Unit II
Management Control System
UNIT II
1
Responsibility Centres
The term responsibility centre is used to denote any
organisation unit that is headed by a responsible manager. In fact,
a company is a collection of responsibility centres, represented by
a box in the organisation chart. These responsibility centres form
a hierarchy. At the lowest level in the organisation are
responsible centres for sections. The whole company is a
responsible centre. A responsible centre exists to accomplish one
or more purposes known as objectives within the organisation goals
and set of strategies lay down to achieve these goals.
Essence of any Responsibility Centres are : Relationship between
inputs and outputs, Measuring inputs and outputs, Efficiency,
Process measurement of performance, Effectiveness as measure of
performance, The role of profit.
Responsibility Centres/Organisation
Inputs
Resource used measured by cost
Outputs
Goods or services
2
Types of Responsibility Centres
Four different types of responsibility centres
In revenue centre, outputs is measures in monetary terms.
In expense centres, inputs are measured in monetary terms.
In profit centres, both revenues (output) and expenses (input)
are measured.
In investment centres, the relationship between profit and
investment is measured.
Revenue Centres
In a revenue centre, outputs (revenue) are measured in monetary
terms, but no formal attempt is made to relate inputs (i.e.,
expenses or costs) to outputs. Revenue centres are, therefore,
marketing organizations that do not have profit responsibility.
Actual sales or orders booked are measured against budgets.
3
Expense Centres
Expense centre are responsibility centres whose inputs, or
expenses are measured in monetary terms, but in which outputs are
not measures in monetary terms. Expense centres are of two types
based on costs
Engineered costs/Standard costs: amount of costs can be
estimated with a reasonable degree of reliability.
Discretionary costs: the amount of costs depend on managements
judgement.
Engineered expense centres/Standard cost centres
Characteristics:
Their input can be measured in monetary terms.
Their output can be measured in physical terms.
The optimal rupee amount of input required to produce one unit
of output can be established.
4
Profit Centres
A profit centre is a responsibility centre in which financial
performance is measured in terms of profit (i.e., the difference
between the revenue and expenses) inputs are measured in terms of
expenses and outputs are measured in terms of revenues. Therefore,
in a profit centre the measures of performance is better and
broader than in an expense centre. In a profit centre both the
elements, cost as well as revenue is evaluated in monetary
terms.
Profit centre can be divided into : (i) natural profit centre(a
product division, uses inputs and produces outputs and (ii)
constructive profit centre(centre constructed to give services to
other departments).
Advantages of Profit Centres
The quality of decisions may improve because they are being made
by mangers closer to the point of decision.
It provides a powerful tool for measuring how well the profit
centre has performed.
The speed of operating decisions may be increased since they do
not have to be referred to corporate headquarters.
The profit centre resembles a business in miniature form.
The profit centre makes decentralized organisation possible.
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6
Investment Centre
It is defined as a responsibility centre in which inputs are
measured in terms of cost/expenses and outputs are measured in
terms of revenues and in assets employed are also measured. In
other words, investment centres consider not only costs and
revenues but also assets used to the division. As a responsibility
centre, the performance of a unit would be measured in relation to
the revenues/profits and the assets employed in a division. The
essence of investment centre analysis is the relationship between
the profits and the assets that are used to generate those profits.
Investment centre is one step above a profit centre, in terms of
the additional financial data (assets).
The investment centre analysis can be used as a basis for
evaluating the contribution of a division as an entity as also the
performance of a division. The measure of performance in an
investment centre is based on the relationship between the
profits/income and the assets employed in generating the profits.
There are two ways to relate income to assets:
(i) Return On Investment (ROI) analysis and (ii) Residual Income
Analysis (Operating income that an investment center is able to
earn above some minimum return on its assets), Analysis or Economic
Value Added. Economic Value Added (EVA), is an estimate of a firm's
economic profit being the value created in excess of the required
return of the company's investors .
Budgetary Control System
Budgetary Control is defined as The establishment of budgets
relating the responsibilities of executives to the requirements of
a policy and the continuous comparison of actual with budgeted
results, either to secure by individual action the objectives of
that policy or to provide a basis for its revision. Budgetary
control system is a tool for MCS.
Steps for Budgetary Control System
Developing the budgets and breaking into departments and for
shorter periods.
Continuous comparison between the budgeted and actuals
figures.
Locate the difference.
Analyzing the reasons for the divergence so pinpointed.
Initiating remedial measures, again through the active
involvement of the operating people, in order to correct the
adverse divergence in the immediate next time-period.
If any major divergence, whether favorable or adverse, is found
to be beyond control during the budget period, then working out a
rational basis for revising the budget itself.
7
Discretionary Expense Centres
The world discretionary means that management has decided on
certain policies that should govern the operations of the company.
There are three points in the control of discretionary expense
centres.
First, the management control system helps only in expense
control.
Second, the difference between budgeted and actual expense is
not a measure of efficiency.
Third, the financial control system measures neither the
efficiency nor the effectiveness of these responsibility
centres.
Committed Expense/Cost
These are expenses that cannot be changed by the responsibility
centre manager during the budget year or expenses that can be
changed only in extraordinary circumstances.
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Discretionary & Committed Cost
The starting point in preparing the budget is the current level
of spending. The budgeter adjusts these amounts for anticipated
inflammation, cost implications of the changes in the job to be
done and in some cases for anticipated productivity improvements.
In some companies, the preparation of budget preceded by a zero
base review.
In the case of engineered expense centre/standard cost centre,
management must decide whether the proposed operating budget
represented the cost of performing a task efficiently for the
coming period.
In the case of discretionary cost centre, while formulating the
budget, managements principal task is to decide on the magnitude of
the job that should be done, because based on such job
expenses/resources are budgeted.
9
Approaches to Budgeting with reference to Engineered/Standard
and Discretionary Costs
Benchmarking is the continuous process of comparing and
measuring an organisations business processes against those of
business leaders anywhere in the world. The objective is to
identify and understand best practices; and the best practice is
simply, the best way to execute a process.
In Engineering expense centre/standard cost centre, finance
control is exercised by setting a standard for performing the task
and reporting actual costs against this standard. While setting the
standard, we can get comparable standard from other operating
units/competitors in the processes called benchmarking. The true
power of benchmarking lies in the ability to apply the insight
gained from another organisations best practices.
10
Benchmarking and Total Cost Management
