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Management Control Systems A Management Control System (MCS) is a system which gathers and Uses information to evaluate the

performance of different organizational resources like Human, Physical, Financial and also, the organization as a whole considering the organizational strategies. It finally influences the behavior of organizational resources to implement organizational strategies. MCS might be formal or informal. Management Control as the process by which managers influence other members of the organization to implement the organizations strategies. Management control systems are tools to aid manag ement for steering an organization toward its strategic objectives. Management controls are only one of the tools which managers use in implementing desired strategies. However strategies get implemented through management controls, organizational structure, human resources management and culture. - Robert N. Anthony. Management Control Systems are the formal, information-based routines and procedures managers use to maintain or alter patterns in organizational activities. Simons.
Set Goals, Measures, Targets Feedback and Learning Evaluate, Reward

Plan and Execute

Monitor Report

The concept of control can be explained by some of the well-known metaphors. These metaphors are as follows: Thermostat: Thermostat a pre-decided level of temperature is set and the device is designed in a way to get turn on or turn off when actual temperature deviates from the set standard. Thus, it is an automatic control system. 98.6 Human Body Temperature: The body temperature is maintained at 98.6 F through a self-regulating mechanism. In a healthy body, this control process is automatic because system corrects the deviations through self-regulation. Only when the deviations are very high e.g. high fever, an external intervention in the form of medicine is required to bring the temperature back to normal. In terms of complexity of control mechanism, the control system of the body temperature is more complex as compared to the thermostat. Driving System of Automobile: The driving system of the automobile provides us the ABC of manmachine control mechanism wherein ABC implies, Accelerator, Brake and the Clutch. It is the control over these three components that gives the driver control over the vehicle. Changing gears according to the road conditions is the essence of this control system. This metaphor of control has interesting lessons for management control in organizations because organizations are man-machine systems. Traffic Control: Traffic Control is a go, no-go system. Red, Yellow and Green represent the three colours of control. Red representing no-go, yellow representing the permission to go and Green representing the go situation. In organizational contexts also, rules and procedures are designed around the concept of go and no-go. Black Box: Black box is a device with input terminal and output terminal and electrical circuitry within the box wherein the nature of the circuit by looking from outside is not known. This idea has been extended to all those operations and systems whos "exact nature cannot be observed Metaphor of Control Thermostat Body Temperature Driving System Traffic Black Box Key Idea Engineering Model of Control Nature's Model of Control, Homeostasis Man Machine Control Model Yes-No Control Model Input-Output Model

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Nature of Management Control (Purpose of Management Control) Planning what organization should do, Coordinating the activities of several parts of organization. Communicating information Evaluating information Deciding what, if any, action should be taken. Influencing people to change behaviour"

The echoes of the POSDCORB mantra can be heard in this amplification of the nature and purpose of management control Purpose of a Management Control System: 1) Clearly communicate the organizations goals. 2) Ensure that every manager and employee understands the specific actions required of him/her to achieve organizational goals. 3) Communicate the results of actions across the organization. 4) Ensure that the management control system adjusts to changes in the environment. Objectives of Management Control System: a) To assist the management b) To evaluate the performance c) To indicate corrective action. Scope of Management Control System: I. Structure (What it is) a. Combination of units and sub-units within the Organization. b. Manager is responsible for the activities of such units. c. Attempt should be made to control system fit into the work and personalities. Process (What it does) a. Communication of information and interaction. b. Setting up of standards. c. Taking remedial measure. d. Strategic Planning. e. Budgeting. f. Resource Allocation. g. Performance Measurement. h. Evaluation and rewards. i. Responsibility centers transfer Pricing.

II.

Elements of Management Control Systems: 1. 2. 3. 4. 5. 6. 7. 8. 9. Planning What Is Desired. Setting the Standards of Performance. Monitoring Actual Performance. Comparing Actual Performance With Target Planned. Taking Corrective Actions. Business Strategy. Organizational Behavior. Human Resource And, Financial & Managerial Accounting.

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Evaluating Management Control Systems:


Motivation Goal Congruence Efforts

Lead to Reward

Monetary

Non-Monetary

Nature of Management Control System: 1) 2) 3) 4) Management. Control. System. Others; a. Future oriented. b. Objective driven. c. Continuous process. d. Coordinate integrated system. e. Not always economically desirable. f. Dynamic. g. Rhythmic. h. Time horizon. i. Nature of information. j. The central focus of MCS is Business Strategy Implementation.

MCS provides knowledge, insight, and analytical skills related to how a corporations senior e xecutive design and implement the ongoing management systems that are used to plan and control the firms performance 1. Management:

Management is the process of designing and maintaining an environment in which individuals, working together in groups, efficiently accomplish selected aims. This basic of As managers, people carry out the managerial functions of planning, organizing, staffing, leading and controlling. Management applies to any kind of organization. It applies to managers at all organizational levels. The aim of all managers is the same to create a surplus. Managing is concerned with productivity; this implies effectiveness and efficiency. Getting things done in the desired manner. Ensure optimum utilization of resources Ensure group works towards a common goal. Exercise Generic Functions - Planning, organizing, directing, coordinating, motivating, controlling etc., Ensure entire organization hierarchy is putting its efforts towards achieving the set Goal. The main objective of management is to achieve the strategic goal thr ough effective and efficient utilization of resources.
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Management Effectiveness: In management, the ultimate measure of management's performance is the metric of management effectiveness which includes:

Execution, or how well management's plans are carried out by members of the organization Leadership, or how effectively management communicates and translates the vision and strategy of the organization to the members Delegation, or how well management gives assignments and communicates instructions to members of the organization Return on investment, or how well management utilizes the resources (financial, physical, and human) of the organization to bring an acceptable return to shareholders Conflict management, or how well management is able to utilize confrontation and collaboration skills; management's ability to be flexible and appeal to common interests. Motivation, how management attempts to understand the needs of others and inspires them to perform. Motivation focuses on how performance is rewarded rather than how failure is punished. Consideration, or how well managers seek to understand and appreciate others' values; and not merely as a means to a business goal.

2. Control: Controlling is the process of checking actual performance against the agreed standards with a view to ensuring satisfactory performance. The process of controlling thus involves the following: Determination of standards for measuring work performance Measurement of actual performance Comparing actual performance with the standard Finding variance between the actual and the standard and the reasons for the same Taking corrective action to ensure attainment of objective. The objective of control is to ensure that the things/activities follow the pre-determined track. Control is two types of Formal devices. One consists of Rules, broadly defined. The other is sy stematic way of planning and controlling. Management Control Systems framework in terms of three types of controls viz. Action Controls, Results Controls and Personnel and Cultural Controls.
Action Control

Personnel & Cultural Control

Result Control

Action controls "involve ensuring that employees perform (or do not perform) certain actions known to be beneficial (or harmful) to the organization". Results controls focus on results and involve "rewarding individuals (and sometimes groups of individuals) for generating good results or punishing for poor results". Personnel and Cultural controls on taking steps that ensure "that employees control their own behaviour or control each others' behaviours". Such controls aim at helping employees do a good job and are based on employees' natural tendencies to control themselves. These controls imply self-monitoring that could include self-control, intrinsic motivation, ethics, trust, transparency etc.

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Characteristics of Control 1. Control is a continuous process 2. Control is a management process 3. Control is embedded in each level of organizational hierarchy 4. Control is forward looking 5. Control is closely linked with planning 6. Control is a tool for achieving organizational activities

Control Process:

Types (Control) System: "Control System Engineering", control system is defined as a "group of components functioning together in coordination to perform a function. This function may be control of a physical variable such as speed, voltage, temperature, pressure, position etc." 1. Open Loop System, also known as non-feedback system, there is no provision within the system for the supervision of the output and no mechanism is provided to correct the system behaviour for any lack of proper performance of system components. Input variable 2. Transfer function Output variable

Example: Automatic city traffic system, alarm clock, washing machine etc.

Closed Loop System is the feedback systems. Such systems are driven by two signals viz. the input signal and the feedback signal. Feedback signal is derived from the output of the system. The advantage of the feedback signal lies in giving the system the capability to act as self-correcting mechanism.

An organization of men and machines, control has four elements: A measuring device which detects the actual state of the variable under control, sometimes called detector. 2. An assessing device which, usually by comparing, show the difference or gap between the actual state and the desired state of variable under control, sometimes called selector. 3. An altering or correcting device which carries out the necessary alteration or correction in the actual state of the variable to achieve the desired state, sometimes called effector. Besides these three elements namely, detector, selector and effector, the control system also includes the means for communicating information such as directives, guidelines, feedback, etc., among these elements. Control in organization: Organizations need controls in order to determine if their goals are being met and to take corrective action if necessary. The Nature of Control in Organizations: Control is the regulation of organizational activities so that some targeted element of performance remains within acceptable limits. The Purpose of Control: Adapting to environmental change Limiting the accumulation 2. of error 1. : : A control system can to anticipate, monitor and respond to Changing environmental conditions. A control system will limit the number of errors that can Accumulate discovery and problem solution. 1.

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3.

Coping with organizational complexity

: :

A factor increasing dramatically over recent times. If it is practiced effectively, control can help reduce costs and Increase output.

4. Minimizing costs

Effective Organizational Control Systems (Characteristics) A Focus on Critical Points. Integration into Established Processes. Acceptance by Employees. Availability of Information When Needed. Economic Feasibility. Accuracy. Comprehensibility.

Control Levels: Control is practiced at many levels in the organization. 1. Strategic Control:

Strategic control focuses on how effectively the organization's strategies result in the attainment of goals. The assessment of strategy requires the organization to integrate strategy and control. Integrating Strategy and Control: Strategic control generally concentrates on organization structure, leadership, technology, human resources, and information and operations control systems. They often are seen as areas in which a strategy is or is not being effectively implemented. Strategic control focuses on the extent to which implemented strategy achieves the organization's strategic goals. If goals are not being attained, the firm will find it necessary to make changes in one or more areas, Structural Control:

2.

Structural control focuses on how well an organization's structural elements serve their intended purpose. It is two very different approaches to structural control: bureaucratic control and clan control. Organizations characterized by these opposite approaches differ structurally in terms of foals, degree of formality, performance focus, organization design, reward system, and level of employee participation. i. ii. 3. Bureaucratic Control: Bureaucratic control is characterized by formal and mechanistic structural arrangements. Organizations that use it tend to rely on strict rules and to have a rigid hierarchy. Clan Control: Clan control is characterized by informal and organic structural arrangements. The goal of clan control is gaining employee commitment. Operations Control:

Control of the processes an organization uses to transform resources into products or services is operations control. a) Preliminary Control: Preliminary control, also known as steering control or feed forward control, focuses on the resources that the organization brings in from the environment. It attempts to monitor the quality or quantity of these resources before they enter the organization. b) Screening Control: Screening control, also known as yes/no control or concurrent control focuses on meeting standards for product or service quality or quantity during the transformation process. Screening control relies on feedback processes. For example, when quality checks are used to provide feedback to workers manufacturing a product, the workers know what, if any, corrective actions to take. c) Post action Control: Post action control, also known as feedback control, focuses on the outputs of the organization after the transformation process is complete. Although post action control used alone may not be as effective as preliminary or screening control, it can provide

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management with information for future planning. Post action control also may be used as a basis for rewarding employees. 4. Financial Control:

The control of financial resources as they flow into the organization, are held by the organization, or flow out of the organization is known as financial control. 1. Budgetary Control:

A budget is a plan expressed in numerical terms: dollars, units of output, time, or any other quantifiable factor. Budgets provide a method for measuring performance across different units within the organization. Budgets have four primary purposes: helping managers coordinate resources and projects, helping define the established control standards, providing clear guidelines about the organization's resources and expectations, and enabling organizations to evaluate the performance of managers and units. a. Types of budgets: i. Financial budget shows the sources and uses of cash ii. Operating budget shows what quantities of products or services the organization intends to create and what financial resources will be used to create them. iii. Non-monetary budget expresses planned operations in non-financial terms such as units of output and machine hours. Many organizations now allow all managers to participate in the budget process.

Developing budgets:

Strengths and weaknesses of budgeting: Budgets facilitate effective control and coordination and communication between departments. But budgets may be applied too rigidly; the process of developing them can be time consuming; and they may limit innovation and change. 2. Other Tools of Financial Control:

Budgets are the most common means of financial control, but there are other useful tools: financial statements, ratio analysis, and financial audits. a. Financial statements: A profile of some aspect of an organization's financial circumstances is a financial statement. The two most commonly used financial statements are the balance sheet and the income statement. The balance sheet shows a snapshot profile of the organization's financial position. The income statement summarizes financial performance over a period of time. Ratio analysis: Financial ratios compare different elements of a balance sheet or income statement to one another. Ratio analysis is the calculation of one or more financial ratios to assess some aspect of the financial health of an organization. Five commonly used financial ratios are liquidity, debt, return, coverage, and operating. Financial audits: Audits are independent appraisals of an organization's accounting, financial, and administrative procedures. An external audit is a financial appraisal conducted by experts who are not employees of the organization. An internal audit is an appraisal conducted by employees of the organization. The objective of these audits is to verify the accuracy of financial and account procedures. Internal audits also assess these procedures for efficiency and appropriateness

b.

c.

General relationship of Planning and Controlling: Planning Establish Objectives Determine Activities Delegate Schedule tasks Allocate Resources Communicate and Coordinate Provide incentives Control Establish standards. Measure and compare Evaluate Results. Feedback and Coach Take Corrective Action.
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Components of Management Control Management control consists of five interrelated components, which are derived from methods used by agencies to conduct their business. Management control is part of the department's operating activities, and links among these components from an integrated system that allows management to dynamically react to changing conditions. The Components of management control are: Control environment Risk assessment. Control activities Information and communication Monitoring

Control Environment The control environment encompasses the attitudes and actions of management regarding control. This environment sets the organizational tone, influence control consciousness and provides a foundation for an effective system of management control. The control environment also provides the discipline and structure for achieving the primary objectives of management control. Control activities are implemented to ensure that management objectives to address risks are fulfilled. Major elements that affect an organizations control environment are as follows: 1. 2. 3. 4. 5. 6. 7. Assignment of authority and responsibility. Commitment to competence. Human resource policies and practice. Integrity and ethical values. Management's philosophy and operating style. Organizational structure. Oversight groups.

Risk Assessment This component of management control highlights the importance of management carefully identifying and evaluating factors that can preclude it from achieving its mission. All departments encounter risks that threaten the achievement of their business objectives. Risks are introduced by numerous external and management sources. Risk assessment is systematic process for integrating professional judgment about probable adverse conditions and events and assessing the likelihood of possible losses (financial and non-financial) resulting from their occurrence. Risk relates to both department-side and activity level objectives. Identifying and analyzing risks is a continuous process critical to maintaining effective management control. Risk assessment incorporates information from various sources, including discussions with management and staff. Department's Mission and Underlying Objectives A precondition to risk assessment is establishment of objectives, linked at different levels and internally consistent, In order to evaluate a department's success, a department must first determine whether its mission and objectives provide clear, well-defined targets for achievement. The establishment of objectives allows departments to formulate critical success factors. These provide the measurement basis for\determining if the department and the various managed activities, attains established objectives and goals. Critical success factors should be established at department-wide and activity levels (and can be established for each employee through the use of position descriptions and performance factors) To be effective and ensure positive results, objectives must be measurable, complementary and linked. "Measurable" objectives, allow management to determine, with reasonable precision, how well the department and its activities achieve their objectives. Measurable objectives are fundamental requirement for most quality initiatives.

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Evaluating Risks The process for identifying and analyzing risk should be incorporate into a department's normal operations to ensure it is conducted as an ongoing process. Risk Identification Management should perform a comprehensive analysis of identifiable risks, including all risks associated with department-side and activity level objectives (derived from the organi2ation's mission). The activities analyzed should include those that support both financial and non-financial objectives. Management planning conferences Periodic reviews of factors affecting the department's activities Qualitative or quantitative methods to identifying and prioritizing control efforts over high-risk activities Short and long-range forecasting Strategic planning

Management must consider external factors that may present risks to the agency, including: Business, political, and economic changes Changing needs or expectations of agency officials or the public Nature catastrophes New legislation or regulations Technological developments

Management factors with inherent risks, include: Changes in management responsibilities Disruption of information, systems processing Downsizing department operations Early retirements that reduce the workforce and knowledge base Highly decentralized program operations Management and employee accessibility to assets Nature of departmental activities and degree of centralization Quality of personnel and training provide Reengineering agency operating processes

Risk Analysis After identifying department-wide and activity level risks, management should perform a risk analysis. The methodology may vary since risks are difficult to quantify; however, the process generally includes the following 1. 2. 3. Estimating risk significance Assessing likelihood/frequency of occurrence Considering how to manage risk

Risk with little significance and low probability of occurrence may require no action while those with high significance and frequency require special attention. After assessing the significance and likelihood of risk, management, must determine how to control it. Risk Management Economic, regulatory, operational,, and other conditions continuously change. Therefore, a mechanism must be devised to identify and manage the risks associated with change. Further, management must continually anticipate the occurrence of new risk resulting from change. This allows the. Implementation of control techniques during the development stages of new or change processes.

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Changing conditions that warrant special consideration with regard to risk include the following: o o o o o o o o o o o o Acceptance of audit findings and corrective action taken Complexity or volatility of activities Geographical dispersion of operations High personnel turnover Implementation of major new technologies, including information systems Management's judgments and accounting estimates New personnel in key positions Organizational, operational, or economic changes Personnel competence, adequacy, and integrity Rapid growth, expansion or downsizing Restructuring or reengineering New laws, rules and regulations

To determine the relative significance of changes, management may weigh the risk factors. This reflects management's judgment on relative impact, when selecting an activity of evaluation Control Activities Control activities occur at all levels and in all activities of the department. Examples of control activities include: policies and procedures; organizational plans; managerial approvals and authorizations; verifications and reconciliation; performance reviews; security maintenance; restrictions on access to resources; segregation of duties; documentation of transactions and event cycles by means of flowcharts and narratives. Control activities are implemented to ensure that management's directives are followed, which in turn reduces risks and contributes toward the achievement of department objectives. Type of Control activities: Control activities include preventive, detective, and corrective controls. The following categories of control activities are common to all departments Policies and Procedures: Documented policies and procedures should clearly indicate the actions and responsibilities of all employees relative to performance of job responsibilities. Management should formally approve these with regular updates on change that may have occurred. Review of Performance by Management: All levels of department managers should review performance reports, analyze trends, and relate results to targeted and historical performance. The accuracy of operational summaries should also be verified. Reconciliation: Managers should periodically reconcile summary information to supporting detail. Physical Control: Equipment, inventories, securities, cash, and other assets vulnerable to risk of loss or unauthorized use, must be physically secured, periodically counted, and compared to amounts shown on control records. Performance Indicators: Control activities must be established to monitor performance indicators. This control requires comparisons and assessments, relating different sets of data to one another for analysis of relationships and appropriate corrective action. Management should investigate unexpected results, unusual trends, or conditions that may prevent the organization from achieving its business objectives Information Processing: Several control activities may be used to verify data accuracy, completeness, and appropriate authorization of transactions. Control activities for information processing include procedures to ensure that: Data entered into systems in subjected to edit checks and matched to approved control files, Transactions are accounted for in numeric sequence File totals are compared with control accounts, Exceptions are examined and acted upon, and

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Access to data, operating system, and program files (source and object code) is granted to only authorized individuals.

