12 Management control, result control and responsibility centres

Question 1

What are the problems managing large teams

Answer 1

How can you align the senior managers decisions with the objectives and actions of junior managers and employees

Question 2

What are the arguments for centralisation vs decentralisation

Answer 2

Large companies which operate over a wide range of regions might experience different regulations. Therefore they might centralise main strategic decision making (to experienced senior managers) but decentralize implementation to more specialist regional managers who can respond to change quicker

Question 3

What is a centralised company

Answer 3

• A centralised firm reserves much of the decision making at the top management level
• Centralised firms provide more control and the expertise of top management can be effectively utilized

Question 4

What is a decentralised company

Answer 4

• A firm is decentralized if it has chosen to delegate a significant amount of responsibility to subunit/departmental/divisional managers
• Decentralized firms are able to make more timely decisions at the operation level as top management lacks the necessary local knowledge

Question 5

Why must organisations adapt to change

Answer 5

• With the ability to adapt to change becoming more important in the business landscape, more time adapting their operations to the new environment than deploying their resources to their current operations efficiently
• In response to increasing competitive pressures and the opening up of former monopolies to competition, many organisations are changing the way they are organised and the way they do business
  o Even in industries that were once thought to have stable environments, such as utilities, couriers, and financial institutions
• This is necessary because they must be able to change quickly in a world where technology, customer tastes, economic factors and competitors’ strategies are constantly changing

Question 6

What might be required if an organisation wants to become more adaptive

Answer 6

• Senior management must delegate or decentralise decision making responsibility to more people in the organisation
• Allows motivated and well trained organisational members to identify changing customer tastes quickly
• Gives front line employees the authority and responsibility to develop plans to react to these changes
• This is especially effective in large multinational firms

Question 7

What are the benefits of decentralisation

Answer 7

• Greater responsiveness to local needs
• Leads to gains from quicker decision making
• Increased motivation of subunit managers
• Assists management development and learning
• Sharpens the focus of subunit managers

Question 8

What are the limitations of decentralisation

Answer 8

• Suboptimal decisions making may occur
• Focuses the manager’s attention on the subunit rather than the organisation as a whole
• Increases the costs of gathering information
• Results in duplication of activities

Question 9

What are suboptimal decisions

Answer 9

• Arises when a decision’s benefits to one subunit is more than offset by the costs or loss to the organisation as a whole
• For instance offering a highly customised product by a regional sales manager might have cause much higher costs to the manufacturing teams in another region

Question 10

What is the planning / control cycle

Answer 10

• Objective setting
  o Focuses on goals
• Strategic control
  o Strategy formulation
• Management control
  o Strategy implementation

Question 11

What is management control

Answer 11

• Management control is a process which ensures people in the organisation carry out the organisational objectives and strategies
• Encourages, enables or sometimes “forces” employees to act in the organisation’s best interests
• Management control includes all the devises and mechanisms managers use to ensure that the behaviours of employees is consistent with the organisation’s objectives and strategies
  o Eliminating suboptimal decisions
  o Create goal congruence
  o Via things like budgeting

Question 12

What is goal congruence

Answer 12

• When individuals and groups work towards achieving the organisation’s goals
• Managers working in their own best interest take actions that align with the overall goals of top management
  o This is not about making managers not act in their best interest it is about making their best interests help the best interests of the firm
  o This is done via management control mechanisms

Question 13

What are the objectives of management control

Answer 13

• Motivate managers to exert a high level of effort to achieve the goals set by top management
• Provide the right incentives for manager to make decisions consistent with the goals set by the top management
  o Align manager efforts with strategic goals
• Determine fairly the rewards earned by managers for their efforts and skill and the effectiveness of their decision making

Question 14

What are the characteristics of effective management control systems

Answer 14

• Motivation, goal congruence, and effort
• Leads to rewards
  o Monetary and non-monetary

Question 15

What are the key issues to cover when developing a framework for organisational performance management

Answer 15

• What are the key objectives that are central to the organization’s overall future success, and how does it go about evaluating its achievement for each of these objectives?
• What strategies and plans has the organization adopted and what are the processes and activities that it has decided will be required for it to successfully implement these? How does it assess and measure the performance of these activities?
• What level of performance does the organization need to achieve in each of the areas defined in the above two questions) and how does it go about setting appropriate performance targets for them?
• What rewards will managers (and other employees) gain by achieving these performance targets (or, conversely, what penalties will they suffer by failing to achieve them)?
• What are the information flows (feedback and feed-forward loops) that are necessary to enable the organization to learn from its experience) and to adapt its current behaviour in the light of that experience?

