financial planning and control systems 2013-3 re

8/22/2019 Financial Planning and Control Systems 2013-3 Re

1/39

4/4/2013 Nitin Kulkarni @ 2012 1

Financial Planning andControl Systems

MFM 4th Semester


2/39


Responsibility Accounting

Responsibility accounting is a system of accounting that

recognizes various responsibility centres throughout theorganization and that reflects the plan of action of each of

these centres by allocating particular revenues and costs

to the one having the relevant responsibility

Responsibility accounting is also known as activity

accounting, profitability accounting and MBO through the

accounting control system


3/39


Essentials of Responsibility Accounting

To create suitable responsibility centres in the organization

To fix the area ofauthority and responsibility for each

centre

To have a clear-cut idea, on the part of each manager as to

what is expected of him

To mention only the revenues, expenses, profits and

investments controllable by the manager in the performance

report of each centre


4/39


Responsibility Centres

Creation of Responsibility Centres

Responsibility Accounting focuses attention on the

responsibility centres where control is exercised over the

costs or revenue

For effective control of all activities a large firm is divided intomeaningful segments, departments or divisions

The sub-units of an enterprise for the purpose of control are

called responsibility centres or decisions centre


5/39




A responsibility centre is sub-unit of an organization under

the control of a manager who has the responsibility for the

activities of that centre.

I.e. Production department,Treasury department,Front orBack office,R & D centre,Dealing room and back office in

case of Brokers in Stock or Forex Market,Housekeeping in

case of Service industry viz Hotel,Health care, Sourcing

incase of Banks, Procurements in the case of Manufacturing.


6/39




The important criteria for creating a responsibility centre

are that the unit of the organization should be separable

and identifiable for operating purposes,and that the

performance measurement should be possible

Responsibility centres are usually classified into three

classes

Cost centres

Profit Centres

Investment Centres


7/39



Cost Centre

A centre where the manager is responsible only for costs

He is not responsible for profit or investment, Hence cost

centres are service departments providing services to

other departments such as PR,R & D, HRD

The performance of the manager is evaluated by

comparing the actual expenses incurred with the

budgeted expenses for the cost centre


8/39



Cost Centre

A cost centre is to be taken as an index of performance for

departments whose product/output cannot be measuredand expressed in financial figures like consultancy, personaland administration

It therefore reflects productivity of I/P i.e. cost per unit ofservice

In a cost centre the consequences of decisions aremeasured by costs alone, the accomplishments of the costcentre are not measured in financial terms. Thus,theeffectiveness and efficiency of the cost centre cannot beproperly evaluated.

This kind of analysis of course ignores the contributionmade by the cost centre to the firms overall profitability


9/39



Profit Centre

A profit centre is a responsibility centre where the

manager is responsible for both costs and revenuesand thus for profits

A profit centre provides more effective assessment of

performance as both costs and revenues are measured

in financial terms

A profit centre is more relevant forprofit planning and

control as it allows the measurement of both output

and input units of the centre


10/39

4/4/2013 Nitin Kulkarni @ 2012 10


Profit Centre

To ensure effective control through the profit centre

control system, the controllable and non controllableactivities should be identified

In a profit centre approach the profit may be targeted

and the manager has full authority

To control costs

To earn revenue

To effect cost-revenues


11/39

4/4/2013 Nitin Kulkarni @ 2012 11


Investment Centre

An investment centre where the manager is responsible for

costs and revenues as well as for investment in assets

used by the centre.

In an investment centre, performance is assessed not only

by profit but by relating profit to investment

Investment centres are treated as separate firms where the

manager is responsible for the overall activities affecting

costs, revenues and investments

The performance of this centre is measured in terms ofROI


12/39

4/4/2013 Nitin Kulkarni @ 2012 12

Responsibility CentresAdaptation of the Accounting System The accounting system catering only to the needs of

external users and is not adequate for the purpose profitplanning and control and internal management

The accounting system should be suitably adapted tofacilitate the planning and control process

It should be structured around the area of responsibility sosound budgetary system needs the creation of aresponsibility accounting system

A responsibility accounting system is primarily orientedtowards the organizational responsibilities and is a means toachieving effective control


