Management Control System and Performance
ManagementControlSystemand PerformanceMeasurement Sigit Wibowo Email: [email protected] MagisterManajemen FacultyofEconomics&Business February15, 2015 . CourseGrade Management ControlSystemand Performance Measurement 1. 2. 3. 4. Caseanalysis(groupassignment) Discussion&participation Mid-termexam Finalexam Management ControlFunction inOrganisation 15% 25% 30% 30% ProfitPlanning Responsibility Centre: Expense Center Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . TopicOutlines Session Description References 1-2 ManagementControlFunctioninOrganisation Case: WalmartStores, Inc. [1], Ch. 1&3 [1], Case1-2 3-4 ProfitPlanning Case: WalkerandCompany [2], Ch. 7 [2], Case11 5-6 ResponsibilityCentre: ExpenseCentre Case: GrandJeanCompany [1], Ch. 4&5 [1], Case4-6 7-8 ResponsibilityCentre: RevenueCentre Case: VershireCompany [1], Ch. 4 [1], Case4-1 9-10 ProfitCenterandTransferPricingProblem Case: NorthCountyAuto, Inc. [1], Ch. 6 [1], Case5-2 11-12 ResponsibilityCentre: InvestmentCentre Case: DellComputerCorp. [1], Ch. 7 [1], Case7-5 13-14 CorporateGovernanceandBoardofDirectors Case: VectorAeromotiveCorporation Management ControlSystemand Performance Measurement Management ControlFunction inOrganisation ProfitPlanning Responsibility Centre: Expense Center Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre [3], Ch. 13, [4] [3], Case4 67 Corporate Governanceand BoardofDirectors . Strategy Management ControlSystemand Performance Measurement 4 ▶ CorporateStrategy ▶ ▶ ProfitPlanning Tomaximizeuseofresources Responsibility Centre: Expense Center BusinessStrategy ▶ .Management ControlFunction inOrganisation Responsibility Centre: Revenue Center Tocompeteinselectedmarkets ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . BasicConcepts Controldevice 2. Assessor. Comparison with standard Management ControlSystemand Performance Measurement 5 .Management ControlFunction inOrganisation ProfitPlanning 1. Detector. Information about what is happening Responsibility Centre: Expense Center 3. Effector. Behaviour alteration, if needed Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Entity .being controlled Responsibility Centre: Investment Centre Figure 1: ElementsofControlProcess 67 Corporate Governanceand BoardofDirectors . BoundariesofManagementControl Activity NatureofEndProduct Strategyformulation Goals, strategies, and policies Management ControlSystemand Performance Measurement 6 .Management ControlFunction inOrganisation ProfitPlanning Managementcontrol Responsibility Centre: Expense Center Implementation of strategies Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem . Taskcontrol Efficient and effective performance of Responsibility Centre: Investment Centre individual tasks Figure 2: Generalrelationshipsamongplanningandcontrolfunctions 67 Corporate Governanceand BoardofDirectors . StrategyImplementation Management ControlSystemand Performance Measurement Implementationmechanism 7 Management controls . Strategy ProfitPlanning Human Resource Management Organisation structure .Management ControlFunction inOrganisation Responsibility Centre: Expense Center Performance Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Culture Figure 3: Frameworkforstrategyimplementation Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . GoalsandStrategy Management ControlSystemand Performance Measurement 8 ▶ StrategyFormulation ▶ ▶ ▶ Goals Howtoattain ProfitPlanning Responsibility Centre: Expense Center StrategyImplementation(Execution) ▶ ▶ .Management ControlFunction inOrganisation Responsibility Centre: Revenue Center Objectives ManagementControlSystems ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . ManagementControl Management ControlSystemand Performance Measurement ▶ Theprocessbywhichmanagersinfluenceother membersoftheorganisationtoimplementthe organisation’sstrategies. ▶ 9 ProfitPlanning Activitiesinclude: ▶ ▶ ▶ ▶ ▶ ▶ .Management ControlFunction inOrganisation Responsibility Centre: Expense Center Planning Coordinating Communicating Evaluating Deciding Influencing Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . ManagementControlSystems