MCS Ch01 - 07 Revised 1 PDF

Chapter 1
Nature of
Management Control Systems
(MCS)
MCSs: Anthony & Govindarajan

Introduction
Definition:
…encourage students…
Illustrations:
1. AC
2. Fridge toward
3. Car goals
4. Organization
FE Usakti - Prihartono MCSs: Anthony & Govindarajan 2

Introduction
Focus:
Strategy implementation; design & implement
on going management system used to plan &
control firm’s performance
Elements of MCS:
strategic planning; budgeting, resource
allocation; performance measurement ,
evaluation & reward; responsibility centers,
and transfer pricing
(strategy, organizational behavior, human
resources, & managerial accounting)
Basic Concepts
2. Assessor: comparison
with standard
1. Detector: information
what is happening
Control 3. Effector: behavior
Device alternation, if needed
Entity
being
controlled

Boundaries of Mgt Control
Activity Nature of End Product
Strategy
Formulation Goals, strategies, & policies
Management
Control Implementation of strategies
Task Efficient & effective

Control
performance indiv. tasks

(Cont.)
Management Control:
Process by which managers influence other
members of organization to implement
organization’s strategies
Mgt Control Activities:
 Planning what org. should do
 Coordinating activities of departments of org.
 Communicating information
 Evaluating information
 Deciding what action should be taken
 Influencing people to change their behavior
(Cont.)
Strategy formulation:
Process of deciding on the goals of
organization & the strategies for attaining
these goals
Task Control:
Process of assuring that specified tasks are
carried out effectively & efficiently
Examples are in exhibit 1.5 p. 12

(Cont.)
Implementation Mechanisms
Management
Controls
P e r f o r m an c e
Strategy
Organization Human Res.

Structure Management
Culture

(Cont.)
Impact of Internet:
 Makes processing of information easier and
faster with fewer error.
 Processing of information becomes more
efficient & effective.
But internet cannot substitute for the fundamental

processes that are involved in management
control because it is essentially behavior in
nature and thus cannot be fully automated.

Road Map for the Reader
1. Management Control Environment:
Chapter 2 – 7 mid test
2. Management Control Process:

Chapter 8 – 12 final test
3. Variations in Management Control:

Chapter 13 – 16 final test

Chapter 2
Understanding Strategies

Introduction
MCSs tools to implement strategies.
Strategies differ between organizations,
and controls should be tailored to
the requirements of specific
strategies.
Different strategies require different
task priorities, different key success
factors, and different skills,
perspective, and behaviors.
Goals
Strategies developed to attain organization’s
goals. Goals are determined by founders of the
organization or Chief Executive Officer (CEO),
E.g.;
1. Profitability:
 Return on Investment (ROI)
 Economic Value Added (EVA)
 Market Value Added (MVA)
 Long-term profitability

Goals (Cont.)
2. Maximizing Shareholder Value
(Henry Ford)
3. Multiple Stakeholder Approach
(Acer)
4. Organizational Effectiveness
5. Corporate Social Responsibility
6. Risk (& Reward)

Concept of Strategy
Strategy:
The general direction in which an organization
plans to move to attain its goals.
• Organization has one or more strategies
• Strategies may not be stated explicitly
• Strategies differ between organizations
• Firms develop strategies by matching its core
competencies with opportunities
• Strategies can be found at two levels;
• Corporate (whole org.)
• Business Units (BUs)

Concept of Strategy (Cont.)
Environmental Internal
Analysis Analysis
(External Org.) (Internal Org.)
Opportunities Strengths and

And Threats Weaknesses
(identify opportunities) (identify competencies)
Match opportunities
with competencies
Firm’s strategies

Concept of Strategy (Cont.)
Strategy Key Strategic General Strategic Primary Org.
Level Issue Options Levels Involved
Corporate Are we in the 1. Single industry

Level right mix of 2. Related diversification Corporate office
industries? 3. Conglomerate
Business What should be 1. Build Corporate office &

Unit level the mission of 2. Hold business unit GM
the BUs? 3. Harvest
4. Divest
How should the 1. Low cost Business Unit GM

business unit 2. Differentiation
compete to real-
ize its mission?

