MANAGEMENT CONTROL SYSTEMS

Every organization has some goals

 These Goals can be accomplished depending on how well individuals in groups perform their tasks.

Management control system attempts to bring this integration & is important for the success of any organization.

CONCEPTS OF MANAGEMENT CONTROL SYSTEMS

1. CONTROL 2.MANAGEMENT 3.SYSTEMS

CONTROL

 Control in simple terms is explained with the example of a vehicle. The Driver controls the vehicle with 3 devices &reaches his destination.

SIMPLE EXAMPLE OF CONTROL SYSTEM

They are Accelerator- speed /fast

Break-stop/slow Steering Wheel- Change Direction.

If any one is not working vehicle out of control.

CONTROL IN ORGANIZATION
An organization is also controlled by the devices to ensure that goals are achieved. However control in organization is more complex than controlling the vehicle.

ELEMENTS OF CONTROL SYSTEM

Every Control system has at least 4 elements. Detector or Sensor

Assessor
Effectors communication net work

4 Elements
Detector or Sensor : A device that measures , What is actually happening in the situation. An Assessor: Comparison between Standard & actual.

An Effectors : To change or alter behavior. If needed after feedback.

A communication Net work : Transfer information between the detector & the assessor , Assessor & Effectors.

METAPHORS
Concept of Control can be explained with some of the well known Metaphors. THERMOSTAT BODY TEMPERATURE AUTOMOBILE DRIVER

Thermostat

Body Temperature

MANAGEMENT
Group of people in an organization work together to achieve certain common goals(satisfactory profit) Except CEO every manager is a boss & subordinate.

The CEO decides strategies to achieve organizational goals.

Functional/departmental managers /unit managers formulate additional strategies , to enable their Departments to attain the goals.

Differences between simple & organizational control

Almost similar except the following: Unlike the Thermostat & body temperature systems ,standard is not preset ,rather it is a result of continuous planning & control , both are involved in management control. Mgt control is not automatic only some detectors may be mechanical , but managers find information personally & warrant action if necessary . MGT control requires coordinators , unlike automobile is controlled by single individual .

A Manager acting as assessor may not be predicted in action ,( high Costs) ,Black BOX.
MGT Control is a self control , not by external devices use their own judgment.

Black box

SYSTEMS

SYSTEMS
System is prescribed or repeated way of carrying out an activity or a set of activities. Recurring in nature , coordinated series of steps followed to achieve the goals.

Example Thermostat ,Body temperature.

Many management actions are Unsystematic, managers regularly encounter situations for which the rules are not well defined ,use their judgment in deciding the actions.

Effectiveness of their actions is determined by their skill in dealing with people ,not by Rule specific to the system.

CHARACTERISTICS OF MCS
The concept of mgt was captured by the catch phrase POSDCORB. This fundamental definition sums up the essence of the nature &purpose of mgt control.

DEFINITION BY ANTHANY &DEARDEN(1981)

Mgt control is the process by which managers assure that resources are obtained &used effectively & efficiently in the accomplishment of organizational goals.

ANTHONY & GOVINDARAJU

Mgt control is the process by which managers influence other members of the organization to implement organizations strategies.

CHARECTERISTICS --- MGT CONTROL ACTIVITIES

Mgt involves variety of activities. planning-what organization should do

Coordinating the parts of several parts of the organization. Communicating information Evaluating information

Deciding the action to be taken if needed

Influencing people to change behavior.

RESPONSIBILITY CENTER

RESPONSIBILITY CENTERS

Responsibility centers
The term responsibility center is used to denote any organization unit headed by responsible managers. Company is a collection of responsibility centers . Responsibility centers form hierarchy , At the lowest level are sections, shifts etc. At the higher level each department is a RC.

For Board of Directors & top management total organization is a RC.

The RC objective is to achieve organizational goals. A RC Uses inputs such as material labor hours ,varieties of services to achieve goals, uses working capital. Equipment & other assets fort this purpose & produces outputs such as goods or services. Goods or services produced by a RC may be used by another RC or by outside world.

INPUTS
RESPONSIBILITY CENTER/ORGANIZATION

ESSENCE OF RC
Relationship between inputs & outputs: 1. Mgt is responsible for ensuring optimum relationship between inputs &outputs. 2. In some centers like Production responsibility is direct example input of raw material becomes part of finished goods. 3. Control focus is easy as per quality standards specifications or not. 4. In some cases inputs are not directly related to output example Advertising based on judgment not on data. 5. Another example R&D ,where results are known after a long period of time.

