ASSIGNMENT

Course Code : MS-43

Course Title : Management Control Systems

Assignment No. : MS-43/TMA/SEM-I/2019

Note : Attempt all the questions and submit this assignment on or before 30th April, 2019 to the
coordinator of your study center.

Q1.Explain the concept of Strategy. Discuss the Models which are used for formulating
Business unit Strategies.

Ans:

The word ‘strategy’ has entered in the field of management from the military services where it
refers to apply the forces against an enemy to win a war. The word “strategy” came from the two
Greek words i.e. Stratus (Army) and Agein (to lead). The Greeks felt that the strategy making is one
of the responsibilities of the Army General. This concept today adopted even in the business. Even
around the same time, the Chinese General Sun Dzu who wrote about strategy also suggested that
the strategy making is one of the responsibilities so the leader. One of the earliest definitions of
Strategy is traced to the ancient Greek writer Xenophon who said “Strategy knows the business you
proposed to carry out.” This definition implies that the knowledge of the business as strategy.

In management, the concept of strategy is taken in more broader terms. In simple terms, strategy
means looking at the long-term future to determine what the company wants to become, and
putting in place a plan, how to get there.

Strategy is both art and science. Strategy is an art because it requires imagination, sensitive
thinking, and an capability to visualize the future, and to encourage and connect those who will
apply the strategy. Strategy is science because it requires analytical skills, the ability to organize
and analyze information and take well knowledgeable decisions. Without a strategy, an
organization is meaningless and weak to changes in the business environment. Strategy acts as
some kind of a guidepost for a company’s ongoing development. Strategy provides a direction for
the company and indicates what must be done to survive, grow and be profitable.

The Models which are used for formulating Business unit Strategies

There are three models that can be used as frameworks for developing a business level strategy.
These are: Porter’s generic model, Miles and Snow’s adaptation model” and Product Life Cycle
model.

Porter’s Model:

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According to Michael E. Porter, a Harvard Business School professor who studied the interplay of
forces within the competitive market place, there are three strategies that can be adopted at the
business level.

They are called “generic” strategies because they can be used in a variety of situations, across
diverse industries at various stages of development. These strategies are cost leadership,
differentiation and focus.

(1) Cost leadership strategy:

This strategy seeks to attain lower costs than the competitors by improving upon the efficiency of
production, distribution and other organizational systems. By cutting costs without sacrificing
quality, the managers can beat the competition and thus acquire gains in the market share with
higher profits.

(2) Differentiation:

The second generic strategy is to differentiate a firm’s products or services from those of its
competitors. When customers perceive a product or a service being unique and superior, they are
willing to pay more for it. Managers can differentiate their products on the basis of technology
(Intel micro-chips), customer service (American Express), product design (Sony’s Walkman) and so
on. Such a strategy results in brand loyalty and a larger customer base.

(3) Focus:

Focus strategy involves special attention to a product or a narrow line of products or to the
segment of the market that gives the company a competitive edge. The objective is to better serve
the targeted market through concentration of organizational resources on such a market.

The target market can further be segmented into such dimensions as demographics (age, gender,
education, religion, income, life-cycle stage), lifestyles (similarities in attitudes, interests) or other
dimensions.

This would assist in developing a focus strategy which addresses the needs of these common
groups. For example, Rolls Royce has targeted economic elitists to sell their cars which are most
expensive and a matter of pride to own.

Miles and Snow’s Adaptation Model:

The major premise of this model is that organizations should relate their business-level strategies
to their environment and should meet the challenges of uncertainty and change in the external
environments though adaptation.

There are four such business-level strategies: defender, prospector, analyzer and reactor.

1. The defender strategy:

An organization emphasizes existing products and current market share and then develops a
strategy to defend its domain through pursuing internal efficiencies rather than worrying about
external environment.

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Defenders, like many small local retailers in our community, try to maintain their level of business
through personal relations with customers or otherwise. However, a defender may be unable to
respond to major shifts in the environment, such as the opening of a major national chain store in
the community which could drive the local retailers out of business.

2. The prospector strategy:

A prospector seeks and exploits new product and market opportunities. The strategy involves
pursuing innovation in a dynamic environment in the face of risk but with products for growth. This
gives the prospector a competitive edge. There is always a risk of over extension, high cost of
innovation and low profitability.

3. The analyzer strategy:

It is a combination of defender and prospector strategies so that an organization maintains a firm

base of traditional products and customers while selectively responding to opportunities for
innovation and change. Thus the organization remains flexible to respond to environmental
changes but also maintains stability to profit from a stable environment.