Corporate Level Strategy
Issues at corporate level:
 Definition of business in which firm will participate
 Deployment of resources among those businesses
1. Single Industry
Firm operates at in one line of business, e.g.:
McDonald’s, Wrigley, Ford Motor, Exxon-Mobil
2. Related Diversification
Firm operates in several industries, and business units
benefit from a common set of core competencies, e.g.:
P&G has skills in chemical technologies and marketing
& distribution expertise in low-ticket branded consumer
products. Typically grow internally trough R & D

Corporate Level Strategy (Cont.)
3. Unrelated Diversification:
Firm operates in businesses that are not related to one
another; the connection between business units is
purely financial, e.g.: Astra International, Para Group,
Bakrie Group, General Electric.
Conglomerates grow primarily through acquisition.
On average, related diversified firms perform

the best, single industry firms perform next
best, and conglomerates firms do not perform
well over the long term.

Business Unit Strategies
Key strategic questions:
1. What should be the BU’s mission (overall
objectives)?
2. How should the BU compete to accomplish
its mission?
Tools for developing BU strategies:

1. BCG/GE matrices
2. Industry structure analysis
3. Value chain analysis

BU Strategies - Mission
BU Mission:
1. Build; increase market share
2. Hold; geared to the protection of BU’s
market share & competitive position
3. Harvest; maximizing short-term cash inflows
4. Divest; withdraw from the business
BU Competitive Advantage:
1. Low cost
2. Differentiation

BU Strategies - Mission (Cont.)
The BCG Model
Cash source
High Low
High High
Star Question mark
Hold Build
Market Cash
growth use
rate
Cash cow Dog
Harvest Divest
Low Low
High Low
Relative market share

BU Strategies - Mission (Cont.)
 BCG uses industry  GE; attractiveness
growth rate as proxy based on weighted
for industry judgments about
attractiveness market size, market
growth, entry barriers,
tech obsolescence
 GE uses market
 BCG uses relative
market share as a share, distribution
proxy for BU’s current strengths, &
competitive position engineering strengths
to assess cp

BU Strategies – Comp. Adv. (Cont.)
Industry Structure Analysis
New
Entrants
Industry
Suppliers Customers
Competitors
Substitutes

Industry Analysis:
1. Rivalry; industry growth, product differentiability,
number & diversity of competitors, level of fixed costs,
exit barriers, etc.
2. Customers; number of buyers, buyer’s switching
costs, significance of BU’s volume to buyers, etc.
3. Suppliers; number of supplier, supplier’s ability to
integrate backward, etc.
4. Substitute; relative price/performance of substitutes,
buyer’s switching costs, etc.
5. New Entry; capital req., access to distr. channels,
tech complexity of product/process, gov policy, etc.

Industry Analysis:
1. The more powerful the five forces are, the less
profitable an industry is likely to be
2. Depending upon the relative strength of the
five factors, the key strategic issues facing the
BU will differ from one industry to another
3. Understanding the nature of each force helps
the firm to formulate effective strategies

Basis for Competitive Advantage
Superior
Cost-Cum
Differentiation Differentiation
Advantage Advantage
Relative
Differentiation
Position
Low-Cost Stuck-in-
Advantage the-Middle
Inferior
Inferior Superior
Relative cost position

Value Chain Analysis
Product Manufac- Marketing Service/

Development turing and Sales Logistics
E.g.: Chevron, Nike, Reebok, Bank Niaga, GE, Carrefour
… control systems have to support

strategies.
Chapter 3
Behavior in Organizations

Goal Congruence (GC)
MCS influence behavior in a goal congruent manner
Goal congruent manner:

Individual actions taken to achieve personal
goals also help to achieve organization’s goal’s.
Perfect goal congruence between them does not
exist.
Needs of individual may influence their action

taken. Maslow outlined five types of needs
(1954).

