Management Control System Structure

The Structure of the MCS

Defining the MCS structure means:

• defining the elementary units of the MCS, i.e. the company sub-systems of which the performance must be evaluated in autonomy respect to the overall performance

• defining the specific information that must be measured relating to each elementary unit

each elementary unit can be considered a “Responsibility Centre” with a dedicated manager which is responsible for the activities of the unit

a “Responsibility Centre Accounting System” is so defined

What is a Responsibility Centre

• A Responsibility Centre is a business segment of the company, where the manager is responsible for a specific set of activities and the related economic-financial variables (costs, revenues, investments) and non- financial measures

• In a responsibility centre:1. inputs are used (resources as materials, labour, overheads,

commercial and administrative resources); 2. service or production activities are carried out (Research

and Development, Production, Logistic, Sales and Administration);

3. outputs are achieved (tangible products or services)

Definition of the responsibility centres

• The responsibility centres can be defined in different ways by the organisations. In general a company can divide the responsibilities according to:

1. company functions (line functions, such as production or sales, or staff units such as finance, administration, research and development, etc..)

2. products and services (Business Units or Divisions) 3. geographic areas (Business Units or Divisions)

• The sub-division of responsibilities reflects normally the Organisational Structure of the company

The responsibility levels

• the responsibility centres belong to different levels of the Organisation Structure of the company (also within the functions, sub-units can exist - departments and offices - ex. within the function “Logistic”, can be defined the sub-unit “Transport” assigned to a specific manager)

• consequently, three basic MCS dimensions can be identified:

1. A VERTICAL dimension2. A HORIZONTAL dimension3. A TRANSVERSAL dimension (PROCESS/PROJECT dimension);

different units belonging to different levels and to different functions can carry out an activity (ex. new product development process)

• It includes the set of organisation levels for which a specific

evaluation is required:

– Corporate level (overall company)– Business Unit level (product/market segment)– Operation level (function, department, office)

1. Vertical dimension

1. Vertical dimension

Understanding the vertical dimension means:

• asking which MCS requirements are relevant at different organisational levels;

• consequently, asking which indicators and specific measures (economic, financial, non-financial) are relevant at different levels

1. Vertical dimension: the relative importance of the requirements

Completeness

Long term orientation

Timeliness

Measurability

Identif. Spec responsibility

Corporate Business Unit Operation

ACCOUNTING TECHNIQUES FINANCIAL TECHNIQUES

NON FINANCIAL TECHNIQUES

BALANCE SHEET (RATIO ANALYSIS)

COST ACCOUNTING

MEASURABILITY High High Low High

IDENTIFICATION OF SPECIFIC RESPONSIBILITIES

Good only at top level (corporate and business level)

Good also at operative level

Good only at top level (corporate and business level)

Good also at operative level

COMPLETENESS Medium (no risk and time value consideration)

Low High Depending on the selected set of indicators

LONG TERM ORIENTATION

Low Low High It depends (high if indicators are selected according to critical success factors)

TIMELINESS Low Low Low High (only physical transactions)

A review of the requirement satisfaction by different measures

1. Vertical dimension: the techniques used at different

organisational level

  Financial indicators

Economic indicators

Non financial indicators

Corporate Main measures

ROE Few measures, relating to the key competitive factors

Business Occasional Main measures (ROI, etc.)

Few measures, relating to the key competitive factors

Operation   Costs and revenues

Main measures (quality, productivity, time, etc.)

Ferrari – benchmarking project

• Define a benchmarking project for the Ferrari company, to be used by the top manager (Luca Cordero di Montezemolo);

• The aim and scope of benchmarking can be synthesised as follows:

– to verify how Ferrari is positioned among the most prestigious car producers in the world

– to envisage its future

Ferrari – benchmarking project

• Given the aim of benchmarking:1.choose the organisations against which the

comparison should be made2.define the method of comparison (aware /

unaware)3.select the specific performance and/or

processes upon which the comparison should be made and the techniques and specific indicators to be used

4.devise appropriate data correction methods (where necessary)

