13 Management Control Systems, The Balanced Scorecard, and Responsibility Accounting

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

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

The Management Control System Set Goals, Measures, Targets Plan and Execute Feedback and Learning Evaluate, Reward Monitor, Report

Setting Goals, Objectives and Performance Measures Top management develops organization-wide goals, measures and targets. They also identify the critical processes. Top management and critical process managers develop critical success factors and performance measures. They also specify objectives Critical process managers and lower-level managers develop performance measures for objectives.

Forms of Organizational Structure President Staff Functional VP Marketing VP Production VP Human Resources VP Finance Divisional Matrix President Functional VPs Staff President Mkt. Prod. H.R. Fin. A B C Divisional VPs VP Division A VP Division B VP Division C

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

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

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

Controllability and Measuring Financial Performance Controllable Cost Uncontrollable Cost Measuring Financial Performance

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

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

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

Contribution Income Statement for Measuring Performance Whole Branch Branch Company A B Net sales revenue $4,000 $1,500 $2,500 Variable costs 3,260 1,200 2,060 Contribution margin 740 300 440 Fixed costs controllable by manager 260 100 160 Contribution controllable by manager 480 200 280 Fixed costs controllable by others 200 90 110 Contribution by segment 280 $110 $170 Unallocated costs 100 Income before income taxes $180 Controllable Costs Direct Costs Uncontrollable Costs Indirect Costs Evaluate manager on "contribution controllable by segment manager" (all controllable costs) Evaluate segment on its "contribution by segment" (all direct costs)

Nonfinancial Performance Measures Control of Quality Control of Cycle Time Control of Productivity

Control of Quality Quality requires meeting customers' requirements and maintaining this level throughout the production and sales process Four categories: 1. prevention 2. appraisal 3. internal failure 4. external failure Total quality management (TQM) focuses on all areas of business

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

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

Successful Organizations and Measures of Achievement FINANCIAL STRENGTH CUSTOMER SATISFACTION BUSINESSS PROCESS IMPROVEMENTS ORGANIZATIONAL LEARNING

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 Financial Strength Customer Satisfaction Organizational Learning Business Process Improvement

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

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

The Future of Management Control Systems A changing environment requires changes in the management control system Four key factors must be monitored at 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 Organizational Goals Organizational Structure Responsibility Centres Performance Measurement