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Mc Graw-Hil l/Irwi n Copyright ©2008 The Mc Graw-Hill Companies, Inc. Al l ri ghts reserved. Fundamentals of Management Control Systems Chapter 12

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McGraw-Hill/Irwin Copyright ©2008 The McGraw-Hill Companies, Inc. All rights reserved.

Fundamentals of Management

Control Systems

Chapter 12

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Learning Objectives:

1. Explain the role of a management control system.

2. Identify the advantages and disadvantages of decentralization.

3. Describe and explain the basic framework for management control

systems.

4. Explain the relation between organization structure andresponsibility centers.

5. Understand how managers evaluate performance.

6. Analyze the effect of dual- versus single-rate allocation systems.

7. Understand the potential link between incentives and illegal or 

unethical behavior.

8. Understand how internal controls can help protect assets.

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Service Department Cost AllocationLO1 Explain the role of a management control system.

A managementcontrol system isdesigned to help

managers makedecisions that will

increase the

organization’sperformance.

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DecentralizationLO2 Identify the advantages and disadvantages of 

decentralization.

The delegation tosubordinates of authority to makedecisions in theorganization’sname.

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Decentralization, Continued. . .

Decisions are made by relatively fewindividuals in the high ranks of theorganizations.

Decisions are spread among relatively manydivisional and departmental managers.

Decisions are delegated todivisional and departmentalmanagers.

Centralized Organization

Decentralized Organization

Few decisions are

delegated.

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Advantages of Decentralization

Better use of local knowledge:

Faster response:

Wiser use of top management:

Reduction of problems to more manageable sizes:

area managers are more aware of local conditions.

local managers respond more quickly to changing environments.

higher level managers can focus on strategies and industry trends.

by dividing large problems into smaller, more manageable parts,

decentralization reduces the complexity of problems.

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Disadvantage of Decentralization

Dysfunctional decision making

When local managers make decisions intheir interest, which can differ from thoseof the organization.

Duplication of administrationLocal managers make thesame types of decisions

made at headquarters.

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Management Control SystemsLO3 Describe and explain the basic framework for

management control systems.

Delegateddecisionauthority

Performanceevaluation andmeasurement

systems

Compensationand reward

systems

A system designed to influence subordinates to act inthe organization’s interest

Used by principals(owners) to influenceagents’ (managers’)behavior

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Delegated Decision Authority

A management controlsystem specifies whatdecisions thesubordinate manager

can make in the name of the organization.

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Performance Evaluation and Measurement

The performanceevaluation system

specifies how theperformance of thesubordinate manager isto be measured and how

the results will be usedin the evaluationprocess.

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Compensation and Reward Systems

A management control

system that specifieshow subordinates willbe compensated for

their performancebased on statedmeasures.

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Balancing the Elements

An effective management control system

balances the following three elements:

Delegated decision authority

Performance evaluationand measurement systems

Compensation andreward systems

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Responsibility AccountingLO4 Explain the relation between organization structure

and responsibility centers.

Responsibility accounting reports revenuesand costs at the level within the organizationhaving the related responsibility.

Responsibility

Costcenter

Revenuecenter

Profitcenter

Investmentcenter

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Cost Center 

Cost

center An organization subunitresponsible only for costs

Managers areresponsible for

cost and volumeof inputs used toproduce anoutput.

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Revenue Center 

Managers areresponsible forselling theproduct.

Revenuecenter

An organization subunitresponsible for revenues and,typically, marketing costs

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Profit Center 

Profitcenter An organization subunitresponsible for profits andthus, revenues, costs,production, and sales

volume. Managers areresponsible forrevenues AND costs.

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Investment Center 

Managers are responsible forlarge amounts of money withwhich to make capital

budgeting and other decisionsaffecting the use of assets.

Investmentcenter

An organization subunitresponsible for profits ANDinvestment in assets

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Goal Congruence

Agreement by allmembers of agroup on a set of 

objectives

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Evaluating PerformanceLO5 Understand how managers evaluate performance.

Control based conceptManagers should beheld responsible forcosts or profits over

which they havedecision-makingauthority

Relative performance evaluation (RPE)

Compares divisional performance withthat of peer group divisions

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Compensation Systems

Based on measuredperformance

Contingent compensation

Fixed compensation

Not directly linked to

measured performance

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Corporate Cost AllocationLO6 Analyze the effect of dual- versus single-rate

allocation systems.

Global ElectronicsLatin America DivisionIncome for the Year (in thousands)

1Global Electronics allocates corporate overhead based on relativerevenue. Corporate overhead was $25 million.

Actual

Revenue 70,000$

(Percentage of corporate revenue) 16%

Direct division costs 1 51,800$

Allocated corporate overhead 4,800$

Operating profit 13,400$

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Corporate Cost Allocation, Continued. . .

Global Electronics

Latin AmericaDivisionIncome for the Year (in

thousands)

My revenue

and costswere ontarget.

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Corporate Cost Allocation, Continued. . .

a

$70 000/16%

I’m not

responsiblefor corporate

revenue.

Global ElectronicsLatin AmericaDivisionIncome for the Year (in

thousands)

Revenue

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Corporate Cost Allocation, Continued. . .

I’m not

responsiblefor corporate

costs.

a

$4 800/16%

Global ElectronicsLatin AmericaDivisionIncome for the Year (in

thousands)

Allocated

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Corporate Cost Allocation, Continued. . .

a cost allocation methodthat separates a

common cost into fixedand variable componentsand then allocates eachcomponent using adifferent allocation base

Dual rate method

Activity

C o s t

Activity

C o s t

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Performance Evaluation Systems IncentivesLO7 Understand the potential link between incentives and

illegal or unethical behavior.

1. Does the measure reflect the results of 

those actions that improve theorganization’s performance?

2. What actions might managers be takingthat improve reported performance butare actually detrimental toorganizational performance?

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What pressures can lead to unethical behavior?

Unrealistic budget pressures, particularly forshort-term results, occur when headquartersarbitrarily determines profit objectives andbudgets without considering actual

conditions.

HELP!!This is

impossible

Unrealistic budget pressure

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What pressures can lead to unethical behavior?

Financial pressure resulting frombonus plans that depend on short-term economic performance isparticularly acute when the bonusis a significant component of theindividual’s total compensation.

Financial Pressure

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Internal Control

Internal control is a process designed to provide reasonable

assurance that an organization will achieve its objectives in

the following categories:

LO8 Understand how internal controls can help protectassets.

Effectiveness and efficiency of operations

Reliability of financial reporting

Compliance with applicable laws and

regulations

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Internal Control – In Practice

Internal controls are detailed methods of protecting assets

and assuring reliable information. Some examples are:

Segregation of duties

Setting limits on the amount of expenditures

Requiring authorization for the use of assets

Reconciling accounts

Rotating personnel

h

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Chapter 12: END!!

Sometimes Ijust don’t getit. What dothey want?