Study Guide Flashcards
What are the two fundamental problems firms face?
-Important information is held by many individuals
-Decision makers may not have the incentives to make the right decision
What are the three elements of organizational architecture (the three-legged stool) and how do they relate to organizational architecture and decision rights?
-Decision making allocation: A person should not be assigned decision rights if the exercise of these rights
-Reward systems: must be matched to those areas over which performance is being measured.
-Performance measurement and evaluation: must measure the agent’s performance in areas over which he/she has been assigned the decision rights. (Simon’s leavers)
Benefits/Costs of Centralization
Benefits:
Coordination is simple
Standardized products and service
Cost efficiency
Costs:
Employees are less empowered
Inflexibility in decision making
Extra layers in hierarchy
Benefits/Costs of Decentralization
Benefits:
Conserves managements time
Empowers employees
Effective use of local knowledge
Costs:
Coordination is costly
Failure is costly
Less effective use of central information
What are the three primary determinants of a business strategy?
Technology
Markets
Regulation
Must consider these to determine their industries and how they want to compete
- Core competencies
-Sustainability (what makes it hard to imitate)
How does Strategy & Decision Rights tie into Simons Levers of Control?
Business strategy -> simon’s levers
Core values= belief systems
Risks to be avoided= Boundary systems
Strategic uncertainties= Interactive control systems
Critical performance variables= Diagnostic control systems
What are the factors that influence decision rights assignment?
-Biases
-Standardized experience and efficency
-Customer intimacy and long term relationships
-Motivation
How do decision-rights assignment affect performance evaluation and reward systems?
Employees should only be evaluated and rewarded based on what they can control (Controllability principal)
What are the roles boundary and belief systems play in offsetting challenges in different franchise arrangements?
Boundaries: tells employees what can and cannot be done
Beliefs: instills a set of values that can be used for situations in which boundaries are not defined
How can the North STAR system engrain culture throughout the organization? and How can North STAR system help prompt cultural change of a long established organization with an entrenched culture
Selection: choose to hire or promote individuals who contribute to culture
Training: train culture into employees
Assessment: assess and provide feedback on how employees are contributing to culture / performing. Broad and cross-functional performance metrics and adherence to values when pursuing results
Reinforcement: Ensure that company values remain an important part of employees’ routines
-symbols like slogals, stories, tshirts, mascots, heroes
-Traditions like quarterly or annual events, public recognition of employees exemplifying values, highlight values in company meetings, non routine activities that capture spirit of company values or pursuits
What are nonfinancial performance measures? and their benefits/costs
Nonfinancial performance measures are a complement to financial measures and can also be leading indicators of financial performance.
Benefits:
-emphasis in value
-Closer link to org strategies
-Less susceptible to noise/gaming
-More comprehensie view
-Focused on components managers canc ontrol
-Clarifies org’s strategy
Costs:
Subject to error
Time/cost to collect
Measures can conflict
difficulty validating links/measuring connectivity/link measures to strategy
difficulty setting targets
lower precision
What are examples of how companies implement and evaluate effectiveness of strategy
-Lifetime value of cust
-Cust profitability
-New products/applications
-Customer satisfaction
What are some advantages of maintaining a strong organizational culture
-Employee retention
-Belief/boundary system
-Align personal and company values
-Motivating
Objective vs Selective model of selecting managers benefits/cost
Objective
- Benefit: perceived as more fair
Cost: subject to gaming, doesn’t capture all dimentions, based on quantity of experiences, not quality
Subjective
-account for soft skills
-Cost: subject to judgement viases
How can the use of proxies measure certain dimensions of organizational performance? (see also Session 253)
They can measure factors that are not traditionally, directly measurable with numbers.