Ferrari Case: Vertical structure

• Consider also “vertical dimension” in your benchmarking project:

– taking into account which are the most important requirements at each level (corporate, business unit, operation) and which are the advantages and limits of each techniques (economic, financial, non financial) with respect to different requirements

illustrate how different techniques and specific indicators are used at different organizational levels

Ferrari – benchmarking project rules and evaluation

• Work-group composition: 5-6 people

• Work-group delivery: end of May

• Work-group evaluation: 0-2 scores to be added to the written examination score

• It identifies the specific responsibilities associated to each unit belonging to a certain level

• Different types of responsibility centres can be distinguished:

– Cost Centres at the operation level– Expense Centres (discretion cost centres) at the operation

level– Revenue Centres at the operation level– Profit Centres usually at business level– Investment Centres at corporate level

2. Horizontal dimension

The responsibility levels: vertical and horizontal dimension

Headquarter

Division Europe

Division USA

Product A Product B ----

--

Production

Marketing

………...

Department 1

(ex. Packaging)

Dep.2 Dep.3

Investment Centres

Profit Centres

Cost Centres,Revenue CentresExpense Centres

2. Horizontal structure at the operation level

Cost centres• output level not defined in autonomy• responsibility on the input employed to achieve the output, that is a

responsibility on costs (price and employment of the input)• production department is the classic example of cost centre• traditionally this responsibility is evaluated through the variance between

standard costs and actual costs• the traditional approach, however, doesn’t allow to take into consideration

the performances that the production cost centres are able to control. On one hand, the employment of the input is only partially controllable by the cost centres due to the fact it depends also on the “quality” of the input (Purchase offices) and on the product design (Design offices). On the other hand, the production decisions have an impact on other variables such as the production quality, the delivery time, the post-sales service requirement, variables linked to the company revenues

• a first solution is to enlarge the set of performance dimensions for which the cost centre is responsible, considering also non-financial measures (delivery time, quality of products, etc.)

• a second solution is the definition of task forces composed by different units (Production, Purchases, Design, etc.) which responsibilities are interdependent in order to improve the collaboration between the units

2. Horizontal structure at the operation level

Expense centres • output that is difficult to be measured in monetary terms• no strong and clear relation exists between resources used (inputs)

and results achieved (outputs)• examples of discretionary expense centres are general and

administrative (G&A) departments (controller, industrial relations, human resources, accounting, legal), research and development (R&D) departments, and some marketing activities such as advertising, promotion and warehousing. All these activities are defined as “supporting activities”

• traditionally, the unique type of control for these units has been the definition of a maximum year level of expenses

• non financial measures (ex. quality, time, productivity, flexibility) and also economic measures (costs) can be introduced according to the type of activity (ex. productivity indicators can be introduced for the more repetitive activities, such as the administrative activities), in order to evaluate the quantity/quality of output of the centre

2. Horizontal structure at the operation level

Revenue centres• responsibility on the sales of goods/services (price and volume of good

sold)• traditionally the performances are measured through the variance

between the expected revenues and the actual revenues• commercial units are the classic examples of revenue centres• the traditional approach, however, doesn’t allow to take into consideration

the set of performance that the revenue centres are able to control. On one hand, the prices can be defined by central offices and the volume can be linked to product features and not only to the sale enforce. On the other hand, the commercial units doesn’t have the responsibility on other controllable activities, such as the customer assistance, which have an relevant impact on sales volume

• a first solution is to enlarge the set of performance dimensions for which the revenue centre is responsible, considering also non-financial measures (ex. customer assistance)

• a second solution is the definition of task forces composed by different units (Sales, Production, Purchases, etc.) which responsibilities are interdependent in order to improve the collaboration between the units

2. Horizontal structure at the business level

Profit centres• responsibility both on the costs and revenues• traditionally, the performance is evaluated through the variances

between the standard and the actual costs, the expected revenues and the actual revenues (the expected profit and the actual profit) building partial profit/loss statements for each centre

• A profit centre is free to:– Select the source for procurement– Choose the acquisition prices– Select the customer– Decide the selling price

• business units and divisions are the classic examples, but sometimes also departments can be defined as profit centres (i.e. maintenance department that sells its services to other units)

2. Horizontal dimension at the corporate level

Investment centre • responsibility on costs, revenues and investments• this responsibility is evaluated considering the assets (invested

capital) through the return on investments measures (ROI, ROS, etc.)

