MANAGEMENT CONTROL SYSTEM GROUP 2 Semester IV

Questions:

1. What are transfer pricing and its objectives? When market based transfer prices are most appropriate? 2. What do you understand by investment centre. Explain 2 different methods by which the performance of this canters are measured. Also discuss their advantages and disadvantages 3. What do you understand by non-profit organization? How do these organizations price their products? What criteria are used to measure their performance? 4. Explain the element of control and how each element is helping the management control, with diagram. (5 elements) 5. Write short notes on: a. c. Approach to marketing by professional service organization Interactive control b. Balance scorecard d. Internal control 6. Case study: North Country Auto

Group member: Nitin manke-47 Forum parmar-50 Prkash thakkar-59 Ritesh shirsat-102 Alok avasthi- 61

1. What are transfer pricing and its objectives? When market based transfer prices are most appropriate?

Transfer pricing A transfer price is the internal price charged by a selling department, division, or subsidiary of a company for a raw material, component, or finished good or service which is supplied to a buying department, division, or subsidiary of the same company. Transfer pricing refers to the setting, analysis, documentation, and adjustment of charges made between related parties for goods, services, or use of property (including intangible property). Transfer prices among components of an enterprise may be used to reflect allocation of resources among such components, or for other purposes. The concept of transfer pricing is fundamentally aimed at stimulating external market conditions within the organization so that the managers of individual business units are motivated to perform well. Therefore, the mechanism for allocating cost in an accounting system; such cost do not include a profit element. The term price as used here has the same meaning as it has when used in connection transaction between independent companies. Objective of transfer pricing If two or more profit center are responsible for product development, manufacturing and marketing each share in the revenue generated when the product is finally sold. The transfer price should be designed so that it accomplishes the following objectives: It should provide unit with the relevant information it needs to determine the optimum trade-off between company cost and revenues. 2. It should aid in reliable and objective assessment of the value added activities by profit centers toward the organization as a whole. 3. It should induce goal congruence decision i.e., the system should be designed so that decision that improve business unit profit will also improve company profits. 4. It should help to measure the economic performance of the individual business units. 5. The system should be simple to understand and easy to administer.
1.

Thus, from the objective, it is understandable that the Transfer price is mainly transferring of goods and services from one unit to another where much important is not given to accounting basis but also to all other effect.

Alternative Methods of Transfer Pricing

2

A transfer pricing policy defines rules for calculating the transfer price. In addition, a transfer price policy has to specify sourcing rules (i.e. either mandate internal transactions or allow divisions discretion in choosing whether to buy/sell externally). The most common transfer pricing methods are described below. 1. Market-based Transfer Pricing When the outside market for the good is well-defined, competitive, and stable, firms often use the market price as an upper bound for the transfer price. Concerns with market-based Transfer Pricing When the outside market is neither competitive nor stable, internal decision making may be distorted by reliance on market-based transfer prices if competitors are selling at distress prices or are engaged in any of a variety of special pricing strategies (e.g., price discrimination, product tie-ins, or entry deterrence). Also, reliance on market prices makes it difficult to protect infant segments.
2. Negotiated Transfer Pricing

Here, the firm does not specify rules for the determination of transfer prices. Divisional managers are encouraged to negotiate a mutually agreeable transfer price. Negotiated transfer pricing is typically combined with free sourcing. In some companies, though, headquarters reserves the right to mediate the negotiation process and impose an arbitrated solution.
3. Cost-based Transfer Pricing

In the absence of an established market price many companies base the transfer price on the production cost of the supplying division. The most common methods are: Full Cost Cost-plus Variable Cost plus Lump Sum charge Variable Cost plus Opportunity cost Dual Transfer Prices Each of these methods is outlined below. 3.1 Full Cost A popular transfer price because of its clarity and convenience and because it is often viewed as a satisfactory approximation of outside market prices. (i) Full actual costs can include inefficiencies; thus its usage for transfer pricing often fails to provide an incentive to control such inefficiencies. (ii) Use of full standard costs may minimize the inefficiencies mentioned above. 3.2 Cost-plus When transfers are made at full cost, the buying division takes all the gains from trade while the supplying division receives none. To overcome this problem the supplying division is frequently allowed to add a mark-up in order to make a reasonable profit. The transfer price may then be viewed as an approximate market price. 3.3 Variable Cost plus a Lump Sum Charge

