AFM 482 Textbook Summary [Full Course] File contains concise, easy-to-read summaries of assigned textbook readings. Readings arranged chronologically by when they were assigned for ease of use; organized by chapter for increased readability.

28 Pages
Unlock Document

University of Waterloo
Accounting & Financial Management
AFM 482
Thomas Manning

AFM 482 Chapter 1 - Elements of management control systems include: o Strategic planning o Budgeting o Resource allocation o Performance measurement o Evaluation and Reward o Responsibility centre allocation o Transfer pricing - Management control is a must in any organization that practices decentralization - One view argues that strategy is first developed through a formal and rational process, and this strategy then dictates the design of the firm’s management systems - An alternative perspective is that strategies emerge through experimentation, which are influenced by the firm’s management systems - When firms operate in industries where environmental changes are predictable, they can use a formal and rational process to develop the strategy first, and then design management control systems to execute that strategy. However, in rapidly changing environments, it is difficult for a firm to formulate the strategy first and then design the management control systems to execute it - Elements of a Control System: o Every control system has at least 4 elements:  Detector/Sensor: A device that measures what is actually happening in the process being controlled  Assessor: A device that determines the significance of what is actually happening by comparing it with some standard or expectation of what should happen  Effector/Feedback: A device that alters behaviour if the assessor indicates the need to do so  Communications Network: Devices that transmit information between the detector and the assessor and between the assessor and the effector - The management control process is the process by which managers at all levels ensure that the people they supervise implement their intended strategies - Management control is not automatic, it requires coordination among individuals. The connection from perceiving the need for action to determining the action required to obtain the desired result may not be clear - A system is a prescribed and usually repetitious way of carrying out an activity or a set of activities - If all systems ensured the correct action for all situations, there would be no need for human managers - Management control must be differentiated from two other systems – or activities – that also require both planning and control: (1) strategy formulation and (2) task control - Strategy formulation is the least systematic of the three, management control is in between, and task control is the most systematic - Strategy formulation focuses on the long run, management control is in between, and task control focuses on short-run activities - Strategy formulation uses rough approximations of the future, management control is in between, and task control uses current accurate data - Management control is the process by which managers influence other members of the organization to implement the organization’s strategies - Management Control Activities: o Planning what the organization should do o Coordinating the activities of several part of the organization o Communicating information o Evaluating information o Deciding what, if any, action should be taken o Influencing people to change their behaviour - Conforming to a budget is not necessarily good, and departure from a budget is not necessarily bad. If a manager discovers a better approach – one more likely than the predetermined plan to achieve the organization’s goals – the management control system should not obstruct its implementation - Goal congruence means that insofar as is feasible, the goals of an organization’s individual members should be consistent with the goals of the organization itself. The management control system should be designed with goal congruence in mind - Management control systems encompass both financial and nonfinancial performance measures. The financial dimension focuses on the monetary “bottom line”. But Virtually all organizational subunits have nonfinancial objectives – product, quality, market share, customer satisfaction, on-time delivery, and employee morale - In industries that are subject to rapid environmental changes, management control information, especially of a nonfinancial nature, can also provide the basis for reconsidering new strategies. This function is referred to as interactive control. Interactive control calls management’s attention to developments – both positive and negative – that indicate the need for new strategic initiatives - Strategy formulation is the process of deciding on the goals of the organization and the strategies for attaining these goals - Complete responsibility for strategy formulation should never be assigned to a particular person or organizational unit - Strategy formulation is the process of deciding on new strategies; management control is the process of implementing those strategies - Task control is the process of ensuring that specified tasks are carried out effectively and efficiently - Most of the information in an organization is task control information: the number of items ordered by customers, the pounds of material and units of components used in the manufacture of products, the number of hours employees work, and the amount of cash disbursed - The most important distinction between task control and management control is that many task control systems are scientific, whereas management control can never be reduced to a science - The Impact of the Internet on Management Control: o Instant access o Multi-targeted communication o Costless communication o Ability to display images o Shifting power and control to the individual Chapter 3 - Management control systems influence behaviour, good management control systems do so in a goal congruent manner - Goal congruence is affected by informal actions and formal systems - Formal systems can be divided into two categories: (1) rules (2) systematic methods for planning and for maintaining control - In a goal congruent process, the actions people are led to take in accordance with their perceived self-interest are also in the best interest of the organization - Goals between employee and employer can never be 100% congruent (e.g. employees want unlimited salary, employer wants to keep the organization economically feasible) - External factors that influence goals congruence are norms of desirable behaviour that exist in the society of which the organization is a part. These norms include a set of attitudes, often collectively referred