Horngren Ima15 Im 09

Chapter 9
Management Control Systems and

Responsibility Accounting
LEARNING OBJECTIVES:
When your students have finished studying this chapter, they should be
able to:
1. Describe the relationship of management control systems to

organizational goals.
2. Explain the importance of evaluating performance and describe

how it impacts motivation, goal congruence, and employee effort.
3. Develop performance measures and use them to monitor the

achievements of an organization.
4. Use responsibility accounting to define an organizational subunit as

a cost center, a profit center, or an investment center.
5. Prepare segment income statements for evaluating profit and

investment centers using the contribution margin and controllable-
cost concepts.
6. Measure performance against nonfinancial performance measures

such as quality, cycle time, and productivity.
7. Use a balanced scorecard to integrate both financial and

nonfinancial measures of performance.
Copyright ©2011 Pearson Education, Inc., Publishing as Prentice Hall. 116

8. Describe the difficulties of management control in service and
nonprofit organizations.
CHAPTER 9: ASSIGNMENTS
CRITICAL THINKING EXERCISES
28. Management Control Systems and Innovation

29. Municipal Responsibility Accounting
30. Control Systems and Customer Service Function of the
Value Chain
31. Control Systems and the Production Function of the
Value Chain
32. Key Performance Indicators
EXERCISES
33. Responsibility for Stable Employment Policy

34. Salesclerk’s Compensation Plan
35. Common Measures on a Balanced Scorecard
36. Goals and Objectives at Health Net
37. Performance Evaluation
38. Simple Controllable Costs
39. Quality Theories Compared
40. Quality Control Chart (EXHIBIT 9-8)
41. Cycle-Time Reporting
PROBLEMS
42. Multiple Goals and Profitability

43. Responsibility Accounting, Profit Centers, and
Contribution Approach
44. Incentives in Planned Economies
45. Balanced Scorecard

46. Quality Cost Report (EXHIBIT 9-7)
47. Six Sigma, Mean, and Variance
48. Productivity
49. Productivity Measurement
CASES
50. Trade-Offs Among Objectives

51. Six Sigma
52. Review of Chapters 1-9
53. Nike 10-K Problem: Strategy at Nike
EXCEL APPLICATION EXERCISE
54. Wages for New Salary-Plus-Bonus Plan
COLLABORATIVE LEARNING EXERCISE
55. Goals, Objectives, and Performance Measures
INTERNET EXERCISE
56. Management Control System at Procter & Gamble

(http://www.pg.com)

CHAPTER 9: OUTLINE
I. Management Control Systems
The foundation for control is the planning process. The outcome of

planning provides the basis for control. Management Control
System (MCS) - a logical integration of management accounting
tools to gather and report data and to evaluate performance. See
EXHIBIT 9-1 for the components of an MCS. The purposes of an
MCS are:
1. clearly define and communicate the organization’s goals.

2. ensure that every manager and employee understands the
specific actions required of him/her to achieve organizational
goals.
3. communicate results of actions across the organization.
4. motivate managers and employees to achieve the
organization’s goals.
A. Management Control Systems and Organizational

Goals {L. O. 1}
A well-designed MCS aids and coordinates the process of
making decisions and motivates individuals throughout the
organization to work toward the same goals. It also
coordinates forecasting revenue- and cost-driver levels,
budgeting, measuring and evaluating performance.
See EXHIBIT 9-2 for a description of the process of setting

goals, objectives, and performance measures. Overall
company goals, objectives, and performance measures are
set by top management, not changed often, and reviewed on
a periodic basis (usually once a year). Goals answer the
question, “What do we want to achieve?” However, goals
without measures do not motivate managers. Targets for
goals are specific quantified levels of the measures.
Goals and measures are often too vague to provide guidance.

Therefore, critical processes and critical success factors are
used. Critical Processes - series of related activities that
directly affect the achievement of organizational goals (e.g.,

the goal “exceed guest expectations” would have “produce
and deliver services” as a critical process). Critical (Key)
Success Factors - actions that must be done well in order to
drive the organization toward its goals (e.g., timeliness is a
critical success factor for the “produce and deliver services”
process and is measured by check-in time, check-out time,
and response time to guest requests). Managers often face
trade-off decisions with measures.

