ACCT440 - Notes Part 1

1
ACCT440 Spring 2021

Introduction to Management Control Process
Management Control Systems
Performance Measurement,
Evaluation, and Incentives 4th edition Organization Objective
Strategy
Operation
Chapter 1 Boss Encourage, enable, Employee
force
The Control Function of Tasks completed
Management
Copyright © 2018, 2012, 2007 Pearson Education, Inc. All Rights Reserved 2
Outline of Chapter 1
Aim of Chapter 1: Control Function of Management
Introduce the ongoing systems 1) Introduction of Management Control

implemented by executives for achieving: 2)Control issues and motivational
i.Planning and control the operation problems
efficiency 3)Control alternatives
i.Completing the task in time by employee 4)Overview
ii.Achieving the organization’s objectives
3 4
1) Management and its components ① Objective setting
①. Objective Setting Objectives are a necessary for a company
• Without objectives, it is impossible …
– to assess whether the employees’ actions
meet the requirements;
②. Strategy Formulation – to make claims about an organization’s
success.
• Objectives can be:
– financial vs. non-financial
③. Management Control – quantified, explicit vs. implicit
– economic, social, environmental, or societal
Copyright © 2018, 2012, 2007 Pearson Education, Inc. All Rights Reserved Copyright © 2018, 2012, 2007 Pearson Education, Inc. All Rights Reserved
③. Management Control Issue

② Strategy formulation
Utilizing physical facilities
Operational-level management
Managing human resources
There are innumerable ways to attain organization
objectives.
Strategies: Encourage employee to take Guard against employee failure
to complete their tasks in time ,
➢ How organizations should use their resources desirable actions to complete
or cause troubles to the
their tasks in time
(human, physical, intangible assets) employer
➢ Strategies put constraints on employees to

Management control has a ...
focus on their activities
… BEHAVIORAL ORIENTATION
2) Employee control issues a. Employee Lack of Direction
• Three issues Employees do not know what the company
/ manager expected from them
i. Do employees understand what the manager
expect of them?
a. Lack of direction Less likely to
ii. Will employees work consistently hard and try complete the tasks
to do what is expected of them?
b. Lack of motivation Solution:
iii. Are employees capable of doing what is COMMUNICATION + REINFORCEMENT
expected of them?
c. Personal limitations
b. Lack of Motivation c. Personal Limitations

i. Lack of goal congruence between the company • Employee are “unable” to do a job because of
and employee certain personal limitations they have
Individual goals do not coincide • Some examples/causes:
with organizational goals
1) lack of requisite knowledge, training, and experience
ii. Employee’s Self-interested behavior 2) employees are promoted above their level of
▪ individuals are prone to being “lazy” … competence
– For example, take long lunches, 3) some jobs are not designed properly.
overspend on things that make life more pleasant, TRAINING
use of sick leaves when not sick, etc.
JOB ASSIGNMENT/PROMOTION
▪ Extreme employee problems:
JOB DESIGN
– Employee crime (fraud and theft)
3) Management Control System Control alternatives
• Control system involve:  Avoid Control problem

 measure performance
 compare with pre-set standard
 take corrective action, if necessary  Use Control Strategies:
– Action controls
Many controls are proactive rather than reactive
– Results controls
– prevent control problems before the
organization suffers any adverse effects on – People controls
performance
 How to Avoid Control Problem  Control Strategies on employee

• Activity elimination (外包, 結束業務 …)
Controls can focus on:
– For example, subcontracts, licensing agreements, and
divestment ACTION CONTROLS
– the actions taken
• Automation / Artificial Intelligence (AI)
– Using computers / robots reduces the human problems
RESULTS CONTROLS
of inaccuracy, inconsistency, and lack of motivation – the results produced
– Automation is only applicable for “routine / repetitive /
codified” tasks. Examples: painting, assembly, packing, – the types of people PEOPLE CONTROLS
driving, book-keeping etc. employed have
• Important decision made by senior executives shared values and
– Mid or low-level people strictly follow instructions norms of the employer
(reduce motivations to knowledgeable employee) Or any combination
Selection of Control method Depending on
Example: Movie Production
(i) Job nature, (ii) ability of people
Knowledge of which specific actions are desirable

PEOPLE Appoint an appropriate movie Ability to measure results on important performance dimensions
CONTROL director
Excellent
Action Control
Performance Measure: and/or Action Control
➢Movie completed within time limit Results Control (e.g., large projects)
RESULT and budgets
➢No. of tickets sold (sales revenue)
CONTROL
➢Comments from experts and
public
Results Control People Control
➢Awards
(e.g., movie director, (e.g., research lab)
entity manager)
Poor
ACTION Impossible to conduct action
CONTROL control during movie production High Low
17 Copyright © 2018, 2012, 2007 Pearson Education, Inc. All Rights Reserved
Overview of Management Control

ACCT440 Spring 2021
Can people be avoided? Yes Control-problem
(e.g., automation, centralization)
avoidance
No
Yes
Can you rely on people involved?
No
Yes
People controls
Chapter 2
Can you make people reliable?
No Results control
Have knowledge about what Yes Able to assess whether
specific actions are desirable? specific action was taken?
Yes
No
Action controls
Have knowledge about what Yes
results are desirable? Able to measure results?
Yes
No
Results controls
?
Principles of Results controls Key Elements of Result Control
1) Rewarding employee for generating good results ➢ Defining the performance dimensions
2) Punishing employee for poor results » What you measure is what you get;
» Results accountability ➢ Measuring performance on these dimensions

