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Management Control System Structure

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Title: Management Control System Structure


1
Management Control System Structure
2
The Structure of the MCS
  • Defining the MCS structure means
  • defining the elementary units of the MCS, i.e.
    the company sub-systems of which the performance
    must be evaluated in autonomy respect to the
    overall performance
  • defining the specific information that must be
    measured relating to each elementary unit
  • ? each elementary unit can be
    considered a Responsibility Centre with a
    dedicated manager which is responsible for the
    activities of the unit
  • ? a Responsibility Centre
    Accounting System is so defined

3
What is a Responsibility Centre
  • A Responsibility Centre is a business segment of
    the company, where the manager is responsible for
    a specific set of activities and the related
    economic-financial variables (costs, revenues,
    investments) and non- financial measures
  • In a responsibility centre
  • inputs are used (resources as materials, labour,
    overheads, commercial and administrative
    resources)
  • service or production activities are carried out
    (Research and Development, Production, Logistic,
    Sales and Administration)
  • outputs are achieved (tangible products or
    services)

4
Definition of the responsibility centres

  • The responsibility centres can be defined in
    different ways by the organisations. In general a
    company can divide the responsibilities according
    to
  • 1. company functions (line functions, such
    as production or sales, or staff units such as
    finance, administration, research and
    development, etc..)
  • 2. products and services (Business Units or
    Divisions)
  • 3. geographic areas (Business Units or
    Divisions)
  • The sub-division of responsibilities reflects
    normally the Organisational Structure of the
    company

5
The responsibility levels
  • the responsibility centres belong to different
    levels of the Organisation Structure of the
    company (also within the functions, sub-units can
    exist - departments and offices - ex. within the
    function Logistic, can be defined the sub-unit
    Transport assigned to a specific manager)
  • consequently, three basic MCS dimensions can be
    identified
  • A VERTICAL dimension
  • A HORIZONTAL dimension
  • A TRANSVERSAL dimension (PROCESS/PROJECT
    dimension) different units belonging to
    different levels and to different functions can
    carry out an activity (ex. new product
    development process)


6
1. Vertical dimension
  • It includes the set of organisation levels for
    which a specific evaluation is required
  • Corporate level (overall company)
  • Business Unit level (product/market segment)
  • Operation level (function, department, office)


7
1. Vertical dimension
  • Understanding the vertical dimension means
  • asking which MCS requirements are relevant at
    different organisational levels
  • consequently, asking which indicators and
    specific measures (economic, financial,
    non-financial) are relevant at different levels


8
1. Vertical dimension the relative importance of
the requirements

Corporate Business Unit
Operation


Completeness Long term orientation Timeliness M
easurability Identif. Spec responsibility
9
A review of the requirement satisfaction by
different measures
ACCOUNTING TECHNIQUES ACCOUNTING TECHNIQUES FINANCIAL TECHNIQUES NON FINANCIAL TECHNIQUES
BALANCE SHEET (RATIO ANALYSIS) COST ACCOUNTING
MEASURABILITY High High Low High
IDENTIFICATION OF SPECIFIC RESPONSIBILITIES Good only at top level (corporate and business level) Good also at operative level Good only at top level (corporate and business level) Good also at operative level
COMPLETENESS Medium (no risk and time value consideration) Low High Depending on the selected set of indicators
LONG TERM ORIENTATION Low Low High It depends (high if indicators are selected according to critical success factors)
TIMELINESS Low Low Low High (only physical transactions)
10
1. Vertical dimension the techniques used at
different organisational level

  Financial indicators Economic indicators Non financial indicators
Corporate Main measures ROE Few measures, relating to the key competitive factors
Business Occasional Main measures (ROI, etc.) Few measures, relating to the key competitive factors
Operation   Costs and revenues Main measures (quality, productivity, time, etc.)