Question 16

What are the different types of control

Answer 16

• Action controls
• Results controls
• People controls

Question 17

What are action controls

Answer 17

• Controlling the actions people can take
• Such as setting a advertising budget to set a cap on spending

Question 18

What are results controls

Answer 18

• Rewarding individuals for generating good results or punishing or poor performance
• Creates results accountability
• It influences actions because it causes employees to be concerned about the consequences of the actions they take
• Such as setting performance related bonuses
• This doesn’t necessarily “control” actions as much as it empowers them

Question 19

What are the elements of results controls

Answer 19

• Defining the performance dimensions
• Measuring performance on these dimensions
• Setting performance targets
• Providing rewards or punishments
  o Salary increases, bonuses, promotions, job security, recognition, etc
• When organisations use a single index to provide a broad assessment of operations, they frequently use a financial number because it is a measure that describes the primary objectives of shareowners in profit-seeking organisations

Question 20

What are people controls

Answer 20

• Selecting people who share a uniform culture, beliefs or norms
• Such as personality tests when hiring

Question 21

What are responsibility centres

Answer 21

• A responsibility centre is an organisational unit for which a manager is made responsible
• It is like a small business
• But not totally autonomous
• Its manager is asked to run that business unit to promote the best interests of the larger organisation

Question 22

What are financial responsibility centres

Answer 22

• A responsibility centre in which the manager’s responsibilities are defined at least partially in financial terms
• The accounting reports reflect the degree of responsibility the manger has towards revenue, cost, profit and investment

Question 23

What are the 4 types of financial responsibility centres

Answer 23

• Revenue centres
• Cost centres
• Profit centres
• Investment centres

Question 24

What are revenue centres

Answer 24

• A responsibility centre whose members control revenue but control neither the manufacturing or acquisition costs of the products or services they sell nor the level of investments (such as new stores)
• They focus on the selling function and are defined either by product line or geographic area

Question 25

What are the costs incurred by revenue centres

Answer 25

• Most revenue centres incur sales and marketing costs and have varying degrees of control over them
• It is common in such situations to deduct the responsibility centre’s traceable costs from its sales revenue to find the centre’s net revenue

Question 26

What are the drawbacks of revenue centres

Answer 26

• Focusing solely on profit can create undesirable outcomes
  o Promotion of a wide product line that might create excessive diversity related costs
  o Offer excessive customised services
   Both might cost the wider organisation more than the benefits created in the centre
   Both suboptimal decisions
• Causes members to increase activities that incur costs in order to promote higher sales revenues

Question 27

What are cost centres

Answer 27

• Managers of cost centres are held accountable for expenses (financial measure of the inputs consumed by the responsibility centre).
• Direct manufacturing and manufacturing support departments are often evaluated as cost centers since these managers have significant direct control over costs but little control over revenues or decision-making for investment in facilities
• In this it is not just costs than need to be considered but quality, delivery time, ethics, etc.

Question 28

What are the types of cost centres

Answer 28

• Standard cost centres or engineered expense centres
  o Costs are mainly variable, controllable
  o Inputs can be measured in monetary terms;
  o Outputs can be measured in physical terms; and,
  o Causal relationship between inputs and outputs.
  o e.g., manufacturing departments
• Managed cost centres or discretionary expense centres
  o Costs are mainly fixed, uncontrollable
  o Outputs produced are difficult to measure; and,
  o Relationship between inputs-outputs is not well known.
  o e.g., R&D, HR, marketing activities

Question 29

What are the controls in cost centres

Answer 29

• Engineered cost centres
  o Standard cost vs. actual cost
   i.e., the cost of inputs that should have been consumed in
  producing the output vs. the cost that was actually incurred.
  o Additional controls
   Volume produced; quality; training; etc.
• Discretionary cost centres
  o Ensuring that managers adhere to the budgeted level of expenditures while successfully accomplishing the tasks of their centre.
  o Subjective, non-financial controls
   e.g., quality of service as perceived/evaluated by users.

