Management Control System Structure
April 3, 2007
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
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 nonfinancial measures
•
In a responsibility centre:
1. inputs are used (resources as materials, labour, overheads, commercial
and administrative resources);
2. service or production activities are carried out (Research and
Development, Production, Logistic, Sales and Administration);
3. outputs are achieved (tangible products or services)
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
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:
1. A VERTICAL dimension
2. A HORIZONTAL dimension
3. 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)
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)
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
1. Vertical dimension: the relative importance
of the requirements
Corporate
Completeness
Long term orientation
Timeliness
Measurability
Identif. Spec responsibility
Business Unit
Operation
A review of the requirement satisfaction by
different measures
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)
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
Costs and
revenues
Main measures
(quality,
productivity, time,
etc.)
Operation
Ferrari Case: Vertical structure
•
If you want, 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
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
The responsibility levels: vertical and horizontal
dimension
Headquarter
Investment Centres
Division
Europe
Product A
Production
Marketing
………...
Dep.2
Dep.3
Department 1
(ex. Packaging)
Division
USA
Product B
-
-
Profit Centres
Cost Centres,
Revenue Centres
Expense Centres
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, doesn’t 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 postsales 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
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
(G&A) departments (controller, industrial relations, human resources,
accounting, legal), research and development (R&D) 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
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, doesn’t 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 doesn’t 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
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)
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
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:
1. The partial Profit/Loss statements for Business Unit:
•  Advanced Direct Costing schema to take into 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)
2. The possible internal trade (goods/services) between business units
•  it is necessary to analyse and to evaluate the internal trade among
units (i.e. transfer pricing)
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
The advanced direct costing schema to evaluate
business unit contribution
Examples
• Superpizza
• Officina Veneta
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 table 1, 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
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:
1. Elaborate Profit/Loss Statement to take into evidence the contribution of each product line to the
overall company net operating income.
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)
Annual amortization: 560.000 euro, in part specific for each line (250.000 for ELEMENT 1; 150.000
for ELEMENT 2; 100.000 for ELEMENT 3)
Other general expenses: 35.000 euro
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
The advanced direct costing schema to evaluate
business unit manager
Example
• JB Trucking
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:
number of deliveries
Total Revenues
Direct variable cost for delivery
Specific fixed costs
•
•
Reno
50
5000 $
50 $
900 $
Lake Tahoe
40
8000 $
75 $
2800 $
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 4.000 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.
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, between the 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
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