Вы находитесь на странице: 1из 149

The best thought-out plans in the world aren't worth the paper they're written on if you can't pull

them off. Ralph S. Larsen Chairman and CEO, Johnson & Johnson

BASIC CONCEPTS 1. Control An organization must be controlled i.e. devices that ensure that it goes where its leaders want it to go must be operative. Any control system has at least 4 elements: 1. A detector or sensor: it is a measuring device that identifies what is actually happening in the process being controlled. 2. An assessor: It is a device for determining the significance of what is happening. Usually, significance is assessed by comparing the information on what is actually happening with some standard or expectation of what should be happening. 3. An effector: it is a device that alters behaviour if the assessor indicates the need for doing so. This device is often called feedback. 4. A communications network: it transmits information between the detector and the assessor, and between the assessor and the effector.

Control device

Assessor, Comparison with standard

Detector. Information about what is happening

Effector. Behaviour alteration, if needed

Entity being controlled

2. Management An organization consists of a group of people who work together. The organization has goals- that is, it wants to accomplish certain results. Management is the process whereby the resources of man, machine and material are integrated to accomplish these goals. Therefore the role of management is to plan, organize, integrate and interrelate organizational activities and resources in order to achieve the organizations objectives. This role is facilitated through appropriate management ctrl systems and processes.

In a business organization, earning a satisfactory profit usually is an important goal. The leader of the organization are its management there is a hierarchy of managers, with the CEO at the top, and business unit, departmental, section and other managers below the CEO. Depending on the size and complexity of the organization, there may be several layers in the hierarchy. Except for the CEO, each manager is both a superior and a subordinate. Each supervises people in his or her own organizational unit and is a subordinate of the manager to whom he or she reports. These relationships usually are shown on the organizational chart. The CEO (or, in some organizations, a team of senior managers) decides on strategies that are expected to attain the organizations goals. If the company is organized into business units, business unit managers formulate strategies for their units, subject to the approval of the CEO. The management control process is the process that managers use to assure that the members of the organization implement these strategies. Systems A system is a prescribed way of carrying out an activity or set of activities; usually the activities are repeated. A system is characterized by a more or less rhythmic, recurring, coordinated series of steps that are intended to accomplish a specified purpose. An important characteristic of systems is control.

Control centers on the prevention and correction of deviations in a systems behaviour from those of standards that have been specified at a given time. In self- regulating systems, the key element for control procedure is feed back. A comparison of output values is made with the standards, and information concerning the degree of deviation is fed back to the other elements in the systems structure so that preplanned activities may be changed if necessary. Systems can be closed or open. The closed systems are also called informationtight systems i.e. information loop is closed and the control mechanism has the capability to affect the processor so that the desire output is achieved. Open systems do not have information-tight control unit. Here the relationships among elements of the system and between the system and its environment are often not known. Open systems characteristically strive to maintain a dynamic balance. The open system receives signals of changes in environment and adapts itself in keeping with its character and goals. An organization is a system of interrelated parts working in conjunction with each other for accomplishing its goals and those of the people involved in it. Management control system A management control system is a system.

A system is an aggregate of machines and people that work toward a common objective. A system can be described as a series of steps or phases consisting of an input phase, a processing phase, and an output phase. A control system adds measurement, analysis and reporting phases to the system. Output is measured, compared against a plan, analyzed if judged significant, and then reported back to the appropriate earlier phases of the system in the form of positive or negative reinforcement. In a management control system, data/information is typically fed back to managers of the various system phases. Responsible managers will then take appropriate action based on the data/information provided. To help ensure that the data/information is of high quality, the management control system must have certain characteristics. There must be a reliable performance measurement system. Realistic standards should be planned and maintained. The standards should be consistently and regularly compared with performance measurement data. Any variances that exceed predetermined thresholds should be enthusiastically investigated and reported to the people who

have responsibility and authority to make appropriate and timely adjustments. All adjustments should be controlled, especially any adjustments that affect predetermined standards and thresholds. Many management actions are unsystematic. A manager regularly encounters situations for which the rules of the system are not well defined; the manage then uses his or her best judgment in acting. Many interactions between managers or between a manager and a subordinate are of this type. The appropriate response is determined by the managers skill in dealing with people, not by a rule specified by the system (although the system may suggest the general nature of the appropriate response). If all systems provided the correct action for all situations, there would be no need for human managers. This is the case in automated factory; managers are needed only in the event of a system failure. Distinguishing characteristics of control systems in organizations. Control systems in organizations operate on the same basic framework as control systems in general. The control process that managers use has the same elements as those in the control systems in general: detectors, assessors, effectors, and a communications system. Only difference is the involvement of people. Thus control in an organization is much more complicated than the control of an automated system.

The process of control in organizations involves the following steps: Information about the actual state of the organization is compiled by people, (detectors report what is actually happening throughout the organisation) it is compared(by people) with the desired state ( the desired state is also decided by people) (assessors compare this information with the desired state, which is the implementation of strategies) and if there is an significant difference, a course of action is recommended (by people) and action taken (by people) (effectors take corrective action if there is a significant difference between the actual state and the desired state;) This is why the process of control is more complex than the automatic control system. Three levels of management An organisation is made of three distinct levels of management: 1. Corporate managementconsists of executives who are responsible for the performance of the organisation as a whole. The chairman or managing director and executives in charge of specific functions such as finance, marketing or personnel constitute the corporate management. 2. Divisional management: consists of executives responsible for total performance of a particular region or product division.


Operating management: consists of executives changed with the management of unit operations or are responsible for specific operational tasks.

Three levels of decision-making The following are the three levels of decision making in an organisation: 1. Strategic thinking and planning takes place at the institutional level. People involved at this level are those who are concerned with general company objectives of the company. 2. the managerial level which focuses on gathering, coordinating and allocating resources for the organisation e.g. planning, budgeting, capital expenditure decision making, etc. 3. The technical level involving the acquisition and utilization of technical knowledge for operational controls e.g. production scheduling, inventory control. Etc. Consistent with the three levels of management and three levels of decision making, the total planning and control system could be subdivide into 3 categories as shown in the figure below.

Strategic planning

Management control

Operational control

Corporate management Divisional management

Institutional level Managerial level

Strategic planning

Management control

Operating management

Technical level

Operational control

Three levels of management, three levels of decision-making and the corresponding three activities of planning and control

Nature of management control systems The aspects of control in an organization are: 1. Planning Process: The desired state or standards against which performance is compared is decided by the management. It is the responsibility of the management to decide what the organization plans to achieve in a given time framework. This is Planning Process. Planning and control are intricately linked because in control, actual performance is compared to planned performance. 2. Measurement of what is happening. 3. The next problem is how to decide whether the difference in the desired state and actual state is significant or not. 4. Then we have to decide what action needs to be taken. Managers will have to seek various

alternatives of action and choose the one that is likely to result in optimal decisions. 5. Follow-up: merely deciding what action needs to be taken is not sufficient. There has to be proper follow-up and therefore, another level of control for the control system. Hence, managers have to influence people in regulating their behaviour for the desired action. 6. Coordination: in order to ensure that subparts of an organization work in harmony, there has to be proper coordinating mechanisms. So control in organizations is needed to ensure proper coordination among various departments. Thus, a control system in and organization is superimposed on smaller control systems in every part of the organization. Problems of control in organization are similar to problems of interconnected ctrl systems. Although the manage control process has the same processes as other control processes, the significant differences are: 1. The standard is not preset but is a result of a conscious planning process. Unlike the thermostat or body temperature systems, the standard is not preset but is a result of a conscious planning process. Management decides what the organisation should be doing, and part of the control process is a comparison of actual accomplishments with these plans. Thus, the control process in an organization involves planning. In many situations, planning and control can be viewed as tow separate


activities. Management control, however involves both planning and control. Management control is not automatic: like control of an automobile, but unlike the thermostat and body temperature systems, mgt control is not automatic. Some of the detectors (i.e. instruments for detecting what is happening in the organization) are mechanical, but important information is often detected through the managers own eyes, ears, and other senses. Although there are routine ways of comparing certain reports of what is actually happening against some standard of what should be happening, managers themselves must judge whether the difference between actual and standard performance is significant enough to warrant action, and, if it is, what action to take. Action taken to alter the organizations behaviour involves human beings; in order to effect change, a manager must interact with another person. Detectors are not just mechanical, managers senses detect important information Although there are routine ways of comparing certain reports of what is actually happening against some standard of what should be happening, managers themselves must judge whether the difference between actual and standard performance is significant enough to warrant action,



and, if it is, what action to take Action taken to alter the organizations behaviour involves human beings; in order to effect change, a manager must interact with another person. Management control requires coordination among individuals: an organization consists of many separate parts, and management control must ensure that the work of these pars is in harmony with one another. This need does not exist at all in the case of the thermostat, and it exists only to a limited extent in the case of the various organs that control body temperature. There is no clear-cut connection between the observed need for action and the behaviour that is required to obtain the desired action: in the assessor function, a manager may decide that costs are too high; but there is no easy or automatic action, or series of actions, that is guaranteed to bring costs down to what the standard says they should be. The term black box is used to describe an operation whose exact nature cannot be observed. A management control system is an black box. We cannot know what action a given manager will take when a significant difference between actual and expected performance is assessed, or what (if any) action others will take in response to the managers signal.


much control is self-control; control in an organization does not come about solely, or even primarily, as a consequence of actions that are taken by an external regulating device like the thermostat. Much control is self-control; i.e. people act in the way they do, not necessarily because they are given specific instructions by their superior but, rather, because their own judgment tell them what action is appropriate.

Boundaries of management control Management control is one of several types of planning and control activities that occur in an organization. It fits between strategy formulation and task control in several respects. Strategy formulation is the least systematic of the three, task control is the most systematic, and management control is in between. Strategy formulation focuses on the long run, task control focuses on short-run operating activities, and management control is in between. Strategy formulation uses rough approximations of the future, task control uses current accurate data, and management control is in between. Each activity involves both planning and control; but the emphasis varies with the type of activity. The planning process is much more important in strategy formulation, the control process is much more important in task control, and planning and control are of approximately equal importance in management control.

General relationships control functions

Activity Strategy formulation




Nature of end product Goals, strategies and policies

Management control

Implementation of strategies

Task control

Efficient and effective performance of individual tasks

Management control Management control is the process by which managers influence other members of the organization to implement the organizations strategies. Management control is the process of evaluating, monitoring and controlling the various sub-units of the organization so that there is effective and efficient allocation and utilization of resources in achieving the predetermined goals. Thus, the focus of management control is on the managers of organisational sub-units and hence its focus is on line managers responsible for the performance of their departments.

Management control, therefore, is the control exercised by the management over the managers. management control is exercised by evaluating the performance of each responsibility centre against planned performance. Planned performance is decided in consultation with the managers of responsibility centres, taking into consideration the activities being managed by them and the resources available to them in terms of men, materials and money. Planned performance is usually translated into monetary terms, although physical achievements are also planned for. Managers are not only responsible for the achievement of physical targets, but also for the corresponding monetary values. Thus, management control is generally built around a financial structure. Actual and planned performance are compared at regular intervals so as to identify resource gaps and, if need be, provide managers with more resources or transfer resources form on organisational unit to another. The end-oftheyear review may be too late to take corrective action. The whole purpose of management control is to decide on corrective action if there are substantial deviations from the planned performance. The management control system also provides mechanisms for proper coordination and integration of various organisational sub-units by interrelating the tasks being performed and deciding on the resource allocation. In the process of management control conflicts are inherent between

managers for resource mobilization, allocation and snatching. Thus there is intense interaction among managers. Aspects(nature and scope) 1. Management control activities Management control involves a variety of activities. These include: 1. planning what the organization should do, 2. coordinating the activities of several parts of the organisation, 3. communicating information 4. evaluating information, 5. deciding what, if any, action should be taken, and 6. Influencing people to change their behaviour. Management control does not necessarily mean that actions should correspond to a plan, such as a budget because: i. If the circumstances are now believed to be different from the circumstances on which stated plans were based on, at the time when they were formulated, the planned actions may no longer be appropriate. ii. The purpose of mgt control is to ensure that strategies are carried out so that the organizations objectives are attained. If a manager discovers a better way of operatingone that is more likely to achieve the organizations goals than the actions stated in the plan- then the management control system

should not prohibit him or her from operating in that fashion. 2. Behavioral considerations The mgt control process is systematic, but not mechanical. The process involves interactions among individuals. There is no mechanical way of describing these interactions. Managers have personal goals, and the central control problem is goal congruence, that is, to induce them to act so that when they seek their personal goals, they help to attain the organisations goals. Goal congruence means that the goals of individual members of an organisation should be, as far as feasible, consistent with the goals of the organisation itself. See pg 93 Perfect goal congruence cannot be achieved. Nevertheless, the system should go as far in this direction as is feasible. The development of optimum compensation plans and other incentives are and important consideration in promoting goal congruence. 3. Tool for Implementing Strategy. Management control systems aid management in moving an organization toward its strategic objectives. Thus, management control focuses primarily on strategy execution. Management controls are only one of the tools managers use in implementing desired strategies. Strategies get

implemented through management controls, organization structure, human resource management, and culture. Organisation structure specifies the roles, reporting relationships, and responsibilities that shape decision making within organisations . Human resource management deals with selection, training, development, evaluation, promotion, and firing of employees. Human resource decisions should be consistent with the chosen strategy and structure so that the required knowledge and skills are developed. Culture refers to the organizations set of common beliefs, attitudes, and norms that explicitly or implicitly guide managerial action. 4. Financial and non-financial emphasis Management control systems encompass both financial and non-financial performance measures. The financial dimension focuses on the monetary bottom line, which s net income, return on equity, or some similar financial figure. Virtually all organisational subunits also have nonfinancial objectives: product quality, market share, customer satisfaction, on-time delivery, employee morale, and so on. 6.Aid in developing new strategies The primary role of management controls is to help in the execution of chosen strategies. In industries that are subject to very rapid environmental changes management control information can also provide the basis for thinking about new strategies. This is referred to as interactive control. Interactive control calls to managements attention developments-either

troubles (e.g. Loss of market share; customer complaints) or opportunities (eg. opening up of a new market because of removal of certain government regulations) that become the basis for managers to adapt to a rapidly changing environment by thinking about new strategies. Interactive controls are not a separate system they are an integral part of the management control systems. Some management control information helps manager think about new strategies. Interactive control information usually, but not exclusively, tends to be non-financial. MANAGEMENT CONTROL PROCESS Management control has 2 aspects: 1) System: the system outlines authority relationships, autonomy delegation, relationship among various organisational sub-units, parameters for performance evaluation, reward and punishments for achievement and nonachievement of targets, and information flow among various responsibility centers of the organization. 2) Process: the processes are managerial processes involved in establishing goals and objectives, performance appraisal of responsibility centers, ensuring achievement of targets and budgets by various organisational sub-units, follow-up of remedial action plans, implementation of decisions taken in performance review meetings.