Maslow’s Hierarchy of Needs
Opportunities for growth, learn-

Self- ing, creative & challenging work
actualization
Praise & recognition, perform-
Ego/esteem ance evaluation, promotions
Work with groups, informal

Social activities
Working conditions,
Safety job security
Food & water, shelter,

Physiological wages & benefits

Factors Influence GC
1. Informal:
a. External, such as norms or work ethics
b. Internal:
1) Culture
2) Management style
3) Informal organization
4) Perception & communication
2. Formal:
a. Rules
b. Formal Control Process (after midtest)

Factors Influence GC
Formal:
1. Rules;
All types of formal instructions &
controls such as; SOP, job des.,
accounting manuals, ethical
guidelines, etc.
2. Formal Control Process;
Strategic planning, budgeting,
reporting, etc (exhibit 3.1 p. 100)
Formal Control Process

Types of Organizations
1. Functional
Manager is responsible for a specified function such
as manufacturing/prod., marketing, finance, R&D,
HR.
2. Business Unit/divisional
Managers are responsible for most of activities of
their units.
3. Hybrid
4. Matrix
Functional units have dual responsibilities
… (exhibit 3.2 p. 101)
Types of Organizations
President
Director
& CEO
Vice President
Vice President Vice President Vice President
Human
Marketing Finance Production
Resources
President
Director
& CEO
VP Exploration VP Marketing VP Chemical

VP Refinery
& Production & Distribution & Others

Functions of Controller
Controller:
Person who is responsible for designing and operating
management control systems.
Chief Financial Officer (CFO) usually responsible for
the portfolio in many organizations.
Functions:
1. Designing & operating information & control systems
2. Preparing financial reports & tax returns
3. Preparing & analyzing performance reports
4. Analyzing programs & budget proposals
5. Supervising accounting control procedures
6. Developing personnel in the department

Functions of Controller (Cont.)
BU Controller:
1. Report to GM Division
2. Report directly to CFO
(controller group)
Regardless of CEO
relationships, controller VP VP CFO VP GM Div.
do not condone or Manager Controller Manager

participate in the
transmission of
misleading information
or in the concealment
of unfavorable
information.
Chapter 4
Responsibility Centers:
Revenue & Expense
Centers

Responsibility Centers
A responsibility center:
An organization unit that is headed by a
manager who is responsible for its activities.
A responsibility center exists to accomplish one

or more objectives. Responsibility centers
receive inputs in the form of materials, labor,
services, etc in order to transform them into
outputs, either tangible (goods) or intangible
(services).

Responsibility Centers (Cont.)
Inputs and Outputs:
 Each managers is responsible for ensuring
the optimum relationship between inputs and
outputs.
 Inputs are not always directly related to
outputs (ads expenses & revenues)
 Cost is a monetary measure of the amount of
resources (inputs) used by a responsibility
center
 Measuring outputs are not easy, sometimes
management used surrogate numbers.
Inputs and Outputs
Inputs Work Outputs

Resources used, Process Goods or services
measured by cost
Capital

Efficiency and Effectiveness:
 Efficiency is the ratio of outputs to inputs, or the
amount of output per unit of input.
 Effectiveness is determined by the relationship
between a responsibility center’s output and its
objective
 Efficiency and effectiveness are not mutually
exclusive; every responsibility center ought to be both
efficient and effective
 A responsibility center is efficient if it does things
right, and it is effective if it does the right things.

Types of Responsibility Centers:
1. Revenue Centers: output (revenue) is measured
in monetary terms, but no formal attempt is made to
relate input to output.
2. Expenses Centers:
a. Engineered
b. Discretionary
3. Profit Centers
4. Investment Centers
…(Exhibit 4.2 p. 152)…

Expense Centers
Expense centers:
Are responsibility centers whose input are
measured in monetary terms, but whose
outputs are not.
1. Engineered:
Input can be measured in monetary terms
a.
b. Output can be measured in physical terms
c. Optimal relationship between i/o can be
measured
Found in manufacturing, warehousing, distribution, etc.

