2007 Management-Control-System

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Q2) Briefly define Discretionary Expense center, Engineered Expense Center, Profit
Centre and Investment Center? How budget prepared in Discretionary Expense
Center? How is performance of the manager evaluation in Discretionary Expense
Center?
1. The Profit Center.Many operating unit managers have responsibility and authority
for both production and sales. They make decisions about what products and services to
produce, how to produce them, their quality level, price, sales and distribution systems. But
these managers may not have the authority to determine the level of capital investment in
their facilities. In these cases, operating profit may be the single best (short- term)
performance measure for how well the managers are creating value from the resources the
company has put at their disposal. Such a unit, in which the manager has almost complete
operational decision-making responsibility and is evaluated by a straightforward profit
measure, is called a profit center.
2. The Investment Center. When a local manager has all the responsibilities
described above as well as the responsibility and authority for his or her center’s working
capital and physical assets, the manager is running an investment center. The performance of
such a unit is best measured with a metric that relates profits earned to the level of physical
and financial assets employed in the center. Investment center managers are with metrics as
return on investment (ROI) and economic value-added.
3. Engineered Expense Center. Engineered cost are those for which the right or
proper amount can be estimated with reasonable reliability, for example material and direct
labour. It have the following characteristic
1. Their input can be measured in monetary terms
2. Their output can be measured in phisical terms
3. The optimum dollar a,,ount of input required to produce one unit of output can be
determined.
For engineered expense center, it decides whether the proposed operating budget
represent s the unit cost of performing its task efficiently. In discretionary expense center,
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budgeting is determined by the magnitude of the job that needs to be done, it usualy carried
out in one of two ways:
Incremental Budgeting; In this model, discretionary expense cente's current level of

expense is taken as starting point. This amount is adjusted for inflation, anticipated in the
workload continuing job, special job, or the cost of compatable jobs in similar units (if
available).
Zero Base Budgeting; In this aproach, budgeting made thorough analysis of each
discretionary expense center on a rolling schedule, all are reviewed in every period (at least
five year).
4. Discretionary Expense Center. Staff units, including general and administrative

(G&A) departments, such as finance, human resources, and legal; research and development
(R&D) departments; and marketing units such as those performing advertising and
promotion, are usually treated as discretionary expense centers. The output from these units is
not easily measured in financial terms, and the relationship between the resources they
expend (inputs) and the outcomes they produce is weak. Companies control these
discretionary expense centers by negotiating and eventually authorizing an annual budget and
then monitoring whether their actual spending remains within the budgeted amounts.Some
organisation units have outputs that are not measured in monetary terms.These are principally
administrative staff units (e.g.;accounting ,legal,industrial relations),research and product
development organisation,and some types of marketing activities,
Management makes budgetary decisions for discretionary expense center that differ
from those foe engineered expense center.Management formulates the budget for
discretionary expense center by determining the magnitude of the job that needs to be done.
The workdone by discretionary expense center falls in to two general

categories:Continuing work is done consistently from year to year ,such as the preparation of
financial statement by the controller office.Special work is a “one-shot”project-for
eg.developing and installing a profit-budgeting system in a newely acquired division.
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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 evaluation.
The primary job of the discretionary expense center’s manager is to obtain the desired
output.Spending an amount that is “on budget” to do this is considered satisfactory;spending
more than that is cause for concern;and spending less may indicate that the planned work is
not being done.In discretionary center as opposed to engineered centers,the financial
performance report is not a means of evaluating the efficiency of the manager.
If these two types of responsibility centers are not carefully distinguished

,management may erroneously treat a discretionary expense center’s performance report as an
indication of the unit’s efficiency,thus motivating those making spending decision to expand
less than the budgeted amount,which in turn will lower otput.For this reason,it is unwise to
reward executive who spend less than the budgeted amount.
Q.3 Every SBU is a profit center but every profit center is not a SBU? What are the
conditions that should be fulfilled for an organization unit to be converted into a profit
center? What are the different ways to measure the performance of profit centers?
Discuss their relative merit & demerits.
Soln:- HAVE TO UPDATE THIS PART

