Fundamentals of Management

Control Systems

Chapter 12
McGraw-Hill/Irwin Copyright ©2008 The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objectives:
1. Explain the role of a management control system.

2. Identify the advantages and disadvantages of decentralization.

3. Describe and explain the basic framework for management control

systems.
4. Explain the relation between organization structure and
responsibility centers.
5. Understand how managers evaluate performance.
6. Analyze the effect of dual- versus single-rate allocation systems.
7. Understand the potential link between incentives and illegal or
unethical behavior.
8. Understand how internal controls can help protect assets.

12-2
Service Department Cost Allocation
LO1 Explain the role of a management control system.

A management
control system is
designed to help
managers make
decisions that will
increase the
organization’s
performance.

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Decentralization
LO2 Identify the advantages and disadvantages of
decentralization.

The delegation to
subordinates of
authority to make
decisions in the
organization’s
name.

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Decentralization, Continued. . .

Centralized Organization
Decisions are made by relatively few
individuals in the high ranks of the
organizations. Few decisions are
delegated.
Decentralized Organization
Decisions are spread among relatively many
divisional and departmental managers.
Decisions are delegated to
divisional and departmental
managers.

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Advantages of Decentralization
Better use of local knowledge:
area managers are more aware of local conditions.

Faster response:
local managers respond more quickly to changing environments.

Wiser use of top management:

higher level managers can focus on strategies and industry trends.

Reduction of problems to more manageable sizes:

by dividing large problems into smaller, more manageable parts,
decentralization reduces the complexity of problems.

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Disadvantage of Decentralization
Dysfunctional decision making
When local managers 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 Systems
LO3 Describe and explain the basic framework for
management control systems.

A system designed to influence subordinates to act in

the organization’s interest
Used by principals
(owners) to influence
agents’ (managers’)
behavior

Performance
Delegated Compensation
evaluation and
decision and reward
measurement
authority systems
systems

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Delegated Decision Authority

A management control
system specifies what
decisions the
subordinate manager
can make in the name of
the organization.

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Performance Evaluation and Measurement

The performance
evaluation system
specifies how the
performance of the
subordinate manager is
to be measured and how
the results will be used
in the evaluation
process.
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Compensation and Reward Systems
A management control
system that specifies
how subordinates will
be compensated for
their performance
based on stated
measures.

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Balancing the Elements
An effective management control system
balances the following three elements:

Delegated decision authority

Performance evaluation
and measurement systems

Compensation and
reward systems

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Responsibility Accounting
LO4 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.

Cost Revenue
center center

Responsibility
Profit
Investment
center
center
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Cost Center

Cost
An organization subunit
center
responsible only for costs
Managers are
responsible for
cost and volume
of inputs used to
produce an
output.

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Revenue Center

Revenue An organization subunit

center responsible for revenues and,
typically, marketing costs
Managers are
responsible for
selling the
product.

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Profit Center

Profit An organization subunit

center responsible for profits and
thus, revenues, costs,
production, and sales
volume. Managers are
responsible for
revenues AND
costs.

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Investment Center

Investment An organization subunit

center responsible for profits AND
investment in assets

Managers are responsible for

large amounts of money with
which to make capital
budgeting and other decisions
affecting the use of assets.

12-17
 Responsibility Centers and Organization Structure
Organizational Structure and Responsibility
Centers Group Vice-President
a
Investment centers

Division Vice- Staff managers

President
Profit centers Discretionary cost
centers

Plant managers District sales

Cost centers managers
Revenue centers
a
Group refers to a group of
divisions.

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Goal Congruence

Agreement by all
members of a
group on a set of
objectives

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Evaluating Performance
LO5 Understand how managers evaluate performance.

Control based 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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Compensation Systems

Fixed compensation
Not directly linked to
measured performance

Contingent compensation
Based on measured
performance

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Corporate Cost Allocation
LO6 Analyze the effect of dual- versus single-rate
allocation systems.
Global Electronics
Latin America Division
Income for the Year (in thousands)
Actual T
Revenue $ 70,000
(Percentage of corporate revenue) 16%
1
Direct division costs $ 51,800
Allocated corporate overhead $ 4,800
Operating profit $ 13,400
1
Global Electronics allocates corporate overhead based on relative
revenue. Corporate overhead was $25 million.

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Corporate Cost Allocation, Continued. . .
Global Electronics
Latin America
Income for the Year (in
Division
thousands)

My revenue
and costs
were on
target.

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Corporate Cost Allocation, Continued. . .
Global Electronics
Latin America
Income for the Year (in
Division
thousands)

I’m not
responsible
for corporate

Revenue
revenue.
a
$70,000/16% 12-24
Corporate Cost Allocation, Continued. . .
Global Electronics
Latin America
Income for the Year (in
Division
thousands)

I’m not
responsible
for corporate

Allocated
$4,800/16% c
costs.

a
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Corporate Cost Allocation, Continued. . .

Dual rate method

Cost
a cost allocation method
that separates a
Activity
common cost into fixed
and variable components
and then allocates each

Cost
component using a
different allocation base
Activity

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Performance Evaluation Systems Incentives
LO7 Understand the potential link between incentives and
illegal or unethical behavior.

1. Does the measure reflect the results of

those actions that improve the
organization’s performance?

2. What actions might managers be taking

that improve reported performance but
are actually detrimental to
organizational performance?
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What pressures can lead to unethical behavior?

Unrealistic budget pressure

HELP!!
This is
impossibl
e

Unrealistic budget pressures, particularly for

short-term results, occur when headquarters
arbitrarily determines profit objectives and
budgets without considering actual
conditions.
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What pressures can lead to unethical behavior?
Financial Pressure
Financial pressure resulting from
bonus plans that depend on short-
term economic performance is
particularly acute when the bonus
is a significant component of the
individual’s total compensation.

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Internal Control
LO8 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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Internal Control – In Practice
Internal controls are detailed methods of protecting assets
and assuring reliable information. Some examples are:

Setting limits on the amount of expenditures

Requiring authorization for the use of assets

Segregation of duties

Reconciling accounts

Rotating personnel

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Chapter 12: END!!

Sometimes I
just don’t get
it. What do
they want?

12-32