II. Designing Management Control Systems and
Organizational Goals
A. Motivating Employees to Achieve Goal Congruence

and Exert Managerial
Effort Through Rewards {L. O. 2}
To achieve maximum benefits at minimum costs, an MCS
must foster goal congruence and managerial effort. Goal
Congruence - individuals and groups aiming at the same
organizational goals. It occurs when employees, working in
their perceived best interest, make decisions that meet the
overall goals of the organization. Managerial Effort -
exertion toward a goal or objective. Effort means not only
working faster, but also working better (i.e., more efficient
and effective).
Incentives must be incorporated in the MCS to encourage

goal-congruent behavior and managerial and employee effort.
Performance evaluation along with bonuses tied to the
achievement of objectives may help in this area. Motivation
- aiming for some selected goal together with the resulting
drive (effort) that creates action toward that goal.
B. Developing Performance Measures {L. O.

3}
Both financial and nonfinancial measures of performance are
important in achieving an organization's objectives. Common
to good performance measures are that they will:
• Relate to the goals of the organization

• Balance long-term and short-term concerns
• Reflect the management of key actions and activities
• Be affected by actions of managers and employees
• Be readily understood by employees
• Be used in evaluating and rewarding managers and
employees
• Be reasonably objective and easily measured
• Be used consistently and regularly

Consideration of nonfinancial measures of performance can
improve operational control. These nonfinancial measures
may be more timely, and more easily understood and closely
affected by employees at lower levels of the organization,
where the product is made or services are rendered.
Activities are now stressed that drive revenues and costs,
instead of explaining the financial measures after the activity
has occurred. The effects of nonfinancial measures of
performance typically are not seen in the financial measures
until considerable ground is lost. Financial measures are
lagging indicators that arrive too late to help prevent
problems and ensure the organization’s health.
C. Monitoring and Reporting Results
A key driver of enterprise performance is the culture within

the company that fosters continual learning and growth at all
levels of management. Improvement in business processes
must take place across all parts of the value chain. The
performance-reporting system, if effective, aligns results with
managers’ goals and objectives, provides guidance to
managers, communicates goals and their level of attainment
throughout the organization, and enables organizations to
anticipate and respond to change in a timely manner (see
EXHIBIT 9-3)
D. Weighing of Costs and Benefits
Designers of an MCS must also weigh the costs and benefits

of various alternatives. These are often difficult to measure,
and both may become apparent only after experimentation or
use.
III. Controllability and Measurement of Financial

Performance
MCS often distinguish between controllable and uncontrollable

events and between controllable and uncontrollable costs. Usually,
responsibility center managers are in the best position to explain
their center's results even if the managers had little influence over
them.

Uncontrollable Cost - cannot be affected by the management of
a responsibility center within a given time span. Controllable
Costs - influenced by a manager's decision and actions. Costs that
are completely uncontrollable tell nothing about a manager's
decisions and actions because, by definition, nothing the manager
does will affect the costs. Uncontrollable costs should be ignored in
evaluating a manager's performance, while controllable costs
should be used. Activity-based costing is helping companies to
identify controllable costs.
A. Identifying Responsibility Centers {L. O. 4}

Responsibility Center - a set of activities assigned to a
manager, a group of managers, or a group of employees.
An effective MCS gives each lower-level manager

responsibility for a group of activities and objectives and then
reports on:
1. the results of activities

