Friday, April 22, 2011

all 21-38

Q.4) Discuss special challenges faced in controlling R & D activities and possible management initiatives

  • Type of financial control: The financial control exercised in a discretionary expense center is quite different from that in engineered center the latter attempts to minimize operating cost by setting a standard and reporting actual costs against this standards. The main purpose of a discretionary expense budget on the other hand is to allow the manager to control Cost for particular in the planning. Costs are controlled primarily by deciding what task should be undertaken and what level of effort is appropriate for each. Thus in a discretionary expense center financial control is primary exercised at the planning stage before the amount are incurred.

  • Measurement of performance: The primary job of the manager of a discretionary expense center is to accomplish the desired output spending an amount that is on budget is satisfactory. This is in contrast with the report in an engineered expense center which helps higher management to evaluate the manger efficiency. If these two types of responsibility center are carefully distinguished management may treat the performance report for the discretionary expense center as if it were an indication of efficiency Control over spending can be exercised by requiring that the manger approved be obtain before the budget is over sometimes a certain percentage of overrun is permitted without additional approval if the budget really set forth the best estimate of actual cost there is 50 percent probability that it will overrun and this is the reason that some latitude is often permitted.

  • Control problems: The control of R & D centers, which are also discretionary expense center is difficult for the following at least a semi tangible output reasons.

1. Results are difficult to measure quantitatively. As contrasted with administrative activities, R&D usually has at least a semi tangible output in patent, new products, or new processes. Nevertheless, the relationship of these outputs to inputs is difficult to measure and appraise. A complete product of an R&D group may require several year of effort; consequently input as stated in an annual budget may be unrelated to outputs. Even if an output can be identified a reliable estimate of its value often cannot be made. Even if the value of the output can be calculated, it is usually not possible for management to evaluate the efficiency of the R&D effort because of its technical nature. A brilliant effort may come up against an insuperable obstacle, whereas a mediocre effort may, by luck result in a bonanza.

2. The goal congruence problem in R&D center is similar to that in administrative centers. The research managers typically want to build the best research organization that money can buy, even though this is more expensive than the company can afford. A further problem is that research people often may not have sufficient knowledge of the business to determine the optimum direction of the research efforts.

3. Research and development can seldom be controlled effectively on an annual basis. A research project may take year s to reach fruition, and the organization must be built up slowly over a long time period. The principal cost is for the work force obtaining highly skilled scientific talented is often difficult, and short term fluctuation in the work force are in efficient. It is not reasonable, therefore to reduce R&D costs in years when profits are low and increase them in year when profits are high. R&D should be looked at as a long term investment not as an activity that varies with short run corporate profitability.

§ The R&D continuum:Activities conducted by R&D organization lie along a continuum. At one extreme is basic research; the other extreme is product testing. Basic research has two characteristics: first, it is unplanned management at most can specify the general area that is to be explored second there is often a very long time lag before basic research result in successful new product introductions. Financial control system has little value in managing basic research activities. In some companies, basic research in included as a lump sum in the research program and budget. In others, no specific allowance is made for basic research as such; there is an understanding that scientists and engineers can devote part of their time to explorations in whatever direction they find most interesting, subject only to informal agreement with their supervisor.For product testing projects, on the other hand, the time and financial requirement can be estimated, not as accurately as production activities.

Q.5) Explain problems faced in pricing corporate services provided to business units organized as Profit Centers

Services are intangible in nature. This characteristic of services makes it difficult for pricing. Charging business units for services furnished by corporate staff units becomes challenging work due to intangibility of services. While pricing corporate services, we exclude the cost of central service staff units over which business units have no control (e.g., central accounting, public relations, and administration). If these costs are charged at all, they are allocated, and the allocations do not include a profit component. The allocations are not transfer prices.

Ø We need to consider two types of transfers:

o For central services that the receiving unit must accept but can at least partially control the amount used.

o For central services that the business unit can decide whether or not to use.

Business units may be required to use company staffs for services such as information technology and research and development. In these situations, the business unit manager cannot control the efficiency with which these activities are performed but can control the amount of the service received. There are three schools of thought about such services.