The control system provides the necessary feedback and other relevant information and thus affects the quality of the decisions. The effectiveness of the control process is dependent on the quality of feedback received and the way it is used by the senior management for performance appraisal. In hierarchical organizations with appropriate decentralization of authority the control process begins with a review of the past performance of strategic business units and responsibility centers, and negotiation of specific objectives and targets for the next year. This is followed by a periodic recording of actual results and reporting of actual results against the targets. The senior management reviews the performance of responsibility centres on the basis of this reported information. During this process, areas where improvement is necessary are identified and reasons for shortfall are analysed. Then, remedial actions are decided upon. In the next review meeting, results of past corrective action together with the current performance are analysed. This process is carried through in each review meeting. In the process of reviewing the performance, specific targets may also get altered as a result of negotiation with the senior management. Thus, the management control process is primarily managerial in nature, secondarily accountingoriented and involves behavioral issues related to superior-subordinate relationships. While the management must identify the objectives of

various sub-units and contributions expected from managers, accountants should help in methods of measuring and reporting results as they are achieved.

Components of management control process








Generation of solutions AS-measurement of actual state DS-desired state as indicated in goals or standards C-comparator, i.e. comparison of actual with standard RA-initiation of remedial action

Distinctions between Strategic Planning, Management Control and Operational Control Basis of Strategic Management Operational distinction planning control control Level of Top Top management Supervisor management management and middle involved with little management are involvement closely involved of middle management Time frame Long range Short to Short intermediate(1 to periods5 years) day to day,

Goals objectives Structuring

and Basic objectives

Activity patterns Character activity Focal point

Tangible goals, with in framework of overall objectives Relatively Fairly highly unstructured structured but flexible Irregular Rhythmic, regular Administrative, little initiative All operations, line management More accurate and reliable as it relates to past or current events or events likely to occur in the near future.

of Creative persuasive Entire organisation Reliability of Reliability is data generated subject to by the process high level of of planning or doubt due to control uncertainties involved

weekly, monthly) Short-term tangible operating unit Quite rigid pre established Highly repetitive Following directions Operating unit More accurate and reliable as it relates to past or current events or events likely to occur in the near future.

The estimates used are impersonal and neutral

Data used for setting standards against which performance is evaluated is

Scope of activity Total

Basis decisions


personalised Overall, consisting of related subsystem.(Whole operation of the organisation) Managerial judgment is required and the scope of quantitative models is limited Organizational effectiveness Human considerations are more dominant. Control is more difficult

Operating unit (Specific tasks) Decision rules developed to decide about optimum decisions Efficiency

Focus of activity

Measures performance


Information/data External used information

The system is more important then the human element becoz system makes the decisions not managers Both in physical Physical terms and terms financial terms Internally Data generated data generated on specific

tasks or activities

Control Environment: THE CONTROL ENVIRONMENT HAS A PERVASIVE structure that affects many business process activities. It includes elements such as managements integrity and ethical values, operating philosophy and commitment to organizational competence. What is the Control Environment? The control environment provides an atmosphere in which people conduct their activities and carry out their control responsibilities. The control environment sets the tone of an organization by influencing the control consciousness of its people. It is the foundation for all other components of internal control, providing discipline and structure. Control environment factors include the integrity, ethical values, and competence of the entity's people; management's philosophy and operating style; the way management assigns authority and responsibility; the way management organizes and develops its people; and the attention and direction provided by the audit committee and board of directors.

What is the Environment?





The objective of the control environment is to establish and promote a collective attitude toward achieving effective internal control over the entity's business. Control environment factors incorporate management's attitude, awareness, and actions concerning an organization's control environment. The following environment: factors constitute the control

A. Management's Philosophy and Operating Style: Management concern about internal controls and the environment in which specific controls function. Management approach to risk taking and accounting policies. Managements responsiveness to crisis situations in both operating and financial areas. The reliability and accuracy of information used by Management to make business decisions. Frequency of reorganization or replacement of management staff or consultants. Turnover of management personnel. Managements ability to adapt to new or untraditional roles required to meet the changing needs of the organization. Communication and feedback systems within the organization.

The organizations financial sustainability. B. The Entity's Organizational Structure: An understanding of organisation behaviour is important for the proper perception of management control system and processes. As the major focus of the control system is on the performance evaluation of the organisational sub-units, the control system designer should also have an understanding of the organisation structure. Structure refers to the way the enterprise is organized so as to enable the total task of the organisation to be performed in an efficient and effective way. The organisational structure is essentially the arrangement of its subsystems with authority and responsibility relation. Thus, it refers to whether the organisation is centralized or decentralized or whether it emphasizes line or staff. The organizational structure should be appropriate for the entity's size and complexity. The structure should enable segregation of duties for initiating and recording transactions and maintaining custody over assets. Delegation of responsibility and authority should be appropriate, and the number of supervisors should be adequate and accessible. Policies and procedures should be established at appropriate levels. Organizational conflict of interest should not exist Major forms of organisation structure 1. Functional organisation in which the tasks are differentiated on the basis of each major function

such as marketing, production, etc. with each manager responsible for the specified function; 2. divisional organisation in which differentiation is on the basis of a product line or group of product lines with the manager responsible for all the functions related to such a product line or group of product lines, 3. Matrix organisation in which there is 2-way differentiation, namely according to functions and according to projects, with both superimposed on each other 4. Network structure aimed at closer interinstitutional coordination among a network of agencies involved in implementing a programme or a project. C. Methods of Assigning Authority and Responsibility: The adequacy of the entity's policies regarding the assignment of responsibility and the delegation of authority for such matters as organizational goals and objectives, operating functions, and regulatory requirements. Employee job descriptions should adequately describe specific duties, responsibilities, reporting relationships, and constraints. D. Management's Monitoring of Performance: Managements involvement organization's performance. in reviewing the

Management control methods should be adequate to investigate unusual or exceptional situations and to take appropriate and timely corrective action. Management's follow-up action should be timely and appropriate in response to communications from external parties, including complaints, notification of errors in transactions with parties, and notification of inappropriate employee behavior. E. Human Resources Policies and Practices: Human resources policies for hiring, retaining, and rewarding capable people. Standards and procedures for hiring, promoting, transferring, retiring, and terminating personnel. Training programs. Written job descriptions and reference manuals. The channels of communication for employees reporting suspected improprieties. Policies on employee supervision. Whether Policies and procedures provide for employee empowerment and encourage and support risk taking and initiatives for performance improvement. F. Budget Control: Guidance material and instructions to provide direction to those preparing the budget. The budget review, approval, and revision process. Management concern for reliable budget information. Management participation in directing and reviewing the budget process.

Management involvement in determining when, how much, and for what purpose expenditures can be made. Comparison of actual expenditures periodically to budgets. G. Compliance with Laws and Regulations: Awareness of Management of applicable laws and regulations and potential problems. A mechanism to inform management of the existence of illegal acts. Management reaction to identified instances of noncompliance with laws and regulations. Policies and procedures for complying with laws and regulations. Policies on such matters as acceptable business practices, conflicts of interest, and codes of conduct. H. Changing Conditions: The mechanisms for identifying and communicating events, activities, and conditions that affect operations or financial reporting objectives. Modification of Accounting and/or information systems in response to changing conditions. Consideration given to designing new or alternative controls in response to changing conditions. Managements responsiveness to changing conditions. Types of organisation and management control system the firms strategy has and important influence on its organisation structure. The type of organisation

structure, in turn, has an influence on the design of management control systems. Although organizations come in all sizes and shapes, their structures can be grouped into three general categories: (1) A functional structure, in which each manager is responsible for a specified function, such as production or marketing; (2) 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 and (3) A matrix structure, in which functional units have dual responsibilities.

Concept of goals and strategies Goals Goals can be defined as broad statements of what the organisation wants to achieve in the long run, or on a permanent basis. Goals are broad objectives. Goals are fairly timeless statements. Goals and objectives are properly defined. If they are vague or ill-defined, it may not be possible to measure the performance of the organisation. The clarity of goals and objectives is quite often more evident to the initial employers and promoters of institutions. With expansion of activities and joining of new member, goals and objectives as

perceived by participants tend to get diffused. Different key managers may have different perceptions about goals and objectives. It is because of this that organisations insist on proper induction of new entrants to the philosophy of the organisation. External pressures, sometimes political in nature, may force an enterprise to alter its goals and objectives, particularly in the case of public institutions, unless effective steps are taken by the top management of the enterprise to counteract such pressures, the enterprises goals and objectives will get diffused and even confused, and will seriously affect the effectiveness of the organisation. Besides achieving the broad goals and objectives, the management also attempts to achieve super ordinate goals. Super ordinate (or shared) goals are the set of values or aspirations that underscore what an organisation stands for and believes in. they are the overreaching purposes to which an organisation and its members dedicate themselves. Super ordinate goals are values that genuinely seek congruence between the individual and the organizations purposes and are higher order objectives beyond the bottom-line goals of ROI, market share, expenses and sales levels. The super ordinate goals encompass the concepts of service to society and therefore the organisations must demonstrate that their products serve social needs before society accepts them.

Strategies Strategy is the route with alternatives for reaching objectives and goals - Smith and Walsh Strategy is an outline of the proposed path of action of an enterprise. It is futuristic and indicative of the direction of growth on the basis of which the plan for growth is formulated. Since strategy pertains to the interface between the enterprise and its environment, the important determinants of strategy in relation to internal environment are: Corporate goals and objectives Physical resources of the enterprise in terms of technology, finance and personnel, Policies and styles of the management Determinants of strategy in relation to external environment are: Competition Technology Political stability Socio-economic factors Governmental controls and policies Strategies are evolved in response to changes in the environment in which the enterprise operates. While some enterprises systematically scan the environment to identify the threats or opportunities, others do it on an as and when basis.

The strategy outlines the growth pattern of an enterprise and strategic decisions therefore can be viewed in terms of product-market combinations. An enterprise can outline its growth on the basis of i) existing product markets ii) existing product, new markets iii) new product, existing market and iv) new product, new markets. Depending upon the choice it makes, there will be a particular product market strategy. The 4 different strategies will be: 1. Market penetration strategy: the firm attempt to increase the overall market share without any change in the product itself or its use. The firm therefore may have an objective of stated increase in market share. The risk element in this strategy is not very high because the product is already accepted in the market. The problem is to increase sales and hence production. 2. Market development strategy: new markets are explored for existing products are made broad-spectrum. For this strategy constant experimentation is needed to find out what different needs can be served by the same product. Thus, the product becomes multipurpose. Here has to be substantial investment in R& D for this. Since the product would serve the diverse needs, the acceptance of the product by varied customers may pose a certain amount of risk. 3. Product development strategy: the aim of this strategy is to innovate new products to

replace current ones. The key variable here is marketing. Since new products are to cater to the same market, choice of technology is critical. 4. Diversification strategy: it involves decisions about new products to cater to new markets. The diversification strategy may include either vertical integration or horizontal diversification. A strategy can be evaluated by asking key questions, such as: 1. is the strategy internally consistent? 2. Is the strategy consistent with environment? 3. Is the strategy appropriate in view of available resources? 4. Does strategy involve an acceptable degree of risk? 5. Does the strategy have an appropriate time horizon? 6. is the strategy workable? A strategy should be consistent with the environment Internally consistent with organisational goals and objectives. Formulated keeping in view resource availability and risk-taking capabilities of the management. Since implementation of strategy involves commitment of resources, the management should determine the time frame over which a given strategic choice will have its impact. The most important aspect of a strategic choice is to know whether the proposition is workable.

Once the organisation has defined its strategy for the organisation as a whole and for each of its strategic business units (SBU), it must elaborate the strategies into policies with a view to facilitating the achievement of goals and objectives. The policies have to be consistent with strategies. Through the process of policy formulation, management coordinates the strategy of each business unit so as to ensure that all organisational units work in harmony to achieve the goals. The policies are formulated in respect of prices, products, personnel, finance, and research and development. The policies act as constraints on the sub-units, for instance a particular transfer pricing policy will act as a constraint within which the divisional manager would have to operate. As the performance results of an organisational subunit are also determined by the managerial policies, the designer of control systems should have a clear understanding of various organisational policies.

Behavioral considerations Decision making process has 2 types of aspects (i) technical aspect and (ii) behavioral aspect. Technical aspects focus on technical details of data processing or external financial reporting, emphasizing compliance with legal requirements or

detections of frauds. management control system is also concerned with inducing the human beings in an organisation to take those actions that will help attain the organisational goals. The important behavioral considerations which should be taken care of while designing a management control system are as follows: 1. top management goals and sub goals 2. working with constraints 3. internal control 4. cost benefit considerations 5. goal congruence 6. managerial effort 7. management motivation 8. fairness and objectivity 1.top mgt goals and sub goals The starting point for judging a system is the specification of top mgt goals. Some mgt s will set a single goal such as the maximization of profit over the long run. This may be a vague goal for most subordinates. Consequently, most organisations specify multiple goals and accompany them with some form of measurement for evaluating performance. Top mgts sub goals are frequently called by other names, such as key-result areas, critical success factors, key variables, or critical variables. Some important goals of a business are as follows: (a) profitability (b) market position (c) productivity (d) product leadership

(e) (f) (g) (h)

personnel development employee attitudes public responsibility balance between short-range and longrange goals

Profitability is usually measured in terms of a single years results. The thrust of the other goals is to offset the inclination of mangers to maximize short run profits to the detriment of long-run profits. Over emphasis on any single goal, be it short-run profits or some other goals, seldom promotes longrun profitability. Balancing the various goals is an important part of mgt control. 2.working within constraints Management control system should be designed to suit specific conditions. The latter are defined here as the way top mgt has arranged the lines of responsibility within and entity. For example, one company may be organized primarily by functions such as manufacturing and sales; another company by divisions bearing profits responsibility such as the eastern and western division; and other companies by some hybrid arrangement. The designer of management control system should ordinarily consider the following: (i) Top- mgt goals (iii) sub goals or key-result areas (iv) trade-offs among the goals in items 1 and 2 (v) organization structure (vi) systems design in light of the foregoing

