EPS and other calculations.

(Maximum 6m)

(b) Up to 2 marks on each metric and 2 marks on impact on management behaviour

(Maximum of 6m)

Total: 12 marks

3 (a) 1 mark per point made; 4 for explaining benchmarking and 4 for
advantages/disadvantages (maximum 8)

(b) 1 mark per point made up to 6 for analysing the computations,

1 mark per point made up to 3 for suggesting further work and

1 mark for a conclusion (maximum 10m)

Professional marks (format, style and structure of report) are available up to a maximum
of 4.

Total: 22 marks (Total for question:50 marks)

 Tutorial 13-14

Questions

Financial control

11-1 Financial control is the formal evaluation of some financial facet of an

organization or a responsibility center to assess organization and
management performance. Financial control uses financial numbers,
such as costs or expenses, as broad indices of performance or
measures of the resources used by a process or organizational unit.
Financial control may involve comparing actual financial numbers
with targets from a standard or budget to derive variances.

11-2 Internal financial control is the application of financial control tools to

evaluate organization units. The resulting information is used inside
the organization and is not provided to outsiders. External financial
control is the application of financial control tools by outside analysts
to evaluate various aspects of organization performance.

11-3 Decentralization is the delegation of decision-making responsibility

from people at higher levels in the organization to people who are
front line decision makers of the organization. The primary reasons
for the evolution of decentralization are:
 As organizations grew larger, it became increasingly difficult
for the central/ core decision-makers to make all organization
decisions;
 As organizations grew larger and geographically dispersed, it
became increasingly difficult to gather and transmit information
about the organization’s environment for the purpose of
evaluation and processing at the organization’s center.

11-5 A responsibility center is an organizational unit for which a manager

is held accountable. The manager is asked to run the center to achieve
the objectives of the larger organization.
11-9 The following are the major differences between cost centers and
investment centers:
 Cost centers are responsibility centers in which employees
control costs but do not control revenues or investment
 levels. Investment centers are responsibility centers in which
the managers and other employees control revenues, costs,
and the level of investment.
 A cost center is a part of an organization. Virtually every
processing group in service operations or in manufacturing
operations is a candidate to be treated as a cost center. On
the other hand, an investment center is like an independent
business.
 Organizations evaluate the performance of cost center
employees by comparing the center’s actual costs with
budgeted cost levels for the amount and type of work done.
Therefore, cost standards and variances figure prominently
in cost center reports. On the contrary, the investment units
are so diverse, senior management uses return on investment
to evaluate each of these business units and their subunits.
11-10 The controllability principle states that the manager of a responsibility
center should be assigned responsibility only for those revenues,
costs, or investments that are controlled by responsibility center
personnel. Revenues, costs, and investments that are controlled by
people outside the particular responsibility center should be excluded
from the assessment of that center’s performance.

11-24 Financial control alone may be an ineffective control scorecard for

three reasons. First, it focuses on financial measures that do not
measure the organization’s other important attributes, such as product
quality and customer service. Second, financial control measures the
financial effect of the overall level of performance achieved on the
critical success factors, and it ignores the performance achieved on the
individual critical success factors. Third, financial control is usually
oriented to short-term profit performance.

11-31 Responsibility centers might include cooking operations, ordering

operations, counter and customer service operations, and maintenance.
All responsibility centers interact in terms of providing customers
with low costs, quality, and service.
11-44 (a) Return on investment is division income divided by investment.
Sales margin is division income divided by sales, and asset turnover is
sales divided by investment. Moreover, return on investment = (sales
margin)  (asset turnover).

Division Asset
Operating Return on Sales Turnover
Division Investment Income Sales Investment Margin
P $375,000 $75,000 $328,000 20.00% 22.87% 87.47%
Q 1,200,000 144,000 937,000 12.00% 15.37% 78.08%
R 840,000 101,000 675,000 12.02% 14.96% 80.36%

(b) Divisions Q and R have nearly identical return on investment, but

R has higher asset turnover, indicating that R generates more sales per
dollar of investment, while Q has a slightly higher sales margin.
Division P has the highest return on investment, sales margin, and
moreover the division’s asset turnover is the highest of the three
divisions.

