Questions 1) Explain briefly features of an IDEAL management control system?

What is the concept of free cash flow as applied to an organization? Explain process of computation? What is Balance Scorecard? What is the process of implementation and difficulties in implementation? Girish Engineering ( MCS-2004) Numerical ABC ltd. (MCS-2008) Numerical

2)
3) 4) 5)

1)

Explain briefly features of an IDEAL management control system?

Management control is a process of assuming that resources are obtained and used effectively and efficiently in the accomplishment of the organizations objectives. It is a fundamental necessity for the success of a business and hence from time to time the current performance of the various operations is compared to a predetermined standard or ideal performance and in case of variance remedial measures are adopted to confirm operations to set plan or policy. Some of the features of MANAGEMENT CONTROL SYSTEM are as follows: MET DEF2 PDC2 Total System: MANAGEMENT CONTROL SYSTEM is an overall process of the enterprise which aims to fit together the separate plans for various segments as to assure that each harmonizes with the others and that the aggregate effect of all of them on the whole enterprise is satisfactory. Monetary Standard: MANAGEMENT CONTROL SYSTEM is built around a financial structure and all the resources and outputs are expressed in terms of money. The results of each responsibility centre in respect to production and resources are expressed in terms of a common denominator of money. Definite pattern: It follows a definite pattern and time table. The whole operational activity is regular and rhythmic. It is a continuous process even if the plans are changed in the light of experience or technology. Coordinated System: It is a fully coordinated and integrated system. Emphasis: Management control requires emphasis both on the search for planning as well as control. Both should go hand in hand to achieve the best results. Function of every manager: Manager at every level as to focus towards future operational and accounting data, taking into consideration past performance, present trends and anticipated economic and technological changes. The nature, scope and level of control will be governed by the level of manager exercising it. Existence of goals and plans: MANAGEMENT CONTROL SYSTEM is not possible without predetermined goals and plans. These two provide a link between such future anticipations and actual performance. Forward looking: MANAGEMENT CONTROL SYSTEM is on the basis of evaluation of past performance that the future plans or guidelines can be laid down. Management Control involves managing the overall activity of the enterprise for the future. It prevents deviations in operational goals.

Continuous process: It is a continuous process over the human and material resources. It demands vigilance at
every step. Deciding, planning and regulating the activities of people associated in the common task of attaining the objectives of the organization is the primary aim of MANAGEMENT CONTROL SYSTEM. People oriented: It is the managers, engineers and operators which implement the ideas and objectives of the management. The coordination of the main division of an organization helps in smoother operations and less friction which results in the achievement of the predetermined objectives.

Scope of control MANAGEMENT CONTROL SYSTEM is an important process in which accounting information is used to accomplish the organizations objectives. Therefore the scope of control is very wide which covers a very wide range of management activities. Policies control: Success if a business depends on formulation of sound policies and their proper implementation. Control over organization: It involves designing and organizing the various departments for the smooth running of the business. It attempts to remove the causes of such friction and rationalizes the organizational structure as and when the need arises. Control over personnel: Anything that the business accomplishes is the result of the action of those people who work in the organization. It is the people, and not the figures, that get things done. Control over costs: The cost accountant is responsible to control cost sets, cost standards, labour material and over heads. He makes comparisons of actual cost data with standard cost. Cost control is a delicate task and is supplemented by budgetary control systems.

Control over techniques: It involves the use of best methods and techniques so as to eliminate all wastages in time, energy and material. The task is accomplished by periodic analysis and checking of activities of each department with a view to avoid an eliminate all non-essential motions, functions and methods. Control over capital Expenditure: Capital budget is prepared for the whole concern. Every project is evaluated in terms if the advantage it accrues to the firm. For this purpose capital budgeting, project analysis, study of cost of capital etc are carried out. Overall control: A master plan is prepared for overall control and all the departments of the concern are involved in this procedure.

2) What

the concept of free process of computation?

cash

flow

is

as

applied

to

organization.