Measuring inputs & outputs

In most of the RCs inputs can be stated in physical terms like labor hours , quarts of oil reams of paper & kilowatt of electricity which is converted in to monetary terms. Expressed as input cost. Inputs are resources used by RCs ,patients & students are not inputs. Input cost is easily measured than output cost Example input costs like advertising ,R&D , HR training may not affect output of that year in which expenditure is incurred ,here input cost is the criteria.

Efficiency
Measure of performance related to establishment of standards regard to amounts of inputs used over a specific period of time for a given level of output and measure actual with standard. Example standards of labor &material in production unit. Comparison of RC efficient than RCB.

PROCESS MEASUREMENT OF PERFORMANCE

The emphasis is on process rather than final output . Example production process not output delivered.

EFFECTIVENESS AS MEASURE OF PERFORMANCE

Effectiveness is measured by output & objectives achieved. More contribution to objectives by RC effective.

THE ROLE OF PROFIT

Profit is an important measure of effectiveness. Profit is the difference between revenue & expense (output &input). Thus profit measures both effectiveness &efficiency

PURPOSE OF RCs
The idea behind RC is to distribute responsibility for various elements of ROI to the decentralized organizational subunits RC measures elements of cost ,quality revenue & investment assigned to that RC Rewards in accordance to performance Combination of RC ,measures of performance & rewards ,knits together decision making of decentralized system ,to effectively achieve organizational profits that include Profit & ROI. ROI = Net Profit After TAX Invested Capital

TYPES OF RCs
4 types of RCs classified on the basis of nature of the monetary inputs & outputs measured for control purposes. Revenue centers --- Output measured in monetary terms.

Expense center ----- Inputs measured in monetary terms.

Profit center --- Both Revenues & Expenses (outputs &inputs ) are measured in monetary terms. Investment Center --- Relation ship between Profit & Investment measured.

TYPES OF RCS

EXAMPLES OF RESPONSIBILITY CENTERS

REVENUE CENTER
Revenue is a monetary measure of output. The output of RC is measured in terms of money. No formal attempt to relate inputs to outputs. Example : Marketing department , orders booked & sales are compared with budgeted sales. Not responsible for profits. Efficiency here is measured by revenues compared with budget. No authority to fix selling price. RC head is responsible for expenses incurred. No relationship between inputs &outputs.

Revenue generators of themes park

EXPENSE CENTER
Expense centers are RCs where inputs, or expenses are measured in monetary terms, not output. Every organizational unit has outputs, however some of them are not measurable in monetary terms. Example HR .

DIFFERENCE BETWEEN EXPENSE & COST CENTERS

Expense center headed by responsible manager. cost center is a location , person or item of equipment for which costs are ascertained. No responsible manager is required in cost center. Example :In coil Winding Department manufacturing chokes , coil winding machine is cost center & coil winding Department is Expense center.

TYPES OF EXPENSE CENTERS

Two types. Engineered expense center

Discretionary expense center

These expenses correspond to two types of costs namely Direct cost & Indirect cost or judgment based costs.

ENGINEERED EXPENSE CENTER

Right amount of costs incurred can be accurately estimated. Input can be measured in terms of money & outputs measured in physical terms. Optimum amount of inputs required to produce one unit of output can be established. They are also known as Engineered cost.

Example : Direct Material , Direct Expenses , Direct Expenses.

RELATION BETWEEN INPUTS & OUTPUS OF ENGINEERED CENTER

Optimal relation can be established between inputs & outputs. Generally found in manufacturing units. Examples : some RCs of Administrative & support Departments like Ware Housing , Transport , Distribution , Payments section .

DISCRETIONARY COST
It is the cost which depends on Management judjement,circumstanses determine what is accurate. Example induction ,Training i.e. HRD Accounting , legal industrial relations departments. Optimal relation between inputs &outputs can not be established like Engineered cost. Depends on Management judgment.

EXAMPLES OF DC
The proper level of DC is subject to change in this dynamic world.

Generally when new management changes there will be lot of change

Example : When John F. Welch Jr became the CEO OF General Electric of U.S.A Staff reduced from 1700-1000 Broke bond(I) Ltd acquired Lipton (I) Ltd Staff reduced. Hence DC reduced. The budged input &actual input cost differences measures efficiency of RC. However output value can not be measured.

