MANAGEMENT

AND COST
ACCOUNTING
SIXTH EDITION

COLIN DRURY

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2004 Colin Drury
 Part Four:
Information for planning, control & performance
Chapter Sixteen:
Management control systems

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
16.1a

Different types of controls

• Action (or behavioural) controls

• Personnel and cultural (or clan and social) controls

• Results (or output controls)

Action (or behavioural) controls

• Consist of:
• Behavioural constraints
• Preaction reviews
• Action accountability

• Focus should be on prevention rather than detection

controls.

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
16.1b

Social, personnel and cultural controls

• Social controls involve selection of people who have been socialized into
adopting particular norms of behaviour.

• Personnel controls build on employees natural tendencies to control

themselves (Emphasis is on selection, training and job design).

• Cultural controls represent a set of values, social norms and beliefs that
are shared by members of an organization and that influence their
actions.

• In recent years there has been a greater emphasis on cultural controls in

the form of employee empowerment.

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
16.2
Results or output controls

• The focus is on reporting

information about the
outcomes of work effort.
• Results controls involve the
following stages:
1. Establishing performance
measures that minimize
undesirable behaviour.
2. Establishing performance
Cybernetic control systems (see above diagram)
targets.
3. Measuring performance.
• Results controls resemble a cybernetic
4. Providing rewards or
(mechanical) control system.
punishments.
• Cybernetic systems involve feedback controls
(actions after the events) but ideally control
should be based on control actions before the
events.

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
16.3

Harmful side-effects of controls

1. Occurs when controls motivate employees to engage in behaviour that is not
organizationally desirable (i.e.system leads to a lack of goal congruence).

2. Results controls:
• Encourages individuals to focus only on what is measured,regardless of
whether it is organizationally desirable (see sheet 16.4)
• Focuses mainly on quantifiable and easily measurable items.
• Subject to data manipulation.
• Can lead to negative attitudes towards the control system.

3. Action controls:
• May discourage creativity

4.Cultural controls:
• Lack of goal congruence where group goals do not coincide with firm
goals

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
16.4
Fig.16.2 The measurement reward process with imperfect measures
(Source: Otley (1987)

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
16.5

Advantages and disadvantages of different types of controls

Personnel/cultural controls
• Few harmful side-effects
• Inexpensive to operate
• Appropriate only in certain circumstances
Action controls
• Direct link between control mechanism and the action.
• Measurement problems do not apply.
• Not feasible where cause-and-effect relationships are not
well understood or easily observable.
• Best suited to stable situations.
Results controls
• Can be applied where knowledge of what actions are
desirable is lacking.
• Focus is on outcomes (individual autonomy is not restricted).
• Subject to limitations described on sheet 16.3.

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
16.6

Management accounting control systems (MACS)

• Tend to be the predominant controls in most organizations because:

1 Monetary measure provides a means of aggregating results from dissimilar activities.
2. Profitability and liquidity are essential for company survival.
3. Financial measures enable a common decision rule to be applied.
4. Measuring results in financial terms enables managers to be given more autonomy.

Responsibility accounting

• Responsibility accounting is a fundamental part of the MACS.

• Four types of responsibility centres:
1. Cost or expense centres (Two types:standard cost centres and discretionary
cost centres).
2. Revenue centres
3. Profit centres
4. Investment centres

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
16.7

MANAGEMENT CONTROL SYSTEMS

The nature MACS

• Two core elements:

1. Formal planning processes (e.g.budgeting and long-term planning) for

establishing performance expectations.

2. Responsibility accounting
• Responsibility accounting assigns differences from the performance target
to the individual who is accountable for the responsibility centre.

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
16.7b

• MACS process involves:

1. Setting performance targets.
2. Measuring performance.
3. Comparing performance against target.
4. Analysing variances and taking remedial actions.

• Responsibility accounting is implemented by issuing

performance reports similar to that on sheet 16.8.

• Issues that must be addressed by responsibility accounting

include:
1. Distinguishing between controllable and non-controllable items (i.e.the
controllability principle).
2. Determining how challenging the targets should be.
3. Determining how much influence managers should have in the setting of
targets.

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
16.8

A typical performance report

Use overhead as transparency

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
16.9a

The controllability principle

• Principle advocates that it is appropriate to charge to a responsibility centre only

those costs that can be influenced by the manager of the responsibility centre.

