Q.3 (a) Difference between EVA and ROI.

Most of the companies employing investment centers evaluate business units on the basis of
Return on Investment (ROI) rather than Economic Value Added (EVA). There are three
apparent benefits of an ROI measure.
1. First, it is, a comprehensive measure in that anything that affects financial statements
is reflected in this ratio.
2. Second, Return on Investment (ROI) is simple to calculate, easy to understand, and
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.
3. 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 collar amount of Economic Value Added (EVA) does not provide such a basis for
comparison. Nevertheless the EVA approach has some inherent advantages. There are four
competing reasons to use EVA over ROI:
1. First, with EVA all business units have the same profit objective for comparable
investments. The ROI approach, on the other hand, provide, different incentive; for
investments across business units. For example, a business unit that currently is
achieving an ROI of 30 percent would be reluctant to expand unless it is able to earn
on ROI of 30 percent 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 an opportunity thats ROI is above the cost of capital but below 30
percent.
2. The use of ROI as a measure deals with both these problems. They relate to asset
investment whose ROI falls between the cost of capital and the centers current ROI.
If investment centers performance is measured by EVA, investments that practice a
profit in excess of the cost of capital will increase EVA and therefore economically
attractive to the manager.
3. 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 of fixed assets to take into account different degrees of
risk. In short, management control systems can be made considered with the
framework used for decisions about capital investments and resources allocation. It
follows that the same type of asset may be required to earn the same return throughout
the company, regardless of the particular business nits profitability. Thus, business
unit managers should act consistently when a deciding to invest in new assets.
4. A fourth advantage is that EVA, in contrast to ROI, has a stronger positive correction
with changes in a companys market value. 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
shareholder value is an important goal of an enterprise. However, since shareholder
value measures the worth of the consolidated enterprise as whole n is nearly
impossible to use it as a performance criterion for an organization individual
responsibility centers. The best proxy for shareholder value at the business unit level
is to ask business unit managers to create and grow EVA. It indicates that companies
with high EVA tend to show high market value added (MVA) or high gains for
shareholders. When used as a performance metric, EVA motivates managers to
increase EVA by taking actions consistent with increasing stockholder value.

Q.3 (b) Discuss in detail various elements of management control system

and draw diagram depicting various elements of management control
process.
Management control systems (MCS) is a system which gathers and uses information to
evaluate the performance of different organizational resources like human, physical, financial
and also the organization as a whole considering the organizational strategies.
MCS influences the behavior of organizational resources to implement organizational
strategies.
Management control systems are tools to aid management for steering an organization toward
its strategic objectives.
Management controls are only one of the tools which managers use in implementing desired
strategies. However strategies get implemented through management controls, organizational
structure, human resources management and culture
It is like a black box whose exact nature cannot be observed. MCS involves the behavior of
managers and these behaviors cannot be expressed by equations.
According to Horngren et al. (2005), management control system is an integrated technique
for collecting and using information to motivate employee behavior and to evaluate
performance. According to Simons (1995), Management Control Systems are the formal,
information-based routines and procedures managers use to maintain or alter patterns in
organizational activities
According to Maciariello et al. (1994), management control is concerned with coordination,
resource allocation, motivation, and performance measurement
Elements of management control system:
1.
2.
3.
4.
5.
6.
7.

Strategic Planning,
Budgeting,
Resource Allocation,
Performance Measurement,
Evaluation And Rewards,
Responsibility Center Allocation And
Transfer Pricing

Q.4 Define Profit Center. Discuss the types of profitability measures.

A profit center is a branch or division of a company that is accounted for on a
standalone basis for the purposes of profit calculation. A profit center is responsible for
generating its own results and earnings, and as such, its managers generally have decisionmaking authority related to product pricing and operating expenses. Profit centers are crucial
in determining which units are the most and least profitable within an organization.
A profitability ratio is a measure of profitability, which is a way to measure a
company's performance. Profitability is simply the capacity to make a profit, and a profit is
what is left over from income earned after you have deducted all costs and expenses related
to earning the income. The formulas you are about to learn can be used to judge a company's
performance and to compare its performance against other similarly-situated companies.
Profitability Ratios
Common profitability ratios used in analyzing a company's performance include gross
profit margin (GPM), operating margin (OM), return on assets (ROA) , return on equity
(ROE).

Gross margin tells you about the profitability of your goods and services. It tells you
how much it costs you to produce the product. It is calculated by dividing your gross
profit (GP) by your net sales (NS) and multiplying the quotient by 100:
o Gross Margin = Gross Profit/Net Sales * 100
o GM = GP / NS * 100

Operating margin takes into account the costs of producing the product or services
that are unrelated to the direct production of the product or services, such as overhead
and administrative expenses. It is calculated by dividing your operating profit (OP) by
your net sales (NS) and multiplying the quotient by 100:
o Operating Margin = Operating Profit / Net Sales * 100
o OM = OP / NS * 100

Return on Assets measures how effectively the company produces income from its
assets. You calculate it by dividing net income (NI) for the current year by the value
of all the company's assets (A) and multiplying the quotient by 100:
o Return on Assets = Net Income / Assets * 100
o ROA = NI/A * 100

Return on equity measures how much a company makes for each dollar that investors
put into it. You calculate it by taking the net income earned (NI) by the amount of
money invested by shareholders (SI) and multiplying the quotient by 100:
o Return on Equity = Net Income / Shareholder Investment * 100
o ROE = NI / SI * 100

Q.5 What is Cost Center? Distinguish Engineered and Discretionary Cost

Center.
Cost Centre
A cost centre is a responsibility centre in which manager is held responsible for
controlling cost inputs. There are two general types of cost centres: engineered expense
centres and discretionary expense centres. Engineered costs are usually expressed as standard
costs. A discretionary expense centre is a responsibility centre whose budgetary performance
is based on achieving its goals by operating within predetermined expense constraints set
through managerial judgement or discretion.
Discretionary Expense Centre
Discretionary costs are those for which no such engineered estimate is feasible; the amount
of costs incurred depends on management's judgment about the amount that is appropriate
under the circumstances.
The costs of the inputs, or resources required to perform such activities are referred to as
discretionary costs.
It is also called Discretionary Expenditure or Managed Cost
Discretionary costs relate to company activities that are important but whose level of funding
is subject to judgment.
Discretionary costs are generated by activities that vary in type and magnitude from day-today and whose benefits are often not measurable in monetary terms.
In addition, performance quality can also vary according to the task and employee skill levels
involved.
Engineered Expense Centre
Engineered costs are elements of cost for which the "right" or "proper" amount of costs that
should be incurred can be estimated with a reasonable degree of reliability.
For example : Costs incurred in a factory for direct labor, direct material, components,
supplies, and utilities.
Characteristics

Their input can be measure in monetary terms .

Their output can be measured in physical terms

The optimal rupee amount of input required to produce one unit of output can be
established.