Management Control System

Nature of Management Control System
Ch-1
Chapter
1 Nature of Management
Control System
Copyright © 2008, Pradip Kumar Sinha
1– 1 Management Control Systems a managerial emphasis Pradip Kumar Sinha Excel Books
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Introduction
The importance of the subject matter covered in the courseware has been felt
upon the collapse of companies such as: Tyco, Global Crossing, WorldCom, and
Enron because of lapse in controls. CEOs and top management compensation
in these companies were so heavily tied up with stock options that executives
were motivated to manipulate financials to buoy the short-term stock price.
Similarly, the long-term success of world-class
world companies such as: Emerson
Electric, Lincoln Electric New York Times, Worthington Industries, 3 M
Corporation, Nucor Corporation, Dell Computer, Wal-Mart, South West Airlines,
Cisco Systems and Analog Devices were not just because they have developed
good strategies, but more importantly, they have designed systems and
processes that energize their employees to execute these strategies effectively.
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What Is a Management Control System (MCS)?

A MCS is a set of inter-related communication structures that facilitates the
processing of information for the purpose of assisting managers in co-ordinating
the parts and attaining the purpose of an organization on a continuous basis. All
organizations use control systems, both formal and informal.
Here we are concerned with three words:
words control, management and systems.
Control
Every control system has at least four elements:
1. A detector or sensor - a device that measures what is actually happening in
the situation being controlled.
2. An assessor i.e., a device for determining the significance of what is
happening i.e., comparison with some standard or expectation.
3. An effector i.e., a device that alters behaviour if the assessor indicates the
need. This device is often called "feedback.“
"feedback
4. A communication network, i.e., devices that transmit information between
the detector and the assessor and between the assessor and the effector.
Cont…. Copyright © 2008, Pradip Kumar Sinha
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These four basic elements of any control system are given in Figure.
Control 2. Assessor: Comparison

Device with standard
1. Detector–Information
about what is happening
3. Effector -Behavior
alteration if needed
Entity being
controlled
Elements of a Control Process
Cont….
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Management
An organization consists of a group of people who work together to achieve
certain common goals (in a business organization, an important goal is to earn a
satisfactory profit). In an organization, you have a hierarchy of managers, with
the Chief Executive Officer (CEO) at the top, the managers of the business units,
departments, sections and other sub-units
sub below the CEO. Depending on the
size and complexity of the organization, there may be several layers in the
hierarchy. Except for the CEO, each manager is both a superior and a
subordinate. Each one supervises people in his own organization unit and is a
subordinate of the manager to whom he reports.
Systems
A system is a prescribed way of carrying out an activity or set of activities,
usually, the activities are repeated. Most systems are less precise than computer
programs, their instructions do not cover all eventualities and the user of the
system must make judgements when these eventualities occur. Nevertheless, a
system is characterized by more or less rhythmic, recurring, co-ordinated series
of steps that are intended to accomplish a specific purpose. Copyright © 2008, Pradip Kumar Sinha
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Boundaries of Management Control
Management Control is one of the several types of planning and control activities
in an organization. The other two control and planning activities are: (a) strategic
planning and (b) task or operational control.
control
Strategic planning occurs at top management levels; task control at the lowest
levels in the organization and management control is in between.
The relationship of these activities is given below:
Activity Nature of the end product
Strategy Goals Strategies and Policies

Formulation
General
Relationship
among
Management Implementation of Strategies Planning
Control and Control
functions
Task Control Efficient and Effective performance Cont….

Of Individual Task Copyright © 2008, Pradip Kumar Sinha
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Management Control
Management control is the process by which managers influence the other
members of the organization to implement the organization's strategies. Several
aspects of the process are given below:
below
Management Control Activities
Management control involves a variety of activities including:
1. Planning what the organization should do
2. Co-ordinating the activities of several parts of the organization
3. Communicating information
4. Evaluating information
5. Deciding what, if any, action should be taken
6. Influencing people to change their behaviour
Cont….
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Goal Congruence
Although systematic, the management control process is by no means
mechanical; it involves interactions among individuals, which cannot be
described as mechanical. Managers have personal as well as organizational
goals. The central control process is to induce managers to act in pursuit of their
personal goals in ways that will help attain the organization's goals as well. Goal
congruence means that as far as feasible, the goals of an organization's
individual members should be consistent with the goals of the organization itself.
The management control system should be designed and operated with the
principles of goal congruence in mind..
 Tools for implementing strategy
 Financial and non-financial emphasis
 Aid in developing new strategies
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Strategic Formulation
Strategic formulation is the process of deciding the goals of the organization and
the strategies for attaining these goals.
goals
Distinction Between Strategic Formulation and Management Control
1. Strategic formulation is essentially unsystematic. Whenever a threat is
perceived or when a new idea surfaces, strategic formulation takes place.
By contrast, the management control process takes place according to a
more or less fixed timetable and the steps occur one after another.
2. Strategic formulation involves only part of the organization; it may result in a
change in one or a few existing strategies. The management control
process, necessarily involves the whole organization and more important
various parts are co-ordinated with one another.
3. Analysis of a proposed strategy usually, involves relatively few people – the
sponsor of the idea, headquarters staff and senior management. By
contrast, the management control process involves managers and their staff
at all levels in the organization.
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Task Control/Operational Control

Task control is transaction oriented i.e
e., it involves the control of individual tasks.
Rules to be followed in carrying out these tasks are prescribed as part of the
management control process.
Distinction Between Task Control and Management Control
1. Many task control systems are scientific, whereas, management control can
never be reduced to science.
2. In task control, either human beings are not involved at all or the interaction
is between a manager and a non-manager. Whereas, in management
control, managers interact with other managers.
3. Task control requires a different task control system for each type of task,
whereas, the management control system is basically similar throughout the
organization.
4. In task control, focus is on specific task performed e.g. manufacturing Job
No. 59268 or ordering 100 nos.. of part 3009. In management control, the
focus is on organization units.
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Formal Control Process and Role Played by Accounting

Systems and Information Handling System
Figure is a broad framework of the formal management control process. A
strategic plan implements the organization's goals and strategies. All available
information is used in making this plan.
plan The strategic plan is converted to an
annual budget that focuses on the planned revenues and expenses for individual
responsibility centres. Responsibility centres are also guided by a large number
of rules and formal information. They carry out the operations assigned to them
and their outcomes are measured and reported. Actual results are compared
with those in the budget. In case of satisfactory performance, there is feedback
to the responsibility centre in the form of praise or other reward. If not, the
feedback leads to corrective action in the responsibility and possible revision of
the plan. Cont….
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Goals and Rules Other

Strategies Information Reward
Feedback
Strategic Budgets Responsibility

Planning Centre Reports act Was
operation vs. Plan performance
satisfactory?
Corrective
Revise Revise Action Measurement
Communication
The Formal Control Process
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Impact of the Internet on Management Control

The pace of information revolution accelerated with the invention of the
computer, is gaining momentum in the 1990s with the advent of the Internet.
The Internet provides major benefits in the following ways:
1. Instant access use: On the web, the huge amount of data can be sent to
anyone anywhere in the world in a matter of seconds.
2. Multi-targeted communication:: The Internet has a vastly expanded one-
to- any reach; one web entry can reach millions of people.
3. Costless communication: Communication with customers via the internet
avoids the costs of salaries of telephone operator.
4. Ability to display images: The Web enables the customers to see the
products being offered for sale.
5. Shifting power and control to the individual: The individual is the "king".
Consumers are in control and can use the web 24 hours a day at their own
conveyance without being interrupted or unduly influenced by sales
representatives or telemarketers..
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The Domain of Management Control System
There is a difference of opinion about the proper domain of control systems
among experts in the field. There are many views: Antony and Govindarajan in
their book "Management Control System", Eleventh Edition, consider strategic
planning, management control and task control as three separate interrelated
process of planning and control. Management control is seen by them as the
process by which managers influence the other members of the organization to
implement the organization strategies."
strategies In their views, the proper domain for
management control system is the successful implementation of strategy. They
do not consider adaptation and innovation as an integral part of the Management
Control Process.
William Newman in his book Constructive Control Design and Use of Control
Systems, considers the domain of control systems to be the control function of
management and believes that "control is one of the basic phases of managing
alongwith planning, organizing and leading."
leading Control is seen as an essential part
of the management process and a part of all the managerial efforts of an
organization. Copyright © 2008, Pradip Kumar Sinha
Contributing Theories of Management Control Systems
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Chapter
2 Contributing Theories of
Management Control
Systems
Ch-2
The Cybernetic Paradigm and the Control Process

This is also referred to as micro control framework, since it helps us to establish
controls or performance measures for a particular problem area in a specific
situation.
"Cybernetics" is derived from the Greek work "Kybernatics" which means

"Steersman". A Steersman is a person who directs or governs a ship and
corrects deviations from planned course as they occur.
Cybernetics has been defined as the "service of communication and control."

The term cybernetics was coined by Norbert Weiner and it aims at the study of
the entire field of control and communication theory, whether in the machines or
the animal and has been extensively used in control system engineering and in
biology. "Cybernetics" as a biological phenomenon, has been defined as "how
systems regulate themselves, reproduce themselves, explore and learn."
Cont….
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The particular version of the paradigm developed by Griesinger (1979)
(Griesinger, Donald W. Management Theory - A Cybernetic Perspective,
Graduate Management Centre Jan. 86)
86 captures all the elements of the control
process, which may be enumerated as follows:
1. Set goals and performance measures
2. Measure achievement
3. Compare achievement with goals
4. Compute the variances as the result of the proceeding comparison
5. Reporting the variances
6. Determine the cause of the variances
7. Take action to eliminate the variances
8. Follow up to ensure that goals are met
Cont….
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Cybernetic Paradigm of the Control Process Cont….

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Designing Management Controls

1. The process of establishing control should be established as a constructive
exercise not a punitive one. Use of controls should be to assist people in
attaining goals and objectives for which they are responsible. Controls will
be viewed by all participants as 'fair', important indicators of the real
purpose of the activity, and 'constructive' as to help people in achieving the
purpose of the activity.
2. Objectives should be expressed in measurable terms whenever possible.
3. Control should focus upon the objectives and key results of an activity and
should be limited in number.
4. In establishing controls, we should seek to establish balance among the
various aspects of the activity being controlled.
5. A single individual should be assigned responsibility for achieving desired
results for an objective.
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The Control Process Hierarchy
Cont….
Control Hierarchy: The Structure of Control Copyright © 2008, Pradip Kumar Sinha
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Adaptive Control Systems: Two Sets of Mutually Supportive Systems
A control system is a set of formal and informal systems that are designed to
assist management in steering the organization towards the achievements of its
purpose by forging unity out of the diverse efforts of sub-units and of individuals.
These two sets of systems are distinctive but highly inter-related and,
sometimes, indistinguishable, sub-division of control systems. They are
considered adaptive if the two systems are internally consistent, consistent with
one another and designed to permit learning that is effective in continuously
meeting the competitive challenges in the environment.
Cont….
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Formal Control INFRASTRUCTURE MANAGEMENT STYLE
-Organization structure AND CULTURE
System -Strategy -Prevailing Style
-Operations External/internal/mixed
Figure contains -Patterns of Autonomy -Principal values
-Measurement methods -Norms and beliefs
an overview of a -Responsibility centre
-Transfer pricing
generic set of
five mutually
FORMAL CONTROL PROCESS
supportive -Strategic planning
-Capital budgeting
management -Operational Planning
-Cost accounting
subsystems and -Budgeting
-Reporting systems
is useful for -Strategy/project management
-Operations/variance analysis
describing the
formal aspects
REWARDS COORDINATION &
of management -Individual and Group INTEGRATION
-Short-term and long -term -Standing Committees
control systems. -Promotional policy -Strategy
-Operations
-Formal conferences
-Involving techniques
Formal Control System Cont…. Copyright © 2008, Pradip Kumar Sinha
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Management Style and Culture of the Organization
Management styles may be summarized on a continuum between highly

directive or autocratic styles (external styles) and highly participative styles
(internal styles). Style influences the design of management systems in that,
these systems serve management and should fit the way management chooses
to operate. The corporate culture consists of shared values, common
perceptions and common decision premises applied by organization’s
participants to the activities and problems of the organization.
Cont….
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Formal Control Process
Two distinct formal planning processes are strategic planning and operations
planning. There are two budgets: one for operations and one for strategy. There
are two sets of reports: one for strategic reports and one for operating activities.
Monthly, quarterly and yearly to date comparisons are made and detailed
operating variances are calculated to assess progress towards achieving
operating plans. Reporting against strategic plans accompany action programme
of projects that are monitored over time.
time
 Infrastructure
 Rewards
 Co-ordination and integration mechanisms
 Informal control process
 Informal organization structure and emergent roles
Cont….
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Informal Control Process
Management decisions are based upon experience, intuition and feeling.
Successful decision-making involves sensing the whole and impact of the
decision on the whole.
 Informal recognition and rewards
Informal rewards are stature-oriented
oriented. These rewards are bestowed upon
the key team members within the informal system. They are, usually, more
intrinsic in nature.
 Informal co-ordinating mechanism
These evolve as people develop working relationships. They depend upon
interpersonal relationships and as such are quite adaptable, growing and
changing to meet the perceived needs of the organizational rewards.
Communications tend to be less guarded during informal communications,
leading to discussion of more sensitive issues. They are exceptionally
helpful in supporting key values of the organization.
Cont….
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Formal Actions based primarily upon the assumptions of formal authority:
The Formal System Actions refer to
Infrastructure Chartering or appointing
Establishing managerial support
Setting a direction or mission
Style and Culture Training in values, beliefs or social dynamics
Planning and Control Process Establishing procedures
Clarifying procedures
Documenting procedures
Developing measurement matrices
Reporting / providing feedback
Reward System Giving a merit increase
Co - ordinating Mechanism Establishing communications among organizational
units
Informal Actions based primarily upon assumptions of perceived need by the

Individual: Cont….
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The Informal System Actions refer to

Emergent Roles Becoming the expert
Assuming new responsibilities
Style and Culture Training in values, beliefs or social dynamics
Active Planning & Control Process Searching and gathering information
Investigating and brainstorming, exploring possibilities
and potential solutions
Discussing developments regarding problems,
projects and goals
Reward System Showing appreciation
Giving thanks
Recognizing accomplishment
Co - ordinating mechanisms Members checking with others in other units
Management will ensure that each subsystem and both subsystems are mutually
supportable. One improperly designed system can block desirable activities in
the other system.
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Macro Cybernetic Framework

The above two models lead to macro-cybernetic
macro framework that incorporates all
aspects of the design of control system, including the MSSM framework. The
figure below is such a macro framework that places the entire task of control
system design within the cybernetic framework.
framework
Cont….
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Macro Cybernetic Control Systems Framework
EXTERNAL Management
Systems Improvements
Initial Conditions Environment
(Uncontrollable)
Internal
(Controllable)
External
(uninfluenceable)
Entity Critical success Performance

factors and Status
Impediments Measures
Stakeholder
Goals and
Strategies Ideal
Major Influencing Factors on the Design of Management Control
Systems
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Chapter
3 Major Influencing
Factors on the Design
of Management Control
Systems
Systems
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Managerial Styles
Managerial style is something that we associate with individual managers. It is
related to Corporate Culture, which is pervasive and is an organizational
concept. The style of top management has a slow but steady influence upon the
style of other managers and upon the culture of the organisation. On the other
hand, culture influences the prevailing styles of management.
Managers differ in their styles; some of the differences are listed below:
Rely heavily on report and other formal Rely heavily on informal contacts
documents
Think in concrete terms Abstract thinkers
Analytical Heuristic
Risk - taker Risk - averse
Process - oriented Result - oriented
People - oriented Task
Task-oriented
Friendly Aloof
Long - term oriented Short - term oriented
Theory X Theory Y
(They dominate decision- making) (They encourage organisation participation
in decision-making)
decision
Emphasis on monetary rewards Emphasis on a broader act of rewards Cont….
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Managerial style is important to the design of control system, because:
1. Control systems influence the behaviour of those controlled in that the

control focuses his energies centralized on the matters "that count",
because this is the manner in which his performance is evaluated.
2. The precise manner in which control system influences behaviour depends

on how the systems are used by the managers.
3. Managers differ in the use of control systems i.e., they have different styles
of control.
Cont….
Systems
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External Control Style
Under the External Control Style, top executives manage the decision-making
mechanism after data are gathered at lower levels in the organisation. The
external style uses a rather mechanical, authoritative, control system whereby
goals are set at a demanding level, comprehensive formal measures are
developed so as to cover all the areas of performance, the measurement system
is designed to prevent manipulation on the part of controllers and rewards are
tied closely to performance measures.
measures This style is likely to produce
considerable tension and will limit the flow of negative information from
subordinates to the superiors.
Internal Control Style
The internal style is more participative and attempts to capitalize upon the
internal needs and motivation of the subordinates, such as-the need to
accomplish mastery, socialization, power and self-esteem in an attempt to build
internal commitment for organizational goals. The formal and informal controls
then emphasize self-control and steering control.
The internal control style reduces dysfunctional "game playing" and encourages
quick reporting of problems, since a more open atmosphere is created. Cont….
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Mixed Control Style
Mixed Control Style includes a wide spectrum of styles consisting of combination

of the two extreme styles. It seeks participation without abandoning central
direction. The rewards are based on performance both objective and subjective
measures. The atmosphere is open but there is also insistence that performance
attain certain levels. This style has the following characteristics: -
The characteristics of control system in the mixed control style:
 Infrastructure
 Rewards
 Communication and integration
 Control process
 Comments and conclusions

Systems
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Corporate Culture
Corporate culture consists of shared values, common perceptions and common
premises that members of an organisation apply to its activities and problems.
Most organizations tend to develop shared value systems and common decision
premises and, therefore, can be said to have a corporate culture. Control
systems are both influenced and constrained by corporate culture.
At the top level, it is possible to identify three different types of corporate control:
1. Bureaucracies
2. Markets and
3. Clan
Deciphering Corporate Culture
The strength of the corporate culture depends upon:
1. Its thickness: How important assumptions are shared by the organisation.
2. How widely the assumptions are shared.
3. The clarity of the ordering: How clear it is that some assumptions are more
Cont….
important than the others. Copyright © 2008, Pradip Kumar Sinha
Systems
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Impact of Corporate Culture on Control Systems
Control systems must be designed to fit and support the prevailing culture of an
organisation. The values that management wants to stress should be measured
and rewarded. These values should be the focal points of the control system.
Major cultural change is unlikely to be produced by changes in the control sub-

systems alone since changes in the control sub-systems will not alter values.
The danger of such an approach is that if control sub-systems are changed
without an appropriate change in values, behaviour will remain unaffected. On
the other hand, there are reported instances of formal control systems the
preventing, adoption of desirable values.
values One may have to change formal control
systems, in some cases, to permit new values to emerge.
Systems
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Evolution and Revolution of Management Control

Systems as Organizations Grow
Mr. Larry E. Greiner (Greiner Larry E. "Evolution and Revolution as
Organizations Grow" Harvard Business Review - July-August 1972, page 165)
maintains that growing organizations move through five distinguishable phases
of developments, each of which contains a relatively calm period of growth that
ends with a management crisis. If the crisis is solved, the company moves ahead
and if not, it ends with declining sales and profitability. The following five phases
can be distinguished:
 Phase I – Creativity
 Phase II – Direction
 Phase III - Delegation
 Phase IV - Coordination
 Phase V - Collaboration
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Stages of Evolution and Revolution

As both age and size increase, another phenomenon becomes evident: the
prolonged growth that has been termed as an evolutionary period. Most growing
organizations do not expand for two years and then retreat for one year. Rather,
those that survive a crisis usually enjoy 4 to 8 years of continuous growth without
a major economic setback. The term evolution is used to describe these quieter
periods because only modest adjustments appear necessary for maintaining
growth under the same overall pattern of management. Even during smoother
periods of evolution, we evidence substantial turbulence, which is termed as
revolution because they typically exhibit a serious upheaval of management
practices.
The speed at which an organization experiences the phases of evolution and
revolution is closely related to the market environment of this industry.
Evolution is not an automatic affair, it is a contest for survival. To move ahead,
companies must consciously introduce planned structures that not only are
solutions to correct a crisis but also are fitted to the next phase of growth.
Cont….
Figure showing the five phases of growth.
growth Copyright © 2008, Pradip Kumar Sinha
Systems
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The five
phases of
growth
Systems
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Information Technology and Information Management

In the era of re-engineering, restructuring and downsizing, the objective of the
business is clear - to improve productivity and reduce costs through de-layering,
redesigning processes, eliminating head count and investing in IT. Today, senior
managers face new waves of IT and information management in their business
as well as the disruptive effects of internet-based
internet competition. Many companies
have undertaken costly initiatives to redesign and automate their demand or
supply chain processes and associated information systems.
In many cases, companies have been motivated by fear, uncertainty and doubt.
The key question for senior managers is: how should we compete with
information and IT to improve business performance? There are basically four
key challenges:
1. To develop the right mindset
2. To understand how information creates business value
3. To use IT to build appropriate business competences and
Cont….
4. To balance business flexibility and standardization Copyright © 2008, Pradip Kumar Sinha
Systems
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How information creates business value Copyright © 2008, Pradip Kumar Sinha
Cont….
Systems
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Figure : Competitive value of IT Investments

H ig h
Distrinctive
Competences
Essential
to complete
Necessary
to operate
Tomorrow's IS/IT
Today's IS/IT
Investments
Investments
Zones of info-based
info
competition in
Low
industries
High Customer Value Low
Competitive value of IT investments Cont….

