All MCS Ppts Rkk

8/6/2019 All MCS Ppts Rkk

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Chapter I : INTRODUCTION

Control is critical function of management.

Control problems can lead to long losses and possibly

organisation failure.

Degrees of Control are:-

i. Excellent Control

ii. Inadequate Control

iii. Lack of Control

iv. Weak Control

v. Excessive Control

vi. Lax Control

Management Control SystemsManagement Control Systems


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Control Types:

i. Reactive Control:

Taking action after the problem has occurred.

ii. Proactive Control:

Taking action to prevent control problems.

Why Control?

Control Influences the (employee) behavior.

Control provides direction.

Control brings in discipline.

Management:

The process of integrating resources and tasks towardsachieving organisational goals.


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Broad Areas of management can be further broken down into:-

1) Functions:

Product/Service development

Operations

Marketing/Sales

Finance etc.

2) Resources: People

Money

Machine,Materials

Information etc.

3) Process (This is the control area)

Objective setting

Strategy formulation

Control


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Control Area of objective setting is perquisite for design of anycontrol or MCS.

Strategy Formulation defines how organisation should use their

resources to meet their objectives.

Strategy is the self imposed constraint by the organisation for

focused approach.


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Strategic Control v/s Management Control:

i. Strategic Control:

Seeks to answer questions like

Is our strategy valid.

Is our strategy still valid.

The effect of changing environment.

ii. Management Control:

Seeks to answer

Are our employees likely to behave (properly)appropriately.

Do our employees understand what we expect of

them Do our employees work consistently hard and try

to do what is expected of them.

Are our employees capable of doing a good job.

What can be done to solve the ManagementControl problems.


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The focus of Strategic Control is external to organisation

(strength/weakness).

The focus of Management Control is internal to organisation

(influence on employees behavior in a desired direction).

Causes ofManagement Control Problem:

Lack of Direction Motivational Problems

Personal Limitations

Features of Good Control:

Good control increases the probability of success. It cannot

eliminate the failure. There is nothing like perfect control.

Good control means an informed person can be reasonably

confident that no major, unpleasant surprises will occur.


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A Good Control is:

i. Future Oriented

ii. Objectives Driven

iii. The absolute assurance of attainment of objectives isnot always economically desirable.

Control Problem Avoidance:

Avoiding the control problems some times is best.

Control Problems can be avoided through:

Elimination

Automation Centralization

Risk Sharing


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Examples of Controls in Manufacturing Firm:

a. Cash payment and Receipts separated.b. Matching of Invoices to goods received report.

c. Cheques dispatch by person not writing the cheques.

d. Matching of Invoices to orders.

e. Bank Reconciliation Statements.f. Surprise cash checking.

g. Placing orders with approved vendors.

h. All procurements by purchase department.

i. Cheque books stored in lock and key position.

j. Standardization of documents.

k. Security checks at main gate

l. Inward/outward material check at first/last point.


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1. DETECTOR

Information

about what is

happening

CONTROL

DEVICE

ENTITY

BEING

CONTROLLED

2. ASSESSORComparison

with

standard

3. EFFECTOR

Behavior

changes if

necessary


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1. Detector : Says what is happening

2. Assessor : Says what should be happening

3. Effector : Is a feedback on need forchanges

4. Communication Network : Does the job oftransmission of information between 1 & 2 ; 2 & 3

Management:

Organisation has goals. Organisation is a group ofpeople working together to achieve the goals.


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The leaders of the organization are the management. The

leaders

are placed at different layers in the hierarchy.

Systems

A system is a prescribed way of carrying out an

activity or set of activities. The activities are usually

repeated. Systems exist for the control of many types ofactivities. The system used by the management to

control the activities of an organization is called as

Management Control System (MCS)

Management control is a process by whichmanagers other members of the organization to

implement the organizations strategies.


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1. Strategy formulation :

L

argely unsystematic process of identifying and decidingon new strategies.

2. Management Control :

The formal system that includes a recurring cycle of

activities.

3. Task Control:

It is the process of assuring that specified tasks are

carried out effectively and efficiently

Above 3 types of planning control activities are found in

a organization


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STRATEGY:

The general direction in which an organisation plans

to move to attain its goals is the strategy.Every Organisation has one or more strategies

although they (strategies) may not be stated explicitly.

GOALS:

A company by itself is a artificial being with no mind

and decision making ability. Hence the company does not

have goals.

The goals are arrived at by the founders, CEO.

Profitability, Maximizing share holder value, high

productivity, company leadership etc., are goals


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Analysis

Environmental/External includes-

competitors, customers, suppliers,

regulator, political/social.

Internal includes- Know how of

technology manufacturing,

marketing, logistic distribution etc

Opportunities/Threats.Strengths & Weakness

Identify StrengthsIdentify Opportunities

Use Strengths to exploit

opportunities to shape

strategy for company

Strategy Formulation and Strategy Implementation

are two different things.

Strategy Formulation:


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Two Levels ofStrategy:

Strategy

Level

Key Strategic Issues Strategic Options Organisation levels

involved

Corporate

Level

Are we in right mix of

industries

What industry or subsidiary

we should be in

Single industry,

Related

diversification;

Unrelated

diversification.

Corporate Office

Business

Unit Level

What should be the mission

of the business unit.How should the business

units compete to realize its

mission.

Build, hold, harvest,

divest.

Low Cost /

Differentiation.

Business Unit head.


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Corporate level strategy deals with the very definition of

business and the allocation of resources among thosebusinesses.

Corporate level strategy analysis results in decisions related

to the businesses to be added, businesses to be retained

businesses to be emphasized and de-emphasized andbusinesses to be divested. Core competence is the key

concept in corporate level strategy.

Business Unit level strategy deals with how to create and

maintain competitive advantage in each of the industries in

which a company has chosen to participate.


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At Business Unit level the strategic questions are related to

the Business Unit missions and how to achieve the

missions.

Sl.no Business Unit Mission The Objective

Buil Incre se Mar et Share

2 Hol Protect the Mar et Share

3 Harvest Maximize Short Term Earnings

4 Divest With raw from Business


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BCG MODEL

Hold

Build

Harvest Divest


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Goal Congruence

GC is a process means that actions it leads people to take in

accordance with their perceived self interest are also in the best interest of

the organization.

GC is affected by factors, which are

Informal Formal

Internal External Rules

Physical controls

Organizational culture WorkE

thicsM

anualsManagement style Systems safeguards

Informal organization

Perception & communication

Co-operation & conflict


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Formal Control Process

Goals and

strategies

Rules Other

information

Strategic

planningBudgeting Responsibility

Center

performance

Report

Actual vs- Plan Wasperformance

satisfactory

yes

no

RewardFeedback

Revise D &E

Take corrective

action at F

BC

FE

HG

D

A


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Functions of Controller

The person responsible for designing and operating MCS is a controller. In most

organizations CFO is the controller.

The functions of controller are

1)Design and Operate information and control system.

2)Prepare financial statements and financial reports to share holders and other

external parties.

3) Prepare and Analyse performance reports and assists managers by interpreting

the reports by analyzing progress and budget proposal, consolidate various

segments plans into overall annual budget.

4) Supervise internal audit and accounting control procedures to ensure validity

of information set up adequate safeguards against theft, pilferages etc.

5) Develop personnel in the controller organization and educate management

people in matters relating to controller function.


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Relationship between Corporate controller and Business Unit controller andbetween Business Unit controller and Business Unit head.

Corporate controller

Business Unit head

Business Unit controller

Dotted line relationship:The Business Unit controller reports to Business Unit head who is the immediate

superior. Corporate controller is functional superior.

