Management control Systems (MCS)

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Why Management control Systems (MCS)?

• Management controls are necessary to guard against the possibilities that people will do something the organizations do not want them to do or fail to do something they should do….

• If all employees could always be relied on to do what is best for the organization there would be no need for management control systems.

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Types of controls

1. Action (or Behavioral) controls

2. Personnel, cultural and social controls

3. Results (or output) controls

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1.Action or behavioral controls

• Behavioral controls (also known as action controls) involve observing the actions of individuals as they go about their work.

• They are appropriate where cause and effect relationships are well understood, so that if the correct actions are followed, the desired outcomes will occur.

• Under these circumstances effective control can be achieved by having superiors watch and guide the actions of subordinates.

• For example, if the supervisor watches the workers on the assembly line and ensures that the work is done exactly as prescribed, then the expected quality and quantity of work should ensue.

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• The aim of behavioral constraints is to prevent people from doing things that should not be done.

• They include physical constraints, such as computer passwords that restrict accessing or updating information sources to authorized personnel, and administrative constraints such as imposing ceilings on the amount of capital expenditure that managers may authorize is an example of an administrative constraint.

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2.Personnel, cultural and social controls

• Social controls involve the selection of people who have already been socialized into adopting particular norms and patterns of behavior to perform particular tasks.

• For example, if the only staff promoted to managerial level are those who display a high commitment to the firm’s objectives then the need for other forms of controls can be reduced.

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Personnel controls • Personnel controls involve helping employees do a good job by

building on employees’ natural tendencies to control themselves. In particular, they ensure that the employees have the capabilities (in terms of intelligence, qualifications and experience) and the resources needed to do a good job.

• Merchant identifies three major methods of implementing personnel controls. They are selection and placement, training and job design and the provision of the necessary resources.

• Selection and placement involves finding the right people to do a specified job. Training can be used to ensure that employees know how to perform the assigned tasks and to make them fully aware of the results and actions that are expected from them.

• Job design entails designing jobs in such a way that employees are able to undertake their tasks with a high degree of success. 7

Cultural controls

• Cultural controls represent a set of values, social norms and beliefs that are shared by members of the organization and that influence their actions.

• Cultural controls are exercised by individuals over one another – for example, procedures used by groups within an organization to regulate performance of their own members and to bring them into line when they deviate from group norms.

• Cultural controls are virtually the same as social control.

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3. Results or output controls

• Output or results controls involve collecting and reporting information about the outcomes of work effort.

• The major advantage of results controls is that senior managers do not have to be knowledgeable about the means required to achieve the desired results or be involved in directly observing the actions of subordinates.

• They merely rely on output reports to ascertain whether or not the desired outcomes have been achieved

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FEEDBACK AND FEED-FORWARD CONTROLS• Feedback control involves monitoring outputs achieved against

desired outputs and taking whatever corrective action is necessary if a deviation exists.

• In feed-forward control instead of actual outputs being compared against desired outputs, predictions are made of what outputs are expected to be at some future time.

• If these expectations differ from what is desired, control actions are taken that will minimize these differences.

• The objective is for control to be achieved before any deviations from desired outputs actually occur.

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• In other words, with feed-forward controls, likely errors can be anticipated and steps taken to avoid them, whereas with feedback controls actual errors are identified after the event and corrective action is taken to implement future actions to achieve the desired outputs.

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MANAGEMENT ACCOUNTING CONTROL SYSTEMS (MACS)

• Therefore, management accounting and control system (MACS) is used for planning, monitoring and control of different organizational activities, to optimize the use of resources, to support the process of decision making and to the performance evaluation process.

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Scope of the MACS

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THE NATURE OF MANAGEMENT ACCOUNTING CONTROL SYSTEM• Management accounting control systems have two core elements.

The first is the formal planning processes such as budgeting and long-term planning .

• These processes are used for establishing performance expectations for evaluating performance.

• The second is responsibility accounting which involves the creation of responsibility centres.

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Technical Considerations in MACS

Technical considerations fall into two categories:

1. Relevance of information generated

2. Scope of the system.

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1. Relevance of information generated

A. Accurate: Management accounting provides accurate information to users. Inaccurate information is not relevant or useful for decision making because it is misleading. Designers have to develop a system that leads to the most accurate information possible, subject to a cost–benefit trade-off.

B. Timely: Information has an objective. There are usually periods within which these objectives operate. Good information neither is produced too frequently nor is compiled after it is need most. Accurate information that is late is also of little use for decision making. The MACS must be designed so that the results of performance measurement are feedback to the appropriate units in the most expedient way possible.

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C. Consistent: Designers must structure the MACS to provide a consistent framework that can be applied globally across the units or divisions of an entity. Consistency means that the language used and the technical methods of producing management accounting information do not conflict within various parts of an organization.

