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Introduction to MCS
Explain briefly features of an IDEAL management control system?
Management control is a process of assuming that resources are obtained and used effectively
and efficiently in the accomplishment of the organizations objectives. It is a fundamental
necessity for the success of a business and hence from time to time the current performance of
the various operations is compared to a predetermined standard or ideal performance and in case
of variance remedial measures are adopted to confirm operations to set plan or policy.
Some of the features of MANAGEMENT CONTROL SYSTEM are as follows:
Total System: MCS is an overall process of the enterprise which aims to fit together the
separate plans for various segments as to assure that each harmonizes with the others and
that the aggregate effect of all of them on the whole enterprise is satisfactory.

Monetary Standard: MCS is built around a financial structure and all the resources and
outputs are expressed in terms of money. The results of each responsibility centre in respect
to production and resources are expressed in terms of a common denominator of money.
Definite pattern: It follows a definite pattern and time table. The whole operational activity
is regular and rhythmic. It is a continuous process even if the plans are changed in the light of
experience or technology.
Coordinated System: It is a fully coordinated and integrated system.
Emphasis: Management control requires emphasis both on the search for planning as well as
control. Both should go hand in hand to achieve the best results.
Function of every manager: Manager at every level as to focus towards future operational
and accounting data, taking into consideration past performance, present trends and
anticipated economic and technological changes. The nature, scope and level of control will
be governed by the level of manager exercising it.

Existence of goals and plans: MCS is not possible without predetermined goals and plans.
These two provide a link between such future anticipations and actual performance.
Forward looking: MCS is on the basis of evaluation of past performance that the future
plans or guidelines can be laid down. Management Control involves managing the overall
activity of the enterprise for the future. It prevents deviations in operational goals.

Continuous process: It is a continuous process over the human and material resources. It
demands vigilance at every step. Deciding, planning and regulating the activities of people
associated in the common task of attaining the objectives of the organization is a the primary
aim of MCS
People oriented: It is the managers, engineers and operators which implement the ideas and
objectives of the management. The coordination of the main division of an organization helps
in smoother operations and less friction which results in the achievement of the
predetermined objectives.

Scope of control
MCS is an important process in which accounting information is used to accomplish the
organizations objectives. Therefore the scope of control is very wide which covers a very wide
range of management activities.
Policies control: Success if a business depends on formulation of sound policies and their
proper implementation.
Control over organization: It involves designing and organizing the various departments for
the smooth running of the business. It attempts to remove the causes of such friction and
rationalizes the organizational structure as and when the need arises.

Control over personnel: Anything that the business accomplishes is the result of the action of
those people who work in the organization. It is the people, and not the figures, that get
things done.
Control over costs: The cost accountant is responsible to control cost sets, cost standards,
labour material and over heads. He makes comparisons of actual cost data with standard
cost. Cost control is a delicate task and is supplemented by budgetary control systems.
Control over techniques: It involves the use of best methods and techniques so as to
eliminate all wastages in time, energy and material. The task is accomplished by periodic
analysis and checking of activities of each department with a view to avoid an eliminate all
non-essential motions, functions and methods.
Control over capital Expenditure: Capital budget is prepared for the whole concern. Every
project is evaluated in terms if the advantage it accrues to the firm. For this purpose capital
budgeting, project analysis, study of cost of capital etc are carried out.

Overall control: A master plan is prepared for overall control and all the departments of the
concern are involved in this procedure.
2. Explain briefly various stages of management control process citing salient features
of each.
Management control process involves communication of information to the managers at various
levels of hierarchy and their interactions arising out of them. These communications aim towards
attaining the organization's goals. But individual managers have their personal goals also. For
example, a young manager with good education, experience, personality and social background
joins a company like Britannia Industries or Reliance. The company finds him fit for the position
as per job specifications, appoints him and makes him aware of what the company expects of
him. The young manager sets his goals of gaining rich experience for his career progress besides
adequate compensation packages. Naturally, his actions will be directed towards achieving his
own objectives and goals while serving the company. Thus, his self-interest and the best interest
of the organization are apparently in conflict. But the best results can be achieved by perfectly
matching the two interests and this is called 'goal congruence'.
It is quite apparent that perfect congruence between the goals of the individual and the
organization individual's goals and the organization's goals can never happen. Yet, the main
purpose of a management control system is to assure goal congruence between the interest of the
individual and the organization as far as practicable.
Management control systems
Formal and Informal Communication
As mentioned earlier, all the communication of information may be either formal or informal.
The formal communication system involves strategic plan, budgets, standards and reports
whereas the informal communication is made through letters and memos, verbally or even by
facial expression.
Formal communications are all documented and addressed to the responsible managers for their
information and actions, if necessary. However, the actions depend on the perception of the
individual managers.
Informal communication, on the other hand, relates to some external factors-work ethics,
management style and culture. Added to these factors is the existence of an informal organization
within the structured formal organization.
Informality refers to the relaxation of sharp differentiation and explicit description of
behavior as indicated in the hierarchy and thereby, moving away from superior/subordinate
relationship. However, such relations depend on the personal capabilities of the manager such as