Predictive validity framework (PVF)
Constructs: cause is DEI causual relation means effect is is organizational performance
Proxy measures: cause is working hard means statistical association is revenue/priofits/growth
Proxy= true value+ measurement error
Noise v biase
Noise= random and unpredictable dif btwn proxy and construct
Bias= predictable dif btwn proxy and construct
Mediating variable
Effect of X on Y flows through Z. X influences z which influences Y
Moderating Variable
Increases or reduces the effect of another cuasal variable
What is a budget?
A financial plan that projects financial statement accounts, operational performance, and expenditures for one or more reporting periods
Why do a budget (4 reasons/elements) and what role(s) does the budgeting process play in organizations?
Attention Directing: forces managers to spell out plans (tell you what to focus on)
Decision Facilitating: help firms plan expenditure and resource usage. (which plan to put resources behind)
Decision Influencing: provide a frame of reference or benchmark for providing feedback and evaluating performance. (performance benchmark)
Coordination Facilitating: help a firm devise operational plans and resource allocations to balance the output of each organizational unit with the demands of its internal customers (combine and see if they make sense)
Why do conflicts among the various budgeting roles arise?
-Budgets should not be used to plan and reward
-subordinates and superiors lie in formation in budget and they game realization of targets
How does the budgeting process fit in the Levers of Control framework, particularly an interactive control system?
Communication and information exchange is necessary between business entities for events such as profit planning. Communication ensure good information enters the budgeting system
-interactive control
What is the relationship between budgeting, organizational architecture, and related decision rights?
Budgeting sets goals which are used as the basis for performance evaluation from which a reward system can be built on. Decision rights also serve as a basis for performance evaluation as managers should be evaluated on what they can control
What are the benefits/costs of budgeting?
Benefits:
Can catch/explain performance errors
Encourage communication
Costs:
Costly to make
Can’ capture non-financial measures
What impact does tying rewards to budget achievement have?
Encourages budget makers to set targets low to ensure that they are met and incentive is earned
What are responsibility centers? What is their purpose?
-Given descision rights and performance measures
-Cost, expense, revenue, Profit, Investment
Responsibility centers are an operational unit or entity within an organization that are responsible for all the activities and tasks structured for that unit.
Cost center: Objective, Decision rights, Performance measures, example
Objective: Minimize cost for a fixed output
Decision rights: Input mix (M,L,OH)
Performance measures: Cost variances, quality measures, continuous improvement
Example: Manufacturing department
Expense center: Objective, Decision rights, Performance measures, example
Objective: Maximize service/output for a fixed budget
Decision rights: Responsibility over relevant cost
Performance measures: Benchmarking, quality easures
Example: Accounting, R and D, Marketing
Revenue center: Objective, Decision rights, Performance measures, example
Objective: Max revenue for a given price w a specific budget
Decision rights: Responsibility over price (revenue)
Performance measures: Sales variances
Example: Sales dept
Profit center: Objective, Decision rights, Performance measures, example
Objective: Max profit w a fixed budget
Decision rights: Input mix, product mix, price. (OP and revenue)
Performance measures: Profit variances
Example: Any division that incurs cost and earns revenue by selling
Investment center: Objective, Decision rights, Performance measures, example
Objective: Max profit subject to investment
Decision rights: Revenue, operating costs, depreciation, capacity resources (all of it so operating income)
Performance measures: ROA, ROI, Residual income
Example: Any division that incurs cost and earns revenue by selling and investments that it makes to earn profits
What are the benefits and costs of using financial performance metrics to measure/evaluate and reward performance?
Benefits:
Cost effective and simple
Easy to communicate and validate
Easy to set goals for
Ultimate goal of owners
Perceived as objective
Costs:
Does not account for non-financial performance measures
Backwards looking measures
Too easy to validate
May encourage myopic behaviors
Variance Analysis – why do we use it? How do we calculate key factors? How do we interpret the variances?
Variance analysis explains the deviations from the budget
Variance figures usually work in tandem to explain budget deviations. For example, a highly favorable price variance, but a highly unfavorable efficiency variance may mean that low quality cheaper goods were used.