13/39

4/4/2013 Nitin Kulkarni @ 2012 13


The New Bank Ltd.Budget for the New Project- Division

Budgeted Total Expenditure Rs.120,000

Training Rs.60,000

Welfare Rs.14,000

Facilities Rs.40,000Other Expenses Rs.6,000


14/39

4/4/2013 Nitin Kulkarni @ 2012 14


The New Bank Ltd.The Budget expressed under Responsibility Accouting Concept

Activity /HeadsV.P. Real Estate V.P. Projects V.P. Strategic Sourcing

Training Rs.10,000 Rs.20,000 Rs.30,000

Welfare Rs.4,000 Rs.8,000 Rs.2,000

Facilities Rs.10,000 Rs.15,000 Rs.15,000

Other Expenses Rs.2,000 Rs.2,000 Rs.2,000


15/39

4/4/2013 Nitin Kulkarni @ 2012 15


Important Ratios for Cost Centre

Operating Ratios

Output-Input Ratios

Waste and Scrap Data

Quality Variance

Cost Variance


16/39

4/4/2013 Nitin Kulkarni @ 2012 16


Important Ratios for Profit Centre

Profitability

Capital/Asset Turnover

Inventory Turnover

Profit trend

ROI


17/39

4/4/2013 Nitin Kulkarni @ 2012 17


Important Ratios for Investment Centre

Those of Cost/Profit Centre ratios

Capital expenditure variance

Asset Turnover

Cost of Capital, D/E Ratio, Liquidity Ratio

Comparative Study of the incremental cost of funds and

incremental revenues from these funds


18/39

4/4/2013 Nitin Kulkarni @ 2012 18

Limitation of Responsibility Centre

Difficulty in designing an organization chart with clearly

delineating lines of authority and responsibility

Difficulty in implementing on account of conflict between

individual interest and organization interest

Ignoring the personal reactions of the personnel involved in

the implementations

Requiring a good reporting system to make the systemuseful and meaningful


19/39

4/4/2013 Nitin Kulkarni @ 2012 19

Cost accounting Vs Responsibilityaccounting Cost Accounting

Historical cost accountinghas paid more attentionto the measurement ofcost of production

It emphasis on productcost basis

It is difficult to use cost

data accumulated forproduct costing purposesfor planning and control

Responsibility accounting

Here emphasis is onplanning and control and noton a product cost basis

Here emphasis is onplanning and control

The cost accumulated forplanning and control purposecan easily be recast forproduct costing purpose

P fit C t


20/39

4/4/2013 Nitin Kulkarni @ 2012 20

Profit Centers

As per the extensive information provided by Anthony and

Govindrajan 93 % of the US firms have more than one

profit center,the corresponding figure in Holland is 89 %and India 66 %

Asea Brown Boveri has 4,500 profit center's, Kyocera of

Japan has 800

K


21/39

Kyocera Maximize revenues and minimize expenses. Measure

your inflow and control your outflow; don't chase profit,

but let it follow your effort.

Pricing is management.-Pricing is top management's

responsibility: to find that one point where customers

are happy and the company is most profitable.

4/4/2013 Nitin Kulkarni @ 2012 21

P fit C t


22/39

4/4/2013 Nitin Kulkarni @ 2012 22

Profit Centers Now computing the profit of these profit centers,many

functions,which one would expect to be discretionary

costs stretch their credibility and charge to other profitcenters charging their services to various profit center with

the costs according to actual or estimated usage.

Hence these service or support units are being treated asprofit centers themselves.

P fit C t


23/39

4/4/2013 Nitin Kulkarni @ 2012 23

Profit CentersService Category Treated as Profit

Center

1 Finance and Accounting 35 %

2 Legal 35 %

3 Electronic Services 63 %

4 General Marketing Services 35 %

5 Advertising 50 %

6 Market Research 36 %

7 Public Relations 24 %

Profit Centers


24/39

4/4/2013 Nitin Kulkarni @ 2012 24

Profit CentersService Category Treated as Profit

Center

8 Industrial Relations 32 %

9 Personnel 35 %

10 Real Estate 37 %11 Operation Research 47 %

12 Purchase 40 %

13 Top Corporate overhead 13 %

14 Corporate Planning 20 %

M t b Obj ti


25/39

4/4/2013 Nitin Kulkarni @ 2012 25

Management by Objectives

Peter Drucker

George Odiorne

M t b Obj ti


26/39

4/4/2013 Nitin Kulkarni @ 2012 26


Management by objectives is a process whereby the

superior and subordinate managers of an organizationjointly identify common goal,define each individuals

major areas of responsibility in terms of the results

expected of them,and use these measures as guides for

appreciating the unit and the contribution of each of its

members

Different goals are sought to be achieved by the

introduction of MBO in organization

M t b Obj ti


27/39

4/4/2013 Nitin Kulkarni @ 2012 27


MBO is used for

To integrate the organizational goals with the

individual goal

As a motivational technique wherein individuals are

driven towards the achievement of goals

To appraise the performance of managers involved in

the process

To control the activities as they are performed

M t b Obj ti


28/39

4/4/2013 Nitin Kulkarni @ 2012 28

Management by Objectives Drucker suggested that objectives are to be specified in the

key resu lt areaof business.

