Performance Management Week 8 Management Control Systems Chapter

Performance Management Week 8 Management Control Systems Chapter 16: Management Control Systems Colin Drury 1

Learning outcomes n n n n Describe three different types of controls used in organisations. Describe the cybernetic control system Distinguish feedback and feed forward controls Explain the potential harmful side- effects of results controls Describe responsibility accounting and controllable principles Determining how challenging the targets should be Describe the influence of participation in budget setting 2

Planning and Controlling Management Accounting System Planning Budgets Control Accounting System Performance Evaluation Performance Reports Feedback Management Decision 3

Planning and Controlling What is planning? Setting goals Predicting results Deciding how to attain goals 4

Planning and Controlling What is control? Deciding and taking actions Deciding on performance evaluation and feedback 5

Planning and Controlling What are budgets? They are quantitative expressions of a proposed plan of action. They aid in the coordination and implementation of the plan. 6

Planning and Controlling What are performance reports? These are reports that compare actual results with budgeted amounts. 7

Management Control Systems Controls • The process of ensuring that an organization’s activities conform to its plans and its objectives are achieved. • No control without plans and objectives ( need to assess the achievement) • They set, specify & predetermine desirable behaviour and procedures for employees to follow. 8

Management Control Systems Controls • Encompasses all methods and procedures directing employees towards achieving the organization objectives • Many mechanisms are used and Management Accounting Control System (MACS) is just one aspect • Necessary to relate the MACS to the whole 9

Management Control Systems Controls • Different level of control: • Strategic control • External focus • Emphasis on external competition internal strengths, weaknesses, and limitations( opportunities and threats) • Management control systems • Internal focus • Collection of control mechanisms • Aim to influence employee behaviours to achieve organizational objectives 10

Management Control Systems Different types of controls • Action or behavioural controls • Personnel, cultural and social controls • Results or output controls 11

Management Control Systems Different types of controls • (1) Action or behavioural controls • Actions are the focus of control • Superiors watch and guide actions of subordinates • Cause and effect relationships are clear and well understood 12

Management Control Systems • Action or behavioural controls • Forms: • behavioural constraints - prevention, restriction, ceilings, authority • pre-action review – scrutiny and approval of action plans of the individuals being controlled. • action accountability – work rules, procedures, codes of conduct, budgets, rewards and punishment 13

Management Control Systems • Action or behavioural controls • Effective if actions are simple, desirable v undesirable, cause-and-effect relationship are clear, production line • Limited if work is complex, uncertain causeand-effect relationship • Need action tracking, good v bad actions • Preventing action ideal – avoid costs of undesirable behaviour • Detection action – useful if applied timely, early stop to undesirable behaviour 14

Management Control Systems (2) Personnel, cultural and social controls • From “clan controls” • fostering strong sense of solidarity & commitment towards organizational goals people immerse in the interest of Company. • high degree of discipline (Japanese pilot) by dedication of individual to interest of the whole • Approach adopted to social and personnel controls 15

Management Control Systems • Personnel, cultural and social controls • Social controls • view as form of corporate culture • Promote people who share committed to same corporate objectives • Personnel controls • Helping employees to institute self-discipline and self-control through: • Selection & placement • Training • Job design 16

Management Control Systems • Personnel, cultural and social controls • Cultural controls (same as social controls) • values, social norms, beliefs shared by members, that influence actions • exercise by one over the others action (procedures) • methods to shape culture: • Codes of conduct - expectation • Group based rewards – collective achievements • Inter-organizational transfers – better understanding 17

Management Control Systems (3) Results or output controls • Collect and report on information on work effort outcome • Establish results – performance measures that minimise undesirable behaviour • Establish performance targets • Measure performance • Provide reward and punishment • Effects of desirable v undesirable behaviours on performance 18

Management Control Systems • Results or output controls • Div manager with current ROI of 30% will reject project with 25% ROI – while project has +ve NPV & will benefit organization • Pre-set and clear performance target essential – quantitative target more motivational • Measurements should sufficiently accurate, objective, bias free, timely • Effective control – individual whose behaviour being controlled must be able to control and influence the result 19

Management Control Systems Cybernetic control systems • Traditional management control approach • mechanical model – thermostat control system • The process • The room temperature • Continually monitored by a thermostat • Deviation • From desired temperature – identified by thermostat • Corrective action • Start if output not equal to predetermined level • Thermostat cause input to be adjusted (temperature) • Turn on/off when temperature same/not same with predetermined level. © 2000 Colin Drury 20

Management Control Systems 21

Management Control Systems Cybernetic control systems • Process is controlled if: • Objectives must exist • Output must be measurable • Compared in terms defined by the objectives. • Predictive model exist – non-attainment can be identified (feed back) • corrective action evaluated 22

Management Control Systems Cybernetic control systems • The thermostat control system • Same as result control system • Performance Standards are determined • Performance monitor by measurement systems • Compare standard with actual • Feedback on variance • Action 23