In order to motivate the buying division to make appropriate purchasing decisions, the transfer price could be set equal to (standard) variable cost plus a lump-sum periodical charge covering the supplying divisions related fixed costs. 3.4 Variable Cost plus Opportunity Cost Also known as the Minimum Transfer Price: Minimum Transfer Price = Incremental Cost + Opportunity Cost. For internal decision making purposes, a transfer price should be at least as large as the sum of: Cash outflows that are directly associated with the production of the transferred goods; and, The contribution margin foregone by the firm as a whole if the goods are transferred internally. Sub-optimal decisions can result from the natural inclination of the manager of an autonomous buying division to view a mix of variable and fixed costs of a selling division plus, possibly, a mark-up as variable costs of his buying division. Dual transfer pricing can address this problem, although it introduces the complexity of using different prices for different managers. 3.5 Dual Transfer Prices To avoid some of the problems associated with the above schemes, some companies adopt a dual transfer pricing system. For example: Charge the buyer for the variable cost. The objective is to motivate the manager of the buying division to make optimal (short-term) decisions. Credit the seller at a price that allows for a normal profit margin. This facilitates a fair evaluation of the selling divisions performance. When market based transfer pricings are more appropriate Microeconomic theory shows that when divisional managers strive to maximize divisional profits, a market-based transfer price aligns their incentives with owners incentives of maximizing overall corporate profits. The transfer will occur when it is in the best interests of shareholders, and the transfer will be refused by at least one divisional manager when shareholders would prefer for the transfer not to occur. The upstream division is generally indifferent between receiving the market price from an external customer and receiving the same price from an internal customer. Consequently, the determining factor is whether the downstream division is willing to pay the market price. If the downstream division is willing to do so, the implication is that the downstream division can generate incremental profits for the company by purchasing the product from the upstream division and either reselling it or using the product in its own production process. On the other hand, if the downstream division is unwilling to pay the market price, the implication is that corporate profits are maximized when the upstream division sells the product on the external market, even if this leaves the downstream division idle. Sometimes, there are cost savings on internal transfers compared with external sales. These savings might arise, for example, because the upstream division can avoid a customer credit check and collection efforts, and the downstream division might avoid inspection procedures in the receiving department. Market-based transfer pricing continues to align managerial incentives
4

with corporate goals, even in the presence of these cost savings, if appropriate adjustments are made to the transfer price (i.e., the market-based transfer price should be reduced by these cost savings). However, many intermediate products do not have readily-available market prices. Examples are shown in the table above: a pharmaceutical company with a drug under patent protection (an effective monopoly); and an appliance company that makes component parts in the Parts Division and transfers those parts to its assembly divisions. Obviously, if there is no market price, a market-based transfer price cannot be used. A disadvantage of a market-based transfer price is that the prices for some commodities can fluctuate widely and quickly. Companies sometimes attempt to protect divisional managers from these large unpredictable price changes.

1. What do you understand by investment centre? Explain 2 different methods by

which the performance of this centers are measured. Also discuss their advantages and disadvantages
Investment centre

An investment center is a classification used for business units within an enterprise. The essential element of an investment center is that it is treated as a unit which is measured against
5

its use of capital, as opposed to a cost or profit center, which is measured against raw costs or profits.
Mantra to govern investment centre is profitable the case then invest else disinvest. Objective of the investment centre in to make sound investment decision. An investment centre converge responsibilities of all the other responsibility centers. It is concerned with the profit earned against the assets employed. It is not only interested in earning profit but also using the assets at its disposal in most effective manner. That mean investment centre is totally in concerned with costs, profit, revenue and assets utilization factor.

Task - Effective utilization of factor Investment centre Revenue centre Profit centre Cost centre

Task- Earn Profit

Task- Generate sales

Task- control costs

To earn satisfactory return on the investment made in an important objective of the profit oriented company, except in some service organization where the capital investment in insignificant. The performance of the investment centre is evaluated by comparing the profit earned i.e. output to the assets employed to earn that profit i.e. input. Just focusing on the profit without concerning about amount of resources being used will mislead the performance evaluation and shall be ineffective control tool. Comparing the absolute profit performance of different business unit is meaningless unless one consider the amount assets employed to generate profits.

