1. Chapter McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Control: The Management Control Process 23

2. 23-2 Phases of Formal Management Control System Strategic planning. Budgeting. Measurement and reporting. Evaluation.

3. 23-3 Strategic planning. = programming = long range planning = deciding on programs to be undertaken and approximate amount of resources to be allocated to each program. Programs = principal activities that organization decides to undertake to implement strategies chosen in strategy formulation process. Strategy formulation is taken as a given.

4. 23-4 Examples of Programs Principal products or product lines. R&D projects. Human resource programs. Public relations programs.

5. 23-5 Budgeting Strategic planning looks forward several years. Budgeting focuses on next year. Budget = a plan expressed in quantitative, usually monetary, terms that covers a specified period of time usually one year. Budget is developed as a result of negotiations between managers of responsibility centers and their managers.

6. 23-6 Plans and Programs Plans are made in terms of programs. Programs are translated into terms of responsibility centers.

7. 23-7 Components of Final Budget Revenues (by revenue center). Resources used (by expense center). Profit (by profit center). Return on investment or residual income (by investment center).

8. 23-8 Measurements Actual and budget cost and revenue data are classified and compared by following categories: –Product (also by other programs). –Responsibility center. –Type of cost or revenue element.

9. 23-9 Reporting Management control system conveys accounting and non-accounting information. Reports are used as a basis for control. –Control reports compare actual and budget, shows variances, and attempt to explain reasons for variances.

10. 23-10 Task Control System used to control specific tasks such as producing a job order or entering customer orders within order processing system.

11. 23-11 Evaluation of Actions to be Taken Evaluations are based on: –Formal control reports. –Personal observations. –Other informally communicated information.

12. 23-12 Possible Responses to Control Reports Adjust current operations. Operating budgets may be revised. Programs need to be revised or eliminated. Nothing.

13. 23-13 Responsibility accounting Accounting information structured by responsibility center Used to measure performance and to provide information for decision making by responsibility center manager.

14. 23-14 Classifications of Costs Controllable or non-controllable. Engineered, discretionary, or committed.

15. 23-15 Controllable Costs Item of cost assigned to a specific responsibility center that is significantly influenced by actions of manager.

16. 23-16 Allocated Cost By definition, may not be controllable. Managers have little influence on amount of costs allocated to their department.

17. 23-17 Direct Costs By definition--costs traced directly to responsibility center. –May be controllable (e.g. supplies usage) or non-controllable (e.g. depreciation on equipment or buildings purchased in previous periods).

18. 23-18 Indirect Costs By definition--allocated to responsibility center. –Therefore, all indirect costs are non- controllable.

19. 23-19 Variable Costs Controllable costs are not same as variable, although most variable costs are controllable. Controllable costs which may be fixed: –Heat, light, power, supervision, depreciation on building, equipment. Variable costs which are non-controllable: –Cost of engine, body, seats to manager of assembly department in an automotive assembly plant.

20. 23-20 Factors Affecting Controllability of Costs Cultural norms: e.g. unacceptability of firing employees. Legal/contract limitations: e.g. union contracts/OSHA requirements. Length of time period used for planning: e.g. one month vs. one year.

21. 23-21 Converting Non-controllable Costs into Controllable Costs Change basis of cost assignment from allocation to direct assignment. –e.g. installing meters to measure and assign electricity usage by department. –Changing focus of responsibility for decisions, that is, decentralization. Almost any item of indirect cost could be converted to a direct and controllable cost. –May not be worthwhile. –e.g. presidents time could be assigned based on hours of effort related to each responsibility center.

22. 23-22 Decentralized vs. Centralized Decentralized organization: relatively more decisions made by lower level managers. Centralized organization: lower level managers make a relatively low proportion of decisions.

23. 23-23 Performance Report Suggestions Controllable reported separately from non- controllable costs. Consider not reporting non-controllable costs. Managers responsible for setting selling prices must see full costs (controllable and non-controllable) to ensure that revenues recover all costs including all support costs.

