Management Accounting & Control 2 – summary
Summary of the chapters from: Fundamentals of Cost Accounting
Chapter 12 – Fundamentals of Management Control Systems
The purpose of the management control system is to align more closely the interests of the
manager and the interest of the organization.
The major role of the management control system is to measure the performance of the
agents.
Decentralization= is the delegation of decision-making authority to subordinates in the
organization’s name. Companies in which decisions are delegated to divisional and
departmental managers.
Principal-agent relationship= When authority in an organization is decentralized.
Relationship between the following:
- Subordinates à Agent
- Superior à principals
Centralization= a few decisions are delegated. Many small businesses are good examples of
centralized authority with the owner making most or all-important decisions.
Local knowledge= Information about local conditions, markets, regulations and so on.
Advantages of decentralization
The larger and more complex an organization is, the more advantages decentralization
offers.
- Better use of local knowledge
- Faster response
- Wiser use of top management’s time
- Reduction of problems to manageable
- Training, evaluation and motivation of local managers
Disadvantages of decentralization
- Local managers can make decisions that are not in the best interest of the
organization’s top managers and the owners
- Administrative duplication
- Dysfunctional decision making/ the possibility of poor decisions based in incomplete
information
Dysfunctional decision making= Decisions made in the interests of local managers that are
not in the interests of the organization.
Management control system
System to influence subordinates to act in the organizations interests. It is the “right”
management control system when it leads to reaching goals and strategy of the company.
,Organizational economics
This is the study of how firms are structured and operated. From the organizational
economics literature, management control systems consist of three elements.
3 elements of a management control system
1. Delegated decision authority (essence of decentralization)
• Specification of the authority to make decisions in the organization’s name.
2. Performance evaluation and measurement systems
• System and specification of how the subordinate will be evaluated/
measured.
• Includes measurements of performance
• Performance evaluation systems should reward people when they do the
right thing.
• Performance measures should reflect the results of actions that improve
organizational performance.
3. Compensation and reward systems
• System that specifies how the subordinate will be compensated for his or her
performance based on a stated measure of performance.
Balancing the elements
An effective, well-functioning management control system balances these three elements
and defines them consistently.
Successful management control system is
- Results in higher share prices
- Hels an organization attain its goals
Appropriate management control system
- Is based on organizational strategy
- Depends on the organization’s environment
Responsibility accounting
System of reporting tailored to an organizational structure so that costs and revenues are
reported at the level within the organization having the related responsibility.
The five basic kinds of decentralized units are:
1. Cost centers
• Organization subunit responsible only for costs
• à Warehouse
• The measure:
i. Comparing actual inputs to standard in puts in a cost center.
- Standard cost centers: if the relationship between costs and outputs can be specified,
the unit is called a standard cost center.
2. Discretionary cost centers
, • This is established when managers are responsible for costs, but the input-
output relationship is not well specified.
• à accounting, advertising and administrative departments
3. Revenue centers
• Organization subunit responsible for revenues and, typically, marketing costs.
• à Large department store
• These are less common than cost centers or profit centers.
• The measure:
i. The contribution of the center.
ii. the amount of revenue earned.
iii. The difference between the center’s revenues and costs.
4. Profit centers
• Organization subunit responsible for profits and revenues, costs, production
and sales volumes.
• à Retail stores, fast food restaurant.
• The measure:
i. Much is left to managerial judgment
ii. Standard or budget plans.
5. Investment centers
• Organization subunit responsibility for profits and investment in assets.
• The measure:
i. Business units
Goal congruence
Agreement by all members of a group on a common set of objectives.
- Total congruence: exists when all members of an organization have incentives to
perform in the common interest. When a group acts as a team.
- Individual goal congruence occurs when an individual’s personal goals are congruent
with organizational goals.
Behavioral congruence
Alignment of individual behavior with the best interests of the organization regardless of the
individual’s own goals.
Two questions managers must answer when thinking about their performance evaluation
systems:
- Does the measure reflect the results of those actions that improve the organization’s
performance?