Example Formal relationship possible-

Outputs Task/Wor Inputs (Money (Money k invested in Profits carrying out the earned) task) Profits earned are related to Capital employed

Performance measure are use to evaluate the investment centre in ROI and/or EVA. EVA is called as economic value added or residual income. It compares the business unit profit with assets employed to earn that profit. The prime concern of investment centre is how effectively and efficiently it uses its assets. Note this is another measure the profitability of the responsibility centre. Profit centre measure the profits in absolute term where as investment centre measure it in terms of assets utilization efficiency. Thus investment centre acts as special type on profit centre. This approach satisfy the both the goals of organization i.e. To earn adequate profit and to maintain optimal relationship between profits earned and assets employed. Usually the business unit manager has two performance objectives, first to generate the profit from the assets/resources at his disposal and seek the investment opportunities which provide the desire returns. To successful implement an investment centre controller must deliberate on following considerations/issues Decision rights need to be granted to centre manager about Input mix Labour, material, supplies Product mix Selling price Capital investment Performance measure to be used Actual ROI Actual Residual income i.e. EVA Actual ROI and RI in comparison with budgeted ROI Typically used when Responsibility centre manager has knowledge about correct price/quantity

Responsibility centre manager has knowledge to select optimal product mix

A controller face the following problems while implementing investment centre What should be assets based for assessing the performance of the investment centre? Whether it should be tangible and/or intangible assets, controllable and/or uncontrollable and/or partially controllable assets, total assets and/or total assets minus liabilities or combination of these etc. How the value of the assets be measured? Whether it is gross block or net block, book value or market value or replacement value etc

Measuring the input or assets employed in business unit The most difficult part in controlling the performance on investment centre is measurement of input i.e. assets employed to earn the profit. Cash Receivables Inventories Working capital Purchase of fixed assets Net book value Gross book value Disposition of assets Depreciation methods Accelerated depreciation

Performance measure foe investment centre ROI and EVA ROI and EVA are the two yardsticks used to evaluate the performance on an investment centre. Both can be easily expressed I term of money value. 1. Return on investment ROI It is the profitability ratio which relates the profits to the investment. Investment in turn represents the assets based utility by the unit to earn the profit. Wide verity of

calculation of this ratio is found, depending upon what assets and which profit terminology is used or dims fits to the purpose 2. Economic value added EVA EVA is the technique to overcoming errors in accounting measurements of performance. It emphasizes the net present value concept in performance evaluation over accounting standards. It looks mare to long tern then short term decisions. RI more closely tracks shareholder value than accounting measurement. Further ROI does not show how much real value has been created by the business unit. Whether the companys value has been enhanced or not? To enhance the companys value not only company has to earn return on investment but also something over and above it. Earning expected rate of return will basically satisfy the all the capital charge and anything leftover gets added to the growth in the company. In other words satisfying all the financer i.e. interest to the long term creditor and dividend to shareholder cannot be the objective of growing firm. ROI fail to depict the companys working in this sense. Hence the new measure has been suggested Economic value added i.e. residual income, the income after all capital charge paid.

1. What do you understand by non-profit organization? How do these organizations price their products? What criteria are used to measure their performance?

Nonprofit organization (NPO) is refers to an organization that uses surplus revenues to achieve its goals rather than to distribute them as profit or dividends. A non-profit company is like any other Company. There is only one important difference. It is not supposed to make profits. In other words, it does not exist for commercial gain. While Non-profit organizations are permitted to generate surplus revenues they must be retained by the organization for its self-preservation, expansion, or plans. NPOs have controlling members or boards. Many have paid staffs including management, while others employ unpaid volunteers and even executives who work without compensation. In general, it is used to meet legal requirements for establishing a contract between the executive and the organization. A Nonprofit organization, as defined by law is an organization that cannot distribute asset or income to or for the benefit of its member officers or director. The organization can of-course compensates its employee including officer and members for service render and goods supplied. This definition does not prohibit an organization for earning a profit, it prohibit only the distribution of profit. A NPO needs to earn a modest profit on average to provide funds for working capital and for possible rainy days.

NPO that meets the criteria of section 501 (C) of the internal revenue court is exempted from income taxes. If they religious, charitable, educational are defined in 501 (c-3) organization. Many such organizations are exempted from property taxes and from certain type of seals taxes. In many industries there are both profit and nonprofit oriented organization. There are non profit and for profit hospitals, nonprofit and profit school and colleges and even for profit religious organization. SRI international is a nonprofit research organization that competes with Arthur D. little, including for profit research organization.