Segregation of Duties: Duties and responsibilities should be divided among staff to reduce the risk of errors, waste, misuse, or fraud. No one individual should control all key aspects of a transaction or event. Information and Communication Each department must capture pertinent financial and non-financial information relating to external and management activities. This information must be identified as relevant to managing the agency and communicated to those who need it. Communication should be in a form and time frame that enables all employees to carry out their control responsibilities. Factors management should consider in establishing management controls related to information and communication are described below: Information: Pertinent information must be identified, captured, and communicated in from and time frame that permits users to perform their duties efficiently. Information systems produce data that enables control of relevant information flowing down, across, and up the organization. Management must clearly communicate to all employees that control responsibility is critical. Employees must understand their role in management control and have a means of communicating critical information of management. There must also be effective communication lines with external customers, contractors, suppliers, and regulators. Information systems support the achievement of all three categories of management control objectives - operational efficiency, reliable financial reporting, and compliance with laws, rules, and regulations. The appropriateness of contents, timeliness, accuracy, and accessibility of information are attributes with which to measure information quality. Quality factors are affected by management control and must be inherent in the information to ensure that informed decisions are made throughout the department. Communication: Information systems inherently imply communications. Information must be captured and promptly' provided to appropriate personnel, so they can perform their operating, financial reporting, and compliance responsibilities. Information must be communicated internally and externally to other appropriate groups. Internal Communication: Internal communication is important for effective management control. To ensure that effective internal communication occurs, the following types of control should be in place. o Management must provide a clear message to all personnel that management control responsibilities are critically important. o Employees must understand their specific duties, aspects of management control, and their role in it. They should know how their work relates to the work of others, which may help to address problem recognition, cause, and corrective action. Any uncertainty the employee has should be clarified. o Personnel should demonstrate acceptable behavior. o Personnel need a means of communicating information upward within the agency. Management must open lines of communication and display a willingness to listen. Separate lines, of communication may be necessary if normal channels prove ineffective. o Personnel must know that there will be no reprisal for reporting information. o Management must update management oversight groups regarding performance, developments, risks, major initiatives, and other significant or relevant events. External communication: Agencies communicate with various external groups that may have an impact on the operations and activities of the department. To ensure effective external communications, management should provide for open lines of communications with contractors, suppliers, and other customers of the agency. These groups provide significant feedback regarding the quality and design of agency business processes and supporting activities.

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Monitoring This component involves assessing the quality of management controls. It involves assessments by appropriate personnel, of the design and operation of controls, noting any deficiencies, and putting into place appropriate corrective actions. A system of management control must be integrated into the everyday operations of each department. To maintain ongoing assurances about the continued effectiveness of the management control structure, management must continually monitor the system to identify the need for changes. Type of Monitoring Monitoring includes management reviews, comparisons, reconciliation procedures, and other duties performed by department employees. Monitoring activities can be categorized into ongoing and separate periodic evaluations. Effective ongoing monitoring activities will often require less need for separate evaluations. Ongoing Monitoring Activities Numerous types of activities may be used to monitor management control on an ongoing basis. Activities that can be incorporated into agency management controls include procedures to determine; o o o o o The extent to which, personnel, in carrying out their activities, obtain evidence as to whether the system of management control is working properly The extent to which communications from external parties corroborate internally generated information Whether assets recorded on the accounting system agree with assets on hand The extent to which employees are responsive to management and external auditor recommendations The extent to which employees clearly understand and comply with the department's code of conduct

Separate Evaluations: While ongoing monitoring activities provide important feedback on the effectiveness of management controls, separate evaluations can be useful by focusing directly on the effectiveness of controls at specified points in time. Testing Management Controls: An important part of any evaluation activity is testing the reliability of management control procedures. Testing can be done (on an ongoing or periodic basis) by reviewing transactions, performance reports, and supporting documentation of program activities. Additional tests may include making inquiries of appropriate personnel; observing how separation of duties and similar control-related activities are carried out; and personally re-performing selected control activities to verify results. The results of these tests should be reviewed and evaluated by management to assess the significance of any errors or deficiencies. Corrective action plans should be established (and monitored) to ensure that errors and deficiencies are addressed System: System can be described simply as a set of joined elements joined together for a common objective. A subsystem is part of a larger system with which one is concerned. All systems for our purpose the organization is the system and the parts (Divisional, Departments functions, etc.,) are the subsystems A system is a prescribed way of carrying out an activity or set of activities; usually the activities are repeated. Well defined/ formal/systematic method of accomplishing a task. Set of coordinated efforts/Components Rhythmic process Recurring pattern giving assured output

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Framework to carry an activity (Input-Process-Output)

Control Systems: Components Elements of Control Systems Planning. Measurement. Reporting

Strategic Uncertainties

Planning, Measurement and Reporting Systems: The Planning, Measurement and Reporting (PMR) cycle is at the heart of designing a management control system. Planning includes the projects, ideas, programmes and activities that organization intends to take up over its planning horizon. It articulates the "strategic intent" in an environment of "strategic uncertainties" created by the changes in the technology, consumer preferences, competitors' strategies etc. Strategic inputs from the top management are incorporated in the budgeting exercise in planning the activities for the year. Measurement process involves measurement of the actual performance against the targets. Reporting involves "achievement reporting" by comparing the actual achievement with the desired achievement as reflected by the targets and the budgets. The above PMR cycle is repeated every year. The cycle can also be repeated over shorter periods of time, say six monthly and quarterly to ensure corrective action on the part of the managers and also to ensure that the "drivers are reaching at the destination point in correct time", Phases of Management Control: Budgeting: It is a statement of expected results expressed in numerical terms for a definite period of time in the future. Budget serves as a mean of co-ordination and control. It serves as standard of measuring actual performance. Budgets may be prepaid for various groups of activities like production, sales, personal, advertising etc. Budget may be prepared in term of money, time & / or resources. Cash budget, production budget, and master budget are the important budgets in business. Execution: In management, the ultimate measure of management's performance is the metric of management effectiveness which includes: execution or how well management's plans are carried out by members of the organization * leadership, or how effectively management communicates and translates the vision Evaluation: Evaluation is systematic determination of merit, worth, and significance of something or someone using criteria against a set of standards. Evaluation often is used to characterize and apprise subjects of interest in a wide range of human enterprises, including the arts, criminal justice, foundations and non-profit organizations, government, health care, and other human services. Programming: Steps to be taken, resources, time frame. A program specifies the steps to be taken resources to be used, time limit for each step and assignment of task. It is a sequence of action steps arranged in the priority necessary to implement a policy and achieve an objective. It defines the contents and scope of activities. Program plan: A onetime plan designed to coordinate a diverse set of activities that are necessary to carry out a complex endeavor. Comprehensive plan that includes future use of different resources in an integrated pattern and establishes a sequence of required actions and time schedules for each in order to achieve stated objectives. Thus a programme includes objectives, policies, procedures, methods, standards and budgets.

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Hierarchy of Control (Strategy, Management Control and Operational / Task Control) Areas of control Physical Resources Human Resources Information Resources Financial Resources : : : : : The four basic organizational resources usually define the areas of control. Control includes inventory management, quality control and equipment control. Control includes selection and placement, training and development, performance appraisal and compensation. Control includes sales/marketing forecasting, environmental analysis, public relations, production scheduling and economic forecasting. Control involves managing the organizations debt, cash flow and receivables/payables. Control of financial resources may be the most important control of all.

Anthony and Dearden provided a conceptual framework of control systems in terms of three leave, processes viz. Strategic Planning, Management Control and Operational Control. This terminology has now been sharpened through the idea of an "interactive hierarchy" of control represented by strategy, management control and the task control. The administrative organizational control system is based on the principles of; Activity Strategic Planning Knowledge Utilization as the Antecedent External Control as the Consequent Stable Environment Incremental Change Continuous, Predicable Nature of Change, Single Loop Learning Static View of Knowledge: Rules, Procedures & Policies Knowledge resides with the Management Nature of End Product Goals, Strategic and Policies

Management Control

Implementation of Strategies

Task Control

Efficient And Effective Performance Of Individual Task

Strategic Planning: Strategic Planning is the Process of deciding on the goals of the organ ization and the strategies for attaining these goals. Management Control: Management Control is the Process by which managers influence other members of the organization to implement the organizations strategies. Task Control: Task Control is the process of assuring that specified tasks are carried out effe ctively and efficiently.

The Old and New Framework of Management Control Systems Old Framework: New Framework: Strategic Planning Strategy Formulation Management Control Management Control Operation Control Task Control
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Management Control and Strategic Planning and Control

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A quick comparison between strategic planning and control, and management control throws up the following points of distinction: Strategic planning focuses on a single aspect of the corporate life at a time whereas management control focuses on all the operations of different subdivisions or units of an organization. The acquisition and deposition of major facilities, creation of division or subsidiaries, research and development of new products, and sources of new permanent capital belong to the domain of strategic planning. The focus of management control extends to the total operations of divisions, plants, etc. The domain of strategic planning comprises unstructured or un-programmed decisions whereas management control is predominantly rhythmic and regular. The nature of information required for strategic planning tends to be tailor-made for the problem, largely external, futuristic and less accurate whereas management control requires integrated, largely internal, historical and accurate information. Strategic planning often uses techniques like SWOT analysis (Strength, Weaknesses, Opportunities and Threats analysis) whereas management control relies on budgeting. Strategic planning is a creative and analytical activity whereas management control is largely administrative and persuasive in nature. The time frame of strategic plans tends to be long, say beyond one year, whereas the management control operates by a year, quarter or even smaller time frames. The appraisal of strategic plain is extremely difficult compared to management control which is relatively easy to evaluate.

Management Control and Operational Control (Task Control) Operational control is yet another category of control, which operates in organizations. In simple words, it ensures that the specific operations or tasks are carried out efficiently and effectively. Some of the ways in which management control differs from operational control are highlighted here under: Management control focuses on all the operations of a sub-division or unit of an organization whereas the focus of operational control is limited to a single task or transaction. Examples of activities for which management control is applicable are the total operations of most manufacturing plants, marketing function and the work of staff units of all types. Examples of tasks susceptible to operational control are the direct production operations of most manufacturing plants, production scheduling, inventory control, the order taking type of selling activity, and order processing, premium billing, pay-roll accounting and cheque handling. The domain of operational control involves little judgment and greater reliance on rules whereas in management control there is greater degree of judgment and subjective decision making. The information needed for operational control is often tailor-made to the operation, nonfinancial, precise and in real time whereas management control often uses integrated, financial. Futuristic and historical information, even approximations sometimes. The time horizon of operational planning and control tends to be day-to-day whereas management control works with weekly, monthly or yearly time frames. The techniques of Operations Research (OR) find wide applications in the area of operational control as the activities are programmable but management control has to work with diverse information generated through Management Information System (MIS), Decision Support System (DSS) and Knowledge Based System (KBS). Organization Structure and Control Process Organization structure is essentially the arrangement of various sub-units, departments and responsibility centers with defined authority and responsibilities. For a proper understanding of the control process, it is important to understand the nature of organization structure. The following are the broad forms of organization structure: o o o o Functional Structure Divisional Structure Matrix Structure Network Structure

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Functional structure: an organization is structured on the basis of critical. Here such as production, marketing, finance, HRD etc., with each manager having responsibility for the respective functions. Integration across functions is ensured by the top management through formal and informal meetings and controls. Divisional structure: an organization is structured on the basis of a product line or group of product lines that constitutes the division; the divisional manager is responsible for all functions related to the division. Integration across divisions is ensured by the top management by initiating divisional performance control systems. Matrix organizations: an organization is structured along two dimensions viz., according to functions and according to projects / products. Such structures are quite common in case of project management organizations / R & D institution's wherein a person is simultaneously responsible to two bosses e.g. the project manager and the functional manager. In such organizations, integration is achieved through task forces and project teams. Network Structures: an organization is structured on the basis of network requirements. Organization is like a fishnet wherein various parts are interwoven and are highly interdependent. Such structures are "horizontal" in nature, in contrast to bureaucratic structures, which are "vertical" in nature, with the advent of Information. Technology, the network structures have emerged as a new form of organization structure. Most Information Technology firms are organized around network structures. Quick information transmission ensures integration between the various nodes of the network structure. Closely related to the concept of organization structure, is the concept of responsibility centre. In fact, organization structure and control systems are linked through the idea of responsibility centre. Broadly speaking, "a responsibility centre is simply an organizational unit headed by a responsible manager". In control systems, a responsibility centre is usually built around financial responsibility say, for cost, revenue, profit and - vestment but also uses non-financial measures based on key or critical variables. The principal types of financial responsibility centres are as follows; Cost Centres Revenue Centres Profit Centres Investment Centres

Standard Cost Centres can be exemplified by foremen in a factory whose responsibility is specified in standard quantities of direct labour and material required for each unit of output. He is also usually responsible for a flexible overhead expense budget, and his objective is to minimize the variance between the standard / budgeted cost and actual cost. Discretionary Cost Centres include most administrative departments viz. accounting department, legal department, labour relations department, factory office, and corporate office. There is no practical way to establish input-output relationship in an engineering sense for these departments. The management, therefore, makes use of their best judgment (discretion), to set up cost budget for these departments. Revenue Centres can be best illustrated by the sales departments whose managers do not have authority to lower price but are judged by the sales revenue. Profit Centres are units such as a product division, where the manager is responsible for maximizing the profit i.e. revenue minus cost. Investment Centres are units where the manager is responsible for maximizing the profitability i.e. profits in relation to the magnitude of investment employed. Goals and strategy:

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The control hierarchy, the focus is on strategy formulation, management control and task control. Strategies indicate the general direction in which an organization is moving to fulfill its mission, goals and objectives, Hence, understanding the nature of competitive strategies is very important. There are a variety of models and frameworks which help us in understanding the concept of strategy. They also help us in formulation of strategies. Goals are defined as "broad statements of what the organization wants to achieve in the long run on a permanent basis" and objectives are defined as "specific statement of ends, the achievement of which is contemplated within a specified time". Many times these terms are also used interchangeably. However; both are subsumed under the term mission, which is indicative of the `strategic intent' and `strategic direction' of the organization. Mission is articulated on the basis of the vision of the founders or the chief executive. Mission is achieved through a properly formulated strategy and action plan with appropriately in-built mid-course correction system. Mission, vision and action indicate the interactive relationship between strategy and management control. In the case of business organizations, an important goal is the Return-on-Investment (ROI). The concept of ROI is defined as follows:

ROI =
= = = Profit Margin% Investment Turnover : R Stands for Revenues, E for Expenses and I for Investment.

ROI is a product of two factors viz. Profit margin in % terms and investment turnover. ROI can be improved either by increasing the profit margin or by increasing the productivity of capital by improving the turnover ratio or by improving both. Concept of Strategy The idea of strategy can be traced to the Greek word `strategies' meaning "the general's art". Stanford Research Institute defines strategy as "a way in which a firm reacts to its environment, deploys its principal resources and marshals its main efforts in pursuit of its purpose". It may be observed that "Pursuit of Purpose" is a key word in this definition. Therefore, for strategies to be meaningful, a firm should articulate its Purpose The concept of corporate strategy was initially formulated by Kenneth R. Andrews: Strategy formulation is a process that senior executives use to evaluate a company's strengths and weaknesses in the light of the opportunities and threats present in the environment and then decide on strategies that would fit the company's competencies with environmental opportunities. In this concept, SWOT analysis is at the heart of strategy formulation. In SWOT analysis focus is on company's strengths and weaknesses and on the opportunities and threats coming from environment/ competition. SWOT analysis is an exercise in `internal analysis' i.e. identifying strengths and weaknesses and `environmental analysis' i.e. identifying opportunities and threats. Once this is done, appropriate strategies are formulated to achieve a fit between the organization and environment. Thus, strategy formulation is essentially a "fitting" process to find appropriate fit between organization and environment. There are four "fitting" responses the SWOT Analysis and Response Strategies Response I: Matching strengths with environmental opportunities: This calls for an aggressive approach to strategy because the company has much strength and many opportunities. If these opportunities are not tapped, they would become missed opportunities. Response II: Coping with threats from the position of strength: When the company has several strengths but it faces a number of threats, the response strategy is one of diversification. Through diversification it can minimize the adverse impact of threats

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Response III: Market offers opportunities but the company has several weaknesses: In such a situation, company should be put into a turnaround gear. It should focus on overcoming its weaknesses so that it can tap the opportunities to its advantages. Response IV: There are many threats and the company has several weaknesses: This is the case of losing battle. Company can focus on protecting its territory through a defensive approach. Unless a `strategic surgery' is done, company will have to divert and say quits to the business. Environmental Analysis Opportunities Threats Internal Analysis Strengths Response I Aggressive Strategy Response III Turnaround Response II Diversify Response IV Defend the Territory

Weakness

SWOT analysis is a useful tool for positioning the company with respect to the environmental conditions. This analysis can also be applied to the product-market strategies. Products have their strengths and weaknesses, markets offer opportunities and threats. There are four positioning strategies; 1) Product has many strengths and Market offers opportunities: Skim the market, increase the market share. 2) Product has strengths but Market is full of threats: Highlight the product's strengths to maintain the market share. 3) Product has weaknesses but Market offers opportunities: Improve the product to the requirements of the market. 4) Product has weaknesses and Market has threats: This is an ICU (Intensive Care Unit) syndrome. Be prepared to say quits both to the product and to the market. Strategies and Core Competencies The idea of core competence was formulated by Prahald and Hammer in their article, "Core Competence of the Corporation". "A core competence is what a firm excels at and what adds significant value for customers". From this definition of core competence, it may be observed that core competence essentially means strengths of the company. Thus, the concept of core competence draws our attention to the first factor of SWOT analysis i.e. the strengths factor. "Strategy should be based on strength", is an ancient quote, used in the context of war between two kingdoms. In competency-based strategy, we find an echo of this ancient wisdom. The idea of core competence when matched with the opportunities and threat analysis provides a contour for strategic directions for the organization. Herein lies the importance and usefulness of the idea of core competence. Since different organizations possess different core competencies, each organization must identify its core competencies and build them further for matching with market opportunities and overcoming the market threats. Corporate Level Strategies Corporate level strategy, the key idea is about the "deployment of resources" and the choice of "right mix of businesses" including the right choice of the "basket of products"

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Remain a single industry firm Diversify in related businesses

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At the corporate level, the strategy issues involve the following decisions;

Diversify in unrelated businesses

Core competencies can be classified in following two categories: Transferable core competencies Non-transferable core competencies

In case of single industry firm, core competencies are easily transferable from one business unit to another, from one location to another. In case of related diversified firm, core competencies can also be transferred from one business unit to another. However, in case of non-related diversified firms, it becomes difficult to transfer core competencies across the entire business spectrum. Transferability of the core competencies provides flexibility to corporate management to respond well to the opportunities and threats. Business Unit Strategies While strategies are formulated at the headquarters, battles are fought at the field. This metaphor has implications for the business organizations. Corporate level strategies determine the overall strategic direction of the organization, the battle for survival and market shares takes place at the level of the business units. Therefore, business unit mission and business unit strategy assumes significance in the overall scheme of things. Business units of an organization have to face the "competition heat" at the market place. In case of single industry firm, the heat of competition is felt both at the corporate level and the business unit level. In case of diversified firms intensity of competition heat is felt more at the business unit level. In both situations, business units must gear it to face the competition. In essence, it should focus on creating a competitive advantage for itself. The following models help us in formulating business unit strategies; The BCG Model: BCG (Boston Consulting Group) model is an important analytical tool for analyzing the business unit strategies. The model provides a 2 x 2 matrix based on market share and market growth as criteria to classify various businesses. The model not only classifies the business but also identifies the strategies for each category. Market Growth High High Star (Hold) Question Mark (Build) Low Cash Cow (Harvest) Dog (Divest)

Market Share

Low

The following are the metaphors used in BCG matrix to classify various businesses; 1) High market share, high market growth Star 2) High market share, low market growth - Cash cow 3) Low market share, high market growth - Question mark 4) Low market share, low market growth Dog BCG matrix suggests that if a company/business unit is in "star" position, the strategy should be to hold on to this position. This is referred to as "hold" strategy. If company is in a "cash cow" position, it should milk the cash cow. This is referred to as "harvest" strategy. If company is in "question mark" position, it should try to increase the market share. This is referred to as "build strategy". If the company is in "dog" situation, it should think of getting out of such a business. This is referred to as "divest strategy".