Master budget, flex budget, as it, actual
formulas
Master: BSQ * BIQ * BIP
Sales volume variance
Flex: ASQBIQ BIP
Efficiency variance
As-If: ASQ* AIQBIP
Input price variance
Actual: ASQAIQ*AIP
Why do we need transfer pricing?
-Only impacts divisional profits, not firm profits
-Allows for the establishment of prices for the goods and services exchanged between affiliates that are part of the same larger enterprise.Transfer pricing affects the revenues of the producing profit center (PC), the costs of the buying PC, and hence, the profits of both units
What four key purposes does transfer pricing serve?
Provide information for accurate performance evaluation
Provide proper economic signals for good decision making (goal congruence)
Preserve divisional autonomy
Purposely move profits between entities/locations (tax-driven)
What are the various types/methods of determining transfer prices? When is it appropriate to use each type/method? (i.e., when is it appropriate to use variable costs, fixed costs or market price for a transfer?)
Market Based: used when a competitive external market exists. Good/service would have been sold to the outside market
TC= VC +Opportuntiy cost (Contribution margin)
Marginal / Variable Cost: used when there is excess capacity. One time exchange
Marginal Cost plus Markup / Full Cost (VC+FC): used when there is no excess capacity. Recurring, long term exchange
Introduction to the Balanced Scorecard (BSC) – what is it and why have one?
A BSC is a strategic planning and management system designed to align business activities to the vision and strategy of the organization, improve communication of strategy, and monitor the performance of an organization against strategic goals.
-Describe and implement org’s strategy
-Provide language to discuss direction and priorities
-Translate vision/strat into coherent and linked set of performance measures
What are the four perspectives of a BSC?
Financial: To succeed financially, how should be appear to our shareholders (Revenue growth or cost reducton)
Customer: To achieve our vision, how should we appear to our customers (customer intimacy, product leadership (speed to market, performance), operational effectiveness (speed of service, returns)
Internal business processes: to satisfy our cusotmers and shareholders, at what business processes must we excel: customer intimacy, product leadership (new products, etc), operational effectiness (supply chain, asset utilization)
Learning and Growth: To achieve our vision, how will we sustain our ability to change and improve. Define core compencies and skills, tech, and corp culture needed to support internal business perspective
What are the four required parts of each perspective of a BSC? What are causal links?
Objectives: dimensions of performance that needs to be improved
Measures: data used to assess performance on the objective
Targets: level of measure to which performance is compared
Initiatives: strategy intended to help achieve target
Causal Links: Link nonfinancial performance measures to strategy
ow and what should you balance with regards to performance measures? (i.e., what are leading and lagging indicators? Objective vs Subjective measures? External vs Internal? Financial vs Non Financial?)
Performance measures should be balanced among the four perspectives of the BSC
Leading Indicators: performance driver measures that dictate when financial performance is going. An example is customer satisfaction scores
Lagging Indicators: outcome measures, like sales
How to measure a company’s strategy
Compare strategy to environment/industry
Funciotns of BSC
Motivate (rewards
Communicate
Monitor performance
How to quantitively confirm descision
- Correlation Analysis
- Regression
- Scatter plot
- Re-run regressions after splitting data at median of crew skills
What are nonfinancial performance measures?
Good nonfinancial measures can be leading indicators of future financial performance thus incentivizing employees to be more forward looking. Thees focus on more subject performance measures
Three requirements for measure management
Measurement error: the performance measure is an imperfect proxy for the construct it represents
Motivation: People are aware of the emasrue used for their evaluation and care about their evaluation ( the more they care the more incentive they have to manage the measure(
Discretion: People have the ability/discretion to distort this measure through either action that effects the raw data or (mis)reporting of that data
Measure management
When employees improve their performance on a measure by taking actions inconsistent w the underlying construct that the measure represents
How can you reduce measure management
-Reduce measurement error (the more closely the measure captures the construct, the more difficult the measure is to manage)
-Conceal measurement from employees (those who don’t know how they are being measured cant easily manage it)
-Monitor and limit discretion-> implement controls
What are the benefits and costs of using nonfinancial performance measures?
