1
Management Control System
UNIT II
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.
Input
s
Resource used
measured by
cost
Responsibility
Centres/Organisat
ion
Output
s
Goods or
services
Types of Responsibility Centres
Four different types of responsibility centres
1.
In revenue centre, outputs is measures in monetary terms.
2.
In expense centres, inputs are measured in monetary terms.
3.
In profit centres,
measured.
4.
In investment centres, the relationship between profit and investment is
measured.
both
revenues
(output)
and
expenses
(input)
are
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.
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
1.
Engineered costs/Standard costs: amount of costs can be estimated with a
reasonable degree of reliability.
2.
Discretionary
judgement.
costs:
the
amount
of
costs
depend
on
managements
Engineered expense centres/Standard cost centres
Characteristics:
1.
Their input can be measured in monetary terms.
2.
Their output can be measured in physical terms.
3.
The optimal rupee amount of input required to produce one unit of output
can be established.
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
1.
The quality of decisions may improve because they are being made by mangers closer to
the point of decision.
2.
It provides a powerful tool for measuring how well the profit centre has performed.
3.
The speed of operating decisions may be increased since they do not have to be referred
to corporate headquarters.
4.
The profit centre resembles a business in miniature form.
5.
The profit centre makes decentralized organisation possible.
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
a)
Developing the budgets and breaking into departments and for shorter periods.
b)
Continuous comparison between the budgeted and actuals figures.
c)
Locate the difference.
d)
Analyzing the reasons for the divergence so pinpointed.
e)
Initiating remedial measures, again through the active involvement of the operating
people, in order to correct the adverse divergence in the immediate next timeperiod.
f)
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.
Discretionary & Committed Cost
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.
Approaches to Budgeting with reference to
9
Engineered/Standard and Discretionary Costs
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.
Benchmarking and Total Cost
Management
10
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.