4. The reactor strategy:

This strategy is not proactive in nature and organizations pursuing this strategy are primarily
responding to competitive pressures in order to survive. They lack a set of consistent mechanism
for adaptation and only respond to environmental changes in ad hoc fashion.

Q2.What is Transfer Pricing? Describe the ARM’s Length Principle and its Applications in
detail.

Ans:

Transfer price is the price at which divisions of a company transact with each other, such as the
trade of supplies or labor between departments. Transfer prices are used when individual entities
of a larger multi-entity firm are treated and measured as separately run entities. A transfer price
can also be known as a transfer cost.

A transfer price arises for accounting purposes when different divisions of a multi-entity company
are in charge of their own profits. When divisions are required to transact with each other, a
transfer price is used to determine costs. Transfer prices generally do not differ much from the
market price. If the price does differ, then one of the entities is at a disadvantage and would
ultimately start buying from the market to get a better price.

Regulations on transfer pricing ensure the fairness and accuracy of transfer pricing among related
entities. Regulations enforce an arm’s length transaction rule that states that companies must
establish pricing based on similar transactions done between unrelated parties.

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Transfer pricing is closely monitored within a company’s financial reporting and requires strict
documentation that is included in financial reporting documents for auditors and regulators. This
documentation is closely scrutinized. If inappropriately documented, it can lead to added expenses
for the company in the form of added taxation or restatement fees. These prices are closely checked
for accuracy to ensure that profits are booked appropriately within arm's length pricing methods
and associated taxes are paid accordingly.

Transfer prices are most often used when companies sell goods to divisions in other international
jurisdictions. This type of transfer pricing is common, and a large part of intentional commerce is
actually done within companies as opposed to between unrelated companies.

Transfer pricing can also refer to regulations that governments and tax authorities use for
regulating intercompany transfers. Intercompany transfers done internationally have tax
advantages, which has led regulatory authorities to frown upon using transfer pricing for tax
avoidance. When transfer pricing occurs, companies can book profits of goods and services in a
different country that may have a lower tax rate. In some cases, the transfer of goods and services
from one country to another within an interrelated company transaction can allow a company to
avoid tariffs on goods and services exchanged internationally. The international tax laws are
regulated by the Organisation for Economic Cooperation and Development (OECD), and auditing
firms within each international location audit financial statements accordingly.

The ARM’s Length Principle

The arm's length principle (ALP) is the condition or the fact that the parties to a transaction are
independent and on an equal footing. Such a transaction is known as an "arm's-length transaction".

It is used specifically in contract law to arrange an agreement that will stand up to legal scrutiny,
even though the parties may have shared interests (e.g., employer–employee) or are too closely
related to be seen as completely independent (e.g., the parties have familial ties).

An arm's length relationship is distinguished from a fiduciary relationship, where the parties are
not on an equal footing, but rather, power and information asymmetries exist.

It is also one of the key elements in international taxation as it allows an adequate allocation of
profit taxation rights among countries that conclude double tax conventions, through transfer
pricing, among each other. Transfer pricing and the arm's length principle was one of the focal
points of the Base Erosion and Profit Shifting (BEPS) project developed by the OECD and endorsed
by the G20

The ARM’s Applications

1 Comparable Uncontrolled Price Method (CUP)

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CUP method generally compares the price charged and that of paid for different products of similar
nature. Therefore, it is also required that the different accounts be adjusted so as to accrue from the
International transaction. It is also required to take into account the price in the open market. The
adjusted price is required to be as per the arm’s length price applicable to International transaction.

2 Resale Price Method (RPM)

The Resale Price method requires the product acquired from within the Associated Enterprises.
This resale is generally reduced by the normal gross profit margin and incurred by the seller. The
amount of gross profit margin has to be taken into consideration.

3 Cost Plus Method (CPM)

Cost Plus Method, helps in discovering the transferred or services by an associated enterprise. The
amount should be determined as comparable uncontrolled transactions. The costs are therefore to
be increased by the adjusted profit mark-up, which are to be taken as per the arm’s length property.

4 Profit Split Method (PSM)

Profit Split Method has to be described as per unique tangibles and inter-related multiple
transactions. It is also required to be separately evaluated. For further applying the method, the
combined net transaction is required. The relative contribution has to be considered taking into
account the functions performed, assets employed and the risks which are resumed. The relative
contribution has to be employed in similar circumstances.