education, experience, expertise, trust and cooperation. For example, Accounts Manager of Nasik
Plant (see the organization chart in the diagram 3.2) reports to the General Manager of the Plant.
While visiting the Corporate Office for attending a Training Course, he meets other colleagues,
parallel officers and even the Finance Director. The latter communicates some important matter
to him verbally and wants action thereon. Accounts Manager carried out the instructions so
given. As per the organization chart, he should inform his General Manager, but it depends on his
own perception of the situation, and he mayor may not report to the General Manager.
Work Ethics, Management Style and Culture
External factors like work ethics vary from place to place. Therefore, organization work culture
depends on the general behavior of the people in the society where the organization situates.
Work culture generally differs because of the life style and the attitude towards the work. For
example, people of Mumbai lead very fast life. Time has more value at Mumbai as compared to
Kolkata, where people take things easily and leisurely. Japanese and Korean people have
reputation for their excellent work culture.
However, the most important internal factor is the organization's culture and climate. The culture
refers to the set of common beliefs, attitudes, norms, relationships and assumptions that are
explicitly or implicitly accepted and evidenced throughout the organization. The writer joined
Union Carbide as an Assistant just three days before Christmas Eve. On the very second day,
when he attended Christmas lunch, his table was shared by none other than the General Sales
Manager Dr. W.R. Correa. He kept us amused with various stories of his recent tour abroad and
recited Urdu 'shairies', even sharing jokes. Such a situation was unthinkable in Jessop & Co.,
where sharp differences were maintained at every level of hierarchy.
Management control systems
Climate is used to designate the quality of the internal environment that conditions the
quality of cooperation, the development of individuals, the extent of members' dedication or
commitment to organizational purpose and the efficiency with which that purpose is translated
into results. Climate is the atmosphere in which individuals work help, judge, and reward,
constrain and find out about each other. It influences moral-the attitude of the individual towards
his/her work and environment.
Culture differs between the organizations, but cultural norms are extremely important. They
are not written like formal communication. But the existence of a good culture can be felt from
the behavior of the members of the organization. Once the writer landed up with his family at
Hyderabad in the early morning to discover that nobody had come to receive them at the station.
His visit was arranged through non other than the Director of the company himself. His unit
being new, telephone directory did not include any number of his unit, but the parent
organization's telephone number was located. When an executive of the parent company was
contacted, he immediately sent an officer of the company with a car to pick us up to their Guest

House, entertain with coffee and then put up in a Hotel. What subsequently happened is a
different matter, but the attitude and treatment of that member of organization speak volumes
about their excellent culture.
In any organization, the culture remains unchanged as long as the Chief Executive remains in
position. When a new executive replaces him, there is likelihood of some change in the culture,
unless the new Chief follows the footsteps of his predecessor and maintains it. Generally, if
higher positions are filled in through promotion of internal executives, the culture remains
unchanged and the traditions are maintained.
The other important internal factor which influences management control system is
management style-that is the attitude of the superior to his subordinates and the latter's reaction
through their perception of the attitude of their superiors. Again, the attitude ultimately stems
from the temperament of the Chief Executive, who controls the entire organization. That is why
R. W. Emerson said "an institute is the lengthened shadow of a man".
Importance of Informal Communication
An organization indulges in informal control process when encountering non-routine decision-making or when seeking new information to increase understanding of some problem areas.
During a very critical period in an organization, the writer found that the Chief Executive used to
call managers informally at his residence or club to extract information in a relaxed manner
rather than in a tense situation prevailing in the factory.

