mcs -by dr sharad joshi

7/30/2019 mcs -by dr sharad joshi

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MANAGEMENT CONTROL

SYSTEMS

Dr Sharad L. JoshiProfessor

Vishwakarma Institute of ManagementPune


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Syllabus Topics1. Characteristics of MCS2. Responsibility Centers

3. Budgetary Control- Engineered,Discretionary, Committed Costs

4. Capital Expenditure Control5. Transfer Pricing

6. Balanced Scorecard, financial and non-financial measures7. MCS in a service organization8. Audit Financial, Internal, Cost,

Management


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Concept, Characteristics1. Management Control is the process by which managers

influence other members of the organization to implementthe organizations strategies.

2. Through the process of Management Control, managers assurethat resources are obtained and used, effectively andefficiently, in the accomplishment of organizations objectives.

3. Control hierarchy is : Strategic Planning, Management Control,Operational Control and Task Control.

4. Achieving Goal Congruence between organizational goals

and individual goals is the objective of Management Control.5. Management Control is a repetitive activity largely based on

financial and non-financial measures of performance


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Example of Management

Control Decision to penetrate market in Southern India is Marketing

Strategy.

Ensuring that this gets reflected in Sales Budget for states inSouth India, breaking it down by Zonal and Regional Offices,and to oversee implementation of the budget through the salesorganization is Management Control.

Ensuring booking of orders, delivery of goods, billing thecustomers and recovering money in one of the cities in South

India is Operational Control. Arranging transport for supply of material against a particular

order and ensuring that the material is delivered as per promiseis Task Control.


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Goal Congruence Goal Congruence means that actions that people take according

to their perceived self interest are also in the interest of theorganization.

In evaluating management control practices, two mostimportant questions are (a) What actions do these practicesmotivate people to take in their self-interest? (b) Are theseactions also in the interest of the organization?

According to agency theory, managers are said to be agents of

the owners. Goal Congruence expects that the agents safeguardand act in the interest of the owners.

Goal Congruence is dependent on factors such as organizations workethic, culture and management style.

A control system needs to accept and consciously promote theobjective of goal congruence.


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Management Control Process

1. Strategic Planning

2. Budgeting System to incorporatestrategy and to assign responsibilities

3. Performance Measurement andperformance reporting

4. Managerial Compensation (or Rewardand recognition system to) assistadherence to budget


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Strategy implementation

framework Organization Structure Design of Roles, Reporting

Relationships and division of responsibilities appropriate forexecution of the strategy

Human Resource Management Policies and practices forSelection, Training, Performance Evaluation, Promotion andTermination of employees so as to develop knowledge, skillsand attitude required to execute organizations strategy

Culture The set of common beliefs, attitudes and norms that

explicitly/implicitly guide actions of members of the organization Management Controls Translating organizations strategy into

targets applicable for individual managers and ensuringadherence to the targets based on specific financial and non-financial measures.


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Implementation Mechanisms

of Strategy

Performance

ManagementControls

OrganizationStructure

HumanResourceManagement

Culture

Strategy


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Case for Strategy Implementation Public Sector Banks will have to leave Comfort Zone.

A comparison of PSU banks with private sector banks indicated thatthe PSU banks have a much lower Fee Income as compared to theprivate sector banks. (Fee income includes income from advisory

services, syndication of loans, providing letters of credit andguarantees, and sale of other banking products). Yes Bank, whichis just 8 year old, earned fee income of Rs 767 cr. for 2011-12,which is higher than 18 other public sector banks.

PSU banks have been reluctant to do this mainly because of theirinherent constraints. Traditionally these banks have been trained to

focus on Interest Income on loans; however loans given withoutadequate due diligence are coming back to haunt them as badloans. Not many PSU banks have developed expertise in the field ofadvisory services despite having a huge network of branches.


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Case continued -Public Sector Banks will have to leave Comfort Zone.

Ms Shikha Sharma CEO and MD of Axis Bank mentioned that herbank has developed a strong fee income infrastructure based onskillset of experienced employees, pursuit of product innovation,

value added services, diverse distribution channels, and above all,commitment to a customer-centric approach. Fee income of AxisBank for 2012 is Rs 4341 Cr. out of a total Rs 27436 Cr. (15.8%).

Bank of Baroda which is a PSU bank has a ratio of Fee Income toTotal Income of 3.7% (out of a total Rs 33589 Cr.). The bank has

taken a policy decision of increasing this ratio to 10 % over a 5-year period; broken down into specific year-wise targets.

Comment on Strategy Implementation measures which may beneeded, and especially on the Management Control Systems.


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Strategic Directions for

Increasing Fee Income Identifying Services/ Products to be focused

Appointing a GM Services as overall in charge

Marketing Strategy / Marketing Communication Training at various levels

Determining and Monitoring progressive Targets

Performance Measurement/ Reward (Group Bonus?)

Management Information System Sharing, Benchmarking (Meetings)


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Griesinger Paradigm1. Cybernetics Science of communication and

control, also the way systems regulate themselves,

replicate, evolve and learn. Credited to NorbertWeiner, a Mathematician.

2. Cybernetics is essentially about systems in self-control. They have goals, can measureperformance, compare performance with goals,

compute variance, report variance, determinecauses of variance, take corrective action, andrepeat the cycle until goals are met.


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The Cybernetic Paradigm of the Control Process


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Applying Griesingers

paradigm to a real life case ET headline - FM asks bankers to pressurize builders

to speed up projects and cut prices of apartments.

The builders are said to be sitting on a largeinventory of unsold apartments, in which huge capitalis blocked. Banks are being asked by FM to putpressure on builders, since they have funded boththe builder and the home loan borrower. For

example, State Banks exposure to Realty sector is144000 Cr, ICICI Banks 81000 Cr.

Review Griesingers diagram. Assign Roles stated in the diagram

to agencies in the situation stated above.


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Applying Griesingers

Paradigm - Solution Information given in the case, especially FM putting pressure on the

banks, passes thru Sensor and results in Formulation of Goals.

The bankers entrusted with persuading the builders are the decision

makers. The information analysis and communication system existingin the bank is Sensor. Based on inputs provided, the decision maker(s)perceive and formulate their Factual Premises. These are comparedwith goals thru a comparator which can be a committee.

The decision maker(s) decide about actions needed to meet the goals.

The effector is an individual or a group which puts into effect what

has been decided, making behavioral choice from an availablerepertoire.

The environment changes; to be assessed by the sensors, for the nextcycle of System even the goals may be altered.


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Controllers Responsibilities1. Designing and Operating Information and Control

Systems Budgets, standards, procedures to

implement the system2. Reporting, analyzing and consulting

3. Internal Audit and Accounting Control Procedures,Protection of assets

4. Economic Appraisals, Cost benefit analyses

5. Developing personnel for Control Organization,Training managers in related matters


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Formal Control Process - I Infrastructure Organization Structure, Strategy,

Operations, Patterns of Autonomy, Measurement

Methods, Responsibility Centers, Transfer Pricing Management Style and Culture Principal Values,

Norms and Beliefs (See slide of Reliance Industries,as an example)

Principal Processes Strategic Planning, Capital

Budgeting, Operating Planning, Cost Accounting,Budgeting, Reporting System, Variance Analysis


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Formal Control Process - II

Rewards and Penalties Individual andFirm level, Short Term and Long Term,Promotion Policy

Coordination and Integration -Standing Committee, Meetings,

Communication Systems, Conferences


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Example of Reliance Industries

Values and Beliefs Accent on high technology areas.