Characteristics of Not-for-profit organizations (NPOs) Following are the main characteristics or the salient features of nonprofit organizations (NPOs): 1. The objective of such organizations is not to make profit but to provide service to its members and to the society in general. 2. The main source of income of these organizations is not the profit earned from purchase and sale of goods and services but is admissions fees, subscriptions, donations, grant-in-aid, etc. 3. These organizations are managed by a group of persons elected by the members from among themselves. This group is called managing committee. 4. They also prepare their accounts following the same accounting principles and systems that are followed by business for profit organizations that are run with an objective to earn profits.

Need For Performance Measurement

One of the principal differences between Not-For-Profit Organizations and profit organizations is that they have different reasons for their existence. In oversimplified terms, it might be said that the ultimate objective of a commercial organization is to realize net profits for its owners through the provision of some product or performance of some services wanted by other people, whereas the ultimate objective of a Not-For-Profit Organization is to meet some socially desirable need of the community or its members. The basic difference that arises is that as there is no profit motive in the NPO sector, and thus no single indicator of performance comparable to business enterprise is bottom-line. In fact, it may be stated that the best indicators of the performance of a NPO are generally not measurable in rupee (currency) terms, though rupee is the language of financial reporting. It, thus, follows that it is more difficult to measure performance in a Not-For-Profit Organization than in a for-profit organization. Indeed the research shows that most NPOs are attempting results measurement of some type, but all are struggling with developing quantitative measures to track their works impact on their mission (Forbes 1998).

Product pricing Many NPO gives inadequate attention to their pricing policies, pricing for services at their full cost is desirable A full cost price is sum of direct cost, indirect cost and perhaps a small allowance for increasing the organization equity. This principle is applies to services that are directly related to the
10

organization objective. Pricing for peripheral activity should be market based. Thus a NP hospital should price its health care services at full cost but prices in its gift shop should be market based. In general, this smaller and more specific the unit of service that is price, the better the basis of decision about the allocation of resources. E.g. A comprehensive daily rate for hospital care, which was conmen practice a few decade ago, marks the revenue for the mix of services actually provided. Beyond a certain point, of course, the cost of the paper work associated with pricing unit of service out ways the benefits. As a general rule, management control is facilitated when prices are established prior to the performance of the service. If an organization is able to recover its incurred cost, management is not motivated to worry about the cost control. Strategic planning and budget preparation In NPO that must decide how best to allocate limited resources to worthwhile activity, strategic planning is more important and more time consuming process that n typical business. The absence of profit measure makes program decision more subjective. Colleges and universities, welfare organization, and organization in certain other nonprofit industries know, before the budget year begins, the approximate amount of their revenues. They do not have the option of increasing revenue during the year by increasing their market efforts. The budget expenses so that the organization will at least break even at the estimated amount of revenue. They required that manager of responsibility center limit spending close to the budget amount. The budget, therefore, the most important management control tool, at least with respect to financial activity. Operation and evaluation In most NPO, there is no way of going what the optimum operation cost are. Responsibility centre manager, therefore, tend to spend whatever is allowed in the budget, even though the budgeted amount may be higher hat its necessary. Conversely, they may refrain from making expenditure that has an excellent pay off simply because the expenditure was not included in the budget. Although NPO have had reputation of operating inefficiently, this perception has been changing for good reason. Many organizations have had increasing difficulty in raising fund, especially from government resources. This has led to belt tightening and to increase the attention to management control. As mention above, the most dramatic change has been in hospital costs, with the introduction of reimbursement of the basis of the standard prices for diagnostic related group.

11

2. Explain the element of control and how each element is helping the management control, with diagram. Basic Elements of Control
Control and Its Nature The regulation of organizational activities so that some targeted element of performance remains within acceptable limits Provides organizations with indications of how well they are performing in relation to their goals. Provides a mechanism for adjusting performance to keep organizations moving in the right direction. Purpose of control: Control basically has four purposes:

Areas of Control Physical resourcesinventory management, quality control, and equipment control. Human resourcesselection and placement, training and development, performance appraisal, and compensation. Information resourcessales and marketing forecasts, environmental analysis, public relations, production scheduling, and economic forecasting. Financial resourcesmanaging capital funds and cash flow, collection and payment of debts.

12

Levels of Control

Steps in control system

Establish standard Control standard- a target against which subsequent performance will be compared. Control standard should be measured in measurable term Control standards should be consistent with organizational goals. Control standards should be identifiable indicator of performance.

13

Measure of performance Performance measurement is an ongoing process. Performance measures must be valid indicators (e.g sales, costs, units produced) of performance. Compare performance against standard Define what is a permissible deviation from the performance standard Utilize the appropriate timetable for measurement Determine the Need for Corrective Action Maintain the status quo (do nothing). Correct the deviation to bring operations into compliance with standard. Change the standard if it set too high or too low.

Operation control: From the operation control:

Financial control:
Control of financial resources as they flow into the organization, are held by the organization (i.e., working capital, retained earnings), and flow out of the organization (i.e., payment of expenses).

Budgetary Control A budget is a plan expressed in numerical term. Budgets may be established at any organizational level. Budgets are typically for one year or less. Budgets may be expressed in financial terms, units of output, or other quantifiable factors.
14

 Budgets serve four purposes: Help managers coordinate resources and projects. Help define the established standards for control. Provide guidelines about the organizations resources and expectations. Enable the organization to evaluate the performance of manager and organizational units

Other Tools of Financial Control Financial Statements A financial statement is a profile of some aspect of an organizations financial circumstances. Balance sheet A listing of assets (current and fixed), liabilities (short- and long-term), and stockholders equity at a specific point in time (typically year-ending) that summarizes the financial condition of the organization. Income statement Summary of financial performancerevenues less expenses as net income (i.e., profit or loss)over a period of time, usually one year. Ratio Analysis The calculation of one or more financial ratios to assess some aspect of the organizations financial health. (Liquidity ratio, debt ratio etc.) Financial Audits Auditan independent appraisal of an organizations accounting, financial, and operational systems. External auditsfinancial appraisals conducted by experts who are not employees of the organization. Internal auditsappraisals conducted by employees of the organization. Structural Control Structural control is concerned with how the elements of the organizations structure are serving their intended purpose. Bureaucratic Control A form of organizational control characterized by formal and mechanistic structural arrangements. Clan Control An approach to organizational control characterized by informal and organic structural arrangements. Organizational Control

15

Strategic Control Integrating Strategy and Control Strategic control Control aimed at ensuring that the organization is maintaining an effective alignment with its environment and moving toward achieving its strategic plan. Focuses on structure, leadership, technology, human resources, and informational and operational systems. Focuses on the extent to which an implemented strategy achieves the organizations goals. Personal reading International strategic control Characteristics of effective control.

1. WRITE SHORT NOTES ON: A. Balance scorecard The Balanced Scorecard (BSC) is a performance management tool which began as a concept for measuring whether the smaller-scale operational activities of a company are aligned with its largerscale objectives in terms of vision and strategy. By focusing not only on financial outcomes but also on the operational, marketing and developmental inputs to these, the Balanced Scorecard helps provide a more comprehensive view of a business, which in turn helps organizations act in their best long-term interests. Organizations were encouraged to measurein addition to financial outputswhat influenced such financial outputs. For example, process performance, market share / penetration, long term learning and skills development, and so on.
16

The underlying rationale is that organizations cannot directly influence financial outcomes, as these are "lag" measures, and that the use of financial measures alone to inform the strategic control of the firm is unwise. Organizations should instead also measure those areas where direct management intervention is possible. In so doing, the early versions of the Balanced Scorecard helped organizations achieve a degree of "balance" in selection of performance measures. In practice, early Scorecards achieved this balance by encouraging managers to select measures from three additional categories or perspectives: "Customer," "Internal Business Processes" and "Learning and Growth." The balance scorecard suggests that we view the organization from four perspectives, and to develop metrics, collect data and analyze it relative to each of these perspectives: The learning and growth perspective : To achieve our vision, how will we sustain our ability to change and improve? The business process perspective : To satisfy our shareholders and customers what business processes must we excel at? The customer perspective : To achieve our vision, how should we appear to our customer? The financial perspective : To succeed financially, how should we appear to our shareholders?

Implementing a Balanced Scorecard We can summarize the implantation of a balanced scorecard in four general steps; 1. Define strategy. 2. Define measure of strategy. 3. Integrate measures into the management system. 4. Review measures and result frequently. Each of these steps is iterative, requiring the participation of senior executive and employees throughout the organization Define Strategy
17

The balance scorecard builds a link between strategy and operational action. As a result it is necessary to begin the process of defining a balanced scorecard by defining the organization goals are explicit and what that targets have been developed. Define Measures of Strategy The next step is to develop measures in support of the articulate strategy. It is imperative that the organization focuses on a few critical measures at this point; otherwise management will be overloaded with measures. Also, it is important that the individual measures be linked with each other in a cause effect manner Integrated Measures into the management system The balanced scorecard must be integrated with the organization formal and informal structure, its culture, and its human resources practice. While the balanced Scorecard gives some means for balancing measures, the measures can still become unbalanced by others system in the organization such as compensation policies that compensate the manager strictly based on financial performance. Review Measures and result Frequently Once the balance scorecard is up and running it must be consistently reviewed by senior management. The organization should be looking for the following How do the outcome measures say the organization is doing? How do the driver measures say the organization is doing? How has the organizations strategy changed since the last review? How has the scorecard measures changed? The most important aspects of these reviews are as follows; They tell management whether the strategy is being implemented correctly and how successfully the strategy is working. They show that management is serious about the importance of these measures. They maintain alignment of measure to ever changing strategies. Difficulties in implementing Balanced Scorecard The following problems unless suitably dealt with, could limit the usefulness of the balanced scorecard approach: Poor correlation between nonfinancial measures and result. Fixation on financial result. No mechanism for improvement. No mechanism for improvement. Measures overload. Poor Correlation between Nonfinancial measures and result Simply put there is no guarantee that future profitably will allow targets achievement in any nonfinancial area. This is probably the biggest problem with the balanced scorecard because there is an inherent assumption that future profitability does follow from achieving the scorecard measures, identifying the cause effect relationships among the different measures is easier said than done. This will be a problem with any system that is trying to develop proxy measures for future performance. While this does not mean that the balanced Scorecard should be abandoned it is imp that comp adopting such a system understand that the links between nonfinancial measures and financial performance are still poorly understood.

18

Fixation on Financial Results As previously discussed not only are most senior managers well trained and very adept with financial measures but they also most keenly feel pressure regarding the financial performance of their comp. Shareholder are vocal and the board of directors often applies pressure on the stakeholders behalf .this pressure often overwhelms the long term uncertain payback of the nonfinancial measures. Non mechanism for Improvement One of the most overlooked pitfalls of the balanced scorecard is that a company cannot achieve Stretch goals if the Company has no mechanism for improvement .Unfortunately achieving many of these goals require complete shifts in the way that business is done yet the company often does not have mechanism to make those shifts . The mechanism available takes additional resource and requires a changed in the company culture. These changes do not happen overnight nor do they respond automatically to a new stretch targets. Inertia often works against the company employees are accustomed to a self limited cycle of setting targets, missing those targets and readjusting the targets to reflect what was actually achieved. Without a method for making improvement, improvements are unlikely to consistently happen no matter how good the stretch goal sound. Measurement overload How many critical measures can one manager track at one time without losing? Unfortunately there is no right answer to this question except it is more than 1 and less than 50. It too few then the manager is ignoring measures that are critical to creating success. If it too many then the manager may risk losing focus and trying to do too many things at once.

A. Interactive control Interactive control the primary role of management control is to help executive strategies. Under this view, as indicated in diagram, the chosen strategy defines the critical success factors which became the focal point for the design and the operation of control system. The end result is the strategys successful implementation. In industries that are subject to very rapid environmental changes, management control information can provide the basis for the thinking about the new strategy. This is known as interactive control.
19

In the rapid changing and the dynamic environment, creating a learning organization is essential to corporate survival. Learning organization refers to the ability of an organizations employee to learn to cope with the environmental changes on the ongoing basis. An effective learning organization is one in which employee at all levels continuously scan the environment, identify potential problems and opportunities, exchange environmental information candidly and openly, and experiment with alternate business models in order to successfully adapt to the emerging environment. The main objective of interactive control is to facilitate the creation of an learning organization. While critical success factors are important in control system design to implement the chosen strategy, strategic undertaking guide, the use of a subset of management control system interactively in developing new strategies. Strategic uncertainties are fundamental environmental shift that could potentially disrupt the rules by which an organization is playing today. There is fundamental difference between strategic uncertainty. Critical success factor strategies; as such, they support the strategies for current product and markets. the other side, are the basis for the firm to such they help developing new businesses. Interactive control alerts management to either trouble or opportunities. This manager to adapt to the rapidly changing about new strategies. critical success factor and are derived from chosen implementation of Strategic uncertainty on search new strategies; as strategic uncertainties, becomes the basis for the environment by thinking

Interactive control has the following characteristics: 1. A subset of management control information that has a bearing on the strategic uncertainties facing the business became the focal point. 2. Senior executive take such information seriously. 3. Manager at all level of the organization focus attention on the information produced by the system. 4. Supervisor, subordinator and peer meet face to face to interrupt and discuss the implementation of information for the future strategic initiative. 5. The face to face meeting takes the discussion in to debate and challenges of the underlying data, assumption and appropriate data. Strategic uncertainties relate to fundamental, nonlinear shifts to the environment potentially can create new business models.

20

Interactive control are not a separate system; they the integral part of the management control system. Some management control information help managers think about new strategies. Interactive control information usually, but not exclusively, tends to the nonfinancial. Because strategic uncertainties are differing from business to business, senior executives from different companies might choose different part of their management control system to use interactively.

A.

Internal control

Internal control is the process designed to ensure reliable financial reporting, effective and efficient operations, and compliance with applicable laws and regulations. Safeguarding assets against theft and unauthorized use, acquisition, or disposal is also part of internal control. In accounting and auditing, internal control is defined as a process effected by an organization's structure, work and authority flows, people and management information systems, designed to help the organization accomplish specific goals or objectives. It is a means by which an organization's resources are directed, monitored, and measured. It plays an important role in preventing and detecting fraud and protecting the organization's resources, both physical and intangible (e.g., reputation or intellectual property such as trademarks). At the organizational level, internal control objectives relate to the reliability of financial reporting, timely feedback on the achievement of operational or strategic goals, and compliance with laws and regulations. At the specific transaction level, internal control refers to the actions taken to achieve a specific objective (e.g., how to ensure the organization's payments to third parties are for valid services rendered.) Internal control procedures reduce process variation, leading to more predictable outcomes. COSO defines internal control as having five components: 1. Control Environment-sets the tone for the organization, influencing the control consciousness of its people. It is the foundation for all other components of internal control. 2. Risk Assessment-the identification and analysis of relevant risks to the achievement of objectives, forming a basis for how the risks should be managed 3. Information and Communication-systems or processes that support the identification, capture, and exchange of information in a form and time frame that enable people to carry out their responsibilities 4. Control Activities-the policies and procedures that help ensure management directives are carried out. 5. Monitoring-processes used to assess the quality of internal control performance over time.

21

Roles and responsibilities in internal control According to the COSO Framework, everyone in an organization has responsibility for internal control to some extent. Virtually all employees produce information used in the internal control system or take other actions needed to affect control. Also, all personnel should be responsible for communicating upward problems in operations, noncompliance with the code of conduct, or other policy violations or illegal actions. Each major entity in corporate governance has a particular role to play: Management: The Chief Executive Officer (the top manager) of the organization has overall responsibility for designing and implementing effective internal control. More than any other individual, the chief executive sets the "tone at the top" that affects integrity and ethics and other factors of a positive control environment. In a large company, the chief executive fulfills this duty by providing leadership and direction to senior managers and reviewing the way they're controlling the business. Senior managers, in turn, assign responsibility for establishment of more specific internal control policies and procedures to personnel responsible for the unit's functions. In a smaller entity, the influence of the chief executive, often an owner-manager, is usually more direct. In any event, in a cascading responsibility, a manager is effectively a chief executive of his or her sphere of responsibility. Of particular significance are financial officers and their staffs, whose control activities cut across, as well as up and down, the operating and other units of an enterprise. Board of Directors: Management is accountable to the board of directors, which provides governance, guidance and oversight. Effective board members are objective, capable and inquisitive. They also have a knowledge of the entity's activities and environment, and commit the time necessary to fulfill their board responsibilities. Management may be in a position to override controls and ignore or stifle communications from subordinates, enabling a dishonest management which intentionally misrepresents results to cover its tracks. A strong, active board, particularly when coupled with effective upward communications channels and capable financial, legal and internal audit functions, is often best able to identify and correct such a problem. Auditors: The internal auditors and external auditors of the organization also measure the effectiveness of internal control through their efforts. They assess whether the controls are properly designed, implemented and working effectively, and make recommendations on how to improve internal control. They may also review Information technology controls, which relate to the IT systems of the organization. There are laws and regulations on internal control related to financial reporting in a number of jurisdictions. To provide reasonable assurance that internal controls involved in the financial reporting process are effective, they are tested by the external auditors, who are required to opine on the internal controls of the company and the reliability of its financial reporting. Limitations Internal control can provide reasonable, not absolute, assurance that the objectives of an organization will be met. The concept of reasonable assurance implies a high degree of assurance, constrained by the costs and benefits of establishing incremental control procedures. Effective internal control implies the organization generates reliable financial reporting and substantially complies with the laws and regulations that apply to it. However, whether an organization achieves operational and strategic objectives may depend on factors outside the enterprise, such as competition or technological innovation. These factors are outside the scope
22