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General Electric (GE) Planning Model The General Electric Planning model considers business strength and industry attractiveness as criteria for categorizing businesses. This model uses a 3 x 3 matrix for classifying businesses in terms of categories such as winners, question marks, average businesses, profit producers and losers. Industry Attractiveness High Average Strong Business Strength Average Low Winner Winner Question Mark Winner Average Businesses Loser Low Profit Producer Loser Loser

When we compare the GE model with BCG model, we can observe that market share is indicative of the competitive position or business strength and market growth rate is indicative of the attractiveness of the industry. In fact, we can reduce 3 x 3 matrix of GE model into a 2 x 2 matrix and refer It as modified GE model. Industry Attractiveness High Low Profit Winner Producer Question Mark Loser

Business Strength

Strong Low

Improving Competitive Advantage An important aspect of business unit strategy relates to improving competitive advantage, for this Porter's five force model is useful to get an understanding of the industry structure. The five forces identified by Porter are as follows; 1) "The intensity of rivalry among existing competitors. Factors affecting direct rivalry are industry growth, product differentiability, number and diversity of competitors, level of fixed costs, intermittent over capacity, and exit barriers. 2) The bargaining power of customers. Factors affecting buyer power are: number of buyers, buyer's switching costs, buyer's ability to integrate backward, impact of the business unit's product on buyer's total costs, impact of the business unit's product on buyer's product quality/performance, and significance of the business unit's volume td buyers. 3) The bargaining power of suppliers. Factors affecting suppler power are number of suppliers, supplier's ability to integrate forward, presence of substitute inputs, and importance of the business unit's volume to suppliers. 4) Threat from substitutes. Factors affecting substitute threat are relative price/ performance of substitutes, buyer's switching costs, and buyer's propensity to substitute. 5) The threat of new entry. Factors affecting entry barriers are capital requirements, access to distribution channels, economies of scale, product differentiation, technological complexity of product or process, expected retaliation from existing firms and government policy".

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The intensity of these forces is indicative of the attractiveness of the industry and competitive pressures within the industry. The five force analysis helps us in focusing our attention on the opportunities and threats in the external environment. Porter suggests two strategies for responding to the opportunities and threats, viz., cost leadership and differentiation. In cost leadership route to competitive advantage, the focus is on gaining competitive advantage through cost advantage. If per unit costs are low because of the economies of scale, cost control, experience, curve advantage, etc., then the firm gains a cost advantage at the market place. In product differentiation route to competitive advantage, the focus is on differentiating the product in terms of product features, product design and product identity. The idea is to "create something that is perceived by customers as being unique". In the third route to competitive advantage, both the cost leadership and product differentiation are combined together. This route to competitive advantage is referred to as cost-dum-differentiation because it combines both the cost advantage and the product differentiation advantage. Hence, it represents the most attractive competitive position. Strategies and Management Control: Interface There is a close interface between strategies and management control. This interface is indicated by the concept of "interactive control" formulated by Simons (1995). Control system is essentially a strategy implementation tool. When viewed from this perspective, strategy and control systems are coupled with each other. Information generated from the control system is useful in formulating new strategies. When control system generates meaningful and useful information for thinking about new strategies, such a control system is referred to as "interactive control". The information from such a control system has a learning value for the managers and the organization as a whole. Because of "strategic uncertainties" such as changes in technologies, competition, lifestyles, Customer preferences etc., it is important that control system should throw up information relating to indicators of strategic uncertainties and indicators of troubles. Then such a control system has learning value for all the employees leading to a proper "learning environment". Such a control system also makes the organization a "learning centre". Thus a strong interface between the strategy and control system makes the organizations learning organization.

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Radical Performance Improvement and Management Controls The idea of Radical Performance Improvement (RPI) has been suggested by Sumantra Ghoshal et. al., in their book, Managing Radical Change. They consider managerial function as "learning to cook sweet and sour". For achieving radical improvements in performance, managers should effectively manage the sour task of improving resource productivity and the sweet task of creating and exploiting new opportunities. In a way, this approach is similar to Simons "interactive controls" wherein strategy and control systems are coupled to generate the synergy. While control systems could represent the sour side, strategy represents the sweet side, as it involves looking for opportunities. However, at times, strategy could also go sour. If both control system and strategy go sour, there will be catastrophic under-performance leading to sickness. In the RPI framework, three stages of competition have been identified, viz. Competition for dreams, Competition for the resources and competencies and Competition for markets. Competition for dreams involves articulating vision for future markets, indicating the corporate ambition and providing an overall sense of purpose to the business. Competition for resources and competencies includes competition for technology, quality people, brands etc. Competition for markets implies articulation of competitive strategy through industry analysis, segmentation and positioning, cost leadership and product differentiation, etc. Competition for Dreams Competition for Resources and Competencies Strategic Architecture Resources (Technology, brands etc.) Competencies Skills Competition for Existing Markets

Opportunity Horizon Vision of future markets Corporate ambition Sense of purpose

Competitive Strategy Industry analysis Strategic segmentation and positioning Cost and differentiation drivers

Designing Management Control Systems Attributes of MCS: Control systems can be broadly classified in the following two categories 1) Reactive Control Systems 2) Proactive Control Systems In reactive control systems, the corrective action is initiated after the happening of the event or a control failure. In proactive control systems, the signals from the environment are anticipated and control system is built to incorporate the impact of such signals for taking the corrective action. Proactive control systems are similar to what Newman calls "steering controls". According the Newman, in steering controls, results are predicted and corrective action is taken to ensure successful completion of operation e.g. astronauts landing on the moon right on target and on time. The essential attributes of management control system are as follows: 1) 2) 3) 4) Proactive orientation Performance Measurement System (PMS) Strategy - Control System Linkage thought Interactive Control Failure Anticipation and Contingency Planning
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Centralization Vs. decentralization has been an important point of debate in the control system literature. It is primarily a concern of the large bureaucratic and hierarchical structures wherein decentralization becomes a necessity. Decentralization ensures freedom and autonomy in decision making with accountability and responsibility as the prerequisite. It may be indicated that with the advent of the Information Technology and new type of organization structures such as network structures, the issue of centralization vs. decentralization has to some extent lost its original relevance. It is generally recognized that "on-line control systems" could create greater centralization, however, as "learning organizations", the organizations are discovering that Information Technology leads to greater decentralization because of "democratic access" to information and knowledge within the organizations. Indeed, because of democratization of information, centralization is giving way to decentralization in decision-making and control. Cybernetic Paradigm or the Feedback Factor Cybernetic paradigm has its origin in cybernetics. Cybernetics is essentially the `science of communication and control'. The fundamental idea in cybernetics is the concept of the "negative feedback" and its role in purposive and adaptive behavior of systems. Cybernetic paradigm finds its application in various organizational contexts, particularly in designing the management control systems and the information systems. According to Mason (1981), "The basic cybernetic model commences with some norm or target being set by decision making information system. Then action is taken pursuant to this goal. Subsequently observations are made to measure the effect that action has on the source and the resulting `feedback' is recorded in a databank". The essential aspect of this paradigm is the feedback factor in ensuring the "goal convergence" of the system. In using cybernetic paradigm for designing control system, the following aspects should be considered: a. Target setting: Proper targets should be set. Past data could be useful in arriving at the standards of performance and achievement. In situations where business is entirely new, based on new ideas, target setting could be based on intuitive judgement. In `knowledge economy' where businesses are based on ideas and knowledge, the traditional target setting concepts may not be relevant. Achievement / Performance measurement: Measure the performance against the targets to assess the achievement. Identify deviations: Identify deviations between targets and achievements. Measure the degree/intensity of variations. Identifying the Causes / Reasons for variations. Use the Feedback Information from the Cause - Effect analysis of variations, to take corrective action.

b. c. d. e.

Thus, cybernetic paradigm provides us a five step framework for designing the control system in organizations. Meaning and Implications of MIS: Management Information System (MIS) has three components, Management, Information and System. Management essentially means planning and controlling operations, but such planning and controlling. Information has to be distinguished from data. For example, customer's invoices are data only, while the inventory analysis, sales analysis etc, are information (after the same data are converted). System essentially implies a systems approach to turn data into information and integrate all systems of a business. Thus, MIS may be defined as a set of integrated, well-knit and scientifically designed system whereby raw data get converted into decision-based and control-oriented information and flow continuously regularly from one end to another. A sound MIS ensures inter-cilia the following:
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Information geared toward aiding managerial decisions for planning and control; Screening of all information at the point of transmission to select the relevant and reject all irrelevant details, keeping an eye on the diverse steeds of management at different levels; and A built-in system of link-up and follow-up.

There are three key elements in any information-flow, namely timing, degree of accuracy and nature of defects. Timing of information is perhaps of the greatest importance in any MIS, since it is an accepted fact that information delayed is information denied. Closely linked with timing is the degree of accuracy which should be determined with reference to the purpose of the proposed information and the decision that might emanate from it. Nature of details or the volume of, information is also an important factor in MIS. Inadequate information and more than adequate information may both be worse than no information. What is information (finished product) to one may be data (raw materials) to another. It all depends upon the levels and functional areas of management. For example, a detailed customer-wise outstanding analysis is an information to the line management but only data to the top management. From these data may be prepared division-wise working capital locked up in respect of outstanding and this may become an information to the top management. It may be mentioned that, MIS should be more future-oriented than just an extrapolation of past data. Taking decisions based on past data alone is the same as driving a vehicle with eyes fixed on the rear view mirror - the vehicle will not achieve even reasonable speed and reach the destination in time. When MIS is future oriented, it becomes a strategy tool; otherwise it remains merely a `control tool'. Design Considerations in Designing MIS: In the above discussion, it has been mentioned that Management Information System (MIS) is an important tool of Management Control Systems. With the advent of information technology, it has become possible to generate Online Management Information System. While information technology has made it easier to generate relevant information, the conceptual and essential aspects of MIS and MRS (Management Reporting Systems) remain valid. In designing MIS, important design considerations are as follows: 1) 2) 3) 4) MIS should be linked to responsibility centre MIS should highlight critical indicators MIS should report both financial and physical information MIS should highlight variations in actual and planned performance

MIS is essentially &decision making and performance monitoring tool. Since it helps in decision making, it should be linked to the various responsibility centres and various levels of management. Top management should get relevant information on performance of responsibility centres and the responsibility centre incharge should also get critical information on various activities and operations of the responsibility centre. Required reports should be generated to bring to the attention of the top management, the problems being faced by the responsibility centres. Top management, in turn, could provide the required support in terms of resources and policy clarity to improve the performance of responsibility centres. MIS is also a diagnostic tool. As a diagnostic tool, it should highlight the critical indicators. Accordingly, it should focus on key performance variables or critical success factors. Key success factors are "crucial to attainment of strategy, goals and objectives". Maciariello and Kirby (1994, p.78) indicate that, "it is necessary to establish them (key variables or key success factors) for each responsibility centre; they are instrumental for achieving the goals and objectives of the responsibility centre. They in turn become the basis for the establishment of appropriate performance measures, responsibility centre designations, reward structures and resource allocation procedures. Once the key success variables are identified, the control system is given focus". It may be indicated that a critical indicator could be financial or non-financial in nature. For example, in case of hotel industry, occupancy rate is a critical indicator. MIS should throw up information on such critical indicators to help managers in taking corrective actions to improve performance of their responsibility units. Thus,

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MIS can be used as a tool for Performance Improvement. For example, if occupancy rate of a hotel is constantly low, it indicates that there is a need for a "radical performance improvement" through certain strategic decisions. Thus, MIS is not just a management control tool but also has a strategic relevance. MIS is useful for performance evaluation. It is a supportive tool for the Performance Measurement Systems (PMS). As a supportive tool, it should report both financial and physical information to inform managers' about the achievements of the responsibility centres / departments. In a holistic view of performance evaluation, both financial and physical parameters are important, hence, MIS should provide the information on both aspects viz., the financial and physical. The ultimate aim of MIS is to motivate managers to improve the performance of their responsibility units. Hence, MIS should highlight variations in actual and planned performance. This helps in drawing managers, attention to areas where action is required. Further it also helps in drawing up an action plan for performance improvement. The above discussion indicates that MIS is essentially a managerial tool for decision making, performance review and performance measurement. With the advent of information technology, it has become easier to generate the required information for performance improvement. Hence, MIS has now become not only a tool for management control but also a tool for strategy. MIS and Total Knowledge Management (TKM) (Special management control situations) Knowledge Management has emerged as a new managerial tool. At the conceptual level, MIS still retains its attractiveness because it draws our attention to the critical success factors and helps us in taking corrective actions. With the arrival of `learning systems' paradigm, we need to go beyond the MIS, while retaining it as an important tool in our managerial kit. Learning systems paradigm aims at making `cybernetic organizations' which are control driven into `learning organizations' which are `learning' driven. While MIS is rooted in the cybernetic paradigm, Knowledge Management is rooted in the `learning system' paradigm. When two ideas are combined together, we arrive at the `cybernetic learning organizations'. In such organizations, MIS is used as a learning tool and a strategy tool rather than merely a control system tool. Thus, MIS gets integrated with Knowledge Management They identified knowledge in terms of `explicit knowledge' and `tacit knowledge'. Explicit knowledge is codified knowledge, available in the form of formula, tested hypothesis, laws, theories etc. Tacit knowledge is the knowledge embedded in individual experience. It is knowledge `residing in the heads' of specialists and workers. Explicit and tacit knowledge can also be referred tows structured and intuitional knowledge. At the strategic planning and strategy formulation level, intuitional knowledge is extremely useful. At the operational control level, structured knowledge has greater relevance. At the management control level, both structured knowledge and intuitional knowledge have role to play. While MIS may largely be based on structured knowledge, in designing KBS (Knowledge Based Systems) for management control, an effort is made to integrate the tacit knowledge with explicit knowledge. Behavioural Aspects Behavioural dimensions are critical in management control systems. Wiener defines cybernetics as "study of the entire field of control and communication theory, whether in machine or animal". Organizations are run by human beings and not by machines or animals. While Weiner may have considered human beings as animals, in reality human beings are not mere animals as some may think. Because organizations are managed and run by human beings, the behavioural dimension becomes a critical factor in the efficacy of the control systems in achieving the purpose for which they are designed. The basic idea of studying behavioural aspects in the context of management control systems is to create conditions for ensuring "goal congruence" between individuals' goals and organizational goals. Individuals working in organizations look forward to fulfilling their personal goals. Top management is interested in ensuring achievement of organizational goals. Integrating individual goals and organizational goals is critical to the success of an organization. The primary objective of management control systems is to achieve this integration and thereby ensure "goal congruence". While money is con-

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sidered as an important motivator, there are several non-monitory factors that help in achieving the goal convergence. Hence, it is important to look at the behavioural processes at the work place to create a work culture that is conducive to goal congruence. The behavioural dimension deals with the following issues: 1) 2) 3) 4) 5) 6) 7) 8) 9) Leadership Communication Motivation Managerial Styles Conflict and Cooperation Organization Culture & Empowerment Ethics Creativity & Self Development Socio-cultural Influences

Management Control Process: Strategic Planning. Budget Preparation. Analyzing financial performance reports. Performance measurement. Management compensation.

RESPONSIBILITY CENTRES A responsibility centre may be defined as an area of responsibility which is controlled by an individual. The responsibility centres require establishment system of accumulation, absorption and allocation of costs to identifiable responsibility centres. Robert N. Anthony and Vijay Govindarajan has defined responsibility centre is an organization unit that is headed by a responsible manager. A company is a collection of responsibility centre. At the lowest level of hierarchy in a company sections or work shifts are responsibility centres. At the higher levels are departments or a strategic business unit who consists of the smaller units, staff and management. At the level of senior management and Board of Directors whole of the company is a responsibility centre. Delegation and Responsibility Centres Determining the responsibility centres in an organization depends upon the philosophy, strategy followed by an organization or company concerned. There are several ways of delegating the authority and associated responsibility. The company management would have to consider and identify key factors for it. They may undertake delegation on the basis of functional responsibilities, such as production, marketing and finance. They may consider product lines and geographical location of the business also as the key factors. Functional Delegation In many organizations authority and responsibility is delegated on the functional basis of production, marketing and finance. One individual will be given the decision making authority and the responsibility for all the production activities, another for all the marketing activities and yet another for all finance activities. Product Lines Some organizations delegate authority based on product lines of the company. A single manager will be responsible for the different functions of production, marketing and finance for the particular production lines. This type of delegation is followed normally by companies who choose to organize themselves into strategic business groups. These product line managers may in turn delegate their decision making authority and responsibility to various subordinate functional managers, namely, production manager, marketing manager and finance manager.

