MANAGEMENT CONTROL SYSTEMS © 2012 Pearson Prentice Hall. All rights reserved.

Class Announcements  Service Learning Assignment:  Schedule a meeting with Danika Leblanc ( prior to contacting your organization  Ensure that I am included in your meeting with the client organization  Final Exam 7:00pm April 11, 2014  Leadership Conferences:  1) KPMG Executive Look March 26,  2 ) Deloitte Leadership Conference Information Session Wednesday, March 5 – 5:00 to 6:00pm Schwartz 205

Class Objectives 1. Understanding management control systems as a mechanism for management and control 2. Modifying behaviour through the management control system 3. Management control systems in a decentralized organization

Management Control Systems  Management control systems are a means of gathering and using information to aid and coordinate the planning and control decisions throughout an organization and to guide the behavior of its managers and other employees.  Well-designed management control systems use information both from with the company (e.g., net income) and from outside of the company (i.e., share price)  Well-designed management control systems use both qualitative and quantitative information. © 2012 Pearson Prentice Hall. All rights reserved.

Management Control Systems  Consist of formal and informal control systems:  Formal systems include explicit rules, procedures, performance measures, and incentive plans that guide the behavior of its managers and other employees.  Informal systems include shared values, loyalties, and mutual commitments among members of the company, corporate culture, and unwritten norms about acceptable behavior. © 2012 Pearson Prentice Hall. All rights reserved.

Management Control Systems: Effective  To be effective, management control systems should  be closely aligned to the firm’s strategies and goals.  be designed to fit the company’s structure and decision- making responsibility of individual managers.  motivate managers and their employees Motivation is the desire to attain a selected goal (goal- congruence) combined with the resulting pursuit of that goal (effort). Goal congruence exists when individuals and groups work toward achieving the organization’s goals—managers working in their own best interest take actions that align with the overall goals of top management. Effort is exertions toward reaching a goal, including both physical and mental actions. © 2012 Pearson Prentice Hall. All rights reserved.

Management Control Systems: Decentralization  To be effective, management control systems should  be closely aligned to the firm’s strategies and goals.  be designed to fit the company’s structure and decision- making responsibility of individual managers.  Decentralization is the freedom for managers at lower levels of the organization to make decisions.  Autonomy is the degree of freedom to make decisions. The greater the freedom, the greater the autonomy.  A decentralized organization has additional issues to consider within the management control system to be effective. © 2012 Pearson Prentice Hall. All rights reserved.

Management Control Systems: Decentralization vs. Centralization  Total decentralization means minimum constraints and maximum freedom for managers at the lowest levels of an organization to make decisions.  Total centralization means maximum constraints and minimum freedom for managers at the lowest levels of an organization to make decisions.  Companies’ structures generally fall somewhere in between these two extremes, as each has benefits and costs. Structure chosen cost vs. benefit analysis. © 2012 Pearson Prentice Hall. All rights reserved.

Management Control Systems: Benefits of Decentralization  Creates greater responsiveness to subunit’s customers, suppliers, and employees  Leads to gains from faster decision making  Increases motivation of subunit managers  Assists management development and learning  Sharpens the focus of subunit managers © 2012 Pearson Prentice Hall. All rights reserved.

Management Control Systems: Costs of Decentralization  Leads to suboptimal decision making, which arises when a decision’s benefit to one subunit is more than offset by the costs or loss of benefits to the organization as a whole.  Also called incongruent decision making or dysfunctional decision making  Focuses manger’s attention on the subunit rather than the company as a whole  Results in duplication of output  Results in duplication of activities © 2012 Pearson Prentice Hall. All rights reserved.

Management Control Systems: Decentralization and Multinational Firms  Multinational firms, companies that operate in multiple countries, are often decentralized because centralized control of a company with subunits around the world is often physically and practically impossible.  Decentralization enables managers in different countries to make decisions that exploit their knowledge of local business and political conditions and to deal with uncertainties in their individual environments.  Biggest drawback to international decentralization: loss or lack of control. © 2012 Pearson Prentice Hall. All rights reserved.

Belanger & Sequin : Context  A boat and inboard engine manufacturer  Three divisions:  Engine – concentrated on diesel single engine for the last 5 years; capacity of 8000 hours per year (2 hours per boat)  Boat –labour intensive operation; operated below planned production last year because sales projections were 950 orders lower; capacity is 200,000 DLH  Sales – sole Canadian distributor for new Fujiama sailboats; want to capture growth in recreational boating with a new 20 ft fiberglass sport boat  Falling profits have reduced ROA to 9.3% overall  Resentment is growing among divisions

Belanger & Sequin : Issues  1) Assess Divisional Profit  Transfer price between divisions  2) Impact on Overall Profitability  Impact of Fujiama sailboat (1,500)  Impact of 20 foot fiberglass sport boat (1,250)  3) Assessment of Management Control System - Evaluation System  Responsibility centre designation –Investment Centre  Evaluation metrics – Return on Assets (ROA)

Belanger & Sequin: Transfer Price  Options for setting Transfer Price:  Current price - $4,  Market price - $5, Capacity is 8000 hours/ 2 hours per engine is 4,000  Net market prices - $ 4,490 Selling price $5,000 – commission $510 = $4,490  Variable cost - $2,200 DM $800 + DL $1,000 + VOH $400 = $2,200

1. Belanger & Sequin : Profit and ROA by Division (Exhibit #1)

1. Belanger & Sequin : Engine Division (Exhibit #2)  1. What profit if sell all 4000 to external market?  2. What profit if sell only current level externally?

1.Belanger & Sequin : Engine Division Sensitivity Analysis

1.Belanger & Sequin : Boat Division (Exhibit #3)  1. What profit if transfer price was $2,200  2. What profit if sales level was as anticipated  1,750 (800 actual expected additional)  Use $4,100 transfer price

1.Belanger & Sequin : Boat Division Sensitivity Analysis

1.Belanger & Sequin : Sales Division (Exhibit #4)  1. What profit if redirected sale to BSL at 1,750  (keep total boat 2,000 in total)

1.Belanger & Sequin : Sales Division Sensitivity Analysis

1.Belanger & Sequin : Overall Analysis

2. New Boat Profitability Analysis

3. Belanger & Sequin: Assessment of Evaluation System  Responsibility centre designation  Investment Centre  Any internal transfer of engines and boast is determined by the sales division estimates of the potential market  Evaluation metrics  ROA  Pretax divisional income divided by assets controlled by the division

3. Belanger & Sequin: Assessment of Evaluation System  Each division is evaluated on ROA  Engine – ROA is 16.5% Commission ($510/engine) on external sales – 4,200 units No commission on internal sales – 800 units Transfer pricing – breaking even on internal sales  Boat – ROA is (10.7%) No commission - internal sales only No outside sales – determined by Sales  Sales – ROA is 12.4% Commission on boats, higher commission on Fujiama Commission on BSL greater than Fujiama

Class Objectives - Revisited 1. Understanding management control systems as a mechanism for management and control 2. Modifying behaviour through the management control system 3. Management control systems in a decentralized organization

Midterm Results  Average: 50.88/70 (73%)  Hi: 71.5/70  Lo: 33.5/70  Comments:  Did not answer question(s)  Misunderstanding what is being asked  Provide evidence or discussion for your opinions/conclusions; do not assume