Systems
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Balance flexibility and

IT standardisation
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Technology
In common parlance, the term 'technology' is associated with mechanical artifact.
In its correct usage, it also refers to expertise or technical know-how in any area.
Woodward's (Woodward J. Industrial Organization Theory and Practice NY,
Oxford University Press 1965) 'contingency theory' is based on data collected
from a hundred British firms manufacturing a wide variety of products. She
concentrated on their 'production technology' and classified them into three
technology groups: unit or small batch production (e.g. custom-made dresses,
furniture, machine tools), mass production (e.g. automobile assembly line), and
process production (e.g. oil refining).
An alternative scheme was suggested by Thompson (Organization in Action, NY,
McGraw Hill 1967). According to him, organizations may be classified into one of
the three groups (i) long-linked technology based on serial interdependence (e.g.
production on assembly lines) (ii) mediating technology (e.g. banks as mediators
between clients with surplus funds, and borrowers), and (iii) intensive technology
based upon pooling of various specialized techniques (e.g. emergency room in a
hospital). Copyright © 2008, Pradip Kumar Sinha
Systems
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Manufacturing Technology
Because of the development in the IT sector, it has become an enabling tool for
the manufacturing sector and industry at large to enhance further their efficiency,
widen market coverage and derive the benefits of lower transaction costs.
Further, corporates have to pay attention to manufacturing management, people
policies, logistics, corporate governance etc., with IT threading through all of
them as a tool that makes each effort better and the sum of its elements.
Machine tools are "mother machines that produce many types of plant and
machinery". Machine Tools add highest value to the manufacturing process
among all engineering products.
Worldwide, a new framework is emerging for competitive manufacturing. It's

known as Next Generation Manufacturing or NGM. It is a strategy to look at the
competencies that firms will need to succeed.
succeed Cont….
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A manufacturer's ability to compete globally is affected by seven key
drivers:
1. Abundant availability and distribution of information
2. Accelerating pace of change in technology
3. Rapidly expanding technology access
4. Globalisation of markets and business competition
5. Global wage and job skill shifts
6. Environmental responsibility and resource limitations
7. Increasing customer expectations
Cont….
Systems
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NGM identifies the following six integrated attributes that successful firms
will require to respond to these drivers.
drivers
The six attributes are:
1. Customer responsiveness
2. Physical plant and equipment responsiveness
3. Human resource responsiveness
4. Global market responsiveness
5. Teaming as a core competency
6. Responsive practices and cultures
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Environment
Organizations exist in environments and each environment takes part in shaping
the internal structure and systems of each organization within it. An organization
can be viewed as a sort of subsystems related to one another. A change in one,
whether internal or external, is likely to induce change in others. These
subsystems, operating together as "Transformation of Elements" act upon inputs
transforming them into outputs.
The two kinds of environments, external and internal, represent the constraints
and the opportunities of the organization.
organization
1. External environment is constituted by three distinct set of factors:
i. Macro economic factors
ii. International scene
iii. Macro social factors
a) Legal social factors
b) Social and cultural personality
Cont….
c) Resource situation and market competition. Copyright © 2008, Pradip Kumar Sinha
Systems
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2. The internal environment is constituted by three separate set of field
forces:
i. Co-ordination and Technology
ii. Organization identity
iii. Operating Quality of Role Attributes
a) The role orientations and processes of the managers
b) (ii) The quality of leadership and management style
Cont….
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Role of
Environment in
Organisation
Structure and
Systems
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Indian Situation on Environment

In India, the internal environment plays a more dominant role as a determinant of
the emergent structure. In Indian organizations, most managers exclusively get
over focused in job responsibility.
responsibility Even senior managers ignore link
responsibility and leave the corporate responsibility content of their roles to the
guidance and instructions of the superior.
superior Managers are very often proud of their
indispensabilities in their jobs. They reflect pride in their statements "Oh, for 10
years, I have not taken any vacation".
vacation" They also do not prepare people working
under them to take over. They foster dependence, both in the system below and
above them.
In India, the authority of a system rests with one person. It is supposedly
delegated to appropriate roles but nothing moves without reference to that 'one'
person in the system.
In India, in most organizations, managers perform their roles by excluding roles
at their own levels. Each tends to act in isolation. Each uses up the top man or
the senior man as his reference. The situation is quite in line with the tradition in
the Indian family where it is based on linear hierarchy. Copyright © 2008, Pradip Kumar Sinha
Infrastructure – Organising for Management Control
Ch-4
Chapter
4 Infrastructure –
Organising for
Management Control
Ch-4
Introduction
In chapter 1, we have defined management control system as a set of inter-
related communication structures that facilitates the processing of information for
the purpose of assisting managers in co-ordinating the parts and attaining the
purpose of an organization on a continuous basis.
It is necessary to design the elements of the control system infrastructure, that is
the organization structure, responsibility centres, performance measures, and
rewards, in a mutually supportive and adaptive way so as to effectively
implement the goals of the overall organization. A properly designed
infrastructure is crucial to ensure that resources will be allocated effectively in
decentralized decision making in pursuit of organisational goals.
The formal organization structure is a communication structure that is
established to process information for the purpose of attaining the purpose for
which the organization is established.
established As such, it is right at the heart of the
control system. To achieve coordinated control, an organization must process
information and reciprocal communications.
communications Copyright © 2008, Pradip Kumar Sinha
Ch-4
Structure in an organization
A firm's strategy has a major influence on its structure. The type of structure in
turn influences the design of the organizations' management control system.
Although organizations come in all shapes and sizes, their structures can be
grouped into the following:
1. Entrepreneurial structure: The entrepreneurial structure is the most
elementary form of structure and is appropriate for an organization that is
owned and managed by one person.person A small-scale industrial unit, a small
proprietary concern, or a mini service outlet may exhibit the characteristics
of organizations that are based on an entrepreneurial structure. The owner
manager looks after all decisions, whether they are day-to-day operational
matters or strategic in nature.
Owner manager
Entrepreneurial
structure
Employees Cont….
Ch-4
The advantages of this type of structure are:
i. Quick decision-making as power is centralized
ii. Timely response to environmental changes
iii. Informal and simple organisation systems.
The disadvantages are:
i. Excessive reliance on the owner-manager

owner and so proves to be demanding
for the owner manager.
ii. May be fully busy with day-to-day

day matters and ignore strategic decisions.
iii. Increasingly inadequate for future requirements if volume of business

expands.
Cont….
Ch-4
2. Functional Structure: As the volume of business expands, the
entrepreneurial structure outlives its usefulness. The need arises for
specialized skills and delegation of authority to managers who can look after
different functional areas.
There are several disadvantages to a functional structure:
i. There is no precise way of determining how much of the profit is earned
by each function.
ii. Co-ordination becomes difficult between different functions.
iii. Functional organization tends to create 'silos' for each function thereby
preventing cross-functional organisation in areas such as: a new product
development.
The management control process in a functional organisation works as
follows:
i. The senior managers are responsible for developing the company's overall
strategy to compete, in its chosen industry as well as its functional
strategies in such areas as: research and development, manufacturing and
marketing.
ii. The strategic plan / long-term planning involves only senior executives and
a planning staff. Cont…. Copyright © 2008, Pradip Kumar Sinha
Ch-4
The diagram of functional organisation is given below:
CEO
Manufacturing Mgr Marketing Mgr
Manager plant 1 Industrial

Products
Manager plant 2
Consumer
Products
Manager plant 3
Financial
Controller HRD Manager Materials and R & D Manager
Logistics manager
Cont….
Functional Organization Structure Copyright © 2008, Pradip Kumar Sinha
Ch-4
3. Business Unit Organization Structure:
Structure The business unit form of an
organisation is designed to solve problems inherent in its functional
organization. A business unit also called a division is responsible for all its
functions involved in producing and marketing a specified product line or
group of product lines. Business unit managers act as if their units are
separate companies. Figure shows a summary form of divisional
organization. They are responsible for planning and co-ordinating the work
of the separate functions - ensuring that the plans of the marketing
department are consistent with production capabilities - and for resolving the
disputes that arise between these functions. The divisional manager's
performance is measured by the profitability of the business unit and this is
satisfactory because profit incorporates the activities of both marketing and
production.
Cont….
Ch-4
The diagram of functional organisation is given below:
Chief Executive Officer
Staff
Manager Manager Manager Financial Materials HRD R&D

Business Business Business Controller & Logistics Mgr Mgr
Unit A Unit B Unit C
Staff Staff
Staff
Plant Mktg Plant Mktg Plant Mktg

Mgr Mgr Mgr Mgr Mgr Mgr
Business Unit Organizations

Ch-4
The following are the advantages of business unit form of organization:
i. It provides a training ground in general management.
ii. Since the business unit is closer to the market for its products, its manager
may make sounder production and marketing than HO might and the unit as
a whole can react to new threats or opportunities more quickly.
Disadvantages are:
i. Business unit staff may duplicate some work that is done at the
headquarters.
ii. In some cases, the layers of business unit staff may cost more than the
value gained by divisionalisation..
iii. Disputes may be there between business unit staffs and headquarters, one
business unit infringing the charter of another unit. There may also be
disputes between business unit personnel and headquarters staff.
Cont….
Ch-4
4. Matrix Structure: In a large organization, there is often a need to work on
major products or projects, each of which is strategically significant, hence
the requirement of a matrix type of organization structure. Figure illustrates
a matrix structure. CEO
Finance Marketing HR Operations
Project Manager
A
Project Manager
B
Project Manager
A
Cont….
Matrix Organization Structure
Ch-4
The advantages of matrix structure are:
i. Allows individual specialists to be assigned where their talents are the most
needed.
ii. Foster creativity because of the pooling of diverse talents.
iii. Provides good exposure to specialists in general management.
The disadvantages of matrix structure are:
i. Dual accountability creates confusion and difficulty for individual team

members.
ii. Requires a high level of vertical and horizontal combination.
iii. Shared authority may create communication problems.
Cont….
Ch-4
Another Dimension of Structure is the use of Teams
Teams are defined as cross-unit groups that are made up of task-relevant
representatives who meet periodically to focus on particular clients, products,
markets or problems. These groups may be formal or informal, permanent or
temporary and may include appropriate membership to ensure that relevant
expertise is available to deal with the task or goal.
Team actions may be classified as follows:
follows
The Formal System If actions refer to
Infrastructure (organization structure) Chartering or appointing
Establishing management support
Setting a direction or mission
Style and culture Training in values, beliefs or social dynamic
Planning and Control Process Establishing procedures
Clarifying procedures
Documenting procedures
Developing measurement metrics
Reporting/ providing feedbacks
Reward System Giving a merit increase
Coordinating Mechanism Establishing communication among
organization units. Copyright © 2008, Pradip Kumar Sinha
Ch-4
Functions of the Controller

The controller performs the following functions:
1. Designing and operating information and control systems.
2. Preparing financial statements and financial reports (including tax returns)
for shareholders and other external parties.
3. Preparing and analyzing performing reports, interpreting these reports for
managers and analyzing program and budget proposals from the various
segments of the company and consolidating them into an overall annual
budget.
4. Supervising internal audit and accounting control procedures to ensure the
validity of information, establishing adequate safeguards against theft and
fraud and performing operational audits.
5. Development of personnel in his function and participating in the education
of management personnel in matters relating to controller function. Cont….
Ch-4
Dotted Line Solid Line
Corporate Corporate
Controller Controller
Business unit
Manager Business unit
manager
Business unit
controller Business unit
controller
Alternative controller relationship
Ch-4
Decentralization as a Management Philosophy

Decentralisation is best held to mean a state or pattern of organisation in which
specific responsibilities have been "delegated".
"delegated" The implication of this is that
'delegation is the process and 'decentralisation' is the resultant embodiment of it.
Centralisation can only mean reserving responsibilities to the given units or

sections of central headquarters, but such units not necessarily of themselves
carrying top management authority.
The delegation or subdivision of management responsibility can be made on

either of two bases: (i) the whole of the process of command can be subdivided
into smaller, self-contained units or (ii) the process of command can be
subdivided in such a way that there is concentration of specialist responsibilities
established to serve the units of direct command.
Cont….
Ch-4
Decentralised Units – Advantages and Potential
1. The speed of operating divisions may be increased because many
decisions do not have to be referred to corporate headquarters.
2. The quality of many decisions may be improved because they can be made
by the business units closest to the point of decision.
3. Corporate management may be relieved of day-to-day decisions and can
concentrate on broader issues.
4. Profit consciousness may be enhanced.
enhanced The business unit manager, who is
responsible for profits, will find ways and means to improve them.
5. Measurement of performance is broadened since profitability is a more
comprehensive measure of performance than either revenue or expenses
separately.
6. A business unit provides an excellent training ground for general
management.
7. Business units are subjects to pressures to improve their competitive
performance. Cont….
Ch-4
Decentralised Units - Difficulties and Problems
1. To the extent that decisions are decentralized, top management may lose
some control. Control has to be exercised instead of personal direction
through management control reports.
reports
2. Competent business unit managers may not be available in a functional
organisation because there may not have been sufficient opportunities for
them to develop general management competence.
3. There is no completely satisfactory system of ensuring that each business
unit by optimizing its own profits will optimize company profits.
4. If the headquarters management is more capable or has better information
than the average business unit manager, the quality of some of the
decisions may be reduced.
5. Divisionalisation may cause additional costs because it may require
additional management, staff personnel and record-keeping.
The Managerial Process of Crafting and Executing Strategy
Ch-5
Chapter
5 The Managerial
Process of Crafting
and Executing Strategy
Ch-5
Introduction
Management control systems are 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, perspectives and behaviours.
Ch-5
Developing a Strategic Vision: The First Direction-

setting Task
Effective strategy making begins with a vision of where the organization needs to
head. Charting a company's course begins with senior management looking at
the road ahead and addressing the following questions: "Where do we go from
here?" and "What difference will these changes make to the company's present
business?"
A strategic vision is a road map showing the route a company intends to take in
developing and strengthening its business.
business It paints a picture of a company's
destination and provides a rationale for going there.
Cont….
Ch-5
The Three Elements of Strategic Vision
1. Coming up with mission statement that defines what business the company
is presently in and conveys the essence of "who we are, what we do, and
where we are now".
2. Using the mission statement as a basis for deciding on a long-term course,

making choices about "where we are going" and charting a strategic path for
the company to pursue.
3. Communicating the strategic vision in clear, exciting terms that arouse

organization-wide commitment.
Ch-5
Establishing Objectives: The Second Direction-setting

Task
Objectives represent a managerial commitment to achieving specific
performance targets within a specific time – they are a call for results that
connect directly to the company's strategic vision and core values. They function
as yardsticks for tracking an organization's performance and progress.
Ideally, managers ought to use the objective-setting
objective exercise as a tool for truly
stretching an organization to reach its full potential. They are also referred to as
goals.
What Kinds of Objectives to Set: The Need for a Balanced Scorecard
Two distinct types of performance yardsticks are required; those relating to
financial performance and those relating to strategic performance-outcomes that
indicate that a company is strengthening its marketing standing, competitive
vitality, and future business prospects.
prospects The following are the examples of
commonly used financial and strategic objectives: Cont….
Ch-5
Financial Objectives Strategic Objectives

*An x percent increase in annual revenues * Winning an x percent market share.
* Annual increase in after tax profits of x * Achieving lower overall costs than rivals.
percent
* Annual increase in earnings per share of x *Overtaking key competitors on product
percent. performance or quality or customer service.
* Annual dividend increase of x percent * Deriving x percent of revenues from the sale
* Profit margins of x per cent. of new products introduced within the past five
* An x percent return on capital employed years.
(ROCE) or shareholders’ equity (ROE). *Achieving technological leadership.
* Increased shareholder value -in
in the form of * Having better product selection than rivals.
an upward -trending stock price and annual *Strengthening the company’s brand name
dividend increases. appeal.
* Strong bond and credit ratings * Having stronger nation al or global sales and
* Sufficient internal cash flows to fund new distribution capabilities than rivals.
capital investment. * Consistently getting new or improved
* Stable earnings during the periods of products to market, ahead of rivals.
recession.
Ch-5
Crafting a Strategy: Phase 3 of the Strategy-Making-

Strategy-Executing Process
An enterprise's CEO, as the captain of a ship, carries the mantles of chief
direction--setter, chief objective-setter,
setter, chief strategy-maker, and chief strategy
implementer for the total enterprise. In most companies, the heads of business
divisions and major product lines, the chief financial officer, and vice-presidents
for production, marketing, human resources and other functional departments
have influential strategy-making roles of their respective functions as well as
strategy implementing roles.
Ch-5
Strategies Strategies formulation

Internal Analysis
Environmental analysis
Definition:
Competitor Technological know -how
Strategies describe Customer Manufacturing know -how
Supplier Marketing know -how
the general Regulatory Distribution know -how
Social/ Political Logistics k now-how
direction in which
an organization
plans to move to
Opportunities and threats Strengths and weaknesses
attain its goals.
Every well- Identify opportunities Identify core competencies
managed
organization has
Fix internal competencies with
one or more external opportunities
strategies, although
they may not be Firm’s strategies
stated explicitly. Copyright © 2008, Pradip Kumar Sinha
Ch-5
Two levels of strategies

Level 1 - Corporate strategy - It is about being in the right mix of business:
1. In which business industries or sub industries - should the firm be
2. The deployment of resources among those businesses
A strategic analysis of the corporate scenario results in decisions involving

businesses to add, businesses to retain, businesses to emphasize, businesses
to de-emphasize and businesses to divest.
divest
Level 2 - Business until strategy
1. For each chosen business, what should be its mission (what are its overall
objectives)?
2. Its competitive advantage i.e., how should the business unit compete in its
industry to accomplish its mission.
mission
Cont….
Ch-5
Corporate-level Strategy
At the corporate level, the issues are:

are
1. The definition of businesses in which the firm will participate.
2. The deployment of resources among these businesses.
Companies can be classified into one of these categories:
1. A single industry firm operates in one line of business. Exxon Mobil, which is
in the petroleum industry, is an example.
example
2. Related diversified firms - Here, the firm participates in a number of

industries but its businesses are connected to each other by common
customers, common distribution channel, common technology or some
other common factor. Here, the emphasis is on ability to share common
resources. Example: Proctor & Gamble.
Gamble Cont….
Ch-5
Types of corporate Single Industry Related diversified Unrelated Corporate

strategy firm firm diversified firm strategy is a
Pictorial continuum with
representation of
strategy
single industry
strategy at one
end of the
spectrum and
unrelated
diversification at
the other hand
(related
diversification is
in the middle of
Identifying features Competes in only Sharing of core Totally autonomous the spectrum). A
one industry competencies businesses in very firm's location on
across
cross boundaries different markets
this continuum
Examples McDonalds Proctor & Gamble General Electric
Corporation Johnson & Johnson L&T
depends on the
Wrigley Du Point HLL extent and type
Ford Motor Gillette Rockwell of its
Nucor Texas Instruments diversification.
AT&T Cont….
Corporate-Level Strategies – Summary of Three Generic Strategies Copyright © 2008, Pradip Kumar Sinha
Ch-5
Business Unit Strategy - Mission and Competitive Advantage
The strategy of a business unit depends upon two inter-related aspects:
1. Mission
i. Two broad set of factors: Factors external to the firm and factors
internal to the firm - determine respectively, the attractiveness of the
market opportunities available to individual business units and their
competitive ability to exploit these opportunities.
ii. Within the firm, competitive ability is likely to vary from one business
unit to another.
iii. The relevant industry's attractiveness is also likely to vary from one
business unit to another.
iv. Thus, the mission (in terms of growth and profitability) varies from one
business to another.
v. Collectively, the missions assigned to the different business units
should help the firm achieve its overall goals.
vi. Resource allocation among business units should be based on their
respective missions. Cont….
Ch-5
High Cash Source Low

High
“Star” “ Question Mark” High
Hold Build
Industry
Growth Cash use
Rate “Cash cow “Dog”
Harvest Divest
Low
High Low
Relative market share
Business unit mission-BCG

mission Portfolio model
Cont….
Ch-5
2. Business unit competitive advantage
Three inter-related questions have to be considered in developing business

unit's competitive advantage - (i) What is the structure of the industry in
which the business units operate? (ii) How should the business unit exploit
the industry's structure? (iii) What will be the basis of the business unit's
competitive advantage?
In answering the first two questions, Mr. Michael E Porter (Competitive

Advantage, New York, Free Press 1985) states that the structure of an
industry should be analyzed in terms of the collective strength of five
competitive forces as given in Figure
Cont….
Ch-5
Threats of new
entry
Powers of
Power of Industry buyers
Suppliers competitions
Direct rivalry Direct rivalry
Business Unit Competitive Advantage: Analysing the structure of industries Cont….

Ch-5
Generic Competitive Advantage
Through five forces, the firm is able to identify the opportunities and threats in
the external environment. With this understanding, the business unit has five
generic ways it can respond to the opportunities in the external environment and
develop a sustainable competitive advantage:
advantage
1. Low cost provider strategy
2. A broad differentiation
3. A best-cost provider strategy
4. A focused (or market niche) strategy based on lower cost
5. A focused (or market niche) strategy based on differentiation
Cont….
Ch-5
TYPE OF COMPETITIVE ADVANTAGE

BEING PURSUED
Lower Cost Differentiation
M
A
R Overall Broad
K A Broad Cross - Low-Cost
Cost Differentiation
E Section of Buyers Leadership Strategy
T Strategy
T
A Best Cost
R Provider
G Strategy
E
T
A Narrow Buyer Focused Focused
Segment Low-Cost Differentiation
(or Market Niche) Strategy Strategy
Cont….
Ch-5
Value Chain Analysis
Product Marketing Service/

Development Manufacturing and Sales Logistic
Support activities: Finance, Human Resources, Information Technology

Value Chain Analysis for a Business
Value chain analysis seeks to determine, within the company's operations - from
design to distribution - customer value can be enhanced or costs lowered.
For each value added activity, the key questions are:
1. Can we reduce costs in this activity, holding revenue value constant?
2. Can we increase revenue in this activity, keeping the costs constant?
3. Can we reduce assets in this activity keeping costs and revenues constant?
4. Most importantly, can we do (a), (b) and (c) simultaneously?
Ch-5
Corporate Strategy and Control System

The logic for linking controls to strategy is based on the following lines of
thinking:
1. Different organizations generally operate in different strategic contexts.
2. For effective execution, different strategies require different task priorities;

different key success factors;; and different skills, perspectives and
behaviours.
3. Control systems are measurement systems that influence the behaviours of

those people whose activities are being measured.
4. Thus, a continuing concern in the design of control system should be

whether the behaviour induced by the system is the one that is consistent
with the strategy.
Cont….
Ch-5
The organizational structure implications of different corporate strategies
are given in the table below.
Single Business Related Diversified Unrelated Diversified
Organizational Functional Business Units Holding Company
structure
Industry familiarity of High Low
corporate
management
Functional Relevant operating Mainly finance
background of experience (mfg.
corporate Mktg. R&D)
management
Decision–making More centralized More Decentralized
authority
Size of corporate staff High Low
Reliance on internal High Low

promotions
Use of lateral High Low
transfers
Cont….
Corporate culture Strong Weak Copyright © 2008, Pradip Kumar Sinha
Ch-5
Single Business Related Unrelated Specific tendencies in the
Diversified Diversified
Programming Vertical–cum–Horizontal Vertical only

design of control systems
corresponding to variations
Budgeting High
Relative control of Low in corporate strategies are
business unit manager
over budget formulation
given in the table below.
Importance attached to High
Meeting the budget Low
Transfer pricing: Low
Importance of transfer High
pricing Different Corporate
Sourcing flexibility Constrained Arm’s–length
Strategies:
market pricing
Management Control
Incentive compensation:
Bonus criteria Financial and non
– Primarily financial Implications
financial criteria criteria
Bonus determination Primarily formula
approach Primarily subjective based
Bonus basis Based both on business Based primarily on

unit and corporate business unit
performance performance
Ch-5
Business Unit Strategy and Control System
In this section, we consider intra-firm
firm differences in control systems. Diversified
corporations segment themselves into business units and typically assign
different strategies to the individual business units. Many chief executive officers
of multi-business organizations do not adopt a standardized, uniform approach
to controlling their business units; rather, they tailor the approach to the strategy
of each business unit.
Business unit strategy consists of two interrelated aspects: mission and
competitive advantage.
Mission
1. The mission of the business unit influences the uncertainties that general
managers face and the short-term term versus long-term trade-offs that they
make.
2. Management control systems can be systematically varied to help motivate
the manager to cope effectively with uncertainty and make appropriate
short-term versus long-term trade-offs.
trade
3. Thus, different missions often require systematically different management
control systems. Cont…. Copyright © 2008, Pradip Kumar Sinha
Ch-5
Build Hold Harvest
Importance of programming Relatively high Relatively low
Formalization of capital Less formal DCF More formal DCF

Expenditure decisions analysis; analysis, shorter
Longer payback payback
Capital expenditure More emphasis on non - More emphasis on

