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BASIC CONCEPTS
1. Control
An organization must be controlled i.e. devices
that ensure that it goes where its leaders want it
to go must be operative.
Any control system has at least 4 elements:
1. A detector or sensor: it is a measuring device
that identifies what is actually happening in the
process being controlled.
2. An assessor: It is a device for determining the
significance of what is happening. Usually,
significance is assessed by comparing the
information on what is actually happening with
some standard or expectation of what should be
happening.
3. An effector: it is a device that alters behaviour
if the assessor indicates the need for doing so.
This device is often called “feedback”.
4. A communications network: it transmits
information between the detector and the
assessor, and between the assessor and the
effector.
Control Assessor, Comparison with
device standard
Entity
being
controlled
2. Management
• An organization consists of a group of people
who work together.
• The organization has goals- that is, it wants to
accomplish certain results.
• Management is the process whereby the
resources of man, machine and material are
integrated to accomplish these goals.
• Therefore the role of management is to plan,
organize, integrate and interrelate organizational
activities and resources in order to achieve the
organization’s objectives. This role is facilitated
through appropriate management ctrl systems
and processes.
• In a business organization, earning a
satisfactory profit usually is an important goal.
• The leader of the organization are its
management there is a hierarchy of managers,
with the CEO at the top, and business unit,
departmental, section and other managers
below the CEO.
• Depending on the size and complexity of the
organization, there may be several layers in the
hierarchy. Except for the CEO, each manager is
both a superior and a subordinate. Each
supervises people in his or her own
organizational unit and is a subordinate of the
manager to whom he or she reports. These
relationships usually are shown on the
organizational chart.
• The CEO (or, in some organizations, a team of
senior managers) decides on strategies that are
expected to attain the organization’s goals. If
the company is organized into business units,
business unit managers formulate strategies for
their units, subject to the approval of the CEO.
• The management control process is the process
that managers use to assure that the members
of the organization implement these strategies.
Systems
A system is a prescribed way of carrying out an
activity or set of activities; usually the activities are
repeated. A system is characterized by a more or
less rhythmic, recurring, coordinated series of steps
that are intended to accomplish a specified purpose.
An important characteristic of systems is control.
Control centers on the prevention and correction of
deviations in a system’s behaviour from those of
standards that have been specified at a given time.
In self- regulating systems, the key element for
control procedure is feed back. A comparison of
output values is made with the standards, and
information concerning the degree of deviation is fed
back to the other elements in the system’s structure
so that preplanned activities may be changed if
necessary.
Systems can be closed or open.
• The closed systems are also called information-
tight systems i.e. information loop is closed and
the control mechanism has the capability to
affect the processor so that the desire output is
achieved.
• Open systems do not have information-tight
control unit. Here the relationships among
elements of the system and between the system
and its environment are often not known. Open
systems characteristically strive to maintain a
dynamic balance. The open system receives
signals of changes in environment and adapts
itself in keeping with its character and goals.
An organization is a system of interrelated parts
working in conjunction with each other for
accomplishing its goals and those of the people
involved in it.
Corporate
Institutional level Strategic planning
management
Operating
Technical level Operational control
management
Management control
2. Behavioral considerations
• The mgt control process is systematic, but not
mechanical.
• The process involves interactions among
individuals. There is no mechanical way of
describing these interactions.
• Managers have personal goals, and the central
control problem is goal congruence, that is,
to induce them to act so that when they seek
their personal goals, they help to attain the
organisation’s goals. Goal congruence means that
the goals of individual members of an
organisation should be, as far as feasible,
consistent with the goals of the organisation
itself.
See pg 93
Perfect goal congruence cannot be achieved.
Nevertheless, the system should go as far in this
direction as is feasible. The development of
optimum compensation plans and other incentives
are and important consideration in promoting goal
congruence.
ENVIRONMENT DS
R
SENSOR AS C
FEEDBACK RA CHOICE
Generation of
solutions
Control Environment:
F. Budget Control:
• Guidance material and instructions to provide
direction to those preparing the budget.
• The budget review, approval, and revision process.
• Management concern for reliable budget
information.
• Management participation in directing and
reviewing the budget process.
• Management involvement in determining when,
how much, and for what purpose expenditures can
be made.
• Comparison of actual expenditures periodically to
budgets.
