CHAPTER 14
Management control systems
Cost and Management Accounting: An Introduction, 7th edition
Colin Drury
ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA
14.1a
Different types of controls
• Action (or behavioural) controls
• Personnel and cultural (or clan and social) controls
• Results (or output controls)
Action (or behavioural) controls
• Consist of:
• Behavioural constraints
• Preaction reviews
• Action accountability
• Focus should be on prevention rather than detection
controls.
Cost and Management Accounting: An Introduction, 7th edition
Colin Drury
ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA
14.1b
Social, personnel and cultural controls
• Social controls involve selection of people who have been socialized into
adopting particular norms of behaviour.
• Personnel controls build on employees natural tendencies to control
themselves (emphasis is on selection, training and job design).
• Cultural controls represent a set of values, social norms and beliefs that
are shared by members of an organization and that influence their
actions.
• In recent years there has been a greater emphasis on cultural controls in
the form of employee empowerment.
Cost and Management Accounting: An Introduction, 7th edition
Colin Drury
ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA
14.2
Results or output controls
• The focus is on reporting
information about the
outcomes of work effort.
• Results controls involve the
following stages:
1. Establishing performance
measures that minimize
undesirable behaviour.
2. Establishing performance
targets.
3. Measuring performance.
4. Providing rewards or
punishments.
Cybernetic control systems (see above diagram)
• Results controls resemble a cybernetic
(mechanical) control system.
• Cybernetic systems involve feedback controls
(actions after the events) but ideally control
should be based on control actions before the
events.
Cost and Management Accounting: An Introduction, 7th edition
Colin Drury
ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA
14.3
Harmful side-effects of controls
1. Occurs when controls motivate employees to engage in behaviour that is not
organizationally desirable (i.e. system leads to a lack of goal congruence).
2. Results controls:
•
Encourages individuals to focus only on what is measured, regardless of
whether it is organizationally desirable (see sheet 4).
•
Focuses mainly on quantifiable and easily measurable items.
•
Subject to data manipulation.
•
Can lead to negative attitudes towards the control system.
3. Action controls:
•
May discourage creativity.
4.Cultural controls:
•
Lack of goal congruence where group goals do not coincide with firm
goals.
Cost and Management Accounting: An Introduction, 7th edition
Colin Drury
ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA
14.4
Figure 2 The measurement reward process with imperfect measures
(Source: Otley (1987)
Cost and Management Accounting: An Introduction, 7th edition
Colin Drury
ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA
14.5
Advantages and disadvantages of different types
of controls
Personnel/cultural controls
• Few harmful side-effects.
• Inexpensive to operate.
• Appropriate only in certain circumstances.
Action controls
• Direct link between control mechanism and the action.
• Measurement problems do not apply.
• Not feasible where cause-and-effect relationships are not
well understood or easily observable.
• Best suited to stable situations.
Results controls
• Can be applied where knowledge of what actions are
desirable is lacking.
• Focus is on outcomes (individual autonomy is not restricted).
• Subject to limitations described on sheet 3.
Cost and Management Accounting: An Introduction, 7th edition
Colin Drury
ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA
14.6
Management accounting control systems (MACS)
• Tend to be the predominant controls in most organizations because:
1 Monetary measure provides a means of aggregating results from dissimilar activities.
2. Profitability and liquidity are essential for company survival.
3. Financial measures enable a common decision rule to be applied.
4. Measuring results in financial terms enables managers to be given more autonomy.
Responsibility accounting
• Responsibility accounting is a fundamental part of the MACS.
• Four types of responsibility centres:
1. Cost or expense centres (two types: standard cost centres and discretionary
cost centres).
2. Revenue centres
3. Profit centres
4. Investment centres.
Cost and Management Accounting: An Introduction, 7th edition
Colin Drury
ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA
14.7a
Management control systems
The nature MACS
• Two core elements:
1. Formal planning processes (e.g. budgeting and long-term planning)
for
establishing performance expectations.
2. Responsibility accounting
• Responsibility accounting assigns differences from the
performance target
to the individual who is accountable for the responsibility centre.
Cost and Management Accounting: An Introduction, 7th edition
Colin Drury
ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA
14.7b
• MACS process involves:
1. Setting performance targets.
2. Measuring performance.
3. Comparing performance against target.
4. Analysing variances and taking remedial actions.
• Responsibility accounting is implemented by issuing
performance reports similar to that on sheet 8.