Faith in Investors

Ethics starts from Board Room Ethics does not prevent from taking business risks

Growth with dignity

Stock market ultimate barometer

Thrive on challenge Keep running to stay at the same place

Consumers final referees


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Informal Control Process Infrastructure Personal Contacts, Networks,

Emergent Roles

Management Style and Culture PrincipalValues, Norms and Beliefs

Control Process Personal Supervision,Meetings

Rewards and Penalties Informal Rewardsand Promotions

Co-ordination and Integration Trust Based,

Personal Contact


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Management Control Systems

- Summary Management Control Systems is the process of

implementing organizations strategy.

In order to translate strategy into performance,management control systems need to be supportedby appropriate Organization Structure, HumanResource Management, and corporate Culture i.e. astructure of norms and values and beliefs.

The control process consists of FIVE components :Control Infrastructure, Management Style andCulture, Specific Processes, Rewards and Penaltiesand Mechanism for Coordination and Integration.


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Responsibility Centers- I All organizations are made up of smaller organizational units

divisions, departments within divisions, sections withindepartments. If any of these units and sub-units is headed by a

supervisor responsible for its performance, the said unit or sub-unit is called a Responsibility Center.

The main purpose of MCS, that of implementing theOrganizational Strategy is put into effect through theresponsibility centers. If each of the responsibility centers meetsits objectives, the objectives of the organization will have beenmet.

An important function of Management Control Systemstherefore is to control the performance of ResponsibilityCenters.


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Responsibility Centers- II

A generic view of functioning of aresponsibility center can be presentedas follows.

Inputs Outputs

(Resources Used, (Goods, Services, Effects)Measured as Cost)

Work


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Responsibility Centers- III

Responsibility Centers differ from eachother in terms of

Measurability of Inputs and Outputs

Measurability of Efficiency and Effectiveness ofOutput, in relation to Inputs. (Efficiency is ratio ofOutputs to Inputs. Effectiveness is closeness of the

output to objectives of the Responsibility Center).

Depending on the above, ResponsibilityCenters are divided in Four Types.


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Types of Responsibility

CentersType Nature of Measurement of

I nputs and OutputsExample

1. Revenue

Center

Output measured in monetary terms;

no formal attempt is made to relateoutput to input

Marketing Function

(Bata Shoe Shop)

2. ExpenseCenter

Input measured in Monetary Terms, noattempt is made to measure output inmonetary terms

ManufacturingFunction (FoundrySection)

3. Profit Center Both measured in monetary terms, the

difference treated as profit(loss)

Internal Business

Unit4. InvestmentCenter

Both measured in monetary terms, thedifference treated as profit(loss).Measurement is by relating it to CapitalEmployed

(Larger) InternalBusiness Unit


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Evaluation of a Revenue

Center Budgeted Revenue Vs Actual Revenue (For

Individual Products/Product Categories)

Comparison with previous period(s)

Comparison with other comparable salesoutlets

Analysis of Quantity, Rate and Mix Variance


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Revenue Center - Problem on

Variance AnalysisThe figures for a BP Petrol Pump for April 2012 and

April 2011 are as follows.

April 2012 April 2011Ltrs Value, Rs Ltrs Value, Rs

Petrol 467896 34137692 406789 27165369

Speed 67986 5069036 65532 4498772

Diesel 267854 11335581 278487 10707825Total 803736 50542310 750808 42371966

Comment on relative performance of the two years.


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Formulae for Computing

Variances Rate Variance Difference in Rates X Current years

Volume

Mix Variance - (Current Year Volume Current YearVolume at Previous years Mix %) X Prev. Year Rate

Volume Variance - (Current Year Volume at Previousyears Mix % - Prev. Year Volume) X Prev. Year Rate

Gross Variance Total of Rate, Mix and VolumeVariances, also Difference between Value betweentwo years


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Calculating Mix Variance

Apr-12 Apr -11

Lt r Rs/ Lt r Value,Rs M ix % Lt r Rs/ Lt r Value,Rs M ix % Rate Var M ix Var Vo l Var Gross V

467896 72.96 34137692 58.22 406789 66.78 27165369 54.18 2891597 2165710 1915015 6972323

67986 74.56 5069036 8.46 65532 68.65 4498772 8.73 401797 -148673 317140 570264

267854 42.32 11335581 33.33 278487 38.45 10707825 37.09 1036595 -1163684 754845 627756

803736 50542310 100.00 750808 42371966 100 4329990 853354 2987000 8170343


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Analysis of VarianceType Amount, Rs %

Rate Variance 43,29,990 53.00Mix Variance 8,53,354 10.44

Volume Variance 29,87,000 36.56

Gross Variance 81,70,344


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Expense Centers Expense Centers are responsibility centers in the case

of which input is measured in monetary terms but

output (goods, services, effects) cannot be or is notattempted to be, measured in monetary terms.

Examples of expense centers are manufacturingdepartments in a factory, administrative and supportdepartments such as accounting and maintenance,

training, transport, research and development etc. Controlling Expense Centers essentially means

ensuring Efficiency and Effectiveness in theiroperations for which both monetary and non-monetary measures are used.


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Expense Centers Control linked to

behavior of 3 types of costs

Engineered Costs are those in the case of which right orproper amount of costs can be calculated with a fair degree ofreliability. (e.g. material costs, piece rate labor)

Committed Costs are those which arise as a result ofCommitment made by the decision maker. The costs remainconstant during the period of the commitment (e.g. Office Rent,interest on term loan)

Discretionary Costs (also known as Managed Costs) arise as

a result of discretion or judgment exercised by the decisionmaker. The right or proper amount cannot be stated withexactness. A range may be stated, it is often, however, toobroad to be of any practical use. Percentage change in costs toachieve desired percentage change in results can also not bestated. (Example: Advertisement Costs)


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Engineered and Discretionary

Expense Centers Engineered Expense centers are those where

Engineered Costs are a dominant form of costs

incurred those in the case of which right orproper amount of costs can be calculated with a fairdegree of reliability.

Discretionary Expense Centers are those where amajority of costs incurred are of Discretionary type

where the right or proper amount to be spentcannot be stated with exactness.

In the case of either of these, other types of costsmay also exist and need to be controlled usingtechniques/ practices suitable for them.


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Controlling Engineered Costs The steps in cost control are as follows.

Measure output in physical terms

Work back expected Input cost on the basisof a set methodology (formula, algorithm)

Compare Actual Costs with expected Costs

Measure Variation Analyze variation

Take corrective action


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Variance Analysis Problem for

Material Costs As per Standards set by Asmita Builders, 1 litre of

Cement Paint, at a standard rate of Rs 58 per litre,

can be used to paint 50 square feet. Actual costincurred at a site for painting 10000 sq.ft. came toRs 11400 for 190 litres of paint used. Compute Rate

Variance and Usage Variance.

Formulae :

Rate Variance Difference in Rates X Actual Usage Usage Variance Difference in Usage X Std. Rate

Net Variance Standard Cost - Actual Cost


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Solution to the Problem Standard usage for 10000 sq ft is 200 litres at

Rs 58/ Ltr. Total Std Cost Rs 11,600.