D. Flexible: MACS designers must allow users to use the system’s available information in a flexible manner so that they can customize its application for local decisions. If flexibility is not possible, a user’s (an employee’s) motivation to make the best decision may be lessened for the decision at hand, especially if different units engage in different types of activities.

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Quiz

• What are the benefits of operating MACS ?

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1. All organizations need to express and aggregate the results of a wide range of dissimilar activities using a common measure. The monetary measure meets this requirement

2. Profitability and liquidity are essential to the success of all organizations and financial measures relating to these and other areas are closely monitored by stakeholders. It is therefore natural that managers will wish to monitor performance in monetary terms.

3. Financial measures also enable a common decision rule to be applied by all managers when considering alternative courses of action. That is, a course of action will normally benefit a firm only if it results in an improvement in its financial performance.

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4. Measuring results in financial terms enables managers to be given more autonomy. Focusing on the outcomes of managerial actions, summarized in financial terms, gives managers the freedom to take whatever actions they consider to be appropriate to achieve the desired results.

5. Outputs expressed in financial terms continue to be effective in uncertain environments even when it is unclear what course of action should be taken. Financial results provide a mechanism to indicate whether the actions benefited the organization

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2. The scope of the system

• The scope of the MACS must be comprehensive and include all activities across the entire value chain of the organization.

• For example, historically, many MACS measure and assess performance in only one part of the value chain - the actual production or throughput process.

• The performance of suppliers, the design activities, and the postproduction activities associated with products and services are ignored.

• Without a comprehensive set of information, managers can make only limited decisions.

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The Value Chain• The value chain describes the full range of activities that firms and

workers do to bring a product from its conception to its end use and beyond. This includes activities such as design, production, marketing, distribution and support to the final consumer.

• The activities that comprise a value chain can be contained within a single firm or divided among different firms.

• Value chain activities can produce goods or services, and can be contained within a single geographical location or spread over wider areas. This concept evaluates the value that is added by each and every activity in the organization

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Total Life Cycle Costing

• The total-life-cycle costing (TLCC) approach is a comprehensive way for managers to understand and manage costs through a product’s design, development, manufacturing, marketing, distribution, maintenance, service, and disposal stages as presented figure 3 (Atkinson et al., 2014).

• It refers to the process of managing all costs along the value chain. Numerous life-cycle costs concepts, such as research development and engineering and post-sales service and disposal, have emerged in various functional areas of business.

• Although each concept is useful within its respective area, a TLCC perspective integrates the concepts so that they can be understood in their entirety.

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• TLCC is the name of the process of managing all costs along the value chain. TLCC is also known as managing costs ‘from the cradle to the grave’.

• The fundamentals of TLCC is to identify and quantify the various cost elements in purchasing and using a particular product or service including annualized cost that would be incurred through its life.

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Target Costing

• Target costing is a technique which developed, in the early 1970s in Japanese manufacturing industry, as consumer demand for more diversified and customized products.

• Sakurai (1989) defines target costing as a ‘cost management tool for reducing the overall cost of a product over its entire life cycle with the help of the production, engineering, R&D, marketing, and accounting departments,

• This is a customer-driven technique that requires in-depth market research to assess the need and perceived value of the product by the customer.

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• The costing system establishes profit margin based on expected return on investment of the organization and then expressed as a percentage on the selling price, which is deducted to the term target profit to determine target cost.

• The target cost is then compare with the estimated cost and establishes cost reduction targets for each components using value engineering and value analysis.

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Kaizen Approach

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Kaizen Costing

• The term kaizen is originated by the Japanese companies for continuous improvement. The Japanese word kaizen is a composition of the words kai and zen where kai, means “change” and zen, means “good or better”.

• The popular meaning of kaizen is continual incremental improvement in all aspects of a company especially gradual, orderly, continual improvement or change for better. The kaizen concept involves everyone in an organization working together to make incremental improvements without large capital investment.

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• Imai (1986) defined kaizen as continuing improvement in personal life, home life, social life, work life and when it is applied to the workplace then kaizen means continuing improvement involving everyone from top managers to workers.

• In business culture and management process the term kaizen refers for continual and gradual improvement. The kaizen approach is not only about doing things better, but getting specific outcomes.

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Benchmarking• Benchmarking of business processes is usually done with top

performing companies in other industry sectors.

• This is feasible because many business processes are essentially the same from sector to sector.

• Benchmarking focuses on the improvement of any given business process by exploiting ‘best practices’ rather than merely measuring the best performance. Best practices are the cause of best performance.

• Companies studying best practices have the greatest opportunity for gaining a strategic, operational, and financial advantage. The systematic discipline of benchmarking is focused on identifying, studying, analyzing, and adapting best practices and implementing the results.

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Balanced Scorecard• Various performance measurement frameworks have been developed

since 1980s with integrating both financial and non-financial measures.