2. the manager's influence on those results
3. effects of uncontrollable events
Responsibility Accounting - identifies what parts of the

organization have primary responsibility for each objective,
develops performance measures and targets to achieve, and
designs reports of these measures by organization subunit, or
responsibility center.
Responsibility centers usually are classified according to their

financial responsibility.
1. Cost Centers, Profit, and Investment Centers
Cost Center - a responsibility center in which a

manager is accountable for costs only (e.g., accounting
department). Its financial responsibilities are to control
and report costs only.
Profit Center - responsibility for controlling

costs (or expenses) as well as revenues (e.g., marketing

department). Nonprofit organizations whose goal is to
break even are also considered profit centers since they
have responsibilities for both revenues and costs.
Investment Center - success is measured

not only by its income but also by relating that income
to its invested capital, as in a ratio of income to the
value of the capital employed. This term is not widely
used in practice. Instead, these responsibility centers
are typically referred to simply as profit center.
B. Contribution Margin {L. O. 5}

Many organizations combine the contribution approach to
measuring income with responsibility accounting (i.e., report
by cost behavior as well as by degrees of controllability). Line
a of EXHIBIT 9-5 gives the contribution margin for each of
the various segments of a retail grocery store. The relevant
segments of the company’s organization chart are shown in
EXHIBIT 9-4.

C. Contribution Controllable by Segment Managers
Line b in EXHIBIT 9-5 gives the contribution controllable by

segment managers. Managers of the various segments may
have control over certain advertising, sales promotion,
salespersons' salaries, management consulting, training and
supervision costs that are deducted from the segment
contribution margin to yield the contribution controllable by
segment managers. When service department costs are
allocated, charges are made for division headquarters, or
store depreciation or lease costs are determined. No easy
answers exist regarding if, and how much of, these costs are
controllable by segment managers.
D. Contribution by Segments
Fixed expenses (e.g., depreciation, property taxes, insurance,

and perhaps the segment manager's salary) are not under the
control of the segment manager. These costs are deducted
from the contribution controllable by segment managers to
give the contribution by segments. Line c in EXHIBIT 9-5
shows segment contributions for a retail grocery store, which
approximate the financial performance of the segments, as
distinguished from the financial performance of its manager,
which is measured in line b.
E. Unallocated Costs
Central corporate costs (e.g., top management and some

corporate-level services, such as legal and taxation) are
frequently not allocated to segments unless a persuasive
cause and effect, or activity-based justification for allocation
of these costs.
IV. Measurement of Nonfinancial Performance
A. Control of Quality {L. O. 6}

Quality Control - the effort to ensure that products and
services perform to customer requirements. In the traditional
approach to maintaining the desired level of quality in the
U.S., companies inspected completed products, and rejected

or reworked those that failed inspection. Due to the expense
of inspection, only a sample of products was tested. The
production process was judged to be in control as long as the
number of defective products did not exceed an acceptable
quality level. This meant that some defective products could
still make their way to customers.
Due to competitive pressures, and seeing the success of

Japanese products, U.S. companies have learned that the
traditional approach is extremely costly. The resources
consumed in making and detecting defective parts are a
waste, and considerable rework may be necessary to correct
the defects. It is also very costly to repair products in use by
customers or to win back a dissatisfied customer. Quality
Cost Report - displays the financial impact in quality. See
EXHIBIT 9-7 for Eastside Manufacturing Company’s quality
cost report. There are four categories of quality costs:
1. Prevention - costs incurred to prevent the production

of defective products or deliver substandard services,
including engineering analyses to improve product
design for better manufacturing, improvements in
production processes, increased quality of material
inputs, and programs to train personnel
2. Appraisal - costs incurred to identify defective products

or services including inspection and testing
3. Internal Failure - costs of defective components, and

final products or services that are scrapped or reworked
4. External Failure - costs caused by delivery of

defective products or services to customers, such as
field repairs, returns, and warranty expenses
The costs stated in reports typically understate the true

quality costs since lost sales are not included due to
measurement difficulty.
In recent years, more companies are taking the total quality

management (TQM) approach to quality control. Total
Quality Management - concentrates on the prevention of

defects and on customer satisfaction and is the application of
quality principles to all of the organization’s endeavors to
satisfy customers. The TQM approach is based on the
assumption that the cost of quality is minimized when a firm
achieves high quality levels. TQM delegates the
responsibilities for many management functions to
employees. For it to be successful, employees must be very
well trained in the process, the product or service, and the use
of quality-control information.
In TQM, employees are trained to prepare, interpret, and act

on quality-control charts, like that shown in EXHIBIT 9-8.
Quality-Control Chart - statistical plot of measures of
various product dimensions or attributes. The plot helps to
detect process deviations before the process generates
defects and identifies excess variation in product dimensions
or attributes that should be addressed by process or design
engineers.
The most recent trend in quality control is six sigma, an

analytical method aimed at achieving near-perfect results on
a production line. Literally, six sigma requires fewer than 3.4
defects per million. The focus is on measuring how many
defects a company has in its process because once it
measures the defects, it can take steps to eliminate them.
B. Control of Cycle Time
Cycle Time (or Throughput Time) - the time taken to

complete a product or service, or any of the components of a
product or service. It is a summary measure of
manufacturing efficiency and effectiveness, and is an
important cost driver. The longer a product or service is in
process, the more costs are consumed. Lowering cycle time
requires smooth-running processes and high quality, and also
creates increased flexibility and quicker reactions to customer
needs. As cycle time is decreased, quality problems become
apparent throughout the process and must be solved if quality
is to improve. Decreasing cycle time also results in bringing
products or services more quickly to customers, a service
customers’ value. The use of bar coding can be used to
measure cycle times. Reports for cycle times, such as that in

EXHIBIT 9-10, can be prepared to alert managers' attentions
to cycle-time problem areas.
C. Control of Productivity
Productivity - a measure of outputs divided by inputs. The

fewer inputs needed to produce a given output, the more
productive the organization. Companies differ as to which
measures of input are most important depending on whether
they are labor-intensive, machine-intensive, or material-
intensive organizations. Examples of different types of
productivity ratios are given in EXHIBIT 9-11.
D. Choice of Productivity Measures
The productivity measures companies choose to manage

depend on the behaviors desired. Sometimes myopic
attention to one or a few measures comes at the expense of
others, resulting in the endangerment of the long-run
profitability of a firm. Rather than specify productivity goals,
managers may concentrate their control on the more
fundamental activities of quality and service. Then the
productivity measures can be used to monitor the actual
benefits of improvements in these activities.
E. Productivity Measures Over Time
Be careful in comparing productivity measures over time

because process changes or inflation can make them
misleading.
F. The Balanced Scorecard {L. O. 7}

Balanced Scorecard - performance measurement and
reporting system that strikes a balance between financial and
operating measures, links performance to rewards, and gives
explicit recognition to the diversity of stakeholder interests.
Line managers can understand the numbers presented due to
the use of nonfinancial measures. The balanced scorecard
focuses on performance measures from across the spectrum
of the organization. This enhances the learning process
because managers are made aware of the results of actions

and how these actions are linked to the organizational goals.
The classic balanced scorecard includes key performance
indicators – measures that drive the organization to meet its
goals – grouped into four categories (see EXHIBIT 9-11):
1. Financial
2. Customers
3. Internal Processes
4. Employee Growth and Learning
IV. Management Control Systems in Service,

Government, and Nonprofit Organizations {L. O.
8}
Service, government, and nonprofit organizations have more
difficulty implementing management control systems than do
manufacturing firms because their outputs are more difficult to
measure. Nonprofit and governmental agencies have the additional
problem of not having a financial "bottom line" as an objective.
Also, many people in nonprofit organizations seek their positions for
reasons other than monetary rewards (e.g., the desire to help
improve conditions in underdeveloped countries). There are six
reasons why control systems will probably not be as highly
developed in nonprofit organizations as they are in profit-seeking
firms.
1. Organizational goals are less clear and multiple, which

requires difficult tradeoffs.
2. Professionals dominate and have been less receptive to the

installation and improvement of a formal control system.
3. Measurements are more difficult because there is no profit

measure and there are many discretionary fixed costs, which
makes the relationships of inputs to outputs difficult to specify
and measure.
4. There is less competitive pressure to improve management

control systems.
5. The role of budgeting is often more a matter of playing

bargaining games with sources of funding than it is
rigorous planning.
6. Motivations and incentives of individuals differ from those