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Geographical Regions Geographical delegation of authority and responsibility is normally resorted to for the simple reason that customs and characteristics of the people, market and the business environment may vary considerably from area to area. This is even more so' in the case of multinational companies operating worldwide. It is a common practice to segregate the organizations on the basis of domestic and foreign operations. In India, it is a common practice for companies operating throughout the country to divide their operations into four or more geographical regions of the country. The Concept of Responsibility Centres: The companies are facing a lot of challenges due to increasing competition, as we are moving towards more and more liberalization and globalization. It has necessitated effective control and management of various operations of the company concerned. 1. 2. 3. Delegation of responsibility for specific to successive lower levels of the organizations. Motivation of the level of management to which a certain task has been delegated. Measurement of achievement of the specified objectives.

The organization structure followed in this framework is mostly pyramidal. Under it, the lower level managers report upward towards their superior as the superiors delegate their authority to lower levels. The key factor or consideration for determining the responsibility centres is its ability to control cost or revenue. As effective control implies, controlling cost and revenue. It fact, the effective planning and control system are structured around the implicit or explicit centres of responsibility within the organization. The managers at different levels should have a clearly defined area of responsibility if their proper evaluation is to be undertaken. The responsibility centres too have to be evaluated on the basis of set criteria which may be as follows; 1) 2) 3) 4) Comparison with budgets and targets; Comparison among different division within the company; Comparison with historical results; Comparison with industry averages.

Organization Structure and Responsibility Centres: At the time of establishing responsibility centres, the existing organization structure should be properly reviewed often, in practice, it requires a change in the existing organization structure. In view of that, following changes may be quite necessary in it: 1) The responsibility for all the revenues and expenses must be assigned to identify competent individuals in the organization. 2) The accounting system should be modified as to accumulate and report expenses and revenues on the lines of assigned responsibilities within the organization. 3) A system of evaluation based on comparison of revenues and expenses of different responsibility centres with pre-assigned targets should be established: If the suitable and necessary changes are not undertaken in the existing organization, the purpose will not be responsive to the needs, required in this connection. Types of Responsibility Centres: The responsibility centres can be classified keeping in mind two important factors. They are; 1) The scope of responsibility assigned, 2) The decision making authority given to individual managers. These are four types of responsibility centres. They are given as follows:

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1.

Expense Centre

It is also known as cost centre. A cost or expense centre is a segment and division of an organization in which the managers are held responsible for the cost incurred in that segment. They may not be responsible for revenue. The expense centre managers have control over some or all of the costs in their segment of business but not over revenues. In a manufacturing organization, the production and service departments are classified as expense centres. In a marketing department, a sales region or a single sales representative may be taken as expense centre. The expense centre managers are responsible for the costs that are controllable by them and their subordinates. There are two general types of expense centres Engineered cost is those elements of costs which can be predicted with fair degree of accuracy e.g. cost of raw material, direct labour, water and electricity etc. Discretionary cost (also called managed costs) are costs for which output can't be measured in monetary terms, e.g. are administrative and support units like accounts department, legal department, public relations department, research and development department, most of the marketing activities etc. 2. Revenues Centre

Revenue centre is a segment of the organization which is primarily responsible for generating sales revenue. The revenue centre manager has control over expenses of the marketing department but he has no control over cost, or the investment in assets. The performance of revenue centre managers is evaluated by comparing actual revenues with the budgeted revenue and actual marketing expenses with budgeted marketing expenses. 3. Profit Centre

Profit Centre is a segment of business often called a division that is responsible both for revenue and expenses. In a non-profit organization, the revenue centre may be used instead of profit centre, as profit is not the primary objectives of such organization. The main purpose of profit centre is to earn the targeted profit. In fact, the profit centre managers are more concerned with finding ways to increase centre's revenue by increasing production or improving distribution methods. The performance of the profit centre is evaluated in term of whether the centre has achieved its budgeted or target profit or not. 4. Investment Centre

An investment centre is responsible for the profits and investment. If a manager controls investment, that area of responsibility can be called as investment centre. He is responsible for the returns on the investment. He is required to control the amounts invested is the centre's assets. The manager of investment centre has more authority and responsibility than the manager of either cost centre or profit centre. Relationship between different Responsibility Centres When the whole company is treated as a profit centre it may have one or more expense responsibility centres. If a company has more than one profit centre, each profit centre will have one or more expense responsibility centres. It may also have a corporate expense responsibility centre to which all expenses, which are not incurred specially for profit centre, may be charged. For example, general administration expense of corporate office may be charged to appropriate corporate expense responsibility centre. Characteristics of a Responsibility Centre a) It is a cleared defined segment of an organization. b) A designated individual is responsible for its performance; namely, the output produced by the segment as well as inputs consumed by the segment. c) The designated individual has the necessary authority to discharge the assigned responsibilities.

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Establishment Responsibility Centres Establishment responsibility centres in an organization are not an easy task. It must be carefully planned and executed. Some of the major steps involved in the process can be described as follows: 1) Study the organization structure, authority-responsibility relationships or job descriptions, layout of the factory and office, various activities, production process and structure of the production flows, and the interrelationships among these different activities. Based on this study, list all the different operations and activities, functions and tasks in the terms. 2) Define each activity in descriptive terms, 3) Evaluate the need for any reorganization required in the context of establishment of responsibility centres and develop an organization structure on the lines of desired responsibility centres. 4) Delineate the organization into various responsibility centres. Ensure that the centres so established satisfy the three characteristics of a good responsibility centre. The establishment of centres can be considered a tentative starting point for evaluation against the following factors: The objectives of the system which will govern the number and type of responsibility centres, the need for cost information relating to a particular activity; The need for flexibility for supplying cost information for occasional requirements; Ease in allocation of costs, measurement of performance and evaluation of variances; Future needs of the organization at least to the extent known from corporate or strategic plans; The volume of information and paperwork to be contended with; Segregation of production departments and service departments; Comparison of the planned responsibility centres with those of a similar company; and A system of coding of the responsibility centres for easy recording and retrieval of information. This can also integrated with account numbers.

Performance Evaluation of Responsibility Centres After assigning the necessary authority and responsibility to individuals at different centres, it becomes quite necessary to undertake evaluation of their performance. Any performance evaluation has to be done taking into account the objectives set as well as the predetermined criteria set for them. The objectives may be different for different responsibility centres. For example, for expense centre, it would be minimizing cost, for revenue centre, it would be maximizing sales revenue, for the profit centre, it would be maximizing profits and for investment centre, it would be maximizing return on investment. The overall performance evaluation concept applied to various responsibility centres is given in the following Types of centres Expense Revenue Profit Investment Control variable of centre Prices and quantities of input Prices and quantities of input Prices and quantities of input and outputs Price and quantities of input and outputs and investment Variable predetermined by top management Prices and quantities of input/budget Quantities to be sold/budget Investment None Objective Minimize cost Maximize sales revenue Maximize profit Maximize return on investment

Profit Centres: A Profit Centre is a segment of a business, often called division that is responsible for both revenue and expenses. In a non-profit organization, the term `revenue centre' may be used instead of profit centre' as profit may not be the primary objective-of such an organization. In other words, a profit centre is a responsibility centre in which inputs are measured in terms of expenses and outputs are measured in

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terms of revenues. The expense centre, expense responsibility centre and profit centre are inter-related. The main objective of expense centre is to effect expense control. In case of profit centre, expense control is only one of the several considerations. In a profit centre the measures of performance is boarder than that of an expense centre as in expense centre, we measure only one element, i.e., cost whereas in profit centre we measure both cost as well as revenue. Similarly, the scope of activities of profit centre is much broader than that of revenue centre because of the responsibility to produce the product more efficiently. In a profit centre, manager has the responsibility air' authority to make decisions that affect both costs and revenues for the department or division. In fact, the main objective of a profit centre is to earn profit. Thus, a profit centre manager aims at both the production and marketing of a product. Such a manager decides about the production policies, the price and marketing strategies. He is concerned with increasing the centre's revenues by increasing production and/or improving distribution methods. However, such a manager does not take decision or has control over the investment in the centre's assets. He may make proposals for the investment in the division but the decisions about it are normally taken by the top management. A typical example of a profit centre is a division of the company that produces and undertakes marketing of different products. Thus, it is concerned both with formation of production strategy as well as marketing strategy. The main objective is being to earn higher profits by pursuing such policies. Advantages of Profit Centres: The operating decisions can be taken quickly without referring to the headquarters. Quality of the decisions is improved because the managers taking these decisions are aware of the ground realities and also closest to the point of decision. Higher management can focus on macro issues leaving the micro issues to be tackled by operational managers. Profit consciousness is enhanced in profit centre managers due to the fact that profit is going to be the criteria for assessment and as a result the managers would be sensitive to the impact of their action on both the expenses and revenue. Managers are free of micro restraints and can use their creativity and initiative. Profit centres are incubators for future business managers at higher level as they are excellent training ground for general management. A profit centre creates a reservoir of managerial talent which a company can use during diversification. Use of profit centres helps the company to locate and diagnose the problem areas quite easily, because profit centres provide information on the profitability of the components of the company.

Difficulties with Profit Centres Top management may lose some control as the control reports prepared by the profit centres are not as effective as personal knowledge of an operation. Managers may be lacking competence in general management operations. There may be unhealthy competition among the various profit centres, which may manifest itself in form of undesirable behaviour of managers. This type of undesirable behaviour may include, hiding of information, hoarding of equipment etc. There may be disagreement among different profit centres regarding transfer, price, sharing of common cost, sharing of revenues generated by joint efforts. Profit centre managers may lay emphasis on short term profits at the expense of long term profits by neglecting crucial area like manpower training and development, maintenance and research and development activities. High profits of the profit centre may not always optimize the profits of the company. Setting up of profit centres may entail extra cost to the company in the form of additional management, staff and record keeping and additional ancillary infrastructure which may lead to redundant tasks at each profit centre.
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Profit Center as Motivational Tool

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a) A profit centre manager is perceived to have a higher status in the organization and hence provides a psychological benefit to the division manager. It is argued that this perceived importance motivates him to perform better. By making the managers responsible for the profit performance of their divisions it tried to blend their objectives with the profit objectives of the company. b) Profit centers tend to enhance the profit consciousness of the managers and subordinates within the division and hence they all strive for maximizing the profits of the division. This leads them to become conscious about the expenses in the division. They constantly try to evaluate every expense decision in the context of its relationship to profits. c) The position of being a profit centre, manager in an organization brings in a sense of pride and belongingness, which in psychological terms provides sustenance for the needs of selfactualization and self-esteem. Most of the organization theorists argue on these lines. d) The freedom and authority given managers imbibe a sense of independence and responsibility in the profit centre managers enabling them to strive for better performance. Transfer Pricing: Transfer price is the price at which the supplying division prices its transfer of output to the user division. As it is only internal transfer and not a sale, transfer price is different from normal price. The price charged to the inter-divisional transfer of goods and services is the revenue to selling division and cost to the buying division. Thus, the price charged will affect the profit of both the divisions. Transfer Pricing and Corporate Policy Introduction and operation of an effective system of transfer pricing in an organizations is entangled with at least major aspects of corporate policy. They are; Divisional autonomy Transfer pricing Performance evaluation

The first two aspects are specific ingredients of general areas of corporate control. Most large organizations may be divisionalised. The divisional managers' freedom of action is not complete. Divisional managers are to make periodic reports to the headquarters. The corporate policy on this may include: a) The level of details in these reports, b) The accountability of decisions and actions, c) The frequency of over-ruling of the divisional manager's decisions, and so on. The headquarters closely controls those aspects which affect the operations of other divisions. This includes quantities of output transferred among the divisions as also the price at which the transfer takes place (the transfer price). Criteria for Determining Transfer Pricing 1. 2. 3. 4. 5. Transfer price should help in accurate measurement of divisional performance. Transfer price should motivate the divisional managers into maximizing the profitability of their divisions and making decisions which are in the best interest of the organization as a whole. The transfer price should ensure that divisional autonomy and authority is preserved. The transfer price should allow goal congruence to take place. It implies that the objectives of the divisional managers are compatible with the objectives of overall company. A transfer pricing system should check the international groups which may try to manipulate transfer prices between countries with a view to minimize the overall tax burden.

Methods of Transfer Pricing


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There are two basic approaches to determination of transfer price. They are: (i) Market based; (ii) Cost based.

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Fundamental principle: the fundamental principle is that the transfer price should be similar to the price that would be charged if the product were sold to outside customers or purchased from outside vendors. The Ideal Situation: A transfer price will induce goal congruence if all the conditions listed below exit. Rarely, if ever, will all these conditions exist in practice. The list, therefore, does not set forth criteria that must be met to have a transfer price. Rather, it suggests a way of looking at a situation to see what changes should be made to improve the operation of the transfer price mechanism. Competent People: ideally, managers should be interested in the long run as well as the short run performances of their responsibility centers. Staff people involved in negotiation and arbitration of transfer prices also must be competent. Good Atmosphere: managers must regard profitability as measured in their income statement as an important goal and as a significant consideration in the judgment of their performance. They should perceive that the transfer prices are just. A Market Price: the ideal transfer price is based on a well-established, normal market price for the identical product being transferred that is, a market price reflected the same conditions (quantity, delivery time, and the like) as the product to which the transfer price applies. Freedom to source: Alternatives should exist, and managers should be permitted to choose the alternative that is in their own best interest. The buying manager should be free to buy from the outside, and the selling manger should be free to sell outside. Full flow of information: managers must know about the available alternatives and the relevant costs and revenues of each. Negotiation: Market Price The most popular method of determining transfer pricing is the market price, as it is quite reasonable for supplying division as well buying division. It is not difficult, as the price is easily available in the open market. When there is a well-established market for the goods or services to be transferred. The transfer price can be easily determined on the market price basis. However, such market price should be taken as ceiling limit for transfer price. When divisions have the alternative to buy or sell from the open market, they would transfer to buy or sell from sister division. When transferred goods are recorded at market price, the divisional performances are more likely to represent the real economic contribution of the division to total company profits. Under certain conditions, there may be deviations from market-based transfer price. Some instances, for such deviations, are as follows: Where the products involved are highly specialized and a ready market does not exist, marketprice determination will be more difficult. Where it is necessary to take advantage of economies of the scale in the production of some goods or services. When it is necessary to shift resources from low priority to high priority divisions. Where considerations of taxation are applicable.

Market-based transfer pricing is more commonly used, as it offers following advantages: They are one of the most simple and easily understood methods. They minimize the complications for performance evaluation. They reduce points of conflict between various divisions. They are usually consistent with the environment outside.

Cost-based Prices

The cost-based prices methods may be as follows:

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When external markets do not exist or are not available to the company or when correct information about external market prices is not available, the cost based transfer price may be used.

a) b) c) d) e)

Variable Cost Actual Cost Cost plus a normal mark-up Standard Cost Opportunity Cost

a) Variable Cost: Under this method, only variable production cost is taken into account. In variable cost, the cost of direct material, direct labour and variable factory overhead are included. In other words, fixed cost is not included in it. Variable cost method for transfer price may be useful when the selling division is operating below capacity. However, the selling division manager would not like it as a basis for transfer price, as it does not provide the profit to that division. b) Actual Cost: If transfer prices based on actual cost, it would include total or full cost of production per unit. It is a simple and convenient method, as the required information is available in the accounting records. However, the selling division would not earn any profit on goods or services transferred to the buying division. The buying division would stand to gain, as it would be lower than the market price. However, it is quite inappropriate for profit center analysis. c) Cost plus Normal Mark-up: Under this method, the transfer prices include cost per unit plus some profit margin or normal mark-up. This mark-up price may be determined in two ways. Either the management of the company may set a target profit or it may be equal to the profit Margin that competing firm might reasonably be expected to realize. However, the decision about the percentage of mark-up may be arbitrary and questionable. d) Standard Cost: Standard Cost is pre-determined cost and is also called `engineered cost'. In practice, it may appear to be more practical and useful and may be taken to be a good choice for transfer price. Standard cost based transfer price encourages efficiency in the selling division as inefficiencies are not transferred on to the buying division. Use of standard cost reduces the risk to the buyer. e) Opportunity Cost: Often in practice, the determination of transfer price on market price or cost may be difficult. Under those circumstances, the transfer price may be based on opportunity cost. Such pricing may also be required where the supplier division is a monopoly producer or the user division is a monopoly consumer. The transfer price may be fixed at a level which equal the opportunity cost of the supplier division and the user division. It also identifies the minimum price that a selling division will be willing to accept and the buying division will be willing to pay. The opportunity costs based on transfer prices for each division are as follows: Selling Division: For the selling division, the opportunity cost of transferring is the greater of; a. The outside sales value of the transferred product; b. Differential production cost for the transferred product. Buying Division: For the buying division, the opportunity cost of acquiring by transfer is the lesser of: a) The price that would be required to purchase from the outside; b) The profit that would be lost for producing the final product if the transferred unit could not be obtained at economic price. In the economic interest of the company, it would be better if the opportunity cost for the selling division is less than the opportunity cost for the buying division. The practical difficulty may arise when the divisions will tend to overstate or understate their opportunity cost so as to influence the transfer price to their advantage. Under such condition, the central management may examine it and bring the necessary changes by obtaining necessary information in this regard. There are two other methods of determining the transfer price. They have been; described briefly as follows:
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1) Negotiated Prices: In practice, the transfer price is determined on the basis of negotiations between the selling and buying division. It may be between the market prices and the cost-based price. While ne-

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gotiating the price, the seller division manager and buying division manager act much the same as the managers of independent companies. If the transfer price is based on negotiated price, the company, as a whole, stands to benefit. Such price avoids mistrusts, bad feeling and undesirable bargaining interest among divisional managers. it provides an opportunity to achieve the objectives of goal congruence, autonomy and accurate performance evaluation. The negotiated price basis may have some limitations also. They are: In the process of negotiation, a great deal of management effort, time and resources may be consumed. Such a price may also depend upon the skill and ability of managers concerned. One divisional manager may take advantage of having some private information which the other manager may not possess. With the result, the negotiated price may not be accurate.