Management ControlSystemand Performance Measurement 10 ▶ ▶ ▶ ▶ Facilitatemanagementcontrol Primarilyfocusonstrategyexecution Encompassbothquantitativeandqualitative performancemeasures Concernedwithbroadlydefinedactivities .Management ControlFunction inOrganisation ProfitPlanning Responsibility Centre: Expense Center Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . TheFormalControlSystem Management ControlSystemand Performance Measurement Goals and strategies Other information Rules 11 Reward(feedback) ProfitPlanning Yes Strategic . planning Budgeting Responsibility centre performance Report actual versus plan Responsibility Centre: Expense Center Was performance satisfactory? Responsibility Centre: Revenue Center No Revise Revise Corrective action .Management ControlFunction inOrganisation ProfitCentreand TransferPricing Problem Measurement Responsibility Centre: Investment Centre Feedbackcommunication Figure 4: Theformalcontrolprocess 67 Corporate Governanceand BoardofDirectors . ConflictofInterests Management ControlSystemand Performance Measurement 12 ▶ ▶ .Management ControlFunction inOrganisation ProfitPlanning Goalcongruenceimpliesthatindividualgoals andorganisationalgoalsareconsistent AgencyTheoryimpliestheopposite Responsibility Centre: Expense Center Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . GoodManagementControl Management ControlSystemand Performance Measurement 13 ▶ ▶ ▶ .Management ControlFunction inOrganisation ProfitPlanning Achievesgoalcongruencebyaligning Organisationalgoals Individualgoals Responsibility Centre: Expense Center Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . GoalCongruence Management ControlSystemand Performance Measurement ▶ Influencedby ▶ ▶ ▶ ▶ 14 Informalfactors External—workethic Internal—culture, managementstyle, informal organisation, perception, communication ProfitPlanning Responsibility Centre: Expense Center Responsibility Centre: Revenue Center Formalfactors ▶ ▶ ▶ .Management ControlFunction inOrganisation Informalfactors Rules Formalcontrolsystem ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . OrganisationalStructure Management ControlSystemand Performance Measurement 15 ▶ Functionalorganisation ▶ ▶ ▶ ProfitPlanning Highlycentralised Responsibility Centre: Expense Center Matrixorganisation Businessunitorganisation ▶ .Management ControlFunction inOrganisation Responsibility Centre: Revenue Center Highlycentralised ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . TheController Management ControlSystemand Performance Measurement 16 ▶ Responsiblefor ▶ ▶ ▶ .Management ControlFunction inOrganisation ProfitPlanning DesignoftheManagementControlSystem OperationoftheManagementControlSystem NormallytheCFO Responsibility Centre: Expense Center Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . Wal-MartStores, Inc. DiscussionQuestions Management ControlSystemand Performance Measurement 17 1. WhatisWal-Mart’sstrategy? Whatisthebasison whichWal-Martbuildsitscompetitiveadvantage? 2. HowdoWal-Mart’scontrolsystemshelpexecute thefirm’sstrategy? .Management ControlFunction inOrganisation ProfitPlanning Responsibility Centre: Expense Center Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . Wal-MartStores, Inc. SelectedFinancialData Management ControlSystemand Performance Measurement Five-YearAverage: 1999–2004 ReturnonEquity(%) Salesgrowth(%) Opt. incomegrowth(%) WalMart Home Depot Kroger Costco Target . . . . . . . . (.) . . . . . . 18 .Management ControlFunction inOrganisation ProfitPlanning Responsibility Centre: Expense Center 2004Data Sales($B) Aspercentageofsales Costofgoodssold Grossmargin Sellingandadmin. Operatingincome NetIncome . . . . . . . . . . . . . . . . . . . (.) . . . . . . . . . . Inventoryturnover ReturnonEquity(%) . . . . . (.) . . . . Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . Wal-MartStores, Inc. Storelocation. Source: http://www.magicalurbanism.com/archives/119 Management ControlSystemand Performance Measurement 19 .Management ControlFunction inOrganisation ProfitPlanning Responsibility Centre: Expense Center Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . Wal-MartStores, Inc. Storelocation. Source: http://www.magicalurbanism.com/archives/119 Management ControlSystemand Performance Measurement 20 .Management ControlFunction inOrganisation ProfitPlanning Responsibility Centre: Expense Center Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . Wal-MartStores, Inc. Storelocation. Source: http://www.magicalurbanism.com/archives/119 Management ControlSystemand Performance Measurement 21 .Management ControlFunction inOrganisation ProfitPlanning Responsibility Centre: Expense Center Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . Wal-MartStores, Inc. Storelocation. Source: http://www.magicalurbanism.com/archives/119 Management ControlSystemand Performance Measurement 22 .Management ControlFunction inOrganisation ProfitPlanning Responsibility Centre: Expense Center Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . Wal-MartStores, Inc. Storelocation. Source: http://www.magicalurbanism.com/archives/119 Management ControlSystemand Performance Measurement 23 .Management ControlFunction inOrganisation ProfitPlanning Responsibility Centre: Expense Center Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . ThreeProfitPlanQuestions Management ControlSystemand Performance Measurement ▶ ▶ ▶ Doestheorganisation’sstrategycreateeconomic value? Doestheorganisationhavethecashtofinance theirstrategyandremainsolvent? Doestheorganisationcreateenoughvalueto attainthefinancialresourcesthatitneedsto financelong-terminvestmentinnewassets? Management ControlFunction inOrganisation 25 . ProfitPlanning Responsibility Centre: Expense Center Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . TheObjectives Management ControlSystemand Performance Measurement ▶ Management ControlFunction inOrganisation Theobjectivesofthisplanningprocess: ▶ ▶ ▶ Totranslatethestrategyofthebusinessintoa detailedplanofcreatevalue Toevaluatewhethersufficientresourcesare availabletoimplementtheintendedstrategy Tocreateafoundationtolinkeconomicgoals withleadingindicatorsofstrategy implementation 26 . ProfitPlanning Responsibility Centre: Expense Center Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . ThreeWheelsofProfitPlanning Operating cash Accounts receivable Sales CASH WHEEL Inventory . Sales PROFIT Investment WHEEL in assets Operating expenses Profits Asset utilitisation Management ControlSystemand Performance Measurement ROE WHEEL Management ControlFunction inOrganisation 27 . ProfitPlanning Responsibility Centre: Expense Center Profits Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Stockholders’ equity Responsibility Centre: Investment Centre Return on equity 67 Corporate Governanceand BoardofDirectors . TheProfitWheel Management ControlSystemand Performance Measurement ▶ Management ControlFunction inOrganisation Thesteps 1. 2. 3. 4. 5. Estimatethelevelofsales Forecastoperatingexpenses Calculateexpectedprofit Pricetheinvestmentinnewassets Closetheprofitwheelandtestkeyassumptions 28 . ProfitPlanning Responsibility Centre: Expense Center Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . TheCashWheel Management ControlSystemand Performance Measurement ▶ Management ControlFunction inOrganisation Thesteps 1. Estimatenetcashflowsfromoperations 2. Estimatecashneededtofundgrowthinoperating assets 3. Pricetheacquisitionanddivestureoflong-term assets 4. Estimatefinancingneedsandinterestpayments 5. Closetheprofitwheelandtestkeyassumptions 29 . ProfitPlanning Responsibility Centre: Expense Center Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . TheROE Wheel Management ControlSystemand Performance Measurement ▶ Thesteps Management ControlFunction inOrganisation 30 1. Calculateoverallreturnonequity 2. Estimateassetutilisation 3. CompareprojectedROE withindustry benchmarksandinvestorexpectations . ProfitPlanning Responsibility Centre: Expense Center Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . WalkerandCompany RequiredTasks 1. CompleteRamseyWaler’sprofitplanforthe children’sbookline. Whatareyourworking assumptions? Whichoftheseassumptionsare criticaltoyouranalysis? 