- What actions might managers be taking that improve reported performance but are
actually detrimental to organizational performance?
Managers should design systems that do not punish people for doing the right thing.
Relative performance versus absolute performance standards
A company is often tempted to compare the performance of its centers and even to
encourage competition among them. The various centers can be in different business, which
can complicate things. It is very difficult to compare the performance of a manufacturing
center with the performance of a center that provides a consulting service and has a
, relatively small investment base. Investment centers operating in different countries face
different risks. When diverse centers exist, management frequently establishes target levels
of performance for the individual investment centers.
- Performance is measured as division income.
- The center might be evaluated by comparing the actual division income with the target
income.
Controllability concept
Idea that managers should be held responsible for costs or profits over which they have
decision-making authority.
- The controllability concept is widely used as a basis for managerial performance
valuation.
- The longer the manager is at the division, the more responsibility she takes for its
success.
Relative performance evaluation (RPE)
Managerial evaluation method that compares divisional performance with that of peer
group divisions.
Purpose of RPE: is to go beyond setting internal targets (for example divisional return on
investment) and compare managers or divisions to other comparable divisions.
Compensation systems
The compensation system has to reward the manager for measured performance to provide
sufficient incentives to influence the manager’s decisions.
The compensation system also is used to better align the risk preferences of the manager
and the firm.
Two categories:
- Fixed compensation: compensation that is not directly linked to measured
performance.
o Is paid to the manager independent of measured performance à salary.
- Contingent compensation: Compensation that is based on measured performance.
o It is the amount of compensation that is paid based on measured performance
à Commission is paid to the sales staff.
Effective corporate cost allocation
This system ensures that the performance of managers who have decision-making authority
over factors that affect the costs will be measured by the costs.
Dual-rate method
Cost allocation method that separates a common cost into fixed and variable components
and then allocates each component using different allocation base.
- Dual-rate method is common when costs have both a fixed and a variable component.
- Fixed and variable costs are allocated using different allocation bases.
Financial fraud
The commission listed examples of pressures that can lead to financial fraud, including the
following:
Summary of the chapters from: Fundamentals of Cost Accounting
Chapter 12 – Fundamentals of Management Control Systems
The purpose of the management control system is to align more closely the interests of the
manager and the interest of the organization.
The major role of the management control system is to measure the performance of the
agents.
Decentralization= is the delegation of decision-making authority to subordinates in the
organization’s name. Companies in which decisions are delegated to divisional and
departmental managers.
Principal-agent relationship= When authority in an organization is decentralized.
Relationship between the following:
- Subordinates à Agent
- Superior à principals
Centralization= a few decisions are delegated. Many small businesses are good examples of
centralized authority with the owner making most or all-important decisions.
Local knowledge= Information about local conditions, markets, regulations and so on.
Advantages of decentralization
The larger and more complex an organization is, the more advantages decentralization
offers.
- Better use of local knowledge
- Faster response
- Wiser use of top management’s time
- Reduction of problems to manageable
- Training, evaluation and motivation of local managers
Disadvantages of decentralization
- Local managers can make decisions that are not in the best interest of the
organization’s top managers and the owners
- Administrative duplication
- Dysfunctional decision making/ the possibility of poor decisions based in incomplete
information
Dysfunctional decision making= Decisions made in the interests of local managers that are
not in the interests of the organization.
Management control system
System to influence subordinates to act in the organizations interests. It is the “right”
management control system when it leads to reaching goals and strategy of the company.
,Organizational economics
This is the study of how firms are structured and operated. From the organizational
economics literature, management control systems consist of three elements.
3 elements of a management control system
1. Delegated decision authority (essence of decentralization)
• Specification of the authority to make decisions in the organization’s name.
2. Performance evaluation and measurement systems
• System and specification of how the subordinate will be evaluated/
measured.
• Includes measurements of performance
• Performance evaluation systems should reward people when they do the
right thing.
• Performance measures should reflect the results of actions that improve
organizational performance.
3. Compensation and reward systems
• System that specifies how the subordinate will be compensated for his or her
performance based on a stated measure of performance.