One school holds that a business unit should pay the standard variable cost of the discretionary services. If it pays less than this, it will be motivated to use more of the service than is economically justified. On the other hand, if business unit managers are required to pay more than the variable cost, they might not elect to use certain services that senior management believes worthwhile from the company's viewpoint. This possibility is most likely when senior management introduces a new service, such as a new project analysis program. The low price is analogous to the introductory price that companies sometimes use for new products.

A second school of thought advocates a price equal to the standard variable cost plus a fair share of the standard fixed costs-that is, the full cost. Proponents argue that if the business units do not believe the services are worth at least this amount, something is wrong with either the quality or the efficiency of the service unit. Full cost represents the company's long run costs, and this is the amount that should be paid.

A third school advocates a price that is equivalent to the market price, or to standard full cost plus a profit margin. The market price would be used if available (e.g., costs charged by a computer service bureau); if not, the price would be full cost plus a return on investment. The rationale for this position is that the capital employed by service units should earn a return just as the capital employed by manufacturing units does. Also, the business units would incur the investment if they provided their own service.

Ø Optional Use of Services

In some cases, management may decide that business units can choose whether to use central service units. Business units may procure the service from outside, develop their own capability, or choose not to use the service at all. This type of arrangement is most often found for such activities as information technology, internal consulting groups, and maintenance work. These service centers are independent; they must stand on their own feet. If the internal services are not competitive with outside providers, the scope of their activity will be contracted or their services may be outsourced completely.

For example, Commodore Business Machines outsourced one of its central service activities-customer service-to Federal Express. James Reeder, Commodore's vice president of customer satisfaction, said, "At that time we didn't have the greatest reputation for customer service and satisfaction. But this was FedEx's specialty, handling more than 300,000 calls for service each day. Commodore arranged for FedEx to handle the entire telephone customer service operation from FedEx's hub in Memphis.

After losing $29 million online the previous year, Borders Group turned to rival Amazon.com to manage its online sales. Borders get to maintain an Internet sales channel and gains the operational effectiveness provided by Amazon.com while being able to focus on the growth of its bricks and mortar business.

In this situation, business unit managers control both the amount and the efficiency of the central services. Under these conditions, these central groups are profit centers. Their transfer prices should be based on the same considerations as those governing other transfer prices.

(Numerical) MCS – 2004

Division B of Shayana company contracted to buy from Div. A, 20,000 units of a components which goes into the final product made by Div. B. The transfer price for this internal transaction was set at Rs. 120 per unit by mutual agreement. This comprises of (per unit) Direct and Variable labour cost of Rs. 20; Material Cost of Rs.60; Fixed overheads of Rs.20 (lumpsum Rs.4 lacs) and Rs.20 lacs that Div. A would require for this additional activity. During the year, actual off take of Div. B from Div. A was 19,600 units. Div. A was able to reduce material consumption by 5% but its budgeted investment overshot by 10%.

a) As Financial controller of Div. A, compare Actual Vs Budgetred Performance

b) Its implications for Management Control?

Solution:

a)

Particulars

Budgeted (Rs. Per Unit)

Budgeted (Total in Rs.)

Actual (Rs. Per Unit)

Actual (Total in Rs.)

Direct and Variable Labour Cost

20

4,00,000

20

3,92,000

Material Cost

60

12,00,000

57

11,17,200

Fixed Overheads

20

4,00,000

4,00,000

Total Cost

100

20,00,000

19,09,200

Transfer Price

120

24,00,000

119.86

23,49,200

Profit

20

4,00,000

4,40,000

Investment

20

20,00,000

22,00,000

ROI = Profit/Investment

20%

20%

Despite of increase in investment by 10%, there is negligible difference in transfer price. Also the sales have decreased by 400 units. Therefore we can say that additional investment has not achieved any positive results.

SET-4

Q.1) A)Explain the concept of ROI. What are its advantages?

Return on investment (ROI) is the ratio of profit before tax to the gross investment.

ROI is calculated with the help of the following formula:

ROI = (Pre-Tax Profit/Sales) X (Sales/Net Assets) or (Pre-Tax Profits/Net Assets)

The numerator is profit before tax as reported in the P&L account. The profit should include only the profits arising out of the normal activities of the division. Unusual items of receipts and expenses should be excluded from the profit figure. One should also ignore windfalls and income from investments not related to the operations of the division. Tax is excluded from the numerator because the marginal of the SBU is not responsible for or in control of the tax paid.