2) Dual Prices: It is also known as `two-way prices'. Under this method the selling division is credited with one price. That may be cost plus profit margin whereas the buying division is charged at different price, which may be equal to variable cost. The difference in the transfer prices for the two divisions could be accounted for by a centralized account. The dual pricing gives motivation and incentive to selling division as goods are transferred at cost plus some profit margin. On the other hand, for the buying division, it would be quite appropriate price. Often, the use of dual prices may lead to a divergence between the segment profits and those of company. However, this is not a serious issue and can be resolved in the interest of the divisions concerned. Transfer Pricing Practices There is a large amount of documented sources on the transfer pricing policies used by companies all over the world. These studies have documented various aspects of transfer pricing policies such as (a) its role as an overall component of reporting and control system in companies, (b) the effect of transfer pricing on intra-corporate conflicts, (c) variations in transfer pricing policies across the world, and (d) environment constraints on use of transfer prices. A brief summary of transfer pricing practices is as follows; i. Companies tend to look at transfer pricing not just as a mere accounting exercise, but also as an important tool in policy formulation towards achievement of corporate objectives. ii. Transfer pricing acts as a major source of political conflict within the organization and this takes place irrespective of the method used for this purpose. Different methods may, however, increase or decrease the possibility of conflict. iii. Companies tend to use a variety of transfer pricing methods. However, the dominant among them are the market prices or the methods based on modifications of the market prices. iv. Even though many companies use transfer prices as a policy variable, it is not the major or principal policy variable. v. International companies use conscious manipulation of transfer prices as an instrument of maximizing achievement of corporate goals. An explicit example is the transfer of profits from subsidiaries to parent companies or other companies in the group through transfer pricing policies relation to supply of capital equipment or inputs by multinational companies. Investment Centres: Investment centre is a responsibility centre in which inputs are measured in terms of cost/expenses and outputs are measured in term of revenues and in which assets employed are also measured. Thus, the investment centre is responsible for the assets under its disposal along with the profit. It involves questions related to as to what assets and liabilities should be included for determining the investment base of the investment centre.

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An investment centre manager is responsible for the production, marketing and investment in the assets employed on that division or segment of the organization. He has to take decisions related to credit policy, inventory policy as well as investment in equipments to be used for production and marketing. That way it may be taken as extension of profit centre that it covers all the elements relevant to the measurement of performance of division. As a responsibility centre, the performance of the division concerned would be measured in relation to the profits and assets employed in the division concerned. Investment Base Investment on asset responsibility implies the authority to buy, sell and use assets. This involves taking decisions related to identification of the assets and liabilities for determining, the investment base of the investment centre. It is not a simple problem, as the accounting theory does not help us in this regard. However, they should be included in such a manner that would motivate the managers concerned to take the best possible decision related to buying, selling and using the various assets. If it is not done, the return on investment in those assets would not be reasonable or as desirable in the given circumstances. The divisional manager has to be motivated to act in the best interest of the organization while taking such decisions. He is supposed to act, like top management in this respect. This would, however, depend upon the way the divisional manager is evaluated by the top management and also the extent of delegation of authority and resultant decentralization. The top management shoo Id is quite careful while evaluating the divisional manager's performance. He may depend upon the traditional method of evaluation, i.e., relating income to assets in terms of return on investment. It may be taken as Segment Return on investment or SROI. Lf the return on investment under the control of division or segment is quite satisfactory or reasonable; the company's return on investment would also be reasonable and satisfactory. Measuring Investment Centre Performance These are two important and popular methods of measuring investment centre performance. They are Return on Investment (ROI) and Residual Income (RI). Return on Investment (ROI) Return on investment is a popular and easier method of measuring investment centre performance. ROI is the relationship between return or profit and investment. It is usually expressed in terms of percentage. The profit here refers to profit before taxes and interest or operating profit. We take such profit as profit before taxes and interest is not influenced by extraneous factors such as financing or taxes over which the divisional manager does not have any control. Similarly, the investment here refers to operating assets which are available for use in the operations. Thus, ROI can be defined as ROI = Net operating investment may be in terms of written down value or the gross value of the fixed assets. The net value of the assets would depend upon the depreciation method used. It would be better to use, the average value of the fixed assets during their useful life. Measuring the Investment Base For the performance evaluation of a division as it has been seen, we take ROI, RI and a few other criteria but the return' or `investment base' cannot be defined without any ambiguity. There are various concepts of returns as well as investment base. The variables to be included in either of them would depend upon the management policy. For measuring investment base, two methods are commonly used. Under one method, we take total assets and, in other, we take total assets minus current liabilities. A general condition, however, is that the investment base should include only those resources which (are used in producing profit for the decision) concerned. Those assets, which are under construction or which remain idle should not be included in the investment base.
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Total assets imply the fixed assets like, building, furniture and machinery and the current assets, like cash, receivable and inventory. For the valuation of either components of the current assets or fixed

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assets, no common methods are used in practice. It differs from company to company and the policies adopted by the management concerned. Cash may be controlled centrally or independently by the division concerned. In most of the companies, the cash is controlled centrally to avoid keeping idle cash. With the result the divisions normally hold smaller amount of cash. Often the required cash is computed on the basis of a certain percentage of turnover or payment requirement for pertain number of days. While taking amount of receivables, they may be taken at their net values, i.e. receivable minus provision for bad and doubtful debts. This commonly accepted method is proper as the divisional managers may influence the amount of receivable through the volume of sales, proportion of cash and credit sales, the period of credit allowed and the efficiency of collection policies. The amount of inventory and its methods of valuation possess more serious problem, while including it as investment base. A common practice, used by most of the division, is to include them at their carrying cost. It is necessary for carrying on smooth operation of the division concerned. However, the fluctuations in demand for its output or supply of inputs have to be duly considered. Some companies used LIFO method of taking inventory, but under the inflationary conditions, its value would be understated. It would be better to use standard or average cost for the valuation of inventories while including them in the investment base. A common practice for valuation of fixed assets is cost less depreciation. Thus, they are taken at historical cost rather than economic cost of the investment required in the fixed assets. If total assets are taken as investment base, it tends to overstate the investment base. Total assets minus current liabilities may be taken to be a better measure for the investment base. In case, the division has very little control over the current liabilities, they should not be deducted from the total assets for the computation of investment base. Problems of Financial Control of Investment Centre As there are problems in computations of the investment base, similarly, there are problems in determining the financial control parameters in the divisionalised companies. Two most important parameters of financial control in the divisionalised companies are as follows; 1) Congruity of objectives; and 2) Ability of top management to evaluate performance of managers. The congruity of objective implies that the divisional manager would take the same decision which the top management would take the given situation. The top management should be duly satisfied that the divisional managers would act in the best interest of the company. With regard to the second parameter, it is necessary that the top management would evaluate the performance of the divisional managers keeping in mind the objectives of the organization. In fact, it is presumed that if the performance of the divisions is satisfactory, the company's overall performance is also going to be satisfactory. There are two issues involved with regard to the effective financial control of investment centres. Firstly, while imposing financial control, it should be kept in mind that such investments should not be included over which the divisional manager does not have any control. Secondly, such control should try to eliminate the possibility of fluctuation in the investments caused but by the divisional manager's action. The financial control should not be undertaken in such manner which many demotivate the manager of the division concerned. Budgeting and Reporting Budgeting and Budgetary control are perhaps the oldest and most popular instruments used in planning as well as monitoring the operations of an enterprise over a short and medium term time-frame. Budgeting and Budgetary Control seek to direct the activities of the enterprise in a certain logical sequence and addresses some basic issues which are essential to the planning and control process:

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Objective Diagnosis Prognosis Strategies Tactics Control

: : : : : :

Where do we want to go? Where are we? Where are we heading? How do we go? How do we implement the strategies? How do we make mid-course corrections? How do we monitor our course?

According to Chartered Institute of Management Accountants, UK (CIMA) Budget is "A plan expressed in money. It is prepared and approved prior to the budget period and may show income, expenditure, and the capital to be employed..." Plan is the end result of the planning process. A detailed and well-knit plan has two axes; (a) physical and (b) financial. Translation of planned activities for a definite period of time i) Into physical terms results in programming ii) Into financial terms results in budgets However, a good budgeting should subsume programming (i.e. physical dimension) also, even while the focus in budgets is the financial aspect. Classification of Budgets for Different Purposes Budgets may be classified into different types and looked at from different viewpoints: 1. Functional or sectional: a. Sales budget b. selling and distribution cost budget c. Production budget d. production cost budget e. purchase budget f. plant utilization budget g. administration cost budget h. research and development cost budget i. personnel budget Consolidated : a. cash budget (to include capital items also) b. summary budgets master budget (containing, inter alia, the budgeted revenue statement and balance sheet) Expense-behaviour wise : a. fixed budget b. flexible or multiple budgets Periodicity : a. basic budget or long term b. budget current annual budget or annual business plan c. Shorter period budgets (annual budget broken down into quarters or months). Responsibility-wise : a. Cost Centre Budgets b. Profit Centre Budgets c. Revenue Centre Budgets Emphasis or Approach : a. production-oriented budgets (under sellers' market situation) b. market-oriented budgets (under buyers' market situation) Building Block : a. principal budgets (primarily financial and partly quantitative) b. subsidiary or support budgets (primarily quantitative and partly financial) Management Style or level of participation : (This classification is of course not very relevant in actual practice) a. Authoritative b. Participative

2.

3. 4.

5.

6. 7. 8.

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Building Blocks of Budgets / Budget Setting Process Important Considerations 1. Corporate Objectives. 2. Corporate Profit Planning. 3. Nature of Markets. 4. Principal Budget Factor. 5. Sales Forecasting. 6. Spending for the future. Functional Budgets and their Inter-relationship Functional Budgets are budgets prepared independently by the functional heads. Then are several types of functional budgets depending on the size, nature and policy of the concern Classification of Functional Budgets of a typical concern vis-a-vis the managers responsible for preparing the same will be as under:

Sales Budget The Sales Budget is a forecast of total sales expressed in monetary and quantitative terms. The preparation of this budget is generally the starting point in the operation of the Budgetary Control System. A sales budget may be prepared under the following classification: a) Product Groups and/or Products Areas, territories or zones b) Areas , territories or zones c) Salesmen or agents d) Types of customers i. National Government ii. State Government iii. Export iv. Wholesalers v. Retailers e) Periods - week, month, quarters, etc. Sales budgets are influenced by a large number of factors, both internal and external, as given below:
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External Factors a) Change in population and in its sex and age group, (demographic factors)

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b) Government Policy and Regulations. c) Income distribution of the prospective buyers. d) Economic trends. e) National and international events. f) Extent and severity of competition. g) Seasonal and cyclical fluctuations. Internal Factors a) Analysis of past sales vis--vis- trend analysis. b) Demand analysis backed by market research. c) Analysis of reports by salesman. d) Review of general business condition. e) Production capacity - scope for improvement in short/long term. f) Profitability analysis through sales mixes planning. g) Use of promotional aids. Methods of Sales Forecasting Basically forecasting the sales of a product depends on its total demand forecasting on the one hand and the present as well projected market share on the other. This exercise needs to be carried out for all major product offerings of the company. There is a plethora of methods and tools used for demand forecasting. These are summarised below, under logical groupings Financial and Semi-Financial Tools h) Historical analogy method -e.g. demand for steel in India now may be related with that in USA in the 70's a) ii) Corresponding period comparison -e.g. demand for textiles in Oct/Nov' 2001 may be equal to demand for the same in Oct/Nov' 2000 plus a suitable percentage or growth factor End-users'/buyers' expectation method-e.g. demand for water filtration chemicals in metro cities, particularly during the rainy seasons. Quantitative and Statistical Tools i. ii. iii. iv. v. vi. vii. viii. ix. x. Time series analysis including adjustments for seasonal and cyclical variations. Trend extension or regression analysis - i.e. trend line fitted into the date for a number of periods in the past. Multi-variate analysis Exponential Smoothing Probabilistic models Input-Output tables Functional models - i.e. establishing a relationship between one dependent variable with one or more independent variable(s) Linking factor-e.g. demand for spare parts may be linked with the population of the equipment, using an estimated "factor" or percentage. Establishing lead-lag relationship-e.g. heavy order bookings of capital goods is an advance indicator of economic prosperity Technology Forecasting (TF) - particularly for products highly susceptible to technological obsolescence.

Qualitative Method Opinions from experts Brain-storming Delphi Technique Scenarios building

Field Survey (primary data) 1. 2. Questionnaire-based survey of representative samples, established preferably by Stratified Random Sampling Technique Bridging factor used in (i) above for estimating universe/population from samples

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3.

Test Marketing.

Literature Survey (secondary sourced): Through a judicious blend of some of the above-mentioned techniques sales forecasting exercise is to be completed first. Thereafter by applying the projected market share ratio the company's forecasted sales figures should be determined separately for each product or product-group. Selling and Distribution Budget: This budget which is closely related to the Sales budget is the forecast of selling and distribution cost in the budget period. Advertising Cost Budget This budget is also dependent on the Sales Budget in as much as this has to take into account the likely increase in demand as a result of advertising or the advertising (promotional) cost needed for sustaining the budgeted sales. Production Budget The production budget is a forecast of production inyhe budget period analysed into production volume budget and in physical units and the production cost budget. Broad factors usually considered are: a) Production planning b) Capacity consideration c) Sales budget d) Inventory policy i.e. the extent to which inventory of finished goods is to be carried. Plant Utilization Budget The budget covers the estimating plant facilities required to meet the budgeted production as set out in the production budget. The budget shows: a) Budgeted machine load b) Bottleneck machinery c) Need for overtime work, sub-contracting and shift working in short term and addition of facilities in the long run. Repairs and Maintenance Budget Maintenance cost budget which is closely related to Plant Utilization budget is prepared in three parts: a) Preventive maintenance b) Corrective maintenance c) Major overhauling Personnel Budget This budget shows in financial as well as in physical terms the type of labour required - skilled, semiskilled, highly skilled, etc. to meet the programme set out in the production budget. Impact of Learning Curve should be given due weightage in formulating this budget. Purchase Budget The budget represents the purchases including capital items to be made during the budget period. The budget is usually based upon:
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b) Production budget c) Capital expenditure budget

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d) e) f) g) h)

Research and development budget Policy of sub-contracting Stock levels in respect of "A" class items Finance available Storage space available Production Cost Budget

Production Cost Budget This budget is analysed into three subsidiary budgets viz : a) Material cost budget b) Labour cost budget c) Factory overhead budget Administration Cost Budget This budget will show the total estimated cost of formulating the policy, directing and controlling the operations of the undertaking. The budget is almost of a fixed nature. Research and Development Cost Budget This budget is considered from both the long and short term view-points and provides and effective tool for planning and balancing the research and development programme. This budget is dependent on the R&D policy, Product Life Cycle and of course the permissible financial resources. Inter-relationship of Functional Budgets: Since the functional budgets are inter-related, change. in any of the functional budgets will generate chain reaction as evident from the following diagram :

Master Budgets Introduction Once the functional budgets are prepares and an such budgets are available, the Budget Controller's office will have to engage itself in the next very important task which is preparation of the Master Budget. This comprises summarization and consolidation of all functional budgets, preparation of the cash budget and developing the profit and loss budget and the budgeted balance sheet. The summary budgets thus prepared are again reviewed, reconsidered and readjusted until an overall satisfactory budget is drafted. This budget is then submitted to the top management for acceptance. Only after such acceptance this set of budgets will be called Master Budget. Master Budget essentially means a finally approved comprehensive set of document covering all budgeting activities with respect to the budget year.

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The said document is also termed `Budget Package'. It is in the fitness of things to obtain a good number of the Budget Package printed and circulate the same among all concerned departmental heads and other senior executives before the budget year starts. This will also serve the purpose of communication which is an essential requirement in the planning process. Cash Budget A cash budget is a forecast of cash position over a period of time, to reflect changes in the position within the same period. Conventionally, cash budget is considered to be an integral part of the total budgeting process and it is prepared only after all sectional or functional budgets are available. However, to install better control on cash flow, the scope of operation of cash budgets can be expanded to cover each function or sub-unit separately and to develop a rolling cash flow plan for each subunit as well as the company as a unit. Fixed and Flexible Budgets Basically the concept of flexible budget is that some sort of budgetary cost adjustments will have to be made for varying levels of output. The underlying principle of flexible budget is to flex the fixed budgets to correspond with the actual level of activity. The CIMA defines flexible budget as "a budget which is designed to change in accordance with the level of activity attained", as against a fixed budget, being defined as "a budget which is designed to remain unchanged irrespective of level of activity actually attained". The fixed budget though rigid in character is subject to revision when there is a significant change in the basic assumptions underlying the fixed budget. A fixed budget has only a limited application, e.g. budgeting of fixed expenses but is ineffective as a control medium, particularly when wide fluctuations in the level of activity could take place due to external factors like market conditions, raw materials availability, etc. As a sharp contrast to fixed budget, flexible budgetary system attempts to develop a series of budgets for different levels of activity under varying sets of assumptions. This is why flexible budgets are also known as multiple budgets. The need for flexible ' budgets arises when due to uncertainties or changes in the environment it becomes extremely difficult to prepare even a reasonably good sales forecast. An attempt is, therefore, made to develop several alternative sales forecasts necessarily leading to the corresponding alternative levels of production, capacity utilisation and therefore, development of multiple budgets accordingly. Sales forecast may at times be difficult due to some situations that might arise in the companies: Which are subject to weather condition, e.g. soft drinks industry; Which frequent, change their product range or introduce new products; Which are affected by change in design e.g. ladies fashion garments; Where production is on made to order basis.

Decentralization and Performance Evaluation Every organization aims at achievement of some group-objectives. An important consideration in organizing activities is the congruity between the objectives of the individuals in the group and the group. Where such congruity exists the group goals would be achieved automatically with the achievement of personal goals. In reality, however is a natural contradiction between individual goals and the group goals. A basic contradiction which can be easily understood is the fact that the individual tends to want to put a small part of effort into achievement of the group's goals and at the same time like to share a larger part of the benefits of the group's activities. It is in the context of this natural tendency that the group must impose some performance evaluation of the individual. The share of the individual in group-achieved benefits (or results) should be proportional to some observable contributions of the individual to the group's objectives.

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The group activities are to be left to the individuals and what success criteria are to be considered in the evaluation of the contribution made by the individual towards the group. The activity of the group to be left to the individual's decision will determine the degree of individual autonomy. The success criteria to be used for evaluating the individual's contribution to the group will determine the method of performance evaluation. The set of observable success criteria may be taken to include absolute profit levels, profit rates, cost levels, revenues, market share, product improvements, and increase in productivity and so on. Managers on the other hand base their controls on various variables such as quantities of inputs purchased and consumed, quantities of output produced, prices obtained on outputs, expense incurred on marketing, research and development, product improvements and so on. It is generally agreed that there are three major principles for developing and implementing performance evaluation system; a. b. c. The criteria and procedure of performance evaluation should be clear and explicit and the superior and subordinate should have common understanding prior to the beginning of the evaluation period. The criteria of performance evaluation should be as accurate possible. It is ideal to use a multiple criteria of performance than any single criteria. It is this central position of transfer pricing in the performance of evaluation of different divisions and the resultant organizational problems that makes it very crucial in the scheme of performance evaluation.