» Objective > financial > market-based: for example, stock price
3) Employees are empowered to take whatever > accounting-based: profit ratio, return on assets,
> non-financial: no. of new customers, repeated customers
actions they believe will best produce the desired » Subjective: for examples: work attitude, cooperative
results
➢ Setting performance targets
» For motivating employee to achieve targets
4) Employee are controlled by budgets and time
limit ➢ Providing rewards (or punishments)
» “Incentives” – monetary (bonus, shares ..)
and non-monetary (promotion, praise…)
Conditions for Abilities to measure results effectively

effective results control • The effectiveness of result measures should
Results controls work best only when the following consider “employee’s ability to carry out the
conditions are present: task, time and resources provided”
– Managers and employee must know what results
• Measurement properties
are desired in the areas being controlled
– Congruence (tasks match the company objective)
– Tasks progress is controllable by employee
– Controllability 由員工決定如何做
(supported by resources, facilities, people ….)
– Precision 量度標準清楚
– Data or information provided to employee
– Objectivity 量度標準可以數字化
regularly
– Timeliness 評核時間表 (多次, 結尾…)
– Results measurable, if possible.
– Understandability 員工明白量度準則 (not complicated)
(It is difficult to quantify the result of a movie, a
– Cost efficiency 容易評核
song, intangible products, service etc.
Pros and cons of results controls ACCT440 Spring 2021
PRO CON
1) Behavior can be influenced 1) Not the important or related
while allowing significant
autonomy
indicators are measured Chapter 3
2) Managers shift risk to
2) They yield greater employee employees
commitment and motivation 3) Some employees don’t want to
3) They are often “inexpensive” take responsibilities
– For example, performance 4) Extra payment to employees for
measures are often already work done 公司額外支付獎金
collected for reasons not 5) Sometimes conflicting functions:
directly related to management – Motivation to achieve
control (e.g., financial
▪ targets should be “challenging”
reporting)
– Compromise among entities
▪ targets should be slightly
conservative
Effectiveness of Action Controls

A. Action Control on employee
• Managers:
• Ensure that employees perform certain – Know what actions are desirable from employee
actions known to be beneficial (or harmful) to ▪ Difficult in highly complex and uncertain or
the organization unmeasurable tasks environments
(e.g., research, accounting, or management)
• Prevention / detection – Have the ability to make sure that the desirable
actions carried out by employee
– Preventing undesirable behaviors by ▪ Giving instructions (verbal, documents) to employee
employee
▪ Clear organizational structure: Flows of work process,
– Preventing not performed by employee procedure, division of duties, workplace layout
Internal Control
Assessment on
Behavioral constraints on Employee
Actions taken by employee
• Physical constraints: Writing up action plans, investment proposals, or
– Locks, passwords, limited access to certain areas budgets
(warehouse, computer room & systems, office of i. Set objective and guidelines for the task
accounting and senior executives), camera etc. ii. Review proposal / budgets and approved by
• Administrative regulations / restriction managers
– Restriction of decision-making authority iii. Regularly check during the process
– Separation of duties, etc. Assigning more resources to a task than necessary
– Limited access to confidential information Are “backup” people or facilities necessary?
– Limited access to certain internal information Backup increase costs and result in waste
systems / meetings / projects etc. materials, unused facilities, workers idle etc.
Action accountability Pros and cons of Action Controls

• Holding employees accountable for their actions PRO CON
taken: It requires:
– Defining what actions are (un)acceptable, training • The most direct form of control • Only for “routine” jobs
– Communicating these definitions to employees
▪ For example, work rules, policies and procedures, codes of • Keep records of action taken • May discourage creativity,
conduct (documentation) for experience innovation and adaptation
sharing or improving existing • May cause sloppiness
– Managers observe or otherwise track what happens
work process
▪ Direct observation / supervision, camera / CCTV • May cause negative
Organizational memory
▪ Periodic tracking (e.g., mystery shoppers, tracking electronic attitudes
device 追蹤手環, regular report to boss…) • An efficient way of coordination – For example, little
– Action control increases the opportunity for creativity
▪ Evidence of actions taken (e.g., activity reports submitted by
predictability of actions and and self-actualization
outdoor employee)
reduce the amount of inter- • Sometimes very costly
– Rewarding good actions, organizational information flows (supervision costs)
Punishing actions that deviate from instructions to achieve a coordinated effort
B. Personnel / cultural controls Self Control
① People are self-controlled when they
①Employee will control their own behaviors – have a conscience that leads them to do what is right
▪ Personnel control – find self-satisfaction when they do a good job and see
▪ Self-monitoring their organization succeed
• Labels …
②Employee will control each other – Self-control (shaped by culture, religion, belief, value)
▪ Cultural controls – Intrinsic motivation 內心滿足感
▪ Mutual monitoring – Ethics and morality 外在規則
– Trust and atmosphere 環境因素
③ Employee will be controlled by – Loyalty
▪ Human supervisors or control device (camera, – Habit, practice
tracking / speed control)
Implementing personnel controls C. People are constrained by culture