Corporate controller

Business Unit head

Business Unit controller

Solid line relationship:

Corporate controller is the immediate superior to Business Unit controller.


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It is an organization unit that is headed by a manager

who is responsible for its activities.

Management control focuses on the behavior of the

managers in responsibility centers.

The responsibility center exists to accomplish one or

more activities(purposes) known as the objectives.


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The objective of the responsibility center is to helpimplement the strategies.

The inputs are - physical quantities of materials.the labor time or hours of work put in by people,

the variety of services.

The outputs are - goods (if tangibles),services(ifintangible). Every responsibility center produces

the output.

work Output (goods/services)Input (Resourcesused

measured by cost)


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1) Direct: Physical inputs used and physical outputis obtained (eg. Manufacturing department)

Focus of control is on: time taken, quantityproduced,quality and specification achieved, howmuch quantity of inputs used.

2) Not Direct: Where relation between input andoutput cannot be measured correctly. Eg.

Advertising expenses to sales volume, R&D

expenses to its success. It is more of judgementin such cases for control.


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The efficiency and effectiveness are used tomeasure the input & output.

Efficiency It is a ratio of output to input. Theamount of output per unit of input. Hence thecomparison of actuals with standards. Doing thethings right

Effectiveness: The relationship between

responsibility centers output to its objectives. Doingthe right things.


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1) Expenses center

2) Revenue center

3) Profit center

4) Investment center

1) Expense center

a) Engineered expensesb) Discretionary expenses


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` Optimal relationship can be established between

input & output.

Eg. Manufacturing function; warehousing;distribution; staff function like accounts, HRD,etc.

work Output (physical)Input (rupees)


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` Efficiency is related to inputs used for producing

the given outputs

` Effectiveness relates to the quality (standards)built into the output.


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` Optimal relationship between input and output

cannot be established

WorkInputs

(Rs)

Output

(physical)


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` Most costs are discretionary in nature guidedby the policy and judgment of managementbut it is not haphazard E.g.. R&D expenses,P&R expenses, advertising expenses,administrating and marketing(order gettingand not order filling)

` The difference between budget and actual isnot a measure of efficiency. The effectivenessis measured by goals and objectives

achieved.

` Budgets describe the amount that can bespent.


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` Input not related to output

WorkInputs (Rupees

only for costs

directly

incurred)

Output

(physical)


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` Output is measured in monetary terms. No formal

attempt is made to relate(expenses, costs) inputs

to outputs

` Marketing organization is the revenue center as

they do not have profit responsibility. No authority

to set selling price is given.

` Each revenue center is a expense center as the

revenue center manager is held accountable forthe expenses incurred directly within the unit.


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` Profit= Revenue- Expenses

` Inputs are related to output.

` Profit center is an organization where both revenue

and expenses are measured in monetary terms.

WorkInputs

(Rupees)

Output

(Rupees)


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To generate revenue the expenses are necessary (must

be made)

The manager concerned is therefore need to achieve a

trade off between revenue and expenses. For this the

manager should have the related information to make

the trade off.

There should be some measures to judge how

effectively the manager is making the trade off.These

two factors are the success factors for profit center.


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Advantages of Profit Center:

1. Delegation of Decision Making.2. Improved Quality of decisions as decision maker

(manager) is closest to the point of decision

3. The top management (corporate offices is relieved of dayto day decisions.) Hence can concentrate on broaderissues.

4. Enhancement of Profit Consciousness.

5. Provides good training ground to groom generalmanager.

6. Provides better performance measure as profit is easilyunderstood.

7. Generates specialists


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Difficulties with Profit Center:

1. Loss of control by top management due to delegation of

decision making.

2. Competent General Managers may not be there.

3. Possibility of unhealthy competition between two units of

organisation as profitability is the measure of

performance.

4. Shifting of long term objectives to short term gain.

5. Results into additional costs.


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Business Unit as Profit Center

Constraints on Authority

Business Unit not completely autonomous. Business

Unit represents trade off between corporate constraints

and Business Unit autonomy. How well this trade off ismade speaks about effectiveness of Business Unit.

To retain the advantages of size and synergy the total

autonomy is not feasible.


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Constraints from other Business Units

Where the Business Units are required to dealwith one another the constraints occur. Theconstraints on decisions related to productdecisions, procurement decisions and marketingdecisions appear far more acute if the organization

is integrated on higher scale.

Measuring the performance and allocating

contribution of each Business Unit to the overallsuccess of product is difficult is when the productline is single.


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Corporate management is imposed constraints on

Business Units

1. Constraints resulting from strategic consideration

particularly financial decision.

2. Constraints due to the necessity of uniformity in

organisation working.

3. Economies of centralisation


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Marketing as a Profit Center

When the manager concerned is in the best

position to make the revenue and expense trade off, then

marketing can be made as profit center.

Marketing as a Profit center is feasible

particularly in cases where marketing is spread in

different geographical areas where conditions are

different. The central control is difficult.


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To enable marketing manager to take

decision on cost or revenue trade off, themarketing department is charged with cost ofproducts sold.

The cost to be charged should be standard

and not actual.

This is to protect the marketing manager frominefficiency of manufacturing department.


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Manufacturing as a Profit Center

It is usually a expense center. The overallmeasure of manufacturing organization is

obtained if it is treated as profit center.

In expense center the performance of

manufacturing is measured against standard cost.

Where standard cost is used has measure of

performance, the quality control, productionscheduling, make or buy choice, setting

standards, should be controlled separately.


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To make manufacturing work as a profit centre.The manufacturing should be given credit for the goods

sold. The credit to be given should be selling price less

marketing expenses.

The arrangement is not totally perfect but works

better. The factors that influence volumes and sales mix

are outside the control of manufacturing, hence thispractice is not perfect totally.


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Two types of profitability measurement are

1. Performance of management.

Focus is on how well the manager is performing.

Reason:To motivate the manager to perform better

Also to assist the manager to carryout the day to dayactivities of

profit center through planning, coordinating and control.

2. Economic Performance:

Focus is to judge how well the profit center is doing as an

economic entity.

3.3. Profitability MeasurementProfitability Measurement


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Types of Profitability Measures

Rs.Rs. MeasuresMeasures

RevenueRevenue 10001000

Cost of SalesCost of Sales (600)(600)

Variable ExpensesVariable Expenses (180)(180)

Contribution MarginContribution Margin 220220 11

Fixed expenses of Profit CenterFixed expenses of Profit Center (90)(90)

Direct ProfitDirect Profit 130130 22

Controllable Corporate chargeControllable Corporate charge (10)(10)

Controllable ProfitControllable Profit 120120 33

Other Corporate allocationOther Corporate allocation (20)(20)Income before TaxIncome before Tax 100100 44

TaxTax (40)(40)

Net IncomeNet Income 6060 55


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` To judge economic preference of profit centre

the net income is used as the yard stick.

` To judge the performance of profit centre

manager the various measures (1-5) are used.


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` Profit centre manager has very less / no control on fixedexpenses.

` The focus of manager is therefore on maximizingrevenue and minimizing the variable expenses.

` The expenses that are fixed by budget and discretionaryin nature (R&D, advertising) such fixed expenses areunder (some) control of manager. Hence if contributionmargin is the profit criteria then the attention of manager

is diverted from this (discretionary / fixed expenses)responsibility.


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` The amount contributed to general overhead

and company profit.

`All the expenses incurred in profit centre(whether controllable or non controllable) are

taken in to consideration.


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` The profit centre has control on (few)corporate expenses therefore accepts the

share of corporate expenses

` In view of control / influence the manager hason corporate expenses the profit is measuredafter giving consideration for such expenses.