3.internal control An internal control system consists of method and procedures that are concerned with the authorization of transactions, safeguarding of assets, and accuracy of the financial records. Both manager and accountants are responsible for developing and evaluating internal control systems. An internal control system has 3 goals: (i)To prevent errors and irregularities by a system of authorization for transactions, accurate recording of transactions, and safeguarding of assets. (ii) to detect errors and irregularities by reconciling accounting recording with independently kept records and physical counts and reviewing accounts for possible write-downs of values. (iii) To promote operating efficiency by examining policies and procedures for possible improvements. A management control system encompasses administrative controls (such as budgets for planning and controlling operations) and accounting controls (such as the common internal control procedure of separating the duties of the person who counts cash form the duties of the person who has access to the accounts receivable records.) top mgt has the ultimate responsibility for both administrative and accounting controls. 4.cost Benefit considerations the choice of a system should be governed by weighing the collective costs and benefits, give the

circumstances of the specific organization. benefits are often difficult to measure. 5.goal congruence


goal congruence exists when individuals and groups aim at the goals desired by top mgt. goal congruence is achieved as managers, when working in their won perceived best interests, make decisions that harmonize with the overall objectives of top mgt. the challenge is to specify segment goals (or behaviors) that induce (or at least do not discourage) decisions that would achieve top-mgt goals. 6.managerial efforts Managerial effort is defined here as exertion toward a goal. It includes all conscious actins (such as watching or thinking) that result in more efficiency and effectiveness. Managerial effort is a matter of degree; it is maximized when individuals and groups strive toward their goals. Goal congruence can exist with little accompanying effort, and vice versa. Performance evaluation is a widely used means of improving congruence and effort because most individuals tend to perform better when they accept such feedback. 7.management motivations Motivation has been defined as aiming for some selected goal (goal congruence) together with the resulting drive (managerial effort) that influences action toward that goal. 8.fairness or objectivity

Managerial effort and motivation, among other things, depend largely on the degree of fairness, or objectivity built into the performance measurement and evaluation. Experience show that people resent evaluation which they consider unfair or subjective or vague rather than evaluation per se. thus, reasonably objective measures of performance should merit special attention of the management control system designers. Goal congruence Management control systems influence human behaviour. The systems should influence behaviors in a goal congruent manner. Goal congruence is affected both by informal processes and also by formal systems. Some of the informal factors are external to the organisation and some are internal. Control is also attained by two types of formal devices 1. rules, broadly defined; 2. a systematic way of planning and controlling. Senior management wants the organisation to attain the organisations goals. However, the members of the organisation have their won personal goals, and these are not entirely consistent with the goals of the organisation. The actions of individual members of the organisation are directed towards achieving their personal goals. The central purpose of a management

control systems, therefore, is to assure, so far as is feasible, goal congruence. Goal congruence in a process means that actions it leads people to take in accordance with their perceived self-interest are also in the best interest of the organisation. Perfect congruence between individual goals and organisational goals does not exist. One obvious reason is that individual participants usually want as much compensation as they can get; whereas, from the organizations viewpoint, there is an upper limit to salaries beyond which profits would be adversely and unnecessarily affected. As a minimum, however; the management control systems should not encourage individuals to act against the best interests of the organisation. For example, if the system signals that the emphasis should be only on reducing costs, and if a manager responds by reducing costs at the expense of adequate quality or by reducing costs that he or she controls by causing a more than offsetting increase in cots in other parts of the organisation, then the manager has been motivated, but in the wrong direction. Two questions are important in evaluating any mgt control practice: 1. What actions does it motivate people to take for their self-interest? 2. Are these actions in the best interest of the organisation?

Informal factors that influence goal congruence (control environment) I. external factors External factors are norms of desirable behaviour that exist in the society of which the organisation is a part. They are of the referred to as the work ethic. They are manifest in employees loyalty to the organisation, their diligence, their spirit, and their pride in doing a good job (as contrasted with merely putting in time). Some of these attitudes are local: they are specific to the city or region in which the organisation does its work. In encouraging companies to locate in their city or state, chambers of commerce or other promotional organisations often claim that their locality has a loyal, diligent work force. Others are industryspecific, still others are national; some countries have a reputation for excellent work ethics. Eg. Japan, South Korea, Hong Kong, and other East Asian countries. II. Internal factors 1. Organizations culture or climate Organisation culture refers to the set of common beliefs, attitudes, norms, relationships and assumptions that are explicitly or implicitly accepted and evidence throughout the organisation. Kenneth R. Andrews-Climate is used to designate the quality of the internal environment that conditions the quality of cooperation, the development of individuals, the extent of

members dedication or commitment to organisational purpose, and the efficiency with which that purpose is translated into results. Climate is the atmosphere in which individuals help, judge, reward, constrain, and find out about each other. It influences morale- the attitude of the individual toward his or her work and his or her environment. Certain practices are rituals, and others are taboos. Culture exists unchanged for many years. There is resistance to any attempts to change the culture. Culture is influenced by: 1. Personality and policies of the CEO (and by those of lower-level managers w.r.t the part of the organisation that they manage.) 2. The rules and norms accepted by the union (if the organisation is unionized) 2. Management style Management style, in particular, the attitude of a managers superior toward control has greatest impact on mgt control. Some managers are charismatic and outgoing Some are less ebullient Some rely on mgt by waling around Others rely more heavily on written reports 3.the informal organisation The relationships that constitute the informal organisation are important in understanding the realities of the mgt control process 4.Perception and communication

Operating managers must know what these goals are and what actions they are supposed to take in order to achieve them. They receive information about what they are supposed to do through various channels like budgets and other formal documents, conversations and other informal means. This information often is not a clear message about what senior mgt wants done. Moreover, the messages received through various information channels may conflict with one another, or manger may interpret them in different ways. Many erroneous perceptions arise from functional fixation-that is, the tendency of people to interpret the meaning of words and phrase according to accustomed definitions, even though these definitions have become obsolete or are not applicable to the current situation. Greater emphasis in mgt control reports on a standard terminology is one way to reduce the impact of functional fixation. 5.cooperation and conflict The lines in the organisation chart imply that the way organisational goals are attained is that senior mgt makes a decision and communicates that decision down through the organisational hierarchy to managers at lower levels of the organisation, who then implement it. This implication ignores the personal goals of individuals, and it is not the way an organisation actually function.

Many actions that a manager may what to take in order to achieve personal goals may have and adverse effect on other managers and on overall profitability .eg. managers may argue about which of them is to obtain the use of limited production capacity or other scarce resources, or about potential customers that several managers want to solicit, unless the management control system provides instruction in advance. The management control system must help to maintain the appropriate balance between conflict and cooperation within the organisation. this is because some conflict is desirable. A certain amount of cooperation is also obviously essential; but if undue emphasis is placed on developing cooperative attitudes, the most able participants will be denied the opportunity of using their talents fully. The formal control system These can be classified into two types: 1.rules 2.the management control system

1.Rules Rules refer to all types of formal instructions and controls. They include standing instructions, practices, job descriptions, standard operating procedures, manuals, and codes of ethics. Rules are in force indefinitely. They are changed infrequently.

They may relate to matter that range from the most trivial to the most important. Some rules are guides and organisation members are permitted to depart from them either is specified circumstances or if departure is in the organizations best interests. Some rules should never be broken Some rules are prohibitions against unethical, illegal, or other undesirable actions. Some are positive requirements that certain actions be taken Types of rules are i. physical controls ii. manuals iii. system safeguards iv. task control systems

Responsibility Centres A responsibility centre can be defined as an organisation unit headed by a responsible executive. It represents a set of activities assigned to a manager or a group of managers. A small collection of machines may be responsibility centre for a production supervisor, a full department for the department head and the centre organisation for the managing director.

The size of a responsibility centre will be determined by the nature of the task, technology, people and the level in organisation hierarchy. From the point of view of the top mgt, a division, which is a significantly large unit, is a responsibility centre. From the point of view of divisional mgt, the marketing department of the division is a responsibility centre and from the point of view of the marketing manager, the sales distribution and advertising departments are responsibility centres. A responsibility center exists to accomplish one or more purposes; these purposes are its objectives. The company as a whole has goals, and senior management has decided on a set of strategies to accomplish these goals. The objectives of responsibility centres are to help implement these strategies. Because the organisation is the sum of its responsibility centers, if the strategies are sound, and if each responsibility center meets its objectives, the whole organisation should achieve its goal. Responsibility centre is a sub system which has both inputs and outputs. Its inputs may include physical quantities of materials, manpower and various services, working capital and fixed assets. It works with these resources. As a result of this work, the responsibility centre produces output. These can be goods or services which either go to other responsibility centres within the organisation or sold to customers in the outside world.

Inputs Resources used, measured by cost Work


Goods or services


Management is responsible for obtaining the optimum relationship between inputs and outputs. In some situations the relationship is causal and direct eg. In production department the inputs become a physical part of the finished goods output. In many situations, however, inputs are not directly related to outputs eg. Advertising expense and R & D expenditure. Types of responsibility centres 1. revenue centres 2. expense centres 3. profit centres 4. investment centres in revenues centres, only outputs are measured in monetary terms; in expense centers, only inputs are measured; in profit centers, both revenues and expenses are measured and in investment centers, the relationship between profits and investment is measured.

1.Revenue centers

in a revenue center, outputs are measured in monetary terms, but no formal attempt is made to relate inputs (I.e. expenses or costs) to outputs. Revenue centers are, marketing organisations that do not have profit responsibility. Actual sales or orders booked are measured against budgets or quotas. Each revenue center is also an expense center in that the revenue center manager is held accountable for the expenses incurred directly within the unit. The primary measurement, however, is revenue. Revenue centers are not charged for the cost of the goods that they market. Consequently, they are not profit centers. Revenue centers do not typically have authority to set selling prices. 2.Expense centers Expense centers are responsibility centers for which inputs, or expenses are measured in monetary terms, but for which outputs are not measured in monetary terms. There are 2 general types: Engineered expense centers: are expense centers in which all or most costs are engineered costs. Engineered costs are elements of cost for which the right or proper amount of costs that should be incurred can be estimated with a reasonable degree of reliability. Const incurred in a factory for direct labour, direct material, components, supplies, and utilities are examples. Discretionary expense centers: are expense centers in which all, or most, costs are discretionary. Discretionary costs/managed costs are those for which no such engineered estimate is feasible the

amount of costs incurred depends on managements judgment about the amount that is appropriate under the circumstances. 3.Profit centers It is a responsibility center is measured in terms of profit, which is the difference between the revenues and expenses. Profit as a measure of performance is especially useful since it enables senior management to use one comprehensive measure instead of several measures that often point to different directions. A typical example of a profit center is a division of the company that produces and markets different products. The manager of this division will be responsible for the setting up of production policies and the price as also marketing strategies. Even though the division manager may propose the investments in the division the decisions are usually made by the top mgt Advantages of profit centers (i) The speed of operation decisions may be increase because many decisions do not have to be referred to corporate headquarters. (ii) Quality of many decisions is improved (iii) Headquarter management is relieved of day-today decisions and can concentrate on broader issues. (iv) Profit consciousness may be enhanced (v) Measurement of performance is broadened. (vi)Managers are freer to use their imagination and initiative. (vii) It provides a training ground for general management. Disadvantages of profit centers

(i) Top mgt may lose some control (ii) Lack of competent general managers (iii) Disadvantageous competition between organisation units. (iv) Friction can increase (v) Too much emphasis on short-run profitability. (vi) No completely satisfactory system for ensuring that each profit center, by optimizing its own profits, will optimize company profits. (vii) The quality of some of the decisions may be reduced. (viii) Additional costs 4.Investment centers: it is a responsibility centre whose performance is evaluated in terms of profit and assets employed in earning the profit. Since different divisions have different investment bases, it is difficult for the top management to compare the profit performance of one division with another division, unless it considers the investment base in each division. The comparison of absolute profits may not yield meaningful results because of different amounts of resources used by each division. The investment base is measured by net assets which consist of net fixed assets plus net current assets. This corresponds to the sum of shareholders equity plus reserves and surplus plus long-term loans in the balance sheet of a company. Thus in the case of divisions, the figure of net assets can be conceived as corporate equity in the division. There are 2 ways in which assets employed can

be related to profits, namely:


Return on investment: The return on investment is calculated by dividing the profits by the amount of investment i.e. assets employed. It is a ratio. Residual income: it is an absolute amount. It is calculated by deducting an interest charge from the profits. The interest charge is obtained by multiplying the net assets by a predetermined interest rate.


The concept of return on investment (ROI) is more widely used than residual income as managers by training are more accustomed to look at ratios. Further, ROI data is generally available for other companies or industries and can be used as a basis of comparison. The residual income concept cannot be used for comparison.


Large organisations are divided into a number of divisions to facilitate managerial control. The problem of transfer pricing arises when one division

of the organisation transfers its output to another division as an input. A transfer price is the price one segment (subunit, department, division etc.) of an organisation charges for a product or service supplied to another segment of the same organisation. The transfer from one segment to another is only an internal transfer and not a sale. Transfer pricing is needed to monitor the flow of goods and services among the divisions of a company and to facilitate divisional performance measurement. The main use of transfer pricing is to measure the notional sales of one division to another division. Thus the transfer prices used in the organisation will have a significant effect on the performance evaluation of the various divisions. This requires that the system of transfer pricing should be objective and equitable. Transfer pricing becomes necessary when there are internal transfers of goods or services and it is required to appraise the separate performances of the divisions or departments involved. Transfer pricing is the process of determining the price at which goods are transferred from one profit center to another profit center within the same company. If profit centers are to be used, transfer prices become necessary in order to determine the separate performances of both the buying and selling profit centers. If transfer prices are set too high, the selling center will be favored whereas if set

too low the buying center will receive an unwarranted proportion of the profits. Objectives that transfer prices should meet (a) Goal congruence: the prices should be set so that the divisional mgt desire to maximize divisional earnings is consistent with the objectives of the company as a whole. The transfer prices should not encourage sub-optimal decision-making. The system should be so designed that decisions that improve business unit profits will also improve company profits. (b) Performance appraisal: the prices should enable reliable assessments to be made of divisional performance. The prices form part of information, which should: 1 Guide decision making 2 Appraise managerial performance 3 Evaluate the contribution made by the division to overall company profits. 4 Assess the worth of the division as an economic unit. The transfer prices should be designed such that they help in measuring the economic performance (c) Divisional autonomy: the prices should seek to maintain the maximum divisional autonomy so that the benefits of decentralization (motivation, better decision-making, initiatives, etc.) are maintained. The profits of one division should not be dependent on the actions of other divisions. (d) Simple and easy: the system should be simple to understand and easy to administer.