24. 23-24 Engineered, Discretionary, and Committed Costs Engineered costs = items of cost for which right or proper amount of cost that should be incurred can be estimated. –e.g. direct material, direct labor. Discretionary (= programmed = managed) costs = items of costs whose amount can be varied at discretion of manager. –No analytical way of determining right amount. –e.g. R&D, advertising, public relations, donations, employees’ parties. Committed (= sunk) costs = items of costs that are inevitable consequences of previous commitments. –e.g. depreciation, salaries of employees under contract.

25. 23-25 Controllable or Not? Engineered and discretionary costs are controllable. Committed costs are not controllable in short run, but are controllable in long run.

26. 23-26 Discretionary Cost Relationships Direction of cause and effect may be deceptive. Approaches to determine discretionary amount: –Same amount as last year. –X% of sales. –Y$ + X% of sales. Cause and effect is fundamentally different than for engineered costs. –For engineered costs: activity level inevitably causes costs. –For discretionary costs: management chooses to spend amounts related to an activity level such as sales.

27. 23-27 Behavioral Aspects of Management Control Social psychology = study of behavior of people in organizations. –Provides underlying principles relevant to control process (and not economics).

28. 23-28 Behavior of Participants Participant = each person in an organization. –People become participants because they believe by doing so they can achieve their personal goals.

29. 23-29 Motivations of Behavior Hierarchy of needs: –Extrinsic needs: Existence. (oxygen, food, shelter, sex) Security. Social. Self-esteem and reputation. Self-control and independence. –Intrinsic needs. Competence, achievement, and self-realization.

30. 23-30 Expansion on “ Needs ” Existence and security must be satisfied before others come into play. Other than intrinsic needs, once a need is satisfied, people cease seeking outcomes relevant to that need. Some outcomes satisfy several needs. Different people assign different degrees of importance to various needs.

31. 23-31 Expectancy Theory of Motivation Motivation to engage in a given behavior is determined by –Beliefs or expectancies about outcomes. –Attractiveness attached to outcomes to satisfy needs. Motivation is weakest when a person perceives a goal as being: –Unattainable. –Too easily attained. Motivation is strongest when there is roughly a 50 – 50 chance of achieving a goal.

32. 23-32 Incentives Positive incentive = reward = outcome that results in increased need satisfaction. Negative incentive = punishment = deprivation = outcome that results in decreased need satisfaction.

33. 23-33 Incentives Research (1 of 3) Senior management’s attitude toward management control system can be a powerful incentive. Rewards are better motivation than punishment. What constitutes a reward is situational.

34. 23-34 Incentives Research (2 of 3) Beyond the subsistence level, the amount of monetary compensation is not necessarily as important as non-monetary rewards. Intrinsic motivation depends on persons’ receiving reports/feedback about performance. Optimal frequency of feedback is related to time between performance of task and when inadequate performance is detectable.

35. 23-35 Incentives Research (3 of 3) Effectiveness of incentives diminishes as time elapses between beginning of reward or punishment and time span of discretion. Performance feedback is accepted more willingly if it is perceived as objective. Beyond a certain point adding more incentives (which adds more pressure) for improved performance accomplishes nothing.

36. 23-36 Types of Incentives Need not be monetary or formal. Formal incentives: Compensation related by formula to responsibility center performance. –Bonuses based on planned vs. actual results. –Bonus plan is most successful when there is agreement that basis of measurement is fair. Rewards and punishments are highly personalized. –Individuals differ in their needs and in their reactions to incentives.

37. 23-37 Goal Congruence Organizational goals are goals of top management and board of directors. Participants act in their own self interest. Management control system should be designed so that incentives/goals of participants are consistent with goals of organization.

38. 23-38 Cooperation and Conflict An organization attempts to maintain a balance between cooperation and conflict. Both are desirable within limits.

39. Chapter McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. End of Chapter 23 23