• Generally, it is about … • Cultural, social pressure and group norms and
“… finding the right people, giving them a good values could control people
work environment and the necessary resources” • Cultural controls are effective because members
• Selection and placement of a group have emotional ties and a sense of
– Finding the right people to do a particular job within the limit responsibility to one another
(resources, human, time etc) • Cultures are built on shared地域,宗教,種族,語言文字,節日慶典
• Training – Traditions, norms
– Give employees a greater sense of professionalism – Beliefs, ideologies
– attitudes
– Create interest in the job by helping employees to understand – ways of behaving, dressing
their job better (rationalization)
It is extremely difficult to build a desired culture if it
• Job design + provision of necessary resources involves personal interests 個人利益. Regulation and
– So that motivated and qualified employees have a high punishment are more effective to change people
probability of success (e.g., equipment, staff support, freedom behaviour.
from interruption)
Ways to shape culture and collective behavior Ways to shape culture and behavior
 Codes of conduct setup by an organization
– Codes of ethics, corporate credos, mission statements, etc.  Intra-organizational transfers 轉換不同崗位
– Formal written documents with broad statements of corporate – Improve the socialization of individuals in an organization and
values, commitments to stakeholders, and the ways in which top alleviate the formation of incompatible goals and perspectives
management would like the firm to function – Improve identification with the organization as a whole as
– Fundamental guiding principles of the company opposed to subunit identification 為大局著想
 Group-based rewards – View things from different points of views
– For example, profit-sharing, employee ownership of company
stock. Peer pressure affects group members’ behavior.
 Physical and social arrangements
– These are cultural controls (plus a result control nature) when – For example, office plans, interior decor, dress codes and
the link between group performance and rewards is strong. vocabulary, etc.
The control effect of individual reward is uncertain. Some people  Tone at the top
are strongly motivated to get personal reward from individual
– Top management statements must be consistent with the culture
assignments while other people don’t care.
they are trying to create, and importantly, their behaviors should
be consistent with their statements
Management Control
ACCT440 Spring 2021
Starts with people controls
• People controls …
– Must always be relied on to a certain extent
Chapter 4
– Have relatively few harmful side-effects
– Involve relatively low out-of-pocket costs
• People control needs supplement with …

– Action controls
– Results controls
Degree of Control Tightness A) Tight action controls (1 of 2)
• Internal Control on behaviour
Good control is said when there is …. – Physical constraints higher control costs
➢ a high probability that the task will be – Administrative constraints
▪ Restricting decision-making to higher organizational levels
completed by employee in time provides tighter controls if:
➢ a low probability that failure or unpleasant – Senior people makes more reliable decisions
– Avoiding subordinates violate the regulations by separation
events will occur of duties or limit access to particular area and computer
systems.
Does tight control provide a high degree of • Pre-action reviews

certainty that people will act as the operation plan ? Controls become tighter if the reviews are frequent, detailed,
and performed by diligent and knowledgeable persons
Tight action controls (2 of 2) B) Tight results control (1/2)

• Action accountability • The achievement of tight results controls depends on:
▪ The definition of (un)desirable actions – The definitions of the desired results areas
– Definitions must be specific and complete ▪ Goal congruence and completeness
• Quantifiable measure is thought objective – Choosing measurable performance dimensions that reflect an
organization’s “true” objectives
– Definitions must be understood and accepted – For example, Number of visitors for the success of a museum.
▪ The effectiveness of the action-tracking system Number of patents for the success of R&D departments.
Annual profits for a company with significant growth prospects.
– Employees should feel that their actions are
▪ Specificity
observed regularly
– Quantification, measure on individual items and all together
▪ The reinforcement provided
– For example, “keep customers happy” vs.
– Significant rewards or punishments 重賞重罰效果 “less than 1% customer complaints”
顯著, 亦可能引起反抗
Tight results control (2 of 2) C) Tight people controls
– Measure of performance / result • The tightness of personnel controls depends
▪ Precision (minimize number of items to be measured ) on matching between people and organization
▪ Objectivity (freedom of “personal bias”, based on figures) – Selection and training
▪ Timeliness (“lag” between occurrence and measurement)
No / little control is required on the right people
▪ Understandability (both employee and boss understand
what is the expected result)
• Cultural controls are often more stable
– The reinforcements / bonus provided Peer pressure makes (i) employees follows the
▪ Links to results and rewards directly corporate culture, (ii) people follows the local culture
群眾壓力令人入鄉隨俗, 否則被迫離去
Summary on Control Alternatives

