mcs-ch1- introduction to mcs

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  • Management Control Systems:

    January, 2014

    By: Prachi Kulkarni

  • MCS-

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    oduction

    Syllabus

    1. Understanding Strategies, perspective of MCS.

    2. Financial goal setting

    3. Organization Hierarchies and behavior

    4. Responsibility centers

    5. Profit Centers

    6. Transfer Pricing

    7. Measuring and Controlling Profits and Assets

    8. Performance Measurement and Control

    9. MCS in service and Non profit organization

    10. Summing up

    11. Audit

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    Paper pattern: Revised 2012

    1. Any Three question out of Six questions each of 12 marks. (Theory) Each Question has 2 sub question of 6 Marks each

    2. Any two questions out of three each of 7 marks. (Problems)

    3. Question no. 10 is compulsory of 10 marks(Case Study)

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    Basic Concepts

    From corporate angle, Study of Management Control

    System requires understanding of 3 terms

    Control

    Management

    Systems

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    Collapse Of Companies

    Consider the collapse of companies such as World Com, Enron and Global Crossings. Part of their demise was the lapse in controls. CEO and Top management compensation in these companies was so heavily tied to stock options that executives were motivated to manipulate financials to buoy the short term stock price

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    World-Class Companies

    Consider the world-class companies such as 3M corporation, Dell Computers, Wal-Mart, South west Airlines. Their long term success is not just because they have developed good strategies, but more importantly, they have designed systems and processes that energize their employees to execute those strategies effectively

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    Control

    Control refers to keeping track of the organizational activities & regulating diversions through a mechanism.

    To do this, knowledge of 4 elements of a Control System

    is required. Elements of a control system consists of:

    1. A detector

    2. An assessor

    3. An effector

    4. A communication network

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    Elements of a control system

    1. A detector or sensor is a device that measure what is actually

    happening in the process being controlled.

    2. An assessor is a device that determines the significance of what is actually happening by comparing it with some standards or expectations of what should happen.

    3. An effector (feedback) is a device that alters behavior if the assessor indicates the need to do so.

    4. A communications network consist of devices that transmit information between the detector and the assessor and between the assessor and the effector.

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    Example: You are driving a car

    Detector= Your eyes Assessor= Your brain Effector= Your foot Communication network= Your nerves system

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    Automobile driver

    Control

    System Detector

    (eyes)

    Assessor (brain)

    Communication

    Network (nerves)

    Effecter

    (foot)

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    Example

    Your eyes (detectors) measure actual speed by observing the speedometer.

    Your brain (assessor) compares actual speed with desired speed (standard: the highest speed is 80 km/hour) to detect a deviation from standard.

    Your brain (assessor) directs your foot (effector) to ease up the accelerator if actual speed (90 km/hour) is faster than the standard speed (80 km/hour), press down the accelerator if the actual speed (70 km/hour) is slower than standard speed (80 km/hour). And, your nerves (communication network) form the communication system that transmits information from eyes (detectors) to brain (assessor) and brain (assessor) to foot (effector)

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    Example : Thermostat

    1. Thermometer which measures the current temperature of a room (detector)

    2. An Assessor which compares the current temperature with the accepted standard for what the temperature should be.

    3. An effectors which prompts a furnace to emit heat or activates an air conditioner which also shuts off these appliances when the temperature reaches the standard levels

    4. A communication network, which transmit information from thermometer to the assessor and from the assessor to the heating or cooling element

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    Example : Body temperature

    1. The sensory nerves scattered through the body 2. The Hypothalamus center in the brain, which

    compares information received from detectors with the 98.6 f standard.

    3. The muscles and organs (effectors) that reduce the temperature when it exceeds the standard and rise the temperature when it falls below the standard

    4. The overall communications system of nerves is self regulating. If the system is functioning properly, it automatically corrects for deviations from the standards with out requiring conscious effort.

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    Management

    In terms of process, Management refers to monitoring the actions of sub-ordinates by the superior to ensure that all actions are in accordance with the organizational strategy & are directed towards achievement of the organizational GOAL.

    This is required on account of multiple levels of hierarchy & complexity of business environment. Though management control system inculcates the 4 elements of a simple control process, there are significant differences between a simple control process & management control process.

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    DIFFERENCE BETWEEN SIMPLE CONTROL SYSTEM & MANAGEMENT CONTROL SYSTEM

    1) In Simple Control System, Standards are pre-set, whereas, in Management Control system, an independent process of planning is carried out which in turn will help in setting up standards. That again, is a continuous process.

    2) Simple Control System usually has an automatic detector while management control is not automatic. It requires self judgment & assessment along with use of mechanical assessor devices, by the person in charge of the control process. Based on such assessment, alteration is initiated, if need is felt, with the approval of higher level of authority.

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    DIFFERENCE BETWEEN SIMPLE CONTROL SYSTEM & MANAGEMENT CONTROL SYSTEM

    3) As against simple control system where function is performed by an individual, the management control requires coordination among individuals.

    4) In a simple control system, action for alteration is easily initiated when need is felt by assessor & communicated to effector. But in management control, such direct initiation is not always possible due to complexities of business vis-a-vis organizational authority structure.

    5) Management Control is unique in the sense that much of the control is self control rather than monitored control by external device.

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    Systems

    System refers to a prescribed & well laid out manner of carrying out an activity on a single basis or as a combination of activities.

    Management Control Systems are quite complex and judgmental. Many occasions arise for which either well defined rules are not available completely or the available rules may not be sufficient to handle the peculiar complexity. This requires judgment from managers, based on their skill and knowledge. The success of such managers depend on how effectively they handle the situation by dealing with people.

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    17

    Need for MCS

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    Result of lack of control at Organizational level .

    In 2001, Enron Corporation , the global energy giant, collapsed , in what was one of the largest case of bankruptcy in US Corporate history.

    WorldCom, the telecom giant , had artificially inflated its earning that rocked the corporate world & shook investors confidence in the stock markets. WorldCom deliberately misrepresented expenses as Capital expenditures, in order to inflate its profits.

    Andersen Consulting, Global crossing, Toyo etc are other prominent examples where demise of company took place due to lack of control

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    Barings Bank

    Founded in 1762 Britains Oldest Merchant Bank It was the official bank of British Queen Nick Leeson was a trader with Barings banks

    Singapore office from 1992 to 1995. At the age of 27, in 1994, he got an annual

    compensation of GBP 2,00,000 He single handedly pulled down the Barings Bank in

    1995 His illegal trading activities resulted in a loss of US $

    1.3 billion (GBP 837 million) for the Bank The bank declared bankruptcy and shut its doors in

    Feb 1995

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    Barings Bank

    It did not happen suddenly. Leeson was accumulating losses since 1992 in a fake account number 88888.

    By the end of 1992, the 88888 account was under water by about GBP 2 million. By the end of 1993 losses had mushroomed to GBP 23 million. By the end of 1994, 88888 account had lost a total of GBP 208 million.

    Barings Banks Head Quarters in London did not know what was happening in Singapore.

    A classic example why business organizations