Formal Control Process

Formal communication system is structured as per the 'hierarchy outlined in the organization
chart. The system has the following four components:
(a) Strategic plan and programme
(b) Budgeting
(c) Operations and measurement in responsibility centers (d) Reporting

(a) Strategic Plan and Programme

The foundation of management control process lies in the organization's goals and its strategies
for attaining these goals. A strategic plan is prepared in order to implement the strategies, after
carefully considering opportunities and threats in the external environment as well as the
strengths and weaknesses in the internal environment. Thus, a strategic plan and programme is
prepared as a guideline to budgeting.
(b) Budgeting

The strategic plan is converted to an annual budget incorporating planned expenditure and
revenues for individual responsibility centers. Expenses and revenues are marked for each
responsibility centre period wise, say monthly, quarterly, half yearly, and annually.
(c) Operations and Measurement
Responsibility centers operate within the framework of the budget, established standards,
standing instructions, practices and operating procedures embodied in 'rules', and 'manuals'.
Thus, besides budget, the responsibility centers are also guided by a large number of rules. They
record the resources actually used and revenue earned. They also classify the data by
programmes as well as by responsibility centers for performance measurement.
(d) Reporting
Actual performance is analyzed, measured and reported against plan, indicating variances and
highlighting areas of weaknesses. If the performance is satisfactory, feedback information is sent
to the responsibility centre concerned for praise or reward. If the same is unsatisfactory feedback
communication is sent to the responsibility centre concerned for corrective action. If such action
requires to be included in the budget, then the latter is revised to give effect to the changed
position. If required, then the plan itself can be revised and a new basis of control may be
The aforesaid formal control process has been presented in the following diagram:


Describe and illustrate significance of human behavior patterns in management

control system.

Ans. Management control systems influence human behavior. Good management control
systems influence behavior in a goal congruent manner; that is, they ensure that individual
actions taken to achieve personal goals also help to achieve the organization's goals. The concept
of goal congruence, describing how it is affected both by informal actions and by formal
Senior management wants the organization to attain the organization's goals. But the individual
members of the organization have their own personal goals, and they are not necessarily
consistent with those of the organization. The central purpose of a management control system,
then, is to ensure a high level of what is called "goal congruence." In a goal congruent process,
the actions people are led to take in accordance with their perceived self interest are also in the
best interest of the organization.
The significance of human behavior patterns in management control system can be explained
with the help of Informal Factors that influence Goal Congruence. In the informal forces both
internal and external factors play a key role.
External Factors
External factors are norms of desirable behavior that exist in the society of which the
organization is a part. These norms include a set of attitudes, often collectively referred to as the
work ethic, which is manifested in employees' loyalty to the organization, their diligence, their
spirit, and their pride in doing a good job (rather than just putting in time). Some of these
attitudes are local that is, specific to the city or region in which the organization does its work. In
encouraging companies to locate in their city or state, chambers of commerce and other
promotional organizations often claim that their locality has a loyal, diligent workforce. Other
attitudes and norms are industry-specific. Still others are national; some countries, such as Japan
and Singapore, have a reputation for excellent work ethics.
Internal Factors

The most important internal factor is the organization's own culture-the common beliefs, shared
values, norms of behavior and assumptions that are implicitly and explicitly manifested
throughout the organization. Cultural norms are extremely important since they explain why two
organizations with identical formal management control systems, may vary in terms of actual
control. A company's culture usually exists unchanged for many years. Certain practices become

rituals, carried on almost automatically because "this is the way things are done here." Others are
taboo ("we just don't do that here"), although no one may remember why. Organizational culture
is also influenced strongly by the personality and policies of the CEO, and by those of lowerlevel managers with respect to the areas they control. If the organization is unionized, the rules
and norms accepted by the union also have a major influence on the organization's culture.
Attempts to change practices almost always meet with resistance, and the larger and more mature
the organization, the greater the resistance is.

