Management Control System - Essay Example

Effect of Fewer Management Control Systems very little performance management in the Company A management Control System is a tool for gathering and using information from the organization. This information assists the managers to take planning and controlling decisions. The management Control systems are the guideline which shapes the behaviour of the employees and managers (Horngren et al., 2007). The control systems are meant to assist the achievement of organizational goals. These systems collect both financial as well as non-financial data. The source of the data for management control systems may be internal from within the company or from the external market. Generally, control systems guide the methods of coordination, resource allocation, motivation, performance measurement, and communication. The major purposes of a management control systems are: Planning the activities of the organization Setting the standards for communication and coordination between various departments of the organization Communicating the relevant information to various units of the organization Set up the mechanism for resource allocation Evaluation of the information and take appropriate decisions to reach the organizational goals Set up the guidelines according to which the performance will be managed and the evaluated. There are many levels at which management control systems can work: At the top: Organizational Level: Here, the examples of relevant information are stock price, Net Income, Profit, Return on Investment etc At the market level, management control systems measure and make use of information such as customer satisfaction etc. At the individual-facility level, information such as material costs, labour costs, absenteeism and accidents etc is the part of management control system. The lowest level where management control systems operate are at the individual activity level where information such as cost and time, storing and despatching of goods etc are the major bases. A management control system has both formal as well as informal parts to it. The formal management control system is designed that is coherent with the hierarchy of the organization. The formal management control system has four components: Strategic plan and programmes Budgeting Operations and Measurement in the responsibility centres Reporting The informal management control system is the one where managers encounter a non-routine decision making problem or a problem that has not been encountered before and requires new information. In such a situation managers, may informally call subordinate and extract information in a relaxed manner. In the absence of a proper management control systems, employees will not be aware of the roles that they are supposed to do. There will be no information on the resources and time that is available for each activity. The employees will not be aware of the plans of the activities that are supposed to be done. A well-designed management system influences the behaviour of the employees in such as way that it is congruent with the goals and objectives of the organization. Often employees have individual goals that might be not synchronous with the organizational goals. A good management control system makes it sure that the actions taken by people to achieve their own goals also help in the achievement of organizational goals. This aspect which is called ‘goal congruence’ in accounting terms implies that the goals of the subordinates and the managers are coherent. A poor management control system will lead to confusion in the minds of employees as regards to the strategy and the goals of the organizations. Often messages from different sources may contradict each other. A good management control system will set out rules and minimise the possibility of such events. Management control systems and performance management are very closely linked with each other. Often the performance management systems are a part of the management control system for the organization. A poor performance management system has a lot of effects on the organization that are not beneficial to the organization. A good performance management system lays down in detail the various job roles, the performance measurement attributes, the targets and objectives and the incentives linked with each of them. The system shall also have a description of the results of failing to achieve the targets and objectives. A good performance management system measures each attribute of contribution of an employee: individually: within a group; within the department and so on. In the absence of a well-designed performance management system, there will be lack of direction amongst employees because the employee is not aware of the standard according to which s/he will be evaluated. The lack of this standard also results in the lack of motivation for the employees. If the performance management measures and the incentives are not stated properly, employees do not have any incentive to put extra effort towards organizational goals. If the performance management system is designed poorly, it may lead to employees thinking that the other individual who got the promotion did not deserve it which may lead to office politics. Such a scenario also results in a drop in the employee’s faith and confidence in his supervisor. To sum up, a good management control system and a performance management system is very important from the perspective of an organization. Often the performance management system is a very crucial part in the wheel of the management control system. A well designed management control system with clearly laid down performance management system increases the motivation level of employees, facilitates information sharing, increases goal congruence and direct the employees to work towards organizational goals. The importance of accurate budgets in an Organization In the simples of terms, budget can be defined as a pan of action based on forecasted transactions, activities and events in an organization. The budget represents the action plan for a specific period by the management. It is the basic aid to coordinate the activities that are needed to implement the plan. A budget has both financial as well as non-financial information. A financial budget is a quantified representation of the management’s expectations regarding the income, profits, and cash flows etc in the subsequent period. These financial budgets are based on non-financial budgets which measure things like the units manufactured, units sold number of employees etc. A budget is the most important part of a company’s strategy. Long-term budgets represent a company’s strategic plans, while short term budgets represent organization’s operational plans. This is as shown in figure 2 (Horngren et al., 2007): The two-sided arrows are an indication of two way inter-dependence between the various items. A budget is not only affected by the plans but also affects the various plans (both strategic and operating). These plans have a two-way relation with the strategy of the organization. A budget serves many purposes: It is a tool to communicate information within the various hierarchical levels of the organization. It is a tool against which performance of the employees, departments, and sub-units can be evaluated. Budget aids in resource planning and better coordination of activities Budget helps manager analyse the inflow and outflow of cash. Budgets help managers see if they are on the correct path of achieving company goals. A well designed budget is one which helps managers relate the short-term objectives with the long-term goals, distributes resources and responsibilities clearly; states performance measurement attributes, and sets goals. There are various approaches to developing a budget, but the most appropriate is that of participative budgeting where the budget is developed after taking necessary information from very level of the company hierarchy. Such a budget will have more supporters amongst the lower levels as compared