(e)the transfer price should provide each segment with the relevant information required to determine the optimum trade-off between company costs and revenues. Fundamental principles for transfer price The fundamental principle is that he transfer price should be similar to the price that would be charged if the product were sold to outside customers or purchase from outside vendors. When profit centers of accompany by from and sell to one another, 2 decisions must be made periodically for each product that is being produced by one business unit and sold to another: 5. Should the company produce the product inside the company or purchase it form and outside vendor? This is the sourcing decision. 6. If produced inside, at what price should the product be transferred between profit centers? This is the transfer price decision. Transfer price systems can range from the very simple to the extremely complex, depending on the nature of the business. Ideal situation A transfer price will induce goal congruence if all the conditions listed below exist. 1. 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 process 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 transferredthat is, a market price reflecting the same conditions (quantity, delivery time, and the like) as the product to which the transfer price applies. The market price may be adjusted downward to reflect savings accruing to the selling unit form dealing inside the company. Freedom to source: alternatives should exist, and managers should be permitted to choose the alternative that is in their own best interest. The buying manger should be free to buy from the outside, and the selling manger should be free to sell outside. If the selling profit center can sell all of its products, either to insiders or to outsiders, and as long as the buying center can obtain all of its requirements form either outsiders or insiders, this method is optimum. The market price represents the opportunity cost to the seller of selling the product inside. Form a company point of view, therefore, the relevant cost of the product is the market price because that is the amount of cash that has been forgone by selling inside. The transfer price



represents the opportunity cost to the company. Full flow of information: managers must know the available alternatives and the relevant costs and revenues of each. Negotiation: there must be a smoothly working mechanism for negotiating contracts between business units.

If all the above conditions are present, a transfer price system based on market prices would fulfill all of the objectives stated above, with no need for central administration. Less than ideal conditions 1. Constraints on sourcing: ideally the buying manager should be given freedom to make sourcing decisions if the profit centre is to operate in an entrepreneurial manner. Similarly, the selling manager should be free to sell products in the most advantageous market. However, in real life, freedom to source either might not be feasible or, even if it is feasible, might be constrained by corporate policy. 2. Limited markets: in many companies, markets for the buying or selling profit centers may be limited. There are several reasons for this. i) ii) the existence of internal capacity might limit the development of external sale if a company has made significant investment in facilities, it is unlikely to use outside source even though outside capacity exists, unless

the outside selling price approaches the companys variable cost, which is not usual. iii) If a company is the sole producer of a differentiated product, no outside capacity exists. Even in the case of limited markets, the transfer price that best satisfies the requirement of a profit centre is the competitive price. How does a company find out what the competitive price is, if it does not buy or sell the product in an outside market? The ways are: a)if published market prices are available, they can be used to establish transfer prices. b)Market prices may be set by bids c) If the production profit centre sells similar products in outside markets, it is of tern possible to replicate a competitive price on the basis of the outside price d)If the buying profit centre purchases similar products from the outside market, it may be possible to replicate competitive prices for its proprietary products In some companies, given the option, buying profit centres prefer to deal with an outside source for the following reasons: i) service: outside sources may be perceived to provide better service ii) Internal rivalry that sometimes exists in divisionalized companies. For whatever reason, management should be aware of the strong political overtones that sometimes occur in transfer price negotiations. There is no guarantee that a profit center will

voluntarily buy from the inside source when excess capacity exists. Thus, even if there are constraints on sourcing, the market price is the best transfer price. If the market price exists or can be approximated, use it. However, if there is no way of approximating valid competitive prices, the other option is to develop cost-based transfer prices. Methods of transfer pricing the methods of transfer pricing can be divided into 4 categories: a)market based pricing b)cost based pricing c) negotiated pricing d)opportunity cost transfer pricing 1. Market based transfer pricing Where a market exists outside the firm for the intermediate product and where the market is competitive (i.e. the firm is a price taker) then the use of market price as the transfer price between divisions would generally lead to optimal decision making. Such a price would meet al of the objectives of a transfer price i.e. - achieve goal congruence - realistic performance evaluation - maintain autonomy of the divisions Where significant external buying and selling costs exist then a transfer may be set somewhat lower than market price to reflect the cost savings from internal transfers. The circumstances may lead to

negotiated market prices where the total cost savings are apportioned between the buying and selling divisions. In such circumstances an arbitration procedure may be required but too much central intervention of this nature could undermine the autonomy of the divisions. Where appropriate market price exists then their use represents a feasible ideal. However the following difficulties may arise in applying the concept: a)no market for the intermediate product or service being considered b)Though market exists, difficulty in obtaining a competitive price. (price is only strictly comparable when all features are identicalquality, delivery, finish, and so on. c) Market exists but is not perfectly competitive i.e . the market is affected by the pricing decision of divisional managers. d)Market prices that are available may be considered unrepresentative eg. there may be considerable excess capacity in the intermediate market that current quotations are well below long run average price. In such circumstances eth use of either the current, abnormally low price or the long run normal price may lead to sub-optimal decision making on the part of the supplying divisional management or to loss of motivation and autonomy of the purchasing division. Adjusted market price: inter-divisional transfers in most situations cannot replicate a competitive market situation. A division may have the advantage or disadvantage of being a captive

buyer or captive supplier. Capacities may be related which are different from the economically competitive capacities to take advantage of the synergies of integration or to remove the uncertainties attached with the supply of critical items by outside parties, etc. these and many other factors may be considered while fixing the transfer prices. They will thus justify the setting of transfer prices based on adjusted market price. The extent of adjustment to market price will still have to be decided. 2. Cost based pricing Cost based transfer pricing systems are commonly used because the conditions for setting ideal market prices frequently do not exist; eg. there may be no intermediate market or the market which does exist may be imperfect. Providing that the required information is available, a decision rule that would lead to optimal decisions for the firm as a whole, would be to transfer at marginal cost up to the point of transfer, plus any opportunity cost to the firm as a whole. Limitations: i) Even assuming that variable outlay costs as conventionally recorded in accounting systems, are a reasonable approximation of economic marginal costs the imposition of such a rule would undermine the concept of profit centres in that the profitability of divisions required to transfer at marginal cost could not be appraised and ii) The autonomy of divisions would be affected.

iii) The cost may include inefficiencies of the selling division which would thus be passed on to the buying division. Accordingly, standard cost, rather than actual costs should be used as the basis of the transfer price in order not to burden the buying department with the inefficiencies of the supplying department. The 2 main cost derived methods are those based on full cost and variable cost. I) full cost transfer pricing this method, and the variant which is full costs plus a profit markup, has the disadvantage that suboptimal decision making may occur particularly when there is idle capacity within the firm. The full cost (or cost plus) is likely to be treated by the buying division as an input variable cost so that external selling price decisions , if based on cost may not be set at levels which are optimal as far as the firm as a whole is concerned. Limitations of full cost transfer pricing a)The calculated cost is only accurate at one level of output. b)The validity of any pricing decision base on past costs is questionable c) When transfers are made at full cost plus a profit markup the selling division is automatically given a certain level of profit rendering genuine performance appraisal difficult

d)When the selling division is inefficient or working at low volume the costs may be unacceptably high as far as the buying division is concerned. II) Variable cost transfer pricing Here transfers are made at the (standard) variable costs up to the point of transfer. Assuming that the variable cost is a good approximation of economic marginal cost then this system would enable decisions to be made which would be in the interest of the firm as a whole. However, variable cost based prices will result in a loss for the selling division so performance appraisal becomes meaning less and motivation will be reduced. Sub-optimal decision making may be minimized by the following: (1.) Two step pricing: a transfer price is established that includes 2 charges: i) a charge is made for each unit sold that is equal to the standard variable cost of production. ii) a periodic (usually monthly) charge is made that is equal to the fixed costs associated with the facilities reserved for the buying unit. One or both of these components should include a profit margin. (2.) Profit sharing: a profit sharing system might be used to ensure congruence of business unit interest with company interest. This operates as follows: I) the product is transferred to the marketing unit at standard variable cost.

II) After the product is sold, the business units share the contribution earned, which is the selling price minus the variable manufacturing and marketing costs. This method of pricing may be appropriate if the demand for the manufactured product is not steady enough to warrant the permanent assignment of facilities, as in the 2-step method. In general, this method accomplishes the purpose of making the marketing units interest congruent with the companys. This dual transfer price approach has an apparent fairness in that credit for profits earned and shared between divisions but performance appraisal based on arbitrarily apportioned profit shares has obvious shortcomings and administrative difficulties.

The problems in implementing a profit sharing system are: i) There can be arguments over the way contribution is divided between the two profit centers. Senior management might have to intervene to settle these disputes which is costly, time consuming, and works against a basic reason for decentralization, namely, autonomy of business unit managers ii) Arbitrarily dividing up the profits between units does not give valid information on the profitability of each segment of the organization. Since the contribution is not allocated until after the sale has been made, the manufacturing units contribution depends on the marketing units ability

to sell and on the actual selling price. Manufacturing units may perceive this situation to be unfair. a variable cost based transfer price so that and, as a separate exercise, credit the supply division with a share of the overall profit which eventually results from the transferred item. 3. Negotiated transfer pricing Transfer price could be set by negotiation between the buying and selling divisions. This would be appropriate if it can be assumed that such negotiations would result in decisions which were in the interest of the firm as a whole and which were acceptable to the parties concerned. A company could establish a formal mechanism whereby representatives from the buying and selling units meet periodically to decide on outside selling prices and on the sharing of profits for products having significant amounts of upstream fixed costs and profit. This mechanism is workable only if the review process is limited to decisions that involve a significant amount of business to at least one of the profit centers; otherwise, the value of these negotiations may not be worth the effort. Limitations of negotiated transfer pricing 1.its unlikely that the parties concerned have equal bargaining power 2.protracted negotiations may be time consuming and divert mgt energies away from their primary tasks 3.Disagreements which are all too likely, will require some form of arbitration by central mgt which

itself undermines the autonomy of divisions and may cause resentment. It must be remembered that the objectives of divisionalisation is to enhance the overall efficiency of the organisation so that care must be taken not to nullify any benefits through inter-divisional wrangling over transfer prices. 4.opportunity cost transfer pricing In several cases there are situations where the pricing of inter-divisional transfers based on market price or its variants becomes difficult because of the lack of existence of reasonable market for such intermediates. This may also be the case where the supplier division is a monopoly producer or the user division is a monopoly consumer. In such circumstances the transfer price is set by the central mgt. an ideal option for the central mgt will be to set the price at a level which equals the opportunity cost of the supplier division and the user division. Both divisions under these circumstances will be encouraged to produce and consume that quantity which is optimal from the point of view of the company as a whole. If the user division fails to provide adequate orders from the supply division the amount of contribution in respect of the production foregone due to lack of orders should be charged from such division.

BUDGET A budget is a plan expressed in quantitative, usually monetary term, covering a specific period of time, usually one year. In other words a budget is a systematic plan for the utilization of manpower and material resources. In a business organization, a budget represents an estimate of future costs and revenues. Budgets may be divided into two basic classes: Capital Budgets and Operating Budgets. Capital budgets are directed towards proposed expenditures for new projects and often require special financing. The operating budgets are directed towards achieving short-term operational goals of the organization, for instance, production or profit goals in a business firm. Operating budgets may be sub-divided into various departmental of functional budgets. The main characteristics of a budget are: 1. It is prepared in advance and is derived from the long-term strategy of the organization. 2. It relates to future period for which objectives or goals have already been laid down. It is expressed in quantitative form, physical or monetary units, or both. Different types of budgets are prepared for different purposed e.g. Sales Budget, Production Budget, Administrative Expense Budget, Raw-material Budget etc. All these sectional budgets are

afterwards integrated into a master budget, which represents an overall plan of the organization. ADVANTAGES OF BUDGETS A budget helps us in the following ways: 1. It brings about efficiency and improvement in the working of the organization. 2. It is a way of communicating the plans to various units of the organization. By establishing the divisional, departmental, sectional budgets, exact responsibilities are assigned. It thus minimizes the possibilities of buck passing if the budget figures are not met. 3. It is a way or motivating managers to achieve the goals set for the units. 4. It serves as a benchmark for controlling on-going operations. 5. It helps in developing a team spirit where participation in budgeting is encouraged. 6. It helps in reducing wastage and losses by revealing them in time for corrective action. 7. It serves as a basis performance of managers. for evaluating the

8. It serves as a means of educating the managers. BUDGETARY CONTROL No system of planning can be successful without having an effective and efficient system of control.

Budgeting is closely connected with control. The exercise of control in the organization with the help of budgets is known as budgetary control. The process of budgetary control includes: 1. Preparation of various budgets. 2. Continuous comparison of actual performance with budgetary performance. 3. Revision of budgets in the light of changed circumstances. A system of budgetary control should not become rigid. There should be enough scope of flexibility to provide for individual initiative and drive. Budgetary control is an important device for making the organization. More efficient on all fronts. It is an important tool for controlling costs and achieving the overall objectives. INSTALLING SYSTEM A BUDGETARY CONTROL

Having understood the meaning and significance of budgetary control in an organization, it will be useful for you to know how a budgetary control system can be installed in the organization. This requires, first of all, finding answers to the following questions in the context of an organization: What is likely to happen? What can the objectives to be achieved? What are the constraints and to what extent their effects can be minimized? Having found answers to the above questions, the

following steps may be taken for installing an effective system of budgetary control in an organization. Organization for Budgeting: The setting up of a definite plan of organization is the first step towards installing budgetary control system in an organization a budget manual should be prepared giving details of the powers, duties, responsibilities and areas of operation of each executive in the organization. 1. Budget Manual: "A document which setout, inter alias, the responsibilities of the persons engaged in, the routine of, and the forms and records required for, budgetary control." 2. Web for obtaining the necessary approval of budgets, the authority of granting approval should be stated in explicit terms. Whether one, two or more signatures are to be required on each document should also be clearly stated. 3. Timetable for all stages of budgeting. 4. Reports, statements, forms and other records to be maintained. 5. The accounts classification to be employed. It is necessary that the framework within which the costs, revenues and other financial amount are classified must be identical both in accounts and the budget department.

There are many advantages attached to the use of budget manual. It is a formal record defining the functions and responsibilities of each executive. The methods and procedures of budgetary control are standardized. There is synchronization of the efforts of all which result in maximization of the profits of the organization. The responsibility for preparation and implementation of the budgets may be fixed as under: Budget Controller Although the chief executive is finally responsible for the budget programme, it is better if a large part of the supervisory responsibility is delegated to an official designated as Budget Controller or Budget Director. Such a person should have knowledge of the technical details of the business and should report directly to the president or the Chief Executive of the organization. Fixation of the budget period Budget period mean the period for which a budget is prepared and employed. The budget period depends upon the nature of the business and the control techniques. For example, a seasonal industry will budget for each season while an industry requiring long periods to complete work will budget for four, five or even larger number of year. However, it is necessary of control purposes to prepare budgets both for long as well as short periods.

Budget Procedures Having established the budget organization and fixed the budget period, the actual work or budgetary control can be taken upon the following pattern: STEPS IN BUDGETARY CONTROL 1. Organization 2. Budget manual + Theory for budgeting

"A document which sets out, inter alias, the responsibilities of the persons engaged in, the routine of and forms and records required for budgetary control." The budget manual is a written document or booklet that specifies the objectives of budgeting organization and procedures. Following are some of the important matters covered in a budget manual: 1. A statement regarding the objectives of the organization and how they can be achieved through budgetary control. 2. A statement regarding the functions and responsibilities of each Executive by designation both regarding preparation and execution of budgets. 3. Procedures to be followed for obtaining the necessary approval of budgets. 4. The authority of granting approval should be stated in explicit terms. 5. Whether one, two or more signatures are to be required on each document 6. Should also be clearly stated.

