Chapter 12

Fundamentals of Management Control Systems

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Alignment of Managerial and Organizational Interests

L.O. 1 Explain the role of a management control system. A management control system is designed to help managers make decisions that will increase the organizations performance.

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Decentralized Organizations
L.O. 2 Identify the advantages and disadvantages of decentralization. Decentralization is the delegation to subordinates of authority to make decisions in the organizations name.

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LO2

Advantages of Decentralization
Better use of local knowledge
Faster response Wiser use of top managements time Reduction of problems to more manageable size Training, evaluation, and motivation of local managers

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LO2

Disadvantages of Decentralization
Dysfunctional decision making: Local managers can make decisions in their interest, which can differ from those of the organization.
Duplication of administration: Local managers make the same types of decisions made at headquarters.

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Management Control System

L.O. 3 Describe and explain the basic framework
for management control systems.

It is a system designed to influence subordinates to act in the organizations interest. Principals (owners) use this system to influence agents (managers) behavior.

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LO3

Elements of a Management Control System

Delegated decision authority

Performance evaluation and measurement systems

Compensation and reward systems

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Responsibility Accounting
L.O. 4 Explain the relation between organization
structure and responsibility centers.

Responsibility accounting reports revenues and costs at the level within the organization having the related responsibility.
Responsibility

Cost centers

Revenue centers

Profit centers

Investment centers
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Evaluating Performance
L.O. 5 Understand how managers evaluate performance. Controllability concept: Managers should be held responsible for costs or profits over which they have decision-making authority. Relative performance evaluation (RPE): Compares divisional performance with that of peer group divisions

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Corporate Cost Allocation

L.O. 6 Analyze the effect of dual- versus single-rate allocation systems.

Global Electronics Latin America Division Income for the Year ($000)
Actual Target Revenue $70,000 $70,000 (Percentage of corporate revenue) 16% 14% Direct division costs 51,800 51,800 Allocated corporate overhead* 4,800 3,500 Operating profit $13,400 $14,700
* Global Electronics allocates corporate overhead based on relative revenue. Corporate overhead was $25 million.
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LO6

Corporate Cost Allocation

Global Electronics Latin America Division Income for the Year ($000) Revenue Direct division costs Actual $70,000 51,800 Target $70,000 51,800

My revenue and costs were on target.

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LO6

Corporate Cost Allocation

Global Electronics Latin America Division Income for the Year ($000) Actual Target Revenue $ 70,000 $ 70,000 (Percentage of corporate revenue) 16% 14% Corporate revenue $437,500a $500,000b
a

$70,000 16% b $70,000 14%

I'm not responsible for corporate revenue.

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LO6

Corporate Cost Allocation

Global Electronics Latin America Division Income for the Year ($000) Actual Target Allocated corporate overhead $ 4,800 $ 3,500 (Percentage of corporate revenue) 16% 14% Corporate costs $30,000a $25,000b
a

$4,800 16% b $3,500 14%

I'm not responsible for corporate costs.

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LO6

Corporate Cost Allocation

Dual rate method: This is a cost allocation method that separates a common cost into fixed and variable components and then allocates each component using a different allocation base.

Cost

Activity Level

Cost Activity Level

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Performance Evaluation Systems Incentives

L.O. 7 Understand the potential link between incentives
and illegal or unethical behavior.

Fundamental questions regarding a performance measurement system:

Does the measure reflect the results of those actions that improve the organizations performance?
What actions might managers be taking that improve reported performance but are actually detrimental to organizational performance?

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Internal Controls
L.O. 8 Understand how internal controls can help protect assets. Internal control is a process designed to provide reasonable assurance that an organization will achieve its objectives in the following categories:

Effectiveness and efficiency of operations

Reliability of financial reporting Compliance with applicable laws and regulations

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End of Chapter 12

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.