Explain

We define net cash flow as net income plus non cash adjustment which typically means net income plus depreciation though that cash flows cannot be maintained over time unless depreciated fixed assets are replaced. So management is not completely free to use its cash flows however it chooses. Therefore we define the term free cash flows. Free cash flow is the cash flow actually available for distribution to investor after the company has made all the investment in fixed assets and working capital necessary to sustain ongoing operation. When we studied income statement in accounting the emphasis was probably on the firms net income, which is accounting profit. However the value of companys operation is determined by the stream of cash flows that the operations will generate now and in the future. To be more specific, the value of operation depends on all the future expected free cash flows, defined as after- tax operating profit minus the amount of new investment in working capital and fixed assets necessary to sustain the business. Therefore the way for managers to make their companies more valuable is to increase their free cash flow. Uses of FCF: 1. Pay interest to debt holders, keeping in mind that the net cost to the company is the after tax interest expense. 2. Repay debt holders, that is, pay off some of debt. 3. Pay dividends to shareholders. 4. Repurchase stock from shareholders. 5. Buy marketable securities or other non operating assets. In practice, most companies combine these five uses in such a way that the net total is equal to FCF. For example, a company might pay interest and dividends, issue new debts, also sell some of its marketable securities. Some of these activities are cash outflows (paying interest and dividends) and some are cash inflows (issuing debt and selling marketable securities), but the net cash flow from these five activities is equal to free cash flows. Computation of free cash flows: Eg: Suppose the company had a 2001 NOPAT of $170.3million and depreciation is only the non cash charge which is $100million then its operating cash flow in 2001 would be NOPAT plus any non cash adjustment on the statement of cash flows. Operating cash flow =NOPAT +depreciation (non cash adjustment) = $17.03 + $100 = $270.3 Company has $1,455million operating assets, at the end of 2000, but $1,800 at the end of 2001.it made a net investment in operating assets of Net investment in operating assets = $18, 00 - $1,455 = $345million

If net fixed assets rose from $870million to $1000million however company reported So its gross investment in fixed assets would be Gross investment = net investment + depreciation = $130 + $100 = $230million Company free cash flows in 2001 was FCF = operating cash flow gross investment in operating assets = $270.3 - $445 = - $174.7million An algebraically equivalent equation is FCF = NOPAT - Net investment in operating assets = $170.3- $345 = - $174.7million

$100million of depreciation.

Even though company had a positive NOPAT, its very high investment in operating assets resulted in a negative free cash flow. Because free cash flow is what is available for distribution to investor, not only was there nothing for investors, but investor actually had to provide additional money to keep the business ongoing. A negative current FCF not necessarily bad provided it is due to the high growth or to support the growth. There is nothing wrong with profitable growth; even it causes negative free cash flow in the short term

3)

What is Balance Scorecard? What is the process of implementation and difficulties in implementation?

The Balanced Scorecard (BSC) is a performance management tool which began as a concept for measuring whether the smaller-scale operational activities of a company are aligned with its larger-scale objectives in terms of vision and strategy. By focusing not only on financial outcomes but also on the operational, marketing and developmental inputs to these, the Balanced Scorecard helps provide a more comprehensive view of a business, which in turn helps organizations act in their best long-term interests. Organizations were encouraged to measurein addition to financial outputswhat influenced such financial outputs. For example, process performance, market share / penetration, long term learning and skills development, and so on. The underlying rationale is that organizations cannot directly influence financial outcomes, as these are "lag" measures, and that the use of financial measures alone to inform the strategic control of the firm is unwise. Organizations should instead also measure those areas where direct management intervention is possible. In so doing, the early versions of the Balanced Scorecard helped organizations achieve a degree of "balance" in selection of performance measures. In practice, early Scorecards achieved this balance by encouraging managers to select measures from three additional categories or perspectives: "Customer," "Internal Business Processes" and "Learning and Growth." The balance 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 learning and growth perspective : To achieve our vision, how will we sustain our ability to change and improve? The business process perspective : To satisfy our shareholders and customers what business processes must we excel at? The customer perspective : To achieve our vision, how should we appear to our customer?

The financial perspective : To succeed financially, how should we appear to our shareholders?

Implementing a Balanced Scorecard We can summarize the implantation of a balanced scorecard in four general steps; 1. Define strategy. 2. Define measure of strategy. 3. Integrate measures into the management system. 4. Review measures and result frequently. Each of these steps is iterative, requiring the participation of senior executive and employees throughout the organization Define Strategy The balance scorecard builds a link between strategy and operational action. As a result it is necessary to begin the process of defining a balanced scorecard by defining the organization goals are explicit and what that targets have been developed. Define Measures of Strategy The next step is to develop measures in support of the articulate strategy. It is imperative that the organization focuses on a few critical measures at this point; otherwise management will be overloaded with measures. Also, it is important that the individual measures be linked with each other in a cause effect manner Integrated Measures into the management system The balanced scorecard must be integrated with the organization formal and informal structure, its culture, and its human resources practice. While the balanced Scorecard gives some means for balancing measures, the measures can still become unbalanced by others system in the organization such as compensation policies that compensate the manager strictly based on financial performance. Review Measures and result Frequently Once the balance scorecard is up and running it must be consistently reviewed by senior management. The organization should be looking for the following How do the outcome measures say the organization is doing? How do the driver measures say the organization is doing? How has the organizations strategy changed since the last review? How has the scorecard measures changed?