7. Timetable for all stages of budgeting. 8. Reports, statements, forms and other records to be maintained. 9. The accounts classification to be employed. It is necessary that the framework within which the costs, revenues and other financial amount are classified must be identical both in accounts and the budget departments. There are many advantages attached to the use of budget manual. It is a formal record defining the functions and responsibilities of each executive. The methods and procedures of budgetary control are standardized. There is synchronization of the efforts of all which result in maximization of the profits of the organization. Making a forecast Consideration of alternative combination of forecasts: Alternative combinations of forecasts are considered with a view to contain the most efficient overall plan so as to maximize profits. When the optimum -profit combination of forecasts is selected, the forecasts should be regarded as being finalized. Sales budget Past sales figures and trend. The record of previous experience forms the most reliable guide as to future sales as the past performance is related to actual business conditions. However the other factors such

as seasonal fluctuations, growth of market, trade cycles etc., should not be lost sight of salesmen's estimates. Salesmen are in a position to estimate the potential demand of the customers more accurately because they come in direct contact with the customers. However, proper discount should be made for over-optimistic or too conservative estimates of the salesmen depending upon their temperament. Plant Capacity. It should be the endeavor of the business to ensure proper utilization of plant facilities and that the sale budget provides an economic and balanced production on the factory. General trade prospects. The general trade prospects considerable affect the sales. Valuable information can be gathered in this connection from trade papers and magazines. Orders on hand. In case of industries where production is quite a lengthy process, orders on hand also have a considerable influence in the amount of sales. Proposed expansion of discontinuance of products. It is affects sales and therefore, it should also be considered. Seasonal fluctuations. Past experience will be the best guide in this respect. However, efforts should be made to minimize the effects of seasonal fluctuations by giving special concessions or off-season discounts thus increasing the volume of sales.

Potential market. Market research should be carried out for ascertaining the potential market, for the company's products. Such an estimate on the basis of expected population growth, purchasing power of consumers and buying habits of the people. Availability of material and supply. Adequate supply of raw materials and other supplies must be ensured before drafting the sales programme. Financial aspect. Expansion of sales usually require increase in capital outlay also, therefore, sales budget must be kept within the bounds of financial capacity. Other factors: a. The nature and degree of competition within the industry; b. Cost of distributing goods; c. Governments controls, rules and regulations related to the industry; d. Political situation - national and international as it may have an influence upon the market. The sales manager, after taking into consideration all these factors, will prepare the sales budget in terms if quantities and money, distinguishing between products, periods and areas of sale.

TYPES OF BUDGETS -The following are the main types of budgets :

Lump Sum Typically, lump sum budgeting involves the allocation by the librarys parent organizations upper-level management of a lump sum of budget resources to the library. Since the lump sum method lacks specific ties to corporate goals and objectives, many library managers prefer other types of budgets. However, lumpsum budgets can be perceived as representing a high-level of flexibility and control within the library itself. Once the lump-

sum is allocated, the library management proceeds with lowerlevel allocations among library programs and services. Formula Budget When a special library is funded through the formula budget, the budget allocation is typically tied to a numeric value such as full-time-equivalencies (FTEs), i.e., number of FTEs registered students multiplied by a fixed dollar amount yields the budget for the library. This method is fraught with weaknesses; primarily, the budget total is calculated at a late point in time and intrudes on

advance planning especially for purchases and staffing increases within the library. Another weakness results from the formula budgets lack of identification with the parent organizations goals and objectives. Another weakness emanates from the unpredictable nature of the budget since the formula is based on variables outside the influence or control of the special library. Line-Item Budget The line-item budget represents the most commonly used budgeting method for special libraries (Warner 9). In a line-item budget, each category of activity is afforded its separate appearance. Line-item budgets facilitate low levels of detail for both planning and cost control purposes. Often, the accounting function of the parent organization develops accounts and subaccounts on a company-wide basis. In that case, the library uses the company accounting scheme. Among the advantages of line-item budgets are ease of preparation, use as detailed planning vehicle and utility as a means

of comparing performance from one fiscal period to another fiscal period. Warner provides a model to illustrate the simplicity and utility of the line-item budget: LINE-ITEM BUDGET Last year This year Salaries Materials Etc. Etc. Miscellaneous TOTAL Next year

Problems identified by Warner include the difficulty of relating the line budget to the goals of the parent organization, the line-item budgets propensity for perpetuating a line, i.e., once a line, always a line, the tendency of the Miscellaneous line to grow unwieldy as technologies and their costs evolve, and the reality that comparing this year to last year is more complex and represents variables unaccounted for within the line-item budget (Warner 10).

Program Budget By its nature, a program budget focuses on the services the library provides to its clients. Therefore, the program budget more readily relates to overall organizational goals and objectives. Its attractiveness is further enhanced by its usefulness when establishing priority for library programs relative to the parent organization. The program budget development is typically an extension of the line-item budget development method. Robinson and Robinson explain that each program in the program budget appears separately and is broken out in categories similar to the line-item budget (Robinson and Robinson 426). following model: PROGRAM BUDGET Program #1 Salaries Materials Etc. Etc. Miscellaneous TOTALS Program #2 Program #3 TOTALS Warner provides the

100% As the model demonstrates, the program budget facilitates

comparative analyses among the librarys multiple programs. Others maintain that a program budget produces a document that is easily understood and demonstrates a willingness to make best use of limited resources by minimizing conflict and overlap among projects (Asantewa 15). A disadvantage associated with the program budget emerges when the adoption of the program budget method forces special library staff members to think along program lines in contrast to the comfort-zone associated with previous budgeting methods. Warner notes that some people can become defensive when required to analyze, report and justify how they spend their time. Performance Budget Performance budgets share characteristics with program budgets, but performance budgets focus primarily on what library staff members do or what functions they perform in the librarys

service complement. Tasks rather than programs are highlighted. Among the functions displayed within a performance budget are technical services (i.e., cataloging, materials processing); planning (budgeting, automation, employee selection, interviewing,

development; patron contact (circulation desk, email & telephone contacts). Warner provides this model for the Performance Budget or Function Budget: PERFORMANCE BUDGET, FUNCTION BUDGET Function Function Function TOTALS #1 #2 #3 Salaries Materials Etc. Etc. Miscellaneous TOTALS % 100% Warner identifies the performance budgets strength as providing an instrument for monitoring staff members and for developing unit costs. The primary disadvantage associated with

performance budgets is the emphasis on quantity, not quality, of the activity being monitored . Zero-Based Budget Zero-based budgeting shifts the emphasis from comparing present performance and/or programs to the past or to the current activity. Rather, zero-based budgeting requires that a clean slate be the starting point for budget development. Therefore, the emphasis is on what will happen in the future that corresponds to the goals and objectives of the parent organization. This from scratch approach is viewed as an appropriate instrument to rank library programs by cost/importance to organizational goals and to identify and eliminate programs that provide minimal value-added (Zach 22)Once the value enhancing activities are identified, then the attendant costs are developed. Accompanying zero-based budgeting is the concept of decision packages, a method used to examine each proposed program and rank its merits vis a vis the parent organizations goals and objectives. Once the top-ranking

programs are identified, a program budget model is typically used to construct the resource details. Advantages associated with zero-based budgeting include its focus on identifying programs that will further the companys goals for the future. Reliance on the way weve always done things violates the basic premise of zero-based budgeting. Most zero-based budgeting advocates maintain that the method promotes innovation, effectiveness and efficiency. The downside of zero-based budgeting relates to its timeconsuming nature. Starting at zero implies that all aspects of the librarys operation will undergo examination and justification. Most special libraries indicate that zero-based budgeting also intrudes on day-to-day operational activities such as journal subscription renewals and standing orders Sales budget - Whether you sell widgets or washing machines, your sales budget is ground zero for the rest of your operating budget. Overestimate your sales budget, and youll likely spend too much money. If you underestimate your sales budget, youll risk losing customers to insufficient inventories or

poor customer service. Either way, your company will have problems. Production budget - The cost of generating or producing the goods and services you offer are included in your production budget. That usually means raw materials, payroll, equipment and overhead expenses. The latter is the cost of things not directly associated with the development of your product or service - items such as rent, utilities, insurance, marketing, and accounting expenses. In other words, if you brew beer, your production budget for beer should include brewing ingredients, packaging materials, your brewery staffs salary and benefits, the cost of the bottles youll keep the beer in, and other related items. Operating expenses budget - Operating expenses are really an offshoot of your production budget. It includes the items in your production budget and breaks them down by department-human resources, advertising and marketing, research and development, manufacturing, sales, and so on. The larger your company gets, the more the need for a good operating expenses budget. Budgeting income statement - Your budgeting income statement is comprised of your sales, production, and operating expenses budget. You cant complete your budget income statement until you have those budgets in order. Your income statement enables you to check your revenues and expenses to ensure you have enough money to keep going. Cash budget - If you take your companys income earned and subtract your expenses, the number you have left is your cash. In other words,

this is the difference between writing those bottomline numbers in black ink or red. Your cash budget will help you figure out what to do with the cash you have in hand. To go back to that brewery analogy, you may use the money to research a new brand of ale, hire a master brewer to make it, or hire a public relations agency to tout it at local restaurants and bars. Cash can also be squirreled away for unexpected needs. And every business has unexpected needs. Work the income/outflow pipeline to your advantage when youre building your business budget. For money owed to your firm, insist on payment as quickly as possible. Thirty days is obviously more preferable to 60 or 90 days. Every time you extend payment terms, youre costing your company money. Conversely, for money you owe, hang on the payment for as long as possible to retain control over your companys finances. Electronic banking is a great way to control your outgoing business expenditures on the timeline that works best for you. The operating budget the municipalitys operating budget lists the planned operating expenditure (costs) and income, for the delivery of all services to the community. Operating expenditure is the cost of goods and services from which there will be short-term benefit - that is, the services will be used up in less than one year. For example, the payment of staff salaries results in a short-term benefit as salaried employees are paid monthly for one month's work. They could resign, next month, and the municipality would not have the benefit of their skills anymore. Examples of operating costs are

salaries, wages, repairs and maintenance, telephones, petrol, stationery. Operating income is the amount received for services delivered for a short-term period. For example, ratepayers pay rates monthly or annually as payment to their municipality for receiving municipal services. Examples of operating income are property rates, service charges, investment interest, and traffic fines. The capital budget - The capital budget puts money aside, for planned expenditure on long-term purchases and big investments such as land, buildings, motor vehicles, equipment and office furniture that will be a municipal asset for more than a year - probably for many years to come. A municipality's capital budget will list the estimated costs of all items of a capital nature such as the construction of roads, buildings and purchase of vehicles that are planned in that budget year. The difference between the operating and capital budgets A useful way for to look at the difference between operating and capital expenditure is to think about the purchase of a car. The purchase of a car is capital as the expected life of the motor vehicle is much more than one year. The cost of fuel and repairs only provide short-term benefit (less than a year) and therefore is operating expenditure. The capital budget and operating budget have to be prepared and discussed together. This is important because planned expenditure that is included in the

municipalitys capital budget will impact on the operating costs and income needed to "operate" the municipalitys assets, efficiently. This link between capital and operating budgets can be explained by using the car example again. If you decide to buy a car, in addition to including funds for this in your capital budget, you are going to have to include money in the operating budget for tyres, drivers wages, petrol, service and other operating expenses. The increase in operating expenditure needs to be considered when making a decision on whether or not to buy a new car. If fuel, tyres, repairs and wages costs cannot be included in the operating budget because of insufficient funds to pay for them, then the municipality should not buy the car! Behavioral aspects of budgets One of the purposes of a management control system is to encourage the manager to be effective and efficient in attaining the goals of the organization. Some motivational considerations in the preparation of operating budgets are described below: 1. Participation in the budgetary process Budget processes are either top down or bottom up. 1. Top down budgeting: With top down budgeting, senior management sets the budget for the lower levels. The top down approach rarely works, however. It leads to a lack of commitment on the part of budgetees; this endangers the plans success.

2. bottom up budgeting: With bottom up budgeting, lower-level managers participate in setting the budget targets. Bottom up budgeting is most likely to generate commitment to meeting the budgeted objectives; however, unless carefully controlled, it may result in objectives that are too easy or in objectives that may not match the companys over-all objectives. Actually, an effective budget preparation process blends the 2 approaches. Budgetees prepare the first draft of the budget for their area of responsibility which is bottom up; but they do so within guidelines established at higher levels, which is top down. Senior managers review and critique these proposed budgets. Research has shown that budget participation (i.e., a process in which the budgetee is both involved in and has influence over the setting of budget amounts) has positive effects on managerial motivation for 2 reasons: I) There is likely to be greater acceptance of budget goals if they are perceived as being under personal control, rather than being imposed externally. This leads to higher personal commitment to achieve the goals. II) Participative budgeting results in effective information exchanges. The approved budget amounts benefit form the expertise and personal knowledge of the budgetees, who are closest to the product/market environment. Further, budgetees, have a clearer understanding of their

jobs through interactions with superiors during the review and approval phase. Participative budgeting is especially beneficial for responsibility centers operating in uncertain environments because managers in charge of such responsibility centers are likely to have the best information regarding the variables that affect their revenues and expenses.

2. Degree of budget target difficulty The ideal budget is one that is challenging but attainable. There are several reason why senior management approves achievable budgets for business units: If the budgeted target is too difficult, managers are motivated to take short-term actions that may not be in the long-term interests of the company. Attainable profit targets are a way of minimizing these dysfunctional actions. Achievable budget targets reduce the motivation for managers to engage in data manipulation (e.g. inadequate provision for warranty claims, bad debts, inventory obsolescence, and the like) to meet the budget. If business unit profit budgets represent achievable targets, senior management can, in turn, divulge a profit target to security analysts, shareholders, and other external constituencies with a reasonable expectation of being correct. A profit budget that is very difficult to attain usually implies an overly optimistic sales target.