In the competitive market environment of today’s business cannot survive unless
there is total accountability and associated responsibility and authority. Distribution sector
also needs to be treated as a business entity if financial viability is to be achieved. The heads
of the business units should be empowered to act and be held accountable for their actions &
performance. Such a concept would be achievable if each circle is declared as a profit center
with its own accounting system. The performance parameters as well as benchmarks can be
set for improvement. This would also bring in the sense of ownership and competition, which
are essential ingredients for success of a business. The MOA stresses upon the need for
declaration of a circle as a profit center and establishing base line parameters as well as bench
marks for measuring improvements consequent upon the commercial, administrative and
technical interventions. The operating expenses of the circle, which contribute towards the
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delivery cost of energy to the customer, can also be monitored more closely as a profit center
concept and measures may be initiated for reduction of the same.
Most business units are created as profit centers since managers in charge of such
units typically control product development, manufacturing & marketing resources. these
managers are in a position to influence revenues and costs and as such can be held
accountable for the “bottom line.” However, a business unit manager’s authority may be
constrained in various ways, which ought to be reflected in a profit center’s design and
operation.
Functional units
Multibusiness companies are typically divided into business units, each of which is
treated as independent profit-generating units. The subunits with in these business units
however, may be functionally organized. it is sometimes desirable to constitute one or more
of the functional units –e.g., marketing ,manufacturing & service operations –as profit
centers. There is no guiding principle declaring that certain types of units are inherently profit
centers and others are not. Management’s decision as to whether a given unit should be a
profit center is based on the amount of influence the units managers exercises over the
activities that affect the bottom line.
Conditions for an organization unit to be converted into a profit center
Functional organization is one 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 marketing ,the
process is termed divisionalization. As a rule, companies create business units because they
have decided to delegate more authority to operating managers. Although the degree of
delegation may differ
From company to company, complete authority for generating profits is never delegated to a
single segment of the business.
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Many management decisions involve proposals to increase expenses with the expectation
of am even greater increase in sales revenue. such decisions are said to involve
expense/revenue trade offs .additional advertising expense is an example, before it is safe to
delegate such a trade-off decision to a lower-level manager, two conditions should exist.
1. The manager should have access to the relevant information needed for making such a
decision.
2. There should be some way to measure the effectiveness of the trade-offs the managers
has made.
A major step in creating profit centers is to determine the lowest point in an organization
where these two conditions prevail.
All responsibility centers fit into a continuum ranging from those that clearly should
be profit centers to those that clearly should not ,management must decide whether the
advantages of giving profit responsibility offset the disadvantages, which are discussed
below .As with all management control system design choices, there is no clear line of
demarcation.
Different ways to measure performance of profit centers
The classification and establishment of responsibility center may help an organization