Expense Centers (Cont.)
2. Discretionary:
a. Inputs (costs) incurred depend on management’s
judgment
b. Output cannot be measured in monetary terms
c. Relationship between i/o difficult to measured
Found in adm. & support units, R&D, mkt, etc.
Control Characteristics:
 Mgt formulates budget by determining the
magnitude of job
 Technique used in preparing usually MBO
Control Characteristics:
 Planning usually carried out by incremental
budgeting or zero base review
 Annual budget tend to be constant percentage of
sales volume
 Financial control primarily exercised at planning
stage
 Measurement of performance primarily through
non-financial (since financial performance cannot
be judged as efficient)

Administrative & Support Units
Control Problems:
1. Difficulty in measuring output
2. Lack of goal congruence
Research & Development Units

Control Problems:
1. Difficulty in relating results to inputs
2. Lack of goal congruence

Research & Development Units
 R&D Continuum: significant time lapse between
initiation of research and introduction of product,
e.g.: DNA 26 years & Xerox 24 years financial
control for its stages.
 No scientific way of determining optimum size of
R&D budget use percentage of average sales as
a base.
 Periodically, mgt measure its performance through
reports by each type of projects or responsibility
centers.

Marketing Units
 Order getting discretionary
 Order filling engineered
 Generate revenue compare actual with
budgeted
(monetary terms & units)

Chapter 5
Responsibility Centers:
Profit Centers

Profit Centers
Profit Center:
A responsibility center that is headed by a
manager who is responsible for profit (difference
between revenues and expenses). Revenues &
expenses are measured in monetary terms.
Conditions for Profit Responsibility

1. Access to relevant information for making
expense/revenue trade-offs decision
2. Some way to measure the effectiveness of making
such decision

Profit Centers (Cont.)
Advantages of Profit Centers:
1. Speed of operating decisions increased
2. Quality of decisions may increase
3. HO can concentrate on strategic issues
4. Excellent training ground for general
management
5. Profit consciousness enhanced
6. Improve performance

Profit Centers (Cont.)
Drawbacks of Profit Centers:
1. Loss of controls
2. Quality of decisions may decrease
3. Frictions may increase
4. Additional costs
5. Manager may emphasis on short-run
profitability

BUs as Profit Centers
Constraints on BU Authority:
1. From other BUs
2. From corporate:
a. Strategic considerations
b. Requirement of uniformity
c. Economies of centralization
Completely independent caused
organization loses advantage of synergies

Non-BUs as Profit Centers
Functional Units:
 Marketing
 Manufacturing
 Service & Support Units
Other Units:
 Branches, retail chains, hotel chains

Measuring Profitability
Types of Measurements:
1. Management performance; how well the
manager is doing.
2. Economic performance; how well the profit
center is doing as an economic entity
Economic performance measured by net
income (profit).
Judgments:
a. How revenues & expenses should be measured
b. Behavior considerations… influence & control

Measuring Profitability (Cont.)
Revenue 10,000
Cost of sales 6,000
Variable expenses 1,800
Contribution margin 2,200 a
Fixed expenses incurred in profit center 900
Direct profit 1,300 b
Controllable corporate charges 100
Controllable profit 1,200 c
Other corporate allocations 200
Income before taxes 1,000 d
Corporate taxes 300
Net income 700 e

Chapter 6
Transfer Pricing

TP - Definition
Transfer pricing: Value placed in accounting
for any transfer of goods & services between
responsibility centers (at least one involved is
profit center).
Transfer pricing refers to the pricing of
contributions (assets, tangible and intangible,
services, and funds) transferred within an
organization (Wikipedia).
Since the prices are set within an organisation (i.e.,
controlled), the typical market mechanisms that
establish prices for such transactions between third
parties may not apply.