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The difficulty is:

` The manager of profit center would resist theacceptance of non-controllable expenses ofcorporate department.

` A satisfactory method of expense allocation is difficultto arrive at.

4.INCOMEBEFORE TAX4.INCOMEBEFORE TAX

This method of profit recognition indicates the considerationof all allocable corporate expenses for profit center.


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The advantages are:

The corporate is formed to control the expenses(which are non controllable by profit center butallocated / charged to profit center).

The performance of center is more realistic and

comparable with competitors.

Forces profit center manager to earn the revenuethat covers all the expenses.


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` The consideration of tax is a justified matter if profitcenter influences taxation.

` This influence could be due to tax. concession enjoyedby profit center at domestic level.

` The variation in tax caused by different tax rates indifferent overseas countries.

` But in most cases tax and taxation decision are beyondthe control of profit center manager as they arecontrolled by corporate office.

` Hence net income is not accepted as profitmeasurement.


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The judgment regarding the measurement of

revenues and cost should be guided by not just theaccounting considerations but more by behavioral

and motivational considerations.

The revenues and expenses on which the managerhas influence therefore need to be given

consideration in judging the managers

performance


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` When two or more profit centers are jointlyresponsible for product development,manufacturingand marketing they interact on regular basis ,theregular interaction gives rise to a possibility that what

is best for one profit center hurts another profit centerand that has a negative impact on the entireorganization.

` When the profit center are jointly responsible as

stated above each should share the revenue,that isgenerated when the product is finally sold.


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` The joint responsibility gives rise to a situation where inone profit center provides/supplies product or servicesto other profit center and charges for such

transfer(supply).

` TransferPricing is therefore an amount changed by oneprofit center of an organization to other profit center ofthe (same) organization for the product/servicessupplied.

Purpose of Transfer Pricing.

1) Helps managers to take division on ,to buy or sell

product/services inside or outside the organization.2)Assists to evaluate the performance of profit center and

motives both buying and selling manager towards goalmanagement decisions


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Fundamental Principle:

TP should be similar to the price that would be changed if the

products were sold to the outside customers or purchased fromoutside supplier or vendors

Decisions to be made:

Sourcing Decisions

To buy or sell from within or outside the company

Transfer price decision

If sourcing is from within what TP should be changed


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An ideal situation for TP to be similar to market price

calls for the existence of :

Competent people

Good atmosphere: TP should perceived as just/right

Market Price

Freedom to source

Full flow of information

Negotiation(Existence of working mechanism for negotiating

contracts between BUs)


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Market price as TP does not work (TP is affected) if anyone of the conditions are not existing.

Constraints on sourcing occur due to non feasibilityarising out of limited market. The market constraints arethe market for intermediate goods is not available or thecompanys product is unique / differentiated for thatmarket is not there.

Out side sourcing is constrained if the capacity is builtexclusively representing significant investment in facility.

Excess of/or shortage of industry capacitya) Excess capacity compels buying from within

b)Shortage of capacity compels not to sell outside.

Working against a & b harms the companys profit.

Market Price


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Cost Based T.P

` When market prices (competitive) are not

available TP is based on cost, cost plus profit.

` The standard cost is the base. The actual cost

is avoided to avoid passing on manufacturing

inefficiencies.


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` Cost percent or investment percent is the basis

` In both cost and profit mark up the expensessuch as selling ,advertising are not included as

the seller does not incur them in internal

transfer.


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` Each succeeding profit center adding its fixed cost

and profit in TP, the final product tends to be more

costly .

` To eliminate that problem the two step pricing is

used


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1) Consider variable cost of supplying unit2) Make periodic charge for fixed cost and profit

BU X is a seller of product ABU Y is buyer of product ABU x expects to sell monthly 5000 units

VC per unit Rs 5Monthly FC assigned to product A Rs 20000Investment (in working capital &facilities) RS.12,00,000Return on investment per year 10%Market price as TP does not work (TP is affected )if any one of

conditions are not satisfying .


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` TP working for product A from BU X to be sold /

transferred to BU Y` VC per unit Rs 5

` FC per unit (Rs.20000/5000 units) Rs 4

` Profit per unit(1200000/12)*0.10/5000 units Rs 2

(10% of monthly investment per unit)` T.P Rs.11

Let us assume :


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` Let us assume :-

1.Monthly sales (expected units ) 5000

2.Monthly sales (less than expected unit) 40003.Monthly sales (more than expected sales) 6000

TP and BU Y to pay to BU X1.Expected units : 5000* Rs 11 = 55000

2.Less than expected units 4000* Rs11 = 440003.More than expected unit 6000* Rs11 = 66000

Now by two step Pricing model

Take VC Rs 5Take monthly Rs 20,000 lump sumTake monthly return Rs 10,000 lump sum[Rs 10000 return = (Rs 1200000*0.10)/12months]


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` BU Y pays to BU X:-

Units 5000 4000 6000

VC (Rs 5*units) 25000 20000 30000

Monthly FC (Rs.) 20000 20000 20000

Return(profit) (Rs.) 10000 10000 10000

TP (Rs.) 55000 50000 60000


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In Two step pricing

` BU Y pays more if units purchase is less than

expected units Case of 4000 units

`

BU Y pays less if units purchased is more thanexpected units Case of 6000 units.


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Units 5000 4000 6000Two step price(Rs) 55000 50000 60000TP (Rs) 55000 44000 66000

-----------------------------------Difference nil +6000 - 6000

BU Y pays Rs 6000/- more if units purchased isdropped to 4000. This is a penalty for not using thecapacity (reserved) by BU X.BU X saves Rs 6000 if units purchased goes up toRs 6000 from BU Y as BU X does not require toinvest additional FC to produce the additional units


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` Profit= Revenue-Expenses

` Profit center is a division/unit where the relation between

inputs and outputs is the focus. Both the inputs and the

outputs are measured in rupees terms.

` The expenses and revenues relate to the operating side.

` When the profit is compared with assets employed in

earning it(profit) it is the investment center.

` The relation between the capital employed by the way of

investments in assets and the profit is the investmentcenter.


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` Investment is in the current assets( cash,

receivables, inventories) and fixed assets

(land, building, plant and machinery)

` Corporate equity and current liabilities are the

sources of investment in assets.

` The sum of assets employed in the investmentcenter is the investment base for earning the

profits.

` The two methods of relating profit to

investment base are (1) ROI (2) EVA (residualincome)

` EVA= Economic Value Added


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Why measure assets employed?

1) To provide information which is useful for making

decision about the assets employed

2) To motivate managers to make sound decisions which

are in the best interest of the company.

3) To measure the performance of business unit as an

economic entity.

Two companies with the similar risk profile with different

investment base(capital employed) show differentperformance though their profit is similar/equal.


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Asset base or investment base of Rs.5 and Rs.10 for

company A and company B having Re.1P

rofitrespectively give different performance indicators.

Company A with smaller capital investment base is a

better performing company.

The objectives of the BU manager are

1. To earn adequate profit from the resources at his/her

command.

2. To invest in additional resources only when such

investment earn adequate return.


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LiabilityLiability Rs.Rs. AssetsAssets Rs.Rs.

EquityEquity 500500 F.A cost 600F.A cost 600

CLCL Depreciation 300Depreciation 300 300300

Account payableAccount payable 9090 Book value 300Book value 300

Other CLOther CL 110110 CA (cash 50+receivableCA (cash 50+receivable150+ inventory150+ inventory200=400)200=400)

400400

Total CL(90+110)Total CL(90+110) 200200

Total LiabilityTotal Liability 700700 Total AssetsTotal Assets 700700


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Assets employed/ Capital employed

IRs.