A key result area may be understood as one,theperformance of which,directly and vitally affected thesuccess and survival of the business

The KRAs vary from business to business .

Since MBO involves a systematic effort towards theachievement of objectives,utmost care has to be exercised

in setting the objectives for all the KRAS

R ibilit b d ti & MBO


29/39

4/4/2013 Nitin Kulkarni @ 2012 29

Responsibility budgeting & MBO

Establishment of goals for the whole organization

Preparation by subordinates, of specific goals within the

framework provided by the superior

Joint discussion of an agreement upon the goals by thesuperior and subordinate

Joint review of progress at regular intervals in the light of

the predetermined goals

Corrective measures, if necessary, as revealed by the

review

Why MBO is not a live force today


30/39

4/4/2013 Nitin Kulkarni @ 2012 30

Why MBO is not a live force today Tying personnel performance

evaluation,promotion,compensation and the like to objectiveachievement is often counter-productive because it

discourages the development ofinnovative,high risk,highreward objectives

Lack oftop management involvement and support.For anMBO programme to succeed

Lack of understanding of the philosophy behind MBO

Poor integration with other systems

Value Based Management


31/39

4/4/2013 Nitin Kulkarni @ 2012 31

Value-Based Management

Value Based Management is the management approachwhich ensures that companies are consistently with the

objective of maximizing shareholder value. It includes

Creating Value

Managing Value

Measuring Value

Value Based Management


32/39

4/4/2013 Nitin Kulkarni @ 2012 32


Godrej implementing the EVA metric of consultants sternStewart and co

The EVA is equal to net operating profit after tax minusthe capital charge

Mermaid Godrej chairman Godrej Group says Our goal isto maximize market value added (MVA) which is equalsthe present value of all future EVA.

The EVA, which measures business performance includes

in its measurement parameters ,setting goals,communication, evaluation strategies, analyzingacquisitions ,measuring performance, paying bonuses

EVA t GODREJ


33/39

EVA at GODREJ

4/4/2013 Nitin Kulkarni @ 2012 33

EVA t GODREJ


34/39

EVA at GODREJ

4/4/2013 Nitin Kulkarni @ 2012 34



35/39

4/4/2013 Nitin Kulkarni @ 2012 35

Value-Based Management The BOOH Factor

Since the companies are financed with a blend of debt andequity ,the cost of capital is a blend of returns required bylenders and owners

The Four Fundamentals strategies identified to improve EVAcan be summarized as BOOH

Build Invest as long as return exceed the cost of capital

Optimize Reduce cost of capital by optimizing capitalstructure

Operate Improve the return earned on existing capital

Harvest Divest capital when return fails to achieve the costof capital



36/39

4/4/2013 Nitin Kulkarni @ 2012 36

Value-Based ManagementGodrej on Learning Curve There is no economic value added if the capital is high.

Reward people on these basis so people will be careful onthe capital used

Excessive capital-intensive usage is not good decision

Minimum capital investment will lead to maximumEVA

No acquisition if it results into negative EVA

Working capital usage has been reduced and Godrej isnow operating on negative working capital

Types of Cost


37/39

4/4/2013 Nitin Kulkarni @ 2012 37

Types of Cost

Engineered Costs

Discretionary Costs

Difference between Engineered costs


38/39

4/4/2013 Nitin Kulkarni @ 2012 38

Difference between Engineered costsand Discretionary costs

Characteristics Engineered Costs Discretionary Costs

Process or

Activity

- Detailed and

Physically

Observable

- Repetitive

-Black

Box(Knowledge of

process is sketchy or

unavailable)

-Non -Repetitive

Level ofUncertainty Moderate or smalli.e. manufacturing

settings

Large i.e. R & D

Eng neere Costs & D scret onary


39/39

4/4/2013 Nitin Kulkarni @ 2012 39

Eng neere Costs & D scret onaryCosts

Costs

Activity

Engineered Costs

Discretionary Costs

financial planning and control systems 2013-3 re

Documents