This may lead to an over commitment of resources to gear up for the higher sales activity. It is administratively and politically awkward to downsize operations. If the actual sales levels do not reach the optimistic targets. When business unit managers are able to meet and exceed their targets, there is a winning atmosphere and positive attitude within the company. Limitation: the business unit managers may not put forth satisfactory effort once the budget is met. This may be overcome by providing bonus payments for actual performance that exceeds the budget. 3. Senior management involvement This is necessary for any budget system to be effective in motivating budgetees. Management must participate in the review and approval of the budgets otherwise some managers will submit easily attained budgets or budgets that contain excessive allowances for possible contingencies. Management must also follow up on budget results. If there is no top management feedback, with respect to budget results, the budget system will not be effective in motivating the budgetee. 4. The budget department It has a particularly difficult behavioral problem. It must analyze the budgets in detail, and it must be certain that budgets are prepared properly and that the information is accurate. To accomplish these tasks, the budget department sometimes must act in ways that line managers

perceive as threatening or hostile eg. ensuring that the budget does not contain excessive allowances or disclosing the fact that the explanation of budget variances provided by the budgetee hide or minimize a potentially serious situation. To perform their function effectively, the members of the budget department must have a reputation for impartiality and fairness. If they do not have his reputation, it becomes difficult, if not impossible, for them to perform the tasks necessary to maintain an effective budgetary control system. The members of the budget department should, of course, also have the personal skills required to deal effectively with people.

ANALYSIS OF VARIANCES The object of standard costing is to exercise cost control and cost reduction. The performance targets with actual performance will enable a control system. The management by exception is possible under standard costing. Cost reduction is possible through the efficiency in use of material and labour. The deviations between standard costs, profits or sales and actual costs, profits or sales respectively will be known as variances. The variances may be favourable and unfavourable. If actual cost is less than the standard cost and actual profit and sales are more than

the standard profits and sales, the variances will be favourable. On the contrary if actual cost is more than the standard cost and actual profit and sales are less than the standard profit and sales, the variances will be unfavourable. The variances are related to efficiency. If variances are favourable, it will show efficiency and if variances are unfavourable it will show inefficiency. The variances may be categorized as controllable and uncontrollable. If a variance can be regarded as a responsibility of a particular person it will be known as controllable variance. In case the variances are not in the control of persons then these will be called uncontrollable variances. fixing responsibility. How To Calculate Variance : Estimate to Planned. This is the difference between what we quoted and how we actually planned to do the work. I look at what has changed and why. It may be that there are new processes, vendors, materials, technology, laws, etc. If the variances are significant, I search for alternatives before work commences whenever possible. If alternatives are not possible, then I learn from the situation and communicate what not to do for subsequent work. You may wonder why there is a difference between planned and estimated. This is A distinction between controllable and uncontrollable variances will be essential for

due to situations where projects are quoted based on best guesses and black magic. In other words, the quote is created without formal detailed planning often by a group who will not actually do the work. As you can imagine, it is advantageous to keep the quoting and planning teams in synch over time. Planned to Actual. This variance looks at the difference between how work is planned and how it actually is executed. By comparing planned to actual, we can see how the work changed once in progress. There may be changes brought on by the project team, by the customer, by vendors or by a change in the environment, such as new regulations. Regardless, the changes need to be analyzed so issues can be identified and mitigation strategies can be developed to protect future work. Estimate to Actual. Here, we compare what we quoted to what we actually did. This is a crucial comparison. If jobs are estimated in a manner that operations cannot support, then there are substantial risks including profit losses and even project failures. Again, by analyzing the numbers, we can determine what changed, why and then take corrective action. For subsequent work, we may need to change vendors, processes, materials, contractual stipulations, etc. Alternatively, unplanned customer change requests may be fully billable, in which case we need to identify those changes as such and invoice accordingly. It is very important to point out that some of the most financially successful groups I have worked with are very adept at writing detailed quotes, assembling solid plans and then capturing customer change requests and billing for them. Why do we do this?

In short, we want to do variance analysis in order to learn. One of the easiest and most objective ways to see that things need to change is to watch the financials and ask questions. Don't get me wrong: You cannot and should not base important decisions solely on financial data. You must use the data as a basis to understand areas for further analysis. For example, if a bandsaw is a bottleneck, then go to the department and ask why. The reasons for the variance may range from the normal operator being out sick, to a worn blade, to there not being enough crewing and a great deal of overtime being incurred. Use the numbers to highlight areas to investigate, but do not make decisions without first investigating further.

CLASSIFICATION OF VARIANCES 1. Direct Material Variances 2. Direct Labour Variances 3. Overheads Cost Variances 4. Sales or profit Variances. 1. Direct Material Variances
Material Cost Variance

Material Price Variance Material Mix Variance

Material Usage Variance Material Yield Variance

(a)Material Cost Variance (b) Material Price Variance (c)Material Usage Variance (d) Material Mix Variance (e)Material Yield Variance. Material Cost Variance = Material Price Variance + Material Usage Variance Material Usage Variance = Material Mix Variance + Material Yield Variance Material Cost Variance = Material Price Variance + Material Mix Variance + Material Yield Variance

1. Material Cost Variance = Standard Material Cost Actual Material Cost 2. Material Price Variance = Actual Quantiy (Standard price Actual price) 3.Material Usage Variance = Standard Price (Standard Quantity Actual Quantity)

4. Material Mix Variance. I. When Actual Weight and Standard Weight of Mix are Equal In this case the formula for calculating mix variance is: Standard cost of standard mix Standard cost of actual mix. (Standard Price Standard Quantity) (Standard Price Actual Quantity) or
Standard unit cost (Standard Quantity Actual Quantity). In case standard quantity is revised due to shortage of one material, the formula will be: Standard unit cost (Revised Standard Quantity).

II. When Actual Wright and Standard Weight of Mix are Different

When quantities of actual material mix and standard material mix are different, the formula will be:
Total Weight of Actual mix Standard Cost of Standard mix Total Weight of Standard mix - Standard cost of actual mix)

In case the standard is revised due to the shortage of one material then revised standard will be used instead of standard, the formula will become:

Total Weight of Actual mix Standard cost of revised Standard mix -(Standard cost of Actual mix) Total Weight of revised Standard mix

(a)Materials Yield Variance. Material Yield variance is calculated with the following formula: Standard Rate (Actual Yield Standard yield)
Standard Cost of Standard mix Standard Rate = Net Standard output i.e., Gross output Standard loss

2. DIRECT LABOUR VARIANCES Labour Variance can be discussed as follows: (a) Labour Cost Variance (b)Labour Rate of Pay or Wage Rate Variance (c) Labour Efficiency or Labour Time Variance (d)Idle Time Variance (e) Labour mix or Gang Composition Variance

Labour Cost Variance = Standard Labour Cost Actual Labour Cost = Standard time Standard Wage Rate) (Actual time Actual Wage Rate)

Labour Rate of Pay Variance = Actual time (Standard Rate Actual Rate)

Labour Efficiency variance = Standard Wage Rate (Standard Time Actual Time)

Idle Time Variance Idle Hours Standard Rate

(e) Labour Mix or Gang Composition Variance:

(a)When standard and actual times of the labour mix are same. In this case the variance is calculated as follows: Labour Mix Variance = Standard Cost of Standard Labour Mix Standard Cost of Actual Labour Mix. Due to the non-availability of one grade of labour, there may be a change in standard labour mix, then revised standard will be used for standard mix. The formula will be:

Labour Mix Variance = Standard cost of Revised Standard Labour Mix Standard Cost of Actual Labour Mix.

(ii) When Standard and actual time of Labour mix are different: In this case the variance will be calculated as follows:
Total Time of Actual Labour Mix Total Time of Standard Labour Mix Standard cost of Standard Labour Mix - (Standard Cost of Actual Labour Mix

As in the earlier case, if labour composition is revised because of non-availability of one grade of labour then revised standard mix will be used instead mix and the formula will become:

Total Time of Actual Labour Mix Standard cost of Revised Labour Mix Total Time of Standard Labour Mix

- (Standard Cost of Actual Labour Mix


4. SALES VARIANCE A:BASED ON SALES MARGIN a) TSMV - SM-AM b)SMQV - (S prop. For Asale*Bud. Q )* SP c) SMPV -(SMPU-AMPU ) *AQ d) SMVol. V (Bud. Units Aq. Units )*SM PU e)SM Mix V (Aq.*ST. Prop. Of Ac.. Sale )*SP

B BASED ON SALES VALUE (SV) a) SVV -Bud.S-Aq. S b) SPV - (AP-SP )* Aq. c) S Vol. V (STQ of s-Aq. of S )*St P d) SQV- Bud.Sales Rev st S e) SMV (SM/Rev.Mof AQ Sold AM )*St. P

PERFORMANCE ANALYSIS AND MEASUREMENT Performance measurement systems These have the goal of strategy implementation. In setting up a PMS, senior management selects a series of measures that best represent the companys strategy. These measures can be seen as current and future critical success factors. If these factors are improved, then the company has implemented its strategy. The success of the strategy depends on the strategy itself. A PMS is simply a mechanism for improving the likelihood of the organization successfully implementing a strategy.

Analysis of financial performance occupies an important place in the duty profile of a manager. The purpose of such analysis is to identify the strong and weak points of business organizations and to make appropriate strategies and plans to keep the business organisation in good position. The performance of business can be measured by comparing actual financial performance compared with budgeted financial performance. This is one type of performance measurement. But financial performance although important, is only one aspect of what an organizations performance is. Financial measures of corporate success, profit and revenue show the results of past decisions the company has taken. Because businesses have been using profit and revenue measures for a long time, these measures have become quite sophisticated. Over the past few years, though, there has been an increasing demand for measuring non-financial results with the same level of sophistication. As a result many companies are turning to PMS as a way to link strategy to action. Even in the past, companies had used financial and non-financial measures. However companies tended to use non financial measures usually at lower levels in the organization for task control, and used financial measures at higher organizational levels for management control. An objective PMS uses a blend of financial and non financial measurements at all levels in the organization. An example of a performance measurement system is the balanced scorecard approach.

The Balanced Scorecard The balanced scorecard is and example of a performance measurement system. It fosters a balance between otherwise disparate strategic measures in an effort to achieve goal congruence, thus encouraging employees to act in the best interest of the organization. It is a tool for focusing the organization, improving communication, setting organizational objectives, and providing feedback on strategy. Every measure on a balanced scorecard addresses and aspect of a companys strategy. In creating the balanced scorecard, executives must choose a set of me What is the Balanced Scorecard? In 1992, Robert S. Kaplan and David Norton introduced the balanced scorecard (BSC), a concept for measuring a company's activities in terms of its vision and strategies, to give managers a comprehensive view of the performance of a business. The key new element is focusing not only on financial outcomes but also on the human issues that drive those outcomes, so that organizations focus on the future and act in their long-term best interest. The strategic management system forces managers to focus on the important performance metrics that drive success. It balances a financial perspective with customer, process, and employee

perspectives. Measures are often indicators of future performance. Implementing the scorecard typically includes four processes: 1. Translating the vision into operational goals; 2. Communicate the vision and link it to individual performance; 3. Business planning; 4. Feedback and learning and adjusting the strategy accordingly

The balanced scorecard is a management system (not only a measurement system) that enables organizations to clarify their vision and strategy and translate them into action. It provides feedback around both the internal business processes and external outcomes in order to continuously improve strategic performance and results. When fully deployed, the balanced scorecard transforms strategic planning from an academic exercise into the nerve center of an enterprise. Kaplan and Norton describe the innovation of the balanced scorecard as follows: "The balanced scorecard retains traditional financial measures. But financial measures tell the story of past events, an adequate story for industrial age companies for which investments in long-term capabilities and customer relationships were not

critical for success. These financial measures are inadequate, however, for guiding and evaluating the journey that information age companies must make to create future value through investment in customers, suppliers, employees, processes, technology, and innovation." A Comprehensive Performance View of Business

Balanced Scorecard is a method and a tool which includes:

a strategy map where strategic objectives are placed over four perspectives in order to clarify the strategy and the cause and effect relationships that exists among them. strategic objectives which are smaller parts of the strategy interlinked by cause and effect relationships in the strategy map. measures directly reflecting strategy. Their prime purpose is to measure that the desired change or development defined by strategic objectives actually takes place. strategic initiatives that constitute the actual change as described by strategic objectives

The balanced scorecard suggests that we view the organization from four perspectives, and to develop metrics, collect data and analyze it relative to each

of these perspectives. The scorecard drives implementation of strategy using perspectives which generally include: 1. The Learning and Growth Perspective 2. The Business Process Perspective 3. The Customer Perspective 4. The Financial Perspective

1. The Learning and Growth Perspective Learning and Growth Perspective refers to measures describing the company's learning curve -for example, number of employee suggestions or total hours spent on staff training.

This perspective includes employee training and corporate cultural attitudes related to both individual and corporate self-improvement. In a knowledgeworker organization, people -- the only repository of knowledge -- are the main resource. In the current climate of rapid technological change, it is becoming necessary for knowledge workers to be in a continuous learning mode. Government agencies often find themselves unable to hire new technical workers, and at the same time there is a decline in training of existing employees. This is a leading indicator of 'brain drain' that must be reversed. Metrics can be put into place to guide managers in focusing training funds where they can help the most. In any case, learning and growth constitute the essential foundation for success of any knowledge-worker organization. Kaplan and Norton emphasize that 'learning' is more than 'training'; it also includes things like mentors and tutors within the organization, as well as that ease of communication among workers that allows them to readily get help on a problem when it is needed. It also includes technological tools; what the Baldrige criteria call "high performance work systems." One of these, the Intranet 2. The Business Process Perspective Business Process Perspective refers to measures reflecting the performance of key business processes, for example the time spent prospecting, number of units that required rework or process cost.

This perspective refers to internal business processes. Metrics based on this perspective allow the managers to know how well their business is running, and whether its products and services conform to customer requirements (the mission). These metrics have to be carefully designed by those who know these processes most intimately; with our unique missions these are not something that can be developed by outside consultants. In addition to the strategic management process, two kinds of business processes may be identified: a) mission-oriented processes, and b) support processes. Mission-oriented processes are the special functions of government offices, and many unique problems are encountered in these processes. The support processes are more repetitive in nature and hence easier to measure and benchmark using generic metrics. 3. The Customer Perspective Customer Perspective refers to measures having a direct impact on customers, for example time taken to process a phone call, results of customer surveys, number of complaints or competitive rankings. Recent management philosophy has shown an increasing realization of the importance of customer focus and customer satisfaction in any business. These are leading indicators: if customers are not satisfied, they will eventually find other suppliers that will meet their needs. Poor performance from this perspective is thus a leading indicator of future

decline, even though the current financial picture may look good. In developing metrics for satisfaction, customers should be analyzed in terms of kinds of customers and the kinds of processes for which we are providing a product or service to those customer groups. 4. The Financial Perspective Financial Perspective refers to measures reflecting financial performance, for example number of debtors, cash flow or return on investment. The financial performance of an organization is fundamental to its success. Even non-profit organizations must make the books balance. Financial figures suffer from two major drawbacks:

They are historical. Whilst they tell us what has happened to the organization they may not tell us what is currently happening, or be a good indicator of future performance. It is common for the current market value of an organization to exceed the market value of its assets. Tobin's-q measures the ratio of the value of a company's assets to its market value. The excess value can be thought of as intangible assets. These figures are not measured by normal financial reporting.