5 Transactional Net Margin Method (TNMM)

This method is applied to net profit margin from an International transaction which is applied for
incurred sales, assets employed etc. Also, the net profit margin is to be applied through incurred
sales, assets employed etc. The net profit is to be realized as per the adjustment margin:-

● The uncontrolled transactions and International Transaction; or

● The enterprises should enter into transactions, which should materially affect the opposite
transactions and the open market net profit margin.

Q3.In an Organization of your choice try to find out the type of short term and long term
incentive plans that are being followed by the Organisation. Give a detailed report of your
findings.

Ans:

Latest analysis of compensation for executives at companies in the S&P 100 shows that income
statement-related performance metrics (revenue, operating income) are typical of short-term
incentives (STIs) whereas market-related metrics (total shareholder return, stock price

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appreciation) – relatively rare in STIs – are common in long-term incentives (LTIs). Additionally,
the analysis finds that LTI plans are generally less complex than STI plans at the same companies,
utilizing fewer performance metrics and incorporating fewer special conditions.

“Until recently, specific information about metrics, weightings, and even performance hurdles
associated with incentive plans hasn’t been available broadly,” said Ted Jarvis, Mercer’s Global
Director of Executive Compensation Data, Research, and Publications. “Public corporations are
sharing much more detail about incentives to their senior executives and this newly disclosed data
provides invaluable insight about the way companies design and administer their incentive plans.”

According to Mercer’s analysis, financial metrics are included in the majority of short- and
long-term incentive awards. Non-financial metrics are fairly common in STI programs, but not LTI.
The most common STI metrics are profit-based (36% of organizations use earnings per share; 49%
use other profit measures) followed by revenues (47%). Total shareholder return or stock
appreciation is the most common LTI metric (used by 55% of the S&P 100) followed by return on
assets or return on equity (49%).

“STI and LTI programs need to complement each other,” said Peter Schloth, Principal with Mercer
specializing in executive compensation. “Properly designed LTI programs should motivate
executives to develop strategies and policies to achieve long-term growth and increase the value of
the organization. Effective STI programs should motivate executives to execute on strategies and
policies, and make good operating decisions to maximize performance over the course of a year.”

Many compensation committees opt for income statement-based metrics to assess annual
performance, while long-term awards are more often tied to market returns. “This aligns with
companies’ goals to grow revenue and expand profit margins over the short term and create market
value for their shareholders over the long term,”

Some of the differences are a result of varying philosophies for measuring value creation. “While
total shareholder return and stock appreciation are directly aligned with shareholders, they are
influenced by economic conditions and market perceptions of future performance of the company
outside the control of executives,”. “Executives have a more direct line-of-sight and ability to
influence value creation metrics like return on assets and return on equity, but there is a risk that
performance on these metrics may not directly align with the value shareholders are realizing over
the typical two- or three-year performance period.”

Analysis also finds that more than 90% of STI performance metrics are evaluated against
pre-established goals set by the Compensation Committee. LTI performance metrics are more likely
than STI metrics to be assessed relative to a defined peer group or index. For STI, the majority of
awards (70%) use pre-established targets to evaluate performance. “Effective calibration of goals is
one of the most important and difficult aspects of incentive programs,” said Mr. Schloth. “A holistic
approach should consider the organization’s business plan and financial projections as well as the
expectations of stock analysts and historical performance for both the company and its peers.”

Number of performance metrics

More than 60% of companies in the S&P 100 use three performance metrics or less in their STI
plans, and 90% use three or less in their LTI plans. “Committees are hesitant to micromanage

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executives with a lot of performance measures,”. “Metrics and weightings tend to be identical for
LTI grantees to ensure alignment within the executive team on the same long-term goals. Some
companies take this approach for their STI program, while others tailor metrics and weightings to
account for differences in responsibilities among executives.”

While every organization must manage a multitude of metrics to be successful, care should be taken
in selecting which metrics to base pay decisions on – too many metrics could diminish an
executive’s focus on the most important ones.

Q4.Design a Management Control System for an Organization which is working in the field of
training Local Farmers for Organic Farming.

Ans:

A management control system (MCS) is a system which gathers and uses information to evaluate
the performance of different organizational resources like human, physical, financial and also the
organization as a whole in light of the organizational strategies pursued.

Management control system influences the behavior of organizational resources to implement

organizational strategies. Management control system might be formal or informal.