• Implemented by either eliminating uncontrollables or reporting controllable and

uncontrollable items separately.

• Types of uncontrollable factors:

1. Economic and competitive factors (Because managers can respond to
some of these changes most MACS do not shield managers
completely from them).
2. Acts of nature (Managers normally protected from them).
3. Interdependencies where outcomes are affected by other units within
the organization:
• Pooled interdependencies
• Sequential interdependencies
• Reciprocal interdependencies

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
16.9b

• Adjustments for the distorting effects of uncontrollables can be made either

before or after the measurement period.

• Adjustments before the measurement period:

1. Specify which budget line items are uncontrollable (eliminate or
report separately in performance report).
2. Insurance

• Adjustments after the measurement period:

1. Variance analysis
2. Flexible performance standards (e.g.flexible budgeting
and ex post budget adjustments)
3. Relative performance evaluations
4. Subjective performance evaluations

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
16.10

An example of flexible budgeting

Budgeted activity = 20,000 units Actual activity = 24,000 units

Budgeted unit variable cost =£5 Actual variable costs = £105,000

Original fixed budget Flexible budget Actual Reported

cost variance
20,000 × £5 =£100,000 24,000 × £5 =£120,000 £105,000 £15,000F

• Ensures that managers are accountable for the conditions applying during the
period and not those envisaged when the budget was set.

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
16.11a

Guidelines for applying the controllability principle

• Price and quantity of service controllable = Controllable expense

• Quantity controllable but not price = Manager accountable for difference

between (actual quantity × budgeted price) and (budgeted quantity
× budgeted price)

• Quantity and price not controllable = Non-controllable expense

• General principle = Hold managers accountable for performance areas you

want them to pay attention to.

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
16.11b

Determining how challenging the targets should be

• A clearly defined quantitative goal is likely to motivate higher levels of
performance.

• Level of budget difficulty should be related to task uncertainty.

• Targets must be accepted to motivate managers to achieve higher levels of

performance.

• Literature identifies a theoretical relationship between budget difficulty,

aspiration levels and performance (see slide 16.12).

• Hypothesized relationships suggest that budget level that motivates best

performance is unlikely to be achieved most of the time ( do not adopt punitive
approach for adverse variances)

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
16.12
The effect of budget difficulty
on performance (Otley 1987)

The effect of budget levels on aspiration and

performance (Source: Hofstede 1968)

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
16.13a

Arguments in favour of setting highly achievable budgets

• Conflict between planning and motivational purposes.

• Psychological benefits (e.g.achievement and self-esteem).
• Shields managers from adverse impact of environmental changes.
• Alleviates harmful side-effects of controls.

Determining how much influence managers should have in setting

standards

• Advantages of participation in the setting of performance standards:

1. Targets more likely to be accepted
2. Reduces the information asymmetry gap
3. Reduces negative attitudes and dysfunctional behaviour

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
16.13b

• Empirical studies provide conflicting evidence on the effectiveness of

participation.

• Factors influencing the effectiveness of participation:

1. Personality variables:
• Authoritarianism
• Locus of control
2. Work situation
3. Job difficulty

• Limitations on the positive effects of participation:

1. Budgetee has the opportunity to negotiate lower targets.
2. Depends on personality traits and work situation.
3. A top down approach may be preferable where a large number of
similar units exist.

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
16.14a

Side-effects arising from using accounting information for performance evaluation

• Hopwood observed three different styles of managerial use of accounting

information for performance evaluation:
1. A budget-constrained style
2. A profit-conscious style
3. A non-accounting style

• Hopwood ’s findings
Style of evaluation
Budget- Profit- Non-
constrained conscious accounting

Involvement with costs High High Low

Job-related tension High Medium Medium
Manipulation of
accounting information Extensive Little Little
Relations with superior Poor Good Good
Relations with colleagues Poor Good Good

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury
16.14b

• Otley replicated Hopwood ’s study and found no significant differences in

terms of budget-constrained and profit-conscious styles in terms of
undesirable behaviour.

• Conflict in findings attributed to differences in managerial

interdependency and task uncertainty.

Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8

© 2000 Colin Drury
© 2004 Colin Drury