Lesson 4 Flashcards
Describe the concept of a Management Accounting Control System (MACS) and explain how it relates to a balanced scorecard
A Managemetn Accounting Control System is a formalized process of ensuring effective control over resources, systems, processes, culture, structure and tasks that support the achievement of an organization’s goals and objectives
- a major objective of MACS is to ensure ee’s behave in a way that is congruent with organizational strategies
- An effective MACS achieves goal congruence within an organization
- a MACS needs to be designed in a way that helps encourage goal congruence by providing internal control within an organization.
_it needs to have measurements and mechanisms to provide diagnostic control with exception reports, intereactive control with strategic information providing feedback on company achievements and expectations.
- A BSC is an integral part of MACS. The BSC perspective provides both diagnostic and interactive controls that are the foundation of MACS.
analyze and evaluate alternative measures of financial performance
-ROI (Return on Investment) = Income/Investment
or Revenues/Investment x Income/Revenues = Income/Investment
ROI Advantages
- comparable measure enables comparison of different sized investment cenres
- simple approach which is commonly used in practice
- using a ratio like 12% makes it easy for an org to compare an investment centre’s effectiveness to the overall company’s cost of capital
ROI Disadvantages
- May encourage goal incongruence as mgrs. may be tempted to invest or divest investments to manipulate their overall ROI especially if compensation is tied to divisional performance
- because the denominator is the depreciated historical value of assets, over time it will decrease (increasing ROI). Mgrs may not invest in new equipment in order to keep their ROI high
analyze and evaluate alternative measures of financial performance
-RI (Residual Income)
= Income - (Required rate of return x investment)
RI advantages
- Not a ratio and therefore enables the company to assess an investment based on overall contribution to the company. Overcomes goal incongruence. If an investor earchs a return over the company’s cost of capital, it will be attractive to managers who are evaluated on the basis of RI. This same investment may not be accepted by those evalauated based on ROI
- Different divisions can have a different RI objective based on their distinctive needs
RI Disadvantages
- Cannot be used to compare unequally sized divisions as it is a dollar based value, not a ratio
- The imputed interest rate can be an arbitrary measure and requires an assessment of risk which can also be arbitrary
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analyze and evaluate alternative measures of financial performance
-EVA (Economic Value Added)
= After-tax operating income - (WACC x (total assets-current liabilities))
EVA advantages
- not a ratio and therefore helps contribute to goal congruence
- uses WACC which is less arbitrary that an imputed rate used in RI, however, it is often difficult to estimate cost of equity
- excludes assets funded through sources that are not part of the company’s cost of capital. Current liabilities are subtracted from the value of total assets to recognize that current assets will need to be used to satisfy this obligation
EVA disadvantages
- cannot be used to compare unequally sized divisions as it is a dollar based value, not a ratio
- the use of an organizational wide WACC does not recognize the differing levels of risk of uncertain divisions
analyze and evaluate alternative measures of financial performance
-ROS (Return on Sales)
ROS advantages
- Since it is a ratio, it allows comparison of divisions that have unequal levels of sales
- effective measure in situations where market growth is limited and the company needs to maximize the profits they receive on each dollar of sales
- a simple approach. Ratio components are not subjective
ROS disadvantages
- Does not measure the use of assets within a company as it is based solely on sales. Therefore it is not a good indicator of how effectively assets are managed.
- short term focus.
analyze technical difficulties that arise when comparing the performance of divisions operating in different countries
- economic, legal, political, social and cultural environments differ significantly across countries
- gov’ts in some countries limit selling prices and impose controls on products (Eg tariffs)
- availability of material and skilled labour as well as costs may vary across countries
- divisions operating in different countries keep score of their performance in different currencies. Issues of inflation and fluctuations in foreign currency exchange rates become important
evaluate the behavioural effects of salaries and incentives in compensation arrangements.
- entrepreneurs are generally more risk tolerant than those who decide to work for others. They have no guaranteed ROI and assume reward is linked to effort. They receive the residual after obligations have been paid
- mgrs. or ees prefer the security of a salary and are willing to accept a lower but certain return for their hardwork
-it is more cost-efficient for owners to bear risk than mgrs., since mgrs. demand a premium for extra risk - ## team based compensation arrangements encourages ees to work together to achieve common goals
describe the interrelationship between performance and rewards in a performance evaluation system
companies should rewarff or compensate individuals for high performance that leads to achieving the company’s overall strategy.
The BSC system must have a method of rewarding the achievement of these measures to encourage the behaviours that lead to corporate strategy.
By rewarding specific performance, ee’s will be encouraged to behave in a way that is in the company’s best interest and achieves overall corporate strategy.
describe the main challenges companies face when trying to develop effective compensation and rewards programs
- developing effective & appropriate performance measures. Performance measures must be tied to company goals and need to be carefully assessed to ensure goal congruence. They need to include more than just financial measures. It is important to include factors such as customer satisfaction and operational efficiency.
- short-term vs long-term incentives. Short term incentives are beneficial since they provide immediate recognition of performance, however they must not be overused for fear an ee will develop short-term focus. Incentives based on long-term strategies will help encourage employees to make decisions that improve overall performance in the long-run.
- salary & incentive mix. The risk a mgr is willing to assume is reflected in the ratio of fixed salary to incentive comparison. Companies that encourage risk behaviour, fixed salaries are lower.
- controllable vs non-controllable revenues and costs. the most effective way to capture a div mgr’s performance is by using only controllable costs in performance evaluation. However, there needs to be a tradeoff between the need to measure mgmt. performance and the need to measure the economic contribution of the segment to the overall organization.
apply strategic concepts to analyze the four levers of control and evaluate their usefulness.
- diagnostic control systems: performance evaluation measures such as ROI, RI, EVA and ROS, customer satisfaction and ee satisfaction
- boundary systems: describe standards of behaviour and codes of conduct expected of all ees, especially actions that are off limits.
- belief systems: articulate the mission, purpose, and core values of a company. They describe accepted norms and patterns of behaviour
- interactive control systems: formal information systems that mgrs. use to focus org attention and learning on key strategic issues. An excessive focus can cause an org to ignore emerging threats and opportunities