Capital employed can be ascertained from the balance sheet by including fixed and current assets. Assets not currently put to divisional use should be excluded from the investment base. One also needs to exclude their relative earnings if any. The company should also exclude intangible assets like goodwill, deferred revenue expenses, preliminary expenses, etc.

ROI can be improved by:

  • Increasing the profit margin on sales.
  • Increasing the capital turnover
  • Increasing both profit margin and capital turnover.
  • Reducing cost as that adds to the total earnings of the firm.
  • Increasing the profits by expanding present operations or developing new product line, increasing market share, etc.
  • Diversifying, introducing productivity imporevement measures, expansion, replacement of old equipments

Advantages of ROI

  • ROI relates return to the level of investment and not sales as the rate of return is more realistic.
  • ROI can be decomposed into other variables as shown. These variables have tremendous analytical value.
  • ROI is an effective tool for inter-firm comparison.

Question 1 (b):

Many experts regard EVA as a concept superior to ROI and yet in certain cases, EVA does not do justice to the evaluation of investment center. Explain this phenomenon with as illustration.

EVA does not solve all the problems of measuring profitability in an investment center. In particular, it does not solve the problem of accounting for fixed assets discussed above unless annuity depreciation is also used, and this is rarely done in practice. If gross book value is used, a business unit can increase its EVA by taking actions contrary to the interests of the company, as shown in Exhibit 7-3. If net book value is used, EVA will increase simply due to the passage of time. Furthermore, EVA will be temporarily depressed by new in­vestments because of the high net book value in the early years. EVA does solve the problem created by differing profit potentials. All business units, regardless of profitability, will be motivated to increase investments if the rate of return from a potential investment exceeds the required rate prescribed by the mea­surement system.

Moreover, some assets may be undervalued when they are capitalized, and others when they are expensed. Although the purchase cost of fixed assets is ordinarily capitalized, a substantial amount of investment in start-up costs, new product development, dealer organization, and so forth may be written off as expenses, and, therefore, not appear in the investment base. This situation applies especially in marketing units. In these units the investment amount may be limited to inventories, receivables, and office furniture and equipment. When a group of units with varying degrees of marketing responsibility are ranked, the unit with the relatively larger marketing operations will tend to have the highest EVA.

In view of all these problems, some companies have decided to exclude fixed assets from the investment base. These companies make an interest charge for controllable assets only, and they control fixed assets by separate devices. Con­trollable assets are, essentially, receivables and inventory. Business unit man­agement can make day-to-day decisions that affect the level of these assets. If these decisions are wrong, serious consequences can occur-quickly. For exam­ple, if inventories are too high, unnecessary capital is tied up, and the risk of obsolescence is increased; whereas, if inventories are too low, production inter­ruptions or lost customer business can result from the stockouts. To focus atten­tion on these important controllable items, some companies, such as Quaker Oats, 17 include a capital charge for the items as an element of cost in the busi­ness unit income statement. This acts both to motivate business unit manage­ment properly and also to measure the real cost of resources committed to these items.

Investments in fixed assets are controlled by the capital budgeting process before the fact and by post completion audits to determine whether the antici­pated cash flows, in fact, materialized. This is far from being completely satis­factory because actual savings or revenues from a fixed asset acquisition may not be identifiable. For example, if a new machine produces a variety of prod­ucts, the cost accounting system usually will not identify the savings attribut­able to each product.

The argument for evaluating profits and capital investments separately is that this often is consistent with what senior management wants the business unit manager to accomplish; namely, to obtain the maximum long-run cash flow from the capital investments the business unit manager controls and to add capital investments only when they will provide a net return in excess of the company's cost of funding that investment. Investment decisions, then, are controlled at the point where these decisions are made. Consequently, the capi­tal investment analysis procedure is of primary importance in investment con­trol. Once the investment has been made, it is largely a sunk cost and should not influence future decisions. Nevertheless, management wants to know when capital investment decisions have been made incorrectly, not only because some action may be appropriate with respect to the person responsible for the mis­takes but also because safeguards to prevent a recurrence may be appropriate.

Q.2 What are the different methods to evaluate the performance of an investment centre? Discuss the merits and demerits of each? Which method would you recommend?

The following techniques are useful in evaluating the performance of an investment centre:

1. Return on investment (ROI):

The rate of return on investment is determined by dividing net profit or income by the capital employed or investment made to achieve that profit.