Performance Measurement A performance measurement system has three constituent parts. Individual measures that quantify the efficiency and effectiveness of actions. A set of measures that combine to assess the performance of an organization as a whole. A supporting infrastructure that enables data to be acquired, collated, sorted, analyzed, interpreted and disseminated.

Measurement is bone of contention in many companies. These disputes are often caused by difference in paradigms. Traditional paradigms about measurement could be serious roadblocks to effective performance measurement and improvement; some of the traditional paradigms about measurement are listed below; a. b. c. d. e. Measurement is threatening Precision is essential to useful measurement Single indicator focus Subjective measures are sloppy Standards acts as ceiling on performance

Framework for Performance Measurement System Purpose of measurement: Performance measurement is a value adding process which has a direct impact on the competitiveness and improvement, but at the same time cost/ benefit has to be evaluated when developing a metrics to measure performance. A clear, unambiguous and well defined purpose make it easier to; Choose the right metrics: Metrics are the methods to quantify the measured information. A clear purpose helps to choose the right kind of metrics. Prioritize Indicators: Measurements are expensive and time consuming; a clear purpose helps to prioritize the indicators to identify the most important ones. Choose appropriate measurement methods Achieve understanding and acceptance: A clear purpose adds to the process of understanding and acceptance, lack of which makes the measurement system prone to manipulations.

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Other important purposes of performance measurement are; 1. Decision support 2. Monitor effect of strategic plan 3. Performance evaluation 4. Diagnosis 5. Manage a continuous improvement process 6. Motivation 7. Comparison 8. Record development Type of Metrics Metrics are the building blocks in a measurement system. A metrics is the specific method to quantity the information regarding the variable which is intended to be measured Hard versus soft metrics: Hard metrics are pure facts that are possible to measure directly e.g. Input, production, net profit etc. whereas soft metrics are used to measure the intangible e.g. Customer satisfaction, brand loyalty, employees satisfaction etc. Both hard and soft metrics have their strength and weakness and should be used according to the purpose of measurement, important thing being that whether the use of a particular metric has been able to provide an understanding or insight about the process and results. Hard Metrics Objective references Accurately known Hierarchical Soft Metrics Observer bias Surrogate indicator Multi Variable Situation

Financial versus Non-Financial Metrics: Financial and non-financial metrics are a subset of hard metrics. Traditionally the indicators of performance are translated into financial terms and for those indicators which can't be translated into financial terms they were all together omitted from framework of performance management. Integration of financial and non-financial metrics is essential for executing meaningful performance measurement. Financial Performance Metrics Budget Vs. Actual Variance Product/product group Profitability Cash flow Return on total capital Overhead absorption Customer profitability Bad debts EBIT Non-financial Performance metrics Inventory turnover Labour efficiency Capacity utilization Defect ratio Lead time Delivery precision Market share Market penetration New product sales

Financial performance targets which are set as a part of organization planning and budgeting process are an important part of financial result control system. They form a basis for performance evaluation and are critical for motivation. Three basic types of Financial performance targets are: 1) Model based versus Historical versus Negotiated targets. 2) Internal versus externally derived targets 3) Fixed versus flexible targets Requirement for a Performance Measurement System A typical performance measurement system consists of the following four steps. 1) Establishing and updating performance measures

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2) Establishing accountability for performance 3) Gathering and analyzing performance data 4) Reporting and using performance information Systems theory Systems Theory: the Trans disciplinary study of the abstract organization of phenomena, independent of their substance, type, or spatial or temporal scale of existence. It investigates both the principles common to all complex entities, and the (usually mathematical) models which can be used to describe them. There are two versions of systems theory. The first, called closed systems came out of classical dynamics. Its modern version called cybernetics. The other called open systems approach comes from environmental science. Management control systems consist of all organization structures, processes and subsystems designed to elicit behavior that achieves the strategic objectives of an organization at the highest level of performance with the least amount of unintended consequences and risk to the organization. Management Control and Systems Theory There are several important implications of applying the (General Systems Theory) GST view to the field of management control systems. First, using GST as a framework means that we view management control systems much like biological organisms that exist in a constant commerce with their environment. If an organization is an open system in constant commerce with its environment, then it follows that the environment will be very important in determining and explaining its behavior and controlling its fortunes. The implication is that a study of management control system must begin by understanding and characterizing an organizations environment. Organizational environments can be benign (few threats) or uncertain and dynamic (rapid change). Effective management control systems must meet the needs of their environment. Second, GST viewpoint when applied to management control would assert that these systems exhibit teleological or purposeful behavior. We embedded this in our definition of management control system when we stated that the purpose of control is to achieve strategic objectives and to avoid unintended consequences. Third, the concept of interrelated subsystems suggests that we should view management control systems as comprising of many interrelated components. Some of these may be structural components such as information, authority delegation, and so on. Others may be behavioral or cultural factors such as motivating behavior or building the right values. These systems are interrelated which means that we must design each one recognizing its impact on the other components. For example, we must consider how information will impact human behavior and vice versa. This means that the challenge for the designer of a management control system is to bring together an organization's structural components and mesh it together with its behavioral and cultural components so all three work together as a singular whole. Fourth, the concept of input-transformation-output links the management control system to the environment. Organizations obtain inputs from their environment, transform them into outputs, and then send the outputs back into the environment. In order to design a good management control system, it is imperative that we have a proper understanding of where in the environment to find the right inputs, what kind of transformation perform, and what output to produce. Differences in management control systems will reflect different input-transformation-output differences. For example, manufacturing organizations that use a mass manufacturing process will have different types of control systems than organizations that use lean manufacturing methods. Understanding the input-transformation-output process helps to determine the special design parameters of a management control system for that organization.
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Fifth, the notion of feedback is a very useful in designing management control systems. In a number of situations, an organization is faced with a choice of choosing whether to design feedback or feed

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forward systems. Budgetary controls typically use negative feedback. Economic and market forecasting systems use feed forward information. In general feed forward controls are better but they are expensive. Feedback systems are less efficient but also less costly to design and implement. Sixth, the concept of homeostasis in the area of management control means that the system is not looking for a steady equilibrium. Rather it is seeking an improved state. Continuous improvement rather than maintenance of status quo becomes a key issue in designing control systems. Control systems must continually scan their environment and improve their operations in order to maximize their chances of long run survival. Finally, tenet number seven of GST deals with the concept of equifinality. The usefulness of this concept for management control is that it keeps the designer from looking for a one best way to do things. It recognizes that many different designs for a management control system can lead to the same end result. The concept of equifinality sensitizes a designer to look for solutions anywhere in the system and introduce change where it will be most likely to be effective in attaining the goals of the organization. For example, the productivity of a worker is affected not simply by how a task is designed; it is also affected social environment in which he or she works. Increase in worker productivity, therefore, can be accomplished by redesigning the task or by redesigning the social system within the worker is operating. Decision making conditions: Decision maker makes the decision for future conditions. In fact, a decision is not a process of making the future decision but a means of reflecting the future in todays decision. Certainty: complete and accurate knowledge of the outcome of each alternative as there is only on outcome of each alternative. Perfectly accurate decision time after time. Highly structured and structured decision making techniques. Risk: Multiple out comes for each alternative can be identified and probability of occurrence can be attached to each outcome.(this type of conditioning the decision maker decide two things amount of risk involved in a decision and amount of risk the organization is ready to assume) Major organization decision. Investment. Part of information can structure, remaining unstructured. Instructed and semi-structure decision making techniques. Uncertainty: if a decision involves a condition about which the decision makes has no information about the relative changes of any single out come. The Decision making Difficulties: The consequences of an error in taking a decision can be far reaching. Decisions have to be taken very quickly to meet the challenges of international competition. New tools and concepts have resulted in several alternate solutions for which it is not easy to choose the best solution. While the available data is much more today than it was several years ago, the tasks of extracting useful information is become mopes. New trends like the protection of the consumer are taking shape even in developing countries. Government policies and restrictions are affecting the business trends. International situation has role to play in decision making. New technological and new materials are making tired and test methods obsolete.

Service Organizations:

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Characteristics of Service Organizations

Absence of inventory buffer: The services can't be stored, if not used at a point of time they get its unused capacity. The cost of many service organizations are fixed in the short run. It can't be reduced with the level of activity in the short run. A key objective in most of the service organizations is to extent possible match current capacity with demand. This can be done in two ways either by stimulation of demand for the current capacity or by adjusting the size of the workforce. Difficulty in controlling quality: It is difficult to quantify the quality of services; even after the service is rendered quantification would be subjective in nature, Labour intensive: Service organizations are labour intensive. With the advent of technology the labour intensiveness has decreased but as compared to manufacturing sector, service sector is more labour intensive. Multi-unit organizations: Some service organizations operate many units at different locations each of which is relatively small. The similarity of these separate units provides a basis for comparison, analyzing budgets and performance evaluation. In order to identify high, medium and low performers the information from each unit can be compared with system wide or area specific averages. Structurally the units may be same but they differ in mix of services they provide and amount of resources they use and this difference should be factored while making such comparisons. A technique which factors in such difference is known as data envelopment analysis. Supply of services can't be increased in the short run: Although services are classified as intangibles, but to produce these Intangible services an extensive tangible infrastructure has to be created which requires time and other resources. Financial Service Organizations: Financial services companies are in the business, primarily, of managing money. Financial system comprising of commercial banks, financial institutions, insurance companies and the capital markets has undergone a very rapid transition during last one and a half decade. In broader terms the transaction has been towards autonomy of these financial institutions and broad basing the ownership, before we move further let us briefly discuss the general characteristics of the financial service sector. General characteristics: Monetary assets Time period of transaction Risk and reward Regulations Technology

General Characteristics of Banks: Management Control Implication If Bank branches are treated as profit centre one needs to look at the following issues; 1. 2. 3. 4. 5. 6. a) b) c) d) The relationship between rate and maturities of deposits (liabilities) to the rate and maturities of loans (assets) Deposit volume. Loan losses. Expenses Join revenue. Transfer prices

Interest Rates. Expense Centre. Volume: Loan losses or Non-performing assets. e) Expenses.

f)

Joint Revenues.
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g) Transfer Prices. h) Account System.

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Risk characteristics of Banks: The points discussed so far relates to the general characteristics of the banks. Now let us discuss about the risks which are faced by the banks in general and in latter part of this section we are going to discuss about the regulatory framework to contain and minimize these risks. Risk has been always present in the banking system but in recent years the management of risk had gained prominence due to the following factors: 1. 2. Growing deregulation of the local markets and their gradual integration with the world markets. Growing diversity in banking operations. Lending and deposit taking are the main functions of a bank, but in recent years the banks have diversified their activities into derivatives trading securities underwriting and corporate advisory service. Some banks have expanded their traditional credit product to include asset securitization and credit derivatives while others have forced into transaction processing, custodial services or asset management business and venture capital funding. With the advancement of information technology more and more banks are venturing into online electronic banking covering traditional banking as well as providing of bill presentation and payment services.

3.

All these developments points towards increase in diversity and complexity of risks. Banks would have to develop risk management systems that are rigorous and comprehensive. The banks are facing four types of risks which are as follows: 1. 2. 3. 4. Credit Risk Interest Rate risks Foreign exchange risk Liquidity risk.

Role of Management Control System in Containing Risk Banks and financial institutions have unique and important place in economic system of any country. Any instability in the banking system has a cascading effect on the whole of the economic system even across the national boundaries. Keeping in view the potential instability which can be created by banks through ill functioning banking system the banking systems are closely regulated at two levels i) Macro level; ii) Micro level. The macro level regulations are broad policy framework issued by central bank (in case of India RBI) within which the banks have to operate. The micro level regulations are specific to a particular bank designed by the top management of the bank which specifies the operating guidelines, authority and power of the managers at different levels. Credit risk: In order to minimize credit risk two areas of banking operation require special attention 1. Loan and Investment policy 2. Ongoing management of loan and investment portfolio. Banks should lay down transparent policies and guidelines for credit dispensation in respect of each of the broad category of economic activity. The banks should clearly articulate risk return philosophy and adopt risk mitigating tools like multi-tier credit approving system, prudential portfolio limits, loan grading, risk pricing portfolio management and loan review mechanism. The prudential limits need to be laid down on various aspects of credit viz. benchmark current debt/equity ratio and profitability ratios, debt service coverage ratios, concentration limits for single/group borrowers, maximum exposure limit to industry etc. Banks should develop a comprehensive risk scoring system that serves as a single point indicator of diverse risk factors of a counter party.

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In case of loan and investment portfolio management the management control systems should centre around adequacy of policies, practices and procedures, operation of the scheme of delegation, classification of assets, loan loss provisioning for loans and investment concentration risk, adherence to prudential exposure norms, scope and adequacy of audit and loan review functions and compliance with rules and regulations. Interest rate risk: In order to contain interest rate risk banks should make a clear distinction between their trading activity and balance sheet exposure. As regards to trading book, Value at Risk (VAR) is presently the standard approach. This method is used to assess the potential loss that would incur on trading position or portfolio due to variation in market interest rates and prices. For balance sheet exposure to interest rate risk banks rely on 'gap reporting system, identifying asymmetry in repricing of assets and liabilities commonly known as gap. Foreign Exchange Risks: The banks in general use the VAR approach to measure the risk associated with foreign exchange exposure. Another strategy is to put limits on the absolute exposure as well as exposure to individual currencies. The banks are required to put 100 percent risk weight to open position limit in foreign exchange. Liquidity Risk: All banks are required to maintain Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR). In order to contain liquidity risk the banks should monitor the liquidity by measuring the cash flow mismatches which arises due to difference in timings of maturity of assets and liabilities. The future cash flows are to be bracketed indifferent time buckets and a tolerance levels for various maturity mismatches has to be fixed depending upon banks asset-liability profile, extent of stable deposit base, nature of cash flows etc. The mismatches of cash flows (negative gap) in time bucket of 1-14 days and 15-28 days should not exceed 20% of the cash outflows. Apart from containment of risk the management control systems should also provide for clear arrangements for delegating authority and responsibility, separations of the functions that involve committing the bank, paying away it funds, proper account for its assets and liabilities and reconciliation of these processes. It should also provide for appropriate independent external or internal audit and adherence to controls as well as applicable laws and regulations. Another area of concern for management control system should be the internal inspection and audit machinery which is responsible for introduction of internal controls system for prevention of frauds. In India the onsite inspection of banks are based of (CAMELS) model where CAMELS stands for (Capital adequacy, asset quality, management, earnings, liquidity and systems and control). The management control system should be designed in a way that it is capable of measuring monitoring and controlling the above parameters. Apart from these the MCS should also pay sufficient attention towards the following parameters; 1) Establishment of internal control culture within the bank 2) Internal control activities shall be designed and implemented to address as an integral part of daily operations. 3) Functional segregation of duties and assignment of responsibilities 4) Establishment of reliable information systems in bank. 5) Control of information system and technologies. 6) Establishment of effective channels of communication. 7) Monitoring activities for internal control process and correction of deficiencies. 8) Risk identification and assessment process. Insurance Companies General Characteristics There are two type of insurance companies a) Life insurance b) General (casualty) insurance. A life insurance company is concerned with insuring the life of human beings. Two type of policies are offered by life insurance companies which are whole life and term insurance policies. Under the whole life policy the person has to pay a premium for a certain period and he is insured for the whole life, the ma-

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turity value of the policy would be only payable on the death of the insured person to his inheritors or the beneficiary of the policy. Whereas under term insurance policy the benefit of insurance is available for the term of the policy only, beyond that the benefits are not available. Under this policy on the completion of the term or upon the death of the policy holder whichever occurs earlier the maturity value of the policy would be paid to the beneficiary of the policy. General (casualty) insurance is concerned with the insurance of property and physical assets. A general insurance company collects premium, invest them and make payments to policy holders for specified losses. General insurance policies provide coverage for a short period, generally three years. Some policies pay for claims made during the period; others pay for losses incurred during the period even though claims are lodged in a later period. Management Control Implications The central management control problem in insurance companies especially life insurance companies is that proper estimation of profits associated with current policy sales can't be estimated until years later. They set premiums based on their best estimates of inflows and outflows associated with the policy. The profit of any policy can't be known until the maturity of the policy and settlement of the final, claims, but management can't wait that long to make control decisions. Due to the nature of insurance business the profits can't be taken as a yardstick for measurement of performance for current business therefore for control purposes insurance managers give more attention to expense control and product pricing. 1. Product pricing: Any insurance company may have dozens of policies, targeted at different strata's of society. An insurance policy apart from containing basic feature of insurance may contain many other features like tax saving, financial planning, capital appreciation etc. The pricing of the policy will depend upon the features incorporated in the policy plus the individual characteristic of the person insured i.e. age, gender, risk profile etc. The, actuary's calculation of premium considers the following factors. Acquisition cost: The commission paid to the sales agents and the cost associated with sales organization. Servicing cost: Cost associated with collection of premiums, accounting for them and allocation of corporate overhead. Lapse probability: The probability that the policy would be cancelled due to nonpayment of premium. Investment income: The income that will be earned by investing the premiums until the policy is paid. Probability of payment: For life policies this depends on the age of the person insured and the probability of death is determined from mortality tables and other demographic data. For casualty companies these estimates depend upon the data on likelihood of occurrence of the events insured against, together with the probable amount of payment against these events. Income taxes and statutory regulations: Income tax regulations for the insurance industry are significantly different from other industry, similarly the insurance companies are required to calculate profits and bonus as per the norms specified. Required earning rate: The rate at which inflows and outflows are discounted to arrive at their present value. 2. 3. Sales Performance Expense control

The management control system should focus on the following areas; 1) Assets Liability Management: A key driver of asset strategy by the insurance companies would be its liability profile and the need to ensure that it holds sufficient assets of appropriate nature, term and liquidity to meet those liabilities which becomes due. This requires the testing of resilience of the asset portfolio on range of market scenarios and investment conditions and its impact on solvency position of the company.