to a top-down approach of budgeting. There are various issues that are affected by the budget design and accuracy: Coordination and Communication: In order to a company being profitable, it is necessary that the various departments and employees in the company work coherently towards the organizational goals. This coordination requires for a communication standard that is understandable and comprehendible by all the employees. A budget is a tool that serves this task very efficiently. A budget states the various measures in a quantifiable manner. These numbers can easily be understood by each of the employees. A good accurate budget will enable easy and correct information sharing between managers and their subordinates. The absence of inaccurate budget on the other hand will lead to chaos and multiple, communication standards and often contrasting messages from various sources. Performance Management System: A good accurate is an excellent framework for measuring the performance of the employees as it does not use past performance as a measure for judging. The quantitative figures in the budget are the ideal goals and the employees shall try to achieve them. At the end of the period, the actual results can be compared to the budgeted and the performance of the employees be measured. A budget assists the manager in setting performance measures, goals and communicating the same to the subordinates. However, it shall be noted that using budgets as the only measurement of performance is not appropriate as it leads to setting up targets that are easily achievable. In the absence of accurate budgets the management has no set benchmark against which the performance of the employees can be measured. Variance Analysis: Besides this, budgets are also a useful tool that shows the areas of strengths and weakness of companies. When the actual results differ from the budgeted results, analysis can be done to see if the variances are positive or negative. A variance that increases the profits of the company indicates the areas of strength and the company the company should try continuing similar performance in the future periods. A variance that reduces the profits of organization represents an area of concern. The management shall try to find out the reasons for the negative deviation and try to remove them in future periods. This technique which is called “variance analysis” requires a budget that is realistic and accurate. In the absence of such a budget, the results form analysis will not be useful. Motivating Managers and Employees: It has been proven by research that challenging budgets improve employee performance (Larnick et al., 1999). Budgets encourage employees to work harder to achieve goals rather than to avoid failing. Budgets set clear verifiable objectives which can be easily measured. These targets motivate employees to work hard. In the absence of an accurate, reliable and achievable budget, the motivation levels of employees may drop. To sum up, accurate budgets are a very important planning and control tools. In the absence of an accurate budgeting process, there will be problems such as lack of proper coordination and communication, a poor performance management system, irrelevant variance analysis and reduced motivation levels of the employees. Accurate budgets are an important tool in analyzing the corporate strategy and communicating the goals and objectives to the lower levels in the organization. Therefore it is important for organizations to have an accurate, measurable and achievable budget targets. Effects of Poor Transfer pricing system Often in big organizations, various subunits take products and services from other subunits. These products or services are called Intermediate products. Transfer price is the price one subunit charges to other for the product and service provided by it. This raises the need of a transfer pricing system which lays down the various systems through which transfer price can be calculated and accounted for in the statements of every subunit. The transfer pricing system shall be according to the company’s organizational structure, promote goal congruence, promote a sustained high level of management effort and assist in achieving the goals and strategies of the organization. Different transfer pricing systems such as market price, cost-based, or negotiated have different extent to which the above said objectives of transfer pricing system are achieved. The management shall choose a method on the actual position of the company, its strategy and goals. Another important factor that impacts the design of transfer pricing system is the tax implications of each. The objective of setting up a transfer pricing system is to stimulate the conditions of external market environment in the organization so that managers of every subunit are motivated to perform well. However, at the same time, it is necessary that managers understand that they do not affect the achievement of organizational goals. This goal congruence is the essence of a good transfer pricing system. In the absence of a good transfer pricing system managers will be more inclined to just achieve the goals of their subunits and may ignore the organizational goals. The importance of transfer pricing system increases in the case of an MNC. International companies have various units either manufacturing or retail or some support system units across various countries in the world. At the same time, different countries have different tax regimes, treatment and rates. It becomes necessary that the taxes, duties and tariffs in inter-country units are less. A good transfer pricing system minimizes these expense heads. The concept of transfer pricing also assumes lot of importance in decentralized companies. Amongst the major challenges in a decentralized company is that of designing the responsibility structure and formulating appropriate policies and methods to determine the performance of the responsibility centers. A good transfer pricing system makes sure that the responsibility structures in the organization work smoothly. Transfer pricing system also plays a major role in the performance appraisal. A good transfer pricing system will help managers make a reliable and objective assessment of the value added activities towards the organization by individual profit centers. A poor transfer pricing system also results in the lack of clear divisional autonomy. Every head of a sub-unit wishes that he should be able to reach the goals of his profit centers with complete freedom from internal or external sources. There should be no interference from other divisions such as buying centers or selling centers. A poorly designed transfer pricing system gives such managers very limited autonomy. This may lead to lack of motivation amongst the managers at the subunit level which may result in failure to achieve subunit and organizational goals. A good transfer pricing system also leads to proper and appropriate distribution of revenues amongst various profit centers of the organization. In the absence of a good transfer pricing system, managers at the subunit level will not be aware of the relevant information regarding the trade-offs between costs and revenues for the company. This may lead to an improper distribution of the revenues and may hamper the organizational goals. Thus, in the absence of a good transfer pricing system, an organization may have improper revenue distribution. It may also lead to inconsistency between the goals of managers at the subunit level and the organizational level. A poorly designed transfer pricing system may lead to managers at the subunit level being de-motivated and higher levels of taxes, duties and customs etc. References Antony, R.N. and Govindarajan, V. (1995). Management Control Systems. IRWIN. Horngren, C.T., Datar, S.M., and Foster, G. (2007). Cost Accounting, 12th ed. New Delhi: Prentice-Hall of India. Larnick, R., Wu, G., and Health, C. (1999). Raising he Bar on Goals”. Graduate School of Business Publication, University of Chicago, Spring 1999. Read More