Management Control Systems Feedback and feed-forward controls • Feedback controlled • The cybernetic control system • Actual output monitored against desired performance • Corrective action on deviation • Feed-forward control • Control b 4 deviation • Monitor base on predicted/expected future output • Take steps to avoid likely errors • Require predictive model (accurate) • Preferable when significant time lag occurs in corrective action • Budget is an example • MACS consist of both feed forward and feed-backward 24

Management Control Systems Harmful side-effects of controls 1. Occurs when controls motivate employees to engage in behaviour that is not organizationally desirable (system lack of goal congruence). 2. Results controls: • focus only on what is measured, regardless of whether it is organizationally desirable • Focuses mainly on quantifiable and easily measurable items. • Subject to data manipulation. ( self measured) • Can lead to negative attitudes towards the control system. ( used as punitive ) (What you measured is what you get) 25

Management Control Systems Harmful side-effects of controls 3. Action controls: • May discourage creativity because divergence are treated as abnormal. 4. Cultural controls: • Lack of goal congruence where group goals do not coincide with firm goals( lead to suboptimisation) © 2000 Colin Drury 26

Management Control Systems Management accounting control systems (MACS) • Tend to be the predominant controls in most organizations because: 1 Monetary measure provides a means of aggregating results from dissimilar activities. 2. Profitability and liquidity are essential for company survival. 3. Financial measures enable a common decision rule to be applied. 4. Measuring results in financial terms enables managers to be given more autonomy. 27

Management Control Systems Responsibility accounting • Responsibility accounting is a fundamental part of the MACS. • Four types of responsibility centres: 1. Cost or expense centres (Two types: standard cost centres and discretionary cost centres). 2. Revenue centres 3. Profit centres 4. Investment centres 28

Management Control Systems • Issues that must be addressed by responsibility accounting include: 1. Distinguishing between controllable and noncontrollable items (i. e. the controllability principle). 2. Determining how challenging the targets should be. 3. Determining how much influence managers should have in the setting of targets. 29

Management Control Systems The controllability principle • Principle advocates that it is appropriate to charge to a responsibility centre only those costs that can be influenced by the manager of the responsibility centre. • Implemented by either eliminating uncontrollables or reporting controllable and uncontrollable items separately. 30

Management Control Systems The controllability principle • Types of uncontrollable factors: 1. Economic and competitive factors (Because managers can respond to some of these changes most MACS do not shield managers completely from them). 2. Acts of nature (Managers normally protected from them). 3. Interdependencies where outcomes are affected by other units within the organization: • Pooled interdependencies • Sequential interdependencies • Reciprocal interdependencies 31

Management Control Systems • Adjustments for the distorting effects of uncontrollable can be made either before or after the measurement period. • Adjustments before the measurement period: 1. Specify which budget line items are uncontrollable (eliminate or report separately in performance report). 2. Insurance • Adjustments after the measurement period: 1. Variance analysis 2. Flexible performance standards (e. g. flexible budgeting and ex post budget adjustments) 3. Relative performance evaluations 32 4. Subjective performance evaluations

Management Control Systems Guidelines for applying the controllability principle • Price and quantity of service controllable = Controllable expense • Quantity controllable but not price = Manager accountable for difference between (actual quantity × budgeted price) and (budgeted quantity × budgeted price) • Quantity and price not controllable = Non- controllable expense • General principle = Hold managers accountable for 33 performance areas you want them to pay attention to.

Management Control Systems Determining how challenging the targets should be • A clearly defined quantitative goal is likely to motivate higher levels of performance. • Level of budget difficulty should be related to task uncertainty. • Targets must be accepted to motivate managers to achieve higher levels of performance. • Literature identifies a theoretical relationship between budget difficulty, aspiration levels and performance (see figure 16. 3 - Drury). • Hypothesized relationships suggest that budget level that motivates best performance is unlikely to be achieved most 34

Management Control Systems Arguments in favour of setting highly achievable Budgets • Conflict between planning and motivational purposes. • Psychological benefits (e. g. achievement and selfesteem). • Shields managers from adverse impact of environmental changes. • Alleviates harmful side-effects of controls. 35

Management Control Systems Determining how much influence managers should have in setting standards • Advantages of participation in the setting of performance standards: 1. Targets more likely to be accepted 2. Reduces the information asymmetry gap 3. Reduces negative attitudes and dysfunctional behaviour 36

Management Control Systems • Empirical studies provide conflicting evidence on the effectiveness of participation. • Factors influencing the effectiveness of participation: 1. Personality variables: • Authoritarianism • Locus of control 2. Work situation 3. Job difficulty • Limitations on the positive effects of participation: 1. Budgetee has the opportunity to negotiate lower targets. 2. Depends on personality traits and work situation. 3. A top down approach may be preferable where a large number of similar units exist. © 2000 Colin Drury 37