in for-profit organizations.
VI. Future of Management Control Systems
Certain management control principles that can guide the redesign

of systems to meet new management needs follow:
1. Always expect that individuals will be pulled in the direction of

their own self-interest.
2. Design incentives so those individuals who pursue their own

self-interests are also achieving the organization's objectives.
When multiple objectives are present, multiple incentives are
appropriate.
3. Evaluate actual performance based on expected or planned

performance, revised, if possible, for actual output achieved.
4. Consider nonfinancial performance to be an important

determinant of long-term success.
5. Array performance measures across the entire value chain of

the company.
6. Periodically review the success of the management control

system. Are objectives being met? Does meeting the
objectives mean that subgoals and goals are being met too?
Do individuals have, understand, and use the management
control information effectively?
7. Learn from management control successes (and failures) of

competitors around the world. Despite cultural differences,
human behavior is remarkably similar. Successful
applications of new technology and management controls
may be observed in the performance of others.

CHAPTER 9: Quiz/Demonstration
Exercises
Learning Objective 1
1. A management control system is distinguished from a purely

accounting system by _____.
a. its focus on motivation and evaluation of performance

consistent with the organization's goals
b. its focus on organizational goals and objectives
c. its focus on internal management decision making
d. all of the above
2. Which of the following affects all components of a management

control system?
a. feedback
b. progress measurement
c. learning
d. A, B, and C
e. A and C
3. In order to encourage goal-congruent behavior and to motivate

managerial effort, a management control system must include
_____.
a. ultimatums from top management regarding the

accomplishment of short-run profitability without regard to
long-run consequences
b. organizational goals that are not rewarded by the
performance evaluation and incentive structure of the firm
c. a performance evaluation and incentive structure inconsistent
with the organization's goals
d. none of these
4. A management control system must foster _____.
a. goal congruence
b. managerial effort

c. individuality
d. A and B
e. B and C
5. Good performance measures will not be _____.
a. readily understood
b. easily measured
c. used to evaluate managers
d. concerned with only long-term goals
6. Which of the following is a financial measure?
a. number of defects
b. number of customer complaints
c. amount of wasted materials by employee
d. required return on investments
7. Which of the following responsibility centers does not have

accountability for revenues?
a. investment centers
b. cost centers
c. profit centers
d. none of the above
8. Which of the following is an example of a cost center?
a. a division
b. a subsidiary
c. a plant
d. an accounting department
9. In a segment income statement prepared using the contribution

margin format, the key measure that is used to evaluate managers
of the segments is _____.

a. contribution margin
b. contribution by segments
c. unallocated costs
d. contribution controllable by segment managers
10. An example of an uncontrollable cost to a raw materials

supervisor is _____.
a. quality costs
b. ordering errors
c. information system support cost
d. shipping costs
11. A quality cost report details the various costs of maintaining and
selling quality products to customers and includes which of the
following four categories?
a. promotion, detention, suspension, and retention

b. recision, derision, provision, and sedition
c. prevention, appraisal, internal failure, and external failure
d. elevation, degradation, normalization, and interpretation
12. An example of an external failure cost is _____.
a. warranty costs
b. scrap costs
c. a decrease in the quality of material inputs
d. inspections costs
13. In order for a company to improve its productivity, it must _____.
a. produce more outputs for the level of inputs used

b. produce fewer outputs for the level of inputs used
c. use more inputs to produce the same level of output
d. use more inputs to produce fewer outputs
14. The classic balanced scorecard’s key performance indicators

include _____.
a. financial
b. employee growth and learning
c. external processes
d. A and B
e. A, B, and C
15. Which of the following examples does not measure financial

performance?
a. market share
b. working capital
c. inventory turnover
d. all of the above
16. Service and nonprofit organizations have more difficulty in

implementing management control systems than do manufacturing
firms because _____.
a. they have no goals

b. their outputs are more difficult to measure
c. they are concerned with the satisfaction of their customers
d. their managers are less sophisticated and do not understand
the purpose and use of management control systems
17. Service and nonprofit organizations differ from profit-seeking

organizations because in service and nonprofit organizations,
_____.
a. organizational goals and objectives are more easily

determined
b. discretionary costs are usually small
c. less competitive pressure is exerted from other nonprofit
organizations
d. budgeting is less of a bargaining game

CHAPTER 9: Solutions to
Quiz/Demonstration Exercises
1. [d] 2. [e] 3. [d] 4.
[d]
5. [d] 6. [d] 7. [b] 8.