ACCT440 Spring 2021
Managers often use multiple forms of controls –
Result control or Action control Chapter 5
+
People control
Control tighter People follow instructions
Performance better ?
Harmful side-effects
Costs of Control
Control costs include: Harmful side-effects arising from highly
 Direct out-of-pocket costs spending on installation of tight control
control device and paying supervisors’ salary.
 Operating delays caused by too tight or too loose 1) Behavioral displacement
control.
 Non-financial costs – harmful side-effects from too- 2) Gamesmanship
tight control.
3) Operating delays
Higher control cost is sure
Tighter control 4) Negative attitudes
Better performance is not guarantee
Human side effect from tight control Human side effect from tight control:
1) Behavioral displacement 2) Gamesmanship
• With results controls, it occurs when the results’ measures • Refers to the actions managers take to improve their
are incongruent with the organization’s true objectives, often personal performance indicators without producing
due to:
– Employee poor understanding of the desired results,
any positive economic effects to the company
or – Data manipulation
– over-emphasis on “measured” results ▪ Trying to “look good” by achieving the control indicators
▪ Ignore what is not counted but also important to the – Data management: eg. affecting the reported results
company through accounting methods
• With action controls, it can be manifested by: – Falsification: reporting incorrect data intentionally
– Means-ends inversion – Creation of slack resources 浪費資源
▪ Employees pay more attention to what they do but lose ▪ Consumption of resources in excess of what is required
sight on the target because the cost is not paid by myself.
– Rigid, non-adaptive, and bureaucratic behavior
Human side effect from tight control Human side effect from tight control
3) Operating delays 4) Negative attitudes
• Job tension, conflict, frustration, resistance
• Mostly associated with action controls, notably, – Often coincident with many harmful behaviors,
such as gaming, lack of effort, absenteeism, and turnover
delays caused by:
– Lengthy review processes 評審時間長 • Action controls often “irritate” employees
– It is difficult for people to enjoy following a strict set of procedures
– Cumbersome authorization layers in for a long period of time
Bureaucratic organizations 官僚架構有過多管理層
• Results controls
• When responsiveness is important, operational – Lack of employee commitment to the performance targets
delays can be quite costly 對於急於回應事件,管理延 ▪ For example, when targets are too difficult, not meaningful and
uncontrollable, unfair evaluations or inappropriate method of
誤可能引致大損失, For examples, late confirm to
evaluation
customer and lose orders, late delivery etc.
Multinational companies encounter

Adaptation costs 為適應異地環境而付出代價 1) National culture differences
• Factors considered by multinational companies (MNC) Control problems are behavioral problems. Behavior is
when making foreign investments: shaped by the local culture, tradition, political structures
1) National culture 文化差異 that foreigners cannot change.
▪ People’s tastes, norms, values, social attitudes, religions, – Individualism potentially affects …
personal priorities, and responses to interpersonal stimuli ▪ Incentives based on individual vs. group performance
2) Local institutions 法規金融體制差異 ▪ Propensity of engaging in myopic, self-centered behavior
▪ Government agencies, banking systems, labor unions, – Power distance potentially affects 當地人對權力認同程度
financial markets, accounting rules, regulations, etc. ▪ Degree of centralization of decision-making 中央集權
3) Local business environments 營商環境(政治,物價,勞動力 ▪ Degree of participation in setting performance targets

水平)差異 – Uncertainty (risk) avoidance potentially affects 規避風險
▪ Stage of economic development, political risk, inflation, ▪ Degree of subjectivity in performance evaluations
labor availability, labor quality, labor mobility, etc. ▪ Degree of formality of planning and budgeting processes
– Discrimination (sex, age, region, race…) potentially affects
▪ Remuneration (monetary or non-monetary), promotion, etc
Multinational companies encounter Multinational companies encounter
2) Local Practice 3) Local business environments
• Power of labor unions and strike 工會與罷工權力 • Risk and uncertainty-related factors
– Political risk
• Use of performance-based rewards
▪ Military conflicts, terrorism, unrest, international trade war, etc.
(merit-based vs. seniority-based 按業績獎賞或按職位高低獎賞)
– Business risk
• Reward by shares or by cash ▪ Adverse: prohibition of layoffs employee, price controls, labor strike
– Frequency of profit measurement, per 6 months or year. ▪ Protective: tax privilege, subsidies, research support, etc.
– Use of short-term incentives for immediate hardworking – Stage of economic development
– Likelihood of myopic behavior caused by short-term events ▪ Infrastructure and logistic developments, degree of computerization
and system security, international treaties signed (trade, tax..),
• Share price affected by local stock markets and participations in international organizations (WTO, OECD, APEC..)
accounting regulations • Inflation
• Reward methods affected by tax charges and – Pricing, cost control etc
• Labor availability, quality, and mobility
administrative workload of paying bonus
– Use of action controls, personnel controls, and long-term incentives
Multinational companies encounter

- Foreign exchange risk (FX risks)
1) Aim of management control:
How to measure managers of overseas business based on getting tasks done by employee within time and
the financial reports? budget limits.
Can subsidiary managers control FX transaction risk and FX 2) Control on employee:
translation risk?
▪ Head office executives make decisions on cross-border
People control plus Result control or Action control.
investment, product sourcing, or marketing strategies. 3) Tight and detailed controls:
▪ They decide the currency and price of purchase or sales Incur higher supervision costs and cause negative
transactions in foreign markets and transfer pricing between effects on employee.
subsidiaries located in different countries.
4) No need for control:
▪ They decide how to handle foreign exchange transactions
(hedging, swaps, arbitrage or nothing) If employee is reliable or
the operation is fully automated
If the subsidiary manager has no authority to the above,
(disruptive innovation 科技進步產生失業)
▪ Write the budget and evaluate overseas managers based on
financial statements of their currency.
ACCT440 Assignment of responsibility
Responsibility centers – organizational units headed
Chapter 6 by managers responsible for the unit’s performance
Four types of responsibility centers
• Revenue centers
• Expense centers (also often called cost centers)
• Profit centers
• Investment centers
2
1. Revenue centers 2. Expenses centers