Question 30

What are the issues with cost centres

Answer 30

• Many organisations make the mistake of evaluating a cost centre solely on its ability to control costs
• Other critical performance measures may include:
  o Quality
  o Response time
  o Meeting production schedules
  o Employee safety
  o Respect for ethical and environmental commitments

Question 31

What is a profit centre

Answer 31

• A responsibility centre where managers and other employees control both the revenues and the costs of the product or service they deliver
• A profit centre is like an independent business, except that senior management, not the responsibility centre manager, controls the level of investment in the responsibility centre
  o For example, if the manager of a supermarket chain in a specific country (e.g. ALDI UK) has responsibility for pricing, product selection, purchasing, and promotion, but not the level of investment in the store, then the supermarket chain meets the conditions to be evaluated as a profit centre

Question 32

What is a contribution income statement

Answer 32

• A common form of profit center evaluation is the contribution income statement, which is based on the contribution margin developed for each profit center and for each relevant group of profit centers
• Contribution by Profit Center (CPC) measures all costs traceable to the individual profit center, including traceable fixed costs

Question 33

What are controllable and non controllable fixed costs

Answer 33

• Traceable fixed costs can be either controllable or noncontrollable from the perspective of each profit center
• Controllable fixed costs are fixed costs that the profit center manager can influence in approximately a year or less, such as advertising, data processing, and management consulting expenses
• Noncontrollable fixed costs are those that are not controllable within a year’s time, such as depreciation and taxes

Question 34

What are measures of performance in profit centres

Answer 34

• Subtracting controllable fixed costs from the contribution margin results in the center’s controllable margin
• The contribution margin income statement can also be used to help determine whether a profit center should be dropped or retained
• One complication in the preparation of this statement is that some costs that are not traceable at a detailed level are traceable at a higher level

Question 35

What are investment centres

Answer 35

• Managers of investment centres are held accountable for the accounting returns (profits) on the investment made to generate those returns.
  o Objective = return on investment
  o Absolute differences in profits are not meaningful if business units use different amounts of resources.
• Managers have two performance objectives:
  o Generate maximum profits from the resources at their disposal
  o Invest in additional resources only when such an
  investment will produce an adequate return.
• A responsibility centre in which the manager and other employees control revenues, costs, and the level of investment in the responsibility centre
• The investment centre is like an independent business

Question 36

Why would you have responsibility centres

Answer 36

• It sets the remit that the managers can be held accountable to and set their rewards against
• They are only held accountable for what they can control
• For instance if you can’t control costs, only on making revenue, make a revenue centre to give them an office and make their rewards in alignment with the organizations goals

Question 37

How does controllability link to profit centres

Answer 37

• Underlying the accounting classifications of responsibility centres is the concept of controllability
• The controllability principle states that the manager of a responsibility centre should be held responsible only for the revenues, costs, or investment that responsibility centre personnel control
• Revenues, costs, or investments that people outside the responsibility centre control should be excluded from the accounting assessment of that centre’s performance
• Although the controllability principle sounds appealing and fair, it can be difficult, often misleading, and undesirable to apply in practice

Question 38

What are the problems with the controllability principle

Answer 38

• A significant problem in applying the controllability principle is that in most organizations many revenues and costs are jointly earned or incurred
• In most organizations, the activities that create the final product are sequential and interdependent
• Evaluating the individual performance of one centre requires the firm to consider many facets of performance

Question 39

What is risk vs uncertainty

Answer 39

• In mathematics, “risk” means an unknown outcome with a known probability
• “Uncertainty” means an unknown outcome but with an unknown probability

Question 40

How can you evaluate control centres

Answer 40

• Variance can be completed to find accuracy to targets
• Sometimes flexible budgets are used to allow for uncontrollable costs
• Relative performance evaluations can be done against similar centres
• Along with the subjective judgements of management
• Goals are typically set at an aspirational level to motivate management without being too high as to demotivate management