ROI = Profit / Invested capital * 100

ROI consists of two components viz.

Profit margin

Investment turnover

ROI = Net profit / Investment

= (Net profit / Sales) * (Sales / Investment in assets)

It will be seen from the above formula that ROI can be improved by increasing one or both of its components viz. the profit margin and the investment turnover in any of the following ways:

Increasing the profit margin

Increasing the investment turnover

Increasing both profit margin and investment turnover

Capital employed is taken to be the total of shareholders funds, loans etc

The profit figure used is in calculating ROI is usually taken from the profit and loss account, profit arising out of the normal activities of the company should only be taken.

Capital employed for the company as a whole can be arrived at as follows:

Share capital of the company xxx

Reserves and surplus xxx

Loans (secured/unsecured) xxx

------

xxx

Less: a. Investment outside the business xxx

b. Preliminary expenses xxx

c. Debit balance of P & L A/c xxx xxx

-------

xxxx

Merits:

Return on investment analysis provides a strong incentive for optimum utilization of the assets of the company. This encourages managers to obtain assets that will provide a satisfactory return on investment and to dispose off assets that are not providing an acceptable return. In selecting amongst alternative long-term investment proposals, ROI provides a suitable measure for assessment of profitability of each proposal.

Demerits:

ROI analysis is not very suitable for short-term projects and performances. In the initial stages a new investment may yield a small ROI which may mislead the management. Most likely the rate would improve in course of time when the initial difficulties are overcome.

The book value of assets decline due to depreciation, the investment base will continuously decrease in value, causing the rate of return to increase.

2. Residual income:

Residual income can be defined as the operating profit (or income) of the company less the imputed interest on the assets used by the company. In other words, interest on the capital invested in the company is treated as a cost and any surplus is the residual income. Residual income is profit minus notional interest charge on capital employed.

Residual income is affected by the size of the organization and therefore will not provide a basis for evaluation of organizational performance. This is probably the main reason why the management continues to make use of ROI which is relative measure.

Not all projects start off with positive or sufficiently large positive profits in the early years of a project to produce a positive increment to residual income.

It has been argued that a more suitable measure of performance for investment centres, which could encourage managers to be more willing to undertake marginally profitable projects, is residual income.

We recommend RI as a method of evaluating performance of an investment centre. Because when RI is adopted for evaluation purposes, emphasis is placed on marginal profit amount above the cost of capital rather than on the rate itself.

Q.3 What are the objectives of Transfer Pricing?

Transfer price if designed appropriately has the following objectives:

It should provide each segment with the relevant information required to determine the optimum trade-off between company costs and revenues.It should induce goal congruent decisions-i.e. the system should be so designed that decisions that improve business unit profits will also improve company profits. It should help measure the economic performance of the individual profit centers. The system should be simple to understand and easy to administer.

ü What is ideal transfer price in the situations of Limited Market Shortage of Capacity in the industry

The ideal transfer price in the situations of Limited Market

By limited market it means that the markets for buying and selling profit centers may be limited.

Even in case of limited market the transfer price that is ideal or satisfies the requirement of a profit center system is the competitive price. In case if a company is not buying or selling its product in an outside market there are some ways to find the competitive price. They are as follows:

If published market prices are available, they can be used to establish transfer prices. However, these should be prices actually paid in the market-place and the conditions that exist in the outside market should be consistent with those existing within the company.

For example, market prices that are applicable to relatively small purchases are not valid in this case.

Market prices are set by bids. This generally can be done only if the low bidder has a reasonable chance of obtaining the business. One company accomplishes this by buying about one-half of a particular group of products outside the company and one-half inside the company. The company then puts all of the products out to bid, but selects one-half to stay inside. The company obtains valid bids, because low bidders can expect to get some of the business. By contrast, if a company requests bids solely to obtain a competitive price and does not award the contracts to the low bidder, it will soon find that either no one bids or that the bids are of questionable value.

If the production profit center sells similar products in outside markets, it is often possible to replicate a competitive price on the basis of the outside price. If the buying profit center purchases similar products from the outside market, it may be possible to replicate competitive prices for its proprietary products. This can be done by calculating the cost of the difference in design and other conditions of sale between the competitive products and the proprietary products.