[d]
9. [d] 10. [c] 11. [c} 12.

[a]
13. [a] 14. [d] 15. [a] 16.

[b]
17. [c]

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Chapter 9

Management Control Systems and

1. Describe the relationship of management control systems to

2. Explain the importance of evaluating performance and describe

3. Develop performance measures and use them to monitor the

4. Use responsibility accounting to define an organizational subunit as

5. Prepare segment income statements for evaluating profit and

6. Measure performance against nonfinancial performance measures

7. Use a balanced scorecard to integrate both financial and

Copyright ©2011 Pearson Education, Inc., Publishing as Prentice Hall. 116

CRITICAL THINKING EXERCISES

28. Management Control Systems and Innovation

33. Responsibility for Stable Employment Policy

42. Multiple Goals and Profitability

Copyright ©2011 Pearson Education, Inc., Publishing as Prentice Hall. 117

50. Trade-Offs Among Objectives

EXCEL APPLICATION EXERCISE

54. Wages for New Salary-Plus-Bonus Plan

COLLABORATIVE LEARNING EXERCISE

55. Goals, Objectives, and Performance Measures

56. Management Control System at Procter & Gamble

Copyright ©2011 Pearson Education, Inc., Publishing as Prentice Hall. 118

The foundation for control is the planning process. The outcome of

1. clearly define and communicate the organization’s goals.

A. Management Control Systems and Organizational

See EXHIBIT 9-2 for a description of the process of setting

Goals and measures are often too vague to provide guidance.

Copyright ©2011 Pearson Education, Inc., Publishing as Prentice Hall. 119

Copyright ©2011 Pearson Education, Inc., Publishing as Prentice Hall. 120

A. Motivating Employees to Achieve Goal Congruence

Incentives must be incorporated in the MCS to encourage

B. Developing Performance Measures {L. O.

• Relate to the goals of the organization

Copyright ©2011 Pearson Education, Inc., Publishing as Prentice Hall. 121

C. Monitoring and Reporting Results

A key driver of enterprise performance is the culture within

D. Weighing of Costs and Benefits

Designers of an MCS must also weigh the costs and benefits

III. Controllability and Measurement of Financial

MCS often distinguish between controllable and uncontrollable

Copyright ©2011 Pearson Education, Inc., Publishing as Prentice Hall. 122

A. Identifying Responsibility Centers {L. O. 4}

An effective MCS gives each lower-level manager

1. the results of activities

Responsibility Accounting - identifies what parts of the

Responsibility centers usually are classified according to their

1. Cost Centers, Profit, and Investment Centers

Cost Center - a responsibility center in which a

Profit Center - responsibility for controlling

Copyright ©2011 Pearson Education, Inc., Publishing as Prentice Hall. 123

Investment Center - success is measured

B. Contribution Margin {L. O. 5}

Copyright ©2011 Pearson Education, Inc., Publishing as Prentice Hall. 124

Line b in EXHIBIT 9-5 gives the contribution controllable by

Fixed expenses (e.g., depreciation, property taxes, insurance,

Central corporate costs (e.g., top management and some

IV. Measurement of Nonfinancial Performance

A. Control of Quality {L. O. 6}

Copyright ©2011 Pearson Education, Inc., Publishing as Prentice Hall. 125

Due to competitive pressures, and seeing the success of

1. Prevention - costs incurred to prevent the production

2. Appraisal - costs incurred to identify defective products

3. Internal Failure - costs of defective components, and

4. External Failure - costs caused by delivery of