In contrast to food labelled as "environmentally-friendly", "green" or "free-range", the label

"organic" denotes compliance with specific production and processing methods. Most synthetic
pesticides and fertilizers, and all synthetic preservatives, genetically modified organisms, sewage
sludge and irradiation are prohibited in all existing organic agriculture standards. Adherence to
organic agriculture standards, including consumer protection against fraudulent practices, is
ensured through inspection and certification. Most industrialized countries have regulations
governing food labelled as "organic". Other terms also used are, depending on the language,
"biological" or "ecological".

Organic agriculture principles are consonant with principles of biodynamic agriculture and
permaculture. Started by Rudolf Steiner in 1924, biodynamic agriculture embraces holistic and
spiritual understanding of nature and the farm within it, where the farm is a self-contained evolving
organism which keeps external inputs to a minimum: biodynamic preparations are used and
requirements include, among others, harmony of cultivation with cosmic rhythms, fair trade and
the promotion of associative economic relations between producers, processors, traders and
consumers. Certification requirements of biodynamic agriculture (labelled under the Demeter
International network in Africa, America, Australia and Europe) include many organic standards,
which are recognized under the United Register of Organic Food Standards and governmental
organic aid schemes.

In the late 1970s, the ecologist Bill Mollison developed the concept of "permaculture" as an
interdisciplinary earth science. Permaculture is a landscape and social design system that works to
conserve energy on-farm (e.g. fuel from crop, firewood, food calories) or to generate more energy
than it consumes. Care for natural assemblies (including wilderness), rehabilitation of degraded

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land and local self-reliance are central to permaculture3. Permaculture does not have distinct
certification but this management approach is embraced by organic agriculture.

"Organic agriculture" is not limited to certified organic farms and products but includes all
productive agricultural systems that use natural processes, rather than external inputs, to enhance
agricultural productivity. Organic farmers adopt practices to conserve resources, enhance
biodiversity, and maintain the ecosystem for sustainable production. This practice is often but not
always oriented towards the market for food labelled as organic. Those who seek to label and
market their foods as organic will usually seek certification - almost certainly if they grow to export.
However, many farmers practise organic techniques without seeking or receiving the premium
price given to organic food in some markets. This includes many traditional farming systems found
in developing countries.

Traditional agriculture includes management practices that have evolved through centuries to
create agricultural systems adapted to local environmental and cultural conditions. Owing to their
nature, traditional systems do not use synthetic agricultural inputs. Many, but not all, traditional
systems fully meet the production standards for organic agriculture.

It is important to distinguish certified from non-certified organic agriculture for the purpose of this
study. Agriculture that meets organic production standards, but is not subject to organic inspection,
certification and labelling is referred to as "non-certified organic agriculture" as distinguished from
"certified organic agriculture." While economic and institutional conditions differ, both rely on the
same technology and principles. Although the results might be similar, non-certified organic
agriculture may not always represent a deliberate choice between alternative production systems -
lack of access to purchased inputs may constrain such choice. Whatever the motivation, an organic
farm reflects an intentional management system in which a producer manages resources according
to organic principles. Non-certified organic agriculture therefore includes traditional systems which
do not use chemicals but which apply ecological approaches to enhance agricultural production.

By contrast, some agricultural systems simply do not use purchased inputs (such as mineral
fertilizers or synthetic pesticides) because the farmer cannot afford them nor has access to them.
These systems cannot be considered as organic according to internationally recognized standards.
These systems usually have low, declining productivity. Negligent systems often result in
environmental degradation (e.g. soil erosion) and can create public nuisances that threaten
neighbouring farms as reservoirs for noxious weeds, pests and diseases.

Organic standards require operators to conserve, restore, and enhance natural processes; to work
with nature to protect crops, rather than to submit to or subdue it. Producer's decision-making is
therefore essential to the meaningful differentiation of organic agriculture from systems that do not
use synthetic inputs by neglect. Production by neglect is not considered "organic" for the purpose of
this study, even if the organic standards in some local jurisdictions have not made this distinction.

All agricultural management systems that apply ecological approaches but which make use of some
synthetic inputs and/or genetically modified organisms (e.g. integrated pest management, zero
tillage, conservation agriculture and low-external input sustainable agriculture) are obviously
excluded from the organic category.

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Training Local Farmers for Organic Farming

Organic farmers usually share one thing in common – strong values. The aspiring farmers that come
to the Organic Farm School want to work outdoors and be inspired by their work as much as they
want to serve their communities through healthy food and to help heal the earth. Organic farming is
a respectable career that can fulfill these dreams but only if it’s done with planning and preparation.
It takes much more than a desire to grow food and a willingness to work hard… it also takes
accepting that farms are small businesses and being willing to research, plan and experiment in
finding the right markets, crops, scale and strategies that can bring real sustainability… socially,
ecologically and financially.

