1 Performance Management Week 8 Management Control Systems Chapter 16: Management Control Systems...

1

Performance Management

Week 8 Management Control Systems

Chapter 16: Management Control SystemsColin Drury

2

Learning outcomesLearning outcomes Describe the three different types of controls Describe the three different types of controls

used in organisations.used in organisations. Describe the cybernetic control systemDescribe the cybernetic control system Distinguish feedback and feed forward controlsDistinguish feedback and feed forward controls Explain the potential harmful side- effects of Explain the potential harmful side- effects of

results controlsresults controls Describe responsibility accounting and Describe responsibility accounting and

controllable principlescontrollable principles Determining how challenging the targets

should be Describe the influence of participation in Describe the influence of participation in

budget settingbudget setting

3

Planning and ControllingPlanning and Controlling

Management Decision Management Accounting System

Planning

Control

PerformanceEvaluation

Budgets

AccountingSystem

PerformanceReports

Feedbac

k

4

Planning and ControllingPlanning and Controlling

What is planning?

Settinggoals

Predictingresults

Deciding howto attain goals

5

Planning and ControllingPlanning and Controlling

What is control?

Decidingand

takingactions

Deciding onperformanceevaluation

and feedback

6

Planning and ControllingPlanning and Controlling

What are budgets?

They arequantitativeexpressions

of a proposedplan of action.

They aid in thecoordination

andimplementation

of the plan.

7

Planning and ControllingPlanning and Controlling

What are performance reports?

These are reports thatcompare actual results

with budgeted amounts.

8

Management Control Systems

Controls

• The process of ensuring that an organization’s activities conform to its plans and its objectives are achieved.

• No control without plans and objectives ( need to assess the achievement)

• They set, specify & predetermine desirable behaviour and procedures for employees to follow.

9

Management Control Systems

Controls

• Encompasses all methods and procedures directing employees towards achieving the organization objectives

• Many mechanisms are used and Management Accounting Control System (MACS) is just one aspect

• Necessary to relate the MACS to the whole control mechanism in an organisation.

10

Management Control Systems

Controls

• Different level of control:

• Strategic control•External focus•Emphasis on external competition - internal strengths, weaknesses, and limitations( opportunities and threats)

• Management control systems•Internal focus•Collection of control mechanisms•Aim to influence employee behaviours

to achieve organizational objectives

11

Management Control Systems

Different types of controls

• Action or behavioural controls

• Personnel, cultural and social controls

• Results or output controls

12

Management Control Systems

Different types of controls

•(1) Action or behavioural controls

•Actions are the focus of control

•Superiors watch and guide actions of subordinates

•Cause and effect relationships are clear and well understood

13

Management Control Systems

•Action or behavioural controls•Forms:

•behavioural constraints - prevention, restriction, ceilings, authority

•pre-action review – scrutiny and approval of action plans of the individuals being controlled. •action accountability – work rules, procedures, codes of conduct, budgets, rewards and punishment

14

Management Control Systems

•Action or behavioural controls

• Effective if actions are simple, desirable v undesirable, cause-and-effect relationship are clear, production line• Limited if work is complex, uncertain cause- and-effect relationship• Need action tracking, good v bad actions• Preventing action ideal – avoid costs of undesirable behaviour• Detection action – useful if applied timely, early stop to undesirable behaviour

15

Management Control Systems

(2) Personnel, cultural and social controls

•From “clan controls”• fostering strong sense of solidarity & commitment towards organizational goals people immerse in the interest of Company.• high degree of discipline (Japanese pilot) by dedication of individual to interest of the whole

•Approach adopted to social and personnel controls

16

Management Control Systems

• Personnel, cultural and social controls

•Social controls• view as form of corporate culture• Promote people who share committed to same corporate objectives

•Personnel controls• Helping employees to institute self-discipline and self-control through:

• Selection & placement• Training• Job design

17

Management Control Systems

• Personnel, cultural and social controls

•Cultural controls (same as social controls)• values, social norms, beliefs shared by members, that influence actions• exercise by one over the others action (procedures)• methods to shape culture:

•Codes of conduct - expectation•Group based rewards – collective achievements

•Inter-organizational transfers – better understanding

18

Management Control Systems

(3) Results or output controls• Collect and report on information on work effort outcome

•Establish results – performance measures that minimise undesirable behaviour•Establish performance targets•Measure performance•Provide reward and punishment

• Effects of desirable v undesirable behaviours on performance

19

Management Control Systems

• Results or output controls• Div manager with current ROI of 30% will reject project with 25% ROI – while project has +ve NPV & will benefit organization

• Pre-set and clear performance target essential – quantitative target more motivational

• Measurements should sufficiently accurate, objective, bias free, timely• Effective control – individual whose behaviour being controlled must be able to control and influence the result

20

Management Control Systems

© 2000 Colin Drury

Cybernetic control systems• Traditional management control approach• mechanical model – thermostat control system

•The process•The room temperature•Continually monitored by a thermostat

•Deviation•From desired temperature – identified by thermostat

•Corrective action•Start if output not equal to predetermined level•Thermostat cause input to be adjusted (temperature)•Turn on/off when temperature same/not same with predetermined level.

21

Management Control Systems

22

Management Control Systems

Cybernetic control systems• Process is controlled if:

•Objectives must exist•Output must be measurable•Compared in terms defined by the objectives.•Predictive model exist – non-attainment can be identified (feed back)• corrective action evaluated

23

Management Control Systems

Cybernetic control systems • The thermostat control system

•Same as result control system•Performance Standards are determined•Performance monitor by measurement systems•Compare standard with actual •Feedback on variance•Action

24

Management Control Systems

Feedback and feed-forward controls• Feedback controlled

• The cybernetic control system• Actual output monitored against desired performance• Corrective action on deviation

• Feed-forward control• Control b4 deviation• Monitor base on predicted/expected future output• Take steps to avoid likely errors• Require predictive model (accurate)• Preferable when significant time lag occurs in corrective action• Budget is an example• MACS consist of both feed forward and feed-backward controls

25

Management Control Systems

Harmful side-effects of controls1. Occurs when controls motivate employees to engage in behaviour that is not organizationally desirable

(system lack of goal congruence).2. Results controls: • focus only on what is measured, regardless of

whether it is organizationally desirable • Focuses mainly on quantifiable and easily measurable

items. • Subject to data manipulation. ( self measured) • Can lead to negative attitudes towards the control system. ( used as punitive ) (What you measured is what you get)

26

Management Control Systems

© 2000 Colin Drury

Harmful side-effects of controls3. Action controls: • May discourage creativity because divergence are treated as abnormal.

4. Cultural controls: • Lack of goal congruence where group goals do not coincide with firm goals( lead to sub- optimisation)

27

Management Control Systems

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.

28

Management Control Systems

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

29

Management Control Systems

• 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.

30

Management Control Systems

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.

31

Management Control Systems

The controllability principle

•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

32

Management Control Systems

• Adjustments for the distorting effects of uncontrollable 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 analysis2. Flexible performance standards (e.g.flexible budgeting and ex post budget adjustments)3. Relative performance evaluations4. Subjective performance evaluations

33

Management Control Systems

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.

34

Management Control Systems

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 figure 16.3 - Drury).

• Hypothesized relationships suggest that budget level that motivates best performance is unlikely to be achieved most of the time

35

Management Control Systems

Arguments in favour of setting highly achievableBudgets• 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.

36

Management Control Systems

Determining how much influence managersshould 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

37

Management Control Systems

© 2000 Colin Drury

• Empirical studies provide conflicting evidence on the effectiveness of participation.

• Factors influencing the effectiveness of participation:1. Personality variables: • Authoritarianism • Locus of control2. Work situation3. 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.