to as the work ethic, which is manifested in employee’s loyalty to the organization, their diligence, their spirit, and their pride in doing a good job - The most important internal factor is the organization’s own culture – the common beliefs, shared values, norms of behaviour; and assumptions that are implicitly accepted and explicitly manifested throughout the organization - The internal factor that probably has the strongest impact on management control is management style. Usually subordinates’ attitudes reflect what they perceive their superior’s attitudes to be, and their superiors’ attitudes ultimately stem from the CEO - Formal systems can be classified as two types (1) the management control system itself, and (2) rules - Examples of Rules: o Physical Controls o Manuals o System Safeguards o Task Control Systems - Although organizations come in all shapes and sizes, their structures can be grouped into three general categories o A functional structure, in which each manager is responsible for a specified function such as production or marketing o A business unit structure, in which business unit managers are responsible for most of the activities of their particular unit, and the business unit functions as a semi- independent part of the company o A matrix structure, in which functional units have dual responsibilities - The skilled specialist should be able to supervise workers in the same function better than the generalist would, just as skilled higher-level managers should be able to provide better supervision of lower-level managers in the same or similar function. Thus, an important advantage of a functional structure is efficiency - There are several disadvantages to a functional structure: o There is no unambiguous way of determining the effectiveness of the separate functional managers (e.g., the managers of marketing and of production) because each function contributes jointly to the organization’s final output. Therefore, there is no way of measuring what fraction of profit was contributed by each o If the organization consists of managers in one function who report to higher-level managers in that function, then a dispute between managers of different functions can only be resolved at the top o Functional structures are inadequate for a firm with diversified products and markets o Functional organizations tend to create “silos” for each function, thereby preventing cross-functional coordination in areas such as new product development. This problem can be mitigated by supplementing the vertical functional structure with lateral cross- functional processes such as cross-functional job rotation and team-based rewards - A business unit, also called a division, is responsible for all the functions involved in producing and marketing a specified product line - Advantages of the business unit structure o It provides a training ground in general management. The business unit manager should demonstrate the same entrepreneurial spirit that characterizes the CEO of an independent company o Because the business unit manager is closer to the market for its products than headquarters is, its manager may make sounder production and marketing decisions than headquarters might, and the unit as a whole can react to new threats or opportunities more quickly - Disadvantages of the business unit structure: o Each business unit staff may duplicate the work that in a functional organization is done at headquarters. The business unit manager is presumably a generalist, but his or her subordinates are functional specialists, and they must deal with many of the same problems addressed by specialists both at headquarters and in other business units as well o Disputes between functional specialists in a functional organization may be replaced by disputes between business units in a business unit organization - The controller is the person who is responsible for designing and operating the management control systems, however in many organizations, the title of this person is Chief Financial Officer (CFO) - The controller usually performs the following functions: o Designing and operating information and control systems o Preparing financial statements and financial reports for shareholders and other parties o Preparing and analyzing performance reports, interpreting these reports for managers, and analyzing program and budget proposals from various segments and consolidating them into an overall annual budget o Supervising internal audit and accounting control procedures to ensure the validity of information, establishing adequate safeguards against theft and fraud, and performing operational audits o Developing personnel in the controller organization and participating in the educations of management personnel in matters relating to the controller function Chapter 4 - A responsibility centre is an organization unit that is headed by a manager who is responsible for its activities. In a sense, a company is a collection of responsibility centres - Cost is a monetary measure of the amount of resources used by a responsibility centre. Note that inputs are resources used by the responsibility centre (patients in a hospital or students in a school are not inputs, rather the resources a hospital or school uses to accomplish its objective of treating patients or educating students) - It is much easier to measure the cost of inputs than to calculate the value of outputs (e.g., a university can easily measure the number of students graduated, but they cannot measure the amount of education they have received) - Many organizations do not even attempt to measure the outputs of such responsibility centres. Others use an approximation, or surrogate numbers, while acknowledging its limitations - The concepts of input, output, and cost can be used to explain the meaning of efficiency and effectiveness, which are the two criteria by which the performance of a responsibility centre is judged - Efficiency is the ratio of outputs to inputs, or the amount of output per unit of input - In many responsibility centres, efficiency is measured by comparing actual costs with some standard of what those costs should have been at the measured output. Though this method can be useful, it has two major flaws: (1) recorded costs are not precise measures of the resources actually consumed, and (2) the standard is merely an approximation of what ideally should have happened under the prevailing circumstances - Effectiveness is determined by the relationship between a responsibility centre’s output and its objectives (i.e., the more this output contributes to the objectives, the more effective the unit) - Efficiency and effectiveness are not mutually exclusive; every responsibility center ought to