2. Reviewthelistoffinancialperformancemeasures presentedabove. Whatmeasuresorcalculations shouldRamseyusetomanagethebusiness? How shouldthosemeasuresbecalculated? 3. Basedonyouranalysis, prepareanagendaofthe topthreeactionitemsthatRamseyshoulddiscuss withGeorgeGibsonandTedRosendfeldduring theirupcomingmeeting. Management ControlSystemand Performance Measurement Management ControlFunction inOrganisation 31 . ProfitPlanning Responsibility Centre: Expense Center Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . ResponsibilityCenter Management ControlSystemand Performance Measurement ▶ ▶ ▶ Anorganisationalunitwithamanager responsibleforitsactivities Usuallyreferstoaunitwithintheorganisation Existstoaccomplishanobjective Management ControlFunction inOrganisation ProfitPlanning 33 .Responsibility Centre: Expense Center Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . Inputs&Outputs Management ControlSystemand Performance Measurement ▶ ▶ Optimumrelationshipbetweeninputsand outputs Withinmanagementcontrolsystem, mustbe measurable ▶ ProfitPlanning 34 Unitmeasurements ▶ ▶ Management ControlFunction inOrganisation Responsibility Centre: Revenue Center hoursoflabor, quantitiesofmaterials, etc. Monetarymeasurements: ▶ .Responsibility Centre: Expense Center ProfitCentreand TransferPricing Problem costs, revenues Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . Efficiency&Effectiveness Management ControlSystemand Performance Measurement ▶ ▶ Notmutuallyexclusive Twocriteriausedtojudgeresponsibilitycentres ▶ Efficiency: ▶ ▶ ▶ Ratioofoutputstoinputs Higherisbetter! Management ControlFunction inOrganisation ProfitPlanning 35 Responsibility Centre: Revenue Center Effectiveness: ▶ ▶ .Responsibility Centre: Expense Center Relationshipofoutputtopredetermined objectives Again, higherisbetter! ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . TypesofResponsibilityCentres Management ControlSystemand Performance Measurement ▶ ▶ ▶ ▶ Revenuecentres Expensecentres(costcentres) Profitcentres Investmentcentres Management ControlFunction inOrganisation ProfitPlanning 36 .Responsibility Centre: Expense Center Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . Expense(Cost)Centre Management ControlSystemand Performance Measurement ▶ ▶ ▶ Inputs, andonlyinputs, aremeasured Measurementisnormallyinmonetaryterms Twotypes ▶ Engineeredexpensecentres ▶ ▶ Management ControlFunction inOrganisation ProfitPlanning 37 Optimalrelationshipbetweeninputsand outputs Responsibility Centre: Revenue Center Discretionaryexpensecentres ▶ .Responsibility Centre: Expense Center ProfitCentreand TransferPricing Problem Optimalrelationshipcannotbeestablished betweeninputsandoutputs Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . ConflictsandGoalCongruence Management ControlSystemand Performance Measurement ▶ Management ControlFunction inOrganisation Managersofrevenueandexpensecentres ▶ Mayseekexcellenceathighcosts ▶ ▶ ▶ ProfitPlanning 38 Mayseekoutputratherthanquality ▶ ▶ Many$$$forslightimprovementinoutput Increaseoflesserqualityproducts .Responsibility Centre: Expense Center Responsibility Centre: Revenue Center Needspecialbudgetarycontrols Mustconsidergoalcongruence ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . BusinessUnits Management ControlSystemand Performance Measurement Management ControlFunction inOrganisation ▶ ▶ ▶ Fullautonomy—normallynotfeasible Goalcongruence—riskoflossincreases CapitalBudgeting—normallylimited ProfitPlanning 39 .Responsibility Centre: Expense Center Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . SelectionofMeasurementItems Management ControlSystemand Performance Measurement Management ControlFunction inOrganisation ▶ Ifmanagercaninfluenceanitem, itcould/should beusedasameasurementofperformance ▶ ▶ ProfitPlanning 40 Totalcontrolisnotnecessary Degreeofcontrolisrelevant .Responsibility Centre: Expense Center Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . GrandJeanCompany I DiscussionQuestions Management ControlSystemand Performance Measurement 1. Howwouldyoudescribethegoal(s)ofthe companyasawhole? Isthis, orarethese, the sameasthegoal(s)ofthecompany’smarketing organizationandthecompany’s25managersof manufacturingplants? Explain. Management ControlFunction inOrganisation ProfitPlanning 41 .Responsibility Centre: Expense Center Responsibility Centre: Revenue Center 2. Evaluatethecurrentmanagementplanningand controlsystemforthemanufacturingplantsand themarketingdepartments. Whatarethe strengthsandweaknesses? ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . GrandJeanCompany II DiscussionQuestions 3. Oneplantmanagerrecommendedthatplantsbe operatedasprofitentersbecauseitwould overcomesomeoftheproblemsdiscoveredand thecasewriters. Thisplantmanagercommented, “[My]competitoristhenearbyindependent manufacturerthatmakesthesamepantsfor GrandJeanasmyplantmakes. Becauseofthe competitivemarket, onlythebestmanagedplants surviveinthisbusiness. Therefore, likethe outsidecompany’smanagerI shouldhavebottom lineresponsibilityandberewardedaccordingly.” Doyouagreeordisagreewiththeprofitcentre conceptforGrandJean’s25manufacturing Management ControlSystemand Performance Measurement Management ControlFunction inOrganisation ProfitPlanning 42 .Responsibility Centre: Expense Center Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . GrandJeanCompany III DiscussionQuestions plants? Howwouldthisapproachaffecttheplant managers’decisions, performance, etc.? 4. IfGrandJean’smanufacturingplantsweretreated asprofitenters, threealternativesweresuggested forrecordingrevenueforeachplant: Management ControlSystemand Performance Measurement Management ControlFunction inOrganisation ProfitPlanning 43 a. UsethesellingpricerecordedbyGrandJean’s salespersonnelforpantssoldtoretailersand distributors. b. Usefullstandardmanufacturingcostperunita “fair”fixedpercentagemarkupforgrossprofit. c. UsetheaveragecontractpriceGrandJeanpaid outsidecompaniesformakingsimilarpanttypes. .Responsibility Centre: Expense Center Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . GrandJeanCompany IV DiscussionQuestions Management ControlSystemand Performance Measurement Management ControlFunction inOrganisation Evaluatethesethreealternatives. Whichone wouldyourecommend? Whyisyourselection thebestone? ProfitPlanning 44 .Responsibility Centre: Expense Center Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . RevenueCentre Management ControlSystemand Performance Measurement ▶ ▶ ▶ Management ControlFunction inOrganisation Output, andonlyoutput, ismeasured Measurementisnormallyinmonetaryterms Typically, sales/marketing ▶ ▶ Cannotsetprice Havenocontrolovercosts ProfitPlanning Responsibility Centre: Expense Center 46 .Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . VershireCompany I Questions 1. OutlinethestrengthsandweaknessesofVershire Company’splanningandcontrolsystem. 2. TracetheprofitbudgetingprocessatVershire, startinginMayandendingwiththeBoardof Directors’meetinginDecember. Bepreparedto describetheactivitiesthattookplaceateachstep oftheprocessandpresenttherationaleforeach. 3. Shouldtheplantmanagersbeheldresponsible forprofits? Why? Whynot? 4. Howdoyouassesstheperformanceevaluation systemcontainedinExhibits2and3? Management ControlSystemand Performance Measurement Management ControlFunction inOrganisation ProfitPlanning Responsibility Centre: Expense Center 47 .Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . VershireCompany II Questions Management ControlSystemand Performance Measurement Management ControlFunction inOrganisation 5. Onbalance, wouldyouredesignthe managementcontrolstructureatVershire Company? Ifso, howandwhy? ProfitPlanning Responsibility Centre: Expense Center 48 .Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . ProfitCentre Management ControlSystemand Performance Measurement ▶ ▶ ▶ ▶ Bothinputsandoutputsaremeasured Measurementisinmonetaryterms Inputsarerelatedtooutputs Twoconditionsmustbemettocreateaprofit centre ▶ ▶ Relevantinformationmustbeavailable Effectivenessofmanagersdecisionsmustbe measurable Management ControlFunction inOrganisation ProfitPlanning Responsibility Centre: Expense Center Responsibility Centre: Revenue Center 50 .ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . MeasuringandControllingAssets Management ControlSystemand Performance Measurement ▶ ▶ ▶ Theterms“profitcenter”and“investmentcentre” areoftenusedinterchangeably Profitcentremeasuredonprofitinrelationtoa profittarget Investmentcentremeasuredonreturnonthe assetsusedtoearnprofit Management ControlFunction inOrganisation ProfitPlanning Responsibility Centre: Expense Center Responsibility Centre: Revenue Center 51 .ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . TransferPricing Management ControlSystemand Performance Measurement ▶ ▶ Management ControlFunction inOrganisation Thepricingsystemforthetransferofgoodsor servicesbetweentwoprofitcentreswithinthe sameorganization. Canalsoapplytoservicesprovidedbycorporate staffunits. ProfitPlanning Responsibility Centre: Expense Center Responsibility Centre: Revenue Center 52 .ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . ObjectivesofaTransferPrice Management ControlSystemand Performance Measurement ▶ ▶ ▶ ▶ Providerelevantinfotoprovideforoptimum companyprofits Inducegoalcongruentdecisions Measureeconomicperformance Simpleandeasytounderstand Management ControlFunction inOrganisation ProfitPlanning Responsibility Centre: Expense Center Responsibility Centre: Revenue Center 53 .ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . FundamentalPrinciple Management ControlSystemand Performance Measurement Management ControlFunction inOrganisation ▶ Thefundamentalprincipleisthatthetransfer priceshouldbesimilartothepricethatwouldbe chargediftheproductweresoldtooutside customersorpurchasedfromoutsidevendors. ProfitPlanning Responsibility Centre: Expense Center Responsibility Centre: Revenue Center 54 .ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . VariousSituations Management ControlSystemand Performance Measurement ▶ ▶ ▶ ▶ ▶ Management ControlFunction inOrganisation MarketPrice Constrained ProfitPlanning LimitedMarkets Excess/ShortageofIndustryCapacity Responsibility Centre: Expense Center Responsibility Centre: Revenue Center Cost-Based ▶ ▶ CostBasis ProfitMarkup 55 .ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . VariousSituations(cont’d) Management ControlSystemand Performance Measurement ▶ Management ControlFunction inOrganisation UpstreamFixedCostsandProfits ▶ ▶ ▶ ▶ Agreement(meetperiodicallyanddetermine) Two-Step(combinevariable&fixedcosts) ProfitSharing TwoSetsofPrices(outsidesalesprice&standard cost) ProfitPlanning Responsibility Centre: Expense Center Responsibility Centre: Revenue Center 56 .ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . CorporateServices Management ControlSystemand Performance Measurement Management ControlFunction inOrganisation ▶ ▶ ▶ ProfitPlanning ControloverServiceProvided OptionalUseofthatService SimplicityofPricing Responsibility Centre: Expense Center Responsibility Centre: Revenue Center 57 .ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . TransferPriceAdministration Management ControlSystemand Performance Measurement Management ControlFunction inOrganisation ▶ ProfitPlanning Negotiation ▶ ▶ Responsibility Centre: Expense Center Arbitration/ConflictResolution ProductClassification Responsibility Centre: Revenue Center 58 .ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . NorthCountryAuto, Inc. I DiscussionQuestions 1. Usingthedatainthetransaction, computethe profitabilityofthisonetransactiontothenew, used, parts, andservicedepartments. Assumea salescommissionof$250forthetrade-inona sellingpriceof$5,000. (Note: Usethefollowing allocations[new, $835; used, $665; parts, $32; service, $114]foroverheadexpenseswhile computingtheprofitabilityofthisone transaction. Theseoverheadallocationsarealso shownasNote13inExhibit3.) 2. Howshouldthetransfer-pricingsystemoperate foreachdepartment(marketprice, fullretail, full cost, variablecost)? Management ControlSystemand Performance Measurement Management ControlFunction inOrganisation ProfitPlanning Responsibility Centre: Expense Center Responsibility Centre: Revenue Center 59 .ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . NorthCountryAuto, Inc. II DiscussionQuestions 3. Ifitwerefoundoneweeklaterthatthetrade-in couldbewholesaledforonly$3,000, which managershouldtaketheloss? 