Evaluation criteri a financial data (market financial data (cost
share, efficient use of efficiency, straight cash
R&D dollars etc.) on cash incremental
return)
Hurdle rates Relatively low Relatively high
Capital investment analysi s More subjective and More quantitative and

qualitative financial
Project approval limits at Relatively high Relatively low

the business unit level
Cont….
Different Strategic Implications for Programming Process Copyright © 2008, Pradip Kumar Sinha
Ch-5
Build Hold Harvest
Role of budget More a short-term More a control

planning tool (document of
restraint)
Business unit manager’s Relatively high Relatively low
Influence in preparing the
budget.
Revisions to the budget Relatively easy Relatively difficult
during the year
Different Strategic
Frequency of informal More frequent on policy Less frequent on
reporting and contacts issued; less frequent on policy issues; more
Implications for
with superiors operating issues frequent on Budgeting
operating issues.
Frequency of feedback Less often More often

from superiors on actual
performance versus the
budget
“Control Limit” used on Relatively high (i.e. Relatively low (i.e.
periodic evaluation against more flexible) less flexible)
the budget
Importance attached to Relatively low Relatively high
meeting the budget
Output versus behaviour Behaviour control Output control
Cont….
control
Ch-5
Different Strategic Implications for Budgeting
Build Hold Harvest
Percent compensation as Relatively high Relatively low

bonus
Bonus criteria More emphasis on non-

non More emphasis on
financial criteria financial criteria
Bonus determination More subjective More formula -

approach based
Frequency of bonus Less frequent More frequent

payment
Ch-5
Competitive Advantage
A business unit can choose to compete either as a differentiated player or as a
low-cost player. The choice of a differentiation approach, rather than a low-cost
approach, increases uncertainty in a business unit's task environment for three
reasons.
First, product innovation is likely to be more critical for differentiation business
units than for low-cost business units.. This is partly because a low-cost business
unit, with its primary emphasis on cost reduction, typically prefers to keep its
product offerings stable over time; whereas a differentiation business unit, with
its primary focus on uniqueness and exclusivity, is likely to engage in greater
product innovation.
Second, low-cost business units typically tend to have narrow product lines to
minimize inventory carry costs as well as to benefit from scale economies.
Differentiation business units, on the other hand, tend to have broader set of
products to create uniqueness.
Third, low-cost business units typically produce no-frill commodity products, and
these products succeed primarily because they have lower prices than
competing products. Cont…. Copyright © 2008, Pradip Kumar Sinha
Ch-5
Objectives in Functional Areas
The organization has goals and senior management has decided on a set of
strategies to accomplish these goals.
goals The organisation as a whole and the
responsibility center, in turn, are required to do their part in implementing these
strategies. They exist to accomplish one or more purposes, these purposes are
its objectives. Because the organisation is the sum of all the responsibility
centres within it, if the strategies are sound and if each responsibility centre
meets its objectives, the whole organisation will achieve its goals.
Every responsibility centre has outputs, that is, it does something. Effectiveness
is the relationship between a responsibility centre's outputs and its objectives.
Cont….
Ch-5
Goals and objectives

Objectives Responsibility Report
Standards of centre actual v/s
performance operation plan
Strategic plan
Corrective
action
Feedback
communication
The relationship of goals and strategies, strategic plans and objectives to management
control process
Cont….
Ch-5
Objectives of the Company
The fixing of objectives is closely linked to the company's organisation structure.
At the first level of responsibility, the overall objective is usually, earning the
required return of the funds invested in the business, consistent with maintaining
the sound financial position of the business.
business At the second level of responsibility,
typical functional objectives that may be fixed are related to the following
functions:
1. Marketing
2. Production
3. Research and Development
4. Personnel
5. Finance
Responsibility Centre
Ch-6
Chapter
6 Responsibility Centre
Ch-6
Introduction
A Management Control System is a set of interrelated communication structures
that facilitates the processing of information for the purpose of assisting
managers in coordinating the parts and attaining the purpose of an organization
on a continuous basis.
It is necessary to design the elements of the control system infrastructure, that
is, the organisation structure; responsibility centres performance measures and
rewards, in a mutually supportive and adoptive way so as to effectively
implement the goals of the overall organisation. A properly designed
infrastructure is crucial to ensure that resources will be allocated effectively in
decentralized decision-making in pursuit of organizational goals.
Responsibility Structure: The responsibility structure of an organisation consists
of responsibility centres and related performance measurement systems.
Ch-6
A Responsibility Centre
The term responsibility centre is used to denote any organization unit that is
headed by a responsible manager.
manager In fact, a company is a collection of
responsibility centres, represented by a box in the organization chart. These
responsibility centres form a hierarchy.
hierarchy At the lowest level in the organization are
responsibility centres for sections, work shifts or other small organization units. At
the highest level are departments or business units (divisions).
A responsibility centre uses inputs, such as: physical quantities of material, hours
of various types of labour and variety of services. As a result of this work, the
responsibility centre produces outputs such as goods or services (in case of staff
units such as: human resources, engineering, accounting, administration). The
goods and services produced by a responsibility centre may be given either to
another responsibility center as inputs or to the outside world, in which case, they
become outputs of the whole organization and revenues are earned by selling
these outputs. Cont….
Ch-6
Shows the Essence of any Responsibility Centre
Inputs Outputs
Responsibility
Resource used Centre/ Organisation Goods or Services
measured by cost
1. Relationship between inputs and outputs

2. Measuring inputs and outputs
3. Efficiency
4. Process measurement of performance
5. Effectiveness as measure of performance
Cont….
6. The Role of Profit Copyright © 2008, Pradip Kumar Sinha
Ch-6
Types of
Responsibility
Centres
Ch-6
Revenue centres
In a revenue centre, outputs (revenues) are measured in monetary terms, but no
formal attempt is made to relate inputs (i.e., expenses or costs) to outputs.
Revenue centres are, therefore, marketing organizations that do not have profit
responsibility. Actual sales or orders booked are measured against budgets or
quotas.
Each revenue centre is also an expense centre so far as marketing expenses for
that responsibility centre. The primary measurement, however, is revenue.
Revenue centres are not charged for the cost of goods that they market.
Consequently, they are not profit centres, because this important expense item is
omitted.
The manager of revenue centre does not have knowledge to make the cost/
revenue trade off required for optimum marketing decisions. Therefore,
responsibility for this type of decision cannot be delegated to a revenue center
manager. For instance, revenue centres typically do not have authority to set
selling prices. Copyright © 2008, Pradip Kumar Sinha
Ch-6
Expense Centres
Expense centres are responsibility centres whose inputs, or expenses are
measured in monetary terms, but in which outputs are not measured in monetary
terms. Expense centres are of two types:
types (based on two types of costs)
1. Engineered costs/Standard costs: costs These are those for which the 'right' or
'proper' amount of costs can be estimated with a reasonable degree of
reliability. Costs incurred in a factory for direct labour, material, components,
supplies and utilities are examples.
examples
2. Discretionary costs: (also called managed costs) are those for which no
such engineered estimate is feasible, the amount of costs depends on
management's judgment about the amount that is appropriate under the
circumstances.
Engineered expense centres/ Standard cost centres: They have the following
characteristics:
1. Their input can be measured in monetary terms.
2. Their output can be measured in physical terms.
3. The optimal rupee amount of input required to produce one unit of output
can be established. Copyright © 2008, Pradip Kumar Sinha
Ch-6
Marketing Centres
Two very different types of activities are grouped under the heading of marketing
- one relating to filling of orders, the other group of activities relate to efforts to
obtain orders and obviously take place before an order is received.
Ch-6
Research and Development Centres

The control of research and development centers is difficult because of
1. Difficulty in relating results to inputs. The results of R&D is difficult to
measure quantitatively but semi-tangible
tangible outputs in the form of patents, new
products or new processes but the relationship of output to input is difficult
to appraise on an annual basis because the completed 'product' of an R & D
group may involve several years of effort.
2. Lack of goal congruence e.g. the research manager typically wants to build
the best research organization money can buy even though may be more
expensive than the company can afford. Further, research people do not
have sufficient knowledge of (or interest in) the business to determine the
optimum direction of the research efforts.
The activities conducted by R & D centre lie along a continuum with basic
research at one extreme and product testing at the other. Basic research has two
characteristics: (1) it is unplanned with management at best specifying the basic
area to be explored and (2) there is often significant time lapse between the
initiation of research and the introduction of a successful new product.
Ch-6
Profit Centres
A profit centre is a responsibility centre in which financial performance is
measured in terms of profit (i.e., the difference between the revenues and
expenses) inputs are measured in terms of expenses and outputs are measured
in terms of revenues. Both the elements of accounting information - cost (input)
and revenues (output) are considered.
considered Therefore, in a profit center, the
measures of performance is better and broader than in an expense centre since
in case of expense centre, the accounting system measures only one element
(i.e., cost) whereas, in a profit centre both the elements, cost as well as revenue
is evaluated in monetary terms. The difference between revenues and costs is
profit. Each profit centre is a relatively independent operating unit and its
manager must have significant control over most operating decisions that affect
profit (for example: volume of production, methods of operation, and cost of
goods sold pricing and product mix).
Ch-6
Other Profit Centres

In addition to business units, there are other profit centers which are not natural
profit centers but constructed profit centres.
centres Some examples are given below:
1. Marketing in a functional organization or in business units
2. Manufacturing
3. Service and support units
4. Other organizations
Ch-6
Profit Centre Evaluation

There are two types of profitability measurements used in evaluating an
organization as a whole:
1. There is the measure of management performance which focuses on how

well the manager is doing. This measure is used for planning, co-ordinating
and controlling the profit centres day-to-day activities and as a device for
providing the proper motivation for its manager.
2. There is a measure of economic performance which focuses on how well

the profit centre is doing as an economic activity.
Cont….
Ch-6
The main sub-categories
categories in a typical segmented income statement are:
1. Sales and other major revenues
2. Controllable variable costs
3. Controllable contribution margin
4. Controllable fixed costs
5. Controllable segment margin
6. Attributable segment costs:
7. Segment profit contribution
8. Common firm wide costs
9. Segment net income
Ch-6
Transfer Pricing
The transfer price is the mechanism for distributing the revenue that is generated
when the product is finally sold. The transfer price is not primarily an accounting
tool. Rather, it is a behavioural tool that motivates managers to take the right
decisions. In particular, transfer price should be designed in such a way that it
can accomplish the following objectives:
objectives
1. It should provide each segment with the relevant information required to
determine the optimum trade-off between company costs and revenues.
2. It should induce goal congruence decisions i.e., the system should be so
designed that decision improves business unit (divisional) profits it will also
improve company profit.
3. It should help determine the economic performance of the individual profit
centres as accurately as possible.
possible
4. The system should be simple to understand and easy to administer.
Ch-6
Administration of Transfer Prices
Implementing transfer price involves long negotiation among the heads of
various units, the classification of products and arbitration and conflict resolution
in case of conflict.
 Negotiation
Business units negotiate among themselves before taking decisions relating
to transfer pricing. The headquarters does not involve itself and leaves it to
line managers to negotiate.
 Arbitration and Conflict Resolution
Irrespective of the formality of arbitration and the process of conflict
resolution, the goal is to make the transfer pricing system effective. There
are four ways to resolve conflicts:
conflicts forcing, smoothing, bargaining and
problem-solving.
 Product Classification
Sourcing and transfer pricing are greatly affected by the number of intra-
company transfers and the availability of markets and market prices. The
larger the number of intra-company
company transfers and the less the availability of
market prices, the greater the need for more formal transfer pricing rules.
Ch-6
Investment Centres
It is defined as a responsibility centre in which inputs are measured in terms of
cost/expenses and outputs are measured in terms of revenues and in which
assets employed are also measured.
measured In other words, investment centres
consider not only costs and revenues but also assets used in the division. As a
responsibility centre, the performance of a unit would be measured in relation to
the revenues / profits and the assets employed in a division.
The investment centre analysis can be used as a basis for evaluating the
contribution of a division as an entity as also the performance of a divisional
manager. The measure of performance in an investment centre is based on the
relationship between the profits/income and the assets employed in generating
the profits. There are two ways to relate income to assets:
(i) Return on Investment (ROI) analysis and (ii) Residual Income (RI) analysis or
economic value added (EVA). Cont….
Ch-6
The Three Components of EVA
i. Net Operating Profit after Tax =Profit before interest and taxes ( 1-tax rate)
ii. Cost of capital
iii. Capital Employed
What Causes EVA to Increase
EVA rises when:
1. The rate of return on existing capital increases because of improvement in
operating performance. This means operating profit increases without
infusion of additional capital in the business.
2. Additional capital is invested in projects that earn a rate of return greater
than the cost of capital.
3. Capital is withdrawn from activities which earn inadequate returns.
4. The cost of capital is lowered by altering the financial strategy.
Cont….
Ch-6
Stern Stewart has identified more than 160 potential adjustments. These
relate to things like:
1. Research and Development
2. Strategic investments
3. Expense recognition
4. Depreciation
5. Restructuring Charges
6. Taxes
7. Marketable Securities
Ch-6
Measurement of Assets Employed

In deciding on the investment base to be used for evaluating managers of
investment centers, two pertinent questions are:
1. What practice will induce business managers to use their assets most
efficiently and to acquire the proper amount and kind of new assets so as to
improve their performance in terms of profits on capital employed?
2. What practices best measure the performance of the entity as an economic
entity?
a) Cash
b) Receivables
c) Inventories
d) Working capital in general
e) Property Plant and Equipment
Ch-6
Multiple Performance Measures

ROI and EVA have been employed with some success by many large sized
undertaking which have resorted to divisionalisation.
divisionalisation However, exclusive reliance
on a single profitability measure may lead to manipulation of the system and
consequent distortion in decision making.
making Managers of business units may delay
a potentially profitable investment in a bid to enhance short-term return on
income at the cost of long run consequences.
consequences
In order to overcome the limitation of "sole dependence in a single measure",
many firms have developed multiple goal structures.
As for example, following are the multiple goal structure of General
Electric Company:
(i) Profitability, (ii) Market position, (iii) Productivity, (iv) Product leadership, (v)
Personnel development, (vi) Employee attitudes, (vii) Public responsibility, (viii)
Balance between long- range and short-range
short goals.
Budgetary Control as an Instrument of Management Control
Ch-8
Chapter
8 Budgetary Control
as an Instrument of
Management Control
Ch-8
Nature of a Budget
Budgets are an important tool for effective short-term planning and control in an
organisation.
1. A budget estimates the profit potential of a business unit.
2. It is stated in monetary terms although the monetary amounts may be
supported by non-monetary amounts (e.g. units sold or produced).
3. It generally covers the period of one year but quarterly breakups, specially
those that are affected by seasonal factors.
4. It is a management commitment;
commitment managers agree to accept responsibility
for attaining the budgeted objectives.
objectives
5. The budget proposal is reviewed and approved by an authority higher than
the budgetee and ultimately, by the Chief Executive Officer (CEO).
6. Once approved, the budget can be changed under special conditions.
7. Periodically, actual financial performance is compared to budget and
variances are analysed and explained.
explained Copyright © 2008, Pradip Kumar Sinha
Ch-8
Relation to Strategic Planning

Strategic planning as already discussed in Chapter 7, is the process of deciding
on the nature and size of several programmes that are to be undertaken in
implementing an organisation's strategies.
strategies The difference between strategic
planning and budgeting are as follows:
follows
1. Both strategic planning and budgeting are planning activities in the two
processes. The budgeting process focuses on a single year, whereas,
strategic planning focuses on the activities that extend over a period of
several years.
2. Strategic planning precedes budgeting and provides the framework within
which the annual budget is developed.
developed
3. Strategic plans are structured by product lines or programmes while the
budget is structured by responsibility centers. This re-arrangement of
programs - so it corresponds to the responsibility centers charged with
executing it - it is necessary because the budget will be used to influence a
manager's performance before the fact and to appraise performance after
Cont….
that. Copyright © 2008, Pradip Kumar Sinha
Ch-8
Contrast with Forecasting
1. A budget is a management plan, with the implicit assumption that positive
steps will be taken by the budgetee - the manager who prepares the budget
to make actual events correspond to the plan. A forecast is a production of
what will likely happen carrying no implication that the forecasts will attempt
to make actual, correspond to the forecast.
2. A budget is stated in monetary terms whereas a forecast may or may not be
stated in monetary terms.
3. A budget usually covers one year, whereas, forecast can be for any time
period.
4. A budget is approved by the higher authority, whereas, forecasts are not
usually approved by higher authorities.
authorities
5. Once approved, the budget can be changed only under specified conditions.
A forecast is updated as soon as new information indicates change in
conditions.
6. In case of budgeting, actual financial performance is compared to budget
and variance analysed and explained.
explained Variances from forecasts are not
analysed formally or periodically. Cont…. Copyright © 2008, Pradip Kumar Sinha
Ch-8
Uses of a Budget
Operating budget has four principal purposes:
1. To fine-tune the strategic plan: Strategic plan is prepared early in the year
and developed on the basis of the best information available at that time; its
preparation involves relatively few managers and it is stated in fairly broad
terms. The budget is completed just prior to the beginning of the budget
year, provides an opportunity to use the latest available information and is
based on the judgement of managers at all levels throughout the
organisation.
2. To help co-ordinate the activities of the several parts of the organisation:
Every responsibility centre manager in the organisation participates in the
preparation of the budget.
3. The approved budget should make clear what each manager is responsible
for.
4. To obtain a commitment that is a basis for evaluating a manager's actual
performance: the budget represents a commitment by the budgetee to his
superior and therefore a benchmark against which actual performance can
be judged. Cont…. Copyright © 2008, Pradip Kumar Sinha
Ch-8
Strategic Plan Operating Budget Capital Budget Contents of an
Revenue and expense for For organisation as a whole Each major capital project Operating
each major programme and for each business unit listed separately
Not necessarily by Classified by responsibility Budget
responsibility centres centres
Not as much detail as Typically includes:
operating budget Revenues
Production cost and Cost of
sales
Marketing expenses
Logistic expenses
General & Administrative
Research & Development
Income tax
Net Income
Expenses may be:
Flexible,
Discretionary or
Committed
For one year, divided into
months or quarters
Total reconciles to strategic
plan (unless revised)
Cash Forecast
Budgeted Balance Sheet
Ch-8
Operating Budget Categories

 Revenue Budgets
 Budgeted Production Cost and Cost of Sales
 Marketing Expenses
 Logistic Expenses
 General and Administrative Expenses
 Research and Development Expenses
Ch-8
Other Budgets
 Capital Budget
 Budgeted Balance Sheet
 Budgeted Cash Flow Statement
 Management by Objectives
Ch-8
Budget Preparation Process

 Budget Department
 The Budget Committee
 Issuance of Guidelines
 Initial Budget Proposal
 Negotiation
 Review and Approval
Ch-8
Budget Revisions
There are two general types of budget revisions:
1. Procedures that provide for systematic (say quarterly) updating of the
budgets.
2. Procedures that allow revisions under special circumstances.
If budget revisions are limited only to unusual circumstances, such revisions
should be adequately renewed. In general, permission to go for budget revision
is difficult to obtain. Budget revisions should be restricted to those cases where
approved budget has become so unrealistic that it no longer provides a useful
control device i.e., budget revision must be justified on the basis of significant
changed conditions from those existing when the original budget was approved.
Contingency Budgets
The contingency budget provides a way of quickly adjusting to changed
conditions if the situation arises. To find the effect of changes in sales volume
while preparing contingency costs are divided into three categories - fixed costs,
unavoidable variable costs and management discretionary costs. Cont….
Ch-8
Behavioural Aspects while Preparing Operating Budgets
One of the purposes of management control system is to encourage the

manager to be effective and efficient in attaining the goals of the organization.
Some of the motivational considerations while preparing the operating budgets
are:
1. Participation in the budgetary process
2. Degree of budget target difficulty
3. Senior management involvement
4. Crucial role of budget dept
Ch-8
Budget Ratios
The following are usually used to measure development from the budget:
1. Labour utilisation can be measured by two ratios, namely:
i. Measured work performance ratio
ii. Attendance time performance ratio
2. Standard capacity usage ratio
3. Actual capacity utilisation ratio
4. Levels of Activity Ratio
5. Efficiency Ratio
6. Calendar Ratio
Ch-8
Management Control of Operations

Management control is working through others, so that the work may get done
effectively. Managers, literally, do not control costs; what managers do is to
influence the actions of the people, who are responsible for incurring the costs.
The manager selects the workforce, makes sure that they are adequately
trained, decides where they fit best in the organisation, provides advice,
suggestions and disciplines, resolves disputes within the responsibility centres,
approves proposed actions that the employees are authorised to take on their
own authorities, interacts with other managers to obtain their coordination and to
resolve problems when their activities impede the work of the responsibility
centre and above all, seeks to create an element that induces employees to
work efficiently and effectively. To carry on these activities, managers need
information which are identified as: Cont….
Ch-8
Formal Information
1. Task control information: A production control system provides
information that schedules the flow of material, labour and other resources,
so the correct end products in the correct quantities emerge at the end of
the production.
2. Budget reports: The approved budget is the prescribed financial device for
controlling the activities of the responsibility centre and a report that
compares actual revenues and expenses with budgeted amounts is the
main part of the report.
3. Non-financial information: Sales volume in units as well as in rupees.
Others are reported because the information may require prompt action.
These are termed as key variables bookings, back orders market share, key
actual numbers, capacity utilisation, quality, on time delivery, inventory
turnover. Recent developments that have influenced the Management
Control System, include just-in-time
time systems, total quality control, computer
integrated manufacturing and decision support systems.
Ch-8
Variance Analysis for Control Actions

Since a budget is an instrument of control, it is necessary to compare the actual
results with the budgeted results. A variance occurs when actual costs differ from
standard costs. The term variance analysis refers to the systematic evaluation of
variances in an attempt to provide managers with useful information for
measuring efficiency and improving performance.
performance
Total Variance
Non-manufacturing costs Manufacturing costs Sales
Variable Fixed Volume Selling

Administration Marketing R&D costs costs price
Material Direct Variable Market Industry

labour overhead share volume
Variance Analysis Disaggregation Copyright © 2008, Pradip Kumar Sinha
Ch-8
Analysis of Sales Variances

There are two distinct methods of computing and presenting sales variance, (1)
Sales value or Turnover method and (2) Sales margin (Profit) method. The first
method shows the effect of variances in terms of turnover and second shows the
effect in terms of profits.
Sales Value Variance
Price Variance Volume Variance
Mix Variance Quantity

Variance
Analysis of sales variances

Ch-8
Market Size and Market Share Variances

The performance of the company is also affected by overall demand for the
industry products and the company's ability to maintain its share of the market.
Statistics for some industries are readily available and so the company can
easily monitor its market share. The sales margin quantity variance can be
subdivided into the market size variance and the market share variance. The
computations for these two variances are given below:
1. Market Size Variance = (Budgeted Market Share Percentage) X
Actual industry sales volume in units –
Budgeted industry sales volume in units) X
Budgeted Average contribution margin
Per unit
2. Market Share Variance = (Actual market share percentage – Budgeted
market share percentage) X Actual industry
sales volume in units X Budgeted Average
Contribution margin per unit.
Ch-8
Analysis of Sales Variances

Alternative way of computing Sales Margin Mix Variance and Sales Margin
Quantity Variance.
Sales Margin Mix Variance
(Total Sales value based on Actual Qty. x Budgeted Price as per Actual Mix -
Total Sales value based on Actual Qty.
Qty as per Budgeted Mix of Budgeted Qty. x
Budgeted Price) - Budgeted Margin % on Budgeted Sales.
Sales value Sales value Total sales Difference Budgeted Variance
budgeted qty. Actual qty. x value in (2) as Second and margin %
x budgeted Budgeted per budgeted third column
price (1) Rs. price (2) mix in (1)
Jug wine 6,000 5,500 8,081 2.581.A 20% 516(A)
Premium 6,400 11,200 8,619 2,581 F 43.75% 1,129 F

wine
12,400 16,700 16,700 613 F
Ch-8
Sales margin quantity variance
(Total Sales value based on Actual Qty and Budgeted Price – Total Sales value
based on Budgeted Qty. and Budgeted Price) × Budgeted Average Margin %
4000
= (16, 700 – 12400) ´ = 1387(F)
12400
é1200 + 2800 ù
ê = Budgeted Average Margin% ú
ë6000 + 6400 û
Expenses variances
Fixed Costs: Variances between actual and budgeted fixed costs are obtained
simply by subtraction since these costs are not affected by either the volume of
sales or the volume of production. This is illustrated below:
Actual Budget Favourable or
unfavourable variances
Fixed overhead Rs. 75000 Rs. 75000 -
Selling expenses 55,000 50,000 (5000)
Admin. Expenses 30,000 25,000 (5000)
1,60,000 1,50,000 (10,000) Cont….
Ch-8
Summary of Variances
There are several ways in which variances can be summarized in a report. The
different methods of calculating variances are: time period of comparison, focus
on gross margin, evaluation standards, full-cost systems and amount of detail
information. These approaches are:
 Time period of comparison
 Focus on gross margin
 Evaluation standards
 Predetermined standards
 Historical standards
 External standards
 Full-cost systems
 Amount of detail information
Cont….
Ch-8
Limitations of Variance Analysis
Variance analysis identifies the occurrence of variance, but it does not tell 'why'
the variance occurred. When using variance analysis, it is difficult to decide
whether a variance is significant or not.
not Another limitation of variance analysis is
that, as the performance reports become aggregated, offsetting variances might
mislead the user of the information. For example, a manager might notice that
the business unit manufacturing cost performance was as budgeted. However,
there may be good performance at one plant which is offsetting poor
performance at another plant.
Fixed (Static) and Flexible Budget:: Control, in order to be effective, requires a

standard or a target with which actual performance can be compared for the
purpose of measurement of the results for timely action, if necessary.
Cont….
Ch-8
Preparation of Flexible Budget
1. Since decentralisation of cost responsibility is an essential features of
flexible budgetary control system, the first step is to define the departments
of the business. A department should be established if its functions or
processes are of a similar nature or are related in one logical group.
2. The budgeted cost of each department will be related to the standard
activity of the department and of the constituent cost centres of the
respective departments.
3. The next step is the establishment of departmental overhead expenses
budgets based on the level of activity planned for each cost centre. Past
experience can serve as a guide.
guide The budgets should by and large be set
on the basis of studies of what is reasonable including possible economies.
4. The next step is to segregate all expenses into fixed and variable. Some of
the expenses are semi variable in nature and hence, these expenses have
to be segregated into fixed and variable for giving proper budget
allowances. Cont…. Copyright © 2008, Pradip Kumar Sinha
Ch-8
Advantages of Flexible Budgeting
1. By giving allowance in accordance with the level of activity attained, the

variances due to volume, efficiency and spending can be analysed and
appropriate action can be taken.
2. The management is able to assess the effect of their decisions. The

deviation from budget arising from a decision to vary the output can be
studied.
3. It is useful for planning changes in the level of output.
Ch-8
Management Action
The cardinal principle in analyzing formal financial reports is that the monthly
report should contain the major surprises.
surprises Significant information should be
communicated by telephone, fax, electronic mail or personal meetings as soon
as it becomes known. The formal report confirms that senior managers have
learned about the specifics and have taken action prior to the receipt of the
formal report.
The importance of formal reporting is that it provides the desirable pressure in
subordinate managers to take corrective action on their own. Further, the formal
report provides more accurate information and provides a basis for analysis as
compared to informal sources which is general and unprecise.
Profit reports does not carry any meaning unless they lead to action. The action
may be by way of praise for the job well done. Suggestions for doing things
differently or more drastic personnel actions. However, these actions are by no
means taken for every business unit every month. As long as business is going
well, praise is the most that may be necessary.
necessary Copyright © 2008, Pradip Kumar Sinha
Performance Measurement and Balanced Scorecard
Ch-9
Chapter
9 Performance
Measurement and
Balanced Scorecard
Ch-9
Introduction
Management Information System can be developed as an act of interrelated
components that collect (or retrieve), process, store and distribute information to
support decision making, co-ordinate and control an organisation.
The importance of Management Information System has increased in recent

times because of the following:
1. Emergence of global economy.
2. Transformation of Industrial Economics - knowledge and information intense

products have become available..
3. Transformation of Multinational enterprises.

enterprises
4. Emergence of digital form.
Ch-9
Performance Measures
Performance measures are a central component of management information and reporting
system. It deals with performance measures for different levels of an organisation and for
managers at these levels - both financial and non-financial performance measures.
Five Level Performance Measures - These are given below:
Representative area at Financial Measures Non-Financial Measures
which data gathered
A) Customer / Market i) Prices of company’s products compared i) Market share held by
level with competition company’s products
ii) Prices of company’s traded securities ii) Third party quality
ratings for all products in
the industry
B) Total organizational i) Return on investment (ROI) i) No. of new products
level ii) Residual income (RI)/EVA introduced
iii) Return on sales ii) No. of new patents filed
Cost and revenue measurements for each
Cont….
responsibility centre according to measure of
performance used (that is cost, revenue,
profit, and return on investments) this is
known as responsibility accounting. Financial
measures includes flexible budget variances)
Ch-9
C) Individual facility level i) Capacity utilization

(includes manufacturing plants, ii) Throughput time for products
distribution sales, customer iii) Percentage of times
service centers, R & D center) promised delivery dates met
(schedule attainment)
D) Individual Activity level (e.g. i) Direct material variance and i) Time taken to set up
activities in a warehouse facility direct labour variances machinery for new production
include receiving, storing, ii) Manufacturing overhead run.
dispatching, etc. variances ii) No. of accounts receivables
iii) Cost per activity level processed per hour
iii) Inventory level not to exceed
certain amounts
iv) Abiding by Plant
Maintenance schedules. Time
period for completion i.e., break
even time is the time from initial
idea date to the time when the
cumulative present value of
cash inflows of the project
equals the present value of total
(to market) cash outflows
Cont….
Ch-9
E) By Product / Programme Cost and Revenues and Time period for completion i.e.,
Investments across break even time is the time
responsibility centers as far as from initial idea date to the time
they pertain to program or when the cumulative present
product (compares to budgeted value of cash inflows of the
/ target amounts). This is project equals the present
sometimes referred to as value of total (to market) cash
activity costing. outflows
Ch-9
Designing Accounting-based
based Performance Measures
Customer/Market Level
Less effort has been devoted to collect data at the customer / market level. Data
at the customer market level include product quality, the time taken to respond to
customer demands and the cost of products marketed. As organizations
increasingly adopt a customer - oriented perspective, more attention is being
given to including customer / market data in management control system.
1. Choosing a variable(s) that represents top management's financial goals
e.g. operating income, net income, and return on investment or revenues.
2. Choosing definition of key items included in variable(s) in the earlier step
(such as operating income, net income after tax return on investment). For
example, investment means total assets or total assets minus liabilities.
3. Choosing measures for key items included in the variable e.g. assets should
be valued at historical cost, current cost or present value.
4. Choosing the timing of feedback e.g. weekly, monthly and quarterly etc.
Ch-9
Performance Reports: Format and Essential Features

1. Tailored to the organization structure and controllability
2. Designed to implement the exception principle in management
3. Repetitive and relate to short-time

time spans
4. Adapted to the requirements of the principal user
5. Simple, understandable and report only essential information
6. Prepared and presented promptly
7. Effective management follow-up

up procedures
Cont….
Ch-9
Type of Reports for Different Levels of Management

1. Top management including Board of Directors and Financial
Management:
i. Balance Sheet
ii. Profit and Loss Statement
iii. Position of Stock
iv. Disposition of funds and working capital and Cash flow statement
v. Capital expenditure and financial commitments together with the
progress of projects in hand
vi. Sales, production and other appropriate statistics
2. Sales Management:
i. Actual sales compared with budgeted sales to measure performance by
products, territories, individual salesman and customers.
ii. Selling expenses in relation to budget and sales value analyzed by
products, territories, individual salesman and customers.
iii. Bad debts and accounts which are slow and difficult to collect.
Cont….
iv. Status report on new or doubtful customers. Copyright © 2008, Pradip Kumar Sinha
Ch-9
3. Production Management:
i. To buyer: Price variations on purchases analyzed by commodities
ii. To foremen/shop leader:
iii. Operational efficiency for individual operations duly summarized as
departmental average
iv. Labour utilization report and causes of lost time and controlled time
v. Indirect shop expenses against the standard allowed, and
vi. Scrap report
4. Specific report:
i. Taxation legislation and its effects on profits
ii. Estimates of the earning capacity of a new project
iii. Break-even analysis
iv. Replacement of capital equipment
v. Special pricing analysis
vi. Make or buy certain components
vii. Statement of surplus available for payment of bonus
Ch-9
Multiple Performance Measures

ROI and EVA have been employed with some success by many large sized
undertaking which has resorted to divisionalisation.
divisionalisation However, exclusive reliance
on a single profitability measure may lead to manipulation of the system and
consequent distortion in decision-making
making. Managers of business unit may delay
a potentially profitable investment in a bid to enhance short-term return on
income at the cost of long-run consequences.
consequences
In order to overcome the limitation of "sole dependence in a single measure",
many firms have developed multiple goal structures.
As for example, following are the multiple goal structures of General Electric
Company:
(i) Profitability, (ii) Market position, (iii) Productivity, (iv) Product leadership, (v)
Personnel development, (vi) Employee attitudes, (vii) Public responsibility, (viii)
Balance between long-range and short-range
short goals. Cont….
Ch-9
Balanced Score Card
It is a device of linking financial and non-financial measures and identifies key
performance measures that give top management, a first but comprehensive
view of the performance of the organization unit (i.e., a division/strategic
business unit). Balance Score Card
How do we look to shareholders?

Financial perspective
How do Goals Measures What most

customers we excel
see us? at?
Customer perspective Vision Internal business process

and perspective
Goals Measures Goals Measures
strategy
Learning and growth

perspective
Goals Measures
Can we continue to improve

and create value? Copyright © 2008, Pradip Kumar Sinha
Ch-9
Establishing Objectives and Performance Measures

The Financial Perspective
AT SBU Level: Operating Profit, Return on Investment, Residual Income, and
Economic Value Added are used for measuring the financial objective of the
business unit.
Other financial objectives include revenue growth, cost reduction and asset
utilization.
 Customer perspective
 Customer retention and loyalty
 Customer acquisition
 Customer satisfaction
 Customer profitability
 Measuring value propositions Cont….
Ch-9
Internal Business Perspective
Innovation process:
1. Percentage of sales from new products
2. New product introduction vs. customers and vs. plan
3. Time to develop new generation of products
4. Number of key items in which the company is first or second in the market.
5. Break-even time i.e., time from the beginning of product development till the
time the product is introduced and generated enough profit to payback the
original investment made.
Operation process:
Financial Measures: Standard costs, budgets and variance analysis
Non-financial Measures: Cycle time, quality measures, cost measures of the
internal business processes through activity based costing
Post-service sales process: Warranty and repair activities, the treatment of
defects and returns, and the process and administration of customer payments.
Ch-9
Learning and Growth Perspective
Employee Capabilities (i.e., employee satisfaction, employee retention and

employee productivity): (i) Annual percentage of key staff that leave, (ii)
Measures for measuring employee productivity i.e., sales revenue per employee,
(iii) Periodically measuring employee’s satisfaction using surveys.
 Information system capabilities
 Motivation, empowerment and alignment
 Performance measurement in service organization
 Companies used the methods to measure performance
Ch-9
Rock Waters Model: Implementation of Balance

Scorecard
Rock Water, an undersea construction company that builds the connection
between the hydrocarbons that are beneath the surface of the sea and the
drilling platform on the surface. Rock Water was originally formed through a
merger of a British and Dutch company.
company
Phase I: Designing the Balance Score Card
1. The process starts by first distilling the mission, then linking it to the
strategic business objectives.
i. Financial objectives
ii. Business from customers’ perspective
iii. Internal business perspective
iv. Innovation and learning perspective
2. From objectives to measures
Customer perspective:
i. Internal process
Cont….
ii. Innovation process Copyright © 2008, Pradip Kumar Sinha
Ch-9
Phase II: The Commitment Phase
This is when we first set targets - stretch targets for three to five years. If we
achieve them, we really, are going to get breakthrough performance. And helps
us align the change and transformation programs because, once we understand
the process and the objectives that are most critical to us, we can see the gap
between where we are today and the stretch targets we've established for the
future.
Phase III: Using the Balanced Store Card as a Management Process
In the third phase, companies use the Balance Store Card measures as the
basis for their periodic reviews. The measures can be changed, perhaps we
didn't select the right measures initially or the measures did not provide clear
direction to employees. Or the business might have changed due to new
opportunities, new competition or new technology. So the objectives and
measures should be reviewed at least annually, as part of the strategic planning
process. The Balance Store Card should be viewed as an interactive, dynamic
process.
Cont….
Ch-9
Bench marking process
Bench mark Bench mark

metrics practices
Generic Bench Marking Process

Bench mark gap How to reduce the gap
-How much -Improved knowledge
-Where -Improved practices
- when -Improved processes
Management commitment
Organization communication
Employee participation
Superior performance
Ch-9
Just-in-Time Technique and Its Influence on

Management Control Process
Just-in-time, as the name indicates, means at the extreme there are zero
inventories, and goods are produced or ordered only when they are needed. The
extreme case is not common but term is catchy way of stating the direction.
The following are just-in-time techniques used:
1. Reducing buffer inventory at each workstation
2. Decrease set up costs
3. Decrease procurement costs
4. Relation with customers
Ch-9
Computer Integrated Manufacturing and Its Influence on

In petroleum refineries, chemical processing and similar processing plants,
materials and energy enter at the start and as various stages of the process and
the finished products come out at the end without any involvement of manpower.
Human beings maintain the equipment, check the quality of the process, and if it
goes out of control, shut it down and bring it back into control. Similarly, product
control systems in other industries also have undergone sea change that have
now come very close to those found in process manufacturing. These
developments include numerically-controlled
numerically machine tools, robots and
computers that integrate the work of other computers. This has resulted in the
reduction of manpower involvement, reduction in paperwork, elimination of
duplicate record keeping, inconsistencies of data in separate systems, decrease
in inventory, decrease in throughput time and consequent reduction in production
costs. Cont….
Ch-9
The following are the implications of management control process:
1. Increase in task control: Fully developed system converts certain
production activities that once required management control into task
control.
2. Better information: The system provides information more accurately more
consistently, with more detail and at much less cost than the systems they
supersede.
3. More prompt information: Information is available shortly after the event
occurs; in some cases, practically instantaneously.
4. Work teams: Under the newer systems, performance focuses on the
performance of the whole team.
5. Business unit controller: One consequence of the team approach is that
business unit controller should be made primarily responsible for assisting
the business unit manager in planning and controlling the units' operations.
Management Compensation
Ch-10
Chapter
10 Management
Compensation
Ch-10
Introduction
The incentive compensation system is a key management control device. Since
it is an important mechanism that encourages and motivates managers to
achieve organizational objectives. Incentives tend to support the following:
1. Individuals get strongly motivated by the potential of earning rewards than
the fear of punishment.
2. A personal reward is relative or situational. Monetary compensation is an
important means of satisfying certain needs but beyond a satisfying level,
the amount of compensation is not necessarily as important as non-
monetary rewards.
3. If senior management by its actions regards the management control
system as important, operating managers will also regard it likewise. If it is
otherwise, the operating managers will follow suit.
4. Individuals are highly motivated when they receive reports or feedback
about their performance. Without such feedback, people are unlikely to
obtain a feeling of achievement or self realization or sense corrective
actions that are needed to meet their objectives. Cont….
Ch-10
Characteristics of Incentive Compensation Package
A manager's total compensation package consists of three components:
1. Salary
2. Benefits and perquisites and
3. Incentive compensation
The three components are interdependent but the third is specially related to the
management control function.
Many corporate laws and securities regulations require that incentives
compensation plans and revisions of existing plans be approved by the
shareholders and before that it has to be approved by the board of directors.
Incentive compensation plans can be divided into:
1. Short-term incentive plans, which are based on performance in the current
year and
2. Long-term incentive plans, which relate compensation to the longer-term
accomplishments. The manager may earn a bonus under both plans. Short-
term bonus is usually paid in cash whereas long-term bonus plan usually
consists of an option to buy the company's equity shares at some price
other than market value. Copyright © 2008, Pradip Kumar Sinha
Ch-10
Short-term Incentive Plans
First of all, the total amount of bonus that can be paid to a qualified group of
employees in a given year which is called the "bonus pool", is decided based on
overall profitability in the current year (in some companies, the current quarter)
and also make the total compensation paid to executives competitive. Several
methods of establishing bonus pool are as given below:
1. Bonus equal to a set percentage of profits. The drawback of this method is
that one has to pay bonus even at low levels of profitability.
2. To base bonus on a percentage of earnings per share, over and above a
predetermined level of earnings per share. This method does not consider
increases in investment from re-invested
invested earnings.
3. To relate profits to capital employed i.e., shareholders’ equity plus long-term
liabilities. Bonus is equal to a percent of the profits before taxes and interest
on long-term debt minus a capital charge on the total of shareholders’ equity
plus long-term debt.
4. To define capital as equal to shareholders’ equity. This has the same
disadvantage as in the earlier method.
method Copyright © 2008, Pradip Kumar Sinha
Ch-10
Long-term Incentive Plans

The basic premise of long-term incentive plans is the growth in the value of
company shares; reflect company's long-run performance. There are several
types of such plans. The popularity of specific plan changes with factors like
changes in income-tax law, changes in accounting treatment and the state of the
stock market. Some of these plans are given below:
1. Stock Options
2. Phantom shares
3. Stock appreciation rights
4. Performance shares
5. Performance units
Ch-10
Incentives for Business Unit Managers

A wide range of options exist in developing an incentive compensation package
for business-unit managers. These are provided below:
1. Types of incentives:
i. Financial rewards
a) Salary increase
b) Bonuses
c) Benefits
d) Perquisites
ii. Psychological and Social Rewards:
Rewards
a) Promotion possibilities
b) Increased responsibilities
c) Increased autonomy
d) Better geographical location
Cont….
e) Recognition Copyright © 2008, Pradip Kumar Sinha
Ch-10
2. Size of bonus relative to salary:
salary
i. Business unit profits
ii. Lower cut-offs
3. Bonus based on:
i. Business unit profits
ii. Company Profits
iii. Combination of the two
4. Performance criteria:
i. Financial criteria
ii. Time period
iii. Non-financial criteria
iv. Relative weights assigned to financial and non-financial criteria
v. Benchmarks for comparison Cont….
Ch-10
5. Bonus determination approach:
approach 6. Form of bonus payment:
i. Formula based i. Cash and Stock
ii. Subjective ii. Stock options and Phantom share
iii. Combination of the two iii. Performance share
Size of Bonus relative to Salary:: There are two philosophies on incentive
compensation: Fixed pay and Performance based pay as given below:
Philosophy 1: Fixed Pay
Recruit good people
Pay them well
Expect good performance

Philosophy 2: Performance based pay
Recruit good people
Expect good performance

Cont….
Pay them well if performance is actually good

Ch-10
Cut-off Levels
A bonus plan may be limited at either end. (1) The level of performance at which
a maximum bonus is reached (upper cut-off) and (2) lower cut-off, the level
below which no bonus award will be available. When business unit managers
recognize that either the maximum bonus has been attained or there will be no
bonus at all, the motivational aspect of bonus system will be contrary to
corporate goals.
Bonus Basis
A business unit manager's incentive bonus could be based solely on total

corporate profits or solely on business unit profits or on some mix of the two.
In a single industry firm, where business units are highly interdependent, the
managers bonus is tied primarily to corporate performance, since inter-unit co-
operation is critical.
Cont….
Ch-10
Performance Criteria
To decide the criteria, as the basis for deciding bonus for business unit
managers, the following need to be considered:
1. Financial criteria
2. Adjustments for uncontrollable factors
3. Benefits and shortcomings of short-term

short financial targets
4. Mechanism to overcome short-term

term bias
5. Benchmarks for comparison
Ch-10
Executive Summary
Corporations in India need to perfect the art of strategic rewards. In the U.S.,
they call it "hitting the sweet spot". Strategic rewards can be defined as a system
for rewarding individuals or groups for achieving or contributing meaningfully to
an organisation's strategic goals. The distinguishing feature of strategic rewards
is its emphasis on motivating only those actions, attitudes and accomplishments
that help move the organisation towards clearly defined goals.
The concept of total rewards comprises two factors on which the survey is
predicted.
1. Extrinsic: This includes base pay, benefits, recognition awards and
incentives.
2. Intrinsic: This includes training, communication, and performance
management.
Corporations in India that are able to transform themselves quickly will lure
world-class winners. If we assume that today's skill and knowledge are the
currencies of corporate success, corporations that hit the sweet spot stands to
be enriched in more ways than one. Copyright © 2008, Pradip Kumar Sinha
Ch-10
Criteria for Evaluating Effectiveness of a formal