to get better performance. However, if we must determine the performance of each
responsibility center, we should take proper means to measure and evaluate it.
Center performance measurement is the process of accumulating and reporting data
relate to center performance. The performance report includes financial data, operating
statistics considered important to performance, and operations budget for evaluation basis.
Performance evaluation is the judgment process of supervisors about the quality of the
performance of subordinates. The results of performance evaluation are qualitative judgments
such as outstanding, good, adequate, or poor. The evaluation takes the forms of a
memorandum that will provide part of the basis for salary increases bonuses, and future
promotions.
Performance measures are the relatively objective numbers resulting from a
performance measurement system, and performance evaluations are the subjective judgment
of managers. If the evaluations are fair and reasonable, there should be some correspondence
between the measures and the judgments.
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Because the responsibility and authority of each center are different, the measurement
approaches of performance of each center are different. In the following section, we discuss
performance measures in responsibility centers.
A profit center may determine which of products and how many products should be
produced and sold. But it only controls costs and revenues related to the profit center other
than those of the entire organization. Thus, the performance of profit center that is gained by
means of its profit that is gained by means of controlling its operational activity, actually
cannot be real profit of the organization, but only be contribution to profit of the organization
or its higher level responsibility center. Often, profit centers are evaluated by means of
contribution margin income statements, in terms of meeting revenues and costs objectives.
This mainly takes form of controllable income to measure.
Controllable income is the excess of contribution margin over fixed costs controlled by the
profit center. Contribution margin is the excess of revenue of the profit center over all
variable costs of those sales. We may measure the performance of the profit center or its
manager by means of the controllable income variance that is the difference between the
actual and planned number of the controllable income.
However, in profit centers, we encounter the usual problems related to measuring profit for
the organization as a whole: how are the organization’s revenues and costs allocated to each
profit center? If a profit center is totally separate from all other
parts of the organization, its profits can be uniquely identified with it. However, most profit
centers have costs (and perhaps revenues) in common with other units. The organization
faces a cost allocation problem.
A related problem involves the transfer of goods between a profit center and other parts of the
organization. Such goods must be priced so that the profit center manager has incentives to
trade with other unite when it is in the organization's best interests. The organization faces
this transfer-pricing problem.
It is not easy to determine how to measure performance in a profit center exist. No matter
what process is chosen, its objectives should be straightforward: Measure employees'
performance in ways that motivate them to work in the best interest of their employers and
compare their performance to standards or budget plans.
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Advantages
A profit centre is that segment of activity of a business which is responsible for both
revenues and expenses and discloses the profit of a particular segment of activity. It
is created as a result of decentralization of operations to measure the performance of
divisional executives. Each profit centre has a profit target and also enjoys authority
to adopt such policies as are necessary to achieve its targets.
1. The chief merit of profit centre is that it makes its managers responsible for the profit
performance – achieving the budgeted amount of profit during a period.
2. Under profit centre concept the whole organization is dividend into a number of
divisions, the performance of each division is measured in terms of both the income
that is earned and the costs that are incurred.
3. Head quarters management, relieved of day to day decision making, can concentrate
on broader issues.
4. Managers in each division have freedom in making decisions. They need not obtain
approval from corporate headquarters for every expenditure.
5. the quality of decisions may improve because they are being made by managers closet
to the point of decision.
6. the speed of operating decisions may be increased since they do not have to be
referred to corporate headquarters.
The possible disadvantages of treating divisions as profit centers are as follows :
1. Division may compete with each other and may take decisions to increase profits at
the expenses of other divisions thereby overemphasizing short term results.
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2. It may adversely affect co-operation between the divisions and lead to lack of
harmony in achieving organizational goals of the company. Thus it is hard to achieve
the objective of goal congruence.
3. It may lead to reduction in the company’s overall total profits.
4. The cost of activities which are common to all divisions may be greater for
decentralized structure than for centralized structure. It may thus result in duplication
of staff activities.
5. Top management loses control by delegating decision marking to divisional