Total assets 700

Less C.L 200

500

II

Non current assets 300

Plus working capital 200C.A C.L=WC (400-200)

500

III


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LiabilityLiability RsRs AssetsAssets Rs.Rs.

CLCL 200200 C.AC.A 400400

Long term liabilityLong term liability 400400 F.AF.A 800800

EquityEquity 0000 Capital WIPCapital WIP 100100

TotalTotal 13001300 TotalTotal 13001300

Total Assets= 1300

Total Asset employed =1300-100 (CWIP)= 1200

TA-CL: 1300-200=1100 (LTC+Equity) (400+700)

Equity :700 1100


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`

It is the cost of capital. Capital charge is determined bycorporate HQ.

` Cost of equity, Cost of debt and Cost of working capital are

the components of capital charge.

` Capital charge is set above the cost of debt as

(i) debt is cheaper

(ii) capital involves debt + equity ( the cost of equity is usually

high)

The W.C cost is set at lower than F.A cost as investment

base is inclusive of debtors/receivables and inventory at

gross value.

Also funds from accounts payable are at zero interest.

I.Calculation ofEVA and ROI


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RsRs

RevenueRevenue 10001000

Expenses 850Expenses 850Depn 50Depn 50 900900

PBT (income before tax)PBT (income before tax) 100100

Tax 35%Tax 35% 3535

PATPAT 6565Capital Charge (10% on 500)Capital Charge (10% on 500) 5050

EVAEVA 1515

ROI: 65 = 13%

500

ROI without Tax 100 = 20%

500

EVA without Tax 50 (100-50 i.e PBT-C/C)


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LiabilitiesLiabilities RsRs AssetsAssets Rs.Rs.

EquityEquity 100100 FAFA 140140

DebtDebt 100100 Net CANet CA 6060

TotalTotal 200200 200200

Profit and Loss accountProfit and Loss account Rs.Rs.

Net salesNet sales 0000

Cost of goods soldCost of goods sold 258258

PBITPBIT 4242

Interest(12% of DebtInterest(12% of Debt--100)100) 1212PBTPBT 00

Tax @ 0%Tax @ 0% 99

PATPAT 2121

Cost of Equity 18%

Cost of debt 12%


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` WACC: Debt and equity form equal proportion (50:50)

` Hence 0.5*18 +0.5*8.4 = 13.20%

` Cost of Debt= I(1-T)= 12 (1-0.3) =8.4%` ROI PAT 21 = 10.50%

Investment 200

` EVA 1) NOPAT= (PBIT)(1-T)

42(1-0.3) = 29.40Less C/C (200*13.20%) = 26.40

EVA = 3.00

2) PAT - Cost of Equity = 21-18(Equity -100 X 18%)

EVA = 3

EVA therefore is a residual income arrived at by


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EVA therefore is a residual income arrived at by

deducting capital charge from the net operating profit.

EVA is the true economic profit of an enterprise.

EVA is the performance measure most directly linked to

the creation of shareholder wealth.

EVA is the amount by which earning exceed or fall

short of the required minimum rate of return that the

shareholders or lenders could get by investing in othersecurities of comparable risk.

EVA is rupee amount of wealth the company has

created or destroyed in each reporting period.

ROI is the ratio between income [NOPAT] and Asset


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ROI is the ratio between income [NOPAT] and Assetemployed/ Capital employed.

To decide the investment base for evaluating

managers performance it is necessary to understand thetype of practices which induce the manager to efficientlyuse the assets, to acquire the new assets. To measure theperformance of the unit as economic entity.

Cash:It is a current asset. In most companies cash is controlledcentrally for optimum use of cash.The cash balance at BUis small.

To show a comparable cash balance in investment base ,

a large cash balance is taken using some formula like % ofannual sales.

If actual/smaller cash balance is shown the return tend tobe very high.

Receivables:


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Receivables:

The BU manager is responsible for collecting the

receivables. Therefore the manager influences the level ofreceivables (to boost sales) as also the credit terms.

The end period balance on intra period balance is taken in

the investment base

The consideration of receivables at cost (cost of goodssold) or at selling price is dependent upon the liberty given

to BU to use (reinvest) the collection or not. If yes, the base

is selling price or else cost alone.

If BU is not controlling the credit terms or collection, then

based on formula (say 30 / 60 / 90 days of sale) the

receivables are taken.

I t


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Inventory:

Inventory at the end of period is considered.Standard cost /average cost is the basis of inventory valuation. The same base isused to measure the cost of sales on BU P/L account.

In case of work in progress (WIP), if advance payment isreceived from buyer/customer,the said advance is deducted fromWIP inventory value or shown as liability (advances received forgoods to be supplied).

The account payable is deducted from raw material inventory ascreditors represent zero cost financing .

When BU manger is in a position to influence the payment terms,account payable is included to encourage manager to seekfavorable terms


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Measurement of Fixed Assets:

THE CONSIDERATIONS ARE :

1. Acquisition of New Asset/equipment.

2. Gross Book Value/ Gross Block3. Disposition/Sale/Removal of Asset

4. Depreciation

5. Leased asset, Idle asset, Intangible assets.

Acquisition of New Asset/ Equipment :


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Acquisition of New Asset/ Equipment :

(Rs 000)

Investment in m/c Rs 100.00

Life 5 yearsSavings/cash inflow Rs 27000 per year

10% rate of return

P.V. of cash flow for 5 years 27000 X 3.791 Rs 102.40

NPV (102.40 100) =2.40

Decision: To acquire the asset i.e. machine

P/L

Before acquisition 1st year with m/c

Rs Rs

Revenue 1000 1000Expenses 850 823

Depreciation 50 900 70 893

Income before tax 100 107 Capitalcharge @ 10% 50 60

EVA 50 47

Note : Expenses have come down by 27 which is due to savings/cash


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Note : Expenses have come down by 27 which is due to savings/cashinflow

resulting from acquisition of machine.

Depreciation is increased by 20 (70 50)

Depreciation = investment in machine = 100 = 20

Life of machine 5

Profit is increased by 7 (107 100).

EVA is dropped by 3 (50 47) which is due to increase in capital charge.

The manager of BU is not encouraged by drop in EVAto acquire the new machine.

From company point of view the situation is favourableas income is increased.

As the asset depreciates, the EVA improves as the income (profit stays)remains the same


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Year Book value Incremental Capital EVA ROI

at the start Income charge (B-C) (B/A)

year (107 100) @ 10% on A Rs100 7 10 -3 7%

1 80 7 8 -1 9%

2 60 7 6 1 12%

3 40 7 4 3 18%

4 20 7 2 5 35%

Declining Book value is due to the asset depreciating by Rs. 20 every yearover

the life of machine which is 5 years.

The depreciable assets included at net book value misstates BU profitability.

The BU manager may not be motivated to take correct investment/ acquisition

decisions.

remains the same.

G B k V l


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YearYear GBV(Rs.)GBV(Rs.) Income(RsIncome(Rs

))

C/C(Rs)C/C(Rs) EVA (Rs.)EVA (Rs.) ROIROI

(%)(%)

11 100100 1010 --33

22 100100 1010 --33

33 100100 1010 --33

44 100100 1010 --33

55 100100 1010 --33

Gross BookValue

Using GBV as investment base shows decline in

profitability which is not the case


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Disposition of Asset

ParticularsParticulars GBVGBV Year 1Year 1

(Net B.V.)(Net B.V.)