Management Control System
Output Criteria
Two very important output criteria have been identified:
1. The extent to which the formal systems are actually used by management to
make decisions in the control process.
process If the systems are not used, they
cannot be effective, no matter how sophisticated they are.
2. This criteria is difficult to apply, though it is equally important. It has to do

with the quality of the decisions made in the control process and the
influence of the systems on the quality.
quality The most objective measure here is
the extent to which the organisation has been achieving its objectives and
goals over a reasonable period of time.
Cont….
Ch-10
Input-related Criteria
Four input-related criteria have been identified against which management
systems should be evaluated:
1. The extent to which each part of the formal management system is linked
with the other. There should be reasonably tight connection among the sub-
processes of environment analysis, business planning, programming,
budgeting, reporting and analysis.
analysis If not, the formal systems may not be
having much influence upon the control process.
2. The criterion has to do with the role of staff. There should be enough staff
support to line management so as to facilitate or provide a catalyst for the
control process.
3. The third criterion has to do with the extent to which the systems focus upon
building commitment to organisational goals and objectives.
4. The fourth criterion is that the system should encourage strategic and
operational thinking on the part of all managers in the organisation.
Designing of Management Control Systems in India Context and
Importance of MCS in the Backdrop of Opening up of Indian Economy
Ch-11
Chapter
11 Designing of Management
Control Systems in India
Context and Importance of
MCS in the Backdrop of
Opening up of Indian
Economy
Ch-11
Introduction
Summary of findings: Some elements of the formal control system are the
hardcore and must be observed by the organizations operating everywhere
since these include chartering activities, establishing managerial support, setting
a direction/vision, establishing and clarifying procedures, providing formal
feedback, and establishing formal links of communication among organizational
subunits. On the other hand, informal control systems based primarily upon the
assumptions of perceived need by the individual and deal with group of people,
their respective practice, culture and issue depending upon the dynamic and
endeavouring sociopsychological ethos of Indian organizations.
Indian culture is basically ‘feminine’ in which emotion and feeling play a
dominant role as distinguished from the ‘masculine occidental culture’, which is
based more on reason and analysis.
analysis This prepares the background for other
areas: leadership and decision making in Indian context.
Ch-11
Culture
The term culture has been defined by different authorities, some of which are
given below:
According to International Encyclopedia of The Social Sciences "Culture or
civilization taken in its wide ethnographic sense is that complex whole which
includes knowledge, belief, art, Chapter 11 v Designing of Management Control
Systems 277 morals, law, custom and other capabilities and habits acquired by
man as a member of the society". This is further clarified when it calls culture
"the learned behaviour“
C Rajagopalachari, writing in his book 'Our Culture', defines culture as "the sum
total of the way of living built up by groups and human beings and transmitted
from one generation to another. Further, he sums up; “culture has more to do
with behaviour and the way of living".
S. Abid Hussain, in his book 'The National Heritage of India', has quoted nearly
half a dozen definitions of the term culture. He synthesizes the meaning of
culture as "a sense of ultimate values possessed by a particular society as
expressed in its collective institutions, by its individual members in their
dispositions, feelings, attitudes, manners as well as in significant forms which
gives to material objects". Copyright © 2008, Pradip Kumar Sinha
Ch-11
Distinguishing Characteristics of Indian Culture
1. Essential divinity of human soul or infinite divinity of all souls: This
characteristic has various implications.
implications Important ones are given below:
i. Animate kingdom as a whole is a one composite unit and all its
components have their own roles to play in unionism as per the scheme
of nature.
ii. The goal of human being is to manifest this divinity within by controlling
nature, external and internal..
iii. This manifestation can be achieved either by work (Karmyog), Worship,
(Bhaktiyog), Psychic Control (Rajyog) or Philosophy (Gyanyog).
iv. According to Swamy Vivekananda, this manifestation is the whole of
religion. Doctrines, Dogmas, rituals, books, temples, or forms are but
secondary.
Cont….
Ch-11
2. Essential oneness and solidarity of universe and all life: Though there
are minor and insignificant difference of opinions about this matter, in the
Indian tradition, yet this is one of the basic truths discovered by Indians right
from Vedic age. In the words of Swami Jitatmananda, “It is a Holistic
Universe”, where at a deeper level of an all pervading consciousness,
everything in the world is inter-connected"
connected".
3. Philosophy of integral experience:

experience Indian culture is one of the oldest
surviving cultures on the earth. With its integral experience, it has become
an integrated culture, which besides being rich, is full and comprehensive.
4. Family is the basic unit of social system: The Indian family was and is
usually still a joint one. Father is the head of the house and administrator of
the joint property. Family, rather than the individual was looked on as a unit
of the social system.
Cont….
Ch-11
5. Rishi and ashramic culture:
Rishi implies the following characteristics:

characteristics
i. Eternal Pilgrim (in the realm of high knowledge)
ii. Piercer of the veil of darkness (in others)
iii. Seer of totality
6. Purusharth-the mission: Purusharth means and connotes the aims,

mission or purpose of life. The purusharths are the Dharma, Arth, Kama,
and Moksh.
7. Varnashram system: Varna Vyavashta is not peculiar to India or Indian

culture. On the basis of capability, the entire society is divided into four
classes.
Ch-11
The Indian and the Occidental Cultures
In this section, the chief characteristics of the Indian and the Occidental Cultures
are brought out. Such a discriminative vision is essential as the management,
which we see in practice today is based more on the cultural ethos of the West.
In a well-known study, G. Hofstede (Motivation, Leadership and Organisation,
"Do American theories apply abroad", Organizational Dynamics (Summer 1998)
PP309-329) identified four basic cultural dimensions which may accrue for
difference in Management and HRD practices across the culture.
These are:
1. The extent to which society emphasizes collectively rather than individual
activity.
2. The extent of power distance or tolerance for social inequality.
3. The extent of acceptance of uncertainty.
uncertainty
4. The extent to which a society emphasizes "masculine" values and
Cont….
behaviour such as: assertiveness, domination, etc. Copyright © 2008, Pradip Kumar Sinha
Ch-11
Feminine-Masculine
Masculine Aspects of Human Nature Dr Subhas
Feminine Masculine Sharma, in his
1. Intuitive Over
Over-rational book
2. Integrative Analytical (Management in
3. Enduring Aggressive New Age (1996),
4. Eternally creative Tendency of self destruction has elaborately
5. Power of sassivity and ‘Soul Force’ Force of direct action and brute force
dealt with the
6. Feeling/emotion (‘heart’) Intellect/cognitive (‘head’
feminine and
7. People oriented Number oriented
Rule bound
masculine aspect
8. Creative
9. Mercy, forgiveness, companionship and ‘Killer –instinct’ and ruthlessness of human nature,
wisdom he has given as 17
10. Cooperation Competition characteristics of
11. Wholeness Separateness these two aspects
12. ‘Strength in weakness” ‘Weakness in strength’ of human nature.
13. Inspirational Forced motivation These are as
14. Soft approaches and humanistic Hard approaches and mechanistic follows:
15. Feminine Masculine
16. Spiritual side of life Secular side of life
17. Energy giving, empowering Energy drawing Cont….
Ch-11
Leadership
This can be divided into the following sections:
The ancient classical wisdom and leadership
1. The contemporary thinking on leadership
i. The Eastern managers views
ii. The Western managers views
2. Management gurus and leadership
i. Eastern viewpoint
ii. Western viewpoint
3. The ancient classical wisdom and leadership
In ancient political literature, the term 'Raajya' (State) is the collective name
for the following seven constituents:
constituents
The King (The leader), The Amatya / Mantri (The Board of Directors), The
"Suhrit" the friendly neighbouring state (the parent company or the
collaborating business entity), The Kosh (Finances), The Danda (The
administrative system encompassing punishments), The Durg (the security
Cont….
system) and The Bal (The work force )
Ch-11
Duties of the Leader (King)
The first duty of the King (Leader) is to protect the state (business entity ) and his
praja (the shareholders) and at the same time enhance their respective welfare.
Maintenance of the internal order is the King's (Leader's) other duty.
Shukracharya has directed the King (Leader) to perform eight functions:
1. Punishment to the wicked
2. Charity for the social causes
3. Protection and welfare of the people
4. Renouncing the disvalues (through worship)
5. Enhancement of the finances through just means
6. Dominating the rivals in business (collecting taxes from other kings)
7. Giving a crushing rebuff to those who behave as enemies and damaging the
company's property and goodwill.
goodwill
8. Ever increasing the market share (adding additional territories to the
kingdom) Copyright © 2008, Pradip Kumar Sinha
Ch-11
Views of Western Managers
It may be clarified that included in this section are the views of political leaders of
exceptionally high standing in the American society and several business
leaders. Lee lacocca, a business leader is a top in the country, others are not so
well-known. Of the rest, a few had attended IIM-Calcutta's MCHV's One Week
"Management by Human Values: Indian Insights" workshop organized by Prof. S
K Chakraborty and thus had the exposure to Vedantic philosophy-Indian Values
and ethics (though limited).
Abraham Lincoln as portrayed by his biographer "There can be no doubt that
Lincoln is the greatest leader in the country and perhaps this world has yet
known (Donald T Philips, in his book Lincoln on Leadership, Page 9)”.
It may be clarified that "He was not a born king of men…. But a child of the
common people who made himself a great persuader, therefore, a leader by dint
of firm resolve, patient effort and dogged perseverance." To sum up, he was a
Cont….
self-made man.
Ch-11
Management gurus and leadership
Prof. S K Chaakraborty (IIM Calcutta) a doyen in the field of 'Indian

Management' has presented the 'Raj Rishi' model of leadership. This is a
comprehensive model. The salient features of the model are:
1. Effective leadership can be viewed as involving more of 'values for

becoming', instead of just 'skills for doing'.
2. Heart-mind-pran'-troika is the foundation of leadership.
3. Management of the senses, i.e., ruling over one's Indriyas is a pre-requisite

for a wise leadership role.
Ch-11
Decision-making
Decision Pertaining to the Family
In a normal family, the Karta enjoys an exalted position, is respected and
inspires others at the same time. His decisions are normally not challenged.
Here, it may be added that decisions pertaining to the family include business
decisions as well.
Decision-making authority always rested with the head of the family. He always
made the decisions keeping the family interest uppermost in his mind.
Decision-Making in the Realm of the State
Here, the organization is big, the number of stakeholders is large and the effect
of decisions is long enduring.
While reviewing the decision-making process, the king was authoritarian, he was
the final authority to take the decisions, but before taking important decisions, it
was enjoined upon him to consult the sabha – the general assembly and the
samiti – the gatherings selected on the basis of specialized knowledge, skills and
dexterity. Cont….
Ch-11
Typology of Decisions
Sharma's observations are that 'In an increasingly rational society, decisions

tend to be more 'Buddhi' and 'Ahankar' driven.
Dr Sharma in his model has also introduced the elements of Vrittis and
Sanskars. This makes the model a bit more complex.
For simple understanding, it can be said that 'rational decisions' are far from
'rationality'. Rationality is interfered with by, 'Mana' which has emotion content
and by Ahankara, which has 'ego' or 'individualization' content. Thus, there is a
likelihood of 'irrationality' and subjectivity' in the so-called
so 'rational' decisions.
Cont….
Ch-11
Review of the Indian Economy - Macro level features
Regulatory Framework: The Pre-reform
reform Scenario
1. Industrial Policy Resolution of 1956: The Industrial Policy Resolution
of 1956 (which is modified and simplified version of Industrial and Policy
Resolution of 1948) important ingredients are as follows:
Industries have been classified into three categories:
i. Schedule A, which are reserved for the state sector e.g. infrastructure
industries (air transport, rail transport, communications and power),
certain basic andheavy industries (iron and steel, heavy machinery etc.),
mineral products (coal, iron, ore etc.), defense related industries and
atomic energy. ii) Scheme B, which the state will generally take initiative
to establish new undertakings
ii. but in which private enterprise will supplement the efforts of the state e.g.
aluminium and other non-ferrous
ferrous metals, machine tools, basic and
intermediate products required for the production of drugs, dye stuffs and
plastics, essential drugs and antibiotics.
antibiotics Cont….
Ch-11
2. Industrial Policy Statement of 1973: The Industrial Policy Statement of
1973 identified high priority industries where investment from large industrial
houses and foreign companies will be permitted.
3. Industrial Policy Statement of 1977: The Industrial Policy Statement of
1977 laid emphasis on decentralization and on the role of small scale, tiny
and cottage industries.
4. Industrial Policy Statement of 1980: (7th Plan Period): The Industrial
Policy Statement of 1980 focused attention on the need for promoting
competition in the domestic market. Technological upgradation and
modernization. This found expression in the Sixth Five Year Plan.
Pitfalls of Indian Economy . Power of Liberalization
1. It suffered from licenses, quotas and control has to a great extent lost its
potency to be competitive in the global scene.
2. In domestic scene, lack of competition in many fields has led to mis-
llocation of resources, stagnation, lack of innovation and even efficiency.
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The Programme of Economic Liberalisation
The New Economic Policy
During the mid 1980s, the Congress Government headed by Rajiv Gandhi made
a move to change its policies regarding business licenses and permits, as also
its attitude towards multinational companies operating in India. However, it was
also during the succeeding Government of Narasimha Rao (1991-96) that a
strategy was actually formulated in this direction, and marketed both in India and
abroad.
Industrial Policy 1991, Liberalized Economic Policy/ Economic Reforms
1. Aim at transforming a regulated economy to an open market economy.
2. Technological and managerial modernization of industry was pursued as the
key instrument for increasing productivity and improving competitiveness in
the world.
3. The industries reserved for public sector, arms and ammunitions and allied
items of defence equipment; atomic energy, mineral oils, coal and lignite,
minerals specified in the Schedule to the Atomic Energy (control of
production and use), railway transport.
transport Cont….
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Industrial Licensing Policy
1. Industrial licensing will be abolished for all projects except for a short list of
industries relating to security and strategic concerns, social reasons,
hazardous chemicals and overriding environmental reasons and items of
elitist consumption. Industries reserved for small sector will continue to be
reserved.
2. Areas where security and strategic consumes predominate will continue to
be reserved for the public sector..
3. In projects where imported capital goods are required automatic clearance
will be given:
i. In cases where foreign exchange availability is ensured through foreign
equity.
ii. In other cases, inputs of capital goods will require clearance from the
Secretariat of Industrial Approvals (SIA) in the Dept. of Industrial
Development and according to availability of foreign exchange
resources. Cont…. Copyright © 2008, Pradip Kumar Sinha
Ch-11
Foreign Investment
At present, an automatic approval is granted for foreign investment in
Industries as under:
1. 100% Foreign Equity in infrastructure related projects (e.g. electricity
generation, transmission and distribution, construction and maintenance of
roads, highways, vehicular bridges, hill roads, and vehicular tunnels, ports
and harbours). The details of such industries are given in Part D of
Annexure - III to the Industrial Policy.
Policy
2. 74% Foreign Equity in high priority-industries
priority referred to in Part 'C' of
Annexure -III to the Industrial Policy.
Policy
3. 51% Foreign Equity in Industries referred to in Part 'B' of Annexure - III to
the Industrial Policy.
4. 50% Foreign Equity in respect of Mining Activities referred to in Part 'A' of
Annexure - III to the Industrial Policy.
Policy Cont….
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Foreign Technology Agreements
1. Automatic permission will be given by Regional Offices of the Reserve Bank
of India for Foreign Technology Agreements in high priority industries
(Annexure III, Annexure – III Part 'A', Part 'B' and Part 'C') upto a lumpsum
payment of US$ 2 million, 5% royalty for domestic sales and 8% for exports,
subject to total payment of 8% of sales over a 10 year period from the date
of agreement or 7 years from the commencement of production. The
prescribed royalty rates are net of taxes and will be calculated according to
standard procedures.
2. In respect of industries other than those in Annexure - III, Part' A', Part 'B'
and Part 'C', automatic permission will be given subject to the same
guidelines as above.
3. All other proposals will need specific approvals under the general procedure
in force.
4. No permission will be necessary for hiring of foreign technicians, foreign
testing of indigenously developed technologies. Payment may be made
from blanket permit or in free foreign exchange according to RBI guidelines.
Ch-11
Steps initiated by the Government of India in other areas
In addition that the Government of India has taken the following further steps:
1. Bringing the corporate tax rates closer to the relatively low level prevailing in
other developed and developing countries.
2. Encouraging the growth of private institutional investors such as private
sector mutual funds and Foreign Institutional Investors (FIIs) registered with
the Securities and Exchange Board of India (SEBI).
3. Dispensing with government intervention on fixing the price of capital Issues
through the office of the Controller of Capital Issues.
4. Phasing the deregulation of interest rates. The number of new instruments
during the last few years or so, is phenomenal e.g., zero coupon
debentures, deep discount bonds, short maturity debentures, warrants,
floating rate loans, floating rate notes or bonds with a market determined
interest rate, benchmark etc.
5. India becoming a member of WTO will benefit from the opportunities in
trade due to comparative advantages.
advantages Copyright © 2008, Pradip Kumar Sinha
Ch-11
The Reform Process and Imperatives
After 1991, there was a two-fold shift in the Indian economic policy – at the
global level as also the national level.
level At the global level, it sought to integrate
the Indian economy with the world economy by allowing free movement of
capital investment both into and from India. This exchange would also expose
India to new technology.
Foreign Direct Investment into India (Rs. in crores)
Year Direct Investments Portfolio

(Indirect Investments)
1993 1787 2595
1994 3289 6791
1995 6820 3854
1996 10389 10803
1997 16425 6207
1998 13340 1480
1999 16868 6697
2000 5908 7067
Cont….
Source: Industry Ministry for foreign direct investment, SEBI for Portfolio Investment. Copyright © 2008, Pradip Kumar Sinha
Ch-11
Effect of the Reform Process
1. Major restructuring of economy leading to growth and generation of
employment, which would ultimately lead to more purchasing power for the
common man.
2. The economy should have a skilled and educated workforce, which can
understand and cope with requirements of IT and other technologies in the
manufacturing and service sectors, leading to the state's heavy investments
in education.
3. In terms of cost globalization drivers, India is increasingly becoming a major
attraction for MNC manufacturing because of the high quality manpower
and lower cost of production.
4. For many MNCs, it is the market attraction and government requirements
for local manufacturing that is influencing their current strategies.
5. Another emerging challenge that Indian companies have had to perforce
address is the infusion of the state-of-the-art technologies and work
practises.
Ch-11
Critical Review on Decade of Reforms
For the first 50 years of the 20th century, the Indian economy grew at a little over
zero per cent per annum. Between 1950 and 1980, growth accelerated to 3.5 per
cent, between 1980 and 2001 to 5.5 per cent.
1980-81 1992-93 1993 1994 1995 1996 1997 1998 1999 2000
to 1991-92 to 200-1 -94 -95 -96 -97 -98 -99 -200 -2001
Agriculture 3.9 3.3 4.1 5 -0.9 9.6 -2.4 7.1 0.7 0.9
Industry 6.3 6.5 5.2 10.2 11.6 7.1 4.3 3.4 6.4 6.6
Services 6.4 8.2 7.6 7.1 10.5 7.2 9.8 8.2 9.6 8.3
Total GDP 5.4 6.4 5.9 7.3 7.3 7.8 4.8 6.6 6.4 6.0
Source: Economic Survey, 2000-01,

01, Ministry of Finance, Govt. of India.
Cont….
Ch-11
There have been two aspects of our tryst with economic transition,
liberalization and re-structuring
We have done well on the liberalization front. Particularly, liberalization of the
external economy. For the foreign investors and the foreign suppliers, the gate is
almost wide open. Never mind if tariff walls still continue to be higher compared
to global standards. They are not uniformly high and not insurmountable in any
case. It is a different thing that though we have opened the gates, the bushes
and the jungle inside, have not been cleaned as yet. But, we are saying we will
do it (in the second phase of liberalization).
liberalization)
For the Indian corporates too, the path leading out of the gate is much smoother
today. There is hardly anything they cannot do. There is total current account
convertibility and near total capital account convertibility. They do not have to
suffocate at home any longer. They are free to go out in search of their fortune,
be a global player, get their stocks listed in the US or Europe, borrow abroad,
spend abroad, and even acquire assets abroad, irrespective of whether such
assets are productive or unproductive.
unproductive Cont…. Copyright © 2008, Pradip Kumar Sinha
Ch-11
Consequences of globalization in the different companies, especially in
the operation of management control systems
1. Virtually, all companies had started laying emphasis on the up gradation of
managerial and professional skills.
skills
2. A proper linkage between technology and management practices is being
focused on. Technology transfer affects the employment situation of an
organization. Increased automation can lead to the reduction of jobs and
subsequently surplus of manpower.
manpower
3. A flat organizational structure had resulted in fewer levels of hierarchy and
enhanced empowerment. Empowerment to all categories, from shop floor
workers to managers, had facilitated independent decision-making, flexibility
and trust.
4. People at the middle levels of management were becoming more
participative and result oriented.
5. Insecurity levels among employees had diminished and their sense of
responsibility had increased. Copyright © 2008, Pradip Kumar Sinha
Management Control of Service Organisations, Non-profit
Non Organisations
and Government Organisations
Ch-12
Chapter
12 Management Control of
Service Organisations,
Non-profit
profit Organisations
and Government
Organisations
Non Organisations
Ch-12
Service Organisations in General
Characteristics that distinguish from manufacturing organizations
 Absence of inventory buffer: Goods in a manufacturing organisation held
in inventory are a buffer that dampens the impact on production activity of
fluctuations in sales volume.
 Difficulties in controlling quality:
quality A manufacturing company can inspect
the products before they are shipped to the customer.
 Labour intensive: Most service companies are labour intensive and cannot
use equipment and automate production lines by replacing labour and
reducing costs.
 Multi-unit organizations: Some service organizations operate many units
in various locations with relatively small unit e.g. fast food restaurant chains,
auto-rented companies, gasoline service stations, etc.
 Historical development: Cost accounting started in manufacturing
companies to value work in progress and finished goods inventories for
financial statements. These systems provided raw data for use in setting
selling prices and for other management purposes.
Non Organisations
Ch-12
Professional Service Organisations
Research and development organizations, law firms, accounting firms,
healthcare organizations, engineering firms, architectural firms, consulting firms,
advertising agencies, etc. are examples of organizations whose products are
professional services.
Special Characteristics
1. Goals
2. Professionals
3. Output and input measurement
4. Small size
5. Marketing
Management Control Systems
1. Pricing
2. Profit centers and transfer pricing
3. Strategy planning and budgeting
4. Control of operations
5. Performance measurement and appraisal Copyright © 2008, Pradip Kumar Sinha
Non Organisations
Ch-12
Financial Service Organisations
Financial service organizations include commercial bank and thrift institutions,
insurance companies and securities firms. These companies are in business
primarily to manage money.
General Observations
1. The financial services sector constitutes an important backbone to world
economies.
2. Financial services firms have used the information technology revolution to
invent new products and discover new methods of trading.
3. The need for controls in the financial services sector has become
paramount to Indian financial crises during the second half of 1990s was in
part, the result of inadequate controls in the banks in Thailand, Indonesia,
Japan and other Asian countries..
4. During the 1990s, new firms of financial instruments (such as derivatives)
designed financial service firms sometimes resulted in massive losses for
the clients.
5. Finally, the corporate scandals during 2002 have created a huge push for
Cont….
investment banks to spin off their research departments. Copyright © 2008, Pradip Kumar Sinha
Non Organisations
Ch-12
While the general principles and concepts of management control systems

apply, they need to be adapted to the following special characteristics of financial
services industry.
1. Monetary assets
2. Time period of transaction
3. Risk and reward
4. Technology
Non Organisations
Ch-12
Healthcare Organisations
Healthcare organizations consist of hospitals, clinics and similar physicians,
organizations, health maintenance organizations, retirement and nursing homes,
home care organizations, and medical laboratories, among others.
1. Different social problems
2. Change in mix of providers
3. Third party payers
4. Professionals
5. Importance of Quality Control
Cont….
Non Organisations
Ch-12
Subject to the characteristic described above, the management control process

in the healthcare industry is similar to manufacturing organisation. Because of
the shift in the product mix and because of increase in the quantity and cost of
new equipment, the strategic planning process in hospitals is important. The
annual budget preparation process is conventional. Huge quantities of
information are available quickly for the control of operating activities. Financial
performance is analysed by comparing actual revenues and expenses with
budgets, identifying important variances and taking appropriate actions on them.
Non Organisations
Ch-12
Problems in Creating and Controlling Intra-company
Investment centres such as Branches of a Bank
General Characteristics
Commercial banks earn income primarily by lending and investing money. The
interest on this money is their revenue.
revenue They obtain the money primarily by
attracting deposits. The interest they pay on these deposits corresponds
approximately to cost of sales in a manufacturing company. Thus, net interest
expense, income, which is the difference between interest revenue and interest,
is a key number for bank management to watch, it corresponds to gross margin
in a manufacturing company. If the difference between interest revenue and
interest expense plus revenue from other activities, more than covers its
operating costs and loan loses, the bank is profitable. Commercial banks are
regulated by the Central Bank Authority.
Authority
Cont….
Non Organisations
Ch-12
Management Control Implications
 Interest rates
 Volume
 Loan losses
 Expenses
 Other income
 Joint revenues
 Profit Centres
 Expense centres
Non Organisations
Ch-12
Non-profit Organisations
The term "non-profit" tends to have negative connotations because it tells us
what these organizations do not do, not what they do.
A non-profit organization is one that is chartered to operate in the interests of the
society. It operates free of any obligation to pay income taxes. It is restricted by
definition from participation in equity markets since it has no shareholders. Its
sources of funds are derived from contributions, grants, operating surplus and
debts instruments of various types. The principal goal of non-profits is defined by
their mission.
Non-profit institutions may be classified into two groups:
Government organizations and private tax-exempt organizations. Private
organizations can be further divided into commercial organisation and charitable
groups, the former includes trade unions, trade associations and clubs and the
latter includes hospitals, religious groups, research, educational and social
Cont….
service organizations. Copyright © 2008, Pradip Kumar Sinha
Non Organisations
Ch-12
Distinctive Characteristics
Designing control systems for non--profit institutions are different from profit-
seeking institutions. The principal characteristics of these institutions that cause
differences in their control systems are:
are
1. The absence of a profit measure, performance evaluation is more difficult.
2. Different tax and legal status. These institutions are not taxed and no
shareholders exist.
3. The tendency of non-profit organizations to be service organizations. This
makes difficult to measure the quantity and quality of service provided.
4. Greater constraints on goals and strategies. Donors may restrict the use of
funds to predetermined purposes.
purposes
5. Less dependence on customers for financial support. Many depend on
endowed sources of support thus making them less dependent upon
circumstances for support. Cont….
Non Organisations
Ch-12
Management Control Systems in Non-Profit
Non Organizations
The issues involved in drafting management control system in a non-profit
organisation can be discussed in the following heads:
1. The mission of non-profits
2. Stakeholders' goals
3. Key success factors
4. Performance measures
5. Infrastructure
6. Management style and culture
7. Formal Control Process
8. Communication systems
9. Rewards
10. Informal control process. Cont….
Non Organisations
Ch-12
1. Political influences
2. Public information
3. Attitude towards clients
4. Red tape
5. Management Compensation
6. Financial Accounting
Cont….
Non Organisations
Ch-12
Management Control Systems
1. Strategic Planning and Budget Preparation: Strategic planning is

important in government organizations, managers and legislations must
make difficult decisions about the allocation of resources. Some of these
decisions reflect political pressures, others are the result of sophisticated
analysis especially benefit / cost techniques, which have become
increasingly formalized. The annual budget process is also an important
control device in government as it is in other non-profit organizations.
2. Performance measurement: Expenses can be measured accurately in

government organizations as in business. Revenue is not a measure of
output in government organizations.
organizations Government has developed non-
monetary indicators, which can be classified as (i) results measures, (ii)
process measures and (iii) social indicators.
Audit
Ch-13
Chapter
13 Audit
Audit
Ch-13
Introduction
Auditing has evolved in the wake of a social need to see that the accounting
statements on which people rely, are reliable. To achieve this objective, certain
procedures and practices have been developed over the years on the basis of
certain concepts that are considered to be the governing forces. Such concepts
are: independence, integrity, objectivity, planning, evidence, due audit care,
confidentiality, fair presentation and ethical conduct; without any of these, the
audit will not achieve the objective of ensuring a reliable accounting statements
for the benefit of auditing and are applicable to all auditing situations and for all
the time till the audit objective undergoes a change through social evolution.
Cont….
Audit
Ch-13
Definition of Audit
International Auditing Practices Committee on International Auditing guideline