• One of the mostly preferred framework is balanced scorecard. This framework proposed that the company should use a balanced set of performance measures incorporating financial and nonfinancial perspectives .

• The framework considers nonfinancial measures are leading indicators, they predict future financial performance rather than simply report what has already happened whereas financial measures are lagging indicators and they report the results of past decision and confirm long-term trends.

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Balance Scorecard

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Bsc Perspectives

1. Financial perspectives: The financial perspective considers of maximizing shareholders wealth as the ultimate goal of a company. The financial measures convey the economic consequences for the actions already taken by the organization, and focus on the profitability related measures on which the shareholders verify the profitability of their investment. Customer perspectives:

2. The customer perspective describes how a company intends to attract, retain, and deepen relationships with targeted customers by differentiating itself from competitors.

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3. The internal business process perspective identifies the critical operation management, customer management, innovation, and regulatory and social processes in which the organization must excel to achieve its customers, revenue growth, and profitability objectives.

4. Innovation and learning perspectives: Innovation and growth perspective of the balanced scorecard is related to the employees of the organization, and measures the extent to which the organization exerts efforts to provide its employees with opportunities to grow and learn in their domain.

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Benchmarking

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RESPONSIBILITY CENTRES

• A responsibility centre may be defined as a unit of a firm where an individual manager is held responsible for the unit’s performance. There are four types of responsibility centres. They are:

1. Cost or expense centres;

2. revenue centres;

3. profit centres;

4. investment centres.

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Cost or expense centers• Cost or expense centres are responsibility centres whose managers

are normally accountable for only those costs that are under their control.

• We can distinguish between two types of cost centres – standard cost centres and discretionary cost centres.

• The main features of standard cost centres are that output can be measured and the input required to produce each unit of output can be specified.

• Control is exercised by comparing the standard cost (that is, the cost of the inputs that should have been consumed in producing the output) with the cost that was actually incurred. The difference between the actual cost and the standard cost is described as the variance.

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Revenue centers

• Revenue centres are responsibility centres where managers are mainly accountable for financial outputs in the form of generating sales revenues.

• Typical examples of revenue centres are where regional sales managers are accountable for sales within their regions.

• Revenue centre managers may also be held accountable for selling expenses, such as salesperson salaries, commissions and order-getting costs. They are not, however, made accountable for the cost of the goods and services that they sell.

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Profit centres• Both cost and revenue centre managers have limited decision-making

authority. • Cost centre managers are accountable only for managing inputs of

their centres, and decisions relating to outputs are made by other units within the firm.

• Revenue centres are accountable for selling the products or services but they have no control over their manufacture.

• A significant increase in managerial autonomy occurs when unit managers are given responsibility for both production and sales.

• In this situation managers are normally free to set selling prices, choose which markets to sell in, make product-mix and output decisions and select suppliers. Units within an organization whose managers are accountable for both revenues and costs are called profit centers.

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Investment centers• Investment centres are responsibility centres whose managers are

responsible for both sales revenues and costs and, in addition, have responsibility and authority to make capital investment decisions.

• Typical investment centre performance measures include return on investment and economic value added.

• These measures are influenced by revenues, costs and assets employed and thus reflect the responsibility that managers have for both generating profits and managing the investment base.

• Investment centres represent the highest level of managerial autonomy.

• They include the company as a whole, operating subsidiaries, operating groups and divisions.

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The objective of responsibility accounting

• The objective of responsibility accounting is to accumulate costs and revenues for each individual responsibility centre so that the deviations from a performance target (typically the budget) can be attributed to the individual who is accountable for the responsibility centre.

• For each responsibility centre the process involves setting a performance target, measuring performance, comparing performance against the target, analyzing the variances and taking action where significant variances exist between actual and target performance.

• Financial performance targets for profit or investment centres are typically in terms of profits, return on investment or economic value added, whereas performance targets for cost centres are defined in terms of costs

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Responsibility accounting involves:

• Distinguishing between those items which managers can control and for which they should be held accountable and those items over which they have no control and for which they are not held accountable (i.e. applying the controllability principle);

• setting financial performance targets and determining how challenging the financial targets should be;

• determining how much influence managers should have in the setting of financial targets.

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Quiz

Explain the different elements of management accounting control systems.

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• Management accounting control systems have two core elements. The first is the formal planning processes such as budgeting and long-term planning.

• These processes are used for establishing performance expectations for evaluating performance.

• The second is responsibility accounting, which involves the creation of responsibility centres.

• Responsibility centres enable accountability for financial results/outcomes to be allocated to individuals throughout the organization. Responsibility accounting involves: (a) distinguishing between those items which managers can control and for which they should be held accountable, and those items over which they have no control and for which they are not held accountable; (b) determining how challenging the financial targets should be; and (c) determining how much influence managers should have in the setting of financial targets.

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End of the Session

• Thank you.

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