Management Style
The internal factor that probably has the strongest impact on management control is management
style. Usually, subordinates' attitudes reflect what they perceive their superiors' attitudes to be,
and their superiors' attitudes ultimately stem from the CEO.
Managers come in all shapes and sizes. Some are charismatic and outgoing; others are less
ebullient. Some spend much time looking and talking to people (management by walking
around); others rely more heavily on written reports.
The Informal Organization
The lines on an organization chart depict the formal relationships-that is, the official authority
and responsibilities-of each manager. The chart may show, for example, that the production
manager of Division A reports to the general manager of Division A. But in the course of
fulfilling his or her responsibilities, the production manager of Division A actually communicates
with many other people in the organization, as well as with other managers, support units, the
headquarters staff, and people who are simply friends and acquaintances. In extreme situations,
the production manager, with all these other communication sources available, may not pay
adequate attention to messages received from the general manager; this is especially likely to
occur when the production manager is evaluated on production efficiency rather than on overall
performance. The realities of the management control process cannot be understood without
recognizing the importance of the relationships that constitute the informal organization.

Perception and Communication

In working toward the goals of the organization, operating managers must know what these goals
are and what actions they are supposed to take in order to achieve them. They receive this
information through various channels, both formal (e.g., budgets and other official documents)
and informal (e.g., conversations). Despite this range of channels, it is not always clear what
senior management wants done. An organization is a complicated entity, and the actions that
should be taken by anyone part to further the common goals cannot be stated with absolute
clarity even in the best of circumstances.
Moreover, the messages received from different sources may conflict with one another, or be
subject to differing interpretations. For example, the budget mechanism may convey the

impression that managers are supposed to aim for the highest profits possible in a given year,
whereas senior management does not actually want them to skimp on maintenance or employee
training since such actions, although increasing current profits, might reduce future profitability.
The informal factors discussed above have a major influence on the effectiveness of an
organizations management control. The other major influence is the formal systems. These
systems can be classified into two types: (1) the management control system itself and (2) rules,
which are described in this section.
The Formal Control System
We use the word rules as shorthand for all types of formal instructions and controls, including:
standing instructions, job descriptions, standard operating procedures, manuals, and ethical
guidelines. Rules range from the most trivial (e.g., paper clips will be issued only on the basis of
a signed requisition) to the most important):e.g., capital expenditures of over $5 million must be
approved by the board' of directors).
Some rules are guides; that is, organization members are permitted, and indeed expected, to
depart from them, either under specified circumstances or when their own best judgment
indicates that a departure would be in the best interests of the organization.
Some rules are positive requirements that certain actions be taken (e.g., fire drills at prescribed
intervals). Others are prohibitions against unethical, illegal, or other undesirable actions. Finally,
there are rules that should never be broken under any circumstances: a rule prohibiting the
payment of bribes, for example, or a rule that airline pilots must never take off without
permission from the air traffic controller.
Some specific types of rules are listed below:

Physical Controls
Security guards, locked storerooms, vaults, computer passwords, television surveillance, and
other physical controls may be part of the control structure.
Much judgment is involved in deciding which rules should be written into a manual, which
should be considered to be guidelines rather than fiats, how much discretion should be
allowed, and a host of other considerations. Manuals in bureaucratic organizations are more
detailed than are those in other organizations; large organizations have more manuals and
rules than small ones; centralized organizations have more than decentralized ones; and organizations with geographically dispersed units performing similar functions (such as fastfood restaurant chains) have more than do single-site organizations

System Safeguards
Various safeguards are built into the information processing system to ensure that the
information flowing through the system is accurate, and to prevent (or at least minimize)
fraud of every sort. These include: cross-checking totals with details, requiring signatures and
other evidence that a transaction has been authorized, separating duties, counting cash and
other portable assets frequently, and a number of other procedures described in texts on
Task Control Systems
Task control is the process of assuring that specific tasks are carried out efficiently and
effectively. Many of these tasks are controlled by rules. If a task is automated, the automated
system itself provides the control.
4. Discuss and illustrate differences and similarities between
a. Strategy Formulation and Management Control
b. Management Control and Task Control
Some Distinction between Strategy Formulation and management Control
a) Focus of plan
b) Complexities
c) Nature of information

d) Structure
e) Communication of
f) Purpose of estimates
g) Persons involved
h) No. of persons involved
i) Mental activity
j) Planning and control
k) Time horizon
l) End result
m) Appraisal of job done

Strategy Formulation
On one aspect at a time
Many variables hence
Tailor-made for the issue,
more external and predictive,
less accurate.
Unstructured and irregular,
each problem being different
Relatively simple