Actaul Usage 190 litres at Rs 60/Ltr, Rs 11400

Rate Variance: (58 - 60) X 190 - Rs 380 (U)

Usage Variance: (200 190) X 58 Rs 580(F) Net Variance: Rs 11600 Rs 11400, Rs 200;

also equal to (Rate Var. + Usage Var).


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Controlling Committed Costs Committed costs can be controlled only at the stage

of making the commitment (e.g. Office Rent or

Interest on Term Loan) Suitable policies and procedures need to be designed

so as to ensure control at the stage of commitment.These will include assigning responsibility ofcontrolling Committed Costs (or a part thereof) to

respective Responsibility Centres. A majority of Committed Costs arise from Capital

Expenditure decisions; which is an important domainunder Management Control.


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Problem on segregating committed costs

Based on Power Expenses for 6 months (Rs lakhs), segregatecommitted and engineered costs.

Prodn Value Power Bill

Jan 327 56.75

Feb 363 58.80

Mar 410 63.10

Apr 352 57.60

May 261 52.44

Jun 314 54.60

(Using equation of the straight line, y= a + bx with Power Bill as y valuesand Production as x values, solution obtained thru LINEST function inEXCEL is a = Rs 32.57821 lakhs and b = Rs 0.072852 lakhs. CommittedCosts are thus Rs 32.58 lakhs, approx.)


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Controlling Discretionary Costs

Principles and Best Practices1. Competent Managers2. Healthy Atmosphere

3. Policies, Procedures, Guidelines, Rules4. Periodic Review of the above5. Using Engineered Cost Method where

possible6. Use of the budget to promote discipline, use

it selectively as ceiling, floor, guide.7. Use of non financial measures8. Benchmarking


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Notes on Controlling

Discretionary Costs - I1. Competent Managers by virtue of theirknowledge and skills, keep the costs

under control and get value for expensesincurred. They are also expected to makeadequate use of expertise available within

and outside the organization - lawyers,auditors, advertising and market researchagencies etc.


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Discretionary Costs - II2. Healthy atmosphere stands forprofessional, task-oriented approach to

work. The employees in such anorganization display efficient, goaloriented behaviour which ensures

teamwork and efficiency as a result ofwhich discretionary expenses are keptunder control.


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Discretionary Costs - III3. Policies, procedures, guidelines and rules is a way ofensuring adherence to standard practices across the

organization. There can be a company policy aboutacquiring branch office on lease or as outrightpurchase. Purchase Procedure will ensure that nopayment is made to a supplier unless goods have beenreceived. Banks may have guidelines about assessing

credit-worthiness of a auto-loan borrower. SEBI has aset ofrules for IPOs by limited companies. All theseensure uniformity, control, and compliance withobjectives.


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Standard Operating Procedure

(SOP) for Purchase of goods Purchase procedure begins with indents prepared by user

departments. Indents are consolidated by Purchase Departmentso that a bulk order can be placed for similar goods. Purchase

Dept. invites quotations for the goods in question. Number ofquotations invited depend on expected value of the purchase(minimum 3). Value above a specified amount calls for an opentender thru a newspaper advertisement. Departmental headshave an authority to decide the source of supply up to a statedamount; beyond which the source is decided by the purchase

committee. Beyond a certain amount, top 3 (or 5) suppliers maybe called for negotiation before the purchase committee.

How will you deal with routine purchase of items of raw material? Whatchanges will be required for e-buying? How to measure performance ofsuppliers?


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Discretionary Costs - IV4. Policies, procedures, guidelines and rules willneed to be reviewed from time to time so as to

keep them up to date. For example, DailyAllowance for outstation travel should keeppace with current price levels. Rules for use ofnew technologies will be required to be framed.

Outdated policies, procedures, guidelines andrules may be detrimental to meetingorganizations objectives.


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Discretionary Costs - V5. Engineered Cost components exist as a part ofDiscretionary Costs. Information Technology

Department is a Discretionary Expense Center, of whichdata entry is an engineered cost, compensated on perentry basis; so is invoice printing as a part of marketingdepartments work. These components can becontrolled on the basis of measuring output, working

back the expected input costs and comparing them withthe actual. Development of metrics for many othertasks is also attempted to control productivity and thecost.


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Discretionary Costs - VI6. Though not as rigid as in the case of other types ofcosts, use of budget is common in discretionary costs to

develop planning and controlling skills amongmanagers, (e.g. for expenses such as advertising andtravel). Budgets can be used as ceiling not morethan the stated amount, floor not less than thestated amount in the case of developmental expenses

and guide around the stated amount. Budgets aredetailed for functions, sub-heads and geographical units(e.g. branches) so as to ensure higher degree offinancial discipline.


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Discretionary Costs - VII7. Non-financial measures to control discretionary costsare used to measure effectiveness, along with

efficiency. Producing monthly Balance Sheet before 7th

of the following month can thus be a target foraccounting department. Preparing a report on ageanalysis of outstanding and ensuring that these are inline with the norms is a way to control Credit Control

Department. Banks can similarly set norms for NPA(Non performing assets). Some of these are expressedas KPIs, considered as important as financial results.


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Discretionary Costs - VIII8. Benchmarking is a simple yet effective method ofimproving performance and indirectly controlling costs.

A bank can compare performance of branches in thesame category with respect to their income from otherservices and identify best practices for the benefit ofall. Benchmarking can be formalized by having anagreement with an organization considered superior in

the specific segment which may share their practiceswith their benchmarking partner at a cost.

Combination of all methods (1 to 8) is needed in orderto control discretionary costs.


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Cost Control of Handling Service Requests and

Complaints at a Mobile Phone Company Service Center

1. Competent Managers, Healthy Atmosphere2. Policies, Procedures, Guidelines, Rules based on above (one of

these could be training to staff, specifying qualifications forcomplaint handlers)

3. Yearly review to identify changes required in policies,procedures, guidelines and rules

4. Budgets, in terms of people and equipment, minimumallocation for new technologies, software, facilities

5. Engineering Cost Method for routine complaints (Targets per

day)6. Use of non-financial measures (Zero Complaint Week for a

particular type of complaint)7. Benchmarking thru comparison between branches8. Use of Mystery Shoppers, performance audit


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Controlling Travel Expenses

A software product company spends Rs 30 crores every

year on marketing, which travel budget alone is approx,50%. This includes expenses for travel and stay. Whatapproach you will suggest for controlling Travel Costs?

(Use approach similar to that used for controlling costsof Mobile Phone Companys service center. Give more

attention to Budgeting Travel Costs by Dept.,Destination, Mode of travel etc)


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Profit (or Financial Performance) Centers

as Responsibility Centers

1. Both input and output is measured in monetary terms. Thedifference, profit(or surplus), is said to measure efficiency aswell as effectiveness. Profit also serves as resource allocator.

2. Considered Tool of Decentralization and of Goal Congruence3. Two types : Natural (e.g. Independent product or a branch)

and Constructive (formed deliberately, such as ComputerDepartment and Law Department)

4. Profit (often called profit contribution) is measured as ProfitCenters Revenue minus direct costs (before tax).

5. Sum total of profits of all divisions may not necessarily equalfirms profit; some of the prices of profit centers are merely formeasurement of their respective contribution.

