Slide AKT202 Chapter 22

Management Control

Systems

_{Management Control Systems are a means of}

gathering and using information to aid and

coordinate the planning and control decisions throughout an organization and to guide the behavior of its managers and other employees

Management Control

Systems

 _{Many management control systems contain}

some or all of the balanced scorecard perspectives:

1. Financial 2. Customer

Management Control

Systems

_{Consist of Formal and Informal control}

systems:

Formal systems include explicit rules,

procedures, performance measures, and

incentive plans that guide the behavior of its managers and other employees

Informal systems include shared values,

loyalties, and mutual commitments among members of the company, corporate culture, and unwritten norms about acceptable behavior

Evaluating

Management Control Systems

_{To be effective, management control systems}

should be closely aligned to the firm’s strategies and goals

_{Systems should be designed to fit the}

Evaluating

Management Control Systems

_{Effective management control systems should}

also motivate managers and their employees

_{Motivation is the desire to attain a selected}

goal (goal-congruence) combined with the resulting pursuit of that goal (effort)

Two Aspects of Motivation

_{Goal Congruence exists when individuals and}

groups work toward achieving the

organization’s goals – managers working in their own best interest take actions that align with the overall goals of top management

_{Effort is exertions toward reaching a goal,}

Organization Structure and

Decentralization

_{Decentralization is the freedom for managers}

at lower levels of the organization to make decisions

_{Autonomy is the degree of freedom to make}

decisions. The greater the freedom, the greater the autonomy

Decentralization vs.

Centralization

_{Total decentralization means minimum}

constraints and maximum freedom for managers at the lowest levels of an organization to make decisions

_{Total centralization means maximum constraints}

and minimum freedom for managers at the lowest levels of an organization to make

decisions

Companies structures generally fall somewhere

Benefits of Decentralization

_{Creates greater responsiveness to local needs} _{Leads to gains from faster decision making}

_{Increases motivation of subunit managers} _{Assists management development and}

learning

_{Sharpens the focus of subunit managers}

Costs of Decentralization

_{Leads to Suboptimal Decision Making, which}

arises when a decision’s benefit to one

subunit is more than offset by the costs or

loss of benefits to the organization as a whole.

Also called Incongruent Decision Making or

Costs of Decentralization

_{Focuses manger’s attention on the subunit}

rather than the company as a whole

_{Increases costs of gathering information} _{Results in duplication of activities}

Decentralization and

Multinational Firms

_{Multinational firms – companies that operate in} multiple countries – are often decentralized

because centralized control of a company with subunits around the world is often physically and practically impossible

_{Decentralization enables managers in different} countries to make decisions that exploit their knowledge of local business and political

conditions and to deal with uncertainties in their individual environments

_{Biggest Drawback to International}

Choices About

Responsibility Centers

_{Regardless of the degree of decentralization,}

management control systems uses one or a mix of the four types of responsibility centers:

Cost Center

Revenue Center Profit Center

Investment Center

Transfer Pricing

_{Transfer Price – the price one subunit}

(department or division) charges for a product or service supplied to another subunit of the same organization

_{Management control systems use transfer}

Transfer Pricing

_{The transfer price creates revenues for the}

selling subunit and purchase costs for the buying subunit affecting each subunit’s operating income

_{Intermediate Product – the product or service}

transferred between subunits of an organization

Three Transfer Pricing

Methods

1. Market-based Transfer Prices

2. Cost-based Transfer Prices

Market-Based Transfer Prices

_{Top management chooses to use the price of}

similar product or service that is publicly available. Sources of prices include trade associations, competitors, etc.

Market-Based Transfer Prices

 _{Lead to optimal decision-making when three}

conditions are satisfied:

1. The market for the intermediate product is

perfectly competitive

2. Interdependencies of subunits are minimal 3. There are no additional costs or benefits to

Market-Based Transfer Prices

_{A perfectly competitive market exists when} there is a homogeneous product with buying prices equal to selling prices and no individual buyer or seller can affect those prices by their own actions

Allows a firm to achieve goal congruence, motivating management effort, subunit

performance evaluations, and subunit autonomy Perhaps should not be used if the market is

currently in a state of “distress pricing”

Cost-Based Transfer Prices

_{Top management chooses a transfer price}

based on the costs of producing the

intermediate product. Examples include:

Variable Production Costs

Variable and Fixed Production Costs

Full Costs (including life-cycle costs)

One of the above, plus some markup

_{Useful when market prices are unavailable,}

Cost-Based Transfer Pricing

Alternatives

_{Prorating the difference between the}

maximum and minimum cost-based transfer prices

_{Dual-Pricing – using two separate}

transfer-pricing methods to price each transfer from one subunit to another. Example: selling

division receives full cost pricing, and the buying division pays market pricing

Negotiated Transfer Prices

_{Occasionally, subunits of a firm are free to}

negotiate the transfer price between

themselves and then to decide whether to buy and sell internally or deal with external parties

_{May or may not bear any resemblance to}

cost or market data

_{Often used when market prices are volatile} _{Represent the outcome of a bargaining}

Comparison of

Transfer-Pricing Methods

Transfer

Pricing

Illustrati

on

Minimum Transfer Price

_{The minimum transfer price in many}

situations should be:

Incremental cost is the additional cost of

producing and transferring the product or service

Opportunity cost is the maximum contribution

Multinational Transfer Pricing and

Tax Considerations

_{Transfer prices often have tax implications} _{Tax factors include income taxes, payroll}

taxes, customs duties, tariffs, sales taxes,

value-added taxes, environment-related taxes and other government levies

Multinational Transfer Pricing and

Tax Considerations

_{Section 482 of the US Internal Revenue Code}

governs taxation of multinational transfer pricing

_{Section 482 requires that transfer prices}

between a company and its foreign division or subsidiary equal the price that would be

charged by an unrelated third party in a comparable transaction

Transfer price could be market-based or “cost-plus”