Output (i.e. revenue) is measured in sales dollars or sales
▪ Managers of expense (cost) centers are held accountable for expenses (a
units financial measure of the inputs consumed by the responsibility center)
Evaluate the center (business unit) by comparing actual sales ▪ “Standard” or “engineered” expense centers (EEC)
▪ Inputs and outputs can be measured in monetary terms
against budgets on regular basis
▪ There is a ‘causal’ relationship between inputs and outputs
Evaluate the manager including financial and non-financial ▪ An example: Manufacturing costs linked to production volume,
measures ▪ “Managed” or “discretionary” expense centers (DEC)
▪ Outputs produced are difficult to measure
Managers of revenue centers are held accountable for ▪ Relationship between inputs and outputs is hard to establish
generating revenues (a financial measure of outputs) but ▪ For example, R&D, human resources departments
ignore expenditures
3 4
2B. Discretionary expense centers
2A. Engineered expense centers
• A common form for administrative and support units, R&D units
Usually found in The units perform • Budgetary control is implemented.
manufacturing repetitive tasks for • Divisional managers are allowed to participate in the planning.
operations, warehousing which standard costs 1.Incremental budgeting
& distribution. can be developed 2.Zero-based budgeting
• Be aware of budgetary slack by divisional manager.

variance analysis (price & Complement with • Ensuring that divisional managers adhere to the budgeted expenses while
quantity variances) are successfully accomplishing the tasks of their center
measures of quality,
performed to evaluate cost » Subjective, non-financial controls
control based on the training and employee For example, quality of service provided
standard product cost. development » Personnel controls
5 6
Investment centres and Profit centers Investment centers and Profit centers
• Profit centers – responsibility center’s financial

performance is measured in terms of profit ($)
• Investment centers – profit is compared with the

assets employed in earning it. Measured in %
based on net assets employed.
7 8
3. Profit centers 3. Measuring profitability
Managers of profit centers are held accountable for achieving targeted
profits Comprehensive
• It incorporates many aspects of performance
(human, revenue, cost control, expenditure)
As a measure of Aware 提防
performance, profit is ...
• Higher short-term profit but lower long-term
profit
Charge standard cost of goods sold to sales-

Has the manager focused entities
significant influence Assign revenues to cost-focused entities
over both revenues
The above two methods are not allowed by tax
and costs?
authorities.
9 10
4. Investment centers Delegating profit responsibility

Managers of investment centers are held accountable for the
accounting returns (profits) on the investment made to generate those
returns The manager of Profit The manager should
and Investment centers have resources (human,
※Return on investment (ROI %): Earnings before interest expenses and taxes ÷ Assets employed are held accountable for facilities, financial) to
※Residual Income (RI $): Earnings before interest expenses and taxes – cost of assets employed generating profit. operate their activities.
» Absolute differences in profits are not meaningful if the various organizational divisions use
different amounts of resources
The manager should
In fact, divisional managers have two performance objectives have access to the Measures include both
» Generate maximum profits from the resources at their disposal relevant information efficiency and
needed for their effectiveness
» Invest in additional project or facilities only when such an investment will
produce an adequate return (after deducting cost of capital) operation.
11 12
Advantages of delegation Difficulties with delegation
 Loss of control if the division is far from head office
 The quality of decisions at operational level may
improve  Increased friction and cause communication problems
 Provide training ground for low-level managers  Additional costs on control and duplicated activities.
 Lack of competent divisional managers

 Profit consciousness is enhanced by the manager of
profit / investment centers.  Division manager put too much emphasis on short-run
profitability and self-interest.
13 14
Summary on financial results controls

• Three core elements
• Financial control on responsibility centers Chapter 7
• Different responsibility levels for the four types of Transfer Pricing between
responsibility centers
• Formal management processes (planning and budgetary control)
responsibility centers
• To define performance expectations and standards for
evaluating performance
• Motivational contracts
• To define the links between results and various
organizational incentives
15
Outline 1. Objectives of a transfer pricing system
– Cross-division activities and transfer price goods or service
Division A Division B
transfer price
1) Four objectives achieved from a transfer pricing
system  It should provide each responsibility center (division) with the
relevant information it needs to determine the optimum trade-off
2) Introduce 3 transfer pricing methods. between company costs and revenues.
3) Main characteristics and management control of  It should induce goal-congruent decisions
shared service centers  It should help measure the economic performance of the
4) Management control on cross-functional teams individual responsibility center.
5) Summary  The system should be simple to understand and easy to
administer.
2 3
2. Transfer pricing methods The ideal situations when

setting up the system Constraints on
1. Market price-based transfer price
sourcing
- The arm’s length principle
• Competent people
Comparable uncontrolled price method
• Good atmosphere • Limited markets for
2. Cost-based transfer prices (Cost-plus method) • A market price exists intermediate products
• Freedom to source
3. Negotiated transfer prices between market price and • Full information • Excess or shortage of
variable cost • Negotiation supplier’s capacity
- Profit split method
4 5
Cost-plus transfer prices Upstream fixed costs and profits
• The cost basis Formal mechanism to reach an agreement among responsibility
✓Standard costs (not actual cost)* is suggested. centers, and the managers meet periodically to review the transfer
price.
 Two-step pricing: (i) variable standard cost, plus
• The profit mark-up
(ii) Charge to cover fixed cost of supply unit.
✓Profit mark-up is based on :
variable cost, variable plus fixed manufacturing cost,  Profit sharing issues
full cost (include admin expenses)…….etc i. Senior management intervene to settle disputes between units,
✓The level of profit allowed to the supply division ii. Costly and time-consuming and against decentralization
(autonomy) if head-office people involve in negotiation.
*Avoid excess costs by supply division passing it to buying division. iii. Profit uncertain until sales of final product completed.
6 7
Example: Cost-plus transfer pricing Administration of transfer pricing system

Two decisions involved in a transfer price system.
Goods 1. Sourcing decision: Should the company produce the product inside? If
Supply division A Buying division B
purchase from outside, no transfer price issue.
2. The transfer pricing decision: What pricing scheme should be used?
Variable cost per unit $5 Negotiation Issues:解決內部爭議
Fixed cost per month $20,000, $4 When arbitration and conflict arise, the senior management solve the
Output 5000 units per month negotiation issues by:
Forcing, smoothing, bargaining and problem solving….
Fixed cost per unit = $20,000 ÷5,000 units = 4
• Products classification 高層只會介入重要產品transfer pricing
Required profit by Supply division: $2 High-class products: Senior management involved in
Asset employed by A $1,200,000, ROI = 10%
negotiation
Required profit per unit = $1,200,000*10%÷5000=2 Common products: negotiation between the divisional managers.
Transfer price asked for by supplier (A) $11
8 9
3. Shared service needs within a company
Shared service centers
Shared service is needed by different divisions
Example 1: Transportation service • Shared service centers are not the same as
Sales department focus on marketing activities but they centralized service units (HRM and accounting..
need centralized service for goods delivery to customers. are expense centers.)
Example 2: Purchasing service
• Shared service is operated as a profit center with
The advantage of economies of scale from centralized
full responsibility for financial performance and
purchase for higher discount. quality of services
• Normally financed by the fees charged to the
buying divisions
10 11
Management control and

Strategic decisions on shared service
shared service centers
Strategic decision made by top management: ➢Service agreements made between supplying
division and buying division of the service about
• Why shared service centers are implemented pricing and other terms.
internally but not out-source?
• Will the responsibility centers be permitted to ➢Include both financial and non-financial measures
purchase support services from outside? such as productivity and customer satisfaction in the
• Will the shared service center be allowed to sell evaluation of managers of shared service centers.
services to outsider customers?
12 13
4. Cross-functional Project Management control and
cross-functional team
• Managers from different responsibility centers work together
in cross-functional teams on a project or an event. • Frequent formal meetings for project task
• Ensure cooperation and coordination between project • Importance of team leaders – cooperation, motivation….
members • Reduce the distance between cross-functional team members
• Challenges the traditional way of managing responsibility if possible
centers • Top management support cross-functional activities
• Need for additional control mechanisms that support the • Project evaluation based on financial and non-financial
horizontal management of cross-functional teams factors
• Bonuses tied to cross-functional team’s outcome and
company performance
14 15
Summary
A transfer pricing scheme is needed for:
➢Goods (intermediate or finished goods) provided from one
responsibility center to another one.
➢Shared service provided to other responsibility centers
Management control:
Budgeting
Top managers decide
(i) The structure of the organization and division of responsibilities.
(ii) Authority of divisional managers to buy inside or outsource,
(iii) Guidelines on transfer pricing system (base of transfer pricing,
profit sharing)
16 1
Planning and budgeting Planning cycle
• Relatively broad processes of thinking
Strategic about the missions, goals, and strategies
Produce written plans that specify:
Incrementally specific, detailed, short-term,

Planning • Normally a top-management process
and involving all organizational levels

– Where the organization wishes to go?
– How it intends to get there? • Specification of specific action programs
– What results should be expected? Programming to be implemented over the next few years
and specification of the resources each
Capital will consume
Purposes of planning and budgeting processes Budgeting • It involves managers at different levels
(top-down/bottom-up)
– To enhance management control
– To engage in long(er)-term thinking • Short-term financial planning
Operational • Budgets match the organization’s
– To achieve coordination (top-down, bottom-up, horizontal) responsibility structure
Budgeting
– To establish “challenging-but-achievable” performance targets • Emphasis on quantitative data
2 3
Characteristics of a budget Budget and management control

♦ It is usually stated in monetary terms
Budgeting involves setting targets that are commonly used as
♦ It generally covers a period of one year standards against which to evaluate performance
♦ It contains an element of management commitment, that is, the - results controls
managers agree to accept the responsibility for attaining the
budgeted objectives Planning and budgeting processes involve formal reviews of plans and
include the actions that are felt to be good for the organization to take
♦ The budget suggested by the middle manager is approved by
- action controls
senior executives. (participative /bottom up budgeting)
♦ Once approved, the budget can be changed only under specified Planning and budgeting processes provide the needed information for
conditions decision making to the relevant managers – personnel controls
♦ Periodically, actual financial performance is compared to budget
and variances are analyzed and explained 4 5
The budget preparation process Types of financial performance targets
The budgeting process takes about 4 months in most firms • Internally based / externally-derived
Budget Committee • Target costing and targeted profit (ROI %)
Top-Down • Benchmarking (same type of business, location, size….)
3. Negotiation
• Economic, social, inflation, demand, competitors, weather..
Budget
Department • Fixed / Flexible budgets
• Should managers be held accountable for achieving their
4. Approval plans regardless of the business conditions they face?
Bottom-Up
Business Managers
• Relative performance targets (%)
6 7
Budget participation Budget target’s difficulty level