Year 2Year 2

EndEnd

Opening BalanceOpening Balance 10001000 5050 5050

Add new machineAdd new machine 100100 100100 9090

Less Old MachineLess Old Machine 5050 1010 55

10501050 840840 835835

With GBV as basis for investment base BU manager is

motivated to get rid of the asset even though the asset hasuseful life left. The substantial reduction in investment

base is the cause for the managers motivation

(Rs.)

Leased Asset

L d t d t th b l h t H


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Leased assets do not appear on the balance sheet. Hence

depreciation on them also does not appear. The lease rent instead

appears as expenses in Profit and Loss Account.

The Low/small investment base reduces (keeps the)

capital charge at the low level. Hence EVA shows improvement.

Therefore the manager is encouraged to have leased assed than

owned assets.

ParticularsParticulars OwnedOwnedassetasset

LeasedLeasedassetasset

RevenueRevenue 10001000 10001000

ExpensesExpenses 850850 850850

DepreciationDepreciation 5050 900900 ------

Lease RentLease Rent -------- ------ 6060 910910

Income before TaxIncome before Tax 100100 9090

Capital chargeCapital charge (500 x(500 x10%)10%)

5050 (200 x(200 x10%)10%)

2020

EVAEVA 5050 00

Rs.


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Idle Asset

Permit BU manager to remove idle asset from

investment base if such(idle) assets are useful to other units

Do not permit the removal if idle assets are not useful to

other units since this would encourage the manager to remove

/idle out the partially, idle assets that are not giving returns as

per the BU profit objective.

Any contribution from partially used assets adds to the

profit.


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ROI V/SEVA:

ROI is a ratio. It is measured on percentage terms.

Anything affects the financial statement is reflected

in ROI.

It is easy to understand and meaningful in absolute

sense. It is a common denominator applicable to any

organizational unit irrespective of the size and

business.

Comparison is easy.


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Div A

Div A

Div B

Div B

Div A

Div A

Div B

Div B

NOINOI 200200 5050 2 52 5 125125

Invested CapInvested Cap 10001000 10001000 15001500 15001500

ROI(Income/Cap)ROI(Income/Cap) 20%20% 5%5% 18.3%18.3% 8.3%8.3%

Capital charge (8% xCapital charge (8% xcap)cap)

8080 8080 120120 120120

EVA (IncomeEVA (Income--C/C)C/C) 120120 --3030 155155 55

ROI as a basis will not induce Division A manger to go for Profit.

EVA as a basis will encourage both Division A and B mangers to

invest in projects.

EVA helps achieve goal congruence.

Particulars With ProjectWithout Project

MVA Calculation ( Rs.)MVA Calculation ( Rs.) 20002000 19991999


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Price per sharePrice per share 2323 2626

Number of SharesNumber of Shares 5050 5050

Market value of EquityMarket value of Equity 11501150 13001300

Book value of Equity(Equity+Retained Earnings)Book value of Equity(Equity+Retained Earnings) 896896 840840

MVA=Market valueMVA=Market value--Book valueBook value 254254 460460

EVA Calculation (Rs)EVA Calculation (Rs) 20002000 19991999

EBITEBIT 284284 263263

Less tax @ 40 %Less tax @ 40 % 114114 105105

NOPATNOPAT 1 01 0 158158

CapitalCapital 18001800 15201520ROI (1 0/1800) (158/1520)ROI (1 0/1800) (158/1520) 9.44%9.44% 10.40%10.40%

After tax cost of CapitalAfter tax cost of Capital 10%10% 10.3%10.3%

Capital chargeCapital charge 180180 1515

EVA=NOPATEVA=NOPAT--Capital chargeCapital charge --1010 11


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Value Addition

EVA more than Zero

Value Destruction

EVA less than Zero


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5.MANAGEMENT COMPENSATION

Incentive compensation is an important mechanism that encourages andmotivates managers to achieve the company objective. Hence it is key

management control device.

The Compensation plans can be :

Short Term Plan :- Which relate compensations to profits currently earned by the

company.

Long Term Plan :- Related to the long term performance of the company.

The incentive system that incorporates :

( i ) The needs, values and beliefs of GM

s who are rewarded( ii ) The culture of the organisation

( iii ) Industry characteristics, competitors compensation practice,

managerial labour market, tax and legal issues are the external

factors

( iv ) Organisations strategies


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Philosophy of Incentive Compensation :

1. Fixed pay

2. Performance based pay

Fixed Pay Philosophy :

Recruit Good Pay Them Expect GoodPeople well performance

Performance Based Pay :

Recruit Good Expect Good Pay Them Well if,

People Performance Performance is

Actually Good.

Types of Incentives Compensation Design :


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1. Types of Incentives :

( a ) Financial Rewards :- Salary, Bonus, Benefits, Perquisites.( b ) Psychological and Social rewards :- Promotion possibilities, Increased

responsibilities, Enhanced autonomy, Recognition, Better geographical

location.

2.

Size of

Bonus relative to

Salary :

( a ) Upper Cutoff : The level of performance at which a maximum bonus is

reached

( b ) Lower Cutoff : The level of performance below which no bonus awards

be allowed / made

3. Bonus Based on :

( a ) B.U. Profits

( b ) Company Profits

( c ) Mix of the Two ( a & b )

4 P f C i i


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4. Performance Criteria :

( a ) Financial Criteria:

1. Contribution margin

2. Direct B.U. Profit3. Controllable B.U. Profit

4. Income before tax

5. Net income

6. ROI

7. EVA

( b ) Time Period :

1. Annual financial performances

2. Multiyear financial performances

( c ) Non Financial Criteria

1. Sales growth

2. Market share3. Quality

4. Customer satisfaction

5. New product development

6. Public responsibility

( d ) Relative weights assigned to Financial and Non Financial criteria


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( d ) Relative weights assigned to Financial and Non Financial criteria

( e ) Benchmark for Compensation:

( i ) Profit budget( ii ) Past performance

( iii ) Competitors performance

( f ) Bonus Determination Approach:

( i ) Formula based

( ii ) Subjective( iii ) mix of ( i ) and ( ii )

5. Forms ofBonus Payments :

( i ) Cash

( ii ) Stock( iii ) Stock options

( iv ) Phantom shares

( v ) Performance shares ( awarding specified number of shares on

achieving the specific long term goals like growth of EPS over a

given period of time of 3 to 5 years )

Agency Theory :


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Agency Theory :

Principals and agents have divergent preferences /

objectives

The divergent preference can be reduced through the

control mechanism of,

( a ) Monitoring and

( b ) Incentive contracts


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PERFORMANCE MEASUREMENT

To exercise effective management the managers

require information.

The sources of information are informal and formal.

T

he informal information is collected through talkingto people.

Formal information is collected through:

Task control reports, [like production schedules,

materials control, payroll, etc]. Financial information [through budgets].

Non-financial information [key success factors,

strategic factors, key variables].


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The performance measure system [PMS] gives the

insight to the manager on what has happened[financial information which shows results of

past decisions]. And what is going to happen.

What has happened and what is going to happen

helps the managers to strike a trade off.

Balanced Scorecard :- [BS]


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[ ]BS is an example ofPMS. It tries to bring a balancebetween different strategic measures to achieve goalcongruence, thus enabling and encouraging the employeesto act in the best interest of the organisation.

The measures on BS address the aspects of company'sstrategy, hence focuses on:i.Critical success factors

ii.Relationship among the individual measures like how non-financial measures affect the long term financial results,thus cause and effect is established.The effort of BS is to create the blend of strategic measureslike :

i.Outcome and driver measure.ii.Financial and non-financial measure.iii.Internal and external measures.