managers. There are risks of mistakes committed by the divisional managers which
the top management may avoid.
6. Series of control reports prepared for several departments may not be effective form
the point of view of top management.
7. It may under utilize corporate competence.
8. It leads to complication associated with transfer pricing problems.
9. It becomes difficult to identify and define precisely suitable profit centers.
10. It confuses division’s result with manager’s performance.
Q.4 What is the objective of the transfer pricing? What is the idea transfer price in the
situation of?
A-limited market
B-shortage of capacity of industry
What do you use cost based transfer price ?
Answer:
Objective of transfer pricing
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If two are more profit centre are jointly for product development ,manufacturing and
marketing, each should share in the revenue generated when the product is finally sold ,the
transfer price is a mechanism for distributing this revenue, the transfer price should be
designed so that it accomplishes the following objective
- Should each business unit with the relevant information it needed to determine the
optimum trade off between company costs and revenue.
- It should induce goal congruent decisions –that is the system should be designed so
that decision that improve business unit profit will also improve company profile.
- It should help measure the economic performance of the individuals business units
- The system should be simple to understand and easy to administer
Designing transfer pricing system is a key management control topic for most corporations as
shown in exhibits 6.1,79, percent, 1000 companies transferred product between profit centres
The ideal situation
A market price –based transfer price will induce goal congruence if all the following
condition exits
Rarely ,if ever will these condition exists in practice, the list there fore dose not exits set
forth’s criteria that must be met to have a transfer price, rather it suggest a way of looking at
situations to see what to see changes should be made to improve the operations of the transfer
price mechanics
-component people
Ideally managers should e interested in the long run as well as short run performance
Goal atmospheres
Managers has regards profitability, as measured in their income statements as an importance
goal and a significant consideration in the judgement of their performance, they should
perceive that the transfer price are just.
A market price
The ideals transfer price is based one well established ,normal market price for the identical
produce being transfer ,that is market price reflecting the same conditions
Freedom to source
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Altertanatives for sourcing should exits, and managers should be permitted to choose the
alternatives that in their on best interstate buying managers should be free to bye from the
outside, and the selling managers should be free to sell outside.
Full information
Managers must know about the available alternatives and the relevant costs and revenues of
each.
Negotiations
There must be a smothery working mechanics for negotiating “contracts “between business
units.
If all these conditions are present, a transfer price system based on market prices would be in
duke goal congruent in which not all of these all hence conditions are presents.
Constraints on sourcing
Ideally the buying managers should be free to make sourcing occasioning, similar the selling
managers should be free top products in the advantages market,
Limited market
In many companies markets for the buying or selling profits centres may be limited .there are
several reasons for this
First the existence of internal capacity might limit the development of external sales most of
large companies in an industry are highly integrated, as in pulp and paper industry, there
tends to e little independence productions capacity for the interdependent product.
Second if company is the sole producers of differentiated products, no outside source exists
Thirds if a company has invested significantly in facilities .it is unlikely it is to use outside
sources unless the outside selling’s prices approaches the company, variable cost which is not
usual for practice purpose, the products are capative, integeted oil companies are good
example of this
Even in the case of limited market ,the transfer price competitive prices measure the
contribution of a profit centre system to a competitive price ,competitive price measure the
contributions of each profit centre to a total company profits ,in the case of integrated oil
company, use of crude oil market prices is the most effective way to evaluate the extracting
and refining unit as if they were stand alone businesses ,if internal capacity is not available
,the company will ye outside at the competitive price ,the difference between the competitive
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price and inside cost is the money saved y producing rather that buying moreover ,a
competitive price measure how a well a profits centre may e performing against competitive.
How Does Company finds out what the competitive prices is it does not buy or sell the
products in an outside market? Here are some ways
1-if published market price is available
2-market price may be set by bids
3-if the production profits centre sells similar products in the outside markets .
4-if the productions profits centre sell similar products in outside market.
5-if the buying profit centre purchases similar products from the outside markets.
6- Shortage of industry capacity
Suppose the selling profits centre cannot sell to the outside market all it can products if
require from the outside vendors while capacity is available on the inside
Conversely suppose the buying profits centre obtain the products it require from the outside
while the selling profit centre is selling to the outside ,this situations occurs when there is a
shortage of a capacity in the industry in this case ,the output of the buying profits centre is
constrained and again company profits not be optimum.
A word cautions is in other is in order at the this point,
Given the option buying profits centres in some companies prefers to deal with an point given
the option buying profits centres in some companies prefer to deal with outside sources ,one
reasons .is perceptions that outside sources provides better service ,another reasons is internal
revelry that sometimes exists in divisionalised companies, for whatever reasons
management should be awards of the strong policies overtones the some times occurs in
transfer price negotiations ,there is no guarantee that a profits centre will voluntary buy from
the inside sources when exits capacity exists.
In arriving at the transfer price .companies typically eliminated advertising financing or other
expenses that the seller does not incur in internal transaction, this is similar to the practice
when two outside companies arrives at a price either buyer ordinarily will pay for cost
components that do not apply to the contracts.
When use the cost based transfer prices]
If companies prices are not available, transfer prices may be set on the basic of cost plus a
profits.enen though such transfer price may be complex to calculate and the result less
satisfactory than a market based price there are tow based decisions must b in a cost transfer
price system.
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-How a define cost