PROFIT CENTERS
Revenue is a measure of output & Expense is a measure of input in monetary terms. Profit is the difference between Revenue & expenses. In profit center both inputs & outputs are measured in monetary terms.

In financial accounting revenue is recognized only when it is realized.

In Management accounting revenue can be defined as the value of output whether realized or not. Example Factory may be a profit center selling to sales Maintenance sell services to other departments. Inputs & outputs are related .

INVESTMENT CENTER
The manager is expected to earn a satisfactory return on capital employed. An Investment center is a RC where manager is responsible for effective utilization of assets as well as for revenues &expenses.

TRANSFER PRICING
Transfer Pricing is the mechanism for distributing revenue from one profit center to another profit center. If two or more profit centers are jointly responsible for product development , manufacturing & marketing.

Each should share the revenue generated when the product is finally sold.

TRANSFER PRICING

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MEANING &CONCEPT
Today many organizations are decentralized , one of the challenges of decentralization is transfer of goods & services in a satisfactory accounting method. The goods & services should be transferred from one profit center to another in companies with more number of transactions by proper negotiations & arbitration.

OBJECTIVES
The Transfer price is designed to accomplish the following objectives. Economic performance of the individual business units is measured. Induce Goal Congruent decisions- decisions should improve unit profits which improves company profits.

Provide information regarding company's costs &revenues (optimum trade off between them)
The system should be simple to understand & easy to administer.

METHODS OF TRANSFER PRICING

MARKET PRICE METHOD ACTUAL COST WITH OR WITHOUT PROFIT VARIABLE COST NEGOTIATED PRICE

MARKET PRICE METHOD

COST BASED TRANSFER PRICES

Transfer prices are established on the basis of cost or cost plus a profit in case competitive prices are not available. The calculations are however complicated. It is inferior to market based prices. Widely used in USA,UK,JAPAN,CANADA&INDIA. In cost based prices 2 decisions are taken. How is Cost defined? How is Profit markup computed?

 Actual Cost basis: Based only on cost of production ,does not include Advertisement,Baddebts ,financing etc. Popular in USA , UK,JAPAN,CANADA,&INDIA.

STANDARD COST: Predetermined cost ,based on management assessment

Variances between Standard & Actual is taken by vendor, not passed to the buyer. Eliminate Advertisement,Baddebts,financial expenses .

Cost plus markup

Recover all costs plus a markup or allowance for profit. 2 decisions are to be made while calculating the profit mark up Base for computing profit markup. Level of profit allowed.

Base for computing profit markup

As far as base for computing profit mark up(% of costs is one of them. Simple to understand Easy to use & as a result it is widely used.

PROFIT MARKUP IS THE LEVEL OR AMOUNT OF PROFIT

Financial performance of a profit center is judged by the profit it earns. Hence profit allowance should be such that it ensures that the business unit earns a rate of return as if it were an independent firm selling to external customers. The profit allowance should be calculated on the investment necessary to produce products required by purchasing from profit centers.

The calculation of investment required would be done at a standard level with inventories & fixed assets being valued at current replacement costs.

MERITS & DEMERITS

Facilitates inter firm comparison as profit & return are good indicators ,profit is the main yardstick on the basis of which the efficiency of management is judged. Demerit: The inclusion of profit in closing stocks are not allowed by statutory Auditors.

VARIABLE COST METHOD

Actual variable costs are considered. The method provides lowest price at which the transfers are made. This method is the best ,as it has the major advantage of ensuring the best utilization of facilities as contribution margin is used as a basis for decision making. Contribution margin is a useful concept especially because fixed costs remain constant in the short run & can not be ignored. In short run it may be profitable where as in long run it may be unprofitable. supply division reports zero profits are loss equal to fixed cost. Performance evaluation of the division becomes difficult & meaningless as fixed costs are yet to be recovered.

NEGOTIATED PRICE
Periodical meetings between the representatives of selling & purchasing units Make decisions on external selling prices & on the sharing of profits in respect of products which have major amount of upstream fixed costs & profit Formal mechanism must be established. Review

MERITS & DEMERITS

Effective method DEMERIT Review process may go beyond profit center decision where work is ceased.

SERVICE ORGANIZATIONS
The service sector plays a dominant role in the economy of developed countries. It contributes towards major contribution of their Gross Domestic Product & provides more employment opportunities than any other sector. In India the share of service sector in GDP increased from 42-48%.

Where as agricultural sector decreased from 30% to 24%.