Financial perspectiveHow do the customers

see the company

How does the

company look to


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Innovation and learning

Perspective

% Revenue from New service,

Rate of Improvement Index,Staff Attitude Survey,

Employee suggestion

Revenue Per Employee

ROCE/ Cash Flow

Project Profitability

Profit Forecast Reliability

Sales Backlog

Customer

Perspective

Customer

Ranking,Customer

Satisfaction,

Market Share,

Pricing

Internal

Business

Perspective

Time with

customer,

Rework Tender

Success Rate,

Safety,

Project

Performance.

see the company company look to

stock holder

What must the Co do

to excel internallyHow does the Co learn

to create & innovate

future

Implementing the Balanced Scorecard:

1 Define Strategy


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1. Define Strategy

2. Define Measures of strategy

3. To link the Measures to the Management System.

4. Review the measure and Results Periodically.

Cause and Effect relationship among measures:-

Perspective Measures

Innovation & learning Manufacturing Skills

Internal Business

Customer

Financial

Order Cycle Time

Sales, Revenue Growth

Cust Satisfaction Survey


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Control System as a Strategy Formation Tool :


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Control System as a Strategy Formation Tool :-

Strategic Uncertainties

Use of Subset of management

Control Information

Interactively

New Strategy


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Strategic Uncertainties refer to fundamental stuffs [likechanges in customer preferences, technologies,

competition, substitute products etc].

Interactive Controls alters management about thestrategic uncertainties. This helps the managers to adoptto a rapidly changing environment.

Interactive Control is not a separate system but a part ofthe system.

Usually and not necessarily the interactive controls arenon-financial in nature.


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The purpose of MCS is to help to implement thestrategies. Different strategies influence themanagement control process.

Many factors influence organisation

structure & management control process.The linkages between control & strategy

is based on the logic that1. Different organisation operate in different strategic

control.2. Different strategies require different task priorities,

different key success factors, different skills,perspectives & behaviour for effective execution.


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3. Control systems are measurement systemsthat influence the behaviour of those peoplewhose activities are being measured.

4. A good control system is one where the

behaviour induced by the system is consistentwith the strategy.

There is a relationship betweendifferent business level strategies different

mission that is build, hold, harvest and differentcompetitive advantage- low cost differentiationand form and control system.


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StrategyStrategy Single industrySingle industry UnrelatedUnrelateddiversificationdiversification

RelatedRelateddiversificatidiversificationon

Organisational structureOrganisational structure FunctionalFunctional Holding companyHolding company B. U.B. U.

1.1. Industry familiarityIndustry familiarity

of corporateof corporatemanagementmanagement

HighHigh LowLow

2.2. FunctionalFunctionalbackground ofbackground ofcorporatecorporatemanagementmanagement

RelativeRelativeoperatingoperatingexperienceexperiencemanufacturing,manufacturing,

marketing,marketing,R & DR & D

Mainly financeMainly finance

3.3. Decision makingDecision makingauthorityauthority

MoreMorecentralizedcentralized

MoreMoredecentralizeddecentralized


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StrategyStrategy SingleSingleindustryindustry

UnrelatedUnrelateddiversificationdiversification

RelatedRelateddiversificatidiversificationon

Organisational structureOrganisational structure FunctionalFunctional HoldingHoldingcompanycompany b. u.b. u.

4.4. Si e of corporate staffSi e of corporate staff HighHigh LowLow

5.5. Reliance on internalReliance on internalpromotionspromotions

HighHigh LowLow

6.6. Use of lateral transfersUse of lateral transfers HighHigh LowLow

7.7. Corporate cultureCorporate culture StrongStrong WeakWeak


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MissionMission BuildBuild HarvestHarvest

Strategic Planning ProcessStrategic Planning Process1.1. Importance ofImportance of

strategic planningstrategic planningRelatively HighRelatively High Relatively lowRelatively low

2.2. Formalisation ofFormalisation ofcapital expenditurecapital expendituredecisiondecision

Less formal, DCF analysis,Less formal, DCF analysis,longer payback periodlonger payback period

More formal, DCFMore formal, DCFanalysis shorter paybackanalysis shorter paybackperiodperiod

.

. Capital ExpenditureCapital Expenditureevaluation criteriaevaluation criteria

More emphasis on NonMore emphasis on Non--Financial data ( MarketFinancial data ( MarketShare, efficient R & D )Share, efficient R & D )

More stress on financialMore stress on financialdata ( Cost efficiency,data ( Cost efficiency,incremental returns )incremental returns )

.

. Discount ratesDiscount rates Relatively highRelatively high Relatively lowRelatively low

5.5. Capital InvestmentCapital Investment

analysisanalysis

More subjective &More subjective &

qualitativequalitative

More objective &More objective &

quantitativequantitative6.6. Project approvalProject approval

limits at B.U. Levellimits at B.U. LevelRelatively highRelatively high Relatively lowRelatively low


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1.1. Role of budgetRole of budget More a short term toolMore a short term tool More a control toolMore a control tool

2.2. B.U. managers influenceB.U. managers influencein preparing the budgetin preparing the budget

Relatively highRelatively high Relatively lowRelatively low

3.3. Revisions to the budgetRevisions to the budget

during the yearduring the year

Relatively easyRelatively easy Relatively difficultRelatively difficult

4.4. Frequency of informalFrequency of informal

reporting & contactsreporting & contacts

with superiorswith superiors

More frequent on policy issues,More frequent on policy issues,

ess frequent on operatingess frequent on operating

issuesissues

ess frequent on policyess frequent on policy

issues, more frequent onissues, more frequent on

operating issuesoperating issues

5.5. Frequency of feedbackFrequency of feedback

on actual performance toon actual performance to

budget from superiorsbudget from superiors

Control limits used onControl limits used on

periodic evaluationperiodic evaluation

against the budgetagainst the budget

Importance attached toImportance attached tomeeting budgetmeeting budget

Output vs. behaviourOutput vs. behaviour

controlcontrol

ess ofteness often

Relatively high i.e., moreRelatively high i.e., more

flexibleflexible

Relatively lowRelatively low

Behaviour controlBehaviour control

More oftenMore often

Relatively low i.e., less flexibleRelatively low i.e., less flexible

Relatively highRelatively high

Output controlOutput control


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1.1. PercentagePercentage

compensation ascompensation as

bonusbonus

Relatively highRelatively high Relatively lowRelatively low

2.2. Bonus CriteriaBonus Criteria More emphasis on nonMore emphasis on non--

financial criteriafinancial criteria

More emphasis on FinancialMore emphasis on Financial

criteriacriteria.. Bonus eterminationBonus etermination

approachapproach

More subjectiveMore subjective More formula basedMore formula based

4.4. Frequency of bonusFrequency of bonus

paymentpayment

ess frequentess frequent More frequentMore frequent


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` Theory X, Theory Y Theory X oriented managers tend to have tight control

while theory Y oriented managers have loose control.

The background & personality of the manager

determines the style of management

SERVICE ORGANISATION


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Health care, educational, transportation, communication, financial,

insurance, real estate, law firms, Chartered Accountants, govt. services etcare the service organization.

Characteristics ofService Organization :

1. Absence of buffer inventory:Hence matching of current capacity with demand.

Adjusting off peak time with capacity is a key issue.

2. Difficulty in controlling the quality.

3. Labour intensive.

Building of cost data is helping in implementation of MCS in service

organization.

Professional organizations do not have a dominant goal of return on

asset employed unlike in manufacturing organization.

SERVICE ORGANISATION

The skill is the asset hence tangible goals are difficult to be set


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Professional organizations have their own behavioral characteristics

hence output measurement are subjective. It cannot be measured in quantity

terms.