-How to calculate the profit mark-up.
-The cost basic
- The usual basic is standards costs, actually costs should not be used because
production inefficient
-Will be passé on to the buying centre ,if standards coasts are used ,an incentives is
needed to tight standards and improve standards .
-The profit makeup
-In calculating the profits makeup there also are two decisions
-What are the profits mark-up is based on the The level of profit an allowed.
The seconds problems with the profit allowance is the amount of profits ,senior managements
precipitations of the financial performance of a profit allowance should approximate the rate
of return that would be earned if the business units an independent company selling required
to meet the volume needed by the buying profit centre ,the investment would be calculated at
a “standards “level with fixed assets and inventories at current replacement costs.
Q.5 -What the different methods are of evaluate of the performance of an

investment centre? Discuss the merit and demerit of each? Which method would be
recommended?
Answer
An investment centre is a classification used for business units within an enterprise.
The essential element of an investment centre is that it is treated as a unit which is measured
against its use of capital, as opposed to a cost or profit centre, which are measured against
raw costs or profits.
The advantage of this form of measurement is that it tends to be more encompassing, since it
accounts for all uses of capital. It is susceptible to manipulation by managers with a short
term focus, or by manipulating the hurdle rate used to evaluate divisions.
When the profit earned by a business unit is compared with the assets employed in earning it
,the business unit is termed as investment center,there are two methods of relating profit to
the investment base.
ROI return on investment
EVA economic value added
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1) To provide information that is useful in making sound decision about assets employed
and to motivate managers to make these decision that are in the best interested of the
organizations
2) 2-to measuring the performance of the business units as economic entity.
Focusing on profits, without considering the assets employed to gendered those profit is an
adequate basic for control, except in certain types of organizations in which the amount of
capitals is significant.
Unless the amount of assets employed is taken into account, it is difficult for senior
management to compare the profit performance of a business units with that of the
other units or to similar outside companies
In general business unit managers have two performance objectives, first they should
generate adequate profits from the resources at their disposal, second they should
invest in additional resources only when the investment would product return,
conversely, they should disinvest if existing assist do not earn adequate return.
MERIT AND DEMERIT

Most companies employing investment centres evaluate business units other basic of
ROI rather than EVA, there are three apparent benefits of ROI measure:
1- it is a comprehensive measure in that anything that affects financial statement is

reflected in the ratio.
2- ROI is simple to calculate, easy to understand and meaningful in absolute sense.
3 -it is a common denominator that may be applied to any organizational unit

responsible for profitability, regarding of size or type of business.
The performance of different units may be directly to one another, also ROI date ate
available for competitors and be used as a basic for comparison.
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EVA has four districts advantages over ROI
1- With EVA all business units have the same profit adjective for the comparable
investment.
2- Decisions that increase a centre ROI may decrease its overall profits.
3- Different interest rate may use for income.
4- EVA has strong positive correlation with changes in company market value, the
best proxy for shareholder value at the business unit level is to business unit
managers to create and grow EVA
When used as a performance metric EVA motivators to increase EVA by taking

actions consistent with increasing shareholder value.
EVA =net profit = capital charge