UNIT-4 MGT CONTROL IN SERVICE ORGANIZATIONS

CHARACTERISTICS OF SERVICE ORGANIZATIONS IN GENERAL : 1. Absence of inventory buffer Goods in mfg organizations can be stored as buffer. Services can not be stored. The goods in stores can generate Example : Air plane seat ,Hotel room ,Hospital operating room , hours of lawyers scientists , & other professionals

 The cost of service organizations are fixed for short run. In the short run costs can not be reduced. Example hotel closing some of the rooms. Professional organizations can not lay off employees, as it effects morale of employees. key variable in service organizations is current capacity matching with demand. Adjust current work force with anticipated demand by training employees in slack seasons& work long in busy hours.

Difficulty in controlling quality: A mfg co inspects the product before delivery . Not possible in service Should be judged at the time of rendering service may be subjective than objective.

LABOUR INTENSIVE
Most service organizations are labor intensive than Equipment In hospitals expensive may be used but it is to provide better treatment to patients.

MULTI UNIT ORGANIZATIONS

Some service organizations operate many units in various locations Example Fast food restaurant , gasoline service stations Some of them are owned , others operate as franchise

Similar can be analyzed with common base for analyzing budgets & evaluating performance.
However caution should be taken while making comparisons. Differences in the resources used by the units. Differences in the composition of services.

Differences in miscellaneous factors.

HISTORICAL DEVELOPMENT
Cost accounting was adopted in mfg cos to value work in progress & finished goods inventories for financial statements They are used to determine selling prices& for other mgt purposes. Service organizations except rail &other regulated industries no need to develop cost data. Product cost &other mgt accounting data is fairly recent.

PROFESSIONAL SERVICE ORGANIZATIONS

Health care organizations , Research & Development organizations , Law FIRMS , Accounting firms , Architectural firms , Consulting firms ,Advertising agencies are professional services

HEALTH CARE ORGANIZATIONS

Nursing homes Hospitals Medical Laboratories ,Medical clinics health maintenance organization. Many of them have profit as the main objective. They exhibit some special features which differentiates them from other organizations.

CHARECTERISTICS OF HCO
QUALITY CONTROL IS IMPORTANT: The quality of service provided by the health care industry assumes utmost importance. As they deal with human lives which are considered more valuable. Procedure followed for ensuring quality control are : Individual physicians work is peer reviewed. Surgical procedures are reviewed by carrying out review of tissue. Federal government (USA) appoints outside agencies for carrying out reviews.

DIFFERENT SOCIAL PROBLEMS

The present health care delivery system is unworkable. O n the other hand ,the cost per treatment is increasing with the development of new equipment & new drug. The no. of ill persons are also increasing.

CHANGE IN MIX OF PROVIDERS

Not only overall cost increased in health care organizations , significant change occurred in the ways in which health care is delivered. Many services that are traditionally provided in hospitals on an inpatient basis are not provided in outpatient clinics or at homes. Entrepreneurs have entered the industry to provide these new services.

THIRD PARTY PLAYERS

Three-fourth of the health care is provided by government & insurance companies , and the balance by individual patients. As there is a increase in hospitals cost per patient &entrepreneur entering the field ,a need is felt to install sophisticated cost accounting systems. These systems provide information on individual patients &report actual costs to standard cost for each diagnostic centers where insurance &other service providers reimburse costs.

Cost information is collected from physicians ,focusing on patients care & cost per laboratory test.

Professionals
Physicians , surgeons , therapists ,dentists ,registered nurses are the professional who work in the health care industry. Professional serve as departmental managers.They perform management functions on a part time basis . Head of surgery performs surgery ,head of medicine prescribes medicines ,. Professionals should be loyal to profession. cost control is one of the neglected area of this profession. Little stress on cost control by physicians.

MANAGEMENT5 CONTROL SYSTEM

Similar to manufacturing organizations. Shift in the product mix, increase in quantity & cost of new equipment. The strategic planning process in hospitals is important.

The annual budget preparation is conventional.

Huge quantities of information is available for controlling operating activities.

Financial performance evaluated by comparing actual revenues &expenses with budgets.

Identify important variances &take appropriate action.

PROFESSIONAL ORGANIZATIONS
Research &Development organizations ,Law firms , Accounting firms , Health care organizations , Engineering firms , architectural firms , Consulting firms ,Advertizing agencies the examples of professional organizations whose products are professional services.

SPECIAL CHARECTERISTICS
Goals : A Professional organization has relatively few tangible assets . Principle asset of these is skill of professional staff. may not appear in balance sheet. Return on assets employed also May not appear in balance sheet.

