MCS PAPER SOLUTION 2008

Q.1. (a):Internal Audit is one of the techniques of control available to the top management for
ensuring continuous improvement for better performance. Comment upon this statement
analyzing it highlighting benefits accruing to the top management.
Ans:Internal audit can be viewed from two different perspectives-the traditional perspective
and the modern perspective. Viewed from a Traditional perspective, internal audit is
found to play the following roles:

Check whether the existing controls are effective and adequate.

Check whether the financial reports and other records show the actual results of
the company.

Check whether the sub-units of the organization are following the policies and
procedures laid down by the management.

The Traditional concept of internal auditing has a narrow scope whereas the Modern
concept has wider scope. The fact that the modern internal auditing is wider is reflected
in the new definition of internal auditing given by the Institute of Internal Auditors,
An independent appraisal function established within an organization to examine and
evaluate its activities as a service to the organization. The objective of internal auditing is
to assist members of the organization in the effective discharge of their responsibilities.
To this end, internal audit furnishes them with analyses, appraisals, recommendations,
counsel and information concerning the activities reviewed.
This definition implies that an internal auditor has to go beyond checking the books of
account and related records. He has to appraise the various operational functions of an
organization and provide recommendations about these.

Thus, according to the modern concept of internal auditing, the internal auditor is
involved in conduction a review of operations, and internal audit and operational audit
are almost synonymous.
Need for Internal Auditing:The need for internal audit is determined by the increasing size and complexity of
organizational operations. Many organizations operate in number of countries and
therefore have a large number of employees. In order to avoid discrepancies from
creeping into their systems, processes, and operations, such organization appoint a team
of specialists called internal auditors to monitor, track and report such discrepancies,
inefficiencies of personnel in the concerned departments.
Benefits of Internal audit to Top Management:Internal audit can be beneficial to most organizations as well as top management because,
if planned properly, it provides management with a methodology to identify those risks
that may prevent the organization from meeting its objectives.
For example, if a company has a strategic objective to raise Rs.20 million in loans to
build a new facility there are a number of risks that may prevent that from occurring. One
risk may be the external factor of increased interest rates. Another risk may be internal
risk that management does not qualify for credit because of covenants they will not be
able to meet.
Financial costs of internal audit will vary based upon the size and goal of the internal
audit function. Additionally, the cost will be based upon the resources used to perform the
work (outsource, co-source, in-house). The most significant non-financial cost may be a
negative reputation of the internal audit role throughout the organization. If the function
is not properly established, socialized and executed then the validity of the function could
be jeopardized.

Internal audit can be a value-add activity but often times it is strictly a policing function,
which is sadly an example when the cost of internal audit usually does not exceed its
benefit.
Key Benefits of Internal Audit:

Inform the management on their possibility of achievement of organizational

objectives.

Better focus on high risk areas.

Strengthens the planning process.

As a means to help managements identify opportunities and downsize threats.

Q.1. (b):-

What are the considerations involved in regulating R&D function by the top management
especially in view of challenges faced on account of Globalization?
Ans:Research & Development Programme:
There is no scientific way of determining the optimum size of and R&D Budget. Many
companies simply use a percentage of average revenue as a base (preferring an average to
a percentage of specific revenues in a given year because the size of an R&D operation
ought to be affected by short term revenue swings). The specific percentage applied is
determined in part by a comparison with competitors R&D expenditures and in part by
the companys own spending history. Depending on circumstances, other factors may
also come into play.
For Example:
Senior Management may authorize a large and rapid increase in the budget if it appears
that there has been a significant breakthrough.
The R&D program consists of a list of programs plus a blanket allowance for unplanned
work; it is usually reviewed annually b y senior management. This research view is often
conducted by a research committee consisting of the CEO, the research director, and the
production and marketing managers. This committee makes broad decision as to which
projects to undertake, which to expand, which to cut back on, and which to discontinue.
These decisions, of course, are highly subjective, but they are within the established
policy limits on total research spending. Thus, the research program is determined not by
calculating the total amount of approved projects, but rather by dividing the research
pie into what seem to be the most worthwhile slices.

