Management Control Systems:

January, 2014

By: Prachi Kulkarni

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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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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 need to ensure control over their activities

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The lesson

It is not enough to prepare a good strategy / plan and implement it or have intention to implement it.

The organization should have a proper system to control to ensure that everything is implemented as per the strategy / plan

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Concept of Management Control

Ensure that Resources are mobilised and deployed efficiently and effectively.

Methods and procedures adopted by management to provide reasonable assurance that available resources and assets are properly deployed and safe guarded against waste, mismanagement and frauds.

Management control covers the administrative, accounting and financial management areas.

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Activities of Management Control Systems

Control systems in an organization involve the following activities:

i. Planning-decides what the organization should do

ii. Coordinating the activities of the organization

iii. Communicating information to different levels of the hierarchical structure

iv. Evaluating information

v. Deciding what, if any, action should be taken

vi . Influencing people to change their behavior.

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Boundaries of MCS

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Strategy Formulation

Management Control

Task or Operations Control

Boundaries of management control

Goals, strategies &

policies

Implementation of

strategies

Efficient & effective

performance of

individual task

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Strategy Formulation

Strategy formulation is the process of deciding on the goals of the organization and the strategies for attaining these goals.

Management control : is the process by which managers influence other members of organization to implement the organizations strategies.

Task control is the process of ensuring that specified tasks are carried out effectively and efficiently.

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Distinctions between

strategy formulation and management control:

Characteristics Strategy Formulation Management Control

System design Unsystematic, Strategic

decision may be made any

time

Rhythmic,

predetermined

procedures

Nature of

information

Tailored-made to faced

problems, more external and

predictive, less accurate

Integrated, more

internal and historical,

more accurate

Communication

of information

Simple Difficult

Involved people Top management and staffs Top management and

line managers

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Distinctions between

strategy formulation and management control:

Characteristics Strategy Formulation Management Control

Number of

involved people

Few people Many people

Mental activity Creative and analytic Administrative and

persuasive

Discipline Economics Social psychology

Time horizon Tend to long-term Tend to short-term

End products Goals, strategies Strategy implementation

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Distinctions between

Management Control and Task Control

Characteristics Management Control Task Control

Focus of activity The whole of operation Individual task or transaction

Nature of

information

Integrated, many

financial data

Tailored-made to individual

task, more non-financial data

Involved people Management Supervisor or none

Mental activity Administrative and

persuasive

Follow direction or none

End products Strategy

implementation

Tasks are carried out

effectively and efficiently

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Distinctions between

Management Control and Task Control

Characteristics Management Control Task Control

Mental activity Administrative and

persuasive

Follow direction or none

Discipline Social psychology Economics, physics

Time horizon Weekly, monthly,

annually

Daily

Type of cost Discretionary costs Engineered costs

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Examples of decisions in planning and control function:

Strategy

Formulation

Management Control Task Control

Enter a new business Expand a plant Schedule production

Change debt to equity

ratio

Issue new debt Manage cash flows

Add direct mail

selling

Determine advertising

budget

Book TV

commercials

Decide magnitude

and direction of

research

Control of research

organization

Run individual

research project

Acquire an unrelated

business

Introduce new product

or brand within product

line

Coordinate order

entry

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MCS - Meaning

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MANAGEMENT CONTROL DEFINED

Robert Anthony and Vijay Govindrajan: Management control is a process by which managers influence other members of the organization to implement the organization strategy.

William Newman: Control is one of the basic phases of managing, along with planning, organizing and leading.

Control is an integral and essential art of the management process and all the managerial efforts of an organization.

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MANAGEMENT CONTROL SYSTEMS

MCS refers to a framework by which the manager controls the actions of his subordinates and the entire operation of an organization.

It facilitates target fixation, collection of

information, comparison of actual with targets, identifying and reporting variations and initiating suitable action to ensure attainment of objectives.

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CHARACTERISTICS OF MANAGEMENT CONTROL

Focuses on programs and responsibility centers.

Relies on two types of information viz. planned data and

actual data.

Aims at assuring that all aspects are in balance and are

operating in close co-ordination.

Built around financial structures

Follows a definite pattern and time schedule

Co-coordinated and integrated to other sub systems

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MCS - Process

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PROCESS OF MANAGEMENT CONTROL

Organizing the process Begin by specifying the organizations goals, subgoals

and objectives Goals are what the organization hopes to achieve in the long run Subgoals or key success factors are more specific and provide

more focus to guide daily actions Objectives are specific benchmarks which management would

like to see achieved It is important to keep all three in balance to avoid

concentrating solely on short-run achievements at the expense of long run goals.

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PROCESS OF MANAGEMENT CONTROL

Segmenting the organization Establish responsibility centers Planning further activities Develop performance measures Management control evaluations -Measure and report on financial performance -Measure and report on non-financial performance

Corrective actions

Reporting

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NATURE OF MANAGEMENT CONTROL SYSTEMS

Focuses on those activities that facilitate attainment of targets of responsibilities centres.

functions on the basis of two sets of information viz. planned data and actual data.

Management Control System covers all functional aspects of a companys operation.

It is built around financial variables, although non-monetary variables are also taken in to consideration.

It follows a definite pattern and sequence of activities.

Management Control System is a coordinated and integrated system.

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SCOPE OF MANAGEMENT CONTROL SYSTEM

Management control system process involves communications and interactions in the form of memoranda meetings and conversations

In addition it also includes the following Programs/Goals Budgeting Operating and Accounting Reporting and Analysis

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Features of ideal MCS

A total system

Monetary standards

Definite pattern

Coordinated system

Line manager

Effective Planning

Involvement of Top Management

Motivation of Employees

Proper communication mechanism

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Significance of human behaviour pattern in Management control.

Perception Attitudes and Beliefs Motivation Goal Congruence Inter-unit Conflict and Cooperation Managerial Styles Force Field Analysis Resistance to Change Entrapment Compromising and Sacrificing Socio-Cultural Influences

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Questions from past examinations:

Explain briefly various stages of management control process citing salient features of each

Management control in matrix structures Describe the features of ideal management control

systems and its processes? Describe and illustrate significance of human

behavior patterns in management control system Explain some factors which may influence top

management style and the implication of the top management style on management control

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THANK YOU