TP - Objectives
The choice of the transfer price will affect the
allocation of the total profit among the parts of
the company.
Objectives:
1. Provide each BUs with relevant information to
determine optimum expense/revenue trade-offs
decision
2. Induce goal congruent decisions
3. Motivate managers
4. Help measure economic performance BUs

Fundamental Principle
Transfer price should be similar to the
price that would be charged if product sold
to outside customers or purchased from
outside vendors
Decisions in designing TP system:
1. Sourcing decision
2. Transfer price decision

Ideal Situation
 Market price
 Competent people
 Good atmosphere
 Market price
 Freedom to source
 Full information
 Smooth negotiation
If all the above conditions present, TP system based on
market price would induce goal congruent decision.
Actually, there are constraints on sourcing:
1. Limited markets
2. Excess or shortage of industry capacity

TP - Methods
1. Market based; with some adjustments for costs
not incurred in intra company transfer
2. Cost-based plus profit
3. Upstream Fixed Costs & Profit:
 Agreement among BUs
 Two-step pricing
 Profit sharing
 Two sets of prices
4. Negotiation
Arbitration mechanism may be necessary for
settling potential disputes
Pricing Corporate Services
1. For central services that receiving units
must accept but can partially control
 Pay standard variable cost of discretionary
services
 Full cost; standard variable cost plus a fair
share of standard fixed costs
 Standard full cost plus profit margin
2. For central services that receiving units
can decide whether or not to use
Administration of TP
 Negotiation
 Arbitration & Conflict Resolution
 TP arbitration responsibility of high level HO
executive (group)
 Resolve conflict: smoothing, bargaining,
problem solving, and forcing
 Product Classification

Chapter 7
Measuring & Controlling

Assets Employed

Investment Center
… a profit center in which profit
compared with its assets employed
Methods of measurement:
1. Return on Investment (ROI)
Return divided by its investment
2. Economic Value Added (EVA)
NOPAT minus WACC
3. Others

Purpose of Measuring
Assets Employed
1. To provide information that is useful in
making sound decisions
2. To motivate managers to make these
sound decisions that are in the best
interests of the company
3. To measure the performance of the
business unit as an economic entity

Purpose of Measuring
Assets Employed
Generally, BU managers have two
performance objectives:
1. Managers should generate adequate
profits from the resources at their
disposal
2. Managers should invest in additional
resources only when the investment will
produce an adequate return

Balance Sheet
Current Assets: Current Liabilities:
Cash $ 50 Account Payables $ 90
Receivables 150 Other Current 110
Inventory 200
Total CA 400 Total CL 200
Fixed Assets:
Cost $ 600 Corporate Equity $ 500
Depreciation (300)
Book value 300
Total Assets $ 700 Total L & E $ 700
Income Statement
Revenues $1,000
Expenses, except depreciation $ 850
Depreciation 50 900
Income before taxes 100
Capital charges ($500 * 10%) 50
Economic Value Added (EVA) 50
Return on Investment = $100 / $500 = 20%
Measuring Assets Employed
Investment base to evaluate inv. centers:
1. What practices will induce manages using
assets most efficiently?
2. What practices best measure performance of
unit as an economic entity?
Cash:
1. Using certain formula (e.g.; x% * annual sales)
2. Omitting cash from investment base

(Cont.)
Receivables:
1. Average balance (less allowance for bad
debts)
2. Selling price
3. COGS
Inventories:
1. Average costs
2. Adjusted advance payments or account
payables from inventories
(Cont.)
Working Capital:
1. All CA in investment base
2. All (CA – CL)
PPE:
1. Gross book value or net?
2. Annuity depreciation
Old assets tends to report larger EVA
(Cont.)
Leased Assets; financing decision?
Idle Assets; exclude from investment base?
Intangible Assets; R&D, capitalized or expensed?
Non-current liabilities: compute separately?
Capital charges;
1. HQ sets the rate
2. Rate for FAs > WC

EVA vs. ROI
Benefits of ROI:
1. Comprehensive measurement
2. Can be applied to any organization
regardless of size or type of business
3. Simple to calculate & easy to understand
4. ROI data are available & can be used for
comparison