H. Changing Conditions:
• The mechanisms for identifying and communicating
events, activities, and conditions that affect
operations or financial reporting objectives.
• Modification of Accounting and/or information
systems in response to changing conditions.
• Consideration given to designing new or alternative
controls in response to changing conditions.
• Management’s responsiveness to changing
conditions.
Types of organisation and management control
system
Goals
Goals can be defined as broad statements of what
the organisation wants to achieve in the long run, or
on a permanent basis.
Goals are broad objectives.
Goals are fairly timeless statements.
Goals and objectives are properly defined. If they are
vague or ill-defined, it may not be possible to
measure the performance of the organisation.
The clarity of goals and objectives is quite often
more evident to the initial employers and promoters
of institutions. With expansion of activities and
joining of new member, goals and objectives as
perceived by participants tend to get diffused.
Different key managers may have different
perceptions about goals and objectives. It is because
of this that organisations insist on proper induction
of new entrants to the philosophy of the
organisation.
External pressures, sometimes political in nature,
may force an enterprise to alter its goals and
objectives, particularly in the case of public
institutions, unless effective steps are taken by the
top management of the enterprise to counteract
such pressures, the enterprise’s goals and objectives
will get diffused and even confused, and will
seriously affect the effectiveness of the organisation.
A strategy should be
• consistent with the environment
• Internally consistent with organisational goals
and objectives.
• Formulated keeping in view resource
availability and risk-taking capabilities of the
management.
Since implementation of strategy involves
commitment of resources, the management should
determine the time frame over which a given
strategic choice will have its impact.
The most important aspect of a strategic choice is
to know whether the proposition is workable.
Once the organisation has defined its strategy for
the organisation as a whole and for each of its
strategic business units (SBU), it must elaborate
the strategies into policies with a view to
facilitating the achievement of goals and
objectives. The policies have to be consistent with
strategies. Through the process of policy
formulation, management coordinates the strategy
of each business unit so as to ensure that all
organisational units work in harmony to achieve
the goals. The policies are formulated in respect of
prices, products, personnel, finance, and research
and development. The policies act as constraints
on the sub-units, for instance a particular transfer
pricing policy will act as a constraint within which
the divisional manager would have to operate. As
the performance results of an organisational sub-
unit are also determined by the managerial
policies, the designer of control systems should
have a clear understanding of various
organisational policies.
Behavioral considerations
7.management motivations
Motivation has been defined as aiming for some
selected goal (goal congruence) together with the
resulting drive (managerial effort) that influences
action toward that goal.
8.fairness or objectivity
Managerial effort and motivation, among other
things, depend largely on the degree of fairness, or
objectivity built into the performance measurement
and evaluation. Experience show that people resent
evaluation which they consider unfair or subjective
or vague rather than evaluation per se. thus,
reasonably objective measures of performance
should merit special attention of the management
control system designers.
Goal congruence
1.Rules
Responsibility Centres
Work
Resources used, Goods or services
measured by cost
Capital
1.Revenue centers
in a revenue center, outputs are measured in
monetary terms, but no formal attempt is made to
relate inputs (I.e. expenses or costs) to outputs.
Revenue centers are, marketing organisations that
do not have profit responsibility. Actual sales or
orders booked are measured against budgets or
quotas. Each revenue center is also an expense
center in that the revenue center manager is held
accountable for the expenses incurred directly
within the unit. The primary measurement,
however, is revenue. Revenue centers are not
charged for the cost of the goods that they
market. Consequently, they are not profit centers.
Revenue centers do not typically have authority to
set selling prices.
2.Expense centers
4.Investment centers:
it is a responsibility centre whose performance is
evaluated in terms of profit and assets employed
in earning the profit. Since different divisions have
different investment bases, it is difficult for the top
management to compare the profit performance of
one division with another division, unless it
considers the investment base in each division.
The comparison of absolute profits may not yield
meaningful results because of different amounts of
resources used by each division. The investment
base is measured by net assets which consist of
net fixed assets plus net current assets. This
corresponds to the sum of shareholders equity
plus reserves and surplus plus long-term loans in
the balance sheet of a company. Thus in the case
of divisions, the figure of net assets can be
conceived as corporate equity in the division.