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2)

The Investment Process: Depending upon the nature of liabilities an insurance company is likely to hold the following assets either directly or via other instruments or through third party investment managers, Bonds and other fixed income securities Equities and equity type instruments Debts, deposits and other rights Property 3) Risk Management Function: A part of the premium collected by insurance companies is used to meet the expenses and for the purpose of settlement of claims. The remaining part is invested in various financial instruments. The returns from these investments are used to pay bonus on policies and settlement of claims. Bad investment can give risk to non-fulfillment of contractual obligation and default on payment of bonus and settlement of claims. In order to avoid these insurance companies should put in place a risk management team which is capable of identifying, monitoring, measuring, reporting and controlling the risks associated with investment activities. The risk management team should be responsible for; a) Monitoring compliance with the approved investment policy b) Formally noting and promptly reporting breaches. c) Reviewing asset risk management activity and results over the past period d) Reviewing the asset/liability and liquidity position e) Assessment of the appropriateness of the allocation limit, to do this regular resilience testing should be undertaken for a wide variety of market scenario and changing operating and investment conditions. Once those situations are identified under which the insurance company is at maximum risk, the risk management team should ensure that appropriate change are made in policies and procedures as defined in its investment manual. 4) Internal Controls: Adequate system of internal control must be present to ensure that the policies and procedures are followed in letter and spirit. The internal control procedure should be documented. The internal control procedure should include the following. Mutual Funds A mutual fund is a vehicle of investment in capital market and other short term money market instruments for investors. "An investment company is a pool of funds belonging to many individuals that is used to acquire a collection of individual investments such as stock, bonds, other publicly traded securities" Management control system for mutual funds The overall activities of mutual funds can be categorized under the following of heads; Reconciliations between front office, back office and the accounting systems. Procedure to ensure that limits and restrictions on the power of all the concerned to enter particular asset transactions are observed. This requires regular and close communication among compliance', legal and documentation divisions. Procedure to ensure that formal documentation is completed promptly. Procedure to ensure reconciliation of position reported by brokers and other intermediaries. Procedure to ensure that trades/positions are properly settled and reported and late payments and receipts are identified Procedures to ensure that transaction are carried out at prevailing market rate terms and conditions. Procedure to ensure that authority and dealing limits are not exceeded and breaches if any be reported immediately. Procedure to ensure independent checking of rates/prices; the system should not solely rely on dealers for rate/price information

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1) Fund Management 2) Operations 3) Customer Service 4) Sales and Marketing Management Control system for each of these activities will span across three dimension: Policies and procedures, systems and organizations. The management control system is basically concerned with the reduction of risks, compliance and overseeing that the regulatory requirements are being meet. The policies and procedures document should build a framework of the fund and should contain; Investment policy including risk philosophy Operating procedures Compliance manual Code of conduct Disaster recovery and business contingency plan Reporting framework

Management control system is on the following areas. 1) Investor service 2) Prevention of frauds 3) New product development 4) Selling and distribution 5) Prevention of critical knowledge loss 6) Augmentation of skill set of employees thereby reducing skill shortage 7) Compliance with regulations Non Profit Organizations: A nonprofit organizations is defined as an organization which cannot distribute assets or income to, or for the benefits, of its members officers or directors however, this does not imply that the employees are not to be given salary. Nonprofit organization are not prohibited from making profits, but are prohibited from distribution of profits. If needs to earn moderate profits on average to provide for working capital, and capital expenditure. Special Characteristics 1. Absence of Profit Measure.

2. Some peculiar Items.


Capital fund. Annual subscriptions. Life membership fees Government Grant. Entrance fees. Donation. Legacy. Endowment Fund 3. Fund Accounting 4. Governance Management control system in nonprofit organization:
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Product Pricing: In case of nonprofit organization the motive is not to earn profit but to engage in welfare activities which are beneficial to the society as a whole. This leads to pricing of services and products

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below cost at subsidized rates. This approach however leads to inefficiency and waste therefore pricing of services and products at full cost is desirable. A full cost price is sum of direct cost, indirect cost and a small allowance for increasing organizations equity. A pricing mechanism based on full cost facilitates the resource allocation process. Nowadays the trend is to have organizations which are self-sustainable. In addition to' this due to increasing fiscal pressures the government all over the world are reducing grants. The same is true of donor agencies and multilateral development agencies. Strategic planning and budget preparations: Since the resources of nonprofit organizations are severely limited the process of strategic planning should chart a framework for allocation of limited resources to worthwhile activities. Most of the nonprofit organization can fairly estimate the revenue stream for the coming year; based on these estimates the activity level and budgets are prepared. Operation and Evaluation: In most of the nonprofit organizations the optimum operating cost can't be predicted which leads to spending of the budgeted amount without taking into consideration the merit and demerit of the activities. Similarly the activities which can lead to excellent pay offs are not executed due to non-inclusion of the same in the budget. Although nonprofit organizations have a bad reputation of operating inefficiently, this perception is changing gradually. The underlying reason for the same has been the crunch of resources. This led to increased attention to management control. Professional Organization: Research and Development organizations, law firms, accounting firms, health care organizations, engineering firms, architectural firms, consulting firms, advertising agencies, symphony and other arts organizations, and sports organizations are examples whose products are professional services. Multinational companies: Differences across Countries National culture Institutions Local environments

Transfer Pricing in Multinational Companies: Transfer pricing of goods, services and technology represents one of the major differences between management control of domestic and overseas operations. In case. Of multinationals apart from normal consideration of transfer prices several other consideration are important in deciding the transfer price. They are briefly discussed below; Taxation. Government regulations Tariffs Foreign Exchange controls Fund Accumulation Joint Ventures

Transfer pricing for an affiliate of a Multi-National Company 1. 2. Transfer price to an affiliate in a country that is facing high inflation may be set at a relatively higher level in order to offset the effects of devaluation of local currency resulting from relatively higher inflation as compared to the home country. The companies which have set up new affiliates in the host country may set transfer price relatively low in order to capture market share and gain a competitive advantage over already established market players.

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Three acceptable ways in which transfer price among affiliates may be determined. These three methods are as follows; 1. 2. 3. Comparable uncontrolled price method or market price method. The resale price method. Cost-plus method

Exchange Rate and Management Control Exchange Rates: An exchange rate is the price of one currency relative to the other currency. it can be either expressed as number of units of the home currency to buy another currency (direct. Quote) or the number of units of foreign currency to buy one unit of home currency (Indirect Quote). Different Types of exchange Rate Exposure In case of multinational organizations their cash flows are in different currencies and changes in value of the currency relative to the currency in which the holding company prepares it account exposes the multinational companies to various risks. These risks regarding exchange rate fluctuations are classified as 1. Translation Exposure: This is the risk faced by MNC's when there are changes in nominal exchange rates. The cash flow of MNC's and it subsidiaries are in multiple currencies and when the accounts of MNC's are consolidated they must be in single currency usually home country's currency. In order to understand the translation exposure in MNC's one should try to answer this question. The cash flow of MNC's and its subsidiaries are in multiple currencies and there has been change in nominal exchange rate of these currencies with respect to the domestic currency, how do we consolidate revenue, expenses, liabilities and assets as on a given date or financial year closing date in a single currency. Transaction Exposure is the exchange rate exposure that the firm faces in its cross border transaction. In this type of exposures the transaction are entered as of today but receipt or payment of consideration for the transaction is on future date. During this intervening period nominal exchange rate could change and put the value of transaction at risks. Example of these type of exposures are receivables and payables, debt and interest payments, insurance premium payable in foreign currency. Economic exposure is the exchange rate exposure of the firm cash flow to the real exchange rate changes.

2.

3.

Control System Design Issues In view of the above stated exposures control system while evaluating performance should be responsive to the following facts: 1. 2. 3. 4. Subsidiary managers should not be held responsible for translation effects as these factors are beyond their control. The way out is to compare budget and actual results using the same parameters and isolate inflation related effects through variance analysis. Transaction exposure is best handled through the parent company keeping in view the overall hedging needs. The subsidiary managers should be held responsible for the dependence effects of exchange rates resulting from economic exposures. The decision to locate or relocate a subsidiary in a particular country should factor in the effects of translation, transaction and economic exposures.

Multi Project organization

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A project is a set of activities intended to accomplish a specified end result of sufficient importance to management.

Project management is no more about managing the sequences leading to completion of the project. It is about working backward and forward, where the needs of the customers are incorporated, creation of a system for resolving trade-offs leading to prioritization of efforts. It involves working concurrently on all aspects of the project and working with cross functional teams. It also involves working closely with other organizational units like manufacturing, logistics, new product development team and marketing. The project management is not an isolated function but requires high level of cooperation and coordination among various organizational units. A project can be defined a `non-repetitive activity' which has the following characteristics. Its goal oriented - it is undertaken with a particular end or goal in mind. It has a particular set of constraints usually time and resources The output of a project is measurable Project Life cycle: Systems definition a. Project plan b. User requirements c. Systems definition d. Advisability study 2. Systems design and development a. Preliminary systems design b. Subsystems design c. Program design d. Programming and testing 3. System implementation a. System implementation b. System test c. Production control turnover d. User training e. System acceptance Three phases of project management: Planning (Design) Do it (Execute) Develop (review and feedback for further improvement). Contrast with Ongoing Operations There are some fundamental differences in process and procedures of projects and ongoing activities which give rise to different management control techniques. Let us look at these differences one by one. Single Objective: As contrasted with the ongoing operations the projects have a single objective. The management of the responsibility centre in ongoing operations takes decision about the day of day activity as well as for the activities of the future whereas a project manager has to take decisions about day to day activities and future activities, but the time horizon of these decisions is limited till the completion of the project. The project performance can be judged in form of the end product delivered whereas in an ongoing operation the performance is judged in terms of all the results that managers achieve. Organization Structure : It is usual to find that the organizational structure of an ongoing operation organization is superimposed and passed on project organization disregarding the fact that the projects have special requirements in terms of manpower specialization and functional knowledge, Similarly for control-purpose the same set of control procedures are adapted as for ongoing operations. This may result in undue cost and time over run, but at the same time the management control system of project must mesh at some point with the management control system of the organization. Focus on the project: Project control focuses on the project, whose objectives are to produce a satisfactory product within the time, cost specified or with the use of optimum resources, whereas in the ongoing operation the focus of control is on activities rather than on results. 1.

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Need for Trade-off: Projects usually involves trade-offs. The trade-offs usually occurs in a project due to constraint of any one of the resources viz. time, and cost. Cost can be reduced by decreasing the scope of the project e.g. In developing LCA (Light Combat Aircraft) the initial scope of the project was to develop the LCA indigenously, but due to time and cost over runs subsequently it was decided to procure engines and sub-assemblies from other countries. It the cost has to be kept within limits one many have to reduce the scope of the project. Similarly if the project schedule is important than extra labour have to be employed resulting in cost overrun but able to complete the project within time Similar trade-offs do occur in an ongoing organizations but their frequency is quite low as compared to the projects. Less reliable standards: Performance standards tend to be less reliable for projects than for ongoing operations. The causes for variation in performance standard are project design which is unique for every project, although the project specification and methods for producing it are same. The standards for repetitive projects can be developed from historical data or from engineering analysis of time and cost; however the changes in the various variables of the project may make these data unreliable. In civil construction projects the previous practice was to fabricate the whole structure on site whereas now days components of the structure are pre-fabricated in casting yards and these pre-fabricated structures are transported to the site and joined to form the whole structure e.g. for building flyovers the various spans of flyover are prefabricated and joined on site. The standards derived from previous projects may be helpful in setting the standards but allowances must be made for changes in technology, quality of labour and material and other variables. Frequent Change in plans: Since projects are a set of inter linked activities a bottleneck at any point may force the project manager to change the sequence of activities. Example A consultancy firm discovers certain facts unknown previously; this new information may altogether change the direction of the plan. hi civil construction contracts bad weather may force temporary suspension of outdoor work etc. The probability of facing unfavourable, unprovisined circumstances is much more in projects rather than in ongoing operations. Different Rhythm: The rhythm of projects in terms of level of activity and expenses differ significantly from that of ongoing organizations. In ongoing organizations the level of activity and expenses are uniform over a period of time and then they change in either direction depending upon the demand and supply factor. In case of projects the initial phase of projects is marked by low level of activity and hence law cumulative expenses, then the level of activity accelerates to reach at its peak and then tapers off as completion is near and only cleans up remains. The following figures depict the level of activity, and cumulative expenses with respect to time.

Greater Environmental Influence: Projects schedule tends to be relatively more influenced by external environment as compared with that of an ongoing operation. The underlying reason being that the inputs and processes for project are sensitive to environmental changes (e.g. floods, high temperature, bitter cold, heavy rains etc.) can disrupt project schedule even damage project property whereas the ongoing organization are relatively insulated from these.

Project Organization Structure

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The Control Environment

A project organization is a temporary organization which is disbanded after the completion of the project. There are many variations in project organization structure depending upon the nature of the project, duration of the project, location of the project, nature of the company executing the project, whether the project is in house or built for an outside agency. Depending upon these factors the product organization would vary and hence the control system. The team members may be the employees of the sponsoring organization, they may be hired on a temporary basis for the purpose of the project or some of them may be engaged under a contract with an outside organization. If the project is entirely handled by an outside organization a formal working relationship should be establish with the personnel's of that organization and both formal and informal means of communication should be developed. The flow of information among the two will depend upon the specifications laid down in the contract. In case the project is undertaken by the sponsoring organization itself a part of the work would be delegated to the various functional units of' the organization, and these functional units will depute some of its employees in that particular project. In this case also the project managers should develop a working relation with the units in question so that the information flow can be started. For e.g. a cement factory wishing to expand its installed capacity wishes to install a new rotary kiln. In order to execute this project the expertise of finance, marketing and operations department (including civil, mechanical and electrical engineers) is required. The project manager may request the unit heads to depute the required number of personnels to the project. Matrix organization : As discussed above if the project team consist of members drawn from the various units of the sponsoring organizations the members faces a unique situation of handling two bosses at the same time, one is the project manager other one the manager of the functional unit they are permanently assigned to. Such an organization is called as matrix organization. In such type of organization the basis control question is how to set priority among the project task and the functional unit task. Given an choice the functional units employees inclination would be to give a superior priority to functional unit task and secondary priority to project task and in part their behaviour would also depend upon the decision taken by unit manager who consider the relative priorities of an the projects which requires the resource he controls : In this type of organization the extent of control which a project manager can exercise over the employees is constrained by the authority of the functional unit's manager. Evaluation of Organization Structure: The structure of the project team changes with the progress of the project. In the planning phase most of the members would be from cross functional areas of finance, marketing, human resource, apart from care team from operations area. The team at this stage may include cost accountants, architects, engineers, supply and procurement officer, human resource consultant, market research analyst, statisticians and logistics experts. At the execution stage bulk of the project team would consist of engineers and logistic expert with few members from support function like accounts and finance marketing and human resources. In the final stage as the work tapers of the principal task is that of obtaining the sponsors acceptance where persons with marketing skills are required.

Contractual Relationship In the projects which are out sourced to contractors an additional level of project control is created. In these types of projects the primary responsibility of control is that of the organization which is executing the project. The primary function of the additional level of project control which is there in such type of contracts is to study the control system of the contractor and adapt and modify it in a ways that it is able to feed the control information requirements of the sponsoring organization. The form of the contractual agreement has an important impact on management control. Contracts are basically of two types: fixed price and cost reimbursement with many variations in between. 1. Fixed Price Contracts: In a fixed price contract the contractor agrees to complete the specified task by a specified date at specified price. The qualitative and quantitative aspects of the tasks are a part of the contract; the contract also specifies the penalties for negative variations in time and quality. From the above discussion it may appear that since the contractor is taking all the risk

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therefore the contractor's firm has all the responsibility for management control, but this is not the case, Due to uncertainties involved or lack of foresight at the planning stage the contractor may encounter conditions not contemplated in the contract, while executing the project or the sponsors may want to alter the scope of the, project in such circumstances a change order is issued. Both the parties must agree on scope, schedule and cost implication of the change order, to the extent the change order involves increased cost; the increased cost is to be borne by the sponsor. A simple project like constructing a house may involve a dozen of change orders, whereas complex projects like ship building, airport construction may involve thousands of change orders. The responsibility of auditing of quality and quantity of work under fixed price contracts is with the sponsors of the project, hence continuous monitoring and control is a necessary component of contracts under fixed price contracts. 2. Cost-Reimbursement Contracts: In a cost reimbursement contract, the sponsor agrees to pay reasonable cost plus a profit in percentage terms or a fixed amount. In these contracts a ceiling on cost is also imposed (the cost should be within a certain price band the lower band decided by the contractor and upper band by the sponsor). In these types of contracts sponsors have considerable responsibility in controlling cost therefore they require a management control system. These types of contracts are suitable in those circumstances when the scope, schedule and cost of the project cannot be estimated reliably in advance.

Contrast contract Types: The price of a fixed type contract is a bid by the contractor. Usually the tenders are called and the contractors quoting the lowest rate are awarded the contract. The tender consist of two parts viz., Technical part in which all the specification of quality, quantity and other details are furnished and financial tender in which the rates are quoted. In arriving at a particular price contractor includes an allowance for uncertainty, the quantum of this allowance varies with the degree of uncertainty associated with the project. This extra allowance over and above the cost and profit is the reward for taking risk. For projects with high degree of uncertainty the sponsors ends up paying more under fixed price contract as compared to cost reimbursement contract. The fixed price contracts are suitable when uncertainties regarding the project are low and scope of the project can be closely specified. In this type of situation the scope for negotiation of change order is considerably reduced. In cost reimbursement contracts the profit component should be a fixed monetary amount, if it is certain percentage of cost; it is going to motivate the contractor to jack up the cost. Variations: These two types of contract are two extremes; there are many variations possible within these two extremes. In an incentive contract completion date, cost targets or any other variable of the contract are defined in advance and if the contractor is able to surpass these pre-defined variables the contractor is rewarded by a certain percentage of cost saved or additional revenue generated by his performance. Such type of contracts are able to overcome the inherent weakness of cost reimbursement contract in which the motivation to reduce cost is totally absent. Different contract types may be used for different activities of a project. For activities having high degree of uncertainty like cost of material wages, direct cost etc. may be reimbursed under a cost reimbursement contract while the contractor's overhead cost may be covered by a fixed price contract which will motivate the contractor to control the cost. Information Structure: Work Packages For the purpose of management control system in project the information is structured by the 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 break down structure. In construction of a house the work packages are laying of the foundation, rising of walls, electric fittings, sanitary fittings fixture of doors and windows etc. A work package is measurable increment of work, usually of fairly short duration. The work package must have a clear identifiable completion point which is called as milestone, continuing from the example stated above if the wall of the house has been raised up to twelve feet from the foundation it is a milestone or after the electric fittings all the points are having electric connection it is a milestone.