(c)
Division
Operating Residual
Division Investment Income Income
P $375,000 $75,000 $37,500
Q 1,200,000 144,000 24,000
R 840,000 101,000 17,000

11-46
(a) ROI = Income . = 900,000 = 45%
Investments 2,000,000
(b) Residual Income = 900,000 – (2,000,000 x 0.1) = $700,000
Q1.

Ratio Formulae Cameron Fraser

Limited Limited
Profitability Ratios
Gross profit % (Gross profit ÷ (5,950 ÷ 23,800) (7,200 ÷
Sales) x 100 x 100 = 25% 24,000) x 100
= 30%
Net Profit % (Net profit ÷ Sales) (3,450 ÷ 23,800) (2,400÷24,000)
x 100 x 100 = 14% x 100 = 10%
Earning on capital employed (Net Profit after tax 2,500 ÷ 12,000 = 1,800 ÷ 20,000
÷ No. of Ordinary 21p = 9p
shares
Return on capital employed (Net profit ÷ (3,450 ÷ 15,625) (2,400 ÷
Capital employed) x 100 = 22% 23,995) x 100
x 100 = 10%
Liquidity ratios
Current ratio (Current Assets ÷ (2,600 ÷ 1,675) :1 (1,800 ÷ 805) :
Current Liabilities) = 1.6 : 1 1 = 2.2 : 1
:1
Acid test ratio ((Current Assets – (2,100 ÷ 1,675) :1 (600 ÷ 805) : 1
Stock) ÷ Current = 1.3 : 1 = 0.7 : 1
Liabilities) : 1

(b) Profitability ratio

Gross profit percentage : Fraser Ltd has a higher gross profit percentage than Cameron
Ltd. The companies both operate in a similar market and have similar turnovers, so it is
unclear why there is a difference. Possibly Fraser is better at keeping supplier costs.
1m

Net profit percentage : Cameron does better than Fraser on net profit percentage,
reversing the gross profit percentage finding. The company is obviously better at
controlling its expenses, which are around half those of Fraser.
1m

Earning per share : Cameron Ltd’s EPS figure is twice that of Fraser Ltd, suggesting on
the face of it that it is a better investment. The difference is mainly due to the number of
shares by which the earnings figure is being divided. However, Cameron Ltd’s post tax
profit is also higher than that of Fraser Ltd. We do not know the market value of the
shares, which would be an important factor when deciding to invest.
1m
Return on capital employed : Cameron Ltd’s return on capital employed is double that
of Fraser Ltd. Fraser Ltd has more money invested, in both shares and loans, but is not
making an effective use of the capital employed. 1m

Liquidity Ratios

Current ratio : Both companies have sufficient assets to cover their liabilities. The
current ratio of Cameron Ltd is not as high as that of Fraser Ltd. However, it is important
to look at the individual companies of working capital.

Both Cameron Ltd’s cash position (RM100,000) is more favourable than Fraser Ltd’s
RM55,000 overdraft).
1m

Acid test ratio : Much of Fraser Ltd’s working capital is tied up in stock. When this is
taken out to give the acid test ratio, Cameron Ltd’s is better. Fraser Ltd may be storing up
liquidity or cash flow problems.
1m
Conclusion : Overall Cameron Ltd looks to be the better performer, both in term of
liquidity and profitability. It would be helpful to have more background information
about the market in which the companies operate, for example industry average ratios,
and also to see the trend compared with previous years.
2m
Q2

(a) (i) Stock turnover = 416 ÷ 68 = 6.1 times

(ii) Debtor days = (52 ÷ 660) × 365 = 29 days
(iii) Current = 134:46 = 2.9:1
(iv) Acid test = 66:46 = 1.4:1

(b) The trader has money in the bank and quick assets (debtors and bank) exceed current
liabilities (creditors). This, alongside the current ratio of 2.9:1, indicates that the business
is not suffering from a liquidity problem.
(c) (i) Debtors adjustment = RM660,000 ÷ 12 = RM55,000 increase in debtors to
RM107,000 (2m)
Bank overdraft now required of RM55,000 − RM14,000 = RM41,000 (1m)
(ii) Stock adjustment = RM416,000 × (2 ÷ 52) = RM16,000 reduction in stock to
RM52,000 (2m)
Bank balance would increase to RM30,000. (2m)