There are 2 ways in which assets employed can
be related to profits, namely:
i) Return on investment: The return on
investment is calculated by dividing the
profits by the amount of investment i.e.
assets employed. It is a ratio.
ii) Residual income: it is an absolute amount.
It is calculated by deducting an interest
charge from the profits. The interest charge
is obtained by multiplying the net assets by
a predetermined interest rate.
The concept of return on investment (ROI) is
more widely used than residual income as
managers by training are more accustomed to
look at ratios. Further, ROI data is generally
available for other companies or industries and
can be used as a basis of comparison. The
residual income concept cannot be used for
comparison.
TRANSFER PRICING
ADVANTAGES OF BUDGETS
BUDGETARY CONTROL
Budget Controller
Making a forecast
Sales budget
Other factors:
flexibility and control within the library itself. Once the lump-
Formula Budget
Line-Item Budget
period.
LINE-ITEM BUDGET
Last year This Next
year year
Salaries
Materials
Etc.
Etc.
Miscellaneous
TOTAL
relating the line budget to the goals of the parent organization, the
(Warner 10).
Program Budget
organization.
following model:
PROGRAM BUDGET
Program Program Program TOTALS
#1 #2 #3
Salaries
Materials
Etc.
Etc.
Miscellaneous
TOTALS
% 100%
Performance Budget
contacts).
Function Budget:
Zero-Based Budget
examine each proposed program and rank its merits vis a vis the
goals for the future. Reliance on “the way we’ve always done
Your cash budget will help you figure out what to do with
the cash you have in hand. To go back to that brewery
analogy, you may use the money to research a new brand
of ale, hire a master brewer to make it, or hire a public
relations agency to tout it at local restaurants and bars.
Cash can also be squirreled away for unexpected needs.
And every business has unexpected needs.
ANALYSIS OF VARIANCES
The object of standard costing is to exercise cost
control and cost reduction. The performance targets with actual
performance will enable a control system. The management by
exception is possible under standard costing. Cost reduction is
possible through the efficiency in use of material and labour. The
deviations between standard costs, profits or sales and actual costs,
profits or sales respectively will be known as variances. The
variances may be favourable and unfavourable. If actual cost is
less than the standard cost and actual profit and sales are more than
the standard profits and sales, the variances will be favourable. On
the contrary if actual cost is more than the standard cost and actual
profit and sales are less than the standard profit and sales, the
variances will be unfavourable. The variances are related to
efficiency. If variances are favourable, it will show efficiency and
if variances are unfavourable it will show inefficiency.
Why do we do this?
In short, we want to do variance analysis in order to learn.
One of the easiest and most objective ways to see that
things need to change is to watch the financials and ask
questions. Don't get me wrong: You cannot and should not
base important decisions solely on financial data.
CLASSIFICATION OF VARIANCES
Labour Cost Variance = Standard Labour Cost – Actual Labour Cost = Standard time × Standard
Wage Rate) – (Actual time × Actual Wage Rate)
Labour Rate of Pay Variance = Actual time (Standard Rate – Actual Rate)
Labour Efficiency variance = Standard Wage Rate (Standard Time – Actual Time)
Labour Mix Variance = Standard cost of Revised Standard Labour Mix – Standard Cost of Actual Labour Mix.
(ii) When Standard and actual time of Labour mix are different:
In this case the variance will be calculated as follows:
SOC—AOC
4. SALES VARIANCE
a) TSMV - SM-AM
a) SVV -Bud.S-Aq. S
b) SPV - (AP-SP )* Aq.
c) S Vol. V –(STQ of s-Aq. of S )*St P
d) SQV- Bud.Sales Rev st S
e) SMV –(SM/Rev.Mof AQ Sold –AM )*St. P
Double-Loop Feedback
Outcome Metrics
Management by Fact
Return on Investment
4. The lag between investment outlays and the recoupment of these outlays
from cash inflows (the greater the time lag, the greater the degree of
overstatement)
5. the growth rate of new investment (faster growing companies will have
lower Return On Investment )
Calculating EVA
where
History
Philosophy
Effects
Benefits
Problems
Definition
As defined by ISO:
Origins
on.
Definitions
A brief history
Computer data
base
Architectures
• Text-oriented DSS,
• Database-oriented DSS,
• Spreadsheet-oriented DSS,
• Solver-oriented DSS,
• Rule-oriented DSS, and
• Compound DSS.
Applications