Shortage of Capacity in the industry

In this case, the output of the buying profit center is constrained and again company profits may not be optimum. Some companies allow either buying profit center to appeal a sourcing decision to a central person or committee. In this scenario a buying profit center could appeal a selling profit center’s decision to sell outside.

The person/group would then make a sourcing decision on the basis of the company’s best interests. In every case the transfer price would be the competitive price. In other words, the profit center is appealing only the sourcing decision.

Even if there are constraints on sourcing, the market price is the best transfer price. If the market price can be approximated, it is ideal transfer price.

ü When do you use Cost Based Transfer Pricing?

We use cost-based transfer pricing if there is no way of approximating valid competitive price. Transfer prices may be set up on the basis of cost plus a profit, even though such transfer prices may be complex to calculate and the results less satisfactory than a market-based price.

Two aspects need to be considered for cost-based transfer pricing:

The cost basis: The usual basis is the standard cost. Actual costs should not be used because production inefficiencies will then be passed on to the buying profit center. If the standard costs are used, there is a need to provide an incentive to set tight standards and to improve standards.

The profit markup: In calculating the profit markup, there also are two decisions:

ü What is the profit markup to be based?

The simplest and most widely used base is percentage of costs. If this base is used, however, no account is taken of capital required. A conceptually better base is a percentage of investment. But there may be a major practical problem in calculating the investment applicable to a given product. If the historical cost of the fixed assets is used, new facilities designed to reduce prices could actually increase costs because old assets are undervalued

ü What is the level of profit allowed?

The second problem with the profit allowance is the amount of the profit. The conceptual solution is to base the profit allowance on the investment required to meet the volume needed by the buying profit centers. The investment would be calculated at a “standard” level, with fixed assets and inventories at current replacement costs. This solution is complicated and, therefore, rarely used in practice.

Q.4 (a) “Transfer Pricing is not an accounting tool” comment with an illustration

If a group has subsidiaries that operate in different countries with different tax rates, manipulating the transfer prices between the subsidiaries can scale down the overall tax bill of the group. For example the tax rate in Country A is 20% and is 50% in Country B. In the larger interest of the group, it would be advisable to show lower profits in Country B and higher profits in Country A. For this, the group can adjust the transfer price in such a way that the profits in Country A increase and that in Country B get reduced. For this the group should fix a very high transfer price if the Division in Country A provides goods to the Division in Country B. This will maximize the profits in Country A and minimize the profits in Country B. The reverse will be true if the Division in Country A acquires goods from the Division in Country B.

There is also a temptation to set up marketing subsidiaries in countries with low tax rates and transfer products to them at a relatively low transfer price.

Transfer price is viewed as a major international tax issue. While companies indulge in all types of activities to lower their tax liability, the tax authorities monitor transfer prices closely in an attempt to collect the full amount of tax due. For this they enter into agreements whereby tax is paid on specific transactions in one country only. But if companies set unrealistic transfer price to minimize their tax liabilities and the same is spotted by the tax authority, then the company is forced to pay tax in both countries leading to double taxation.

There have been instances where companies have fixed unrealistic transfer prices. The first case relates to Hoffman La Roche that imported two drugs Librium and Valium into UK at prices of 437 pounds and 979 pounds per kilo respectively. While the tax authorities in UK accepted the price, the Monopolies Commission did not accept the company's argument, since the same drugs were available from an Italian firm for 9 pounds and 28 pounds per kilo.

The company's lawyers argued the case before the Commission on two grounds viz.

1. The price was not set on cost but on what the market would bear and

2. The company had incurred an R&D cost that was included in the price.

These arguments did not go well with the Commission and the company was fined 1.85 million pounds for the manipulative practices adopted while fixing the transfer price.

The second case is of Nissan. The company had falsely inflated freight charges by 40-60% to reduce the profits. The manipulation helped the company to hide tax to the tune of 237 million dollars. The next year Nissan was made to pay 106 million dollars in unpaid tax in the USA because the authorities felt that part of their US marketing profits were being transferred to Japan, as transfer prices on import of cars and trucks were too high. Interestingly the Japanese tax authorities took a different view and returned the double tax.