Budgeting process could be either top-down or bottom-up.
Motivation / Performance
Operational managers are allowed to participate in budgeting:
➢ The budgetee is both involved and has influence over setting the
budget
➢ Leads to better acceptance of budget targets, and hence, commitment
to achieve them by the operational managers
➢ Is an effective way of information sharing bringing together corporate
priorities and constraints with lower-level insights about business
potentials and risks
➢ But, potential for slack, bias (personal benefit), conservatism, … Easy Impossible
Goal Difficulty
8 9
Budget target’s difficulty level Budget target’s difficulty level- easy
In theory (lab experiments): In practice (field research)
“Good targets” are about 25–40% achievable Targets are about 80–90% achievable
Probability
Probability
Target Performance Target Performance
10 11
Challenging but achievable budgets What is a “good” budget target?

1. To minimize dysfunctional management actions Purpose of Budgeting Target Difficulty
➢Avoid myopic (short-sight) behavior, data manipulation
• Motivation
Conservative
2. To increase manager’s commitment to budget targets
• Planning
3. To reduce the cost of organizational interventions
• Coordination Best guess
➢ Implement Management-by-exception
• Cost control
4. To protect against the cost of realistic revenue projections
Optimistic
➢ Avoid overstate of budgeted resources • Evaluation
5. To create a “winning” atmosphere and positive attitude Target should be after-the-fact assessment of what could
have been accomplished, not any of the three choices listed
Budget gaming
Critique against budgeting
Budget gaming depends on:
• Show a better budget 1.公司制度是否存在玩弄手段機會, 2.個人,
• Creates internal gaming and myopia
that expected - 3. 回報金額大少
• Too resource consuming (time, data collection, exposure • Senior managers
effort, difficult to achieve a compromise….)
• Profitability of the business
• Calendar year is not an appropriate period.
(eg. Academic year start from September) • Show a worse budget • Uncertainty of the market
• Impossible to make a reliable budget that expected - • Reward system
• Makes organizations less flexible hedging • Personality
14 15
Types of budgets
1. Revenue budget (unit & $) and receipt schedules
2. Production budget for manufacturing companies
3. Purchase budget (units and $) and payment schedules
4. Marketing expenses, General and administrative
Incentive Systems and Behaviors
expenses (fixed and variable costs; non-cash items)
5. R&D expenses (People & result controls, budgetary
control)
6. Income Statement and balance sheet (targeted ROI)
7. Capital budget
8. Cash flow statement
Chapter 9
16
Copyright © 2018, 2012, 2007 Pearson Education, Inc. All Rights Reserved
Forms of rewards and punishments Positive and negative incentives
– Monetary
▪ Salary increases
▪ Bonuses • Positive incentives “rewards”
▪ Benefits – Things employees value
▪ Perquisites – Monetary
– Club ▪ No / low salary raise
memberships ▪ No / low bonus • Negative incentives “punishments”
– Vacation trips ▪ Benefits withdrew – Things employees want to avoid
– Non-monetary
▪ Promotion & titles – Non-monetary
▪ Autonomy ▪ No promotion
▪ Recognition ▪ Interference in job • Compensation package short-term
▪ Participation in from superiors
decisions ▪ Loss of job = salary + bonus + benefits + incentive
▪ Office assignments ▪ Assignment to
▪ Preferred parking unimportant tasks long-term
places ▪ Humiliation
Short-term incentive plans Long-term incentive plans

(quantitative measures, monetary reward)
• Based on the performance measured over
• Based on performance in the current year or month periods greater than 1 year
– For example, piece-rate or hourly payments, – Better for higher management levels who will work for
commissions, bonuses. the company longer
– Accounting measure
e.g., earning per share (EPS), return on assets (ROA)
• Calculation (by formula) of short-term incentives average over a period of 3–5 years
– For example, 2% of actual sales; 10% of net profits – Market-based measure
– For example, 60% of target bonus at 80% of target;
▪ Stock options 股票期權
100% of target bonus at 100% of target
(where target bonus = 30% of salary) ▪ Restricted stock 限售股
▪ Shares award
Purpose of incentives (1 of 3) Purpose of incentives (2 of 3)
1. Motivating employee 2. Attraction / retention of employee
– Motivation has two elements – Paying employees only guaranteed salaries tends to
attract risk-averse employees
▪ Inducing effort: getting employees to work hard
– Employees typically put forth more (less) effort on – Paying performance-based compensation tends to
activities that are (not) rewarded attract employees who are more risk tolerant, more
aggressive, more confident in their abilities
▪ Directing effort: helping employees understand
what is expected of them – Restricted stock, for example, often are geared toward
– Rewards attract the employees’ attention and employee retention
inform them of the relative importance tasks
▪ “Golden handcuffs”
Purpose of incentives (3 of 3) Purpose of incentives (3 of 3)