No. I has stated that the objective of an audit is to express an opinion on the
financial statements. In the early days of auditing, detection of frauds and errors
was an important audit objective. Over the decades, gradual but significant shifts
have taken place in this regard and the present day concept as given in the
International guidance have emerged..
According to SAP (AAS) - I (Standard Auditing & Assurance Practices) issued by

the Institute of Chartered Accountants of India) Basic Principles governing an
audit – "An audit is the independent examination of financial information of any
entity, whether profit oriented or not and irrespective of the size or legal form.
When such an examination is conducted with a view to expressing an opinion
thereon". In this statement, the term 'financial information' encompasses financial
statements.
Audit
Ch-13
Basic Principles of Audit

1. Integrity, objectivity and independence
2. Confidentiality
3. The audit should be performed and the report prepared
4. Work performed by others
5. Documentation
6. Audit Evidence
7. Accounting system and internal control
8. Audit conclusions and reporting
Cont….
Audit
Ch-13
Scope of the Audit

1. The scope of an audit of financial statement will be determined by the
auditor having regard to the terms of the engagement, the requirements of
relevant legislation and the pronouncement of the Institute (Institute of
Chartered Accountants of India).
2. The audit should be organized to cover adequately all aspects of the
enterprise as far as they are relevant to the financial statements being
audited.
3. The auditor assess the reliability and sufficiency of the information
contained in underlying accounting records and other service data by:
i. Compliance and substantive tests, and
ii. Carrying out such other tests, enquiries and other verification
procedures of accounting transactions and account balances as he
considers appropriate in the particular circumstances.
4. The auditor's work involves exercise of judgement. Further, much of the
evidence available to the auditor can enable him to draw only reasonable
conclusions thereon.
Audit
Ch-13
Types of Audit
The following types of audit have been identified:
1. Internal Audit 2. Financial Audit 3.

3 Cost Audit
1. Internal Auditing
i. Internal auditing is a tool and technique for a periodical review of

organizational systems and procedures arising out of activities within
the organisation to ensure overall efficiency.
ii. Internal auditing is the study of accounting and financial aspects

directed towards compliance with accounting manual, correctness in
accounting data and detection of fraud.
iii. Internal auditing is complementary to statutory auditing.

Cont….
Audit
Ch-13
Internal audit - objectives and scope
1. Adequacy and reliability of management information and control system.
The internal auditor's role will be to evaluate as to the extent the various
types and levels of communication are effective and a motivating force for
all the people in the organisation..
2. Adequacy, accuracy and effectiveness of internal control systems in relation
to operational activities.
3. Appraisal, review and evaluation of the adequacy and on-time financial
accounting and reporting.
4. Achievement of management objectives through performance appraisal.
5. Safeguarding assets, utilization and accounting.
6. To ensure that all facilities (other than assets) are properly utilized and
safeguarded.
7. Ascertaining the extent of compliance with management plans, policies,
systems and procedures.
Cont….
8. Appraising the systems and procedures.
procedures Copyright © 2008, Pradip Kumar Sinha
Audit
Ch-13
Basic principles of audit
1. Integrity, objectivity and independence
2. Confidentiality
3. Skill and competence. These are acquired through a combination of general

education, technical education and practical experience
4. Documentation
5. Planning
6. Evidence
7. System and internal control
8. Conclusion and reporting

Cont….
Audit
Ch-13
2. Financial Audit
Financial audit has been defined by the Institute of Internal Auditors Inc. as
follows: "It is an historically oriented, independent evaluation performed by
the external auditor for the purpose of attesting as to the fairness, accuracy
and reliability of the financial data, providing protection for the entity's
assets, and evaluating the adequacy and accomplishment of the system
(internal control) designed to provide for the aforementioned fairness and
protection. Financial data, while not being the only source of evidence, are
the primary evidential source. The evaluation is performed on a planned
basis rather than a request."
Cont….
Audit
Ch-13
Objectives of financial audit

1. Assessing whether there is compliance with the accounting procedure laid
down which will include all forms of control measures instituted by the
management so far as they relate to financial accounting and allied aspects
of the business.
2. Prevention of fraud, waste and detection of error.
3. Plugging the loopholes in the financial management policy laid down or
arising from the process of working.
working This type of audit in most of the
appraisal is of a historical nature..
4. Verify whether the documentation and workflow is in conformity with the
internal control systems introduced and developed within the organisation.
5. Compliance with the Companies (Auditors Report) Order 2003 [C(AR)O,
2003].
6. Ascertaining the compliance with statutory laws and rules particularly in
respect of financial and accounting matters. Cont….
Audit
Ch-13
Duties of an Auditor under the Companies Act 1956
1. Duty to make an audit report:
i. Report to members: It is the duty of the auditor to make a report to the
members by sending to Board of Directors or the Secretary and the
latter will circulate to the members.
members
ii. Reading of the auditor’s report:report The auditor’s report shall be read
before the company in the general meeting and shall be open to
inspection by any member of the company.
iii. Scope of the audit: The audit report, as laid before the company, in
general meeting shall relate to the following documents: (i) the accounts
examined by him (ii) every balance sheet and profit and loss account of
the company and documents annexed to the balance sheet and profit
and loss account.
2. Duty to attend the meetings of audit committee [Section 292 A(5)]: The
auditor of the company shall attend and participate in all meetings of the
audit committee formed up US 292A of the Companies Act, 1956. Audit
committee is to be formed by every public company having a paid up capital
Cont….
of Rs. 5 crores or more. Copyright © 2008, Pradip Kumar Sinha
Audit
Ch-13
Contents and form of financial audit report
International Auditing guideline on the Auditor’s Report on Financial Statements
provides guidance on the form and contents of the auditor's report issued after
an examination of financial statements.
statements According to the guideline, the basic
elements of the auditor's report are as follows:
1. Title
2. Addressed
3. Identification of financial statements
4. Reference to auditing standards or practices
5. Opinion on the financial statements
6. Signature
7. Auditor's address
Cont….
8. Date of the report Copyright © 2008, Pradip Kumar Sinha
Audit
Ch-13
3. Cost Audit
In the terminology published by the ICMA London, Cost Audit has been defined
as "The verification of cost accounts and a check on adherence to cost
accounting plan." In Cost Audit in Industry published by the ICWA of India, Cost
Audit has been defined as "an audit of efficiency, of minute details of expenditure
while the work is in progress and not a post-mortem examination.“
The important aspects of cost audit are:
1. Property audit: It is the audit of executive action and plans bearing on the
finance and expenditure of the company.
company
2. Efficiency audit: It ensures the application of basic economic principles so

that resources may flow into the most remunerative channels.
Cont….
Audit
Ch-13
Objective and scope of cost audit
Objective and scope of cost audit may be stated as:
1. Verification of cost accounts and to see that the cost accounting plan has
been adhered to.
2. Comparison of historical costs with those attainable under efficiency
standards.
3. Isolation of abnormal costs with a view to highlight them.
4. Development of a reasonable degree of cost consciousness and
establishment of social justice to the community in a controlled and scarce
economy.
5. Examination of variances and their correct interpretation to the
management.
6. Examination of the operating efficiencies or inefficiencies of an enterprise
and optimization of the use of resources.
resources
7. Analysis of the methods applied for allocation of overheads, examination of
system of valuation of stock etc. with a view to eliminating the malpractices
causing harm to the community at large.
Cont….
8. Making an inter-firm and intra-firm
firm comparison of costs. Copyright © 2008, Pradip Kumar Sinha
Audit
Ch-13
Distinction Between Financial Audit and Cost Audit
Basis of distinction Financial Audit Cost Audit

1. Nature of Companies Financial Audit is compulsory Cost Audit is to be conducted
for all companies only when so directed by the
Central Govt.
2. Scope of audit Financial Audit covers all Cost audit covers only cost
records kept by the
t company records
including Cost records
3. Qualifications Financial Audit is conducted Cost Audit is - conducted by a

by a practising Chartered practicing Cost Accountant
Accountant
4. Method of appointment Financial Auditor
Audit is appointed Cost Auditor is - appointed by
by the company in General the Board of Directors with the
Meeting previous approval of Central
Govt
5. Reporting to whom Financial Auditors submit his Cost Auditors submits his
report to the members of the report to the Central Govt.
Company with a copy of the report to the
company.
Audit
Ch-13
Statutory Cost Audit in India

The Companies (Amendment) Act 1965 in India introduces several provisions
regarding maintenance of Cost Accounting records and Cost Audit.
Section 209(1) (d) implies that Central Government should select the class of
companies that are engaged either in production, processing, manufacturing or
mining activities, shall be required to include in their books of accounts such
particulars relating to the utilization of material or labor or other items of cost as
may be prescribed by the Central Government. Therefore, the intention of
Section 209(1) (d) is to ensure that prior to ordering the Cost Audit in a company,
adequate cost accounting records must be maintained under the above section,
the Central Government have been making rules through notification in the
official gazette on maintenance of cost accounting records.
Cont….
Audit
Ch-13
Management Audit
The term "management audit, 'operational audit' and the modern concept of the
term 'internal audit' often convey more or less the same meaning. There is no
clear-cut demarcation of the audit activities and the areas, which may fail in the
orbit of these three terms. In an audit assignment to review operations and
performances, it is difficult to say as to which portion of the audit programme
relates to internal audit, which to operational audit and which to management
audit.
Operational audit as given by Federal Financial Officers, Institute in Canada, is
defined:
"A systematic independent appraisal activity within an organization for a review
of the entire departmental operations as a service to management. The overall
objective of operational auditing is to assist all levels of management in the
effective discharge of their responsibilities by furnishing them with objective
analyses, appraisals, recommendations and pertinent comments concerning the
activities reviewed". Cont….
Audit
Ch-13
Objectives
The objectives and activities of management audit may be illustrated as below:
Management Audit Means
Review and Appraisal of an

organisation
To Locate To Search for To Suggest To Find out To Help
Better and Using the

improved Better Better and human and
Waste and methods system of more physical
deficiencies control efficient facilities in a
operation better manner
Cont….
Audit
Ch-13
Operations Audit
"An operational audit is a future-oriented,
oriented, independent and systematic evaluation
performed by the internal auditor for the management of the organizational
activities and controlled by top, middle and lower-level management for the
purposes of improving organizational profitability and increasing the attainment
of the other organizational objectives;
objectives achievement of programme purposes,
social objectives and employees, development.
development Included are an evaluation of the
management control system in terms of existence, compliance and adequacy
and the management decision-making
making process in terms of existence, compliance
and relevance to the attainment of organizational objectives. [The Institute of
Internal Auditors, Florida, USA]
In short, operational audit embraces:
1. Auditing the operational activities for efficiency and economy.
2. Auditing the organizational objectives for more improved profitability.
3. Auditing the management information and control system for effectiveness.
Audit
Ch-13
Operational Audit Management Audit Difference

Audit for management Audit of management
Audit of operations carried on as a Audit of plans, policies, objectives
Between
Result of management decisions and organizational structure
Operational
Auditing the performance for Auditit of the performances of Audit and
Management Management
Audit of the performance of Audit of the performances of

Management
Operations management
Audit
Audit of operating levels of Audit of the performance
Management management The distinction
Audit of operational arising Audit of top management between
out of management plans, functions concerning formulation of
operational
Policies and objectives Plans, policies and objectives
Extension of financial audit Extension of operational audit audit and
Levels of audit operation:
Operating personnel
Levels of audit operation: Top
management
ement personnel
management
Audit is directed towards operating Audit is directed towards the root
audit may be
levels of functioning borne out of management functional process
top management plans, policies,
summarised as
objectives and decisions
follows:
Whether the operations are carried Whether the methods of management
on as stipulated by management are effective or require changes for
and/or stipulation requires changes better management Copyright © 2008, Pradip Kumar Sinha
Audit
Ch-13
Management Control and Management Audit

Management control is vital to the effectiveness of running an organization.
Hence, it is natural that one of the main audit objectives of management auditor
will be to evaluate such control measures.
measures The main mechanisms of controls
with which the management auditor will be concerned are:
1. Nature of control process in management and administration
2. Effectiveness of control measures operating in the organisation
3. Necessity of introducing additional or changed control measures
4. Establishing standards for performance
5. Design measures to restore effective controls
6. Identify the measurable and non--measurable control factors
7. Identify any special problems of controls
Cont….
Audit
Ch-13
Conducting Management Audit

Management audit requires a review of all aspects of the managerial function
hence a multi-disciplinary approach is required. It should be conducted by a
team of experts consisting of a finance man, the operations research specialist,
the industrial engineer and the social scientist. Each team member should have
an analytical mind and an ability to look at the management function from the
overall organisation point of view.
While receiving various activities in a business undertaking, a management
auditor can adopt and use a number of techniques of verification of audit as
follows:
 Inquiry
 Examination
 Confirmation
 Observation of pertinent activities and conditions
 Correlation of information
Audit
Ch-13
Definition of Social Audit

Blake, Fredrick and Myers in their book 'Social Auditing' define social audit as
systematic attempt to identify, analyze, measure, evaluate and monitor the effect
of an organization's operations on society.
society Turnbull (1995) defines social audit as
'the process whereby an enterprise measures and reports on its performance in
meeting its declared social, community or environmental objectives. The words
'social audit' have been often used wrongly to mean activities pertaining to a
company's social programmes, social surveys etc. For example, in India
erstwhile "MAOCARO" Management and Other Companies Auditors Report
Order, the report given by the company's auditor was wrongly taken as a social
audit report.
Cont….
Audit
Ch-13
Features of Social Audit

1. Social audits adhere to the specified norms. These norms may pertain to
the government's standards of social performance, standards established by
the organization and norms set by outside agencies.
2. The aim of conducting a social audit is to influence the policies, objectives
and actions of the concerned organization to improve its social
performance.
3. Social audit is conducted by professionals who have knowledge about the
social aspects of business.
Approaches to social audit
Any one of the following approaches can be adopted to conduct a social audit:
 Inventory approach
 Programme management approach
 Cost benefit approach
Cont….
 Social indicator approach Copyright © 2008, Pradip Kumar Sinha
Audit
Ch-13
Types of Social Audit
Fredrick, Myers and Blake have identified six types of social audit. These audits
mainly differ in terms of their scope and coverage.
 Social balance sheet and income statement
 Social performance audit
 Macro-micro social indicator audit
 Constituency group attitudes audit
 Government mandated audits
 Social process or programme audit
Management Control and Emerging Areas
Ch-14
Chapter
14 Management Control
and Emerging Areas
Ch-14
Control in the Age of Empowerment

Introduction: To encourage entrepreneurship and enhance employee initiative,
managers need to give greater responsibility and authority to employees.
Managers also have to counsel and coach employees and provide them with the
resources needed to accomplish their goals. Facilitating and providing greater
autonomy to employees in achieving their goals is called employee
empowerment.
Several successful organizations have entrusted their employees with decision-
making authority. However, empowering employees and giving them greater
autonomy may have a negative implication for control. In many companies,
management control failures, following greater employee empowerment, were
responsible for losses and damaged reputation.
reputation
Another important aspect for consideration is the conflict that arises out of
control systems. Conflict is defined as "a state of disagreement or disharmony."
Ch-14
Balancing Empowerment and Control

A major problem managers face today is maintaining control, efficiency and
productivity while still giving employees the freedom to be creative, innovative
and flexible. In other words, managers have to balance empowerment and
control. How can managers protect their companies from control failures in an
environment where employees are highly empowered? One method is to revert
to the bureaucratic system of management.
management In this system, employees are told
how to do their jobs and are monitored constantly by superiors to ensure the
instructions are carried out.
Managers must find ways to encourage employees to be creative and to initiate
process improvements, but must still retain enough control to ensure that
employee creativity benefits the company.
company To avoid a trade-off between creativity
and control, managers can use the following four types of control levers or
systems:
1. Diagnostic control systems
2. Belief systems
3. Boundary systems Cont….
4. Interactive control systems Copyright © 2008, Pradip Kumar Sinha
Ch-14
Levers of Control:
Potential Organizational Blocks Managerial solution Control Lever

To achieve Lack of focus or Build and support clear Diagnostic control
resources targets systems
To contribute Uncertainty about Communicate core Belief systems
purpose values and mission
To do right Pressure or temptation Specify and enforce the Boundary systems
rules of the game
To create Lack of opportunity or Open organizational Interactive control
fear of risk dialogue to encourage systems
learning
Ch-14
Control Systems and Conflict Resolution

As organizations grow, they need to decentralize their operations. Alongwith
decentralization, they should delegate authority to the lower levels of the
hierarchy. Often, this does not happen.
happen Decentralization is not always followed
by delegation of authority. Instead stringent control measures are put in place to
prevent irregularities. This creates an atmosphere of distrust in which employees
feel alienated. They feel that it is because the top management does not have
faith in them that they have imposed such control measures.
Planning and control systems have a number of sub-systems. The sub-systems
of planning and control are:
1. Planning
2. Measuring
3. Recording
4. Appraising
5. Reporting
6. Remedial action Copyright © 2008, Pradip Kumar Sinha
Ch-14
Framework for Conflict Resolution

For conflict resolution, organizations should try to achieve goal congruency while
designing control systems. Achieving goal congruency will help in reducing
conflicts that arise from various control subsystems. A control system can be
termed as effective if it encourages managers to take actions that eventually
have a positive impact on the company.
company Finally, it is necessary for large
companies to review the mechanisms of their control systems from time to time.
They should constantly try to determine the effect of control systems on
employee creativity and motivation. For this purpose, companies can conduct
attitude surveys that measure some of the following indices:
1. Span of control
2. Levels in hierarchy and their appropriateness
3. Ratio of administrative to production personnel
4. Time span for appraisals
Ch-14
Management Control And Ethical Issues

Principles of Management Control Systems
The word 'ethics' is derived from the Greek word 'ethos,' which means character
or manners. Hence, ethics is the science of morality and recognized rules of
conduct. Business ethics is the application of ethical rules and principles to a
business environment.
Over the years, various economists and management thinkers have given
several explanations of the relationship between business and ethics. Overview
has proposed the 'separatist' on. According to this view, there is no room for
morality and ethics in business. The main aim of business should be to make
profits and maximize its shareholders' wealth. Social and moral issues should be
tackled by government and not by the business organizations. Unitarian view
opposes the separatist view. It states that, if a business wants to sustain itself for
a long-term, then morality and ethics cannot be separated from it. Ethics and
business should be combined into a new area, called as 'Business Ethics'.
Cont….
Ch-14
Identifying Control-related Ethical Issues
There are a number of ethical issues that have strong implications for control
systems within an organization. These are:
1. Creating budgetary slack
2. Responding to flawed control indicators
3. Managing earnings
4. Using excessively tight control measures
Cont….
Ch-14
Cybernetic Control Process for Developing an Ethics Programme

Organizations usually adopt a cybernetic approach to develop an ethics
programme. Such an approach consists of six steps:
1. The first step is to comply with all laws, ethical codes and policies of the
organization.
2. The second step is to sensitize all managers and employees as to what kind
of behaviour is improper.
3. The third step is to audit the behaviour of employees regarding their
interaction with all stakeholders.
4. The fourth step is to report significant deviations from the desired ethical
conduct.
5. The fifth step is to investigate violations of the prescribed ethical conduct.
6. The sixth and final step is to implement measures to correct improper
behaviour.
Ch-14
Control System Supporting The Ethics Programme

Here, we will discuss the control structures needed for supporting an ethics
programme. The given figure represents the various elements of a control
system needed for an ethics programme.
programme The control system is made up of:
1. Management style and culture
2. Infrastructure
3. Rewards
4. Co-ordination and integration
Ch-14
The Ethical Principle of Fairness in the Design of

Control Systems
The objectives of control systems are to assist managers to achieve the goals
and objectives of the organization. A control system, in which all sub systems are
designed to achieve these goals and objectives, is a goal-congruent subsystem.
For a control system to be ethical, it requires an environment conducive to
ethical conduct. This requires aligning with each stakeholder an environment that
is congruent with ethical behaviour, business objectives and stakeholder
objectives. Thus, the concept of fairness is stressed to achieve the environment
which is conducive to ethical behaviour.
behaviour
Managerial controls that go by the concept of fairness tend to create stress for,
and resentment among the employees.
employees Unfair controls result in loss of
employees' goodwill for the organization.
organization
The concept of fairness should not be confined to the employees of the
organization; it should be extended to the company's stakeholders too. Cont….
Ch-14
INFRASTRUCTURE MANAGEMENT STYLE

-Corporate responsibility AND CULTURE
committee of the board -Dimensions of morality,
-Ethics administrator responsibility and
-Human resource integrity in culture and
department style
-Legal department
-Operating department
CONTROL PROCESS
-Establish
Establish standards of conduct
using both formal and informal
means.
-Conduct
Conduct training sessions to impact
standards.
-Periodic
Periodic reports on compliance
REWARDS COORDINATION &

-Penalties and sanctions INTEGRATION
for violations - -Various ethical policies
-Positive reinforcements for and procedures.
outstanding ethical conduct -Lines of communications
for reporting violations.
Ethics committee
Control Systems for Ethics Programme
Management Control of Multinational Organisations
Ch-15
Chapter
of Multinational
Organisations
Ch-15
Introduction
This chapter will cover topics on financial management practices for the MNC.
This will include:
1. Why MNCs make capital expenditure in productive capacity in foreign lands,

rather than first producing domestically and then exploring overseas
markets.
2. International Capital Structure and cost of capital of an MNC.
3. How to adjust the present value framework for the parent firm to analyse a
capital expenditure in foreign operations.
operations
4. Issues in Cash Maintenance.
5. International tax environment and double taxation avoidance agreement.