Benefits:
Leading/intermediate information; thus, good diagnostic tool
Focused on components of operations that managers can control
Employees receive better information on specific actions that achieve strategic objectives
Costs:
Not always easy to reliably measure
Can be difficult to confirm their association with value creation
Interpretation is tricky and may depend on context
How can business use regression analysis to help determine if a strategy is appropriate and if appropriate, whether or not the organization can achieve the strategy given its competencies and resources?
They can use the regression analysis to test whether their strategy is actually having the intended effect on a designated measure.
How do mediating and moderating variables differ?
Moderators influence the relationship between variables while mediators explain the relationship
Does performance measure management induce noise or bias?
Bias: measurement is a more direct difference between the proxy and construct
What impact does tying rewards to the achievement of diagnostic measures have?
Often decreases their informativeness—especially when employees have the flexibility to take actions to improve the measure that are not consistent with the measure’s underlying construct
What makes up Simon’s Levers of Control?
Business Strategy at the center
Belief systems: core values / beliefs of the company
Boundary systems: code of conduct / rules
Diagnostic Control Systems: feedback systems used to monitor organizational outcomes and correct deviations from preset standards of performance
Interactive Control Systems: facilitate information exchange
Internal controls as the foundation
Internal control polices do what
Safeguard assets
Ensure reliable accounting records and financial information systems
Ensure compliance with laws and regulations
Promote operational efficency
Coso’s Internal control
-Control environment
-Risk assesment
-Control activities
-Information and communication
-Monitoring
Control Environment
COSO cube
Standards, process and structure that provide basis for internal control; tone at the top
Commitment to integrity and ethical values
Board of directors demonstrates independence from management and exercises oversight of the development and performance of internal control
Management establishes appropriate reporting lines
Organizations demonstrate a commitment to attract, develop, and retain competent individuals
The organization holds individuals accountable for the internal control responsibilities
ex:
Control environment
Good culture
Support controls
Training peopler
Care about value
Not trying to cut corners
Emphasize and live to mission statement
COSO
Board of directors pays attention
Mission statement-> walk the talk, encourage people to have good ethics
Doing the right thing
Risk Assessment
The organization must be aware of and handle the risks it faces, where risk is the possibility that an event will occur and adversely affect the achievement of the organization’s objectives. It must establish mechanisms to identify (scan the external and internal environment), analyze, and management the related risks.
Objectives must be clearly specified objectives to facilitate the identification of risks
The organization identifies risks to the achievement of objectives and discusses how to handle the risks
The organization considers the potential for fraud in assessing risks to the achievement of objectives
The organization identifies and assesses changes that could significantly impact the system of internal control
Control Activities
Actions via policy and procedures to help ensure directives to mitigate risk are carried out
The organization selects and develops control activities that contribute to the mitigation of risks
Develops control activities over technology
Deploys control activities through policies that establish what’s expected and procedures to put policies in place
Information and Communication
These systems enable the organization’s people to capture and exchange the information needed to conduct, manage, and control its operations.
The organization obtains or generates and uses relevant, quality information to support the functioning of internal control
The organization internally communicates information, including objectives and responsibilities for internal control, necessary to support the functioning of internal control
The organization communicates with external parties regarding matters affecting the functioning of internal controls.
Monitoring
Ongoing evaluation and/or separate evaluations to check whether the five components of control are present and functioning. In this way, the system can react dynamically, changing as conditions warrant.
The organization selects, develops, and performs ongoing and/or separate evaluations to determine whether internal control components are present and functioning
The organization evaluates and communicates internal control deficiencies in a timely manner to parties responsible for taking corrective actions
Types of control activities
Authorization of transactions: preventative control that requires approval for risky actions
Segregation of duties: separate asset custody, recordings, and authorization
Adequate records and documentation: detective and corrective control that sees the maintenance of supporting documentation
Security of assets and documents: detective and corrective control that sees the maintenance of supporting documentation
Independent checks and reconciliation: detective and corrective control that compares documentation for accuracy
What are the AICPA Trust Services Principles?