Management Control
On entire organisation
Less complex

Show expected results

Staff and top management
Creative, analytical
Planning dominant but some
Tends to be long
Policies and precedents
Extremely difficult

Lead to desired result

Line and top management
Administrative, persuasive
Emphasis on both planning
and control
Tends to be short
Action within policies laid
Less difficult

Integrated, more internal and

historical, more accurate.
Rhythmic, definite pattern,
set procedure
Relatively difficult

b) Some Distinction between Management Control and Task Control

a) Focus of plan
b) Nature of information

c) Persons involved
d) Mental activity

e) Time horizon
f) Type of cost

Task Control
Single task or transaction
Tailor-made to operation,
specific, often non- financial,
real time
Follow directives or none as
in case of machines or set
Day to day
Engineered- Existence of
objective standard against
which actuals can be
compared makes control

Management control
On entire organization
Integrated, more internal and
historical, more accurate
Line and top management
Administrative, persuasive

Tends to be short
Discretionary- Control
subjective consideration.


5. What the concept of free cash flow is as applied to organization. Explain process of
We define net cash flow as net income plus non cash adjustment which typically means net
income plus depreciation though that cash flows cannot be maintained over time unless
depreciated fixed assets are replaced. So management is not completely free to use its cash flows
however it chooses. Therefore we define the term free cash flows.
Free cash flow is the cash flow actually available for distribution to investor after the company
has made all the investment in fixed assets and working capital necessary to sustain ongoing
operation. When we studied income statement in accounting the emphasis was probably on the
firms net income, which is accounting profit. However the value of companys operation is
determined by the stream of cash flows that the operations will generate now and in the future.
To be more specific, the value of operation depends on all the future expected free cash flows,
defined as after- tax operating profit minus the amount of new investment in working capital and
fixed assets necessary to sustain the business. Therefore the way for managers to make their
companies more valuable is to increase their free cash flow.
Uses of FCF:
Pay interest to debt holders, keeping in mind that the net cost to the company is the after
tax interest expense.
Repay debt holders, that is, pay off some of debt.
Pay dividends to shareholders.


Repurchase stock from shareholders.

Buy marketable securities or other non operating assets.

In practice, most companies combine these five uses in such a way that the net total is equal to
FCF. For example, a company might pay interest and dividends, issue new debts, also sell some
of its marketable securities. Some of these activities are cash outflows (paying interest and
dividends) and some are cash inflows (issuing debt and selling marketable securities), but the net
cash flow from these five activities is equal to free cash flows.
Computation of free cash flows:
Suppose the company had a 2001 NOPAT of $170.3million and depreciation is only the non cash
charge which is $100million then its operating cash flow in 2001 would be NOPAT plus any non
cash adjustment on the statement of cash flows.
Operating cash flow =NOPAT +depreciation (non cash adjustment)
= $17.03 + $100
= $270.3
Company has $1,455 million operating assets, at the end of 2000, but $1,800 at the end of 2001.it
made a net investment in operating assets of Net investment in operating assets = $18, 00 $1,455 = $345million
If net fixed assets rose from $870million to $1000million however company reported
$100million of depreciation. So its gross investment in fixed assets would be
Gross investment = net investment + depreciation
= $345 + $100 = $445million
Company free cash flows in 2001 was
FCF = operating cash flow gross investment in operating assets
= $270.3 - $445 {345 + 100}
= - $174.7million
An algebraically equivalent equation is
FCF = NOPAT - Net investment in operating assets
= $170.3- $345
= - $174.7million

Even though company had a positive NOPAT, its very high investment in operating assets
resulted in a negative free cash flow. Because free cash flow is what is available for distribution
to investor, not only was there nothing for investors, but investor actually had to provide
additional money to keep the business ongoing. A negative current FCF not necessarily bad
provided it is due to the high growth or to support the growth. There is nothing wrong with
profitable growth; even it causes negative free cash flow in the short term.


