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Management Control Systems, The Balanced

Scorecard, andResponsibility Accounting

13

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Management Control System

• A management control system is a logical integration of management accounting tools to gather and report data and to evaluate performance

Purposes of a management control system• clearly communicate the organization’s goals• ensure that every manager and employee

understands the specific actions required of him/her to achieve organizational goals

• communicate the results of actions across the organization

• ensure that the management control system adjusts to changes in the environment

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Management Control System Steps

1. Begin by specifying the organization's 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• Important to keep all three in balance to avoid concentrating

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

2. Establish responsibility centers

3. Develop performance measures

4. Measure and report on financial performance

5. Measure and report on non-financial performance

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The Management Control System

Set Goals,Measures,

Targets

Feedbackand

Learning

Monitor,Report

Planand

Execute

Evaluate,Reward

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Setting Goals, Objectives and Performance Measures

Top management develops organization-wide goals, measuresand targets. They also identify the critical processes.

Top management develops organization-wide goals, measuresand targets. They also identify the critical processes.

Top management and critical process managers developcritical success factors and performance measures.

They also specify objectives

Top management and critical process managers developcritical success factors and performance measures.

They also specify objectives

Critical process managers and lower-level managersdevelop performance measures for objectives.

Critical process managers and lower-level managersdevelop performance measures for objectives.

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Forms of Organizational Structure

VPProduction

VPMarketing

VPHuman Resources

VPFinance

StaffFunctional

Staff

VPDivision B

VPDivision A

VPDivision C

President

Divisional

Functional VPs

DivisionalVPs

Matrix

A

B

C

Mkt. Prod. H.R. Fin.

President

President

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Responsibility Centres

• Set of activities assigned to a manager or a group of managers/employees

• Based on principle of responsibility accounting which holds that managers should be evaluated on the activities which they can influence or control

Cost Centre• Area for which cost data is accumulated such as an assembly department

Expense Centre• Area dominated by discretionary expenses such as legal or accounting

Revenue Centre• Area primarily responsible for generating sales such as a sales office

Profit Centre• Area responsible for controlling costs and generating revenues

Investment Centre• Area responsible for income (revenues - expenses) in relation to its

invested capital

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Motivating Employees to Excel

• To achieve maximum benefits at minimum cost, a management control system must foster goal congruence and managerial effort

• Goal Congruence exists when individuals and groups aim for the same organizational goals through their decision-making

• Managerial Effort is an exertion toward a goal or objective i.e. working faster and better

• Incentives are needed for both to be achieved

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Developing Measures of Performance

Good performance measures will

1. Relate to the goals of the organization

2. Balance long-run and short-run concerns

3. Reflect the management of key decisions and activities

4. Be affected by actions of managers and employees

5. Be readily understood by managers and employees

6. Be used in evaluating and rewarding employees

7. Be reasonably objective and easily measured

8. Be used consistently and regularly

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Controllability and MeasuringFinancial Performance

• Controllable Cost

• Uncontrollable Cost

• Measuring Financial Performance

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Controllable Cost

• Cost which is directly influenced by the manager of a responsibility centre during a particular time period

• Absolute or total control is not required in order for a cost to be classified as controllable

• Key is to look for the manager or managers who are in the best position to explain the results achieved

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Uncontrollable Cost

• Any cost that cannot be affected by management of a responsibility centre within a given time span

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Measuring Financial Performance

• Principle of responsibility accounting holds that it is fair to evaluate managers only on the costs under their control

• Uncontrollable costs should be ignored in evaluating the manager because nothing he or she does will affect these costs

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Contribution Income Statement for Measuring Performance

• Evaluate manager on "contribution controllable by segment manager" (all controllable costs)

• Evaluate segment on its "contribution by segment" (all direct costs)

Whole Branch BranchCompany A B

Net sales revenue $4,000 $1,500 $2,500Variable costs 3,260 1,200 2,060Contribution margin 740 300 440Fixed costs controllable by manager 260 100 160Contribution controllable by manager 480 200 280Fixed costs controllable by others 200 90 110Contribution by segment 280 $110 $170Unallocated costs 100Income before income taxes $180

ControllableCosts

DirectCosts

IndirectCosts

UncontrollableCosts

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Nonfinancial Performance Measures

• Control of Quality

• Control of Cycle Time

• Control of Productivity

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Control of Quality

• Quality requires meeting customers' requirements and maintaining this level throughout the production and sales process

• Four categories:1. prevention2. appraisal3. internal failure4. external failure

• Total quality management (TQM) focuses on all areas of business

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Control of Cycle Time

• Cycle time is the time taken to complete a product or service

• Summary measure of effectiveness and efficiency and an important cost driver

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Control of Productivity

• Relationship of outputs to inputs for material, labour and equipment

• Multiple productivity measures may include

• Labour cost as a % of sales dollars• Sales per employee• Machinery & equipment investments per

employee• Total labour cost per hour

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Successful Organizations and Measures of Achievement

CUSTOMER SATISFACTIONCUSTOMER SATISFACTION

BUSINESSS PROCESS IMPROVEMENTSBUSINESSS PROCESS IMPROVEMENTS

ORGANIZATIONAL LEARNINGORGANIZATIONAL LEARNING

FINANCIALSTRENGTH

FINANCIALSTRENGTH

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Balanced Scorecard

• Performance reporting approach which links organizational strategy to actions of managers and employees

• Combines financial and operating measures• Links performance to rewards• Recognizes diversity in organizational goals

FinancialStrength

CustomerSatisfaction

Business ProcessImprovement

OrganizationalLearning

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Management Control Systems in Service, Government and Nonprofit Organizations

• Control systems are more difficult to implement and maintain:

• Outputs are more difficult to measure• Quality ratings are less clear

• Important to properly train and motivate employees to achieve organization's goals and consistent monitoring of objectives in accordance with critical subgoals

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Management Control Systems in Service, Government and Nonprofit Organizations• Government and nonprofit organizations face further

problems:

• Goals and objectives are less clear• Professionals less receptive to control

systems• Lack of profit measure makes measurements

more difficult• Less pressure to improve from "owners"• Budgeting is more of a bargaining game to

acquire additional funding and less of a planning tool

• Motivations and incentives of organizational employees are often drastically different from for-profit organizations

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The Future of Management Control Systems

ResponsibilityCentres

OrganizationalGoals

OrganizationalStructure

PerformanceMeasurement

• A changing environment requires changes in the management control system

Four key factors mustbe monitoredat all times

Important factors to keep in mind:• Individuals will generally behave in their own self-interest• Design systems so that individuals pursuing their own self-interest will also

achieve the organization's objectives • Best benchmark for evaluating current performance is expected or budgeted

performance• Nonfinancial performance is just as important as financial performance• Periodically review the success of the management control system• Learn from your and your competitors' mistakes