Balancing the elements
An effective, well-functioning management control system balances these three elements
and defines them consistently.
Successful management control system is
- Results in higher share prices
- Hels an organization attain its goals
Appropriate management control system
- Is based on organizational strategy
- Depends on the organization’s environment
Responsibility accounting
System of reporting tailored to an organizational structure so that costs and revenues are
reported at the level within the organization having the related responsibility.
The five basic kinds of decentralized units are:
1. Cost centers
• Organization subunit responsible only for costs
• à Warehouse
• The measure:
i. Comparing actual inputs to standard in puts in a cost center.
- Standard cost centers: if the relationship between costs and outputs can be specified,
the unit is called a standard cost center.
2. Discretionary cost centers
, • This is established when managers are responsible for costs, but the input-
output relationship is not well specified.
• à accounting, advertising and administrative departments
3. Revenue centers
• Organization subunit responsible for revenues and, typically, marketing costs.
• à Large department store
• These are less common than cost centers or profit centers.
• The measure:
i. The contribution of the center.
ii. the amount of revenue earned.
iii. The difference between the center’s revenues and costs.
4. Profit centers
• Organization subunit responsible for profits and revenues, costs, production
and sales volumes.
• à Retail stores, fast food restaurant.
• The measure:
i. Much is left to managerial judgment
ii. Standard or budget plans.
5. Investment centers
• Organization subunit responsibility for profits and investment in assets.
• The measure:
i. Business units
Goal congruence
Agreement by all members of a group on a common set of objectives.
- Total congruence: exists when all members of an organization have incentives to
perform in the common interest. When a group acts as a team.
- Individual goal congruence occurs when an individual’s personal goals are congruent
with organizational goals.
Behavioral congruence
Alignment of individual behavior with the best interests of the organization regardless of the
individual’s own goals.
Two questions managers must answer when thinking about their performance evaluation
systems:
- Does the measure reflect the results of those actions that improve the organization’s
performance?
- What actions might managers be taking that improve reported performance but are
actually detrimental to organizational performance?
Managers should design systems that do not punish people for doing the right thing.
Relative performance versus absolute performance standards
A company is often tempted to compare the performance of its centers and even to
encourage competition among them. The various centers can be in different business, which
can complicate things. It is very difficult to compare the performance of a manufacturing
center with the performance of a center that provides a consulting service and has a
, relatively small investment base. Investment centers operating in different countries face
different risks. When diverse centers exist, management frequently establishes target levels
of performance for the individual investment centers.
- Performance is measured as division income.
- The center might be evaluated by comparing the actual division income with the target
income.
Controllability concept
Idea that managers should be held responsible for costs or profits over which they have
decision-making authority.
- The controllability concept is widely used as a basis for managerial performance
valuation.
- The longer the manager is at the division, the more responsibility she takes for its
success.
Relative performance evaluation (RPE)
Managerial evaluation method that compares divisional performance with that of peer
group divisions.
Purpose of RPE: is to go beyond setting internal targets (for example divisional return on
investment) and compare managers or divisions to other comparable divisions.
Compensation systems
The compensation system has to reward the manager for measured performance to provide
sufficient incentives to influence the manager’s decisions.
The compensation system also is used to better align the risk preferences of the manager
and the firm.
Two categories:
- Fixed compensation: compensation that is not directly linked to measured
performance.
o Is paid to the manager independent of measured performance à salary.
- Contingent compensation: Compensation that is based on measured performance.
o It is the amount of compensation that is paid based on measured performance
à Commission is paid to the sales staff.
Effective corporate cost allocation
This system ensures that the performance of managers who have decision-making authority
over factors that affect the costs will be measured by the costs.
Dual-rate method
Cost allocation method that separates a common cost into fixed and variable components
and then allocates each component using different allocation base.
- Dual-rate method is common when costs have both a fixed and a variable component.
- Fixed and variable costs are allocated using different allocation bases.
Financial fraud
The commission listed examples of pressures that can lead to financial fraud, including the
following:
