MANAGEMENT CONTROL SYSTEM

CITRA DEWI WULANSARI14/374248/PEK/19683REGULER 36

Ch.4 Responsibility Center & Revenue Expenses

Concept of MCS2

Management Control :“is the process by which managers assure that the resources obtained are used efficiently and effectively in the accomplishment of organizational goals” : Anthony

Efficiency : doing the things right ie. Relationship between input and output

I/P efficiency O/P

Effectiveness : doing the right things ie. Relationship between output and objectives

O/P effectiveness OBJECTIVES

System is a prescribed way or a systematic way of carrying out a set of activities which are usually repetitive in nature

Responsibility Centers - Basic3

Responsibility Centers (RC) constitute the structure of a control system and the assignment of responsibility to organizational units must reflect the organizations strategy.

RC is an organization unit that is headed by a manager who is responsible for its activities

RC exists to accomplish some purpose that are called as its objectives

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Responsibility Centers – Core operation

RC receives inputs. Using capital and assets it converts this input in an output, that can be either tangible (goods) or intangible (services)

Management is responsible for ensuring the optimum relationship between inputs and outputs

WorkInputs Outputs

Resources usedMeasured by “cost”

Goods or services

Responsibility Centers –Measuring inputs and outputs

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Cost is a monetary measure of the amount of resources used by a RC

It is much easier to measure the cost of input than to calculate the value of outputs. For example, a college can easily measure how many students have passed but it is difficult to measure how much education each of them acquired

Responsibility Centers – Measuring inputs and outputs – Efficiency and Effectiveness

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Efficiency and effectiveness are the 2 performance measurement criteria for RC

Efficiency is a ratio of input to output (doing things right)

Effectiveness is determined by the relationship between a RC’s output and its objectives (doing right things)

These 2 e’s are not mutually exclusive; each RC has to be efficient and effective as well

Profit as a measure of performance measures both efficiency and effectiveness because profit is the major objective (effectiveness) and it is also the difference between output and input (efficiency)

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Responsibility Centers - Types

InputsWork

Outputs

(monetary value) (physical)

Optimal relationshipCan be established

Example – Manufacturing Function

Above is the relationship between input and output in case ofAn ENGINEERED EXPENSE CENTER

Characteristics : - 1. Input can be measured in monetary terms2. Output can be measured in physical terms3. Optimum relationship between amount of input

for one unit of output can be established

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Responsibility Centers - Types

InputsWork

Outputs

(monetary value) (physical)

Optimal relationshipcant be established

Example – R & D Function

Above is the relationship between input and output in case ofAn DISCRETIONARY EXPENSE CENTER

1. Reflects management’s decisions regarding certain policies2. Weather to match or exceed the marketing efforts of competitors3. To find the appropriate amounts to spend for R&D

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Responsibility Centers - Types

InputsWork

Outputs

(monetary value only for costs directly incurred)

(monetary value)

Inputs not related to outputs

Example – Marketing Function

Above is the relationship between input and output in case ofa REVENUE CENTER

1. Mostly are sales unit that do not have authority to set selling price2. Focus on target revenue only3. Market demands is hard to predict

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Responsibility Centers - Types

InputsWork

Outputs

(monetary value) (monetary value)

Inputs are related to outputs

Example – BU

Above is the relationship between input and output in case ofa PROFIT CENTER, the role of profit :

1. Profit as an objectives is an important measure of effectiveness

2. Profit is the difference between revenue (output) and expense (input)

3. Thus, profit measures both effectiveness and efficiency“Who may be effective but not efficient, with the frugal manager, who uses less input but produces less than the optimum output ?”

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Responsibility Centers - Types

Inputs Capital employed

Outputs

(monetary value) (monetary value)

Profits are related to capital employed

Example – BU

Above is the relationship between input and output in case ofan INVESTMENT CENTER :

- Chapter 7 Measuring & Controlling Asset Employed

Responsibility centersEngineered & Discretionary expense center

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Point Engineered EC Discretionary EC

Nature of expenditure Engineered costs are those for which standards can be easily established

Discretionary costs are those for which standards cant be easily established

I/p - o/p relationship Optimal relationship can be established

Optimal relationship cant be established

Application Manufacturing function Service function

Budget preparation Budget represents unit cost of performing task efficiently

Budget determined by the magnitude of the job to be done

Budgetary control Difference between budget and actual is a measure of efficiency (since input and output optimum relationship can be established)Being “within budget” is important

Difference between budget & actual is not a measure of efficiency (since input and output optimum relationship cant be established)Doing the task is more important (doesn’t mean that budget is not to be adhered; emphasis differs)

Financial control During performance More at planning stage

Responsibility centersProfit center & Revenue center

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Profit Center Revenue Center

Meaning A responsibility center that is responsible for both revenues and expenses is profit center.