• usually, it is applied to the corporate level or to the business units with a strong autonomy

2. Horizontal dimension at business level

• Business units are independent units which have the responsibility on one product/market

• To evaluate the economic performance of BU it is necessary to evaluate:

1. The partial Profit/Loss statements for Business Unit: Advanced Direct Costing schema to evidence the

contribution of each unit (i.e. product line) to the overall company net operating income; only fixed “specific” costs are assigned to each business unit in order to avoid any arbitrary allocation of common costs

“Controllable” costs to evaluate business unit manager (II Controllable Contribution Margin)

2. The possible internal trade (goods/services) among business units it is necessary to analyse and evaluate the internal trade

among units (i.e. transfer pricing)

The advanced direct costing schema to evaluate business unit

contributionBU “A” BU “B” BU “C” TOTAL

Revenues X X X X

Variable costs (i.e. direct material; direct labor; energy)

X X X X

I Contribution Margin

X X X X

Fixed Specific costs (i.e. amortization)

X X X X

II Contribution Margin

X X X X

Fixed Common costs (i.e. amortization, indirect labor; general and administrative costs)

X

Net operating income

X

The advanced direct costing schema to evaluate business unit

contribution

Examples

• Superpizza• Officina Veneta

SUPERPIZZAIn 20X0, Mr. Gennaro Esposito, decided to start up his own activity. He started, at first, with the production and sale of pizzas “take away” and then he added the delivery of pizzas at home in the evening hours. By the way, he realized that a combination pizza + drink was very appreciated by customers. He decided to apply a unique price for each combination: 6 euro for the combination “take away”; 7 euro for the delivery at home. In the following year, Mr. Esposito decided to rent a place to offer all the activities, included the service on the table. The combination was the same but offered with a price equal to 7,5 euro. For this specific activity, it was also necessary to engage a waiter. The “take away” cashier could be dedicated also to the new activity for a 20% of time. Another person (named “pony”) was specifically dedicated to the delivery at home and he personally managed the takings. For the deliveries, he used a small van, available for the overall activities (purchases of materials, etc.). Besides, 5 producers of pizza (“pizzaioli”) were engaged. In the following table, data concerning the first semester 20X1 are reported.

-Elaborate the Profit/Loss Statement for the first semester 20X1 in order to point into evidence the contribution provided by different selling combinations to the net operating income for the overall company.

Sales TAKE AWAY 18.000 combinations

Sales DELIVERY AT HOME 7.500 combinations

Sales SERVICE ON THE TABLE 4.500 combinations

Pizzaioli (each one, each month) 1.500 euro

Waiter (each month) 1.500 euro

Cashier (each month) 1.000 euro

Pony (each month) 500 euro

Place rent (each month) 2.200 euro

Small van rent (each month) 300 euro

Power and wood (each month) 1.000 euro

Direct materials for pizzas production (each semester)

60.000 euro

Costs for sold drinks (each semester) 15.000 euro

OFFICINA VENETAOfficina Veneta (O.Ve.) is a small company that produces components for kitchen

production, in particular structural elements for ovens: ELEMENT 1; ELEMENT 2; ELEMENT 3.

Production is carried out by means of three production lines:- Line 1 is devoted to ELEMENT 1;- Line 2 is devoted to ELEMENT 2;- Line 3 is devoted to ELEMENT 3.

Due to the particular nature of some activities, it has been possible to calculate a direct labor cost per unit (see Annex 1).

Indirect Workers (for activities supporting production) are the following:- 2 workers for warehouse management;- 2 workers for maintenance and repairing;- 2 administrative employees.

On the basis of other information in Annex 1:1. Elaborate Profit/Loss Statement to take into evidence the contribution of each

product line to the overall company net operating income.