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If the project consist of many similar work packages each of the work packages should be defined in the same way so that the cost and schedule informations are comparable. Similarly if the industry averages about the work packages, cost and schedule standards are available they should be made use of: Indirect Cost Accounts: Apart from defining work packages for direct project work. The direct costs are changed to the concerned work package, but what about the cost and expenses which can't be charged to any of the work package e.g. for administrative and support activities. For these type of expenses separate cost accounts are established and their estimated cost usually stated as per unit of time (such as month) are charged to these accounts. The cost accounts should be charged as per the rules already defined. These rules relating to charging of costs to the projects, the approving authority and their specific signing powers are developed in advance. The rules and procedures also specify which cost items are to be directly charged to work package, what is going to be the lowest level of monetary cost aggregation, how cost commitments be recorded in addition to actual costs incurred and how the overhead cost and equipment usage be allocated to the work packages. Project Planning In the planning phase the starting point are the rough estimates that were used in decision to undertake the project. These rough estimates are refined into detailed, specification for the product, schedule and cost. In this phase the management control system and underlying task control systems are designed for the project. The planning process prepares a road map regarding how the activities of the project are going to be coordinated how is responsible for which task and the time schedule for completion of each task, The process of project planning takes places at two levels first one being the strategic level tactical level where the question is `what happens'. This is a tactical level plan which needs to be converted into `how' it is going to be carried out or operationalized. For the planning process the inputs is going to be the project brief the control environment both external and internal which provides for activation, the constraints and the quality standards for the planning process and the mechanism$ provide the means by which the process can happen, fig shows this whole activity, of planning

Nature of the project plan:

The finalized plan consist of three parts: Scope, schedule and cost

The scope part states the specification for each work package and person or organizational unit responsible for the particular work package. If the project is of the nature where specifications are not known beforehand this section is brief and general e.g. R&D projects etc. The schedule part states the sequence of the activities and the estimated time required for completion of each activity. It also specify the inter relationship between various activities.

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Costs are stilted in the project budget which is known as control budget, the reason behind calling it control budget is that the actual cost incurred are compared against the cost stated in the budget usually the monetary cost are shown only for aggregate of several work packages until and unless the work package quite large. Resources to be used for each work package are stated in non-monetary programs such as number of man hours, cubic foot of cement, kilograms of iron etc. Estimating Costs

Project Planning and Control Techniques Several techniques are known to be used for project planning, monitoring and control, but three are very popularly used. These are Gantt chart, Programme Budget technique and Network technique. Gantt chart: Gantt is a simple technique of showing through horizontal bar graphs, the starting time and completion time of different activities in a project. Further each activity is broken up into different phases in which starting of a phase depends on the completion of the previous phase. Programme Budgeting: When a project is in the implementation stage, but not yet commissioned, Programme budget technique comes handy in monitoring programme of project. The method basically approaches the problem by breaking up the project into several work units and establishing expenditure norms for such work units. If the previous example of road construction is taken, the work could be divided into components of taken, the work could be divided into components of pure earth work, concrete work, metal work, etc. Pure earth work and concrete work can be measured in units of cubic meters 'whereas metal work in cubic meters or square meters. The cost norm for cubic meters or square meters of work may also be established. Control under programme budget is done by comparing the actual physical performance (in terms of work units) with planned expenditure. The following formula is used as the basis of control. If the conditions in the formula are fulfilled the project is assumed to be satisfactory.

1. = 2. = 3. = = 1st actual expenditure budgeted expenditure =

The first formula considers only the work done vis-a-vis plan and therefore it measures only the effectiveness of progress. It does not take into account the resources used for doing such work. Thus it fails to reveal the efficiency in resource utilization. The second method overcomes this problem, but not fully, It shows the effectiveness of progress, but not the degree of effectiveness. Similarly, it indicated that resources are used within budget limit, but fails to indicate the degree of efficiency in resource utilization. The third formula primarily emphasizes efficiency in resource utilizations. Because of its format of output input or productivity ratio, it appeals to the user and is therefore commonly used for control. In addition to the above three formulae, sometimes a ratio called project status index is also used for monitoring progress. This index into account both time and cost dimensions and combines them to find an overall measure of progress.
Project Status Index (PSI) =

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We have discussed about only time and cost. As mentioned earlier quality of work in a project should also be measured if proper control is to be exercised. Sometimes if quality is bad or poor either compensations has to be paid or some amount of rework has to be done on customer complaint. In either

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case, extra expenditure is incurred. If this expenditure is high in relation to total project's value if indicated that quality of work has not been satisfactory. A Quality index can be computed; Quality Index = Network technique (PERT): Project planning and control through Programme Evaluation and Review Technique (or PERT) is a very common phenomenon today. Under this method a project is divided into a number of activities and the time requirement for these activities as well as relationship between the activities are analyzed and their precedence established. These activities are drawn on a chart called PERT chart. On a PERT chart an activity is represented by an arrow. The starting and completion points of an activity are known as 'events' and marked by circles. Project Execution The results (output) of the planning process acts as guidelines for project execution. The planning process results into specifying, a specification of work packages, a schedule, and a budget; and the manager who is responsible for each work package is identified. The schedule shows the time associated with each activity, and the budget estimated shows estimated cost of each project part. If the resources required are shown in non-monetary terms the control budget converts the same in monetary terms but for a sizeable aggregation of individual work packages. In the control process the actual data regarding specification, schedule and cost are compared with these estimations. Both the sponsors and the project manager are concerned with three questions a) It is project going to be completed Ly the scheduled completion date? b) Is the completed work going to meet the stated specification? c) Is the work going to be completed within the estimated cost? The underlying variables for any project are susceptible to change and the changes in these variables have as bearing on answer to these questions. If at any point of time during the course of the project the variations are negative, both the sponsors and project managers need to know the reasons and alternative corrective actions undertaken. These three parameters of specification, time and cost are not independent of each other and sometimes a trade-off has to be done among the three variables. Systems of Reporting for Project Control As discussed above the project managers and sponsor are interested in variance of cost, schedule and specifications. For any work Breakdown Structure (WBS) the project manager is interested in the relationship between planned value of work for a given time period and actual cost of work for the same time period. The difference between the two will give the total variance for the task; by computing more detailed variances one can trace ifs course. These are five potential causes for any total variance. 1) Completion of more or less work than scheduled. 2) More or less usage of labour than planned for the actual work. 3) More or less wages paid than planned for the actual labour used.

4) Usage of more or less material than planned for the work completed.
5) Paid more or less than planned for the material actually used The portion of the variation attributable to (1) as referred above is called the "schedule variance", and the portion attributable to (2) through (5) is called the spending variance. The total variance for a given task is = Budgeted Value of Work Planned - Actual Cost of Work Completed = Total Variance The schedule variance is given by = Budgeted Value of Work Planned Budgeted Value of Work Completed = Schedule Variance

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The spending variance is given by = Budgeted Value Of Work Completed - Actual Cost Of Work Completed = Spending Variance The spending variance can be further subdivided into labour and material variance The total labour variance for a task is = Standard Labour Cost - Actual Labour Cost = Total Labour Variance The total labour variance can be subdivided into labour time and rate variances Labour time variance = (Standard hours - actual hours) x Standard rate = time variance Labour rate variance = (Standard rate - actual rate) x actual hours = Rate variance Similarly the material variance can he subdivided into quantity and price variance Total material variance Standard material cost - actual material cost = total material variance Material Quantity Variance = (Standard quantity - Actual quantity) x Standard price = quantity variance Material Price Variance = (Standard price - Actual price) x Actual quantity = price variance These nine variances may be computed for each level of the WBS and for each functional organization at regular intervals. The total variance for a WBS end item tells the project managers whether there is a problem or not regarding cost and schedule performance. If the problem exists manager can request more detailed reporting information for the next level of the WBS and find out where exactly the problem is, concerned with schedule slippage or with labour or material spending variance. In order to keep track of the projects managers require three type of reports which are as follows; 1. Trouble reports both the trouble which had already occurred and also anticipated future trouble Critical problems are flagged. Since the areas contained in the report require urgent attention of the manager, these reports are communicated through both formal and informal channels of communications. Precision is often sacrificed for the sake of speed, In case the reported information is significant than oral reports are confirmed by written reports so as to provide a record. Progress reports: report about the status of the project and compares the actual schedule and cost with planned schedule and cost. Variances are measured quantitatively and reported. Financial reports are concerned with project costs. These reports are important because based on these reports payments to contractors are made under cost reimbursement contract. They are also necessary for fixed price contracts because based on these financial accounting entries are made.

2. 3.

Apart from the above stated reports much of the information comes from detailed records collected in task controls systems. These include such documents as work schedule, time sheet, inventory records, purchase orders, requisitions and equipment records. The task control systems should be designed in a way which would integrate the information generated from these systems with management control systems. Punch list: Near the completion of the project the sponsor prepares a list of work still to be done and a list of defects still to be rectified. This punch list is negotiated with the project manager. The final payment is released only after the agreed upon work is completed. Progress payments made during the course of the project are somewhat less than the cost plus profits to date thereby providing cushion for this purpose. Revisions: Projects are generally complex and lengthy and the probability of not adhering to project plan in terms of cost, scope and schedule is quite high. In case of deviation of any of these three aspects the following alternative exists for the sponsor of the project.

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1. 2.

Accept the deviation and proceed as originally planned. Include in a trade-offs between these three aspects viz if schedule is critical authorize use of extra manpower which requires payment of overtime wages which are higher than normal wages or if scope is critical authorize the cost of increase

3. 4.

Replace the project manager if deviations are unwarranted. Terminate the project

Leaving apart the last alternative choosing any of the above stated alternatives would require the revision of the plan. Once the plans are revised it gives rise to another question that of tracking future progressagainst the revised or original plan. The main drawback of using revised plan is that it hides inefficiencies which have accumulated till date and aptly referred to as rubber baseline, although revised plans are better indicators of performance that is currently accepted. A way out of this problem is to compare the actual cost with both the revised and original plan. The first part of this report will show original budge, the revision that has been authorized till date and the reasons for the revision. The second part will contain cost estimates and the reasons which caused variance between the revised budget and the current estimates of costs. Project Auditing: Project auditing involves two areas of project (i) cost (ii) quality. There are two approaches which are followed for auditing purpose. One is to audit the work as soon as it is completed and another one is to wait for substantial amount for work to be completed and then start the audit work. Out of these two approaches the former should be adopted as subsequent stages of work will cover any deficiencies in the earlier work. For example in construction of house plumbing, electric fillings and sanitary fittings should be inspected at the time of execution itself, it done at later stage it is cumbersome and costly and any rectification involves major costs. At the sometime the auditors should also be cautious that they do not take undue time for auditing purpose. Project Evaluation Project evaluation mainly consist of two sperate aspects of the project (1) an evaluation of performance in executing the project (2) an evaluation of the results obtained from the project. The former is undertaken shortly after the completion of the project and the latter is a continuous process and a more complex process. For example computerization of banks is a project. Now as far as first aspect of project evaluation is concerned it is going to measure the cost, time and scope of the project as against the standards envisaged in the plan. The second aspect is concerned with operational efficiency, customer satisfaction, manpower reduction, introduction of new products, strengthening of internal controls etc. Again these variables depend upon other variables. Keeping in view the long term impact of the project, this aspect of project evaluation is complex and continuous process. Evaluation of performance The evaluation of performance in executing the project has two aspects; a) An evaluation of project management b) An evaluation of managing the project The first aspect of evaluation is concerned with project managers and teams and its purpose is to assist in decision making regarding rewards, promotion, reassignment, transfer, deputation etc. The second aspect of evaluation is mainly concerned with feedback so that the strength and weakness identified in this project could be factored in the planning of future projects. In many cases the evaluation is informal. In cases where the variances are of high order organization opts for formal evaluation. Since the projects are not structured and standardized activities like manufacturing, the project evaluation is more of subjective nature. Cost overruns : When actual costs are more that the budgeted cost, there is said to be a cost overrun, To some this implies that actual cost were high, but an equally plausible conclusion can be that the budgeted cost were low. If there is an cost overrun due to change in the scope of the project or other uncontrollable factors the reason could be inadequacy of planning or underestimate of cost rather that the inefficiency at the operating level. Interpretation of the costs should be done by analyzing both the budgeted as well as actual costs.

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A common error in analyzing cost is to assume that the budget represents what cost should have been. It is not, budget is merely an estimate of cost based on the available information at that point of time, and it is not a reflection of conditions encountered at the time of execution of budget. Evaluation of results Based on the nature of the project, the time frame for measurement of actual benefits may vary. Some projects have a long gestation period and a still longer period when the benefits of project become visible. Another problem with the evaluation of results is that the impact can't be specifically measured as there are other variables affecting the same. To take an example, let us take two examples from banking industry (i) Introduction of ATM's (ii) Computerization of bank branches In the first case the result of the project (installation of ATM machines) can be specifically measured which is the reduction in waiting time for cash withdrawals. Now let us take the second example of computerization of bank branches. In this case there are many tangible and intangible results of the project. The tangible results are; 1. Elimination of arithmetical mistakes 2. Automation of processes 3. Reduction in clearing time for various instruments. 4. Reduction in customer pressure. These are tangible benefits which can be measured and attributed to the project. At the same time there are some intangible benefits such as; 1. Customer satisfaction 2. Employees satisfaction 3. Strengthening of internal control etc. Which are not directly measurable. Evaluation of the project should be done in the following cases; 1. 2. 3. The project should be important enough to warrant the considerable expenditure of effort that is associated with formal evaluation. The result should be quantifiable and capable of being attributed to the project e.g. if increased sales is the result, the contribution of the project in increased sales should be clearly identifiable. Results of evaluation should lead to action; the evaluation process should lead to refinement of planning and procedures.

Management Control Systems Fail (Reasons) A control system is necessary in any organization in which the activities of different divisions, departments, sections, and so on need to be coordinated and controlled. Most control systems are pastaction-oriented and consequently are inefficient or fail. For example, there is little an employee can do today to correct the results of actions completed two weeks ago. Steering controls, on the other hand, are future-oriented and allow adjustments to be made to get back on course before the control period ends. They therefore establish a more motivating climate for the employee. What's more, although many standards or controls are simply estimates of what should occur if certain assumptions are correct, they take on a precision in today's control systems that leave little or no margin for error. Managers would be better off establishing a range rather than a precise number and changing standards as time passes and assumptions prove erroneous. This would be fairer and would positively motivate employees. There are three fundamental beliefs underlying most successful control systems.
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First, planning and control are the two most closely interrelated management functions.

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Second, the human side of the control process needs to be stressed as much as, if not more than, the tasks or 'numbers crunching' side. Finally, evaluating, coaching, and rewarding are more effective in the long term than measuring, comparing, and pressuring or penalizing New Development / Techniques of Management and Management Control Total Quality Management (TQM) Business Process Reengineering (BPR) Enterprise Resource Planning (ERP) Value Added Analysis Programme and Performance Budgeting (PPB) Agency Theory Framework Management by Objective (MBO) Activity Based Costing (ABC)

Limitation of Management Control Judgement Mistakes: Effective management control may be limited by the realities of human judgement. Decisions are often made within a limited time frame, without the benefit of complete information, and under time pressures of conducting agency business. These judgement decisions may affect achievement of objectives, with or without good management control. Management control may become ineffective when management fails to minimize the occurrence of errors (e.g., misunderstanding instructions, carelessness, distraction, fatigue, or mistakes). Management Override: Management may override or disregard prescribed policies, procedures, and controls for improper purposes (e.g., to enhance presentation of their agency's financial or compliance status). Override practices include misrepresentations to state officials, staff from the central control agencies, auditors, or others. Management override must not be confused with management intervention (i.e., the departure from prescribed policies and procedures for legitimate purposes). Intervention may be required in order to process non-standard transactions that otherwise would be handled inappropriately by the management control system. A provision for intervention is needed in all management control systems since no system anticipates every condition. Management's actions to intervene in management control should be documented and disclosed to appropriate personnel. Collusion: Collusion activities can result in control failure. Individuals, acting collectively to perpetrate and conceal an action from detection, may alter financial data or other information in a manner that cannot be identified by the management control system. Cost versus Benefits: The cost of management control must not exceed benefits to be derived. Potential loss, associated with exposure, should be weighed against the cost to control it. Although the costbenefit relationship is a primary criterion to be considered in designing management control, the precise measurement of cost is generally not possible. The challenge is to find a balance between excessive control (which is costly and counterproductive) and too little control. The formal Control Process:

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Types of Organization: the firms strategy has an important influence on its organization structure. The type of organization structure, in turn, has an influence on the design of management control systems. 1. 2. 3. The functional structure, in which each manager is responsible for a specified functions. Such as production or marketing. A business unit structure, in which each business unit manager is responsible for most of the activities of a business unit, which is a semi-independent part of the company, A matrix structure, in which functional units have dual responsibilities.

The structural organization implies the following things: The formal relationships with well-defined duties and responsibilities; The hierarchical relationships between superior and subordinates within the organization. The tasks or activities assigned to different persons and the departments; Coordination of the various tasks and activities; A set of policies, procedures, standards and methods of evaluation of performance which are formulated to guide the people and their activities

Functional organization: When units and sub-units of activities are created in organization on the basis of functions, it is known as functional structure. Thus, in any industrial organization, specialized functions like manufacturing, marketing, finance and personnel constitute as separate units of the organization. All activities connected with each such function are placed in the same unit. As the volume of activity increases, sub-units are created at lower levels in each unit and the number of persons under each manager at various levels gets added. This results in the interrelated positions taking the shape of a pyramid.

Advantages Specialization each department focuses on its own work Accountability someone is responsible for the section Clarity know your and others roles Business Unit Organization:

Disadvantages Closed communication could lead to lack of focus Departments can become resistant to change Coordination may take too long Gap between top and bottom

A "product structure", the divisional structure groups each organizational function into a division. Each division within a divisional structure contains all the necessary resources and functions within it. Divisions can be categorized from different points of view. The divisional structure is characterized by decentralization of authority. Thus, it enables managers to take decisions promptly and resolve problems appropriate to the respective divisions. It also provides opportunity to the divisional managers to take initiative in matters within their jurisdiction. But such a structure involves heavy financial costs due to the duplication of supporting functional units for the divisions. Advantages Clear focus on market segment helps meet customers needs Positive competition between divisions Disadvantages Duplication of functions (e.g. different sales force for each division) Negative effects of competition

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Better control as each division can act as separate profit centre

Lack of central control over each separate division

Functions and Controller: (Financial Officer is controller) The controller usually performs the following functions; Design and operates information and control systems. Prepares financial statements and financial reports (includes tax returns) to shareholders and other external parties. Prepares and analyses performance reports and assist managers by interpreting these reports, by analyzing program and budget proposals, and by consolidating the plans of various segments into an overall annual budget. Supervises internal audit and accounting control procedures to ensure the validity of information, establishes adequate safeguards against theft and defalcation, and performs operational audits. Develops personnel in the controller organization and participates in the education of management personnel in matters relating to the controller functions.

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