The measurement of input is the time spent.

The measure of output is the effectiveness.

Small Size :

By and large the professional organizations are small in size,enabling thereby the top management to personally observe the working and

thus motivate the people. Therefore, there is less need for sophisticated MCS.

Nevertheless, budget, budget analysis, compensation are the MCS tools

needed.

In professional organizations, there is no clear cut line

between production and marketing.

Some professional organizations are governed by code of

conduct, hence no open marketing.

MCS i P f i l O i ti


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MCS in Professional Organization :1. Price :

Pricing is time based, since skill is the asset, the time spent isconsidered as the basis for pricing.

The cost involved, is the cost of acquiring the skill and cost of training

which are factored in time.

2. Profit centre and Transfer pricing :

Charging the unit for such services like maintenance, MIS,

transportation, telecommunication, etc., by the support units on profit centreconcept.

The principles of T.P. are the same as of for manufacturing

organization.

Strategic Planning :

Is mainly centered around long range staffing plan.Budgeting is similar to manufacturing organization.

The control of operations :

The attention is on scheduling of time. The ratio of available hours to

the billed hours.

Performance Measurement and Appraisal :

The performance measurement is judgment based in relation to skills


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p j g

and qualification.

Appraisal is by superiors, subordinates, peers and self appraisal. For

cost performance, budget is used as basis. For time utilization (time budget)budgeted time V/S actual time.

Health Care Organization :

Hospital, clinics, physicians organization, health maintenance

organization, etc.,

Health care is a social problem. The development in medical science

has improved the life span. The increased life span calls for suitable health care

facilities.

Third Party Payers :

Govt., Insurance Cos, Employees association are the payers to a largeextent, hence cost control was not the real issue in health care organization.

The diagnostic related group act as an assessor of medical expenses based

on which the hospitals are reimbursed. This has made hospitals cost conscious,

hence cost accounting systems are practiced.


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MCS process in health care organization comprises of strategic planning,

budgeting, analysis of financial performances, performance measurement and

management compensation.

Non-Profit Organization :

An organization which earns the profit to fund the day to day requirements(i.e. working capital needs and provision for working in difficult period ) and not

with the intention to distribute the profit to the stake holders. Hence non-profit

organization need to earn the profit but a modest one.

The (profit) financial performance is not the dominant goal however for

survival it is a necessary goal. The use / interpretation of financial statement isdifferent. High profit is a signal of non-provision of adequate services to those who

supplied the resources and thereby had a right.

C t ib t d C it l


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Contributed Capital :

Unlike issue of shares and dividend payment, the capital contributed

by contributions in kind like building and equipment are providing funds forthese.

The donation, gifts & endowments form other means of capital contribution.

Fund Accounting :

The method of accounting where funds collected / contributed for

specific purpose are earmarked for and used for the intended purpose.

Governance :

Is by board of trustees the necessity of strong board is important as

vigilance of board is the only effective way of controlling the organisation and

detecting the poor performance.


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Product Pricing :

No adequate attention is paid in pricing. Full cost (direct cost and indirect

cost + some allowances for increasing organisations equity) basis is practiced.

Establishment of price before the service is provided help for better management

control.

Strategic Planning and Budget Making :Allocation of limited resources to the worthwhile activities is the

principle in strategic planning, hence it is more important and time consuming

process. The absence of profit, makes the decision more subjective.

The budget preparation process is similar to manufacturing / business organisation.

Operation and Evaluation :

The responsibility centre managers tend to spend whatever is allowed in

the budget. It can also be true that the opportunities are not tapped because of

budget not making any provision. Hence there is no particular way of what

optimum cost is.

Govt. Organisation :


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Electricity, water supply, sanitation, etc., are (govt. owned) service

organisations. Except for business like activities they operate like non-profit

organisation.Features: Political influence is high, hence operate under pressure.

Public Information :

The right to information (in democratic set up) makes the press stronger.

To reduce the opportunities for media stories, the sensitive information is

restricted. This lessens the effectiveness of the system.

Attitude Towards the Client :

Though clients are the revenue generating sources, additional clients are

taken as burden, as additional clients create further demand on fixed amount of

service capacity. This generates the well known complaints of poor services.

Red Tape :

Number of rules and regulations create red tape in the working.

Management Compensation :

By and large the managers are not adequately compensated compared to

the managers at same level in business. This makes govt. service unattractive.

MCS :


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Strategic Planning and Budgeting :

Allocation of limited resources makes the decision making

difficult. Political pressure prevails. Hence strategic planning is important.

Annual budget is the important control device.

Performance Measurement :

Expenses is the measure of input. But revenue is not the measure

of output. Hence the non-monetary measures like :Result measures

Process measures and

Social indicators, are developed

Result measures are also known as outcome measures and are

related to organisations objectives.

Process measures are related to the activity carried on by the

organisation. These relate to efficiency i.e. what was done rather than to

effectiveness i.e. that what was done helped achieve the organisation objective.

Social indicators are broad measure of output, reflecting the work of


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p , g

organisation. They are useful in the long range analysis of strategic problems.

Merchandising organisation :Retailers, wholesales, distributors are this type of organisation. They

are neither manufacturing nor service organisations.

Inventory is important in such organisation so procurement function

is important. Inventory and buying is the control device. Working capital

control is vital.Space utilization is the control mechanism. Sales per sq. ft. or sq. mtr

of showroom is worked out to measure the performance.


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Commercial banks, Insurance companies, securitiesfirms, etc., comprise the financial service

organisations.

Primarily to manage the money is the business of

Financial service organisations


131/151

The type of business determines the features:1. Banks: are the intermediaries. Receipt of deposits and

lending of money. Hence intermediation is the primary

feature of bank

2. Risk shifting : Insurance companies assume risk of

their clients. Collect the premium and assume the risk,

is the business of insurance companies.

3. Securities Firm: Deal in trading of securities i.e.,

buying and selling of securities either for their own

account or for their customers.

The general principle and concepts of MCS apply to FSO.

The special characteristics of FSO make the

adaptation different.


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1. MonetaryAssets:

Most of the assets of FSO are monetary, Hence themeasurement of the values is much more easy compared to the

measurement of value of plant, machinery, building.

Each rupee is worth a rupee valued at both its face amount and

purchasing power, what changes is the purchasing power and not

the rupee.Therefore everyones rupee has same quality at any given

point of time. Quality control safeguards for money is not required.

Easy transferability of money makes it vulnerable, hence the

protection is the biggest issue

` The

Physical measures to protect the currency

` The Documentary measures to protect the ownership

` The System measures to protect the integrity

These are the control issues


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2. Time Period for transaction:The time period for transaction are fairly long, hence the

success or failure of the bond, loan, insurance policy dependupon the soundness of loan or policy. The purchasing power andsoundness of policy may also change

The ultimate performance of designers of policy or product orpricing or selling cannot be measured immediately / in short run.

The control measures require continued surveillance ofsoundness of transaction, soundness of policy, periodic audits ofoutstanding loans.

The transactions involving securities are extremely informationsensitive as such in few minutes the transactions are completed.

The control issues in these type call for accurate, prompt

system of getting the information, summarizing the information,and thus estimating the risk of securities.


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3. Risk and Reward:The risk and reward / return trade off is moreexplicit in FSO. Risk is based on assumptionswhich may turn out to be accurate.

4. Technology:Technology has revolutionised FSO.

Innovative services, electronic market places,online banking, brokerage, web based

marketing, etc., are the results of technology.System protection is the control issue.


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The MCS applicable to controlling the foreign companies (MNCs)

are similar to domestic companies.