- USED FOR IT
Security: risks associated with both physical and digital unauthorized access to assets or documents
Availability: risks associated with ensuring that key systems stay online and usable
Processing Integrity: risk associated with inaccurate, incomplete, or improperly authorized information
Online Privacy: risks associated with keeping client information private
Confidentiality: risks associated with keeping company information private
Five categories of IT general controls
Authentication of users and limiting unauthorized access: limit access to sensitive documents
Hacking and other network break-ins
- Online forced entry
Organizational structure
- Govern the development and operation of IT controls
Physical environment and physical security of the system
- Controls over the physical environment of the system and physical access controls to limit who is in contact with the system
Business continuity: Business lives and evolves forever?
There are three sets of IT application controls for an IT application
Input: ensure the accuracy and completeness of data input procedures and the resulting data
EX: Using a calendar selection menu instead of manually entering a date for a flight
Processing: intended to prevent, detect, or correct errors that occur during the processing in an application
EX: Ensuring that a credit card is active
Output: ensure the accuracy and completeness of the output, and to properly maintain the safekeeping of the output reports
Ensure that products sent to customers are correct
Revenue Cycle- seller
- Sales order entry
- Shipping of goods
- Billing for goods shipped
- cash collections
Expenditure cycle- Buyer
- Request goods
- Order goods
- Receive goods
- Approve vendor invoice
- Pay for goods ordered
Understand the three key “control objectives” of the revenue and cash receipts cycles.
Sales transactions and cash receipts are authorized and accurately and completely executed and recorded
Assets are safeguarded
Revenue and uncollectible accounts are recognized in accordance to GAAP
Be able to identify weaknesses in a given revenue or cash receipts process.
Are inventory levels checked as a part of sales approval?
Was the customer’s credit checked?
Were the prices for the sale verified?
Was the packing slip compared to the purchase order prior to shipment?
Was the customer’s check matched against the purchase order?
Was the inventory account updated in a timely fashion?
Was the shipping log updated?
Why do orgs assign descision making responsibilities to those in the responsibility centers
They have better info abt their products, services,a nd customers
Balanced Scorecards Design Checkpoints
Do the objectives reflect the strategy?
Are the objectives all actions?
Have you identified cause and effect links between the objectives?
Are the objectives included within the correct perspective?
Do you have a “balance” of:
the four perspectives?
financial and non-financial objectives/measures?
leading and lagging objectives/measures?
Do you have a measure for each objective?
Do you have an initiative for each measure/objective?
causal relationships balanced scorecard
Learning and growth->Internal business perspective
Internal business perspective->Financial perspective
OR
Internal business perspective->Customer perspective
Customer perspective->financial perspective
Levers of control
- Internal Controls – Mechanisms designed to prevent fraud, asset misappropriation, and ensure
accuracy and completeness of the accounting records that underpin financial statements and
their related disclosures. - Diagnostic Control Systems – Used by senior management to monitor critical performance
variables or things that the company must do well in order to achieve strategic objectives.
These systems should highlight to busy managers where their limited attention is needed and
when corrective actions are needed. - Belief Systems – Belief systems communicate the entity’s core values and mission to employees
(e.g., mission statements, vision statements, etc.). These systems remove uncertainty about the
organization’s mission, how employees are expected to manage internal and external
relationships, and inspire employees to pursue new, value-increasing opportunities. - Boundary Systems – Boundary systems identify those actions and risks the employees must
avoid – they state what employees should not do (examples include codes of conduct and
operating guidelines). - Interactive Control Systems – Interactive Control Systems are mechanisms that allow managers
to learn about opportunities, risks, and uncertainties in their employees’ environment that may
require a shift in the entity’s strategy. 22
