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Management Control System

UNIT II

Responsibility Centres
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The term responsibility centre is used to denote any organisation unit that is headed by a
responsible manager.

A company is a collection of responsibility centres, represented by a box in the

organisation chart. These responsibility centres form a hierarchy.

At the lowest level in the organisation are responsible centres for sections.

The whole company is a responsible centre.

A responsible centre exists to accomplish one or more purposes known as objectives
within the organisation goals and set of strategies lay down to achieve these goals.

Inputs
Resource used
measured by cost

Responsibility
Centres/Organisatio
n

Output
s
Goods or
services

Essence of any Responsibility Centres

Relationship between inputs and outputs

Measuring inputs and outputs, Efficiency

Process measurement of performance

Effectiveness as measure of performance

The role of profit.

Types of Responsibility Centres

Four different types of responsibility centres

1.

In revenue centre, outputs is measures in monetary terms.

2.

In expense centres, inputs are measured in monetary terms.

3.

In profit centres, both revenues (output) and expenses (input) are measured.

4.

In investment centres, the relationship between profit and investment is measured.

Revenue Centres
In a revenue centre, outputs (revenue) are measured in monetary terms, but no formal
attempt is made to relate inputs (i.e., expenses or costs) to outputs. Revenue centres are,
therefore, marketing organizations that do not have profit responsibility. Actual sales or
orders booked are measured against budgets.

Expense Centres

Expense centre are responsibility centres whose inputs, or expenses are measured in
monetary terms, but in which outputs are not measures in monetary terms. Expense
centres are of two types based on costs
1.

Engineered costs/Standard costs: amount of costs can be estimated with a

reasonable degree of reliability.

2.

Discretionary costs: the amount of costs depend on managements judgement.

Engineered expense centres/Standard cost centres

Characteristics:
1.

Their input can be measured in monetary terms.

2.

Their output can be measured in physical terms.

3.

The optimal rupee amount of input required to produce one unit of output can be
established.

Profit Centres

A profit centre is a responsibility centre in which financial performance is measured in terms of

profit (i.e., the difference between the revenue and expenses) inputs are measured in terms of
expenses and outputs are measured in terms of revenues.
A profit centre the measures of performance is better and broader than in an expense centre.
In a profit centre both the elements, cost as well as revenue is evaluated in monetary terms.
Profit centre can be divided into :
(i) natural profit centre and
(ii) constructive profit centre.
Advantages of Profit Centres
1.

The quality of decisions may improve because they are being made by mangers closer to the
point of decision.

2.

It provides a powerful tool for measuring how well the profit centre has performed.

3.

The speed of operating decisions may be increased since they do not have to be referred to
corporate headquarters.

4.

The profit centre resembles a business in miniature form.

5.

The profit centre makes decentralized organisation possible.

Investment Centre

It is defined as a responsibility centre in which inputs are measured in terms of

cost/expenses and outputs are measured in terms of revenues and in assets employed
are also measured. In other words, investment centres consider not only costs and
revenues but also assets used to the division. As a responsibility centre, the performance
of a unit would be measured in relation to the revenues/profits and the assets employed
in a division. The essence of investment centre analysis is the relationship between the
profits and the assets that are used to generate those profits. Investment centre is one
step above a profit centre, in terms of the additional financial data (assets).
The investment centre analysis can be used as a basis for evaluating the contribution of
a division as an entity as also the performance of a division. The measure of
performance in an investment centre is based on the relationship between the
profits/income and the assets employed in generating the profits. There are two ways to
relate income to assets:
(i) Return On Investment (ROI) analysis and (ii) Residual Income (RI) Analysis or
Economic Value Added (EVA).

Budgetary Control System

CIMA terminology defines Budgetary Controls as The establishment of budgets relating the
responsibilities of executives to the requirements of a policy and the continuous comparison
of actual with budgeted results, either to secure by individual action the objectives of that
policy or to provide a basis for its revision. Budgetary control system is a tool for MCS.
Steps for Budgetary Control System
a)

Developing the budgets and breaking into departments and for shorter periods.

b)

Continuous comparison between the budgeted and actuals figures.

c)

Locate the difference.

d)

Analyzing the reasons for the divergence so pinpointed.

e)

Initiating remedial measures, again through the active involvement of the operating
people, in order to correct the adverse divergence in the immediate next time-period.

f)

If any major divergence, whether favorable or adverse, is found to be beyond control

during the budget period, then working out a rational basis for revising the budget
itself.

Discretionary & Committed Cost

Discretionary Expense Centres

The world discretionary means that management has decided on certain policies that
should govern the operations of the company. There are three points in the control of
discretionary expense centres.

First, the management control system helps only in expense control.

Second, the difference between budgeted and actual expense is not a measure of
efficiency.

Third, the financial control system measures neither the efficiency nor the
effectiveness of these responsibility centres.

Committed Expense/Cost
These are expenses that cannot be changed by the responsibility centre manager during
the budget year or expenses that can be changed only in extraordinary circumstances.

Approaches to Budgeting with reference to

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Engineered/Standard and Discretionary Costs

The starting point in preparing the budget is the current level of spending. The budgeter
adjusts these amounts for anticipated inflammation, cost implications of the changes in
the job to be done and in some cases for anticipated productivity improvements. In some
companies, the preparation of budget preceded by a zero base review.
In the case of engineered expense centre/standard cost centre, management must
decide whether the proposed operating budget represented the cost of performing a task
efficiently for the coming period.
In the case of discretionary cost centre, while formulating the budget, managements
principal task is to decide on the magnitude of the job that should be done, because
based on such job expenses/resources are budgeted.

Benchmarking and Total Cost

Management

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Benchmarking is the continuous process of comparing and measuring an organisations

business processes against those of business leaders anywhere in the world. The
objective is to identify and understand best practices; and the best practice is simply, the
best way to execute a process.
Engineering expense centre/standard cost centre, finance control is exercised by setting a
standard for performing the task and reporting actual costs against this standard. While
setting the standard, we can get comparable standard from other operating
units/competitors in the processes called benchmarking. The true power of benchmarking
lies in the ability to apply the insight gained from another organisations best practices.