Fundamentals of Management Control Systems

Chapter 12

Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Alignment of Managerial and Organizational Interests

L.O. 1 Explain the role of a management control system.

• A management control system is designedto help managers make decisions that willincrease the organization’s performance.

12 - 2

Decentralized OrganizationsL.O. 2 Identify the advantages and disadvantages of decentralization.

• Decentralization is the delegation tosubordinates of authority to makedecisions in the organization’s name.

12 - 3

Advantages of DecentralizationLO2

• Better use of local knowledge

• Faster response

• Wiser use of top management’s time

• Reduction of problems to more manageable size

• Training, evaluation, and motivation of local managers

12 - 4

Disadvantages of DecentralizationLO2

• Dysfunctional decision making:Local managers can make decisions in their interest,which can differ from those of the organization.

• Duplication of administration:Local managers make the same types of decisionsmade at headquarters.

12 - 5

Management Control SystemL.O. 3 Describe and explain the basic framework

for management control systems.

• It is a system designed to influence subordinatesto act in the organization’s interest.

• Principals (owners) use this system to influenceagents’ (managers’) behavior.

12 - 6

Elements of a ManagementControl System

LO3

• Delegated decision authority

• Performance evaluation and measurement systems

• Compensation and reward systems

12 - 7

Responsibility AccountingL.O. 4 Explain the relation between organization

structure and responsibility centers.

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

Responsibility

Costcenters

Revenuecenters

Profitcenters

Investmentcenters

12 - 8

Evaluating PerformanceL.O. 5 Understand how managers evaluate performance.

• Controllability concept:Managers should be held responsiblefor costs or profits over which they havedecision-making authority.

• Relative performance evaluation (RPE):Compares divisional performance with thatof peer group divisions

12 - 9

Corporate Cost AllocationL.O. 6 Analyze the effect of dual- versus single-rate allocation systems.

Global ElectronicsLatin America Division

Income for the Year ($000)

Revenue(Percentage of corporate revenue)Direct division costsAllocated corporate overhead*Operating profit

$70,000 16% 51,800 4,800$13,400

$70,000 14% 51,800 3,500$14,700

* Global Electronics allocates corporate overhead based on relative revenue.Corporate overhead was $25 million.

Actual Target

12 - 10

Corporate Cost AllocationLO6

Global ElectronicsLatin America Division

Income for the Year ($000)

RevenueDirect division costs

$70,000 51,800

$70,000 51,800

Actual Target

My revenueand costs

were on target.

12 - 11

Corporate Cost AllocationLO6

Global ElectronicsLatin America Division

Income for the Year ($000)

Revenue(Percentage of corporate revenue)Corporate revenue

$ 70,000 16%$437,500a

$ 70,000 14%$500,000b

Actual Target

a $70,000 ÷ 16%b $70,000 ÷ 14%

I'm notresponsible for

corporaterevenue.

12 - 12

Corporate Cost AllocationLO6

Global ElectronicsLatin America Division

Income for the Year ($000)

Allocated corporate overhead(Percentage of corporate revenue)Corporate costs

$ 4,800 16%$30,000a

$ 3,500 14%$25,000b

Actual Target

a $4,800 ÷ 16%b $3,500 ÷ 14%

I'm notresponsible for

corporatecosts.

12 - 13

Corporate Cost AllocationLO6

• Dual rate method:This is a cost allocation method that separates acommon cost into fixed and variable componentsand then allocates each component using adifferent allocation base.

12 - 14

Performance EvaluationSystems Incentives

L.O. 7 Understand the potential link between incentivesand illegal or unethical behavior.

• Fundamental questions regarding a performancemeasurement system:

• Does the measure reflect the results of those actionsthat improve the organization’s performance?

• What actions might managers be taking that improvereported performance but are actually detrimental toorganizational performance?

12 - 15

Internal ControlsL.O. 8 Understand how internal controls can help protect assets.

• Internal control is a process designed to providereasonable assurance that an organization willachieve its objectives in the following categories:

• Effectiveness and efficiency of operations

• Reliability of financial reporting

• Compliance with applicable laws and regulations

12 - 16

End of Chapter 12

Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin