Management Control System Structure

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Management Control System Structure
2
The Structure of the MCS

• Defining the MCS structure means
• defining the elementary units of the MCS, i.e.
  the company sub-systems of which the performance
  must be evaluated in autonomy respect to the
  overall performance
• defining the specific information that must be
  measured relating to each elementary unit
• ? each elementary unit can be
  considered a Responsibility Centre with a
  dedicated manager which is responsible for the
  activities of the unit
• ? a Responsibility Centre
  Accounting System is so defined

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What is a Responsibility Centre

• A Responsibility Centre is a business segment of
  the company, where the manager is responsible for
  a specific set of activities and the related
  economic-financial variables (costs, revenues,
  investments) and non- financial measures
• In a responsibility centre
• inputs are used (resources as materials, labour,
  overheads, commercial and administrative
  resources)
• service or production activities are carried out
  (Research and Development, Production, Logistic,
  Sales and Administration)
• outputs are achieved (tangible products or
  services)

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Definition of the responsibility centres

• The responsibility centres can be defined in
  different ways by the organisations. In general a
  company can divide the responsibilities according
  to
• 1. company functions (line functions, such
  as production or sales, or staff units such as
  finance, administration, research and
  development, etc..)
• 2. products and services (Business Units or
  Divisions)
• 3. geographic areas (Business Units or
  Divisions)
• The sub-division of responsibilities reflects
  normally the Organisational Structure of the
  company

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The responsibility levels

• the responsibility centres belong to different
  levels of the Organisation Structure of the
  company (also within the functions, sub-units can
  exist - departments and offices - ex. within the
  function Logistic, can be defined the sub-unit
  Transport assigned to a specific manager)
• consequently, three basic MCS dimensions can be
  identified
• A VERTICAL dimension
• A HORIZONTAL dimension
• A TRANSVERSAL dimension (PROCESS/PROJECT
  dimension) different units belonging to
  different levels and to different functions can
  carry out an activity (ex. new product
  development process)

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1. Vertical dimension

• It includes the set of organisation levels for
  which a specific evaluation is required
• Corporate level (overall company)
• Business Unit level (product/market segment)
• Operation level (function, department, office)

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1. Vertical dimension

• Understanding the vertical dimension means
• asking which MCS requirements are relevant at
  different organisational levels
• consequently, asking which indicators and
  specific measures (economic, financial,
  non-financial) are relevant at different levels

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1. Vertical dimension the relative importance of
the requirements

Corporate Business Unit
Operation

Completeness Long term orientation Timeliness M
easurability Identif. Spec responsibility
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A review of the requirement satisfaction by
different measures
ACCOUNTING TECHNIQUES ACCOUNTING TECHNIQUES FINANCIAL TECHNIQUES NON FINANCIAL TECHNIQUES
BALANCE SHEET (RATIO ANALYSIS) COST ACCOUNTING
MEASURABILITY High High Low High
IDENTIFICATION OF SPECIFIC RESPONSIBILITIES Good only at top level (corporate and business level) Good also at operative level Good only at top level (corporate and business level) Good also at operative level
COMPLETENESS Medium (no risk and time value consideration) Low High Depending on the selected set of indicators
LONG TERM ORIENTATION Low Low High It depends (high if indicators are selected according to critical success factors)
TIMELINESS Low Low Low High (only physical transactions)
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1. Vertical dimension the techniques used at
different organisational level

  Financial indicators Economic indicators Non financial indicators
Corporate Main measures ROE Few measures, relating to the key competitive factors
Business Occasional Main measures (ROI, etc.) Few measures, relating to the key competitive factors
Operation   Costs and revenues Main measures (quality, productivity, time, etc.)

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Ferrari benchmarking project

• Define a benchmarking project for the Ferrari
  company, to be used by the top manager (Luca
  Cordero di Montezemolo)
• The aim and scope of benchmarking can be
  synthesised as follows
• to verify how Ferrari is positioned among the
  most prestigious car producers in the world
• to envisage its future

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Ferrari benchmarking project

• Given the aim of benchmarking
• choose the organisations against which the
  comparison should be made
• define the method of comparison (aware / unaware)
• select the specific performance and/or processes
  upon which the comparison should be made and the
  techniques and specific indicators to be used
• devise appropriate data correction methods (where
  necessary)

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Ferrari Case Vertical structure

• Consider also vertical dimension in your
  benchmarking project
• taking into account which are the most important
  requirements at each level (corporate, business
  unit, operation) and which are the advantages and
  limits of each techniques (economic, financial,
  non financial) with respect to different
  requirements
• ? illustrate how different techniques and
  specific indicators are used at different
  organizational levels

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Ferrari benchmarking project rules and
evaluation

• Work-group composition 5-6 people
• Work-group delivery end of May
• Work-group evaluation 0-2 scores to be added to
  the written examination score

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2. Horizontal dimension

• It identifies the specific responsibilities
  associated to each unit belonging to a certain
  level
• Different types of responsibility centres can be
  distinguished
• Cost Centres at the operation level
• Expense Centres (discretion cost centres) at the
  operation level
• Revenue Centres at the operation level
• Profit Centres usually at business level
• Investment Centres at corporate level

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The responsibility levels vertical and
horizontal dimension

Headquarter

Investment Centres
Division Europe
Division USA
- - -
Profit Centres
Product A
Product B
- - -
Production
Marketing
Cost Centres, Revenue Centres Expense Centres
...
Department 1 (ex. Packaging)
Dep.2
Dep.3
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2. Horizontal structure at the operation level

• Cost centres
• output level not defined in autonomy
• responsibility on the input employed to achieve
  the output, that is a responsibility on costs
  (price and employment of the input)
• production department is the classic example of
  cost centre
• traditionally this responsibility is evaluated
  through the variance between standard costs and
  actual costs
• the traditional approach, however, doesnt allow
  to take into consideration the performances that
  the production cost centres are able to control.
  On one hand, the employment of the input is only
  partially controllable by the cost centres due to
  the fact it depends also on the quality of the
  input (Purchase offices) and on the product
  design (Design offices). On the other hand, the
  production decisions have an impact on other
  variables such as the production quality, the
  delivery time, the post-sales service
  requirement, variables linked to the company
  revenues
• a first solution is to enlarge the set of
  performance dimensions for which the cost centre
  is responsible, considering also non-financial
  measures (delivery time, quality of products,
  etc.)
• a second solution is the definition of task
  forces composed by different units (Production,
  Purchases, Design, etc.) which responsibilities
  are interdependent in order to improve the
  collaboration between the units

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2. Horizontal structure at the operation level

• Expense centres
• output that is difficult to be measured in
  monetary terms
• no strong and clear relation exists between
  resources used (inputs) and results achieved
  (outputs)
• examples of discretionary expense centres are
  general and administrative (GA) departments
  (controller, industrial relations, human
  resources, accounting, legal), research and
  development (RD) departments, and some marketing
  activities such as advertising, promotion and
  warehousing. All these activities are defined as
  supporting activities
• traditionally, the unique type of control for
  these units has been the definition of a maximum
  year level of expenses
• non financial measures (ex. quality, time,
  productivity, flexibility) and also economic
  measures (costs) can be introduced according to
  the type of activity (ex. productivity indicators
  can be introduced for the more repetitive
  activities, such as the administrative
  activities), in order to evaluate the
  quantity/quality of output of the centre

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2. Horizontal structure at the operation level

• Revenue centres
• responsibility on the sales of goods/services
  (price and volume of good sold)
• traditionally the performances are measured
  through the variance between the expected
  revenues and the actual revenues
• commercial units are the classic examples of
  revenue centres
• the traditional approach, however, doesnt allow
  to take into consideration the set of performance
  that the revenue centres are able to control. On
  one hand, the prices can be defined by central
  offices and the volume can be linked to product
  features and not only to the sale enforce. On the
  other hand, the commercial units doesnt have the
  responsibility on other controllable activities,
  such as the customer assistance, which have an
  relevant impact on sales volume
• a first solution is to enlarge the set of
  performance dimensions for which the revenue
  centre is responsible, considering also
  non-financial measures (ex. customer assistance)
  
• a second solution is the definition of task
  forces composed by different units (Sales,
  Production, Purchases, etc.) which
  responsibilities are interdependent in order to
  improve the collaboration between the units

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2. Horizontal structure at the business level

• Profit centres
• responsibility both on the costs and revenues
• traditionally, the performance is evaluated
  through the variances between the standard and
  the actual costs, the expected revenues and the
  actual revenues (the expected profit and the
  actual profit) building partial profit/loss
  statements for each centre
• A profit centre is free to
• Select the source for procurement
• Choose the acquisition prices
• Select the customer
• Decide the selling price
• business units and divisions are the classic
  examples, but sometimes also departments can be
  defined as profit centres (i.e. maintenance
  department that sells its services to other
  units)

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2. Horizontal dimension at the corporate level

• Investment centre
• responsibility on costs, revenues and investments
• this responsibility is evaluated considering the
  assets (invested capital) through the return on
  investments measures (ROI, ROS, etc.)
• usually, it is applied to the corporate level or
  to the business units with a strong autonomy

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2. Horizontal dimension at business level

• Business units are independent units which have
  the responsibility on one product/market
• To evaluate the economic performance of BU it is
  necessary to evaluate
• The partial Profit/Loss statements for Business
  Unit
• ? Advanced Direct Costing schema to evidence the
  contribution of each unit (i.e. product line) to
  the overall company net operating income only
  fixed specific costs are assigned to each
  business unit in order to avoid any arbitrary
  allocation of common costs
• ? Controllable costs to evaluate business unit
  manager (II Controllable Contribution Margin)
• The possible internal trade (goods/services)
  among business units
• ? it is necessary to analyse and evaluate the
  internal trade among units (i.e. transfer
  pricing)

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The advanced direct costing schema to evaluate
business unit contribution
BU A BU B BU C TOTAL
Revenues X X X X
Variable costs (i.e. direct material direct labor energy) X X X X
I Contribution Margin X X X X
Fixed Specific costs (i.e. amortization) X X X X
II Contribution Margin X X X X
Fixed Common costs (i.e. amortization, indirect labor general and administrative costs) X
Net operating income X
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The advanced direct costing schema to evaluate
business unit contribution

• Examples
• Superpizza
• Officina Veneta

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• SUPERPIZZA
• In 20X0, Mr. Gennaro Esposito, decided to start
  up his own activity. He started, at first, with
  the production and sale of pizzas take away and
  then he added the delivery of pizzas at home in
  the evening hours. By the way, he realized that a
  combination pizza drink was very appreciated by
  customers. He decided to apply a unique price for
  each combination 6 euro for the combination
  take away 7 euro for the delivery at home. In
  the following year, Mr. Esposito decided to rent
  a place to offer all the activities, included the
  service on the table. The combination was the
  same but offered with a price equal to 7,5 euro.
  For this specific activity, it was also necessary
  to engage a waiter. The take away cashier could
  be dedicated also to the new activity for a 20
  of time. Another person (named pony) was
  specifically dedicated to the delivery at home
  and he personally managed the takings. For the
  deliveries, he used a small van, available for
  the overall activities (purchases of materials,
  etc.). Besides, 5 producers of pizza
  (pizzaioli) were engaged.
• In the following table, data concerning the first
  semester 20X1 are reported.
• Elaborate the Profit/Loss Statement for the first
  semester 20X1 in order to point into evidence the
  contribution provided by different selling
  combinations to the net operating income for the
  overall company.

Sales TAKE AWAY 18.000 combinations
Sales DELIVERY AT HOME 7.500 combinations
Sales SERVICE ON THE TABLE 4.500 combinations
Pizzaioli (each one, each month) 1.500 euro
Waiter (each month) 1.500 euro
Cashier (each month) 1.000 euro
Pony (each month) 500 euro
Place rent (each month) 2.200 euro
Small van rent (each month) 300 euro
Power and wood (each month) 1.000 euro
Direct materials for pizzas production (each semester) 60.000 euro
Costs for sold drinks (each semester) 15.000 euro
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• OFFICINA VENETA
• Officina Veneta (O.Ve.) is a small company that
  produces components for kitchen production, in
  particular structural elements for ovens ELEMENT
  1 ELEMENT 2 ELEMENT 3.
• Production is carried out by means of three
  production lines
• Line 1 is devoted to ELEMENT 1
• Line 2 is devoted to ELEMENT 2
• Line 3 is devoted to ELEMENT 3.
• Due to the particular nature of some activities,
  it has been possible to calculate a direct labor
  cost per unit (see Annex 1).
• Indirect Workers (for activities supporting
  production) are the following
• 2 workers for warehouse management
• 2 workers for maintenance and repairing
• 2 administrative employees.
• On the basis of other information in Annex 1
• Elaborate Profit/Loss Statement to take into
  evidence the contribution of each product line to
  the overall company net operating income.