11
Ferrari benchmarking project
  • Define a benchmarking project for the Ferrari
    company, to be used by the top manager (Luca
    Cordero di Montezemolo)
  • The aim and scope of benchmarking can be
    synthesised as follows
  • to verify how Ferrari is positioned among the
    most prestigious car producers in the world
  • to envisage its future

12
Ferrari benchmarking project
  • Given the aim of benchmarking
  • choose the organisations against which the
    comparison should be made
  • define the method of comparison (aware / unaware)
  • select the specific performance and/or processes
    upon which the comparison should be made and the
    techniques and specific indicators to be used
  • devise appropriate data correction methods (where
    necessary)

13
Ferrari Case Vertical structure
  • Consider also vertical dimension in your
    benchmarking project
  • taking into account which are the most important
    requirements at each level (corporate, business
    unit, operation) and which are the advantages and
    limits of each techniques (economic, financial,
    non financial) with respect to different
    requirements
  • ? illustrate how different techniques and
    specific indicators are used at different
    organizational levels

14
Ferrari benchmarking project rules and
evaluation
  • Work-group composition 5-6 people
  • Work-group delivery end of May
  • Work-group evaluation 0-2 scores to be added to
    the written examination score

15
2. Horizontal dimension
  • It identifies the specific responsibilities
    associated to each unit belonging to a certain
    level
  • Different types of responsibility centres can be
    distinguished
  • Cost Centres at the operation level
  • Expense Centres (discretion cost centres) at the
    operation level
  • Revenue Centres at the operation level
  • Profit Centres usually at business level
  • Investment Centres at corporate level


16
The responsibility levels vertical and
horizontal dimension

Headquarter


Investment Centres
Division Europe
Division USA
- - -
Profit Centres
Product A
Product B
- - -
Production
Marketing
Cost Centres, Revenue Centres Expense Centres
...
Department 1 (ex. Packaging)
Dep.2
Dep.3
17
2. Horizontal structure at the operation level
  • Cost centres
  • output level not defined in autonomy
  • responsibility on the input employed to achieve
    the output, that is a responsibility on costs
    (price and employment of the input)
  • production department is the classic example of
    cost centre
  • traditionally this responsibility is evaluated
    through the variance between standard costs and
    actual costs
  • the traditional approach, however, doesnt allow
    to take into consideration the performances that
    the production cost centres are able to control.
    On one hand, the employment of the input is only
    partially controllable by the cost centres due to
    the fact it depends also on the quality of the
    input (Purchase offices) and on the product
    design (Design offices). On the other hand, the
    production decisions have an impact on other
    variables such as the production quality, the
    delivery time, the post-sales service
    requirement, variables linked to the company
    revenues
  • a first solution is to enlarge the set of
    performance dimensions for which the cost centre
    is responsible, considering also non-financial
    measures (delivery time, quality of products,
    etc.)
  • a second solution is the definition of task
    forces composed by different units (Production,
    Purchases, Design, etc.) which responsibilities
    are interdependent in order to improve the
    collaboration between the units

18
2. Horizontal structure at the operation level
  • Expense centres
  • output that is difficult to be measured in
    monetary terms
  • no strong and clear relation exists between
    resources used (inputs) and results achieved
    (outputs)
  • examples of discretionary expense centres are
    general and administrative (GA) departments
    (controller, industrial relations, human
    resources, accounting, legal), research and
    development (RD) departments, and some marketing
    activities such as advertising, promotion and
    warehousing. All these activities are defined as
    supporting activities
  • traditionally, the unique type of control for
    these units has been the definition of a maximum
    year level of expenses
  • non financial measures (ex. quality, time,
    productivity, flexibility) and also economic
    measures (costs) can be introduced according to
    the type of activity (ex. productivity indicators
    can be introduced for the more repetitive
    activities, such as the administrative
    activities), in order to evaluate the
    quantity/quality of output of the centre

19
2. Horizontal structure at the operation level
  • Revenue centres
  • responsibility on the sales of goods/services
    (price and volume of good sold)
  • traditionally the performances are measured
    through the variance between the expected
    revenues and the actual revenues
  • commercial units are the classic examples of
    revenue centres
  • the traditional approach, however, doesnt allow
    to take into consideration the set of performance
    that the revenue centres are able to control. On
    one hand, the prices can be defined by central
    offices and the volume can be linked to product
    features and not only to the sale enforce. On the
    other hand, the commercial units doesnt have the
    responsibility on other controllable activities,
    such as the customer assistance, which have an
    relevant impact on sales volume
  • a first solution is to enlarge the set of
    performance dimensions for which the revenue
    centre is responsible, considering also
    non-financial measures (ex. customer assistance)
  • a second solution is the definition of task
    forces composed by different units (Sales,
    Production, Purchases, etc.) which
    responsibilities are interdependent in order to
    improve the collaboration between the units