Annual Budgets:

If the company has decided on a long-range R&D program and has implemented program
with a system of project approval, the preparation of the annual R&D budget is a fairly
simple matter, involving mainly the Calendarization of the expected expenses for the
budget period. If the budget is in line with the strategic plan, approval is routine- it
primarily serves to assist in cash and personnel planning. Preparation of the budget
allows management to take another look at the R&D program with this question in mind:
In view of what we now knew, is this the best way to use our resources next year?
The annual budget process also ensures that actual costs will not exceed budgeted
amounts without managements knowledge. Significant variances from the budget should
be approved by management before they are incurred.
Measurement of Performance:
At regular intervals, usually monthly or quarterly, most companies actual expenses with
budgeted expenses for all responsibility centers and ongoing projects. These comparisons
are summarized for managers at progressively higher levels to assist the managers of
responsibility centers in planning their expenses and to assure their superiors that those
expenses are remaining at approved levels.
In many companies, management receives two types of financial reports on R&D
activities. The first type compares the latest forecast of total cost with the approved
amount for each active project. It is prepared periodically for the executives who control
research spending, to help them determine whether changes should be made in the list of
approved projects. The second type of financial report consists of a comparison between
budgeted expenses and actual expenses in each responsibility center. Its main purpose is
to help research executives anticipate expenses and make sure that expense commitments
are being met. Neither type of financial report informs management as to the
effectiveness of the research effort. Such information is formally provided by progress
reports, which from a partial basis for managements judgments about the effectiveness of
a given project. It is important to note, however, that managements primary tool in
evaluating effectiveness is face-to-face discussion.
Q.3. (a):-

What is Two-step transfer pricing and profit sharing approach? Narrate merits &
demerits thereof.
Ans:
Two step pricing Approach
It includes 2 charges:
First, for each unit sold, a charge is made that is equal to the standard variable cost of
production. Second, a periodic (usually monthly) charge is made that is equal to the fixed
cost associated with the facilities reserved for the buying unit. One or both of these
components should include a profit margin.
Profit Sharing Approach
It is used to ensure congruence between business unit and company interest. This system
operates as follows:
1. The product is transferred to the marketing unit at standard variable cost.
2. After the product is sold, the business units share the contribution earned, which is the selling
price minus the variable manufacturing and marketing costs.

This method of pricing may be app. If demand for the manufactured product is not steady
enough to warrant the permanent assignment of facilities, as in the 2step pricing method.
In general, this method does make the marketing units interest congruent with the
companys.

Q3 (b):

Adopting Profit Center Approach may not be appropriate solution always`. Do you agree
with this statement? Give reason for your answer quoting various situations in business.
Ans:
Establishing organization units as profit centers provides the following advantages:

The quality of decisions may improve because they are being made by managers
closest to the point of decision.

The speed of operating decision may be increased since the do not have to be
referred to corporate headquarters.

Headquarters management, relieved of day-to-day decision making, can

concentrate on broader issues.

Managers, subject to fewer corporate restraints, are freer to use their imagination
and initiative.

Because profit centers are similar to independent companies, they provide an

excellent training ground for general management. Their managers gain
experience in managing all functional areas, and upper management gains the
opportunity to evaluate their potential for higher-level jobs.

Profit consciousness is enhanced since managers who are responsible for profits
will constantly seek ways to increase them. (A manager responsible for marketing
activities, for example, will tend to authorize promotion expenditures that increase
sales, whereas a manger responsible for profits will be motivated to make
promotion expenditures that increase profits.)

Profit center provide top management with ready-made information on

profitability of the companys individual components.

Because their output is so readily measured, profit centers are particularly

responsive to pressures to improve their competitive performance.

EXAMPLE. ABB (Asea Brown Boveri), a European multinational in the business of

power generation, transmission, and distribution, was organized into 4,500 small profit

centers-each with profit and loss responsibility and meaningful autonomy. Percy
Barnevik, ABB`s CEO, explained why: We are fervent believers in decentralization.
When we structure local operations, we always push to create separate legal entities.
Separate a company allows you to create real balance sheets with real responsibility of
cash flow and dividends. With real balance sheets, managers inherit results from year to
year through changes in equity. Separate companies also create more effective tools to
recruit and motivate managers. People can aspire to meaningful career ladders in
companies shall enough to understand and to be committed to
Many Japanese companies use profit centre. The Kyocera Corporation, a technology
company divided itself into 800 small companies (nick named amoebas), which were
expected to trade both internally and externally. HIgashimaru Shoya, a soy sauce maker,
turned each stage in production process into a separate profit centre, instructing these
separate units to buy and sell to any other. Matsushita, consumer electronics giant,
operated its divisions as profit centers and focus managers attention on two numbersprofit margin and the bottom line. The consumer electronic industries were
characterized by two factors: product life cycles tended to be short and profit margins
were higher in the initial stages of the product life cycle than in the later stages. The focus
on profit margins motivated managers to introduce new products, and the focus on the
bottom line motivated managers to extract the minimum profits from current products.

Difficulties with profit centers

However, the creation of profit centers may cause difficulties like:

Decentralized decision making will force top management to rely more on

management control reports than on personal knowledge of an operation,
entailing some loss of control.

If headquarters management is more capable or better informed than the average

profit centre manager, the quality of decision made at the unit level may be
reduced.

Friction may increase because of argument over the appropriate transfer price, the
assignment of common costs, and the credit for revenues that were formerly
generated jointly by two or more business units working together.

Organization units that once cooperated as functional units may not be in

competition with one another. An increase in profits for one manager may mean a
decrease for another. In such situations, a manager may fail to refer sales leads to
another business unit better qualified to pursue them; may hoard personnel or
equipment that, from the overall company standpoint, will be better off used in
another unit; or may make production decisions that have undesirable cost
consequences for other units.

Divisionalization may impose additional cost because of the additional

management, staff personal, and record keeping required, and may lead to task
redundancies at each profit center.

Competent general managers may not exit in functional organization because

there may not have been sufficient opportunities for them to develop general
management competence.

There may be too much emphasis on short rum profitability at an expense of long
run profitability. In the desire to report high current profits, the profit centre
manager may skimp on R&D, training programs, or maintenance. This tendency
is especially prevalent when the turnover of profit centre managers is relatively
high. In this circumstance, managers may have good reason to believe that their
actions may not affect profitability until after they have moved to other jobs.

There is no completely satisfactory system for ensuring that optimizing the profits
of each individual profit center will optimize the profits of the company as a
whole.

Q4)
what is balance score card? Describe steps involved in implementation thereof,
difficulties & reasons for failure thereof, in any?
Ans:(A) BALANCE SCORE CARD:The establishment, through data gathering of targets & comparators, through those
whose use relative levels of performance (and particularly areas of under performance)
can be identified. By the adoption of identified best practices it is hoped that performance
will improve.
-CIMA OFFICIAL TERMINOLOGY
The Balanced Scorecard (BSC) complements financial measures of past performance
with measures of the drivers of future performance. The objective & measures of the
scorecard are derived from an organizations vision & strategy. BSC shows how to link
the organizational visions to critical success factors or outcomes & key performance
indictors, representing all perspectives of the business. This compels the senior
management team to operate as a unified team, balancing competing objectives to
achieve the optimum result for the organization as a whole. BSC expands the set of
business unit objectives beyond summary financial measures. Corporate executives can
now measure how their business unit creates value for current & future customers & how
they must enhance internal capabilities & investment in people, system & procedures
necessary to improve future performance.

BSC captures the critical value creation

activities created by skilled, motivated organizational participants, while retaining the

financial performance as short term financial measures, the balance scorecard clearly
reveals the values drivers for superior long term financial & competitive performance.
many organization are using their financial & non financial performance measures only
for tactical feed back & control of short term operation.

(B) STEPS IN IMPLEMENTING BALANCE SCORECARD

The framework for action in implementing of BSC is shown in the following figure:

Translating the vision

Clarifying the vision
Gaining consensus
Feedback & learning
Articulating the shared vision
Supplying strategic feedback
Facilitating strategy review & learning
Business planning

Setting targets
Aligning strategic initiatives
Allocating resources
Establishing milestones

Communicating & linking

Communicating & educating

 Setting goals
Linking rewards to performance measurement

Steps involved in implementing Balance Scorecard

Identify the key outcome to the success of the organization

Identify the process that lead to these outcomes
Develop key performance indication for these processes
Develop reliable data capture & measurement system
Develop a mechanism for reporting these to the relevant managers & staff.
Enact improvement programmes to ensure that performance improves.

(C) Benefits & limitations of balance scorecard

Benefits
It avoids management reliance on short term financial measures
It can successfully communicate corporate strategies to the functional heads &
organizations subunits & forcing them to develop there own goals to achive the
corporate mission & goals & to make consistent policies to corporate strategy.
In can assist stakeholders in evaluating the firm if measures are communicated
externally.

Limitations

There is no clear relationship between BSC & shareholder value

It does not leads to a single aggregate summary of control
The measures may give conflicting signals & confuse management
It involves substantial shifts in corporate culture.

Q5.
Economic Value Added (EVA) is a technique of management control, considered by
some as superior to that of ROI. Analyze the statement, and give your comments,
quoting illustrations/ situations prevailing in the Business World, in support of your
argument.

Ans.
Most companies employing investment centers evaluating business units on the basis of
ROI rather than EVA. Ther4e are three apparent benefits of an ROI measure. First, it is
comprehensive is that any thing that affects financial statements is reflected in this ratio.
Second, ROI is simple to calculate, easy to understand, meaningful in an absolute sense.
For example, an ROI of less than 5 percent is considered low on an absolute scale, and an
ROI of over 25 percent is considered high. Finally, it is a common denominator that may
be applied to any organizational unit responsible for profitability, regardless of size or
type of business. The performance of different units may be compared directly to one
another. Also ROI data are available for competitors and can be used as a basis for
comparison.
The dollar amount of EVA does not provide such a basis for comparison. Nevertheless,
the EVA approach has some inherent advantages. There are four compelling reasons to
use EVA over ROI>
First, with EVA all business units have the same profit objective for comparable
investments. The ROI approach, on the other hand, provides different incentives for
investments across business units. For example, a business unit that currently is achieving
an ROI of 30percent or more on additional assets; a lesser return would decrease its
overall ROI below its current 30 percent level. Thus, this business unit might forgo
investment opportunities whose ROI is above the cost of capital but below 30 percent.
Example. Based on ROI Wal-mart would have chosen to stop expanding since the late
1980s because its ROI on new stores slipped from 25% to 20% even though both rates
were substantially above its cost of capital.
Similarly, a business unit that currently is achieving a low ROI- say 5% would benefit
from anything over 5% on additional assets. As a consequence, ROI creates a bias
towards little or no expansion in high profit business units while, at the same time, low
profit units are making investments at rates on return well below those rejected by the
high profits units.

Second, decision that increase a centers ROI may decrease its overall profits. For
instance, in an investment centre whose current ROI is 30%, the manager can increase its
over all ROI by disposing of an assets whose ROI is 25%. However, if the cost of capital
tied up in the investment centre is less than 25%, the absolute dollar profit after deducting
capital cost will decrease for the centre.
The use of EVA as a measure deals with both these problems. They relate to assets
investment whose ROI falls between the cost of capital and the centers current ROI. If
an investment centers performance is measured by EVA, investments that produce a
profit in excess of the cost of capital will increase EVA and therefore be economically
attractive to the manager.
A third advantage of EVA is that different interest rates may be used for different types of
assets. For example, a low rate may be used for inventories while a relatively higher rate
may be used for investments in fixed assets. Furthermore, different rates may be used for
different types type of fixed assets to take into account different degrees of risk. In short,
management Control System can be made consistent with the framework used for
decision about investments and recourse allocation. It follows that the same type of assets
may be required to earn the same return throughout the company, regardless of the
particular business units profitability. Thus, business units managers should act
consistently when deciding to invest in new assets.
A fourth advantage is that EVA, in contrast to ROI, has a stronger positive correlation
with changes in companys market value. Shareholders are important stakeholders in a
company. There are several reasons why shareholder value creation is critical for the
firm. It (a) reduces the risk of takeover, (b) creates currency for aggressiveness in mergers
and acquisitions, and (c) reduces cost of capital, which allows faster investment for future
growth.
Thus, optimizing shareholding value is an important goal of an enterprise. However,
because shareholder value measures the worth of consolidated enterprise as a whole, it is
nearly impossible to use it as a performance criterion for an organizations individual
responsibility centers. The best proxy for shareholder value at a business unit level is to
ask business unit managers to create and grow EVA.

How EVA is understood is as under:

EVA= Net profit Capital charge

Where,
Capital charge = Cost of capital * Capital employed

(1)

Another way to state equation (1) would be:

EVA = Capital employed (ROI Cost of capital)

(2)

the following action can increase EVA as shown in equation (2): (i) increase in ROI
through business process reengineering and productivity gains, without increasing the
asset base; (ii) divestment of assets, products, and/or businesses whose ROI is less than
the cost of capital; (iii) aggressive new investments in assets, products, and/or businesses
whose ROI exceeds the cost of capital; and (iv) increase in sales, profit margins, or
capital efficiency (ratio of sales to capital employed), or decrease in cost of capital
percentage, without affecting the other variables in equation (2). These actions clearly are
in the best interests of shareholders.

Q.9- Discuss and illustrate difference and similarities between:(a) Strategy Formulation & Task Control:
Ans.:-

Strategy Formulation

Task Control

1. Acquire an unrelated Business

1.

Coordinate order entry

2. Enter a new Business

2.

Schedule production

3. Add direct mail selling

3.

Book TV Commercial

4. Change Debt/Equity Ratio

4.

Manage cash flows

5. Adopt affirmative action policy

5.

Maintain personal records

6. Devise Inventory

6.

Reorder an item

7. Speculation Policy

7.

Run individual research project

8. Decide Magnitude & Direction of

research

9. (b) Management Control & Task Control:

Management Control
1. Introduce new Product or Brand within
product line

Task Control
1. Coordinate order entry

2. Expand a plant

2. Schedule production

3. Determine advertising budget

3. Book TV Commercial

4. Issue new debt

5. Implement minority Recruitment
Program

4. Manage cash flows

5. Maintain personal records

6. Decide Inventory levels

6. Reorder an item

7. Control Research organization

7. Run individual research project