6. The system presupposes a certain degree of professionalmaturity and systems support


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Transfer Price Since at least a part of the business transacted by the profit

centers is with other intra-company profit centers, the pricescharged and paid by them to each other (transfer prices)

become important. Unless based on sound rules the TransferPrices can emerge as a major source of dispute between thecenters; thus negating purpose of achieving goal congruence.

Unlike Inter-company profit centers, intra company profitcenters do not have complete freedom to set prices.

3 possibilities (1)Profit Centers do not have the freedom tobuy from outside; they must buy internally at negotiated prices.(2) Profit Centers have a long term arrangement to buy or sellintra-company (3) Buy or Sell decisions can be taken on a shortterm basis. (Case of large open market)


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Transfer Prices 3

alternatives1. Market Based Using Market price as a base

2. Cost Based Cost Plus Profit

Full Cost+ Profit for high Capacity Utilization

Variable Cost+ Profit for low CapacityUtilization

Use of standard rather than actual Costs isdesired in either case

3. Negotiated Price


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Special Pricing Alternatives1. Two step Pricing

Transfer Price is made up of 2 components, a fixedmonthly charge plus per unit charge, usually onvariable cost basis (like domestic electricity bills)

2. Dual Pricing

Transferring and Transferee departments havedifferent prices for the purpose of computing profit

3. Profit Sharing : Downstream profit is shared between upstream

responsibility centers


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Hostel Pricing Case1. An Engineering college has a Hostel. The Hostel and

Engineering College are both Financial Performance (Profit)Centers.

2. The Cost Per student according to Hostel Management comes

to Rs 22,500 per student.3. The students find the rate on the higher side. Comparable

accommodation in the area is available at Rs 15,000.4. The management desires to offer the rooms at Rs 15,000,

provided the college subsidizes the difference.5. The college questions the cost, arguing, hostel makes no effort

to control costs since these can be passed either to thestudents or to the college.6. What should be the transfer price policy which will ensure

efficiency and motivation to perform at the Hostel level? Howto ensure that the College and the Management are alsomotivated?


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Possible plan of action1. Subsidy required to protect the interest of the Institution so

that hostel facility is offered to students and that rooms do notremain vacant.

2. Consider Market Price to decide subsidy3. Compute hostels per students cost as Standard Cost Plus

Profit, not actual cost

4. Hostels performance with respect to admissions should beevaluated on actual vs. budget.

5. Subsidy should be charged to a Control Account; which may

be distributed to colleges (on the basis of their admissionquota in hostel, number of students in college or total fees).

6. Charging subsidy direct to college is dysfunctional; they maynot send students to hostel, preferring alternatives.


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Transfer Price ProblemDiv A and Div C are 2 intra-company profitcenters. Div A suplies units to Div C.

Division Cs Annual Purchase 1000 UnitsDiv As (Supplying Dept) Price Rs 150

Market Price Rs 135

As Variable Cost P.U. Rs 120As Fixed Cost P.U. Rs 20


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Will the company benefit if

purchased from market? No.

Purchase Cost per Unit Rs 135

Variable Cost saved P.U. Rs 120

Loss per unit Rs 15

Total for 1000 units Rs 15000


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If A can use the facilities elsewhere toearn Rs 18000

will the company benefit?

Yes.

Loss in Contrbn thru buying Rs 15000

Earning thru use of facilities Rs 18000

Net Benefit Rs 3000


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If market price drops from 135 to

115 should we buy from outside?

Yes.

Outside purchase price Rs 115

As variable cost Rs 120

Saving per Unit Rs 5

Total for 1000 units Rs 5000


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Problem 2. Dept A (Supplying dept) Variable Cost Rs 84

p.u., Fixed Cost Rs 6 p.u., Selling Price Rs 92

p.u. Dept B (Receiving Dept) Extra Variable Cost

Rs 80 p.u., Fixed Cost Rs 10 p.u., FinalSelling Price Rs 176 p.u.

B has offer from an outside supplier at Rs 90p.u.

Should B buy from A or from outside? WhatTransfer Price should be allowed to A?


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Investment Centers1. Investment Centers are basically profit centers where profit

center managers also have the freedom to control theirInvestments i.e. fixed as well as current assets deployed bythem. Instead of absolute profit, profit related to Investment(ROI) is therefore used as a tool of measurement. ROI alsoserves as a resource allocator.

2. Investment Centers are even a better tool of Decentralizationand of Goal Congruence.

3. Along with Profit, assets deployed by the resp. center alsoneed to defined. Allocating all assets in Balance Sheet is oftena difficult exercise in the case of intra company investmentcenters.

4. The system presupposes a high degree of professionalizationand systems support. Asea Brown Boveri, a MNC, has 1000investment centers and 5000 profit centers.


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Measures of performance for Investment

Centers - ROI, ROA, EVA, MVA

1. Return on Investment PBIT/ Total Assets*

ROI measures efficiency in use of funds from an insiders(controllers) point of view.

2. Return on Assets PAT/ Total Assets*

ROA measures efficiency in use of funds from ashareholders point of view.

3. Economic Value Added = [PAT + (1-t) x Interest] [Cost ofCapital (of Equity and Debt)]

4. Market Value Added = Market Value of (Equity + MarketableDebt) their Book Value.

*Total Assets = Non Current Assets + Net Current Assets

Net Current Assets = Current Assets Current Liabilities


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Measures of performance for Investment Centers - ROI,

ROA for Asian Paints Ltd, 2011-12

1. Return on Investment PBIT/ Total Assets

PBIT Rs 1394 Cr, *Av. Total Assets - Rs 2435 Cr

ROI - 1394/2435, 57.25%

2. Return on Assets PAT/ Total Assets

PAT Rs 958 Cr, *Av. Total Assets - Rs 2435 Cr

ROA - 958/2435, 39.34 %

*Av Total Assets = Rs 1802 Cr (Non-Current) +

Rs 633 Cr (Current Assets Current Liabilities)


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Centers - EVA for Asian Paints Ltd, 2011-12

3. EVA = Net Operating Profit After Tax - Cost of Capital

Net Operating Profit after Tax [PAT+(1-t) Interest]

PAT Rs 958 Cr, Interest- Rs 31 Cr, Tax Rate (t): 32.45%,

PAT+ (1-t) Interest = 958+ (1-.3245) x 31 = 978.94 Cr

Cost of Capital

Equity 2232 Cr (92%), Debt 203 Cr (8%), Total 2435 Cr

Cost of Equity 13 %, Cost of Debt 14% x (1- .3245) , 9.46%

Weighted Av. Cost of Capital = 13 x .92 + 9.46 x .08 = 12.72%Cost of Capital = 2435 x 12.72% = 309.73 Cr

Economic Value Added

NOPAT Cost of Capital = 978.94 Cr 309.73 Cr = 669.21 Cr


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Centers - MVA for Asian Paints Ltd, 2011-12

4. MVA = Market Value of the firm (of Equity andDebt) Book Value (Equity+ Debt)

Market Value of Asian Paints, Rs 17600 CrBook Value of Equity + Debt, Rs 2435 Cr

Market Value added (MVA), Rs 15165 Cr


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Du Pont Analysis Return on

Total Assets (ROA)Net Profit Net Profit Net Sales

------------------------- = ------------- x --------------------------

Average Total Assets Net Sales Average Total Assets

Return on Assets Net Profit Total Assets

Margin Turnover Ratio

Note: Av Total Assets = [Fixed Assets + (Current Assets CurrentLiabilities)]. Du Pont takes Net Profit as Profit after taxes, not PBIT.