Performance Measurement System

1. Explain the concept of ROI. What are its advantages?

Return on investment (ROI) is the ratio of profit before tax to the gross investment.
ROI is calculated with the help of the following formula:
ROI = (Pre-Tax Profit/Sales) X (Sales/Net Assets) or (Pre-Tax Profits/Net Assets)
The numerator is profit before tax as reported in the P&L account. The profit should include only
the profits arising out of the normal activities of the division. Unusual items of receipts and
expenses should be excluded from the profit figure. One should also ignore windfalls and income
from investments not related to the operations of the division. Tax is excluded from the
numerator because the marginal of the SBU is not responsible for or in control of the tax paid.
Capital employed can be ascertained from the balance sheet by including fixed and current
assets. Assets not currently put to divisional use should be excluded from the investment base.
One also needs to exclude their relative earnings if any. The company should also exclude
intangible assets like goodwill, deferred revenue expenses, preliminary expenses, etc.
ROI can be improved by:
a) Increasing the profit margin on sales.
b) Increasing the capital turnover
c) Increasing both profit margin and capital turnover.
d) Reducing cost as that adds to the total earnings of the firm.
e) Increasing the profits by expanding present operations or developing new product line,
increasing market share, etc.
f) Diversifying, introducing productivity imporevement measures, expansion, replacement
of old equipments
Advantages of ROI
a) ROI relates return to the level of investment and not sales as the rate of return is more
b) ROI can be decomposed into other variables as shown. These variables have tremendous
analytical value.
c) ROI is an effective tool for inter-firm comparison.
2. Many experts regard EVA as a concept superior to ROI and yet in certain cases, EVA
does not do justice to the evaluation of investment center. EVA does not solve all the
problems of measuring profitability in an investment center. In particular, it does not solve the

problem of accounting for fixed assets discussed above unless annuity depreciation is also used,
and this is rarely done in practice. If gross book value is used, a business unit can increase its
EVA by taking actions contrary to the interests of the company, If net book value is used, EVA
will increase simply due to the passage of time. Furthermore, EVA will be temporarily depressed
by new investments because of the high net book value in the early years. EVA does solve the
problem created by differing profit potentials. All business units, regardless of profitability, will
be motivated to increase investments if the rate of return from a potential investment exceeds the
required rate prescribed by the measurement system.
Moreover, some assets may be undervalued when they are capitalized, and others when they are
expensed. Although the purchase cost of fixed assets is ordinarily capitalized, a substantial
amount of investment in start-up costs, new product development, dealer organization, and so
forth may be written off as expenses, and, therefore, not appear in the investment base. This
situation applies especially in marketing units. In these units the investment amount may be
limited to inventories, receivables, and office furniture and equipment. When a group of units
with varying degrees of marketing responsibility are ranked, the unit with the relatively larger
marketing operations will tend to have the highest EVA.
In view of all these problems, some companies have decided to exclude fixed assets from the
investment base. These companies make an interest charge for controllable assets only, and they
control fixed assets by separate devices. Controllable assets are, essentially, receivables and
inventory. Business unit management can make day-to-day decisions that affect the level of these
assets. If these decisions are wrong, serious consequences can occur-quickly. For example, if
inventories are too high, unnecessary capital is tied up, and the risk of obsolescence is increased;
whereas, if inventories are too low, production interruptions or lost customer business can result
from the stockouts. To focus attention on these important controllable items, some companies,
such as Quaker Oats, 17 include a capital charge for the items as an element of cost in the business unit income statement. This acts both to motivate business unit management properly and
also to measure the real cost of resources committed to these items.
Investments in fixed assets are controlled by the capital budgeting process before the fact and by
post completion audits to determine whether the anticipated cash flows, in fact, materialized.
This is far from being completely satisfactory because actual savings or revenues from a fixed
asset acquisition may not be identifiable. For example, if a new machine produces a variety of
products, the cost accounting system usually will not identify the savings attributable to each
The argument for evaluating profits and capital investments separately is that this often is
consistent with what senior management wants the business unit manager to accomplish; namely,
to obtain the maximum long-run cash flow from the capital investments the business unit
manager controls and to add capital investments only when they will provide a net return in
excess of the company's cost of funding that investment. Investment decisions, then, are

controlled at the point where these decisions are made. Consequently, the capital investment
analysis procedure is of primary importance in investment control. Once the investment has been
made, it is largely a sunk cost and should not influence future decisions. Nevertheless,
management wants to know when capital investment decisions have been made incorrectly, not
only because some action may be appropriate with respect to the person responsible for the mistakes but also because safeguards to prevent a recurrence may be appropriate.