PROFESSIONALS
Labor intensive. Labor also of special; type. Many professionals prefer to work independently. Inadequate weight to financial implications of their decisions. They want to do best job regardless cost. This attitude affects supporting staff &non professionals Inadequate cost control.

OUTPUT & INPUT MEASUREMENT

The output of professional organizations can not be measured in physical terms such as units ,tons or gallons. Number of hours lawyer spends on case is a measure of input but not output .

Output is lawyers work but not no of hours in court room or no. of pages in a brief.
In some professional organizations revenue may be the measure of output. Here quantity is measured not quality..non repetitive. Time spent can not be judged accurately.

SMALL SIZE
Professional organizations are relatively small & operate in a single location. Senior management personally observes & motivates employees. Less need for sophisticated management control system with profit centers & formal performance reports.

MARKETING
A clear segregation between marketing activities & production activities does not exist in most professional organizations. Follows ethical code hence in marketing efforts may be limited hence selling person may not be assigned appropriate credits.

MANAGEMENT CONTROL SYSTEM

PRICING : Pricing differs from one profession to another. Some professionals based on time. Investment banking base on size of issue Fixed price for the project.

PROFIT CENTRES &TRANSFER PRICING

Supporting units such as maintenance , information processing ,transportation ,telecommunication ,printing & procurement of material & services ,charge consuming units for their services principle of transfer pricing is similar like manufacturing organizations.

STRATEGY PLANNING &BUDGETING

While manufacturing companies have well developed formal strategic planning systems, professional organizations lack this. Management commitments to purchase plant, machinery, & equipment. These decisions affect both the capacity as well as the costs of the manufacturing companies for many years 7can not be reversed. professional organizations do not need this planning system. The main asset is H.R Can easily reduce or increase the staff compared to the capacity of plant.

Control of operations
Norms & standards can be set for manufacturing organizations. Not possible in service organizations. Planning 7 control of daily activities in a professional organization is difficult. scheduling time availability for professionals is difficult.

Measurement of performance & evaluation

Performance of professionals at extremes can be measured. Difficult to evaluate the performance of the major percentage of professionals who are not in extremes. Human judgment forms the basis of evaluation of performance. The superiors, self peer ,clients &subordinates may role in making such judgment.

 1980 witnessed a turbulent situation in the financial services sector leading to failure of several commercial banks & allied situations. Many of the banks were merged & there was a significant reduction in the number of banks. The collapse of England's oldest merchant bank called Barings was the failure in this sector. Weaknesses in the Management control systems were partially responsible for the failure of Barings.

MNAGEMENT CONTROL FOR FINANCIAL SERVICE ORGANIZATIONS

The main business of financial service organizations is to manage money. The financial services sector plays an important role in the economy of the country. The share of financial services sector in gross domestic product rose from 11.53 % in 93-94 to 20 % in 2013.

CHARACTERISTICS
MONETARY ASSETS TIME PERIOD OF TRANSACTION RISK & REWARD TECHNOLOGY

MONETARY ASSETS
Most of the assets of financial services are monetary. The current value of monetary assets is much more easily measured than the value of plant & patents. Can be transferred from one person to another.

TIME PERIOD OF TRANSACTIONS

The time frame of financial transactions vary. Success or failure of services of long term nature can not be estimated accurately. transactions completed quickly requires information.

RISK & REWARD

Most business decisions involve a trade off between risk 7 reward. The greater the risk the greater is the reward. Accuracy is known in the future date.

TECHNOLOGY
Technology revolutionized financial services industry. New innovations are entered because of technology.

REGULATIONS
More regulations. IRDA,SEBI,RBI etc.

NON-PROFIT ORGANIZATIONS
A non profit organization operates in the interest of the society. no obligation to pay taxes. can not participate in Equity market. Sources of funds are contributions, grants ,operating surplus &debt instruments of various types. The principle goal is defined by its mission. Can not make profit ,it needs a modest profit to finance working capital. Schools,colleges,universities,hospitakls come under this category.

CHARACTERISTICS
CONTRIBUTED CAPITAL PROFIT MOTIVENOT EXISTING GOVERNANCE ACCOUNTING FOR FUNDS FINANCIAL ACCOUNTING

MANAGEMENT CONTROL SYSTEM

STRATEGIC PLANNING BUDGETING PRODUCT PRICING OPERATION &EVALUATION