Norm Norm for PBIT should be 18%. With 1:1 Debt-Equity Ratio,14 % rate of Interest and 32% Tax Rate, PAT should be 7.5%of Total Assets. The norm will change with Debt/ Equity Ratio.For a company with no Debt, the Norm will be approx. 12%.


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Du Pont Analysis for Asian Paints Ltd, 2011-12

Return on Assets

Net Profit / Av. Total Assets

Net Profit (PAT) Rs 958 Cr, Av.Total Assets-Rs 2435 Cr

ROA - 958/2435, 39.34 %

Net Profit/ Net Sales (Profit Margin)

Net Profit (PAT) Rs 958 Cr, Total Sales Rs 8105 Cr

NP to Sales 958/ 8105 11.82%

Net Sales/ Av. Total Assets (Asset Turnover or Rotation)

Net Sales Rs 8105 Cr, Av Total Assets Rs 2435 CrRotation 8105/2435 , 3.329 Times

Crosscheck 11.82 x 3.329 = 39.34% ( 958 = 958 x 8105

2435 8105 2435 )


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Du Pont Analysis, Extended,

Return on Equity (ROE)Net Profit = Net Profit Net Sales Av. Tot. Assets

----------- = ----------- X ---------- x -----------------

Equity Net Sales Av. Total Assets Equity

Return on Net Profit Assets Financial

Equity Margin Turnover Leverage

958/ 2232 = 958/8105 x 8105/2435 x 2435/2232

42.92% = 11.82% x 3.329 x 1.09

Equity holders get 42.92%, while overall ROI is 39.34%.


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UoP December 2011 Problem A division of XYZ Ltd has assets of Rs 30 lakhs,

invested Capital Rs 22 Lakhs and Income of Rs 8lakhs ignoring taxes.

1. What is Divisions ROI?

2. If weighted average Cost of Capital is 18%, what is EVA?

3. If management uses ROI as a performance measure, whateffects on management behaviour do you expect?

4. If management uses EVA as a performance measure, whateffects on management behaviour do you expect?


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UoP December 2011 - Solution to the

Problem - I

1. ROI = Profit Ignoring Tax / Av. Total Assets

= Rs 8 Lakhs / Rs 30 Lakhs

= 26.67% Approx.

2. EVA = Profit Ignoring Tax Cost of Capital X Capital

= Rs 8 Lakhs - 18% X Rs 22 Lakhs

= Rs 8 Lakhs - Rs 3.96 lakhs

= Rs 4.04 Lakhs


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Uop December 2011 -Solution to the

problem (Continued)

3. To use ROI as a performance measure, the management willhave to specify ROI norms. While overall ROI may be higher thanthe norm, some of the projects may not have covered Cost of

Capital and may thus destroy value. These projects need to bereworked or discontinued; this does not happen under ROImethod. Pursuit of higher ROI may result in rejecting projectswhich may have yielded positive EVA; thus opportunities lost.

4. With EVA as a performance measure, projects yielding positiveEVA will be selected. This is good enough since Cost of Capital will

always be covered. Problems stated above with respect to ROI willbe overcome. Using variable Cost of Capital depending on assetclass (e.g. Working Capital), managers can be guided to chooseprojects that add value for shareholders and thus achieve goalcongruence .


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Capital Expenditure Control1. Important because large amounts are involved.

Wrong choice can be disastrous. Delays may meanlost opportunities/ cost overruns.

2. Pre, During and Post Expenditure Control needed3. Sound judgment, effective monitoring mechanism

important

4. Financing Capital Expenditure projects also a part ofthe system. Raising funds for new projects,

allocation of funds for on-going projects, financingoverruns are all important.

5. Risk Management may be practiced to control uncertainties(Study Impact & Probability. Use Escalation, Extra WorkClause, Insurance, Hedging)


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Format of Capital Expenditure

BudgetBudget2011-12Rs. Lakhs

BudgetProvisionB/ F

BudgetProvisionCurrent Yr

Total BudgetedExpenditureCurr. Year

BudgetedExpenditureC/ F

Head Office - 34.00 34.00 34.00 -

Factory 36.00 147.00 183.00 97.00 86.00

Western

Region

- 17.00 17.00 15.00 2.00

EasternRegion

24.00 - 24.00 24.00 -

60.00 198.00 258.00 170.00 88.00


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Capital Expenditure Pre

Expenditure Control Generating viable, superior project ideas is an

important step to maintain/ improve ROI.

Evaluation and approval based on financial and non-financial measures. Screening and ranking criterianeed to be decided (Payback, IRR, Present Value)

Five Categories Repair and Replacement,Improvement, Cost Reduction, Capacity

Enhancement, New Products. Capital ExpenditureBudget to be allotted to each. Screening/ Ranking notrelevant for the first two.


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Capital Expenditure During

Project Expenditure Control Crucial for effective control of expenditure

Techniques of project management (such as PERT/

CPM) may be used for reporting and monitoring. An illustration for effective project control and

reporting follows.


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SrN Task Status BCWS BCWP ACWP ScheduleVariance

CostVariance

1 Completed 50 50 50 0 0

2 Completed 50 50 40 0 +20%

3 Completed 90 90 140 - -55.5%

4 Not Started 70 0 0 -100% -

5 Started 100 80 90 -20% -12.5%

6 Not Started 90 0 0 -100% -

7 Completed 60 60 50 - +16.6%

8 Not Started - - - - -

Total 510 330 370 -35.29% -12.12%

Key: BC Budgeted Cost WS Work Scheduled WP Work Performed AC- Actual Cost

Schedule Variance (BCWP BCWS)/BCWS. Cost Var.- (BCWP ACWP)/BCWP

Expected Cost at Completion (say) Rs 5.50 lakhs * (370/330) = 6,16,667

Expected Overrun Rs 6,16,667 Rs 5,50,000 = Rs 66,667


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Capital Expenditure Post

Expenditure Control Comparison of Actual Payback, IRR, PV

with Planned to be carried out regularly

Guidelines to be provided for futureplanning based on the comparison

Delay/ Cost Over-run may require

revision of Capital Expenditure projects


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Capital Budgeting Problem

UoP May 2012The expected cash flow of a project is as follows.

