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Chapter 9 Management Control Systems and Responsibility Accounting Copyright © 2014 Pearson Education, Inc.

Chapter 9 Learning Objectives 1. Describe the relationship of management control systems to organizational goals. 2. Explain the importance of evaluating performance and describe how it impacts motivation, goal congruence, and employee effort. 3. Develop performance measures and use them to monitor the achievements of an organization. 4. Use responsibility accounting to define an organizational subunit as a cost center, a profit center, or an investment center. Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 -3

Chapter 9 Learning Objectives 5. Prepare segment income statements for evaluating profit and investment centers using the contribution margin and controllable-cost concepts. 6. Measure performance against nonfinancial performance measures such as quality, cycle time, and productivity. 7. Use a balanced scorecard to integrate financial and nonfinancial measures of performance. 8. Describe the difficulties of management control in service and nonprofit organizations. Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 -4

Learning Objective 1 Management Control Systems This is a logical integration of techniques for gathering and using information. Motivating Planning and control Budgeting Evaluating Forecasting Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 -5

Planning and Control Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9

Key Success Factors are characteristics or attributes that managers must achieve in order to drive the organization toward its goals. Goals provide a long-term framework around which an organization will form its comprehensive plan for positioning itself in the market. Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 -7

Translating Goals and Objectives into Performance Measures Copyright © 2014 Pearson Education, Inc. publishing

Learning Objective 2 Evaluating Performance Good management control systems foster goal congruence and managerial effort. Goal congruence is achieved when employees, working in their own perceived best interests, make decisions that help meet the overall goals of the organization. Managerial effort must accompany goal congruence. Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 -9

Managerial Effort Managerial effort is exertion toward a goal or objective. Planning Supervising Thinking Effort means working harder, faster, and better. Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 - 10

Motivation is a drive toward some selected goal. It creates effort. It creates action

Learning Objective 3 Developing Performance Measures Effective performance measurement requires multiple performance measures, both financial and nonfinancial. Effective performance measures will: 1. Reflect key actions and activities that relate to the organization’s goals 2. Be affected by actions of managers and employees 3. Be readily understood by employees 4. Be reasonably objective and easily measured 5. Be used consistently and regularly to evaluate and reward 6. Balance long-term and short-term concerns Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 - 12

Financial Measures of Performance Financial measures are often lagging indicators that arrive too late. Operating Budgets Profit Targets Return on Investments Often the effects of poor nonfinancial performance do not show up in the financial measures until considerable ground has been lost. Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 - 13

Nonfinancial Measures of Performance Nonfinancial measures often motivate employees toward achieving important performance goals. AT&T Universal Card Services uses 18 Performance measures for its customer inquiries process. These measures include average speed of answer, abandon rate, and application processing time. Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 - 14

Monitoring and Reporting Results Feedback and learning are at the center of the management control system. At all points in the planning and control process, it is vital that effective communication exists among all levels of management and employees. Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 - 15

A Successful Organization and Measures of Achievement Copyright © 2014 Pearson Education, Inc. publishing

Controllability and Measurement of Financial Performance Management control system Copyright © 2014 Pearson Education,

Controllability and Measurement of Financial Performance An uncontrollable cost is any cost that cannot be affected by the management of a responsibility center within a given time span. Controllable costs include all costs that a manager’s decisions and actions can influence. Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 - 18

Learning Objective 4 Responsibility Centers A responsibility center is a set of activities assigned to a manager, a group of managers, or other employees. System designers apply responsibility accounting to identify what part of the organization has responsibility for each action. Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 - 19

Identifying Responsibility Centers Cost centers Profit centers Investment centers Copyright © 2014 Pearson Education,

Identifying Responsibility Centers Cost centers In a cost center, managers are responsible for costs only. A cost center may encompass an entire department, or a department may contain several cost centers. The determination of the number of cost centers depends on cost-benefit considerations—do the benefits exceed the higher costs of reporting? Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 - 21

Identifying Responsibility Centers Profit centers Profit-center managers are responsible for controlling revenues as well as costs—that is, profitability. Profit centers exist in nonprofit organizations, despite the name, (though it might not be referred to as such) when a responsibility center receives revenues for its services. Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 - 22

Identifying Responsibility Centers Investment centers An investment center adds responsibility for investment to profit-center responsibilities. Investment-center success depends on both income and invested capital, measured by relating income generated to the value of the capital employed. Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 - 23