be both efficient and effective - In summary, a responsibility center is efficient if it does things right, and it is effective if it does the right things - A major objective of any profit-oriented organization is to earn a satisfactory profit. Thus, profit is an important measure of effectiveness. Furthermore, since profit is the difference between revenue (a measure of output) and expense (a measure of input), it is also a measure of efficiency. This, profit measures both effectiveness and efficiency - There are four types of responsibility center, classified according to the nature of the monetary inputs and/or outputs that are measured for control purposes: o Revenue centers o Expense center o Profit centers o Investment centers - Each type of responsibility center requires a different planning and control system - In a revenue center, output (i.e., revenue) is measured in monetary terms, but no formal attempt is made to relate input (i.e., expense or cost) to output - Typically revenue centers are marketing/sales units that do not have authority to set selling prices and are not charged for the cost of the goods they market. Actual sales or orders booked are measured against budgets or quotas, and the manager is held accountable for the expenses incurred directly within the unit, but the primary measurement is revenue - Expense centers are responsibility centers whose inputs are measured in monetary terms, but whose outputs are not - There are two general types of expense centers: o Engineered  Engineered costs are those for which the “right” or “proper” amount can be estimated with reasonable reliability (e.g., a factory’s costs for direct labour, direct material, components, supplies, and utilities)  Output multiplied by the standard cost of each unit produced measures what the finished product should have cost. The difference between the theoretical and the actual cost represents the efficiency of the expense center being measured  In summary:  their input can be measured in monetary terms  their output can be measured in physical terms  their optimum dollar amount of input required to produce one unit of output can be determined o Discretionary  Discretionary costs (also called managed costs) are those for which no such engineered estimate is feasible. In discretionary expense centers, the costs incurred depend on management’s judgment as to the appropriate amount under the circumstances  Discretionary expense centers include administrative and support units (e.g., accounting, legal, industrial relations, public relations, human resources)  The work done by discretionary expense centers falls into two general categories (1) continuing and (2) special  Continuing work is done consistently from year to year, such as the preparation of financial statements by the controller’s office  Special work is a “one-shot” project (e.g., developing and installing a profit-budgeting system in a newly acquired division)  A technique often used in preparing a discretionary expense center’s budget is management by objectives, a formal process in which a budgetee proposes to accomplish specific jobs and suggests the measurement to be used in performance evaluations  Incremental budgeting: in this model, the discretionary expense center’s current level of expenses is taken as the starting point. This amount is adjusted for inflation, anticipated changed in the workload of continuing job, special job, and – if the data is readily available – the cost of comparable jobs in similar units  Drawbacks of incremental budgeting: o First, the discretionary expense center’s current level of expenditure is accepted and not re-examined during the budget preparation process o Second, managers of these centers typically want to increase the level of services, and thus tend to request additional resources, which – if they make a sufficiently strong case – are usually provided (Parkinson’s Second Law: overhead costs tend to increase, period.)  Zero-Base Review: An alternative budgeting approach is to make a thorough analysis of each discretionary expense center on a rolling schedule, so that all are reviewed at least once every five years or so  Zero-base reviews are time-consuming, and they are likely to be traumatic for the managers whose operations are being reviewed (this is one of the reasons for scheduling such reviews so infrequently)  Unlike costs in engineered expense centers, which are strongly affected by short-run volume changes, costs in discretionary expense centers are comparatively insulated from such short-term fluctuations. This difference stems from the fact that in preparing the budgets for discretionary expense centers, management tends to approve changes that correspond to anticipated changes in sales volume (e.g., allowing for additional personnel when volume is expected to increase, and for layoffs or attrition when volume is expected to decrease) - Administrative centers include senior corporate management and business unit management, along with the managers of supporting staff units. Support centers are units that provide services to other responsibility centers - The control of administrative expense is especially difficult because of (1) the problems inherent in measuring output and (2) the frequent lack of congruence between the goals of departmental staff and of the company as a whole - In many companies, two very different types of activities are grouped under the heading of marketing, with different controls being appropriate for each. One group of activities relates to the filling of orders. These are referred to as logistics activities and, by definition, take place after an order has been received. The other group of activities relates to efforts to obtain orders, and, obviously, take place before an order has been received. These are true marketing activities - In summary, there are three types of activities within a marketing organization, and, consequently, three types of activity measures. First, there is the logistics activity, many of whose costs are engineered expenses. Second, there is the generation of revenue, which is usually evaluated by comparing actual revenue and physical quantities sold with budgeted revenue and budgeted units, respectively. Third, there are order-getting costs, which are discretionary because no one knows what the optimum amounts should be. Consequently the measurement of efficiency and effectiveness for these costs is highly subjective Chapter 5 - When a responsibility center’s financial performance is measured in terms of profit, the center is called a profit center - A functional organization is one in which each principal manufacturing or marketing function is performed by a separate organization unit. When such