Year Cash Flow

0 - 1,00,000

1 20,000

2 30,000

3 40,000

4 50,000

5 30,000

The cost of capital is 12 percent. Calculate the following:

(a) Net Present Value

(b) Internal Rate of Return

(c) Payback Period


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Computation of Present Value

at 12% Discounting RateYear Cash fl ow

Compound ingFactor

Discount ingFact o r Presen t Valu e

(1.12 raised t oyear)

(1 / Com poundingfactor)

(Cash flo w X discount ingfactor)

0 -100000 1 1 -100000.001 20000 1.12 0.892857 17857.14

2 30000 1.2544 0.797194 23915.82

3 40000 1.404928 0.711780 28471.21

4 50000 1.573519 0.635518 31775.90

5 30000 1.762342 0.567427 17022.81

Total 170000

Net PresentValue 19042.88


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Computing Internal Rate of Return by trial

and error methodYear Cash Flow PV at 12% PV at 16% PV at 18% PV at 19%

0 -100000 -100000 -100000 -100000 -100000

1 20000 17857.14 17241.38 16949.15 16806.72

2 30000 23915.82 22294.89 21545.53 21184.94

3 40000 28471.21 25626.31 24345.23 23736.63

4 50000 31775.9 27614.55 25789.44 24933.44

5 30000 17022.81 14283.39 13113.28 12571.48

NPV 19042.88 7060.52 1742.64 -766.78

No te : IRR is t he rat e at w hich N PV is zero . IRR in t his case is th us bet w een18% and 19 %, > 18 % and < 19%. Ratio of 766.78 t o (174 2.64 + 766.78 ) is.31. IRR, by inter po lat io n, is t hu s (19% - .31) = 18.69%.


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Computing Payback Period

Year Cash Flo w Cash Flo w, Cum u lat ive

0 -100000

1 20000 20000

2 30000 50000

3 40000 90000

4 50000 140000

5 30000 170000Note : Cumulative Cash inflow exceeds Cash Outflow of Rs100000 between year 3 and 4. Shortfall at the end of year 3 is Rs10000, while cash inflow for year 4 is Rs 50000. .2 Year(10000/50000) is sufficient to cover the shortfall. Payback periodis thus 3.2 years.


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Budgetary Control Purpose of the Budget is to translate Strategic Plan in time-

bound activities, to be accomplished by respective responsibilitycenters. Budget is said to be one year slice of the Strategic Plan.

(e.g. Current year sale as a part of a long term new marketpenetration strategy, State level budgets).

It is also the most common form of Management Control.Adhering to budget automatically ensures goal congruence.

Budget may contain both monetary and non-monetary targets.

All four types of responsibility centers viz. Revenue Centers,Expense Centers, Profit Centers and Investment Centers comeunder the purview of Budget.

Budget represents two way commitment on the part of themanagement and the responsibility center managers.


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Uses of the Budget Fine Tuning of the Strategic Plan, operationalizing it

in realistic terms.

Coordination between interdependent departmentswhile setting targets which affect each other (e.g.Production and Sales)

Assigning responsibility for action(s)

Creating a basis for performance evaluation

Promoting planning skills and self discipline acrossorganizational units (Budgets are said to be like

school bells and Monday mornings).


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Budget Preparation Process Setting up a Budget Department to administer the

Budget. An important task is to provide necessaryinformation, formats and technical assistance

Forming Budget Committee at Senior Level for reviewand approval, resolving problems

Issuance of guidelines related to overall assumptions,growth objectives, corporate policies

Steering Budgets through a bottom up and top downprocess with a time bound plan

Negotiation, review, approval, circulation


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Behavioral aspect of the

Budget Budget needs to be participatory so as to ensure

acceptance and implementation

Ideal budget is said to be challenging but attainable,most companies prefer achievable budgets withincentive for exceeding the budget

Senior Management Involvement is a must

Budget Department should have a reputation for

impartiality and fairness. It also has to ensure thatbudgets do not contain buffer.

Budgets mature over time. Persisting with budgetarycontrol over a long period is necessary.


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Zero Base Budgeting (ZBB) Zero Base Budgeting was formulated by Peter Phyrr in 1970. It is not a

new technique but an approach to formulation of the budget.

In a typical budget, current years budget is formed with a few(usually) upward changes in the previous years figures. ZBB arguesthat each years figures should start with Zero, and then builtobjectively based on properly justified needs for current year.

ZBB works with a Decision Unit which is a responsibility center. Eachdecision unit will need to justify each of the tasks undertaken, knownas decision packages, separately, based on cost benefit analysis.Consequences of not funding the decision package need also be stated.

A decision package can be stated as one among stated options. It can

also start with a minimum to be expanded as per justified need.

Overall budget is made up of accepted decision packages (i.e. tasks).

ZBB has a potential to cut down vast unnecessary expenditure.


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Budgetary Control with respect to Engineered,

Discretionary and Committed Costs

Budgetary Control for Engineered Costsl is usually throughFlexible Budgeting. Since cost per unit is known, additionalbudgetary provision can be made based on output. (e.g.

Painting cost per sq. ft.). Variance analysis should be used toanalyze deviation from the budget.

The budget for discretionary cost should be prepared in detailand itemized so as to develop clarity and financial disciplineamong managers (e.g. Dept. wise/ Destination-wise/ mode-wiseTravelling Expenses). It may be stated as Floor, Ceiling or a

guide to promote desired behaviour. Committed Cost budget needs to be approved by a high level

committee, since committed costs can be best controlled at thestage of commitment (e.g. Interest on Long Term Loan)


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Performance Measurement

Financial Measures Since purpose of MCS is to implement strategy, measuring

performance of responsible managers (with respect toimplementation) is an essential part of the system. This is done

with the help of Financial and Non-financial Measures. Financial Measures of performance are those discussed in the

context of Revenue and Expense Centers, Profit Centers andInvestment Centers. These include Budgets, Analysis of

Variance, Transfer Pricing, Profit Computations, Return onInvestment, Du Pont Analysis, EVA, MVA etc.

Organizations also use a variety of ratios based on FinancialStatements; these are evaluated in comparison with specifiednorms (e.g. 2:1 Norm used for Current Ratio).


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Performance Measurement Non

financial Measures Responsibility centers also have non financial objectives such as

Market Share and Talent Acquisition, which are equallyimportant for attainment of goal congruence.

Key Success Factors (KSF) and Key Performance Indicators(KPI) are often stated in measurable, yet non-financial terms(e.g. Restricting attrition rate to maximum 2.5% for a BPOfirm). An example of KSFs for a tour and travel companyfollows. Evolving meaningful non-financial measures is animportant feature of a Management Control System.

Balanced Score Card is a widely accepted system to balancefinancial and non financial perspective on performance. Similarmethodologies, such as Malcom Baldrige criteria are also used.


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Key Success Factors (KSFs) for a

tour and travel operator

Latest Information (about travel, stay and food)

Adequate occupancy ratio Cash Flow

Speedy redressal of customer complaints

Trained Manpower

The control system for the company will revolve aroundcreating measures for each one of these and use themas tools of control.


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Balanced Score Card BSC was developed by Robert Kaplan and David Norton over

1990 to 1996. The technique has been adopted by severalorganizations not merely for performance measurement but as

a strategic management system; it is thus used to(a) clarify vision and strategy

(b) Communicate and link strategic objectives and measures

(c) Plan, Set Targets and align strategic initiatives

(d) Enhance strategic feedback and learning

Four perspectives of Balanced Score Card are as follows.

1. Financial Perspective

2. Customer Perspective

3. Internal Business Perspective

4. Learning and Growth Perspective


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Implementing BSC in practice Balanced Score Card works by requiring an

organization to spell out precise strategic initiatives ineach of the four perspectives of the BSC.

Further, measures for every strategic initiative aredefined so that responsible managers have clarityabout actions to be taken and about measurement ofperformance.

Examples for the four aspects and two case studieson BSC implementation follow.