Contribution Margin The contribution margin is especially helpful for predicting the impact on income of short-run changes in activity volume. Managers may quickly calculate any expected changes in income by multiplying increases in dollar sales by the contribution margin ratio. Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 - 24

Contribution Controllable by Segment Managers help explain the total segment contribution, but they are responsible only for the controllable contribution. Controllable fixed costs are deducted from the contribution margin to obtain the contribution controllable by segment managers. Controllable costs are usually discretionary fixed costs such as local advertising and some salaries, but not the manager’s salary. Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 - 25

Learning Objective 6 Performance Measures Many organizations, in recent years, have developed an awareness of the importance of controlling aspects of nonfinancial performance measures. Quality Control Cycle Time Productivity Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 - 26

Quality Control Quality control is the effort to ensure that products and services perform to customer requirements. The traditional approach to controlling quality in the U. S. was to inspect products after completing them and reject or rework those that failed the inspections. Because testing is expensive, companies often inspected only a sample of products. Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 - 27

Cost of Quality Report Four categories of quality costs Prevention Internal failure Appraisal External

Cost of Quality Report Prevention costs are the costs incurred to prevent the production of defective products or delivery of substandard services. Appraisal costs are the costs incurred to identify defective products or services. Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 - 29

Cost of Quality Report Internal failure costs are the costs of defective components and final products or services that are scrapped or reworked. External failure costs are the costs caused by delivery of defective products or services to customers, such as field repairs, returns, and warranty expenses. Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 - 30

TQM Total quality management (TQM) focuses on prevention of defects and on achievement of customer satisfaction. The TQM approach assumes an organization minimizes the cost of quality when it achieves high quality levels. TQM is the application of quality principles to all the organization’s efforts to satisfy customers. Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 - 31

Quality-Control Chart The quality-control chart is a statistical plot of measures of various product dimensions or attributes. This plot helps detect process deviations before the process generates defects. Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 - 32

Quality-Control Chart Percentage of Defects 3 2 1 0 Actual Goal = 0. 6% 3/12 3/19 3/26 4/2 4/9 4/16 4/23 4/30 5/7 5/14 Week of Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 - 33

Six Sigma is a continuous processimprovement effort designed to reduce costs by improving quality. It has broadened into a general process to define and measure a process, analyze it, and improve it to minimize errors. Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 - 34

Control of Cycle Time Cycle time, or throughput time, is the time taken to complete a product or service, or any of the components of a product or service. The longer a product or service is in process, the more costs it consumes. Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 - 35

Control of Productivity is a measure of outputs divided by inputs. Productivity = Outputs Inputs Productivity measures vary widely according to the type of resource with which management is concerned. Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 - 36

Control of Productivity How should outputs and inputs be measured? Labor-intensive organizations are concerned with increasing the productivity of labor, so laborbased measures are appropriate. Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 - 37

Measures of Productivity Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9

Learning Objective 7 Balance Scorecard A balanced scorecard is a performance measurement and reporting system that strikes a balance between financial and operating measures. It links performance to rewards. It gives explicit recognition to the diversity of organizational goals. Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 - 39

The Balanced Scorecard . . . measures that drive the organization to achieve its goals. Financial Internal processes Customers Innovation and learning Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 - 40

Learning Objective 8 Service, Government, and Nonprofit Organizations Most service, government, and nonprofit organizations have more difficulty implementing management control systems. Outputs of service and nonprofit organizations are more difficult to measure than are the cars or computers that are produced by manufacturers. Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 - 41

Service, Government, and Nonprofit Organizations These organizations have problems in designing and implementing an objective similar to the financial “bottom line” - the unifying goal in private industry. In nonprofit organizations, many people seek primarily nonmonetary rewards. Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 - 42

Service, Government, and Nonprofit Organizations Management control systems in nonprofit organizations are not as highly developed as those in profit-seeking firms because: § Organizational goals and objectives are less clear. § Professionals dominate these organizations. § Measurements are more difficult – no profit measure and heavy fixed costs. § Less competitive pressure to improve management control systems. § The role of budgeting is more a matter of playing bargaining games. § Motivations and incentives differ from for-profit organizations. Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 - 43

Future of Management Control Systems As organizations mature and environments change, managers expand refine their management control tools. A changing environment often means that organizations must adjust their goals or key success factors. Copyright © 2014 Pearson Education, Inc. publishing as Prentice Hall 9 - 44

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