ANNEX 1:• Production/sales in units and selling price per unit:90.000 units ELEMENT 1; 11 euro per unit; daily production: 360 units90.000 units ELEMENT 2; 5,5 euro per unit; daily production: 630 units90.000 units ELEMENT 3; 7,5 per unit; daily production: 840 units

• Annual average indirect worker cost: 35.000 euro• Annual average administrative employee cost: 40.000 euro• Direct material per unit:3,15 euro per ELEMENT 1;1,62 euro per ELEMENT 2;2,25 euro per ELEMENT 3.

• Direct labor cost per unit:1,16 euro per ELEMENT 1;0,44 euro per ELEMENT 2;0,16 euro per ELEMENT 3.

• Annual energy cost: 80.500 euro (the energy consumption is considered a variable cost depending on number of operating days per line)

• Annual amortization: 560.000 euro, in part specific for each line (250.000 for ELEMENT 1; 150.000 for ELEMENT 2; 100.000 for ELEMENT 3)

• Other general expenses: 35.000 euro

The advanced direct costing schema to evaluate business unit manager

BU “A” BU “B” BU “C” TOTAL

Revenues X X X X

Variable costs X X X X

I Contribution Margin

X X X X

Fixed Specific Controllable costs

X X X X

II Controllable Contribution Margin

X X X X

Fixed Specific Non Controllable costs

X X X X

II Contribution Margin

X X X X

Common costs X

Net operating income

X

The advanced direct costing schema to evaluate business unit manager

Example

• JB Trucking

JB TRUCKING• Jb Trucking is a transport company which is operating in the North California and in Nevada. In order to

evaluate performances, the company Profit/Loss has been divided for geographic areas. An area, the Truckee Meadows, is dedicated to sub-areas Reno and Lake Tahoe, in California. The information relating to the deliveries of January are the following:

• Direct variable costs include oil and fuel costs and the costs for the car loading. • The specific fixed costs includes the amortisation, the maintenance (provided by Jb Trucking central shop),

the licence costs for the trucks. In particular, the maintenance costs (400$ for Reno; 800$ for Lake Tahoe) are not controllable by the sub-area managers because maintenance is carried out monthly on the basis of government rules.

• The geographic areas, and the sub-areas of delivery, are considered profit centres.• Truckee Meadows’ costs of administration and marketing (“common” to sub-areas) are equal to 3.700

euro.

Questions:

1) Elaborate a partial profit/loss statement to evaluate a) the profitability of the sub-areas; b) the performance of the sub-areas managers.

2) If common costs are allocated on the basis of sub-areas revenues, which is the impact on sub-areas’

profitability? Discuss this type of solution.

Reno Lake Tahoenumber of deliveries 50 40Total Revenues 5000 $ 8000 $Direct variable cost for delivery 50 $ 75 $Specific fixed costs 900 $ 2800 $

Common Corporate Costs allocation to Business Units

• The allocation of common corporate costs to Business Units has an impact on their profitability and therefore on their performance evaluation (examples of corporate costs are general costs, legal costs, research and development costs)

• In the practice it is possible to have the following alternatives:– to allocate to the BU all the corporate costs using arbitrary

allocation basis – to allocate only a share of corporate costs, in particular

those costs which are specific for each business unit (see the Advanced Direct Costing schema). For example, research costs: only the costs of applied research specifically “used” by business units. In this case the corporate level “sells” its services to the business units

Corporate Costs allocation : advantages and disadvantages

• Complete allocation: – the business unit performance decreases with the increase of

corporate costs; – common is the proportional allocation (based on revenues) which

is not consistent with the specific responsibility principle (a BU which increases its revenues receives a higher share of corporate costs even if the activity increase does not cause a higher use of the corporate resources!).

– corporate inefficiency can be unfairly assigned to the business units

• Partial allocation: – more consistent with the specific responsibility principle; – the BU can require a lower corporate service level with

disadvantaged in term of long-period company competitiveness, in order to avoid the allocation of corporate costs