20
2. Horizontal structure at the business level
  • Profit centres
  • responsibility both on the costs and revenues
  • traditionally, the performance is evaluated
    through the variances between the standard and
    the actual costs, the expected revenues and the
    actual revenues (the expected profit and the
    actual profit) building partial profit/loss
    statements for each centre
  • A profit centre is free to
  • Select the source for procurement
  • Choose the acquisition prices
  • Select the customer
  • Decide the selling price
  • business units and divisions are the classic
    examples, but sometimes also departments can be
    defined as profit centres (i.e. maintenance
    department that sells its services to other
    units)

21
2. Horizontal dimension at the corporate level
  • Investment centre
  • responsibility on costs, revenues and investments
  • this responsibility is evaluated considering the
    assets (invested capital) through the return on
    investments measures (ROI, ROS, etc.)
  • usually, it is applied to the corporate level or
    to the business units with a strong autonomy

22
2. Horizontal dimension at business level
  • Business units are independent units which have
    the responsibility on one product/market
  • To evaluate the economic performance of BU it is
    necessary to evaluate
  • The partial Profit/Loss statements for Business
    Unit
  • ? Advanced Direct Costing schema to evidence the
    contribution of each unit (i.e. product line) to
    the overall company net operating income only
    fixed specific costs are assigned to each
    business unit in order to avoid any arbitrary
    allocation of common costs
  • ? Controllable costs to evaluate business unit
    manager (II Controllable Contribution Margin)
  • The possible internal trade (goods/services)
    among business units
  • ? it is necessary to analyse and evaluate the
    internal trade among units (i.e. transfer
    pricing)

23
The advanced direct costing schema to evaluate
business unit contribution
BU A BU B BU C TOTAL
Revenues X X X X
Variable costs (i.e. direct material direct labor energy) X X X X
I Contribution Margin X X X X
Fixed Specific costs (i.e. amortization) X X X X
II Contribution Margin X X X X
Fixed Common costs (i.e. amortization, indirect labor general and administrative costs) X
Net operating income X
24
The advanced direct costing schema to evaluate
business unit contribution
  • Examples
  • Superpizza
  • Officina Veneta

25
  • SUPERPIZZA
  • In 20X0, Mr. Gennaro Esposito, decided to start
    up his own activity. He started, at first, with
    the production and sale of pizzas take away and
    then he added the delivery of pizzas at home in
    the evening hours. By the way, he realized that a
    combination pizza drink was very appreciated by
    customers. He decided to apply a unique price for
    each combination 6 euro for the combination
    take away 7 euro for the delivery at home. In
    the following year, Mr. Esposito decided to rent
    a place to offer all the activities, included the
    service on the table. The combination was the
    same but offered with a price equal to 7,5 euro.
    For this specific activity, it was also necessary
    to engage a waiter. The take away cashier could
    be dedicated also to the new activity for a 20
    of time. Another person (named pony) was
    specifically dedicated to the delivery at home
    and he personally managed the takings. For the
    deliveries, he used a small van, available for
    the overall activities (purchases of materials,
    etc.). Besides, 5 producers of pizza
    (pizzaioli) were engaged.
  • In the following table, data concerning the first
    semester 20X1 are reported.
  • Elaborate the Profit/Loss Statement for the first
    semester 20X1 in order to point into evidence the
    contribution provided by different selling
    combinations to the net operating income for the
    overall company.

Sales TAKE AWAY 18.000 combinations
Sales DELIVERY AT HOME 7.500 combinations
Sales SERVICE ON THE TABLE 4.500 combinations
Pizzaioli (each one, each month) 1.500 euro
Waiter (each month) 1.500 euro
Cashier (each month) 1.000 euro
Pony (each month) 500 euro
Place rent (each month) 2.200 euro
Small van rent (each month) 300 euro
Power and wood (each month) 1.000 euro
Direct materials for pizzas production (each semester) 60.000 euro
Costs for sold drinks (each semester) 15.000 euro
26
  • OFFICINA VENETA
  • Officina Veneta (O.Ve.) is a small company that
    produces components for kitchen production, in
    particular structural elements for ovens ELEMENT
    1 ELEMENT 2 ELEMENT 3.
  • Production is carried out by means of three
    production lines
  • Line 1 is devoted to ELEMENT 1
  • Line 2 is devoted to ELEMENT 2
  • Line 3 is devoted to ELEMENT 3.
  • Due to the particular nature of some activities,
    it has been possible to calculate a direct labor
    cost per unit (see Annex 1).
  • Indirect Workers (for activities supporting
    production) are the following
  • 2 workers for warehouse management
  • 2 workers for maintenance and repairing
  • 2 administrative employees.
  • On the basis of other information in Annex 1
  • Elaborate Profit/Loss Statement to take into
    evidence the contribution of each product line to
    the overall company net operating income.