an organization is converted to one in which each major unit is responsible for both the manufacture and the marketing, the process is termed divisionalization - Two conditions should exist before it is safe to entrust a lower-level manager with expense/revenue trade-off decisions: o The manager should have access to the relevant information needed for making such a decision o There should be some way to measure the effectiveness of the trade-offs the manager has made - Advantages of Profit Centers: o The quality of decisions may improve because they are being made by managers closest to the point of decision o The speed of operating decisions may be increased since they do not have to be referred to corporate headquarters o Headquarters management, relieved of day-to-day decision making, can concentrate on broader issues o Managers, subject to fewer corporate restraints, are freer to use their imagination and initiative - Disadvantages of Profit Centers: o Decentralized decision making will force top management to rely more on management control reports than on personal knowledge of an operation, entailing some loss of control o If headquarters management is more capable or better informed than the average profit center manager, the quality of decisions made at the unit level may be reduced o Friction may increase because of arguments over the appropriate transfer price, the assignment of common costs, and the credit for revenues that were formerly generated jointly by two or more business units working together - To realize fully the benefits of the profit center concept, the business unit manager would have to be as autonomous as the president of an independent company. As a practical matter, however, such autonomy is not feasible. Consequently, business unit structures represent trade- offs between business unit autonomy and corporate constraints. The effectiveness of a business unit organization is largely dependent on how well these trade-offs are made - It is useful to think of managing a profit center in terms of control over three types of decisions: o The product decision o The marketing decision o The procurement (outsourcing) decision - The constraints imposed by corporate management can be grouped into three types: o Those resulting from strategic considerations o Those resulting because uniformity is required o Those resulting from the economies of centralization - A marketing activity can be turned into a profit center by charging it with the cost of the products sold. The transfer price provides the marketing manager with the relevant information to make the optimum revenue/cost trade-offs, and the standard practice of measuring a profit center’s manager by the center’s profitability provides a check on how well these trade-offs have been made - There are two types of profitability measurements used in evaluating a profit center, just as there are in evaluating an organization as a whole: o First, there is the measure of management performance, which focuses on how well the manager is doing. This measure is used for planning, coordinating, and controlling the profit center’s day-to-day activities and as a device for providing the proper motivation for its manager o Second, there is the measure of economic performance, which focuses on how well the profit center is doing as an economic entity - The performance of the profit center manager may be evaluated based on five different measures of profitability: o Contribution margin o Direct profit  This measure reflects a profit center’s contribution to the general overhead and profit of the corporation o Controllable profit  Headquarters expense can be divided into two categories (1) controllable and (2) noncontrollable. The former category includes expenses that are controllable, a least to a degree, by the business unit manager o Income before income taxes o Net income - Managers should be measured against those items they can influence, even if they do not have total control over those items Chapter 6 - If two or more profit centers are jointly responsible for product development, manufacturing, and marketing, each should share in the revenue generated when the product is finally sold. The transfer price is the mechanism for distributing this revenue - The transfer price should be designed so that it accomplishes the following objectives: o It should provide each business unit with the relevant information it needs to determine the optimum trade-off between company costs and revenues o It should induce goal congruent decisions – that is, the system should be designed so that decisions that improve business unit profits will also improve company profits o It should help measure the economic performance of the individual business units o The system should be simple to understand and easy to administer - The term transfer price refers to the value placed on a transfer of goods or services in transactions in which as least one of the two parties involved is a profit center - The fundamental principal is that the transfer price should be similar to the price that would be charged if the product were sold to outside customers or purchased from outside vendors - When profit centers of a company buy products from, and sell to, one another, two decisions must be made periodically for each product: o Should the company produce the product inside the company or purchase it from an outside vendor? This is the sourcing decision o If produced inside, at what price should the product be transferred between profit centers? This is the transfer price decision - An idea situation to induce goal congruence by implementing a market price based transfer price will include the following conditions: o Competent People o Good Atmosphere o A Market Price o Freedom to Source o Full Information o Negotiation - Constraints on Sourcing o Limited Markets o Excess/Shortage of Industry Capacity - When using a cost-based transfer price two decisions must be made: (1) how to define cost and (2) how to calculate the profit mark-up o The usual cost basis is standard costs. Actual costs should not be used because production inefficiencies will be passed on to the buying profit centre. If standard cost are used, an
More Less

Related notes for AFM 482

Log In


Don't have an account?

Join OneClass

Access over 10 million pages of study
documents for 1.3 million courses.

Sign up

Join to view


By registering, I agree to the Terms and Privacy Policies
Already have an account?
Just a few more details

So we can recommend you notes for your school.

Reset Password

Please enter below the email address you registered with and we will send you a link to reset your password.

Add your courses

Get notes from the top students in your class.