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Financial Perspective1. Return on Capital

2. Cash Flow

3. Profitability

4. Consistency of performance


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Customer Perspective1. Value for Money

2. Competitive Pricing

3. Transparent, Hassle free relationship

4. Professional after sales service

I t l B i P


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Internal Business Process

Perspective1. Quality service

2. Safety, Loss Control

3. Superior Project Management

4. Just In Time Delivery


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Innovation Perspective1. Continuous Improvement

2. Product/ service Innovation

3. Empowered WorkForce


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Case 1: Customer Perspective Offering great shopping experience is a strategic initiative

adopted by a fashion retailer as a part of Customer Perspective.The store translated this into six actionable elements as follows.

1. Great looking store with fashion impact2. Customer welcomed by attractive associates with a smile

3. Clear communication of special sales

4. Associates with good product knowledge

5. Personal name recognition by attending associate

6. Sincere thanks and an invitation to return soon

Mystery Shopper audits would be used to evaluate performance ofindividual stores.

C 2 L i d G th


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Case 2: Learning and Growth

Perspective Employee Satisfaction is an objective adopted by an

organization as a part of Learning and Growth Perspective. Thistranslated this into six actionable elements as follows.

1. Involvement with decisions2. Recognition for doing a good job

3. Access to sufficient information to do the job well

4. Active encouragement to be creative and use initiative

5. Support from staff functions

6. Overall satisfaction with companyEmployees will be required to score their ratings on 1 to 5 scale.Executives have a drill-down capability to determine satisfaction bydepartments, location and supervisor.


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MCS in Service Organizations1. Service Sector growing, has special features such as No

inventorying, Production/Consumption simultaneous etc.)

2. Pricing done differently e.g. Time Basis

3. Transfer Pricing needed same rules

4. Control Problems Inability to set standards, Team workimperative, Matrix Organization, Behavioral Characteristics ofindividuals differ

5. Performance Appraisal difficult of people not at extremes

6. Control on Managed Costs Important, same rules

7. Budgeting necessary8. Activity Based Costing useful for Cost Control, Resource

Allocation

9. Risk Management Important for Fin. Services Companies

C t lli Di ti C t


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Controlling Discretionary Costs

Principles and Best Practices1. Competent Managers2. Healthy Atmosphere3. Policies, Procedures, Guidelines, Rules4. Periodic Review of the above5. Using Engineered Cost Method where

possible6. Use of the budget to promote discipline, use

it selectively as ceiling, floor, guide.7. Use of non financial measures8. Benchmarking

B ki C f ICICI B k


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Banking Case of ICICI Bank

2011-12 (Rs Cr) Interest Earned-Advances 23858

Interest Earned-Investments 9684

Other Income 7503 41045

Interest Expended 22809

Operating Expenses 7850

Prov. For contingencies 3921 34580

Net Profit 6465

(Other Income inclusive of Interest on Investments is 17187 Cr,

while Profit is 6465 Cr. Without O.I., there is loss).

ICICI B k I t t


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ICICI Bank Important

Indicators Interest Expended / Interest Earned 68%

Other Income/ Total Income 18%

Total Assets/ Libilities Rs 473647 Cr

Total Investments Rs 159560 Cr Total Deposits Rs 255500 Cr

Total Advances Rs 253728 Cr

Investments / Total Assets 34%

Advances / Total Assets 54%

Advances / Deposits 99%


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Insurance Business Case of Bajaj Allianz

Insurance Co. Ltd 2011-12(Rs Cr.)

1. Net Earned Premium 2474.7

2. Net Incurred Claims 1905.3

3.

Net Commissions 74.94. Management Expenses 672.2

5. Total Expenses (2+3+4) 2652.4

6. Underwriting results(1-5) -177.7

7. Income from Investments 371.7

8. Profit Before Tax 194.0

Insurance Segments of Bajaj


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Insurance Segments of Bajaj

Allianz Fire

Marine

Auto (Comprehensive and Third Party) Health

Credit

Aviation

Workmens compensation

Personal Accident

KSFs for Banks Insurance


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KSFs for Banks, Insurance

Companies

Risk Management (Avoid NPAs, Hedging w.r.t.foreign exchange/ stock market, Reinsurance)

Effective use of Information Technology

Volumes spread is leveraged with large scale,distribution of risk also with scale

B2B Skills for bank, insurance managers

Excellent systems for Internal Checks


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KSFs for BPOs Human Resource Management (Manpower

Development, Training, Compensation,

Motivation) Superior Technology Support (should include

transaction logs)

Effective Complaint Redressal

(Mystery caller audits useful to ensurecompliance)


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Auditing Auditing is defined as A systematic examination of the books

and records of a business in order to ascertain or verify and toreport upon the facts regarding financial operation and theresult thereof.

Auditing supports Control Systems by locating the errors ofomission and commission, systems lacunae, deviations fromprocedures and acts of dishonesty. This results in improvingreliability and accuracy of accounting records. More importantlyit enforces higher degree of discipline and compliance with

policies, procedures, guidelines and rules.


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Principles of Auditing1. Segregation of duties (interdependent tasks carriedout by different rather than same individual).

2. Adequate physical supervision

3. Open line of information from bottom to the top

4. Defined levels of authority

5. Restricting access to organizations assets

6. Verification of records by an independent authority

(external auditor)

7. Respecting independence of the external authority

8. Existence of a top level committee to oversee audit


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Types of Audit

1. Financial Audit

2. Cost Audit

3. Internal Audit

4. Management Audit


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Financial Audit

Financial Audit is a historically oriented independentevaluation performed by an external auditor for the

purpose of attesting the fairness, accuracy andreliability of financial data, providing protection forthe entitys assets and evaluating the adequacy andaccomplishments of systems designed to provide forthe aforesaid fairness and protection.

Financial data while not being the only source, is theprimary evidential source. The evaluation isperformed not on order but on a planned basis.


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Objectives of Financial Audit1. Assessing compliance with accounting procedure laiddown by management.

2. Prevention of fraud, waste and detection of error.

3. Plugging loopholes in financial management policy orarising out of process of working.

4. Compliance with the Companies (Auditors Report)order, 2003.

5.Ascertaining compliance with statutory laws and rulesrelating to financial and accounting matters.


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Internal Audit Internal Audit is carried out using similar

methodology as for external audit, with a muchlarger sample and with higher frequency.

Internal Audit aims at covering areas of operationwhich are likely to be left out of external audit,because of a smaller sample. Internal Audit thusplays a role complementary to External Audit.

External Audit works, by and large, at the level ofManagement Control. Internal Audit works at thelevel of Operational Control, ensuring that routineprocedures are adhered to.


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Objectives of Internal Audit1. Assessing compliance with accounting procedure laid down by

management. (Kitchen Order Tickets in restaurants is an example).

2. Assessing adequacy and reliability of management information

and control systems3. Appraisal, review and evaluation of the adequacy and timelinessof financial reporting.

4. Safeguarding assets, ensuring asset accounting and utilization

5. Appraising systems and procedures

6. Compliance with statutory laws and rules7. Prevention and detection of fraud, misappropriation andembezzlement


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Cost Audit Cost Audit is an audit of efficiency; of expenditure

while work is in progress and not as a post mortemexamination.

Propriety audit is an audit of executive actions andplans financial expenditure.

Efficiency audit ensures that resources flow intothe most remunerative channels.

Pricing, Product Mix, Cost Control and InventoryValuation are objectives of Cost Accounting. CostAudit ensures that these are satisfied.


