Management Control System Notes

Chapter 6

Designing and evaluating management control systems

Designing control systems

• Two basic questions

• What is desired?
• What is likely to happen?

• If what is likely is different from what is desired, then two basic MCS-design questions must be addressed

• What controls should be used?
• How tightly should each be applied?

What is desired?

• Start from objectives and strategies

• They should be important guides to the actions that are expected, especially if they are specific
• For example, “Become a leader in the industry” vs. “15% ROI and 20% sales growth”

• Identify the key actions (KA)

Actions that must be performed to provide the greatest probability of success

• Identify the key results (KR)

Key areas where things must go right (or cannot go wrong) for the business to flourish

What is likely?

• Three questions

• Do employees understand what they are expected to do (key actions) or to accomplish (key results)? lack of direction

• Are they properly motivated? lack of motivation

• Are they able to fulfill their desired roles? personal limitations

• The discrepancy between what is desired and what is likely will determine the choice and the tightness of the management control systems

Control system change

• As firms grow, their controls evolve usually toward:

• Increased formalization of procedure for action accountability purposes And/or

• Development of more elaborate information (“accounting”) systems for results control purposes

Section 3 Financial results control systems

Chapter 7 Financial responsibility centers

Financial results controls

• Three core elements

• Financial responsibility centers

The apportioning of accountability for financial results within the organization

Formal management processes (planning and budgeting)

• To define performance expectations and standards for evaluating performance

Motivational contracts

• To define the links between results and various organizational incentives

Responsibility centers

Responsibility center

• An organization unit (entity) headed by a manager with responsibility for a particular set of inputs and/or outputs

Financial responsibility center

• A responsibility center in which the manager’s responsibilities are defined primarily in financial terms

Revenue centers (RCs)

Managers of revenue centers are held accountable for generating revenues (a financial measure of outputs)

• For example, sales departments in commercial organizations
• For example, fundraising managers in not-for-profit organizations

No formal attempt is made to relate inputs (measured as expenses) to outputs

• However, most revenue center managers are also held accountable for some expenses (e.g., salespeople’s salaries and commissions)

Revenue centers (RCs)

• But, still they are not profit centers because:

Such costs are only a small fraction of the revenues generated

Revenue centers are not charged for the costs of the goods they sell

• If sales are not “equally endowed,” then revenue responsibility will not necessarily lead to the most profitable sales

Expense centers (ECs)

• Managers of expense (cost) centers are held accountable for expenses (a financial measure of the inputs consumed by the responsibility center)

“Standard” or “engineered” expense centers (EEC)

• Inputs and outputs can be measured in monetary terms
• There is a “causal” relationship between inputs and outputs

• For example, manufacturing departments

Expense centers (ECs)

• “Managed” or “discretionary” expense centers (DEC)

Outputs produced are difficult to measure

Relationship between inputs and outputs is hard to establish

For example, R&D and human resources departments

Control in expense centers

• Engineered expense centers

• Standard cost vs. actual cost

Analysis of the cost of inputs that should have been consumed in producing the output vs. the cost that was actually incurred

• Additional controls

Volume produced, quality, etc.

• Discretionary expense centers

• Ensuring that managers adhere to the budgeted expenses while successfully accomplishing the tasks of their center
• Subjective, non-financial controls

For example, quality of service provided

• Personnel controls

Profit centers (PCs)

• Managers of profit centers are held accountable for generating profits (a financial measure of the difference between revenues and costs)
• As a measure of performance, profit is …

• Comprehensive

That is, it incorporates many aspects of performance

• Unobtrusive

That is, the profit center manager makes the revenue/cost tradeoffs