27
  • ANNEX 1
  • Production/sales in units and selling price per
    unit
  • 90.000 units ELEMENT 1 11 euro per unit daily
    production 360 units
  • 90.000 units ELEMENT 2 5,5 euro per unit daily
    production 630 units
  • 90.000 units ELEMENT 3 7,5 per unit daily
    production 840 units
  • Annual average indirect worker cost 35.000 euro
  • Annual average administrative employee cost
    40.000 euro
  • Direct material per unit
  • 3,15 euro per ELEMENT 1
  • 1,62 euro per ELEMENT 2
  • 2,25 euro per ELEMENT 3.
  • Direct labor cost per unit
  • 1,16 euro per ELEMENT 1
  • 0,44 euro per ELEMENT 2
  • 0,16 euro per ELEMENT 3.
  • Annual energy cost 80.500 euro (the energy
    consumption is considered a variable cost
    depending on number of operating days per line)

28
The advanced direct costing schema to evaluate
business unit manager
BU A BU B BU C TOTAL
Revenues X X X X
Variable costs X X X X
I Contribution Margin X X X X
Fixed Specific Controllable costs X X X X
II Controllable Contribution Margin X X X X
Fixed Specific Non Controllable costs X X X X
II Contribution Margin X X X X
Common costs X
Net operating income X
29
The advanced direct costing schema to evaluate
business unit manager
  • Example
  • JB Trucking

30
  • JB TRUCKING
  • Jb Trucking is a transport company which is
    operating in the North California and in Nevada.
    In order to evaluate performances, the company
    Profit/Loss has been divided for geographic
    areas. An area, the Truckee Meadows, is dedicated
    to sub-areas Reno and Lake Tahoe, in California.
    The information relating to the deliveries of
    January are the following
  • Direct variable costs include oil and fuel costs
    and the costs for the car loading.
  • The specific fixed costs includes the
    amortisation, the maintenance (provided by Jb
    Trucking central shop), the licence costs for the
    trucks. In particular, the maintenance costs
    (400 for Reno 800 for Lake Tahoe) are not
    controllable by the sub-area managers because
    maintenance is carried out monthly on the basis
    of government rules.
  • The geographic areas, and the sub-areas of
    delivery, are considered profit centres.
  • Truckee Meadows costs of administration and
    marketing (common to sub-areas) are equal to
    3.700 euro.
  • Questions
  • 1) Elaborate a partial profit/loss statement to
    evaluate a) the profitability of the sub-areas
    b) the performance of the sub-areas managers.
  • 2) If common costs are allocated on the basis of
    sub-areas revenues, which is the impact on
    sub-areas profitability? Discuss this type of
    solution.

31
Common Corporate Costs allocation to Business
Units
  • The allocation of common corporate costs to
    Business Units has an impact on their
    profitability and therefore on their performance
    evaluation (examples of corporate costs are
    general costs, legal costs, research and
    development costs)
  • In the practice it is possible to have the
    following alternatives
  • to allocate to the BU all the corporate costs
    using arbitrary allocation basis
  • to allocate only a share of corporate costs, in
    particular those costs which are specific for
    each business unit (see the Advanced Direct
    Costing schema). For example, research costs
    only the costs of applied research specifically
    used by business units. In this case the
    corporate level sells its services to the
    business units

32
Corporate Costs allocation advantages and
disadvantages
  • Complete allocation
  • the business unit performance decreases with the
    increase of corporate costs
  • common is the proportional allocation (based on
    revenues) which is not consistent with the
    specific responsibility principle (a BU which
    increases its revenues receives a higher share of
    corporate costs even if the activity increase
    does not cause a higher use of the corporate
    resources!).
  • corporate inefficiency can be unfairly assigned
    to the business units
  • Partial allocation
  • more consistent with the specific responsibility
    principle
  • the BU can require a lower corporate service
    level with disadvantaged in term of long-period
    company competitiveness, in order to avoid the
    allocation of corporate costs
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