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ppt spm chapter 6 binusTRANSCRIPT
Financial Responsibility Centers
Course : F0942 – Management Control SystemYear : 2013-2014
Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition © Pearson Education Limited 2007
Slide 7.3
Chapter 7:Financial Responsibility Centers
Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition © Pearson Education Limited 2007
Slide 7.4
Financial results controls
Three core elements:
– Financial responsibility centers» The apportioning of accountability for financial results within
the organization.
– Formal management processes (planning & budgeting) » To define performance expectations and standards for
evaluating performance.
– Motivational contracts» To define the links between results and various organizational
incentives.
Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition © Pearson Education Limited 2007
Slide 7.5
Responsibility centers
Responsibility center» Organization unit headed by a manager with
responsibility for a particular set of inputs and/or outputs.
Financial responsibility center» Responsibility center in which the manager's
responsibilities are defined at least partially in financial terms.
Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition © Pearson Education Limited 2007
Slide 7.6
Revenue centers Managers of revenue centers are held accountable for
generating revenues (a financial measure of outputs).» e.g., Sales departments in commercial organizations;» e.g., Fundraising managers in not-for-profit organizations.
No formal attempt is made to relate inputs (measured as expenses) to outputs.
» However, most revenue center managers are also held accountablefor some expenses (e.g. salespeople's salaries and commissions);
» But, still they are not profit centers because: These costs are only a tiny fraction of the revenues generated; Revenue centers are not charged for the costs of the goods
they sell.
If sales are not "equally endowed," then revenue responsibilitywill not necessarily lead to the most profitable sales.
Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition © Pearson Education Limited 2007
Slide 7.7
Expense centers Managers of expense (cost) centers are held accountable
for expenses (financial measure of the inputs consumed by the responsibility center).
» Standard cost centers or engineered expense centers Inputs can be measured in monetary terms; Outputs can be measured in physical terms; and, Causal relationship between inputs and outputs.
– e.g., manufacturing departments, but also, warehousing, distribution, personnel administration, catering.
» Managed cost centers or discretionary expense centers Outputs produced are difficult to measure; and, Relationship between inputs-outputs is not well known.
– e.g., R&D, PR, HR, marketing activities.
Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition © Pearson Education Limited 2007
Slide 7.8
Control in expense centers Engineered expense centers
» Standard cost vs. actual cost i.e., the cost of inputs that should have been consumed in
producing the output vs. the cost that was actually incurred.
» Additional controls Volume produced; quality; training; etc.
Discretionary expense centers» Ensuring that managers adhere to the budgeted level of expenditures
while successfully accomplishing the tasks of their center.
» Subjective, non-financial controls e.g., quality of service as perceived/evaluated by users.
» Personnel controls
Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition © Pearson Education Limited 2007
Slide 7.9
Profit centers Managers of profit centers are held accountable for generating
profits (a financial measure of the difference between revenues and costs).
As a measure of performance, profit is» Comprehensive
i.e., it incorporates many aspects of performance;» Unobtrusive
i.e., the profit center manager makes the revenue/cost tradeoffs.
Has the manager significant influence over both revenues and costs?
» Charge standard cost of goods sold to sales-focused entities;» Assign revenues to cost-focused entities;» Pseudo profit centers.
Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition © Pearson Education Limited 2007
Slide 7.10
Measuring “profit”
RevenueCost of goods sold
Gross marginAdvertising and promotion
Research and development
Profit before taxIncome tax
Profit after tax
Gross MarginCenter
IncompleteProfit
Center
Before-taxProfit
Center
CompleteProfitCenter
Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition © Pearson Education Limited 2007
Slide 7.11
Investment centers
Managers of investment centers are held accountable forthe accounting returns (profits) on the investment madeto generate those returns.
» Objective = return on capital;
» Absolute differences in profits are not meaningful ifbusiness units use different amounts of resources.
In fact, managers have two performance objectives:» Generate maximum profits from the resources at
their disposal;
» Invest in additional resources only when such aninvestment will produce an adequate return.
Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition © Pearson Education Limited 2007
Slide 7.12
Organization structure
Administrativeand Financial
Vice Presidents(DCC)
President(IC)
Group Vice President
(IC)
SBU Manager(PC)
SBU Manager(PC)
SBU Manager(PC)
SBU Manager(PC)
Group Vice President
(IC)
Procurement(ECC)
Manufacturing(ECC)
Sales(RC)
Divisional Staff Functions (DCC)... ... ...
......
...
Prevalence of profit centers amongFortune 1000 firms
% of firms inFortune 1000
with two or moreprofit centers
Reece & Cool(1978)
Govindarajan& Chitkara
(1993)
96% 93%
Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition © Pearson Education Limited 2007
Slide 7.13
Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition © Pearson Education Limited 2007
Slide 7.14
Transfer pricing
Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition © Pearson Education Limited 2007
Slide 7.15
Definition The price at which products or services are transferred
between profit centers within the same corporation.– It affects the revenues of the producing profit center (PC),
the costs of the buying PC, and hence, the profits of both entities.
Purposes– Provide proper economic signals so that PC managers make
good economic decisions from a corporate standpoint;
– Provide information for evaluating PC performance;
– Purposely move profits between company entities/locations.» e.g., for tax purposes, or in joint-ventures.
Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition © Pearson Education Limited 2007
Slide 7.16
Market-based transfer prices Where a (perfectly competitive) external market exists.
Managers of both the selling and buying PC will make decisions that are optimal from a corporate perspective, and reports of their performances will provide good information for evaluation purposes.
Actual price charged to external customers, listed price of a similar product, or the price a competitor is offering (bid price). Deviations can be allowed that reflect differences between internal and external sales:
» Savings in marketing, selling, and collecting costs;» Differences in quality standards, special features, or special
services provided.
Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition © Pearson Education Limited 2007
Slide 7.17
Marginal cost transfer prices It excludes upstream fixed costs and profits, and
hence, the marginal costs remain visible for thePC that finally sells to outside customers.
It provides poor information for evaluation purposes» The selling PC incurs a loss;» The profits of the buying PC are overstated.
Rarely used in practice Variation: Marginal cost and lump-sum fee
» The marginal cost of the transfer remains visible;» The selling PC can recover its fixed cost and a profit margin
through the lump-sum fee;» Problem: estimation of capacity to reserve for internal sales.
Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition © Pearson Education Limited 2007
Slide 7.18
Full-cost transfer prices Popular in practice
Relatively easy to implement» Firms have cost systems in place to calculate the full cost of
production;
» But, full costs rarely reflect actual, current costs of producing the products because of financial accounting conventions(e.g. depreciation) and arbitrary overhead cost allocations.
There is no incentive for the selling PC to transfer internally since there is no profit margin.
The profit of the selling PC is understated.
Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition © Pearson Education Limited 2007
Slide 7.19
Full-cost and mark-up
It allows the selling PC to earn a profit on internally transferred products/services.
Crude approximation of the market price in cases where no competitive external market price exists.
– Such transfer prices, however, are not responsiveto market conditions.
Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition © Pearson Education Limited 2007
Slide 7.20
Negotiated transfer prices Transfer prices are negotiated between the selling
and buying PC managers themselves.
» Both PC managers should have some bargaining power(i.e. some possibilities to sell or source outside).
» The outcome is often not economically optimal, but rather depends on the negotiating skills of the managers involved.
It is costly (management time), accentuates conflicts between PC managers, and often requires corporate management intervention.
Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition © Pearson Education Limited 2007
Slide 7.21
Dual-rate transfer prices Method
» The selling PC is credited with the outside sales price;» The buying PC is charged the marginal cost of production only;» The difference is charged to a corporate account and eliminated
at the time of financial statement consolidation. Advantages
» It provides proper economic signals for decision making;» It maintains proper information for evaluation purposes;» It ensures that internal transactions will take place.
Disadvantages» It destroys incentives to negotiate favorable outside prices
for supplies (buying PC now only pays the marginal cost);» It destroys incentives to improve productivity (selling PC
finds easy sales inside).