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• ANNEX 1
• Production/sales in units and selling price per
  unit
• 90.000 units ELEMENT 1 11 euro per unit daily
  production 360 units
• 90.000 units ELEMENT 2 5,5 euro per unit daily
  production 630 units
• 90.000 units ELEMENT 3 7,5 per unit daily
  production 840 units
• Annual average indirect worker cost 35.000 euro
• Annual average administrative employee cost
  40.000 euro
• Direct material per unit
• 3,15 euro per ELEMENT 1
• 1,62 euro per ELEMENT 2
• 2,25 euro per ELEMENT 3.
• Direct labor cost per unit
• 1,16 euro per ELEMENT 1
• 0,44 euro per ELEMENT 2
• 0,16 euro per ELEMENT 3.
• Annual energy cost 80.500 euro (the energy
  consumption is considered a variable cost
  depending on number of operating days per line)

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The advanced direct costing schema to evaluate
business unit manager
BU A BU B BU C TOTAL
Revenues X X X X
Variable costs X X X X
I Contribution Margin X X X X
Fixed Specific Controllable costs X X X X
II Controllable Contribution Margin X X X X
Fixed Specific Non Controllable costs X X X X
II Contribution Margin X X X X
Common costs X
Net operating income X
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The advanced direct costing schema to evaluate
business unit manager

• Example
• JB Trucking

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• JB TRUCKING
• Jb Trucking is a transport company which is
  operating in the North California and in Nevada.
  In order to evaluate performances, the company
  Profit/Loss has been divided for geographic
  areas. An area, the Truckee Meadows, is dedicated
  to sub-areas Reno and Lake Tahoe, in California.
  The information relating to the deliveries of
  January are the following
• Direct variable costs include oil and fuel costs
  and the costs for the car loading.
• The specific fixed costs includes the
  amortisation, the maintenance (provided by Jb
  Trucking central shop), the licence costs for the
  trucks. In particular, the maintenance costs
  (400 for Reno 800 for Lake Tahoe) are not
  controllable by the sub-area managers because
  maintenance is carried out monthly on the basis
  of government rules.
• The geographic areas, and the sub-areas of
  delivery, are considered profit centres.
• Truckee Meadows costs of administration and
  marketing (common to sub-areas) are equal to
  3.700 euro.
• Questions
• 1) Elaborate a partial profit/loss statement to
  evaluate a) the profitability of the sub-areas
  b) the performance of the sub-areas managers.
• 2) If common costs are allocated on the basis of
  sub-areas revenues, which is the impact on
  sub-areas profitability? Discuss this type of
  solution.

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Common Corporate Costs allocation to Business
Units

• The allocation of common corporate costs to
  Business Units has an impact on their
  profitability and therefore on their performance
  evaluation (examples of corporate costs are
  general costs, legal costs, research and
  development costs)
• In the practice it is possible to have the
  following alternatives
• to allocate to the BU all the corporate costs
  using arbitrary allocation basis
• to allocate only a share of corporate costs, in
  particular those costs which are specific for
  each business unit (see the Advanced Direct
  Costing schema). For example, research costs
  only the costs of applied research specifically
  used by business units. In this case the
  corporate level sells its services to the
  business units

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Corporate Costs allocation advantages and
disadvantages

• Complete allocation
• the business unit performance decreases with the
  increase of corporate costs
• common is the proportional allocation (based on
  revenues) which is not consistent with the
  specific responsibility principle (a BU which
  increases its revenues receives a higher share of
  corporate costs even if the activity increase
  does not cause a higher use of the corporate
  resources!).
• corporate inefficiency can be unfairly assigned
  to the business units
• Partial allocation
• more consistent with the specific responsibility
  principle
• the BU can require a lower corporate service
  level with disadvantaged in term of long-period
  company competitiveness, in order to avoid the
  allocation of corporate costs