Kaplan and Norton do not disregard the traditional need for financial data. Timely and accurate funding data will always be a priority, and managers will do whatever necessary to provide it. In fact, often there is more than enough handling and processing of financial data. With the implementation of a corporate database, it is hoped that more of the processing can be centralized and automated. But the point is that the current emphasis on financials leads to the "unbalanced" situation with regard to other perspectives. There is perhaps a need to include additional financial-related data, such as risk assessment and cost-benefit data, in this category. Specific measures are chosen based on the organization's goals. Typically organizations "get what they measure" so care in creating measures and revisiting the measures regularly is recommended by most practitioners. The method helps separate creation of strategy from strategy implementation, which can push power downwards while making the leaders' jobs easier. It can also help detect correlation between activities. For example, the process objective of implementing a new telephone system can help the customer objective of reducing response time to telephone calls, leading to increased sales from repeat business.


Balanced Scorecard Based Management



The balanced scorecard methodology builds on some key concepts of previous management ideas such as Total Quality Management (TQM), including customer-defined quality, continuous improvement, employee empowerment, and -- primarily -measurement-based management and feedback. Double-Loop Feedback In traditional industrial activity, "quality control" and "zero defects" were the watchwords. In order to shield the customer from receiving poor quality products, aggressive efforts were focused on inspection and testing at the end of the production line. The problem with this approach -- as pointed out by Deming -- is that the true causes of defects could never be identified, and there would always be inefficiencies due to the rejection of defects. What Deming saw was that variation is created at every step in a production process, and the causes of variation need to be identified and fixed. If this can be done, then there is a way to reduce the defects and improve product quality indefinitely. To establish such a process, Deming emphasized that all business processes should be part of a system with feedback loops. The feedback data should be examined by

managers to determine the causes of variation, what are the processes with significant problems, and then they can focus attention on fixing that subset of processes. The balanced scorecard incorporates feedback around internal business process outputs, as in TQM, but also adds a feedback loop around the outcomes of business strategies. This creates a "double-loop feedback" process in the balanced scorecard.

Outcome Metrics You can't improve what you can't measure. So metrics must be developed based on the priorities of the strategic plan, which provides the key business drivers and criteria for metrics that managers most desire to watch. Processes are then designed to collect information relevant to these metrics and reduce it to numerical form for storage, display, and analysis. Decision makers examine the outcomes of various measured processes and strategies and track the results to guide the company and provide feedback. So the value of metrics is in their ability to provide a factual basis for defining:

Strategic feedback to show the present status of the organization from many perspectives for decision makers

Diagnostic feedback into various processes to guide improvements on a continuous basis Trends in performance over time as the metrics are tracked Feedback around the measurement methods themselves, and which metrics should be tracked Quantitative inputs to forecasting methods and models for decision support systems

Management by Fact The goal of making measurements is to permit managers to see their company more clearly -- from many perspectives -- and hence to make wiser longterm decisions. The Baldrige Criteria (1997) booklet reiterates this concept of fact-based management: "Modern businesses depend upon measurement and analysis of performance. Measurements must derive from the company's strategy and provide critical data and information about key processes, outputs and results. Data and information needed for performance measurement and improvement are of many types, including: customer, product and service performance, operations, market, competitive comparisons, supplier, employeerelated, and cost and financial. Analysis entails using data to determine trends, projections, and cause and effect -- that might not be evident without analysis. Data and analysis support a variety of company purposes, such as planning, reviewing company performance, improving operations, and comparing

company performance with competitors' or with 'best practices' benchmarks." "A major consideration in performance improvement involves the creation and use of performance measures or indicators. Performance measures or indicators are measurable characteristics of products, services, processes, and operations the company uses to track and improve performance. The measures or indicators should be selected to best represent the factors that lead to improved customer, operational, and financial performance. A comprehensive set of measures or indicators tied to customer and/or company performance requirements represents a clear basis for aligning all activities with the company's goals. Through the analysis of data from the tracking processes, the measures or indicators themselves may be evaluated and changed to better support such goals."

Actual Usage of the Balanced Scorecard Kaplan and Norton found that companies are using the scorecard to:

Clarify and update budgets Identify and align strategic initiatives Conduct periodic performance reviews to learn about and improve strategy

In 1997, Kurtzman found that 64% of the companies questioned were measuring performance from a

number of perspectives in a similar way to the balanced scorecard. Balanced scorecards have been implemented by government agencies, military units, corporate units and corporations as a whole, nonprofits, and schools; many sample scorecards can be found via Web searches, though adapting one organization's scorecard to another is generally not advised by theorists, who believe that much of the benefit of the scorecard comes from the implementation method.

Return on Investment

Definition: Return on Investment (abbreviated ROI) is a measure of a company's ability to use its assets to generate additional value for shareholders. It is calculated as Net Profit divided by Net Worth, and expressed as a percentage. Examples: Our target for this fiscal year is to increase our Return on our Investment to 37%. A performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments. To calculate ROI, the benefit (return) of an investment is divided by the cost of the investment; the result is expressed as a percentage or a ratio.

Return on investment is a very popular metric because of its versatility and simplicity. That is, if an investment does not have have a positive ROI, or if there are other opportunities with a higher ROI, then the investment should be not be undertaken. Keep in mind that the calculation for return on investment can be modified to suit the situation -it all depends on what you include as returns and costs. The term in the broadest sense just attempts to measure the profitability of an investment and, as such, there is no one "right" calculation. For example, a marketer may compare two different products by dividing the revenue that each product has generated by its respective expenses. A financial analyst, however, may compare the same two products using an entirely different ROI calculation, perhaps by dividing the net income of an investment by the total value of all resources that have been employed to make and sell the product. This flexibility has a downside, as ROI calculations can be easily manipulated to suit the user's purposes, and the result can be expressed in many different ways. When using this metric, make sure you understand what inputs are being used.

The degree to which Return On Investment (ROI) overstates the economic value depends on at least 5 factors: 1. length of project life (the longer, the bigger the overstatement)

2. capitalization policy (the smaller the fraction of total investment capitalized in the books, the greater will be the overstatement) 3. The rate at which depreciation is taken on the books (depreciation rates faster than straight-line basis will result in a higher ROI) 4. The lag between investment outlays and the recoupment of these outlays from cash inflows (the greater the time lag, the greater the degree of overstatement) 5. the growth rate of new investment (faster growing companies will have lower Return On Investment )

Economic Value Added (EVA) is often defined as the value of an activity that is left over after subtracting from it the cost of executing that activity and the cost of having lost the opportunity of investing consumed resources in an alternative activity. In business terms, one could calculate EVA as Income from Operations - rate of interest in sovereign debt, if sovereign debt can be considered an alternative opportunity to invest working capital and equity. The concept of economic profits is closely linked to EVA. However, Economic Profit is not adjusted. The underlying concept was first introduced by Eugen Schmalenbach, and the current theory was formulated by Joel M. Stern.

Calculating EVA In the field of corporate finance, economic value added is a way to determine the value created, above the required return, for the shareholders of a company.

The basic formula is:

where , called the return on capital employed (ROCE) is the firm's return on capital, NOPAT is the Net Operating Profit After Tax, c is the Weighted Average Cost of Capital (WACC) and K is capital employed. Shareholders of the company will receive a positive value added when the return from the equity employed in the business operations is greater than the cost of that capital.

Management control in service organisations

The type of control which would be suitable for a particular firm depends upon the nature and complexities of its operations. A suitable control system has to be designed to suit the specific requirements of a particular firm. Service organisations are those organisations that provide intangible services. Service organisations include hotels, restaurants, and other lodging and eating establishments; barbershops, beauty parlors and other personal service; repair services; motion picture, television and other amusement and recreation services; legal services; and accounting, engineering, research/development, architecture and other professional service organisations. Characteristics of service organisations 1. Absence of inventory: services cannot be stored. If the services available today are not sold today, the revenue from these services is lost forever. In addition the resources available for sale in many service organisations are essentially fixed in the short run. A key variable in most service organisations therefore is the extent to which current capacity is matched with demand. Organisations attempt this matching in 2 ways: i) They try to stimulate demand in off-peak periods by marketing efforts and price concessions. Airlines and resort hotels offer



low rates in off-seasons; utilities offer low rates on slack periods during a day. ii) if feasible, they adjust the size of the work force to the anticipated demand, by such measures as scheduling training activities in slack periods and compensating for long hours in busy periods with time off later. Labour intensive: service organisations tend to be labour intensive. It is difficult to control the work of a labour-intensive organisation than that of an operation whose workflow is paced or dominated by machinery. Manufacturing companies add equipment and automate production lines that replace labour and reduce costs. Most service companies cannot do this. Hospitals do add expensive equipment; but most of these provide better treatment, and they increase, rather than reduce costs. Quantity measurement: it is not easy to measure the quantity of many services. For many services, the amount rendered can be measured only in the crudest terms, if at all it can be measured. Quality measurement: the quality of a service cannot be inspected in advance (as in the case of tangible goods). At best, it can be inspected during the time that the service is being rendered to the client. Judgments as to the adequacy of the quality of most services are subjective; measuring instruments and objective quality standards do not exist. A public accounting firm can measure the number of hours spent on an audit, but not the


thoroughness of the work done during those hours.


Historical development: cost accounting started in manufacturing companies because of the necessity for valuing work-in-process and finished goods inventories for financial statement purposes. These amounts provided raw data that was easily adapted to use, first for setting selling process and then for other management problems. Standard cost systems, the separation of fixed and variable costs, and the analysis of variances and the foundation of actual cost systems, and the fact that managers in manufacturing companies were accustomed to using cost information facilitated the general adoption of these techniques. Until the last few decades, most books on cost accounting and related subjects dealt only with manufacturing companies. Size: with some notable exceptions, service organisations are relatively small and operate in a single location. Top management in such organisations can personally observe what is going on and personally motivate employees. Thus, there is less need for a sophisticated management control system, with profit centres and heavy reliance on formal reports of performance. (Nevertheless, even a small organisation needs a budget, a regular comparison of actual performance against a budget, and the other essential ingredients of a management control system.



multi unit organizations: some service organizations operate many units in different locations, each of which is relatively small. These include fast food restaurant chains, auto rental companies, gasoline service stations, and many others. Some of the units are owned; others operate under a franchise. The similarity of these separate units provides a basis for analyzing budgets and evaluating performance that is not present in the usual manufacturing company. The information for each unit can be compared with system wide or regional averages, and high performers and low performers can be identified. Because units differ in the mix of services they provide, in the resources that they use, and in other ways, care must be taken in making such comparisons.

Implications for Management Control System in service organisations There are some differences between management control system in service organisations and those in manufacturing organisations. There are differences in degree, rather than in kind, however. The essential features are the same in both types of organisations. In both, planning is done in terms of programs and responsibility centers, including profit centers and investment centers for organisation units that meet the criteria. The management control process in both organisations involves the steps of programming, budgeting, the measurement of performance, and the appraisal of that performance.

Because of their relatively recent development, systems currently found in service organisations tend to be less advanced than those in manufacturing organisations. Because of the difficulty of measuring both the quantity and the quality of output, judgments about both the efficiency and the effectiveness of performance are more subjective than is the case when output consists of physical goods, which means that there is more room for legitimate differences of opinion about performance. Managers are coming to recognize that performance is not easy to measure; this suggests that a search for better tools for improving its measurement is likely to be eminently worthwhile.

Modern control methods

JIT TQM DSS Just in time (JIT) Just in time mcs tries to ensure that there are no zero inventories, and goods are produced or ordered only when they are needed. Hence the name, justin-time. In actual practice zero inventories may not be possible but the term JUST-IN-TIME states the direction in which lot size should be headed. Just In Time (JIT) is an inventory strategy implemented to improve the return on investment by reducing in-process inventory and its associated costs. The process is driven by a series of signals, or Kanban that tell production processes to make the next part. Kanban are usually simple visual signals, such as the presence or absence of a part on a shelf. When implemented correctly, JUST-IN-TIME can lead to dramatic improvements in a manufacturing organization's return on investment, quality, and efficiency. New stock is ordered when stock reaches the reorder level. This saves warehouse space and costs. Drawback of the just-in-time system: The reorder level is determined by historical demand. If demand rises above the historical average planning

duration demand, the firm could deplete inventory and cause customer service issues. To meet a 95% service rate a firm must carry about 2 standard deviations of demand in safety stock. History The technique was first used by the Ford Motor Company. The technique was subsequently adopted and publicised by Toyota Motor Corporation of Japan as part of its Toyota Production System (TPS).Japanese corporations cannot afford large amounts of land to warehouse finished products and parts. Philosophy The just-in-time inventory system is all about having the right material, at the right time, at the right place, and in the exact amount. The ideas in this philosophy come from many different disciplines including; statistics, industrial engineering, production management and behavioral science. In the just-in-time inventory philosophy there are views with respect to how inventory is looked upon, what it says about the management within the company, and the main principle behind JUST-INTIME. 1. Inventory is seen as incurring costs instead of adding value, contrary to traditional thinking. Under the philosophy, businesses are encouraged to

eliminate inventory that doesnt add value to the product. 2. It sees inventory as a sign of sub par management as it is simply there to hide problems within the production system. These problems include backups at work centres, lack of flexibility for employees and equipment, and inadequate capacity among other things. Salient features of just-in-time 1. Reduce buffer inventory: buffer inventory exists partly because a manufacturing workstation may breakdown and partly due to uncertain supply from suppliers. When these events happen, production in following workstation is disrupted unless there is an inventory on which they can draw. The amount of buffer inventory can be reduced if steps are taken to minimize machine breakdown and improve product quality. The purpose of just-in-time is to ensure that every workstation produces and delivers to the next workstation the right items in the right quantity at the right time; if this purpose is achieved there would be no need for buffer inventory. 2. Decrease Set-up costs: with computer controlled machine tools, set up involves simply inserting a new computer program into a machine. Thus, after the computer program has been created, the cost of setting up for all succeeding lots becomes trivial. 3. Decrease procurement costs: just-in-time also aims at decreasing procurement costs. Traditionally,

procurement involved issuing requests for bids form many vendors, analyzing bids, placing an order with the best (usually the cheapest) vendor, and receiving and inspecting the incoming goods. As per the justin-time philosophy companies now reduce the cost of each of these components by establishing relationships with one or two vendors for each item. 4. Relation with customers: just-in-time also aims at establishing permanent relationships with customers for automatic ordering. Some manufacturers have systems in which their salespersons automatically place orders from retailers or other customers on the basis of preset formulas that determine reorder time and quantities; this reduces the customers ordering costs and also cements a relationship between the customers and the manufacturer. Implications for management control 1. Work-in-process inventory becomes so insignificant that it is disregarded. The only inventories are for raw materials and finished goods. 2. There is reduction in record keeping because job-cost system is transformed into a processcost system with only one cost center elimination of the tedious task of calculating equivalent production, which is necessary to find work-in-process inventory amounts when the inventory consists of partially completed products. 3. a just-in-time system focuses management attention on time in addition to the traditional focus

on cost. a reduction in cycle time can lead to a reduction in cost. Effects 1. A huge amount of cash released as in-process inventory is built out and sold. 2. The response time of the factory falls, resulting in improved customer satisfaction. 3. Products may be built to order; completely eliminating the risk they will not be sold. This dramatically improves the company's return on equity by eliminating a major source of risk. 4. Dramatic improvement in product quality 5. In the commercial sector, it eliminates one or all of the warehouses in the link between a factory and a retail establishment.



