Management Control Systems

Management Control Systems are a means of

gathering and using information to aid and coordinate the planning and control decisions throughout an organization and to guide the behavior of its managers and other employees

Management Control Systems

Many management control systems contain some or all of the balanced scorecard perspectives:
Financial 2. Customer 3. Internal Business Process 4. Learning and Growth
1.

Management Control Systems

Consist of Formal and Informal control systems: Formal systems include explicit rules, procedures, performance measures, and incentive plans that guide the behavior of its managers and other employees Informal systems include shared values, loyalties, and mutual commitments among members of the company, corporate culture, and unwritten norms about acceptable behavior

Evaluating Management Control Systems

To be effective, management control systems should

be closely aligned to the firms strategies and goals Systems should be designed to fit the companys structure and decision-making responsibility of individual managers

Evaluating Management Control Systems

Effective management control systems should also

motivate managers and their employees Motivation is the desire to attain a selected goal (goalcongruence) combined with the resulting pursuit of that goal (effort)

Two Aspects of Motivation

Goal Congruence exists when individuals and groups

work toward achieving the organizations goals managers working in their own best interest take actions that align with the overall goals of top management Effort is exertions toward reaching a goal, including both physical and mental actions

Organization Structure and Decentralization

Decentralization is the freedom for managers at lower

levels of the organization to make decisions Autonomy is the degree of freedom to make decisions. The greater the freedom, the greater the autonomy

Decentralization vs. Centralization

Total decentralization means minimum constraints

and maximum freedom for managers at the lowest levels of an organization to make decisions Total centralization means maximum constraints and minimum freedom for managers at the lowest levels of an organization to make decisions Companies structures generally fall somewhere in between these two extremes, as each has benefits and costs. Structure chosen cost vs. benefit analysis

Benefits of Decentralization
Creates greater responsiveness to local needs
Leads to gains from faster decision making Increases motivation of subunit managers Assists management development and learning Sharpens the focus of subunit managers

Costs of Decentralization
Leads to Suboptimal Decision Making, which arises

when a decisions benefit to one subunit is more than offset by the costs or loss of benefits to the organization as a whole.
Also called Incongruent Decision Making or

Dysfunctional Decision Making

Costs of Decentralization
Focuses mangers attention on the subunit rather than

the company as a whole Increases costs of gathering information Results in duplication of activities

Decentralization and Multinational Firms

Multinational firms companies that operate in multiple countries are often decentralized because centralized control of a company with subunits around the world is often physically and practically impossible Decentralization enables managers in different countries to make decisions that exploit their knowledge of local business and political conditions and to deal with uncertainties in their individual environments Biggest Drawback to International Decentralization: Loss or lack of control

Choices About Responsibility Centers

Regardless of the degree of decentralization,

management control systems uses one or a mix of the four types of responsibility centers:
Cost Center

Revenue Center
Profit Center Investment Center

Transfer Pricing
Transfer Price the price one subunit (department or

division) charges for a product or service supplied to another subunit of the same organization Management control systems use transfer prices to coordinate the actions of subunits and to evaluate their performance

Transfer Pricing
The transfer price creates revenues for the selling

subunit and purchase costs for the buying subunit affecting each subunits operating income Intermediate Product the product or service transferred between subunits of an organization

Three Transfer Pricing Methods

1.
2. 3.

Market-based Transfer Prices Cost-based Transfer Prices Negotiated Transfer Prices

Market-Based Transfer Prices

Top management chooses to use the price of similar

product or service that is publicly available. Sources of prices include trade associations, competitors, etc.

Market-Based Transfer Prices

Lead to optimal decision-making when three conditions are satisfied:

The market for the intermediate product is perfectly competitive 2. Interdependencies of subunits are minimal 3. There are no additional costs or benefits to the company as a whole from buying or selling in the external market instead of transacting internally
1.

Market-Based Transfer Prices

A perfectly competitive market exists when there is a

homogeneous product with buying prices equal to selling prices and no individual buyer or seller can affect those prices by their own actions Allows a firm to achieve goal congruence, motivating management effort, subunit performance evaluations, and subunit autonomy Perhaps should not be used if the market is currently in a state of distress pricing

Cost-Based Transfer Prices

Top management chooses a transfer price based on

the costs of producing the intermediate product. Examples include:

Variable Production Costs

Variable and Fixed Production Costs

Full Costs (including life-cycle costs) One of the above, plus some markup

Useful when market prices are unavailable,

inappropriate, or too costly to obtain

Cost-Based Transfer Pricing Alternatives

Prorating the difference between the maximum and

minimum cost-based transfer prices Dual-Pricing using two separate transfer-pricing methods to price each transfer from one subunit to another. Example: selling division receives full cost pricing, and the buying division pays market pricing

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Negotiated Transfer Prices

Occasionally, subunits of a firm are free to negotiate

the transfer price between themselves and then to decide whether to buy and sell internally or deal with external parties May or may not bear any resemblance to cost or market data Often used when market prices are volatile Represent the outcome of a bargaining process between the selling and buying subunits

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Comparison of Transfer-Pricing Methods

Transfer Pricing Illustration

Transfer Pricing Illustration

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Minimum Transfer Price

The minimum transfer price in many situations should

be:
Minimum Transfer Price

Incremental cost per unit incurred up to the point of transfer

Opportunity Cost per unit to the selling subunit

Incremental cost is the additional cost of producing and

transferring the product or service Opportunity cost is the maximum contribution margin forgone by the selling subunit if the product or service is transferred internally

Multinational Transfer Pricing and Tax Considerations

Transfer prices often have tax implications
Tax factors include income taxes, payroll taxes,

customs duties, tariffs, sales taxes, value-added taxes, environment-related taxes and other government levies

Multinational Transfer Pricing and Tax Considerations

Section 482 of the US Internal Revenue Code governs

taxation of multinational transfer pricing Section 482 requires that transfer prices between a company and its foreign division or subsidiary equal the price that would be charged by an unrelated third party in a comparable transaction
Transfer price could be market-based or cost-plus based

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