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Objectives of Cost Audit1. Verification of cost accounts and to examine

whether the the cost accounting plan has beenadhered to.

2. Examining adequacy of Budgetary Control System

3. Examining prices in related party transactions andcommenting on their deviation from normal prices

4. Suggesting measures to achieve break-even point,

where necessary and comment on defaults if anyw.r.t. Government and Financial Institutions

5. Commenting on scope and performance of InternalAudit.


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Management Audit Management Audit attempts to evaluate the

performance of various management processes andfunctions. It is an audit to examine, review and

appraise policies and actions of the management onthe basis predetermined standards. It is an extensionof the Management Control Process.

With a view to achieving these objectives,Management Audit carries out a thorough

examination of Panning and Control functions. Itreviews Systems and Procedures in use. It alsomakes a detailed review of functional areas likePurchase, Manufacturing, Marketing, Logistics,Human Resource Management and Finance.

Objectives of Management


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Objectives of Management

Audit

1. To locate waste and deficiencies

2. To search for better and improved methods3 To suggest better systems for control

4. To find out better and more efficient ways toexecute plans

5. To help using human and physical facilities ina better manner


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Illustration I - Internal Controls for

operating Bank Account

Bank Accounts should be regularly reconciled

Issue of cheques should be controlled,

signing authority should be specified Documents supporting a Cheque should be

specified and maintained, issue of duplicatecheques against same documents stopped

As far as possible only crossed cheques beissued


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Illustration II - Internal Controls on

Accounting for Fixed Assets

Capital Expenditure should be authorized byspecified persons only

Plant and property registers should bemaintained

Fixed Assets should be physically verified atperiodic intervals

Sale, scrapping and write-off should be under

proper authorization Depreciation rates should be properly

authorized


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Control System Design Troston Company has 175 employees, paid

on hourly rate, 40 Hours week. Overtime ispaid at twice the rate.

Employees swipe bar coded clock cards keptin a rack near the factory gate. How to ensure that only the authorized

employees enter? that there are no proxies?that O.T. is authorized?

What is the crosscheck on overall number ofemployees every month?

How to ensure that time spent in the factory is forlegitimate tasks only?


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Solution to Troston Case In order to ensure that unauthorized persons do not enter, it is

necessary that a supervisor who knows the employees is present nearthe gate. To ensure that employees do not swipe cards of friends,supervision is necessary. Introduction of biometric identification (thruthumb impression or iris scanning) will help in overcoming both these

problems. However attention is still necessary to prevent entry ofunauthorized individuals. Overtime should always be authorized by immediate superior and

endorsed by Production Planning Dept. Before signing the payroll, the Chief Accountant should reconcile

current months total employee strength = prev. months figure +Employees added during the month employees left during the month.The latter two should be reported by Personnel Dept. every month.

There should be several time recording machines inside the factory torecord start time and end time of jobs, which are to be punched by theworkers. Total time spent on various jobs by a worker should matchwith total time spent computed as difference between in and outtimes.


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UoP May 2011A company has practice of fixing inter-departmentaltransfer price for its product on the basis of cost plusreturn on investment in the division. The budget for

division A for the year is as follows.Annual Budgeted Output 6,00,000 Units

Variable Cost Rs 10 per Unit

Fixed Cost For Div. A Rs 10.20 lakhs

Total Investment in the Division Rs 20 lakhsExpected Return on Investment 24%

Calculate transfer price for Div A.


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UoP 2011 SolutionComputation of Transfer Price

Amount Quantity,Units

Per Unit, RS

Variable Cost, P.U. 10.00

Fixed Cost 10,20,000 6,00,000 1.70

Return On Investment

24% on Rs 20 lakhs

4,80,000 6,00,000 0.80

Transfer Price 12.50


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UoP December 2010Division X of a large divisionalized manufacturing firm produces a part that is used as as inputby Division Y to manufacture the finished product. The various per unit costs incurred byDivision X are as follows.

Direct Material Costs Rs 25 Other Costs incurred by Division X are:

Direct Labour Cost Rs 6 Fixed Selling and Admin. Cost Rs 10,00,000

Variable Overhead Rs 4 Variable Selling Cost Per Unit Rs 2Fixed Overheads* Rs 8 *At volume of 2,00,000 Units

Rs 43

Currently DIV X is selling the part to an external customer at Rs 65 p.u. Div X has a capacity of2 lakh units per year. However due to recession it expects to sell 1.50 lakh units. The variableselling expenses are available in case units are not transferred to Div Y. Div Y has been buyingthe same part from outside at Rs 60 p.u. Div Y expects to purchase 50,000 units in the comingyear. Div Y offers to buy 50,000 units from Div X ar Rs 40 P.U. You are required:

a) To determine the minimum transfer price that Div X would accept.

b) To determine the maximum transfer price that Div Y would pay.

c) Should Div X accept the proposal of Div Y?

d) With Av. Investment of Div X, of Rs 100 lakhs, compute ROI assuming 50,000 units aretranferred to Div Y at Rs 48 each.


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UoP December 2010 Solution

1. Minimum transfer price that Div X will accept is Rs 35up to sale of 50,000 units since Rs 35 is its variable cost

and it currently has idle capacity of 50,000 units.

2. Maximum transfer price that Y will pay is Rs 60 sincethis is the price at which it buys components from themarket.

3. X should accept the proposal of Div Y of sale at Rs40 p.u. since it is above its variable cost Rs 35 p.u.



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Continued.Computation of ROI for Division X is as follows.

Sale of 1,50,000 Units at Rs 65 Rs 97,50,000

Sale of 50,000 Units at Rs 48 Rs 24,00,000

Total Rs 111,50,000 (A)

Less Variable Cost of 1.50 lakh units at Rs 37 Rs 55,50,000Variable Cost of 50,000 units at Rs 35 Rs 17,50,000

Total Variable Cost Rs 72,50,000 (B)

Contribution Rs 39,00,000 (C=A-B)

Less Fixed Overhead 2 lakh units at Rs 8 p.u. Rs 16,00,000

Fixed Selling and Admn Costs Rs 10,00,000

Total Fixed Costs Rs 26,00,000 (D)Profit for Div X Rs 13,00,000 (C-D)

ROI on Rs 100 lakhs 13%


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UoP 2009M/s Suparna fixes interdivisional transfer price of its product on the basis of costplus an estimated return on Investments in its divisions. The relevant portion of thebudget for Div X for the year 2009-10 is given below.

Land and Building Rs 3,00,000

Plant and Machinery Rs 5,00,000Stock Rs 2,00,000

Bills Receivable Rs 1,00,000

Debtors Rs 2,00,000

Annual Fixed Cost of the Divn. Rs 8,00,000

Variable Cost Per Unit Rs 10

Budgeted Volume of production per year (units) 5,00,000Desired Return on Investment 27%. You are required to determine transfer pricefor the Division.


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UoP 2009 SolutionTransfer Price for M/ s Suparna for 2009-10

Amount Quantity,Units

Per Unit, RS

Variable Cost, P.U. 10.00

Fixed Cost 8,00,000 5,00,000 1.60

Return On Investment27% on Rs 13 lakhs

(Total of all assets)

3,51,000 5,00,000 0.702

Transfer Price 12.302


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Thank you !