Ch-15
Foreign Direct Investment

Through Foreign Direct Investment, a firm invests directly in facilities to produce
and/or market a product in a foreign country. Example: In the early 1980s,
Honda, a Japanese automobile company, built an assembly plant in Ohio and
began to produce cars for the North American market. These cars were
substitutes for imports from Japan. Once a firm undertakes FDI, it becomes a
Multinational Enterprise (The meaning of multinational being "more than one
country").
FDI takes on two main forms; the first is a green field investment, which involves
the establishment of a wholly new operation in a foreign country. The second
involves acquiring or merging with an existing firm in a foreign country.
Acquisition can be a minority (where the foreign firm takes a 10% to 49% interest
in the company's Share Capital and voting rights), or majority (foreign interest of
10% to 99%) or full outright stake (foreign interest of 100%).
Ch-15
Foreign Direct Investment In the World Economy

The flow of FDI refers to the amount of FDI undertaken over a given time period
(normally, a year). The stock of FDI refers to the total accumulation of foreign
owned assets at a given time.
FDI is growing more rapidly than world trade and world output for several
reasons.
1. Fear of protectionist pressure despite the general decline in trade barriers –
Example: Much of the Japanese automobile companies' investments in the
United States during the 1980s
1980 and early 1990s were driven towards
reduction of exports from Japan, thereby removing trade tensions between
nations.
2. Dramatic political and economic changes that have been occurring in many
of the world's developing nations, the general shift towards democratic
political institutions and for market economies has encouraged FDI.
Economic growth, economic deregulation and privatisation programmes that
are open to foreign investors and removal of many restrictions on FDI have
made Asia, Eastern Europe and Latin America more attractive to foreign
investors. Copyright © 2008, Pradip Kumar Sinha
Ch-15
Why do Firms Locate Production Facilities Overseas?

Some of the key factors that are important for firms to invest overseas:
1. Trade barriers
2. Imperfect labour market
When workers are not mobile because of immigration barriers, firms should
move to the workers to benefit from underpriced labour services. MNCs are
making FDIs in less developed countries such as: Mexico, China, India and
South East Asian countries like Thailand, Malaysia and Indonesia where labour
services are underpriced.
1. Intangible Assets
2. Vertical Integration
3. Product Life Cycle
4. Shareholders Diversification Services
Ch-15
Political Risk and FDI

Political risk refers to the potential losses to the parent firm resulting from the
outright expropriation of foreign assets to an unexpected change in the tax laws
that hurt the profitability of foreign projects.
projects Depending on the incidence, political
risk can be classified into two types:
1. Macro risk
2. Micro risk
Depending on the manner in which firms are affected, political risk can be
classified into three types:
1. Transfer risk
2. Operational risk
3. Control risk
Cont….
Ch-15
Measurement of Political risk

It is necessary to evaluate a set of key factors such as:
1. The host country's political and government system. If a country has too
many political parties and frequent changes in government (like Italy for
example), government policies may become inconsistent and discontinuous,
creating political risk.
2. Track records of political parties and their relative strength. This reveals a
great deal about how they would run the country.
3. Integration into the world system.
system If a country is politically and economically
isolated and segmented from the rest of the world, it would be less willing to
observe the rules of the game.
4. The host country's ethnic and religious stability, e.g. Rwanda, Northern
Ireland, Israel, Sri Lanka.
5. Regional security: Real and potential aggression from a neighbouring
country is a major source of political risk. Kuwait is a recent example.
Ch-15
International Capital Structure and Cost of Capital

Recently many firms throughout the world have begun to internationalise their
capital structure by raising funds from foreign as well as domestic sources. This
trend reflects not only a conscious effort on the part of the firms to lower the Cost
of Capital by international sourcing of funds but also the ongoing liberalisation
and de-regulation of international financial markets that become accessible to
many firms.
If international financial markets are completely integrated, it would not matter
whether the capital hailed from domestic or foreign sources since the cost of
capital would be equal across countries.
countries
Cost of Capital
The Cost of Capital as we have seen is the minimum rate of return an
investment project must generate to pay its financing cost. When a firm identifies
and undertakes an investment project that generates a return exceeding its Cost
of Capital, the firm's value will increase.
increase It is thus important for a value-
maximising firm to try to lower its Cost of Capital. Copyright © 2008, Pradip Kumar Sinha
Ch-15
International Capital Budgeting

The main added complications which distinguish a foreign project from a
domestic project can be summarised as follows:
1. Project cash flows versus parent cash flows
2. Exchange risk and capital market segmentation
3. Political and country risk
4. International Taxation
5. Blocked Funds
Ch-15
Cash Management In Multinational Corporations

With the existence of branches/subsidiaries in different countries, MNCs have
the scope and the need to mobilize and deploy cash in multiple currencies.
Hence, cash management in MNCs has become significant.
Multinational corporations, by virtue of their presence in different countries, have

access to much wider international money markets. Hence, there is a need for
the finance manager to develop a strategy to meet the requirements of the MNC
which proposes either to mobilise funds or to deploy the surplus cash in
investments. The objective of cash management is (i) to maximise the return by
proper allocation of short-term investments, and (ii) to minimise the cost of
borrowing in different money markets..
Cont….
Ch-15
To achieve the above objective, MNCs have to evolve a strategy by taking the
following aspects into consideration:
1. The borrowing cost in a particular currency and the relationship between
nominal interest rate between the currencies and anticipated exchange
rates of the currencies (International Fisher effect).
2. The exchange risk of the MNC consequent to the firm's exposure in different
currencies with regard to the receivables and payables.
3. The level of risk acceptable to the management of the MNC.
4. The availability of tools for hedging.
hedging
5. Tax structure prevailing in various countries.
6. Political environment and the consequent risk relating to various countries.
MNCs have access to various international financial instruments like CPs,
Banker's acceptances, CDs and bank loans etc., for their short-term borrowing
or investment. Copyright © 2008, Pradip Kumar Sinha
Ch-15
International Taxation
The international tax environment is useful to multinational firms in their tax
plannings and also informative to investors in international financial assets.
 Income Tax
 Withholding Tax
 Value Added Tax
 Worldwide Taxation
 Territorial Taxation
 Foreign Tax Credits
Ch-15
Alternative Organisation Structures to Plan Tax

Liabilities
Different forms of structuring a multinational organisation within a host country
can result in variation in tax liabilities for the multinational organisation. These
are being discussed below.
Branch and Subsidiary Income
An overseas alternate of an MNC can be organised as a branch or a subsidiary.
A foreign branch is not an independently incorporated entity separate from the
parent; basically, it is an extension of the parent. Consequently, active or passive
foreign source income earned by the branch will be consolidated with the
domestic source income of the parent for determining the parent's tax liability,
regardless of whether the foreign income has been repatriated to the parent in
the foreign country or not.
A foreign subsidiary is an affiliate organisation of the MNC that is independently
incorporated in the foreign country with the parent owning at least 10% of the
voting equity stock. A foreign subsidiary in which the parental owns more than
10% but less than 50% of the voting equity is a minority foreign subsidiary or an
uncontrolled foreign subsidiary. Copyright © 2008, Pradip Kumar Sinha
Ch-15
Transfer Pricing-Payments
Payments to and from Foreign
Affiliates
MNCs in order to minimise their global tax liability, can have suitable transfer
pricing strategies. Transfer price is an accounting value assigned to a good or
service transferred from one affiliate to another. With higher transfer price, the
larger will be the gross profit of the transferring division relative to the receiving
division. Consequently, it is beneficial to follow a high mark-up policy on
transferred goods and services from the parent to a foreign affiliate when the
income tax rate in the host country is greater than the tax rate in the parent
company because of lower taxable income in the high-tax cost country. On the
other hand, when the parent company has a higher tax rate, a low mark up
policy will enable higher taxable income in the host country and corresponding
higher dividend remittance, which again will bear the high tax rate. However, if
foreign source retained earnings were needed for re-investment in the host
country, a low mark -up policy would result in tax savings (assuming that
undistributed profits are not subject to high tax in the host country). Cont….
Ch-15
Tax Haven
A tax haven country is one that has a low corporate income tax and low
withholding tax rates on passive income.
income Some major tax haven countries are
the Bahamas, Bahrain, Bermuda, British Virgin Islands, Cayman Islands,
Channel Island and the Isles of Manama.
Manama
Fronting Loans
A fronting loan is a loan between a parent and its subsidiary channelled through
a financial intermediary, usually a large international bank. In a direct intra-firm
loan, the parent company lends cash directly to the foreign subsidiary and the
subsidiary repays it later. In a fronting loan, the parent company deposits funds
in an international bank, and the bank then lends the same amount to the foreign
subsidiary. Thus, a US firm might deposit $ 100,000 in a London bank. The
London bank then lends that $100,000 000 to an Indian subsidiary of the firm. From
the bank's point of view, the loan is risk-free because it has 100% collateral in
the form of the parent's deposit. The bank 'fronts' for the parent, hence the
name. The bank makes a profit by paying the parent company a slightly lower
rate on its deposit than it charges the foreign subsidiary on the borrowed funds.
Ch-15
Deposit $ 1 million Loan $ 1 million
London
Tax haven subsidiary Bank Foreign operating subsidiary
-free)
Pays 8% interest (tax Pays 9% interest (tax
- deductible)
An example of tax aspects of fronting loan
Cont….
Ch-15
Tax Treaties: The Elimination of Double Taxation

The primary purpose of tax treaties is to prevent international double taxation or
to provide remedies when it occurs.
occurs The general pattern between two treaty
countries is to grant reciprocal reductions on dividends withholding and to
exempt royalties and sometimes interest payments from any withdrawing tax.
Double Taxation Avoidance Agreement
The Central Government under Section 90 of the Income Tax Act, 1961 has
entered into double tax avoidance agreement (hereinafter referred to as Tax
Treaties) with other countries. These tax treaties serve the purpose of providing
protection to tax payers against double taxation and thus, preventing any
discouragement which the double taxation may otherwise promote in the free
flow of international trade, international investment and international transfer of
technology. These treaties aim at preventing discrimination between the tax
payers in the international field and providing a reasonable element of legal and
fiscal certainty within a legal framework.
framework
Ch-15
Control Strategies
Control is necessary to achieve international objectives. It is much more than just
the ownership of some voting share to direct company policy. Control is
management planning, implementation, evaluation and correction of
performance to ensure that the organisation meets its objectives. The top
management's toughest challenge is to balance the company's global needs with
its need to adapt to country level differences.
differences
Control keeps a company's decisions or strategies on track. Control is also
needed so that individuals may make decisions that may endanger the entire
company.
Several factors make control more difficult internationally than it is
domestically:
1. Distance
2. Diversity
3. Uncontrollable
Cont….
4. Degree of Certainty Copyright © 2008, Pradip Kumar Sinha
Ch-15
Although the above factors make control more difficult in the international
context, managers try to ensure that foreign operations comply with overall
corporate goals and philosophies. The following are the five aspects of the
international control process.
i. Planning
ii. Organisation Structure
iii. Location of decision-making
iv. Control mechanism
v. Special situations including the dynamics of control
Cont….
Ch-15
The various structures are given below:

CEO
Industrial Automotive Electronics International

Division Division Division Division
Diesel Company Electronics Brake

Country I Company Company
Country I country2
CEO
International Division Structure

Production Marketing
Marketing Marketing
Prod. North Production North America Europe
America Europe
Cont….
Functional Division Structure Copyright © 2008, Pradip Kumar Sinha
Ch-15
CEO
Power system Industry Group

Group
Elevator Construction
Electric Co Meter Co Company Prod, Italy
(Belgium) (Argentina) Belgium
Product Division Structure

CEO
Europe & Latin North America &

America Divisions Pacific Division
US Japan Canadaa
UK Venezuela Italy
Belgium
Matrix Division Structure Copyright © 2008, Pradip Kumar Sinha
Ch-15
Matrix Organization Structure and the Multinational Firm

The problem of achieving coordination and efficiency in multinational enterprises
differ from domestic product organization in two ways:
1. There is a greater geographical dispersion of various units of the enterprise.
As a result, multinational firms often subdivide their organization by areas of
the world; each division is responsible for all products in each geographical
area. The divisions are often careful enough to employ fully each of the
functions within the division and achieve significant economies of scale, with
some loose coordination of each function among various divisions taking
place at headquarters.
2. Such each division of a multinational firm is responsible for sale and
sometimes, production of all the company's products in a given area of the
world, little attention can be given to the development, in production and
coordination of a given product for the company as a whole. This intensifies
the need for the matrix structure..
Ch-15
Exchange Risk Management

Foreign exchange exposure results in foreign exchange risk due to anticipated
variability in exchange rates. As business becomes increasingly global, more
and more firms find it necessary to pay careful attention to foreign exchange
exposure and to design and implement appropriate strategies to handle such
risks. Suppose, for example, that the US dollar substantially depreciates against
the Japanese yen, the change in exchange rate can have significant economic
consequences for both US and Japanese firms. For example, it can adversely
affect the competitive position of Japanese car makers in the highly competitive
US market by forcing them to raise dollar prices of their cars by more than their
US competitors do.
Changes in exchange rates can affect not only firms that are directly engaged in
international trade but also purely domestic firms. For example, a US bicycle
manufacturer that sources only domestic materials and sells exclusively in the
US market with no foreign currency receivables or payables in its accounting
book, can be subject to foreign exchange exposure if it competes against
imports say from a Taiwanese bicycle manufacturer. Cont…. Copyright © 2008, Pradip Kumar Sinha
Ch-15
Currency Exposure
Short-term Long-term
Accounting Cashflow Operating Strategic

(Translation)
Contractual Anticipated
(transaction)
Schematic picture of currency exposure

Cont….
Ch-15
Transaction Exposure
This is a measure of the sensitivity of the home currency value of assets and
liabilities which are denominated in foreign currency, to unanticipated changes in
the exchange rates, when the assets or liabilities are liquidated. The foreign
currency values of these items are contractually fixed i.e., they do not vary with
exchange rate.
Some examples that lead to transaction exposure are:
1. A currency has to be converted in order to make or receive payment for
goods and services.
2. A currency has to be converted to repay a loan or make an interest payment
(for foreign currency loan) or receive a repayment of loan or an interest
on loan and advances (denominated in foreign currency).
3. A currency has to be converted to make a dividend payment, royalty
payment (to overseas shareholders or overseas collaborators).
The important points to be noted are:are
1. Translation exposures usually have short-term horizons and
Cont….
2. Operating cash flows are affected.
affected
Ch-15
Strategic Exposure
Competitive exposure is often referred to as "Statistic Exposure" because it has
significant implications for some strategic business decisions. It influences the
firm's choice of markets, products, source of inputs, location of manufacturing
activity and decisions as to whether foreign operation should be started.
A number of examples from recent history clearly bring out the nature of
operating exposure:-
1. The increase in dollar during the first half of the 1980s eroded the
competitive position of many US firms where the costs were dollar
denominated, e.g. Kodak found that their sales were spread all over the
world, whereas the costs were dollar denominated. They faced stiff
competition from Japanese firms such as Fuji both in the US market as well
as third country markets.
2. Further, when the dollar started falling against the yen and the deutsche
mark around mid-1985 and continued to fall for over two years, Japanese
and German car makers found their operating margins being squeezed.
They responded by starting manufacturing in the US and partly by moving
up into premium priced luxury cars where consumer sensitivity to price
increases is relatively less. Cont…. Copyright © 2008, Pradip Kumar Sinha
Ch-15
Management of Exchange Risk
Transaction exposure: A firm is subject to transaction exposure when it faces

contractual cash flows that are fixed in foreign currencies. Suppose that a US
firm sold its product to a German customer on three month credit terms and
invoiced in Euro. When the US firm receives Euros in three months, it will have
to convert (unless it hedges) the Euro into dollar at the spot exchange rate
prevailing on the maturity date, which cannot be known in advance. As a result,
the dollar receipt from this export sale becomes uncertain; should the Euro
appreciate (depreciate) against the dollar, the dollar receipt will be higher (lower).
Cont….
Ch-15
The above example suggests that whenever the firm has foreign currency
denominated receivables or payables, it is subject to transaction exposure and
their settlements are likely to affect the firm's cash flow position. The various
ways of hedging transaction exposure are as follows:
Financial contracts
1. Forward market hedge
2. Future market hedge
3. Option market hedge
4. Money market hedge
Operational techniques
1. Exposure netting
2. Heading and lagging
3. Hedging by choosing the currency of invoice
4. Hedging through sourcing Copyright © 2008, Pradip Kumar Sinha
Management Control of Projects
Ch-16
Chapter
of Projects
Ch-16
Nature of Projects
A project is a set of activities intended to accomplish a specified end result of
sufficient importance to be of interest to management. Projects include
construction projects, the production of a sizable unique product (such as,
turbine), rearranging a plant, developing and marketing a new product,
consulting engagement, audits, acquisitions and divestitures, litigation, financial
restructuring, research and development work, development and installation of
information systems and many others.
others
A project begins when management has approved the general nature of what
has to be done and has authorized the approximate amount of resources that
are to be spent in doing this work. The project ends when its objective has been
accomplished e.g. completion of the construction of a building, completion of
development project may lead to an ongoing operation.
Cont….
Ch-16
Difference of Management Control of Project with Management Control of

Ongoing Operations
Different characteristics of projects:
projects
1. Single objective
2. Organisation structure
3. Focus on the project
4. Need for trade-offs
5. Less reliable standards
6. Frequent changes in plans
7. Different rhythm
8. Greater environmental influence
9. Information structure Cont….
Ch-16
A-In
In an Operating Organisation
Annual Planning
Programming
Strategies
Revisions
Execution
Evaluation
Cont….
Ch-16
Phases of Management Centre
Programming Detailed
Decision to Revision Revision
Planning
undertake
Final
Evaluation Evaluation Evaluation
Phase 1 Phase 2 Phase 3

execution execution execution
Work
Time Start Complete
Ch-16
The Control Environment

Project Organization Structure
A project organization is a temporary organization. A team is assembled for
executing the project, and the team is disbanded when the project is completed.
Team members may be employees of the sponsoring organization, they may be
hired for the purpose, or some or all of them may be engaged under a contract
with an outside organization.
If the project is contracted entirely or partly by an outside contractor, the project
sponsor should quickly establish satisfactory working arrangements with the
contractor's personnel. These relationships are influenced by the terms of the
contract.
 Matrix organization
 Evaluation of organization structure
Cont….
Ch-16
Contractual Relationships
If the project is conducted by an outside contractor, an additional level of project

control is required. In addition to the control exercised by the contractor who
does the work, the sponsoring organization has its own control responsibilities.
The contractor may bring its own control system to the project, and this system
may need to be adopted to provide the information that the sponsor needs.
The form of contractual arrangement has an important impact on management

control. Contracts are of two types: fixed price and cost reimbursement, with
many variations within each type.
Cont….
Ch-16
Information Structure
 Work packages
In a project control system, information is structured by elements of the
project. The smallest element is called a work package, and the way in
which these work packages are aggregated is called the work breakdown
structure.
A work package is a measurable increment of work, usually of fairly short
duration (a month or so). It should have an unambiguous, identifiable
completion point, which is called a milestone. Each work package should be
the responsibility of a single manager.
manager
 Indirect cost accounts
In addition to work packages for direct project work, cost accounts are
established for administrative and support activities. Unlike the work
packages, these activities have no defined output. Their estimated costs
usually are stated as per unit of time, such as, a month, just as the
overhead costs of ongoing responsibility centres are stated.
Ch-16
Project Planning
In the planning phase, the project planning team takes as a starting point the
rough estimates that were used as the basis for the decision to undertake the
project. It refines these estimates into detailed specifications for the product,
detailed schedules and a cost budget.
budget It also develops a management control
system and underlying task control systems and an organization chart. The
boxes on this organization chart are gradually filled with the names of personnel
who are to manage the work.
Nature of the Project Plan
The final plan consists of three related parts: scope, schedule, and cost.
The scope part states the specifications of each work packages and the name of
the person or organization unit responsible.
responsible
The schedule part states the estimated time required to complete each work
package and the interrelationships among work packages, that is, which work
packages should be completed before another can be started. The set of these
relationships is called a network.
Costs are stated in the project budget, usually called the control budget. Cont….
Ch-16
Network Analysis
Scheduling techniques
All activities consume resources of three kinds viz, time, men and materials (or
money). The project scheduling techniques are concerned with the resource
'time'. One of the objectives of project management is to optimize the use of
resources. Scheduling techniques offer solutions to optimizing the project time.
Bar charts
Bar chart is a pictorial representation showing the various activities involved in a

project. The chart has two co-ordinate
ordinate axes, one axis represents the activities
and the other activities represent the time required for completion of the
individual activities. Bar chart was first developed by Henry L.Gantt and hence,
referred as Grantt chart.
Ch-16
Critical Path Method

A network represents the logical sequence of activities contained in a project.
The activities are represented by arrows and arrows flow from the left to right. In
a network, there may be many paths starting from the initial event and leading to
the last event. If the duration of all activities that lie on a particular path is added,
it gives the duration of that path. Each path in a network will have different
duration. The path that has the longest duration is called the critical path and the
activities that lie on the critical path are called critical activities. It is the critical
path that sets the overall duration of the project. If there are say five paths in a
network and if the duration of these paths are say 15 weeks, 13 weeks, 14
weeks, 25 weeks and 26 weeks respectively, the path having 26 weeks duration
is the critical path. This represents that the project duration is 26 weeks. Though
other paths in the network have duration less than 26 weeks, the project will be
completed in all respects only by the end of 26th week. This path that has the
Cont….
duration of 26 weeks is called the critical path. Copyright © 2008, Pradip Kumar Sinha
Ch-16
Characteristics of Critical Path
1. A critical path is the longest path (time-wise) connecting the initial and final
event.
2. A critical path may run through dummy activity/activities.
3. The number of activities lying on a critical path may be less than the number
of activities in other non-critical paths.
paths
4. It is possible that the network may have more than one critical path i.e., if
two or more paths have the same time duration which is maximum then all
such paths will have critical paths.
paths
Ch-16
Programme Evaluation and Review Technique (PERT)