• Issues that must be addressed by responsibility accounting
include:
1. Distinguishing between controllable and non-controllable items (i.e. the
controllability principle).
2. Determining how challenging the targets should be.
3. Determining how much influence managers should have in the setting of
targets.
Cost and Management Accounting: An Introduction, 7th edition
Colin Drury
ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA
14.8
Cost and Management Accounting: An Introduction, 7th edition
Colin Drury
ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA
14.9a
The controllability principle
• Principle advocates that it is appropriate to charge to a responsibility centre only
those costs that can be influenced by the manager of the responsibility centre.
• Implemented by either eliminating uncontrollables or reporting controllable and
uncontrollable items separately.
• Types of uncontrollable factors:
1. Economic and competitive factors (because managers can respond to
some of these changes most MACS do not shield managers
completely from them).
2. Acts of nature (managers normally protected from them).
3. Interdependencies where outcomes are affected by other units within
the organization:
• Pooled interdependencies
• Sequential interdependencies
• Reciprocal interdependencies.
Cost and Management Accounting: An Introduction, 7th edition
Colin Drury
ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA
14.9b
• Adjustments for the distorting effects of uncontrollables can be made either
before or after the measurement period.
• Adjustments before the measurement period:
1. Specify which budget line items are uncontrollable (eliminate or
report separately in performance report).
2. Insurance.
• Adjustments after the measurement period:
1. Variance analysis
2. Flexible performance standards (e.g. flexible budgeting
and ex post budget adjustments)
3. Relative performance evaluations
4. Subjective performance evaluations.
Cost and Management Accounting: An Introduction, 7th edition
Colin Drury
ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA
14.10
An example of flexible budgeting
Budgeted activity = 20,000 units
Budgeted unit variable cost =£5
Original fixed budget
20,000 × £5 =£100,000
Actual activity = 24,000 units
Actual variable costs = £105,000
Flexible budget
Actual
cost
Reported
variance
24,000 × £5 =£120,000
£105,000
£15,000F
• Ensures that managers are accountable for the conditions applying during the
period and not those envisaged when the budget was set.
Cost and Management Accounting: An Introduction, 7th edition
Colin Drury
ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA
14.11a
Guidelines for applying the controllability principle
• Price and quantity of service controllable = Controllable expense
• Quantity controllable but not price = Manager accountable for
difference between (actual quantity × budgeted price) and (budgeted
quantity × budgeted price)
• Quantity and price not controllable = Non-controllable expense
• General principle = Hold managers accountable for performance
areas you want them to pay attention to.
Cost and Management Accounting: An Introduction, 7th edition
Colin Drury
ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA
14.11b
Determining how challenging the targets should be
• A clearly defined quantitative goal is likely to motivate higher levels of
performance.
• Level of budget difficulty should be related to task uncertainty.
• Targets must be accepted to motivate managers to achieve higher levels of
performance.
• Literature identifies a theoretical relationship between budget difficulty,
aspiration levels and performance (see slide 12).
• Hypothesized relationships suggest that budget level that motivates best
performance is unlikely to be achieved most of the time (do not adopt punitive
approach for adverse variances).
Cost and Management Accounting: An Introduction, 7th edition
Colin Drury
ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA
14.12
The effect of budget difficulty on performance
Cost and Management Accounting: An Introduction, 7th edition
Colin Drury
ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA
14.13a
Arguments in favour of setting highly achievable budgets
• Conflict between planning and motivational purposes.
• Psychological benefits (e.g. achievement and self-esteem).
• Shields managers from adverse impact of environmental changes.
• Alleviates harmful side-effects of controls.
Determining how much influence managers should have in setting
standards
• Advantages of participation in the setting of performance standards:
1. Targets more likely to be accepted.
2. Reduces the information asymmetry gap.
3. Reduces negative attitudes and dysfunctional behaviour.
Cost and Management Accounting: An Introduction, 7th edition
Colin Drury
ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA
14.13b
• Empirical studies provide conflicting evidence on the effectiveness of
participation.
• Factors influencing the effectiveness of participation:
1. Personality variables:
2. Work situation
3. Job difficulty.
• Limitations on the positive effects of participation:
1. Budgetee has the opportunity to negotiate lower targets.
2. Depends on personality traits and work situation.
3. A top down approach may be preferable where a large number of
similar units exist.
Cost and Management Accounting: An Introduction, 7th edition
Colin Drury
ISBN 978-1-40803-213-9 © 2011 Cengage Learning EMEA