Fundamentals of Management

Control Systems

Chapter 11
 11-2

Learning Objectives
1. Explain the role of a management control system.

2. Identify the advantages and disadvantages of

decentralization.
3. Describe and explain the basic framework for
management control systems.
4. Explain the relation between organization structure and
responsibility centers.
5. Understand how managers evaluate performance.
6. Analyze the effect of dual versus single rate allocation
systems.
7. Understand the potential link between incentives and
illegal or unethical behavior.
 11-3

Management Control System

L.O. 1 Explain the role of a management control system.

A management control
system is designed to
influence subordinates to
act in the organization’s
interest.
 11-4

Decentralization
L.O. 2 Identify the advantages and disadvantages of decentralization.

The delegation to
subordinates the
authority to make
decisions in the
organization’s name.
 11-5

Decentralization Continued

Centralized Organization
Decisions are made by relatively few individuals
in the high ranks of the organizations.
Few decisions are delegated

Decentralized Organization
Decisions are spread among relatively many
managers.
Decisions are delegated
to divisional managers
 11-6

Advantages of Decentralization
Local managers have information about local
conditions and can react quicker than top
management.

Local managers have opportunity for on-the-job

training in decision making and have the
satisfaction of making their own decisions.

Top managers have knowledge about strategic

issues and have more time for strategic decision
making.
 11-7

Disadvantage of Decentralization

Dysfunctional decision making

When local managers make decisions in their
best interest that may not be in the best
interest of the organization.

Duplication of administration
Local managers make the
same types of decisions
made at headquarters.
 11-8

Management Control Systems

L.O. 3 Describe and explain the basic framework for
management control systems.

A system designed to influence subordinates to act in

the organization’s interest
Used by principals (owners)
to influence agents’
(managers’) behavior

Delegated Performance Compensation

decision evaluation and and reward
authority measurement decision
 11-9

Delegated Decision Authority

A management control
system specifies what
decisions the subordinate
manager can make in
the name of the
organization.
 11-10

Performance Evaluation and Measurement

A management control
system specifies how the
subordinate manager’s
performance is measure
and evaluated.
 11-11

Compensation or Reward

A management control
system defines how the
subordinate manager is
compensated.
 11-12

Balancing the Elements

The goal of the organization is to make
money. The goal of the subordinate
manager is to make money.

An effective management
control system influences the
subordinate manager through
compensations and rewards to
make decisions that make
money for the organization.
 11-13

Responsibility Accounting
L.O. 4 Explain the relation between organization structure and
responsibility centers.

Costs and revenues are reported at the level

within the organization having the related
responsibility.

Cost Revenue
center center

Responsibility
Profit center Investment
center center
 11-14

Cost Center
Cost
Manager is responsible for costs
center
Cost and volume
of inputs used to
produce an
output
 11-15

Revenue Center
Revenue Manager is responsible for revenues
center

Selling a product
 11-16

Profit Center

Profit Manager is responsible for

center revenues AND costs

Revenues, costs,
production, sales
volume
 11-17

Investment Center
Investment Manager is responsible for profits
center AND investment in assets

Profits, capital
budgeting, use of
assets
 11-18

Responsibility Centers and Organization Structure

Organizational Structure and Responsibility Centers
Group Vice-President a
Investment centers

Division Vice-President Staff managers

Profit centers Discretionary cost centers

Plant managers District sales managers

Cost centers Revenue centers
a Group refers to a group of divisions.
 11-19

Goal Congruence

Agreement by all
members of a
group on a set of
objectives
 11-20

Evaluating Performance
L.O. 5 Understand how managers evaluate performance.

Controllability concept
Managers should be
held responsible for
costs or profits over
which they have
decision-making
authority

Relative performance evaluation (RPE)

Compares divisional performance with
that of peer group divisions
 11-21

Compensation Systems

Fixed compensation
Not performance based

Contingent compensation
Performance based
 11-22

Corporate Cost Allocation

L.O. 6 Analyze the effect of dual versus single rate allocation systems.
Global Electronics
Latin America Division
Income for the Year (in thousands)
Actual Target
Revenue $ 70,000 $ 70,000
(Percentage of corporate revenue) 16% 14%
Direct division costs $ 51,800 $ 51,800
Allocated corporate overhead $ 4,800 $ 3,500
Operating profit $ 47,000 $ 48,300

Global Electronics
allocates corporate
overhead based on
relative revenue.
 11-23

Corporate Cost Allocation Continued

Global Electronics
Latin America Division
Income for the Year (in thousands)

Actual Target
Revenue $ 70,000 $ 70,000
Direct division costs $ 51,800 $ 51,800

My revenue
and costs
were on
target.
 11-24

Corporate Cost Allocation Continued

Global Electronics
Latin America Division
Income for the Year (in thousands)
Actual Target
Revenue $ 70,000 $ 70,000
(Percentage of corporate revenue) 16% 14%
a b
Corporate revenue $ 437,500 $ 500,000

I’m not
responsible for
corporate
a
$70,000/16% revenue.
b
$70,000/14%
 11-25

Corporate Cost Allocation Continued

Global Electronics
Latin America Division
Income for the Year (in thousands)
Actual Target
Allocated corporate overhead $ 4,800 $ 3,500
(Percentage of corporate revenue) 16% 14%
a b
Corporate costs $ 30,000 $ 25,000

I’m not
responsible for
corporate
a
$4,800/16% costs.
b
$3,500/14%
 11-26

Corporate Cost Allocation Continued

Dual rate method

Cost
Separates a common
cost into fixed and
Activity
variable components and
then allocates each
component using a

Cost
different allocation base

Activity
 11-27

Performance Evaluation Systems Incentives

L.O. 7 Understand the potential link between incentives and
illegal or unethical behavior.

Does the measure reflect the results of the

actions that improve the organization’s
performance?

What actions can improve reported

performance but which are detrimental to
organizational performance?
 11-28

Unrealistic Budget Pressure

HELP!!
This is
impossible

Unrealistic budget pressures,

particularly for short-term results,
occur when headquarters
arbitrarily determines profit
objectives and budgets without
considering actual conditions.
 11-29

Financial Pressure
Financial pressure resulting from
bonus plans that depend on short-
term economic performance is
particularly acute when the bonus is
a significant component of the
individual’s total compensation.
 11-30

Chapter 11

Sometimes I
just don’t get
it. What do
they want?