With a view to avoid such cases from recurring, Organisation for Economic Cooperation and Development issued some guidelines in 1995. These guidelines aim at encouraging world trade. They evolved what came to be known as the arm's length price. The principle states that the transfer price would be arrived at on the basis as if the two . companies are independent and unrelated. The price is determined through:

Comparable Price Method where the price is fixed on the basis of prices of similar products or an approximation to one.Gross Margin Method where a gross margin is established and applied to the seller's manufacturing cost.

In spite of all these efforts, it has to be admitted that setting a fair transfer price is not easy. So the onus of proving the price has been put on the taxpayer who is required to produce supporting documents. If the taxpayer fails to do this he is required to pay heavy penalty. For example, in USA, failure to provide documentary evidence results in a 40% penalty on the arm's length price. In UK the penalty is to the tune of 100% of any tax adjustment. Other countries are also in the process of evolving tight norms for the same. Countries across the globe also allow the taxpayer to enter into an Advance Pricing Agreement whereby dispute can be avoided and so also the costly penalty of double taxation and penalty.

Q.4.( b) Market Price is ideal transfer price even in limited markets. Comments

By limited market it means that the markets for buying and selling profit centers may be limited.

Even in case of limited market the transfer price that is ideal or satisfies the requirement of a profit center system is the competitive price. In case if a company is not buying or selling its product in an outside market there are some ways to find the competitive price. They are as follows:

1. If published market prices are available, they can be used to establish transfer prices. However, these should be prices actually paid in the market-place and the conditions that exist in the outside market should be consistent with those existing within the company. For example, market prices that are applicable to relatively small purchases are not valid in this case.

2.Market prices are set by bids. This generally can be done only if the low bidder has a reasonable chance of obtaining the business. One company accomplishes this by buying about one-half of a particular group of products outside the company and one-half inside the company.

The company then puts all of the products out to bid, but selects one-half to stay inside. The company obtains valid bids, because low bidders can expect to get some of the business. By contrast, if a company requests bids solely to obtain a competitive price and does not award the contracts to the low bidder, it will soon find that either no one bids or that the bids are of questionable value.

3.If the production profit center sells similar products in outside markets, it is often possible to replicate a competitive price on the basis of the outside price.

4.If the buying profit center purchases similar products from the outside market, it may be possible to replicate competitive prices for its proprietary products. This can be done by calculating the cost of the difference in design and other conditions of sale between the competitive products and the proprietary products.So we see from the above arguments that market price is ideal transfer price even in limited markets

SET .5

Q.1) Describe and illustrate significance of human behavior patterns in management control system.

Ans. Management control systems influence human behavior. Good management control systems influence behavior in a goal congruent manner; that is, they en­sure that individual actions taken to achieve personal goals also help to achieve the organization's goals. The concept of goal congruence, describ­ing how it is affected both by informal actions and by formal systems.

Senior management wants the organization to attain the organization's goals. But the individual members of the organization have their own personal goals, and they are not necessarily consistent with those of the organization. The cen­tral purpose of a management control system, then, is to ensure a high level of what is called "goal congruence." In a goal congruent process, the actions people are led to take in accordance with their perceived self­ interest are also in the best interest of the organization.

The significance of human behavior patterns in management control system can be explained with the help of Informal Factors that influence Goal Congruence. In the informal forces both internal and external factors play a key role.

External Factors

External factors are norms of desirable behavior that exist in the society of which the organization is a part. These norms include a set of attitudes, often collectively referred to as the work ethic, which is manifested in employees' loy­alty to the organization, their diligence, their spirit, and their pride in doing a good job (rather than just putting in time). Some of these attitudes are local­ that is, specific to the city or region in which the organization does its work. In encouraging companies to locate in their city or state, chambers of commerce and other promotional organizations often claim that their locality has a loyal, diligent workforce. Other attitudes and norms are industry-specific. Still others are national; some countries, such as Japan and Singapore, have a reputation for excellent work ethics.

Internal Factors

Ø Culture

The most important internal factor is the organization's own culture-the com­mon beliefs, shared values, norms of behavior and assumptions that are implicitly and explicitly manifested throughout the organization. Cultural norms are extremely important since they explain why two organiza­tions with identical formal management control systems, may vary in terms of actual control. A company's culture usually exists unchanged for many years. Certain prac­tices become rituals, carried on almost automatically because "this is the way things are done here." Others are taboo ("we just don't do that here"), although no one may remember why. Organizational culture is also influenced strongly by the personality and policies of the CEO, and by those of lower-level man­agers with respect to the areas they control. If the organization is unionized, the rules and norms accepted by the union also have a major influence on the organization's culture. Attempts to change practices almost always meet with resistance, and the larger and more mature the organization, the greater the resistance is.