Many MNCs are legal entities incorporated in the host country and

hence must maintain complete set of accounting records for legal and tax

purpose.

The foreign operations can be organized as profit centre, investmentcentre, expenses centre, revenue centre.

In MCS operations in MNC compared with domestic company, two

different issues are prominent namely transfer pricing and exchange rate.

The design of MCS to MNC required to be attempted within the

context of cultures prevailing in that particular country. Hence the planningand control process of strategic planning, budget preparation, variance

analysis, reporting, performance evaluation and management compensation

should follow the cultural context of the country in which the organization is

operating.

Transfer Pricing :


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Besides the considerations applicable to Transfer Pricing in domestic

set-up, the additional consideration that govern Transfer Pricing are,

1. Taxation : Effective I.T rate differ among foreign countries2. Government Regulations

3. Tariffs

4. Foreign exchange controls

5. Funds accumulation: T P is a means to shift funds from one country

to another country6. Joint Ventures

Transfer Pricing method : ( As per sec 482 of USA IT Act.)

Cost based methods :

Variable Cost (actual or std VC)Full Cost (actual or std)

VC + Mark up

Full Cost + Mark up

Market Based Method :

M k t i


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Market price

Market price less selling expenses &

Negotiated price

1. Comparable uncontrolled price method

TP = Price paid in comparable uncontrolled sales +/- Adjustments

Controlled sales = Transaction between two members of a controlled Group.

Uncontrolled Sales = One of the two parties is not a member of controlled group.

2. Resale Price Method :

TP = Applicable resale price - Appropriate markup +/- Adjustments

Applicable Resale Price = The price at which the purchases are made in

controlled sale group and resold by the buyer

in uncontrolled sale.

3. Cost Plus Method

Exchange Rate :


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Exchange Rate :

MNC operate in different countries. The local (country) currency unit is

the measure of financial performanceWhile the consolidation is done at the corporate level, the

performance of all units is reported in single /one currency of parent company

country. Hence exchange rate plays a crucial role.

Exchange Rate Lead to Exchange Rate Exposures :

1. Translation Exposure2. Transaction Exposure

3. Economic Exposure

Translation Exposure :

Is the result of consolidation of financial performance (P-L & Balancesheet) into the single home country currency.

Transaction Exposure :

Results out of exchange rate fluctuations. The transactions entered

into today, the settlement of which take place at a future date.

Economic Exposure :

Exposure of companys cash flow to changes in real exchange

rate Economic exposure is due to the appreciation or depreciation of foreign


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rate. Economic exposure is due to the appreciation or depreciation of foreign

currency in relation to home currency

Control System Design Issues :

1. Should the subsidiary manager be held accountable / responsible for

exchange rate fluctuation effect.

2. Usage of local currency or home country currency in performanceevaluation

3. Should parent Co. distinguish between the effects of various types of

exchange rate exposures to evaluate the managers performance.

4. How to judge the performance of subsidiary Co. and the manager of

that Co. with respect to the effects of exchange rate exposures.

MANAGEMENTCONTROLOFPROJECT


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OPERATINGORGANISATIONS

Annul Planning

Strategies StrategicPlanning

Execution

Evaluation

R

evisio

n


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Decision toundertake StrategicPlanning DetailedPlanning Revision Revision

Evaluation

Phase 1

Execution

Phase 2

Execution

EvaluationFinal

Evaluation

Phase n

Execution

Time StartWork Complete

AProject is a set of activities intended to accomplish a specified end

result of sufficient importance to be of interest to management.


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Project

` Single objective

` Time horizon is the end of theproject

` Desired end product is basis forperformance judgment.

` Organisation structure issuperimposed on ongoingoperations structure. Hence,satisfactory relationship must beestablished between the two MCS isalso super imposed

` Focus is on end product withspecified time and cost

` Trade off is between scope,

schedule & cost` Standards are less reliable

` Frequent changes in plans

` Start, build, peak & taper is therhythm

` Greater Environmental influence

Ongoing Operations

` Multiple objectives

` Work is not limited to time horizon

` Todays operation and the futureoperation readiness is the basis tojudge the performance

` Organisation structure and MCSare set and work for long time oncontinuous basis

` Focus is on time specified activities& all products falling in that timeperiod

` Trade offs are not typical of day today activities

` Standards are more reliable

` Same activity level, steady rhythm

` Not much environmental effect


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a. Organisation Structure:i. Temporary and is disbanded after the project

ii. The employees from within the organisation when

associated have to work on project as additional work

assignment. Hence matrix organisation structure

iii. Different (specialist) types of management personnel

play their part at their specified part of project time


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b. Contractual Relationship:i. Fixed Price contract

ii. Cost reimbursement contract

Fixed PriceFixed Price

Better for project where scope canBetter for project where scope canbe specified in advancebe specified in advance

Uncertainties are lowUncertainties are low

Price is fixed taking into accountPrice is fixed taking into account

the contingencythe contingency High motivation towards costHigh motivation towards cost

controlcontrol

Cost ReimbursementCost Reimbursement

Scope cannot be determined inScope cannot be determined inadvanceadvance

Uncertainties are highUncertainties are high

Price does not includePrice does not include

contingency, since it is costcontingency, since it is costreimbursementreimbursement

Motivation towards high costMotivation towards high cost


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` Information is structured by elements of project` Work package is the smallest element` The completion point of work package is the

milestone` Each work package should be the responsibility

of a single manager` Cost information is for the direct project. Cost for

administrative & support activities is established` Well in advance the rules for charging the cost,

the approval authority, the signing powers aredeveloped.


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Scope relates to the specification

Schedule relates to the time element

Cost relates to the control (budget)The cost estimate is done taking in account:

a. Known Unknown:The nature of the task isknown, hence cost though unknown (not easy

to estimate) can be estimated reasonablyb. Unknown unknown:The uncertainties give rise

to these factors, hence very difficult to estimate

SCOPE SCHEDU E

COST


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` Trouble report: The happened trouble and the anticipated trouble

Help for initiating action, according priority. The idea isto make the project work more smoothly

` P

rogress report:

The actual schedule & cost is compared with plannedschedule & cost

The variance analysis help locate potential problemsand initiate the management by exception

The attention is directed towards unsatisfactoryprogress areas


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` Financial Reports:

To work out progress payment, the accuratereports are required. This information ispresented in financial report.

` Informal (Report) Sources:Adhoc meeting, discussion with staff, spotinspection, regular talk with staff help forcorrective actions.


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` Evaluation of performance:Relate to evaluation of performance of project

team (individual)Management of project is one yardstick to decide

on reward, compensation. This is one evaluation.

The evaluation of process of managing the projectyardstick helps for discovering better ways to handlefuture projects.Cost Overrun:Actual costs being higher thanbudgeted cost.

Cost overrun should be looked at on the basis ofinformation available at the time of estimates drawnand not just merely the actual to budget. The level ofinformation accuracy is vital.

Hindsight (Retrospection): Looking back whether rightdecision were made, diversion of funds and or assetusage took place any major specification changes


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usage took place, any major specification changes,proper authorization etc.,

Evaluation of Results:This relates to the evaluation of project i.e. the

expected benefits/results from the project have beenrealized or not. It takes longer time period. Theevaluation gets complicated when the anticipatedbenefits were not explicitly stated in objective,measurable terms, and the actual benefits are notmeasurable.

In such cases reliance on judgment byknowledgeable people about projects accomplishmentstakes place.

The part evaluation is the actual results comparisonwith anticipated results when project was sanctioned.

The anticipated results were based on certainassumptions.


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All MCS Ppts Rkk

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