3. Other considerations of an incentive scheme
3. How incentive schemes support
– Make compensation variable with firm performance:
management control? Bonus payment requires cash. When bonus is linked
 Informational - directing employee efforts on to the firm’s profitability, it becomes flexible depends
important areas the financial ability of the company.
 Motivational – encourage employee work hard – Cash planning of the employer.
 Control – attraction and retention of personnel – Tax considerations: It is better for the whole bonus
payable by installments under the progressive salaries
tax rates.
– HRM: Some employees will quit jobs after getting the
one-off bonus. Paying bonus by installments can
retain employees stay longer.
Key elements to be considered Proportion of variable pay
(At-risk pay)
 Size of awards (fixed salary vs. at-risk pay) – Performance-based rewards impose risk on the
 Level and type of measurement employees as performance is never fully
controllable
– Performance at the individual, group or company level
– Financial vs. non-financial performance; – Across firms, differences in the proportion of “at-
risk” pay are greater than differences in base pay
Single or multiple measures or performance criteria
– Performance not measurable Basic salary
 Shape of the incentive-performance function (see p.12)
 Use of “subjectivity” – mutual trust between
managers and employee, may cause employee Performance High basic salary + Low commission
frustration, demotivation and friction. measurable Low basic salary + High commission
Shape of reward function Bonus Criteria

• Lower cutoff (Minimum requirement to get bonus)
• Commonly, the link between rewards and results is
linear, but over a restricted performance range only – To avoid paying bonuses for average or poor performance.
• Upper cutoff (upper limit on bonus)
MAX
– To maintain difference in bonus between different levels of
Rewards ($)
employees) , upper limit is higher for senior manager

– To keep total compensation somewhat smooth over time
– To avoid that managers maximize personal short-term
bonus at the expense of long-term.
Results (profit)
ZERO – To avoid undeserved bonuses due to good luck
LOW 80% 100% 200% HIGH
of of of – To alleviate the possibility of a faulty compensation plan
budget budget budget
target target target design
Group Bonus Bonus determination
• Objectively- Formal scheme (bonus formula)
• Team-based rewards are often used to – The performance-reward link is explicit
implement personnel / cultural controls
– Avoid bias in assessing and rewarding performance
– Group members monitor and sanction each other’s but
behaviors (mutual monitoring) advantage
– Performance reward scheme cannot be applied on jobs
– Free rider can also get group rewards disadvantage that are difficult to quantify performance. (e.g., R&D, HRM,
accounting)
• Group bonus rarely provides a direct incentive effect • Subjectively
on individual performance
– Allows performance to be evaluated on quality of
– Stock-based plans are more effective for motivating senior performance.
managers and less effective for lower-level employees – Lack of explicitness increases the employee's risk (due to
bias)
Criteria for evaluating reward systems Criteria for evaluating reward systems
1) Rewards should be valued by employee 4. Rewards should be given in the right time, one-
– Rewards that have no value do not provide off or by installments (cash availability,
motivation employee needs, retention of employee..)
– Reward effect vary across individuals and are 5. Rewards should be durable for motivation
situational 6. Irreversible reward should be carefully given
2) Rewards should be large enough to have impact Promotions, for instance, are difficult to reverse
(encourage, avoid misbehavior)
7. A reward system should be cost efficiency: it is
3) Rewards should be understandable (Reason of not so time consuming or difficult to calculate
bonus) the amount of bonus
Summary
1. Different forms of rewards and punishments

2. Short-term and long-term incentive plans
and duration of motivation
3. Purposes of incentive: motivating and
directing, retention and control of employee.
4. Size of incentive, upper and lower limits
5. Criteria for a reward system: motivational
effect, timely
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ACCT440 Spring 2021

Introduce the ongoing systems 1) Introduction of Management Control

③. Management Control Issue

➢ Strategies put constraints on employees to

b. Lack of Motivation c. Personal Limitations

• Control system involve:  Avoid Control problem

 How to Avoid Control Problem  Control Strategies on employee

Knowledge of which specific actions are desirable

Overview of Management Control

» Results accountability ➢ Measuring performance on these dimensions

Conditions for Abilities to measure results effectively

Effectiveness of Action Controls

Action accountability Pros and cons of Action Controls

Implementing personnel controls C. People are constrained by culture

• People control needs supplement with …

Does tight control provide a high degree of • Pre-action reviews

Tight action controls (2 of 2) B) Tight results control (1/2)

Summary on Control Alternatives

Multinational companies encounter

3) Local business environments 營商環境(政治,物價,勞動力 ▪ Degree of participation in setting performance targets

Multinational companies encounter

1. Revenue centers 2. Expenses centers

• Be aware of budgetary slack by divisional manager.

• Profit centers – responsibility center’s financial

• Investment centers – profit is compared with the

Charge standard cost of goods sold to sales-

4. Investment centers Delegating profit responsibility

 Lack of competent divisional managers

Summary on financial results controls

2. Transfer pricing methods The ideal situations when

Example: Cost-plus transfer pricing Administration of transfer pricing system

Management control and

Incrementally specific, detailed, short-term,

and involving all organizational levels

Characteristics of a budget Budget and management control

Budget participation Budget target’s difficulty level

Challenging but achievable budgets What is a “good” budget target?

Short-term incentive plans Long-term incentive plans

Purpose of incentives (3 of 3) Purpose of incentives (3 of 3)

Shape of reward function Bonus Criteria

employees) , upper limit is higher for senior manager

1. Different forms of rewards and punishments

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