of internal control; therefore, effective internal control provides only timely information or feedback on progress towards the achievement of operational and strategic objectives, but cannot guarantee their achievement.The BSC method of Kaplan and Norton is a strategic approach and performance management system that enables organizations to translate a company's vision and strategy into implementation, working from 4 perspectives:

6. CASE STUDY: NORTH COUNTRY AUTO Case Background Each of the departments of North Country Auto, Inc. namely, the new cars sales and used cars sales, service, parts, body shop and oil change operated as part of one business before George Liddy bought into the dealership. The Department Managers were paid salaries and a year-end bonus. However, feeling that this system would not motivate employees, he devised a system wherein he could track effectively the departmental performance. For this, he developed a system for so that each department will be treated as decentralized profit centers. This new system requires that cost be broken down per department. Also, the bonuses per each department head will be based on departmental gross profits. So far as the outcome of the new system is concerned, a recent new car purchase sparked friction and disagreements among division heads on the matter of setting of transfer prices and allocation of costs and profits. It was important that as one department aims to maximize profit, it does not negatively affect other departments. Issues that needed to be resolved include setting of transfer prices between departments, formalizing intercompany transactions, the divisional structure (use of profit or cost center), and the proper allocation of company profits among departments. Problem The different departments of North Country Auto, Inc. must choose between three pricing systems: base on market price, full retail better than others, and based on book value. Also, the company must decide whether they should continue treating each department independently in order to gain huge profits considering that the managers incentives are determined upon the departments earnings. Analysis In examining the issues faced by the company, the car purchase discussed in the interdepartmental meeting is used as illustration. Companys current operations Comparison: -retail full price considered (new car sold for $5200 without any repairs) -book value considered (used car sold for $5200)

23

Guide book value at wholesale and assumed market price Retail price Trade in allowance

$3,500 5200 4800

The trade in allowance of $4800 is the value that is essentially believed by the new and used car sales force believes that the car can be sold. Considering the market price of $3500, the calculated profit is $1700. But, it should be recognized that this profit is at the expense of the $1300 profit from the initial transaction. This is due to the difference between the cars trade value ($4800) and the market price ($3500). With this, the used car manager must receive the credit or consequences for the profit or loss. This is due to the fact that the used car managers are the appropriate ones to receive incentives in selling the used cars. On the other hand, the new car managers are the ones to receive the incentives in increasing the trade-in value of the cars above the market value. This in turn, makes it easier for people to buy new cars. The illustration above brings up the issue of having the used car manager receive incentives because of the cars value determined by the new car manager. Explanation on $59000 loss on wholesaling of used cars

The loss may have occurred because new car owners are pushing for trade-in car values above market valuations on their used cars. For example, if new cars are sold for $4800 and used cars for $3500, the used car group would have a difficult time making a profit. This is because they may have sold the car for $5200 (as shown in the example above). Most of the time, it will be hard for the used car department to sell the used cars above its book value of $3500. Thus, the used car division may incur loss since they are using cost for the used cars that is too high. Recommendations Incentives should be based on company profits. A better system should be established such that managers of the two departments are given incentives based not on the gross profits of their respective departments but on the profits of the company as a whole. This would help ensure that conflicts of the two departments will be lessened and that the two departments will no longer compete but will work together to enrich the value of the firm. In order to be more profitable, the firm could use blue book values for the trade-in value and use that as the cost to the used car division. However, if it is better for the firm to provide added incentive to customers to trade in their cars, the firm could allow for higher trade-in values but responsibility for those added costs should reside in the new sales division. Regarding the issue of costs, whether it should be at wholesale or retail, it should be considered that North Country is a company offering more on services. The cost of service of making the
24

cars sellable differs minimally from the market price. And these service costs should be added to the cost of used cars in wholesale. The profit on repairs must be akin to competitors values as well as to the industry.

THANK YOU

25