4. NorthCountryincurredayear-to-datelossof about$59,000 before allocationoffixedcostson thewholesalingofusedcars(seeNote2in Exhibit3). Wholesalingofusedcarsis theoreticallysupposedtobeabreak-even operation. Wheredoyouthinktheproblemlies? 5. Shouldprofitcentersbeevaluatedongrossprofit or“fullcost”profit? 6. Whatadvicedoyouhavefortheowners? Management ControlSystemand Performance Measurement Management ControlFunction inOrganisation ProfitPlanning Responsibility Centre: Expense Center Responsibility Centre: Revenue Center 60 .ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 Corporate Governanceand BoardofDirectors . ROI vs. EVA Management ControlSystemand Performance Measurement ▶ ▶ ROI: Management ControlFunction inOrganisation Income AssetEmployed ProfitPlanning Responsibility Centre: Expense Center EVA: Netprofit − Capitalcharge Responsibility Centre: Revenue Center or ProfitCentreand TransferPricing Problem Capitalemployed × (ROI − Costofcapital) 62 67 .Responsibility Centre: Investment Centre Corporate Governanceand BoardofDirectors . DellComputerCorporation DiscussionQuestions Management ControlSystemand Performance Measurement Management ControlFunction inOrganisation 1. WhatisDell’sstrategy? Whatisthbasisonwhich Dellbuildsitscompetitiveadvantage? 2. HowdoDell’scontrolsystemshelpexecutethe firm’sstrategy? ProfitPlanning Responsibility Centre: Expense Center Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem 63 67 .Responsibility Centre: Investment Centre Corporate Governanceand BoardofDirectors . CorporateGovernance Management ControlSystemand Performance Measurement ▶ Management ControlFunction inOrganisation Thesetsofmechanismsandprocessesthathelp ensurethatcompaniesaredirectedandmanaged tocreatevaluefortheirownerswhile concurrentlyfulfillingresponsibilitiestoother stakeholders(e.g. employees, suppliers, society atlarge). ProfitPlanning Responsibility Centre: Expense Center Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 65 67 .Corporate Governanceand BoardofDirectors . CorporateGovernance(cont’d) ▶ Management ControlSystemand Performance Measurement Threeimportantcomponents: ▶ ▶ ▶ Management ControlFunction inOrganisation Boardofdirectors Auditcommittees—independentoversightover companies’financialreportingprocesses, internalcontrols, andindependentauditors Compensationcommittees—ensuringthatthe company’sexecutivecompensationprogramsare fairandappropriatetoattract, retain, and motivatemanagersandthattheyarereasonable inviewofcompanyeconomicsandtherelevant practicesofcomparablecompanies. ProfitPlanning Responsibility Centre: Expense Center Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 66 67 .Corporate Governanceand BoardofDirectors . BoardofDirectors Management ControlSystemand Performance Measurement ▶ Basicfiduciaryduties Management ControlFunction inOrganisation 1. Dutyofcare—dutytomake/delegatedecisions inaninformedway. 2. Dutyofloyalty—dutytoadvancecorporateover personalinterests. 3. Dutyofgoodfaith—dutytobefaithfuland devotedtotheinterestsofthecorporationandits shareholders. 4. Dutynotto“waste”—dutytoavoiddeliberate destructionofshareholdervalue. ProfitPlanning Responsibility Centre: Expense Center Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Responsibility Centre: Investment Centre 67 67 .Corporate Governanceand BoardofDirectors . References Management ControlSystemand Performance Measurement Anthony, R.N., &V.Govindarajan ManagementControlSystems, 12thed. Irwin-McGrawHill, 2007(AG) Management ControlFunction inOrganisation Simons, R. PerformanceMeasurementandControlSystemsforImplementing Strategy: TextandCases Prentice-Hall, 2000(S) ProfitPlanning Responsibility Centre: Expense Center Merchant, K.A.&W.A.VanderStede ManagementControlSystem: PerformanceMeasurement, Evaluationand Incentives, 2nded PrenticeHall, 2007(MV) Responsibility Centre: Revenue Center ProfitCentreand TransferPricing Problem Shleifer, A.&R.W.Vishny A SurveyofCorporateGovernance TheJournalofFinance, 50(2), 1997, pp.737–783. Responsibility Centre: Investment Centre 68 67 .Corporate Governanceand BoardofDirectors Thankyou
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