Ø Management Style

The internal factor that probably has the strongest impact on management control is management style. Usually, subordinates' attitudes reflect what they perceive their superiors' attitudes to be, and their superiors' attitudes ulti­mately stem from the CEO.

Managers come in all shapes and sizes. Some are charismatic and outgo­ing; others are less ebullient. Some spend much time looking and talking to people (management by walking around); others rely more heavily on written reports.
The Informal Organization

The lines on an organization chart depict the formal relationships-that is, the official authority and responsibilities-of each manager. The chart may show, for example, that the production manager of Division A reports to the general manager of Division A. But in the course of fulfilling his or her responsibilities, the production manager of Division A actually communicates with many other people in the organization, as well as with other managers, support units, the headquarters staff, and people who are simply friends and acquaintances. In extreme situations, the production manager, with all these other communica­tion sources available, may not pay adequate attention to messages received from the general manager; this is especially likely to occur when the production manager is evaluated on production efficiency rather than on overall perfor­mance. The realities of the management control process cannot be understood without recognizing the importance of the relationships that constitute the in­formal organization.

Ø Perception and Communication

In working toward the goals of the organization, operating managers must know what these goals are and what actions they are supposed to take in order to achieve them. They receive this information through various channels, both formal (e.g., budgets and other official documents) and informal (e.g., conver­sations). Despite this range of channels, it is not always clear what senior man­agement wants done. An organization is a complicated entity, and the actions that should be taken by anyone part to further the common goals cannot be stated with absolute clarity even in the best of circumstances.

Moreover, the messages received from different sources may conflict with one another, or be subject to differing interpretations. For example, the budget mechanism may convey the impression that managers are supposed to aim for the highest profits possible in a given year, whereas senior management does not actually want them to skimp on maintenance or employee training since such actions, although increasing current profits, might reduce future prof­itability. The informal factors discussed above have a major influence on the effective­ness of an organization’s management control. The other major influence is the formal systems. These systems can be classified into two types: (1) the man­agement control system itself and (2) rules, which are described in this section.

The Formal Control System

Rules

We use the word rules as shorthand for all types of formal instructions and controls, including: standing instructions, job descriptions, standard operat­ing procedures, manuals, and ethical guidelines. Rules range from the most trivial (e.g., paper clips will be issued only on the basis of a signed requisi­tion) to the most important):e.g., capital expenditures of over $5 million must be approved by the board' of directors).

Some rules are guides; that is, organization members are permitted, and indeed expected, to depart from them, either under specified circumstances or when their own best judgment indicates that a departure would be in the best interests of the organization.

Some rules are positive requirements that certain actions be taken (e.g., fire drills at prescribed intervals). Others are prohibitions against unethical, ille­gal, or other undesirable actions. Finally, there are rules that should never be broken under any circumstances: a rule prohibiting the payment of bribes, for example, or a rule that airline pilots must never take off without permission from the air traffic controller.

Some specific types of rules are listed below:

Ø Physical Controls

Security guards, locked storerooms, vaults, computer passwords, televi­sion surveillance, and other physical controls may be part of the control structure.

Ø Manuals

Much judgment is involved in deciding which rules should be written into a manual, which should be considered to be guidelines rather than fiats, how much discretion should be allowed, and a host of other considerations. Man­uals in bureaucratic organizations are more detailed than are those in other organizations; large organizations have more manuals and rules than small ones; centralized organizations have more than decentralized ones; and or­ganizations with geographically dispersed units performing similar func­tions (such as fast-food restaurant chains) have more than do single-site organizations

Ø System Safeguards

Various safeguards are built into the information processing system to en­sure that the information flowing through the system is accurate, and to pre­vent (or at least minimize) fraud of every sort. These include: cross-checking totals with details, requiring signatures and other evidence that a transac­tion has been authorized, separating duties, counting cash and other portable assets frequently, and a number of other procedures described in texts on auditing.

Ø Task Control Systems

Task control is the process of assuring that specific tasks are carried out efficiently and effectively. Many of these tasks are con­trolled by rules. If a task is automated, the automated system itself provides the control.

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