Set up times are significantly reduced in the warehouse. Cutting down the set up time to be more productive will allow the company to improve their profits, to look more efficient and focus time spend on other areas that may need improvement. The flows of goods from warehouse to shelves are improved. Having employees

focused on specific areas of the system will allow them to process goods faster instead of having them vulnerable to fatigue from doing too many jobs at once and simplifies the tasks at hand. 3.Employees who possess multi-skills are utilized more 4. 5. efficiently. Having employees trained to work on different parts of the inventory cycle system will allow companies to use workers in situations where they are needed when there is a shortage of workers and a high demand for a particular product. 6. Better consistency of scheduling and consistency of employee work hours. If there is no demand for a product at the time, workers dont have to be working. This can save the company money by not having to pay workers for a job not completed or could have them focus on other jobs around the warehouse that would not necessarily be done on a normal day. 7. Increased emphasis on supplier relationships. No company wants a break in their inventory system that would create a shortage of supplies while not having inventory sit on shelves. Having a trusting supplier relationship means that you can rely on goods being there when you need them in order to satisfy the company and keep the company name in good standing with the public. 8. Supplies continue around the clock keeping workers productive and businesses focused

on turnover. Having management focused on meeting deadlines will make employees work hard to meet the company goals to see benefits in terms of job satisfaction, promotion or even higher pay. Problems

1. The major problem with Just In Time operation is that it leaves the supplier and downstream consumers open to supply shocks. 2. just-in-time requires a business to resupply frequently instead of holding excess stocks. In practice JIT works well for many businesses, but it is not appropriate if ordering cost per order is not small. 3.Any delay in delivery means that additional 'safety stocks' need to be held if a stock out is to be rendered very unlikely.

Total Quality Management Total Quality Management management strategy aimed at em (TQM) is a

bedding awareness of quality in all organizational processes.

TQM has been widely used in manufacturing, education, government, and service industries, as well as NASA space and science programs. Total Quality provides an umbrella under which everyone in the organization can strive and create customer satisfaction. TQ is a people focused management system that aims at continual increase in customer satisfaction at continually lower real costs. Definition As defined by ISO: "TQM is a management approach for an organization, centered on quality, based on the participation of all its members and aiming at long-term success through customer satisfaction, and benefits to all members of the organization and to society." In Japanese, TQM comprises four process steps, namely:



Kaizen Focuses on Continuous Process Improvement, to make processes visible, repeatable and measurable. Atarimae Hinshitsu The idea that things will work as they are supposed to (e.g. a pen will write.). KanseiKansei Examining the way the user applies the product

4. leads to improvement in the product itself. 5. Miryokuteki Hinshitsu The idea that things should have an aesthetic quality which is different from "atarimae hinshitsu" (e.g. a pen will write in a way that is pleasing to the writer.) TQM requires that the company maintain this quality standard in all aspects of its business. This requires ensuring that things are done right the first time and that defects and waste are eliminated from operations. Origins "Total Quality Control" was the key concept of Armand Feigenbaums 1951 book, Quality Control: Principles, Practice, and Administration, a book that was subsequently released in 1961 under the title, Total Quality Control . Joseph Juran, Philip B. Crosby, and Kaoru Ishikawa also contributed to the body of knowledge now known as TQM. The American Society for Quality says that the term Total Quality Management was first used by the U.S. Naval Air Systems Command "to describe its Japanese-style management approach to quality improvement." TQM approach can be summarized below under three headings: responsibility for quality, product design, and relation with suppliers. 1.Responsibility for quality

The traditional view was that quality problems start on the factory floor, that workers were primarily responsible for poor quality, and that the best way to control quality, therefore, was to inspect quality into the final product. This required a large quality control department. The total quality control view is that responsibility for quality should be shared by everyone in the organization; in fact most of the problems arise before the product reaches the factory floor. Under total quality management, the philosophy is to build quality into the product rather than inspect quality of the product. Errors in design, raw material procurement, and so on should be detected at the source. Workers should be held responsible for their own work and should not pass a defective unit on to the next work station; thus, the worke rs are their own inspectors. Instead of inspecting product quality at the end of production, the quality control staff should monitor the production process and enable workers to make the product right the first time.

Product design: studies have shown that many quality problems originate with the design or the product. Some designers pay inadequate attention to the manufacturability of the product. Others include pars that are unique to the product, whereas pars that are common to several products would be satisfactory and are available at lower cost; or they design more separate parts than are necessary, which gives

inadequate recognition to the cost involved in setting up machines for each part. Under total quality control, there has been an effort to have the designers work closely with production engineers who are familiar with the manufacturing problems.

Designing for manufacturability is one aspect of design. The other aspect of design is designing for marketablility, that is, the quality of a product should be what the customer wants, not more. Thus there should be close cooperation between designers and marketing people.

Relation with suppliers: total quality management involves a change in the traditional relationship with suppliers. Instead of awarding contracts to several suppliers, based primarily on which one bid the lowest price, there are only one or two suppliers for a given item; they are selected on the basis of quality and on-time delivery as well as on, price. Long term relationships are established with them.

Implications for management control Companies collect non-financial information about quality, including the number of defective units delivered by each supplier, number and frequency of late deliveries, number of parts in a product, percentage of common versus unique parts in a product, percentage yields, first-pass yields (i.e.

percentage of units furnished without rework), scrap, rework, machine breakdowns, number and frequency of times that production and delivery schedules were not met, number of employee suggestions, number of customer complaints, level of customer satisfaction (obtained by questionnaire surveys), warranty claims, field service expenses, number and frequency of product returns, and so on. There are 2 major advantages with these nonfinancial measures: (1) most of them can be reported almost on a daily basis, and (2) Corrective actions can be taken almost immediately. Thus reporting performance on non-financial measures is essential to provide continuous feedback to managers and workers in their pursuit for better quality

Decision support system Decision support systems are a class of computerbased information systems including knowledge

based systems activities.





A DSS is a computerized system for helping make decisions.

A decision is a choice between alternatives based on estimates of the values of those alternatives. Supporting a decision means helping people working alone or in a group gather intelligence, generate alternatives and make choices. Supporting the choice making process involves supporting the estimation, the evaluation and/or the comparison of alternatives. In practice, references to DSS are usually references to computer applications that perform such a supporting role. Decision support systems are end-user computing systems. Decision support systems tend to be used in planning, modeling, analyzing alternatives and decision making. They generally operate through terminals operated by the user who interacts with the computer system. Decision support systems are especially useful for semi-structured proble

ms where problem solving is improved by interaction between the manager and the computer system. The emphasis is on small, simple models which can easily be understood and used by the manager rather than complex integrated systems which need information specialists to operate them.


Finlay (1994) and others define a DSS rather broadly as "a computer-based system that aids the process of decision making" Turban (1995) defines it more specifically as "an interactive, flexible, and adaptable computer-based information system, especially developed for supporting the solution of a nonstructured management problem for improved decision making. It utilizes data, provides an easy-to-use interface, and allows for the decision maker's own insights." Keen and Scott Morton (1978), "DSS are computer-based support for management decision makers who are dealing with semistructured problems" Sprague and Carlson (1982), DSS are "interactive computer-based systems that help decision makers utilize data and models to solve unstructured problems." Power (1997), the term decision support system remains a useful and inclusive term for

many types of information systems that support decision making. A brief history According to Keen and Scott Morton (1978), the concept of decision support has evolved from two main areas of research: 1. The theoretical studies of organizational decision making done at the Carnegie Institute of Technology during the late 1950s and early 1960s, and 2. The technical work on interactive computer systems mainly carried out at the Massachusetts Institute of Technology in the 1960s.

Characteristics of decision support systems 1. a user with unstructured or semi structured problems 2. one or more corporate databases 3. one or more user data bases 4. a set of quantitative models stored in a model base 5. a dialogue capability a primary ingredient in a decision support system is the users ability to simulate a business situation

over and over using different parameters and solution values i.e. to perform what- if analysis. Decision support systems

Computer data base

Online terminal

Dialogue system using a planning language

User data base

DSS model base

Criteria for application of decision support system 1. there should be a large database 2. There should be large amount of computation or data manipulation required. 3. complex inter-relationships

4. Analysis by stages- where the problem is an iterative one with stages for re-examination and re-assessment. 5. judgment required 6. communication- where several people are involved in the problem solving process, each contributing some special expertise, then the coordinating power of the computer can be of assistance

Thus, decision support systems are inappropriate for unstructured problems and unnecessary for completely structured problems because these can be dealt with wholly by the computer and man/machine interaction is unnecessary; In outline decision support system require a database, the software to handle the database and decision support programme including, for example, modeling, spread sheet and analysis packages, expert systems and so on. Implications for management control DSSs may reduce the need for certain types of managers- that is, thy may convert management control activities into task control activities. They may also permit managers to spend a larger fraction of their time on other problems. A DSS is a double-edged sword insofar as its use is concerned:

1. It can increase the quality of decisions and reduce (or, in some cases, eliminate) the time required to make them. 2. They permit many types of decisions to be made by the computer or by lower level personnel and thus, reduce the level of expertise required and, in some cases eliminate jobs entirely.

Decision support systems belong to an environment with multidisciplinary foundations, including (but not exclusively) database research, artificial intelligence, human-computer interaction, simulation methods, software engineering, and telecommunications. Httenschwiler (1999) differentiates active, and cooperative DSS.


A passive DSS is a system that aids the process of decision making, but that cannot bring out explicit decision suggestions or solutions. An active DSS can bring out such decision suggestions or solutions. A cooperative DSS allows the decision maker (or its advisor) to modify, complete, or refine the decision suggestions provided by the system, before sending them back to the system for validation. The system again improves, completes, and refines the suggestions of the

decision maker and sends them back to her for validation. The whole process then starts again, until a consolidated solution is generated. Using the mode of assistance as the criterion, Power (2002) differentiates communication-driven DSS, data-driven DSS, document-driven DSS, knowledgedriven DSS, and model-driven DSS.

A model-driven DSS emphasizes access to and manipulation of a statistical, financial, optimization, or simulation model. Model-driven DSS use data and parameters provided by users to assist decision makers in analyzing a situation; they are not necessarily data intensive. Dicodess is an example of an open source model-driven DSS generator (Gachet 2004). A communication-driven DSS supports more than one person working on a shared task; examples include integrated tools like Microsoft's NetMeeting or Groove (Stanhope 2002). A data-driven DSS or data-oriented DSS emphasizes access to and manipulation of a time series of internal company data and, sometimes, external data. A document-driven DSS manages, retrieves and manipulates unstructured information in a variety of electronic formats. A knowledge-driven DSS provides specialized problem solving expertise stored as facts, rules, procedures, or in similar structures.

Using scope as the criterion, Power (1997) differentiates enterprise-wide DSS and desktop DSS. An enterprise-wide DSS is linked to large data warehouses and serves many managers in the company. A desktop, single-user DSS is a small system that runs on an individual manager's PC. Architectures Sprague and Carlson (1982) fundamental components of DSS: identify three

(a) the database management system (DBMS), the Data Management Component stores information (which can be further subdivided into that derived from an organization's traditional data repositories, from external sources such as the Internet, or from the personal insights and experiences of individual users); (b) the model-base management system (MBMS), the Model Management Component handles representations of events, facts, or situations (using various kinds of models, two examples being optimization models and goalseeking models); and (c) the dialog generation and management system (DGMS). the User Interface Management Component is of course the component that allows a user to interact with the system.

According to Power (2002), DSS has four major components: (a) The user interface, (b) The database, (c) The model and analytical tools, and (d) The DSS architecture and network. Httenschwiler (1999) identifies five components of DSS: (a) Users with different roles or functions in the decision making process (decision maker, advisors, domain experts, system experts, data collectors), (b) A specific and definable decision context, (c) A target system describing the majority of the preferences, (d) a knowledge base made of external data sources, knowledge databases, working databases, data warehouses and meta-databases, mathematical models and methods, procedures, inference and search engines, administrative programs, and reporting systems, and (e) A working environment for the preparation, analysis, and documentation of decision alternatives. Marakas (1999) proposes a architecture made of five distinct parts: generalized

(a) The data management system, (b) The model management system, (c) The knowledge engine, (d) The user interface, and (e) The user(s). Classification of DSS applications Holsapple and Whinston (1996) classify DSS into the following six frameworks: Text-oriented DSS, Database-oriented DSS, Spreadsheet-oriented DSS, Solver-oriented DSS, Rule-oriented DSS, and Compound DSS.

The support given by DSS can be separated into three distinct. interrelated categories (Hackathorn and Keen, 1981): Personal Support, Group Support and Organizational Support. Additionally, the build up of a DSS is also classified into a few characteristics. 1) Inputs: this is used so the DSS can have factors, numbers, and characteristics to analyze. 2) User knowledge and expertise: This allows the system to decide how much it is relied on, and

exactly what inputs must be analyzed with or without the user. 3) Outputs: This is used so the user of the system can analyze the decisions that may be made and then potentially 4) make a decision: This decision making is made by the DSS, however, it is ultimately made by the user in order to decide on which criteria it should use. DSSs which perform selected cognitive decisionmaking functions and are based on artificial intelligence or intelligent agents technologies are called Intelligent Decision Support Systems (IDSS) Applications 1. Clinical decision support system for medical diagnosis. 2. A bank loan officer verifying the credit of a loan applicant. 3. An engineering firm that has bids on several projects and wants to know if they can be competitive with their costs. 4. DSS is extensively used in business and management. Executive dashboards and other business performance software allow faster decision making, identification of negative trends, and better allocation of business resources.

5. in agricultural production, sustainable development.



6. Decrease the incidence of derailments: A specific example concerns the Canadian National Railway system, which tests its equipment on a regular basis using a decision support system. A problem faced by any railroad is worn-out or defective rails, which can result in hundreds of derailments per year. Under a DSS, CN managed to decrease the incidence of derailments at the same time other companies were experiencing an increase. 7. A DSS can be designed to help make decisions on the stock market, or deciding which area or segment to market a product toward.