EVA vs. ROI
Benefits of EVA:
1. All BUs have same profit objective for
comparable investments
2. Different interest rates may be used for different
types of assets
3. Decisions that increase a center’s ROI may
decrease its overall profits
4. EVA has a stronger positive correlation with
changes in a company’s market value
…Exhibit 7.12

Evaluating Managers
 Additional considerations
Controllable and uncontrollable, particularly FAs
& Non-CL
 Economic performance
1. Economic reports are diagnostic instrument,
focus on future profitability, whereas mgt
reports use historical data.
2. Value of BU; present value of its future free c/f

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Chapter 1

MCSs: Anthony & Govindarajan

FE Usakti - Prihartono MCSs: Anthony & Govindarajan 2

Device alternation, if needed

FE Usakti - Prihartono MCSs: Anthony & Govindarajan 4

Task Efficient & effective

FE Usakti - Prihartono MCSs: Anthony & Govindarajan 5

Examples are in exhibit 1.5 p. 12

FE Usakti - Prihartono MCSs: Anthony & Govindarajan 7

Organization Human Res.

FE Usakti - Prihartono MCSs: Anthony & Govindarajan 8

But internet cannot substitute for the fundamental

FE Usakti - Prihartono MCSs: Anthony & Govindarajan 9

2. Management Control Process:

3. Variations in Management Control:

FE Usakti - Prihartono MCSs: Anthony & Govindarajan 10

MCSs: Anthony & Govindarajan

FE Usakti - Prihartono MCSs: Anthony & Govindarajan 13

FE Usakti - Prihartono MCSs: Anthony & Govindarajan 14

FE Usakti - Prihartono MCSs: Anthony & Govindarajan 15

Opportunities Strengths and

FE Usakti - Prihartono MCSs: Anthony & Govindarajan 16

Corporate Are we in the 1. Single industry

Business What should be 1. Build Corporate office &

How should the 1. Low cost Business Unit GM

FE Usakti - Prihartono MCSs: Anthony & Govindarajan 17

FE Usakti - Prihartono MCSs: Anthony & Govindarajan 18

On average, related diversified firms perform

FE Usakti - Prihartono MCSs: Anthony & Govindarajan 19

Tools for developing BU strategies:

FE Usakti - Prihartono MCSs: Anthony & Govindarajan 20

FE Usakti - Prihartono MCSs: Anthony & Govindarajan 21

FE Usakti - Prihartono MCSs: Anthony & Govindarajan 22

FE Usakti - Prihartono MCSs: Anthony & Govindarajan 23

FE Usakti - Prihartono MCSs: Anthony & Govindarajan 24

FE Usakti - Prihartono MCSs: Anthony & Govindarajan 25

FE Usakti - Prihartono MCSs: Anthony & Govindarajan 26

FE Usakti - Prihartono MCSs: Anthony & Govindarajan 27

Product Manufac- Marketing Service/

E.g.: Chevron, Nike, Reebok, Bank Niaga, GE, Carrefour

… control systems have to support

MCSs: Anthony & Govindarajan

Goal congruent manner:

Needs of individual may influence their action

FE Usakti - Prihartono MCSs: Anthony & Govindarajan 30

Opportunities for growth, learn-

Work with groups, informal

Food & water, shelter,

FE Usakti - Prihartono MCSs: Anthony & Govindarajan 31

FE Usakti - Prihartono MCSs: Anthony & Govindarajan 32

FE Usakti - Prihartono MCSs: Anthony & Govindarajan 34

VP Exploration VP Marketing VP Chemical

FE Usakti - Prihartono MCSs: Anthony & Govindarajan 36

FE Usakti - Prihartono MCSs: Anthony & Govindarajan 37

relationships, controller VP VP CFO VP GM Div.

do not condone or Manager Controller Manager

MCSs: Anthony & Govindarajan

A responsibility center exists to accomplish one

FE Usakti - Prihartono MCSs: Anthony & Govindarajan 40

Inputs Work Outputs

FE Usakti - Prihartono MCSs: Anthony & Govindarajan 42

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