The critical path method (CPM) uses only one time estimate for each activity,
whereas PERT uses three time estimates.
estimates These estimates are used for each
activity with a view to overcoming the uncertainty in project time estimate:
1. Optimistic time estimate
2. Pessimistic time estimate
3. Most likely time estimate
Expected Time Estimate
PERT assumes that the optimistic time (to) the pessimistic time (tp) are equally
likely to occur while the most likely time™ is four times more likely to occur than
the other two. Hence, for arriving at the expected time (te) equal weights are
assigned to ‘to’ & ‘tp’ while the weight of ‘tm’ is taken as 4 times that of ‘to’ and
‘tp’:
Accordingly, te =to+4tm+tp/ 6.
Ch-16
Graphical Evaluation and Review Technique (GERT)

Graphical Evaluation and Review Technique is similar to PERT, except that it
allows multiple project activities by way of looping and branching project
activities. Suppose an activity fails due to some unavoidable reasons, then the
project manager has to look for alternative ways to obtain the end result.
Similarly, some of the activities may not be carried out at all, some way be
partially carried out and some that may be repeated. PERT cannot show
alternative plans in a single network diagram.
diagram GERT overcomes these problems
as it shows alternative ways to continue the project.
Ch-16
Duration Compression Techniques

When the project manager finds that the expected completion time of the project
is more than the desired time, he attempts to reduce the project time by
compression techniques like crashing, fast tracking etc.
Crashing: Here, the project manager reduces the project duration by allotting
more resources, subcontracting some activities, using more labour, etc. The
following are the types of activities that are considered for crashing.
1. A critical activity of the project.
2. An activity of longer duration.
3. An activity that has low per unit crash cost.
4. An activity that does not cause any quantity problems, if crashed.
5. An activity that is labour intensive.
intensive
Cont….
Ch-16
Fast tracking
In this technique, the project manager attempts to reduce the project duration by
doing project activities in parallel. Suppose activity B can be started only after
the completion of activity A in normal conditions. But the project manager can
start both activities at the same time, but makes modifications to activity B as per
the changes in activity A. This, ultimately, reduces the duration of the entire
project.
Schedule control
Schedule control studies all the factors that affect project schedules. Schedule
determines the schedule changes and manages to complete them within the
desired duration. Based on the changes, the project manager updates the
project schedule.
The project manger has to consider the project schedule, performance reports
and change requests while controlling the schedule. The project schedule
represents the planned start and expected finish dates for each project activity.
Ch-16
Computer Aided Project Management

When the size of the project increases, it becomes difficult and, at times, even
impossible to plan, schedule, budget and control activities using manual
techniques. Hence, for larger projects, the task is made easier with the help of
computers. It is therefore necessary to have Computerized Project Management
System (CPMS) for projects of bigger size and complex nature. The advantages
of using CPMS are as under:
1. CPMS can analyze the problem at very high speed as compared to manual
analysis. Because of its high speed, any number of permutations and
combinations can be handled with ease which cannot be done manually.
For example, sensitivity analysis of profitability estimate can be done using
computers by varying the different parameters and studying their impacts on
profit.
2. Since computers can store and process large volumes of data, CPMS is
best suited for large and complex projects that require the handling and
analysis of voluminous data.
3. Accuracy of results produced by CPMS can be relied upon while there is
Cont….
element of committing mistakes in manual computations. Copyright © 2008, Pradip Kumar Sinha
Ch-16
Essential Requirements of Project Management Softwares
Some of the common, but essential requirements of project management
softwares are as under:
1. The project management softwares should be able to handle multiple
projects together.
2. It should support a variety of graphs and reports in different formats.
3. It should have filtering capacity to extract a set tasks and milestones from a
scheme for the purpose of analysis and for producing the required reports.
4. It should support a range of file formats for importing and exporting data.
Some of the features of project management softwares that are desired as
under:
1. The project management softwares should be as far as possible, one that is
compatible with the software currently being used by the organization.
2. It should be easy to learn and easy to implement.
3. It should have extensive online help so that the learner will gain confidence
in putting the software to use without apprehension.
4. It should have the capacity to solve a wide range of problems. Cont….
Ch-16
Software packages for CPMS

Some of the popular software packages used in project management is as
under:
1. Microsoft Project
2. Harvard Total Project Manager
3. Project Planner
4. PRISM
5. YOGNA
6. INSTA PLAN
7. Quick Net
8. PC-projaks
9. Proman
10. Project Scheduler 8 etc. Cont….
Ch-16
Estimating costs
For practical reasons, cost estimates are often made at a level of aggregation
that incorporates several work packages.
packages Resources used on individual work
packages are controlled in terms of physical quantities, rather than cost, and
costing out each work package would serve no useful purpose.
Preparing the control budget
The control budget is prepared close to the inception of the work, allowing just
enough time for approval by decision makers prior to the commitment of costs.
For a long duration project, the initial control budget may be prepared in detail
only for the first phase of the project, with fairly rough cost estimates for later
phases. Detailed budgets for the later phases are prepared just prior to the
beginning of work on these phases. Delaying preparation of the control budget
until just prior to the start of work ensures that the control budget incorporates
current information about scope and schedule, the result of cost analyses, and
current data about wages rates, material prices, and other variables.
Ch-16
Project Execution
At the end of the planning process, there exists for most projects a specification
of work packages, a schedule, and a budget; also, the manager who is
responsible for each work package is identified. The schedule shows the
estimated time for each activity, and the budget shows estimated costs of each
principal part of the project. This information often is stated in a financial model.
If resources to be used in detailed work packages are expressed in non-
monetary terms, such as, the number of person-days required, the control
budget states monetary costs only for a sizable aggregation of individual work
packages. In the control process, data on actual cost, actual time and actual
accomplishment are compared with these estimates. The comparison may be
made either when a designated milestone in the project is reached or at
specified time intervals, such as: weekly or monthly.
Cont….
Ch-16
Nature of Reports
Managers need three different types of reports: trouble reports, progress reports,
and financial reports.
Quantity of Reports
In order to avoid unnecessary reports in the course of the project, a review of the
set of reports often is desirable to eliminate some reports and simplify others.
 Percent complete
 Summarizing progress
 Punch list
Use of Reports
 Trouble reports
 Progress reports
 Cost to complete
 Informal sources of information Cont….
Ch-16
Project Auditing
In many projects, the audit of quality is done in time. If it is delayed, defective

work on individual work packages may be hidden they are covered up by
subsequent work e.g. the quality of plumbing work on a construction project
cannot be checked after walls and ceilings have been finished.
In some projects, the audit of costs also is done as the work progresses; in
others, the cost audit is not made until the project is completed.
In recent years, internal auditors have expanded their function into what is called
operational auditing. In addition to examining costs incurred, they call attention to
management actions that they believe, are substandard. Properly done
operational auditing can be useful.. The auditors should second-guess the
actions, managers have taken in the light of the circumstances prevailing at the
time decisions are taken.
Ch-16
Project Evaluation
The evaluation of projects has two separate aspects: (1) an evaluation of
performance in executing the project;
project and (2) an evaluation of the results
obtained from the project. The former is carried out shortly after the project has
been completed, the latter may not be feasible until several years alter.
Evaluation of Performance
The evaluation of performance in executing the project has two aspects:
1. An evaluation of project management-the

management purpose is to assist in decisions
regarding project managers including rewards, promotions, constructive
criticisms, or reassignment.
2. An evaluation of the process of managing the project-to discover better

ways of conducting future projects.
projects In many cases, these evaluations are
informal. Cont….
Ch-16
Evaluation of Results
The success of a project cannot be evaluated until enough time has elapsed to
permit measurement of its actual benefits and costs. This may take years.
Unless the impact can be specifically measured, such an evaluation may not be
worthwhile. For example, the benefits of installing a labour saving machine will
not be identifiable, if the resulting costs are buried in a variety of product costs
and not separately traced to the new machine. Furthermore, there is no point in
attempting to evaluate a project unless some action can be taken based on this
analysis.
For many projects, evaluation of results is complicated by the fact that the
expected benefits were not stated in objective, measurable terms, and the actual
benefits also were not measurable.
A Guide to Case Analysis in Management Control Systems
Ch-17
Chapter
17 A Guide to Case Analysis

in Management Control
Systems
Ch-17
Introduction
In most courses in business management, cases are being used about actual
companies to practise strategic analysis and to gain some experience in the
backdrop of theories, principles and methodology i.e., that have been taught. A
case sets forth in a factual manner, the events and organizational circumstances
surrounding a particular managerial situation.
situation It puts readers at the scene of the
action and familiarizes them with all the relevant circumstances. The essence of
case analysis is to diagnose and size up the situation described in the case and
then to recommend appropriate action steps.
Why use cases to practise management?
A student of business with tact
Absorbed many answers he lacked
But acquiring a job
He said with a sob
Cont….
"How does one fit answer to fact?" Copyright © 2008, Pradip Kumar Sinha
Ch-17
Objectives of Case Analysis
Using cases to learn about the practice of management is a powerful tool to
accomplish five things:
1. Increase in one's understanding of what managers should and should not
do in guiding a business to success.
success
2. Build one's skills in sizing up company resource strengths and weaknesses,
and in conducting strategic analysis in a variety of industries and
competitive situations.
3. Get valuable practice in identifying strategic issues that need to be
addressed, evaluating strategic alternatives and formulating workable plans
of action.
4. Enhance one's sense of business judgement, as opposed to uncritically
accepting the authoritative crutch of the professor or "back-of-the-book“
answers.
5. Gaining in-depth exposure to different industries and companies, thereby
acquiring something close to actual business experience. Cont….
Ch-17
Preparing a Case for Discussion
To prepare a case for discussion, the following approaches are suggested:
1. Skim the case rather quickly to get an overview of situation it presents
2. Read the case thoroughly to assimilate the facts and circumstances
3. Carefully review all the information presented in the exhibits
4. Decide what the strategic issues are
5. Start your analysis of the issues with some number crunching
6. Apply the concepts and techniques of strategic analysis that have been
studied
7. Check out conflicting opinions and make some judgements about the
validity of all the data and information provided
8. Support your diagnosis and opinions with reasons and evidence
9. Develop an appropriate action plan and set of recommendations Cont….
Ch-17
The 10 Commandments of Case Analysis

Given below are "The 10 commandments of Case Analysis" which summarises
how to approach the task of case analysis.
analysis If one observes all or even a majority
of these recommendations faithfully by preparing a case either for class
discussion or for a written report, the chances of doing a good job on the
assigned cases will be improved.
1. Go through the case twice, once for quick review and another to gain full
details of the facts, and then take care to explore the information in each of
the exhibits.
2. Make a complete list of the problems and issues that the company's
management needs to address.
3. Be thorough in your analysis of the company's situation. Work through the
case preparation exercises or make a maximum of one or two pages of
notes detailing your diagnosis.
4. Use every opportunity to apply the concepts and analytical tools in the text
chapters and you are expected to apply them in analyzing the cases. Cont….
Ch-17
5. Do enough number crunching to discover the story told by the data
presented in the case.
6. Support any and all opinions with well-reasoned arguments and numerical
evidence; don't stop until you can purge "I think" and "I feel" from your
assessment and instead be able to reply completely on "My analysis
shows".
7. Prioritize your recommendations and make sure that they can be carried out
in an acceptable time frame with the available resources.
8. Support each recommendation with persuasive argument and reasons as to
why it makes sense and should result in improved company performance.
9. Review your recommended action plan to see if it addresses all of the
problems and issues you identified - any set of recommendations that does
not address all of the issues and problems you identified is incomplete and
insufficient.
10. Avoid recommending any course of action that can result in unfavourable
consequences if it doesn't work out as planned; therefore, be as alert to the
downside risks of your recommendations as you are to their upside potential
and appeal. Copyright © 2008, Pradip Kumar Sinha
Managerial Costing – Traditional Systems and Activity Based
Systems
Ch-18
Chapter
18 Managerial Costing –
Traditional Systems and
Activity Based Systems
Systems
Ch-18
Introduction to Cost Systems

The primary goal of cost systems is to provide information for decision making
like pricing products, managing costs, selecting market segments and
distribution channels, evaluating make-buy and outsourcing decisions,
establishing transfer prices, evaluation of plant closing and making capital
investment, and abandonment decisions etc.
Designing of Costing Systems
Direct costs, usually labour and material traced directly to the cost object.
Overheads are allocated to products through a two-stage process:
1. In the first stage, overhead costs are allocated to cost pools (e.g. machines,
departments and so on) using predetermined allocation criteria or cost
drivers.
2. In the second stage, costs allocated to cost pools, are again allocated to
cost objects (for example, products) using cost drivers, which are chosen to
capture a product’s consumption of overheads costs. The two-stage
procedure is given in the Figure Cont…. Copyright © 2008, Pradip Kumar Sinha
Systems
Ch-18
The two-stage
stage procedure
Resources
Allocate
Overhead
Cost pools
Allocate
Overhead
Trace direct costs Products
Traditional costing methods had little trouble in tracing direct labour and direct
material to cost objects. But overhead allocation, both in the first stage and in the
second, have been problematic leading to very inaccurate measurement of
product costs as well as costs associated with other decisions.
Systems
Ch-18
Type of system used for
existing products/services
Actual Costing
Systems
Standard
Costing Systems
Activity-based
Costing Systems Cost Systems
Nature of process Whereby
goods/ services are produced
*Unique product *Unique product *Unique product or
Options
or services or services services
*Actual direct *Standard direct *Actual or standard
labour and labour and direct labour and Cost system design
material charges material charges material charges
Job order production
*Standard
overhead rates
*Standard
overhead rates
* Actual or
Standard overhead
options are given below:
*Relatively few *Relatively few rates
first and second first and second *Mutiple first and
stage drivers for stage drivers for second stage
overhead overhead drivers for
overhead
*Homogeneous *Homogeneous *Homogeneous
products or products or products or
services. services. services.
*Actual direct *Standard direct *Actual or standard
labour and labour and direct labour and
Process production material charges. material charges. material charges.
*Actual overhead *Standard *Actual or
charges overhead charges standard overhead
* Relatively few * Relatively few charges
first and second first and second * Multiple first and
stage drivers for stage drivers for second stage
overhead overhead. drivers for
*Variances overhead
computed for
processes
Mixed Job order / Process Combines elements of job order and process production and Cont….
Production uses all three costing systems Copyright © 2008, Pradip Kumar Sinha
Systems
Ch-18
Factors Leading to Emergence of Activity Based Costing
Traditional product costing systems were designed decades ago when most
companies manufactured a narrow range of products, and direct labour and
materials were the dominant factory costs.
costs Overheads were relatively small and
distortion (if any) resulting from inappropriate overhead allocations were not
significant. Information processing costs were high and it was therefore difficult
to justify more sophisticated overhead allocation methods.
In today's scenario, companies produce a wide range of products, direct labour
represents only a small fraction of time costs and overhead costs are of
considerable importance.
Limitations of traditional costs systems
Traditional costing systems accurately measured volume-related resources that
are consumed in proportion to the number of units produced of the individual
products. Such resources include direct labour, materials, energy and machine-
related costs. Cont….
Systems
Ch-18
What is Activity based Costing system?
ABC system assumes that activities cause costs and that products (and
customers) create the demands for activities. Costs are assigned to products
based on individual products consumption or demand for each activity. ABC
system recognizes that business must understand the factors that drive each
major activity, the cost of activities and how activities relate to products. An
outline of an ABC system is given below:
below
1. Identify the major activities that take place in the organization.
2. Determine the cost driver for each major activity.
3. Create a cost centre/cost pool for each major activity.
4. Trace the cost of activities to products according to a product’s demand for

Cont….
activities. Copyright © 2008, Pradip Kumar Sinha
Systems
Ch-18
Comparison Between Traditional and Activity-based

Activity Cost Allocation
a) Traditional costing system
Overhead Cost Accounts

(For each individual category of expenses e.g. property taxes, depreciation)
First Stage
Allocation
Cost Centre I Cost Centre 2 Cost Centre N
(normally dept) (Normally dept) (Normally depts .)
Second Stage
Allocation
(Direct Labour
or Machine Hour
Direct Cost Cost objects (products, services, customers)
Cont….
Systems
Ch-18
b) Activity based costing system
Overhead Cost Accounts

(For each individual category of expenses e.g. property taxes, depreciation)
First Stage
Allocation
(Resources cost
Drivers)
Activity Activity Activity
Cost Centre I Cost Centre 2 Cost Centre N
Second Stage
Allocation
(Activity Cost
Drivers)
Direct Cost Cost objects (products, services, customers)
Two stage allocation process for traditional and activity based costing system. Cont….
Systems
Ch-18
Benefits of ABC
1. Activity-based costing results in the identification of activities that need to
cut in order to reduce costs. These activities include set-ups, material
handling and transportation. Set up overheads may be reduced by reducing
the time to set-up, by producing larger batches with fewer resultant set-ups
and by using factory workers rather than more expensive indirect labour to
perform set-ups. Material handling costs may be reduced by making fewer
deliveries to, and from the factory.
factory
2. An ABC study may convince management that they must take a number of
steps to become more competitive.
competitive As a result, they could attempt to
increase quality while simultaneously focusing on reducing costs.
3. With the improved costs analysis management could conduct more
accurate analysis of the volume required to break-even on low volume
products.
4. Management will be in a position to make more competitive bids.
5. Through an analysis of cost data and resource consumption patterns,
management can begin to re-engineer
re the manufacturing process to
Cont….
achieve more efficient and higher quality output patterns. Copyright © 2008, Pradip Kumar Sinha
Systems
Ch-18
Use of ABC Information in Decision-making

Decision
1. Pricing
2. Market segments and distribution channels
3. Make-buy
buy decisions and outsourcing
4. Transfer pricing
5. Plant closings
6. Capital investment
Systems
Ch-18
Target Costing
When a company wants to introduce a new product, it must determine the price
to be charged based on products already on the market of similar function and
quality. A target cost is the maximum manufactured cost for a product and is
calculated by subtracting required margin on sale from expected market price.
Target costing is a market-driven design methodology and involves estimating a

cost for a product and then designing the product to match the cost.
Target costing is a cost management tool for reducing product costs over its
entire life cycle. It becomes an important reference point for cost management.
Target costing includes actions management must take to establish reasonable
target costs, develop methods for achieving those targets and develop means by
which to test the cost effectiveness of different cost-cutting scenarios.
Cont….
Systems
Ch-18
Several stages to the methodology

1. Conception (Planning) phase:
i. Competition products should be analysed with regard to price, quality,
service and support, delivery and technology.
ii. After preliminary testing, the company should be able to pinpoint a
market niche, it believes, is under supplied and which might have some
competitive advantage.
2. Development phase:
i. The design department should subject the most competitive product on
the market to reverse engineering analysis.
ii. After trying to identify the cost structures of the competitor, the
company should develop estimates for the internal cost structure based
on internal costs of similar products being produced by the company.
iii. After preliminary analysis of the cost structures of both competition and
itself, the company should further define these cost structures in terms
Cont….
of cost drivers. Copyright © 2008, Pradip Kumar Sinha
Systems
Ch-18
3. Production phase: Target costing is most effective in the development and

design phases of new products but it is also useful in the later stage of the
product life cycle. In these stages, target costing becomes a tool for
reducing cost of existing products.
products The search for better, less expensive
products should continue in the framework of continuous improvement.
i. ABC can be beneficial as a tool for target costing of existing products.
Using ABC, a company can attack the root causes of costs (through
cost driver analysis). Target costing at the activity level makes
opportunities for cost reduction highly visible.
ii. Consumer survey can give features they prefer in products priority wise.
These surveys help management do cost-benefit analysis on different
features of a product and then try to reduce costs on features that are
not ranked highly.
iii. Target costing also provides incentives to more towards less expensive
means of production, as well as production techniques that provide a
Cont….
more even-flow of goods.
Systems
Ch-18
Benefits of Target Costing
1. The target costing provides detailed information on the costs involved in
producing a new product as well as better way of testing different cost
scenarios through the use of ABC.
ABC
2. Target costing reduces the development cycle of the product.
3. Target costing greatly increases the profitability of new products, through
promoting reduction in costs while maintaining or improving quality. Target
costing also promotes the requirements of consumers and therefore find
better acceptance than existing products.
products
4. Target costing is also used to forecast future costs and provides motivation
to meet future cost goals.
5. Target costing is used to control costs before the company incurs any
production costs which save a great deal of time and money. Furthermore,
target costs may be used continually to control costs throughout the
production life cycle. Copyright © 2008, Pradip Kumar Sinha

Management Control System

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Nature of Management Control System

Copyright © 2008, Pradip Kumar Sinha

Copyright © 2008, Pradip Kumar Sinha

What Is a Management Control System (MCS)?

Control 2. Assessor: Comparison

Elements of a Control Process

Strategy Goals Strategies and Policies

Task Control Efficient and Effective performance Cont….

Copyright © 2008, Pradip Kumar Sinha

Task Control/Operational Control

Formal Control Process and Role Played by Accounting

Goals and Rules Other

Strategic Budgets Responsibility

The Formal Control Process

Copyright © 2008, Pradip Kumar Sinha

Impact of the Internet on Management Control

Copyright © 2008, Pradip Kumar Sinha

The Cybernetic Paradigm and the Control Process

"Cybernetics" is derived from the Greek work "Kybernatics" which means

Cybernetics has been defined as the "service of communication and control."

Cybernetic Paradigm of the Control Process Cont….

Designing Management Controls

The Control Process Hierarchy

Formal Control System Cont…. Copyright © 2008, Pradip Kumar Sinha

Management styles may be summarized on a continuum between highly

Informal Actions based primarily upon assumptions of perceived need by the

The Informal System Actions refer to

Copyright © 2008, Pradip Kumar Sinha

Macro Cybernetic Framework

Entity Critical success Performance

Copyright © 2008, Pradip Kumar Sinha

1. Control systems influence the behaviour of those controlled in that the

2. The precise manner in which control system influences behaviour depends

Mixed Control Style includes a wide spectrum of styles consisting of combination

The characteristics of control system in the mixed control style:

 Communication and integration

 Comments and conclusions

Major cultural change is unlikely to be produced by changes in the control sub-

Copyright © 2008, Pradip Kumar Sinha

Evolution and Revolution of Management Control

Stages of Evolution and Revolution

Copyright © 2008, Pradip Kumar Sinha

Information Technology and Information Management

Figure : Competitive value of IT Investments

High Customer Value Low

Competitive value of IT investments Cont….

Balance flexibility and

Copyright © 2008, Pradip Kumar Sinha

Worldwide, a new framework is emerging for competitive manufacturing. It's

1. Abundant availability and distribution of information

2. Accelerating pace of change in technology

3. Rapidly expanding technology access

4. Globalisation of markets and business competition

5. Global wage and job skill shifts

6. Environmental responsibility and resource limitations

7. Increasing customer expectations

The six attributes are:

2. Physical plant and equipment responsiveness

3. Human resource responsiveness

4. Global market responsiveness

5. Teaming as a core competency

6. Responsive practices and cultures

Copyright © 2008, Pradip Kumar Sinha

i. Co-ordination and Technology