A responsibility center that is responsible for revenues but not for the expenses is revenue center.

I/p - o/p relationship Optimal relationship is established between value of output (revenue) and value of input (expense)

Optimal relationship cant be established between value of output (revenue) and value of input (expense)

Application Business units Marketing offices

Goal Maximizing profit by controlling both revenue and expenses

Maximizing revenue

Responsibility Centers – General control characteristics of Discretionary EC’s

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Budget preparation – based on the magnitude of the task to be done. Tasks divided into 2 :

Continuing Special

Incremental Budgeting

Zero Based Review

Cost variability – not in short run

Type of Financial control – planning important

Measurement of performance – Doing the planned work is important

Incremental budgeting is budgeting based on slight changes from the preceding period's budgeted results or actual results.

This is a common approach in businesses where management does not intend to spend a great deal of time formulating budgets, or where it does not perceive any great need to conduct a thorough re-evaluation of the business.

Budgetary control – Incremental Budgeting

Drawbacks in incremental budgeting method :

1. The current level’s expenditure is accepted and not reexamined during the budget preparation process.

2. Managers typically want to increase the resource level, thus tend to request additional budget.

3. Overhead cost are sometimes drastically reduced without any adverse consequences.

Budgetary control – Incremental Budgeting

Budgetary control – Zero based review

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• In contrast to incremental budgeting, Zero Based Review starts the budget from the scratch (de novo)

• Managers are required to justify the items with proper bases

• Thus ZBR is an intensive review of the budgetary allocations

• Certain basic questions are asked like – should the activity under review be performed at all? What should the quality level be?

• It is a good way of doing budgeting and can eliminate a lot of waste. However it demands some time and energy.

Variable costs are costs that change in proportion to the good or service that a business produces.

Discretionary expense centers, managers tend to approve changes that correspond to anticipated changes in sales volume.

Uneconomical to adjust the work force for short-run fluctuations.

Example : allowing additional personal when volume is expected to increase and layoff when volume is decrease.

Budgetary control – Variable cost

The objective is to become cost competitive by setting a standard and measuring the actual cost.

Allowing the manager to participate in the planning of discretionary expense budgeting.

Financial control is primarily exercised at the planning stage before the cost are incurred.

Budgetary control – Financial control

Spending amount that is “on budget” is satisfactory, spending more may will cause for concern, spending less may indicate the planned work is poorly done.

Total control over discretionary expense centers is achieved primarily through nonfinancial performance measure.

The best indication for quality service is the satisfaction and opinion of the user.

Budgetary control – Measurement of Performance

Responsibility Centers – Administrative & Support Centers – Control problems & Budget preparation

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2 important reasons for control problems Difficulty in measuring output Lack of goal congruence

Budget preparation Section covering costs of “being in business” Discretionary activities Justification for proposed increases in budget

Responsibility Centers R&D centers – control problems, budget preparation & performance measurement

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Budget preparation One should understand R & D continuum

• Basic research – applied research – development – production engineering – testing

No scientific way of determining R & D budget Some companies use % of revenue for R&D budget For basic research, budget can be a lump-sum

amount For testing, number of testing can be a budget base

Performance measurement Monthly/quarterly reports on budgeted and

actual expense 2 types of financial reports – one reporting

total R&D expense, the other reporting it separately for each RC

Effectiveness of research is informed though progress reports ( these are not financial reports)

Responsibility Centers – Marketing Centers – activities and related controls

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Logistic Activities These RCs are similar to expense centers in

manufacturing plants and can be safely called as engineered expense centers

Marketing activities – control problems• Measuring output is easy, evaluating effectiveness

is difficult because of influence of “other” factors on sales

• Marketing expenses are often budgeted at % of sales not because sales volume cause marketing expenses but because it gives larger affordability

• “Order-getting costs” are that way discretionary and controls cannot be easily standardized