The Organic Farm training Area works to prepare you for success, instilling a holistic perspective
on what it takes to successfully start and manage a small-scale (5-20 acre) commercial organic farm
from the field tasks of tillage, planting and harvesting to the office tasks of crop planning, marketing
and financial management. Understanding this spectrum of tasks that farmers engage in helps our
students get a jumpstart on realizing their farming dreams.

Q5.Study the case of ‘Dakshin Rasayan Nigam Limited’ and answer the questions given at the
end of this case.

Q1.How well do budgets help as a total of cost control in the secretarial and legal department
of DRN?

Ans:

The work done by this department consists of scrutiny of contracts entered into by DRN to ensure
that the interest of DRN are fully protected. Also it advises top management of the legal implications
of any changes in the law of the land. it also looks after problems relating to customs and excise
duties.

The bulk of the work is given to outside counsels. This is so because each contract is unique in itself
and it will be very expensive and difficult to develop the legal expertise within the company itself.
Also, it might lead to under utilisation of the capacities of some legal specialists employed by the
company. DRN selects the outside counsel and mostly pay their tees. DRN's own counsel, however,
actively participates in the preparation of all the contracts. He frequently prepares the first draft or
in lieu reviews the draft prepared by the outside counsel. He thus acquires a broad based
knowledge of the legal problems in the company and also ensures consistent application of the
company's policies. The major objective is to turn out `defect free' contracts, as even a small defect
can cost a large amount of money to the company.

Budgeting and Control

The output of the secretarial and legal department is controlled through a budget. Early September
every year, the budget committee, headed by Mr. Gopal, sends out a memorandum to every
department to submit their budgets for the folk wing year. The budget for the legal and secretarial
department is the aggregate of the budgets of the three sections detailed above. The department
head is answerable for large overruns, though a leeway of 5% over budget is automatically given.

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The management recognised that as work done by this department was largely qualitative, not
much significance is attached to the budgeted costs and overruns.

Due to the high cost of training and the specialised nature of work, extreme care was taken in
selecting a person for the department. Mr. Sivaprakasam also kept himself informed about the
working of the department by occasionally going through the output of an assistant. The aim of the
department was to produce `no-defect' contracts and to expedite share transfers. It may be
mentioned here that it is possible to get the share transfers done by the company registrars' office
at 50% of the current costs, but in the interest of customer satisfaction, the company is willing to
spend the extra 50%.

Budget Reports

Mr. Gopal was thoroughly familiar with the above background information as he contemplated the
budget reports given by the secretarial and legal department for January 1979. The budget
summary for each of the three sections are given in Exhibit 2: Mr. Copal was wondering what
questions he should ask Mr. Sivaprakasam and how should he use the information available to
correctly assess the performance of the department.

Q2.If you believe that budgets are not an affective tool of control what other method of
control, would you recommend?

Ans:

● Top management support All management levels must be aware of the budget’s
importance to the company and must know that the budget has top management’s
support. Top management, then, must clearly state long-range goals and broad
objectives. These goals and objectives must be communicated throughout the
organization. Long-range goals include the expected quality of products or services,
growth rates in sales and earnings, and percentage-of-market targets. Overemphasis
on the mechanics of the budgeting process should be avoided.
● Participation in goal setting Management uses budgets to show how it intends to
acquire and use resources to achieve the company’s long-range goals. Employees
are more likely to strive toward organizational goals if they participate in setting
them and in preparing budgets. Often, employees have significant information that
could help in preparing a meaningful budget. Also, employees may be motivated to
perform their own functions within budget constraints if they are committed to
achieving organizational goals.
● Communicating results People should be promptly and clearly informed of their
progress. Effective communication implies (1) timeliness, (2) reasonable accuracy,
and (3) improved understanding. Managers should effectively communicate results
so employees can make any necessary adjustments in their performance.
● Flexibility If significant basic assumptions underlying the budget change during the
year, the planned operating budget should be restated. For control purposes, after
the actual level of operations is known, the actual revenues and expenses can be
compared to expected performance at that level of operations.
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 ● Follow-up Budget follow-up and data feedback are part of the control aspect of
budgetary control. Since the budgets are dealing with projections and estimates for
future operating results and financial positions, managers must continuously check
their budgets and correct them if necessary. Often management uses performance
reports as a follow-up tool to compare actual results with budgeted results.

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