The most important aspects of these reviews are as follows; They tell management whether the strategy is being implemented successfully the strategy is working. They show that management is serious about the importance of these measures. They maintain alignment of measure to ever changing strategies. Difficulties in implementing Balanced Scorecard

correctly

and

how

The following problems unless suitably dealt with, could limit the usefulness of the balanced scorecard approach: Poor correlation between nonfinancial measures and result. Fixation on financial result. No mechanism for improvement. No mechanism for improvement. Measures overload. Poor Correlation between Nonfinancial measures and result Simply put there is no guarantee that future profitably will allow targets achievement in any nonfinancial area. This is probably the biggest problem with the balanced scorecard because there is an inherent assumption that future profitability does follow from achieving the scorecard measures, identifying the cause effect relationships among the different measures is easier said than done. This will be a problem with any system that is trying to develop proxy measures for future performance. While this does not mean that the balanced Scorecard should be abandoned it is imp that comp adopting such a system understand that the links between nonfinancial measures and financial performance are still poorly understood.

Fixation on Financial Results As previously discussed not only are most senior managers well trained and very adept with financial measures but they also most keenly feel pressure regarding the financial performance of their comp. Shareholder are vocal and the board of directors often applies pressure on the stakeholders behalf .this pressure often overwhelms the long term uncertain payback of the nonfinancial measures. Non mechanism for Improvement One of the most overlooked pitfalls of the balanced scorecard is that a company cannot achieve Stretch goals if the Company has no mechanism for improvement .Unfortunately achieving many of these goals require complete shifts in the way that business is done yet the company often does not have mechanism to make those shifts . The mechanism available takes additional resource and requires a changed in the company culture. These changes do not happen overnight nor do they respond automatically to a new stretch targets. Inertia often works against the company employees are accustomed to a self limited cycle of setting targets, missing those targets and readjusting the targets to reflect what was actually achieved. Without a method for making improvement, improvements are unlikely to consistently happen no matter how good the stretch goal sound. Measurement overload How many critical measures can one manager track at one time without losing? Unfortunately there is no right answer to this question except it is more than 1 and less than 50. It too few then the manager is ignoring measures that are critical to creating success. If it too many then the manager may risk losing focus and trying to do too many things at once. 4) Girish Engineering (MCS-2004) Numerical Responsibility budgeting was introduced in a medium sized organization Girish Engineering. Monthly report (in part) for an expense centre in factory is: Direct Labour Indirect Labour Total Controllable Costs Department Fixed Costs Allocated Costs All figures in Rs. Lacs Actual Variance 100.13 0.21 (Favourable) 66.34 8.10 (Unfavourable) 168.47 8.50 (Unfavourable) 38.82 -------53.62 --------

Questions: 1. Why no variance is shown in two items? Is this correct approach in performance reporting? 2. Should overhead expenses mentioned above be included in Controllable Costs? Why? Why not? Solution (a): Variances between actual and budgeted departmental fixed costs are obtained simply by subtraction, since these costs are not affected by either the volume of sales or the volume of production. Thats why no variance is shown for departmental fixed costs. Allocated costs are a share of the costs of a resource used by a project, where the same resource is also used by other activities. These are different to the Incurred costs because these costs are not exclusively related to any individual project. However, the cost of the resource still needs to be recovered, and making a fair and reasonable charge to all projects using the resource does this. The key difference between costs and Allocated costs is that the latter will be charged based upon an estimate, rather than actual cash values. Thus as it is charged based upon an estimate the budgeted figure is the same as the actual figure and hence no variances. Solution (b): Overhead Expenses mentioned above should not be included in controllable costs because some costs are uncontrollable like fixed costs. They don't vary with the change in short run managerial decisions and output. And some costs are controllable i.e. they can be managed and changed with the managerial decisions and output. As the above overhead expenses would have certain portion of fixed expenses this is hard to control. So, these should not be a part of controllable cost. 5 ABC ltd. (MCS-2008) Numerical Particulars Division X (Rs.) Division Y (Rs.)

ROI Sales Investment EBIT

28% 100 Lacs 25 lacs 7 Lacs

26% 500 lacs 100 Lacs 26 lacs

Analyze and comment upon performances of both the divisions Solution: Division X ROI Profit Profit margin = = = = = = = = = = = = = = = = = = (Profit / investment)* 100 (28/100)*25lacs 7lacs (Profit/sales)*100 (7/100)*100 7% (Sales/investment)*100 (100/25)*100 4 times (Profit / investment)* 100 (26/100)*100lacs 26lacs (Profit/sales)*100 (26/500)*100 5.2% (Sales/investment)*100 (500/100)*100 5 times

Turnover of investments

Division Y ROI Profit Profit margin

Turnover of investments

Profit margin of X is better than profit margin of division Y. Turnover of investment of division Y is better than Division X. Hence cost management of Division X is better than Division Y.