Capital charge=cost of capital x capital employed
EVA =capital employed x (ROI-cost of capital)
The following actions EVA can increase ROI though BPR and productivity gains
without increasing the assets base
1-increase ROI through BPR and productivity going without increasing the assets
base.
2-divest assets product and or business as whose ROI is less than cost of capital.
3-aggressive new investment in assets products andor businesses who’s ROI exceeds
the cost of capital.
4-increase in sales, profit margined or capital efficiency without effecting other

variable in equation (2)
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EVA solve a problems of differing profit objective for the same assets in different
business unit and the same profits objectives for different asset in the same unit, the methods
makes it possible to incorporated in the measurement system the same decision rules that are
applied in the planning process, the more sophisticated the planning system more complies
could be EVA calculations.
EVA does not sole all the problems of measurement profitability in an investment if
gross book value is used ,a business unit can increase its EVA by taking actions contrary to
the increase of the company .if net book value is used EVA will increase simply with the
passage of time ,EVA does not solve the problem created by differing profit poteantional ,all
business unit will be motivated to increase investment if the rate of return from the positional
investment exceeds the rate of return prescribed by the measurement system.
Q7) what do u understands by balance scorecard? Why is it considered superior to

other methods of performance appraiser? Prepare balance scorecard for any
organization you are familiar with?
ANS:- The Balanced Scorecard (BSC) is a performance management tool which began as a
concept for measuring whether the smaller-scale operational activities of a company are
aligned with its larger-scale objectives in terms of vision and strategy.
By focusing not only on financial outcomes but also on the operational, marketing and
developmental inputs to these, the Balanced Scorecard helps provide a more comprehensive
view of a business, which in turn helps organizations act in their best long-term interests.
The balanced scorecard approach provides a clear prescription as to what companies

should measure in order to 'balance' the financial perspective. The balanced scorecard is a
management system (not only a measurement system) that enables organizations to clarify
their vision and strategy and translate them into action. It provides feedback around both the
internal business processes and external outcomes in order to continuously improve strategic
performance and results. It captures both the financial and non-financial aspects of a
company's strategy and discusses the cause and effect relationship that drives business
results. It is a proven tool to translate a company's strategy into action.
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"The balanced scorecard retains traditional financial measures. But financial measures
tell the story of past events, an adequate story for industrial age companies for which
investments in long-term capabilities and customer relationships were not critical for success.
These financial measures are inadequate, however, for guiding and evaluating the journey
that information age companies must make to create future value through investment in
customers, suppliers, employees, processes, technology, and innovation."
The balanced scorecard suggests that we view the organization from four
perspectives, and develop metrics, collect data and analyze it relative to each of these
perspectives:
1. The Learning and Growth Perspective This perspective includes employee training
and corporate cultural attitudes related to both individual and corporate self-improvement. In
a knowledge economy, Human resources are the main resource. In the current climate of
rapid technological change, it is becoming necessary for knowledge workers to be in a
continuous learning mode. The Organisation has to identify the infrastructure that must be
built in order to create long term growth and improvement. The objective is to build up
mechanism to fill up the existing gaps in knowledge and processes and to be continually
innovative. Kaplan and Norton emphasize that 'learning' is more than 'training'; it also
includes things like mentors and tutors within the organization, as well as that ease of
communication among workers that allows them to readily get help on a problem when it is
needed.
2. The Business Process Perspective This perspective refers to internal business
processes. This perspective allows the managers to know how well their business is running,
and whether its products and services conform to customer requirements. It should be
carefully analyzed by those who know these processes most intimately. The main focus of
this perspective is on defining the critical business processes in which the organization seeks
to excel. The company must understand its value chain. In addition to the strategic
management process, two kinds of business processes may be identified: a) mission-oriented
processes, and b) support
3. The Customer Perspective Current business philosophy has shown an increasing
realization of the importance of customer focus and customer satisfaction in any business.
These are leading indicators: if customers are not satisfied, they will eventually find other
suppliers that will meet their needs. Poor performance from this perspective is thus a leading
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indicator of future decline, even though the current financial picture may look good. Key
parameters in this perspective to be analyzed are customer satisfaction, customer retention,
new customer acquisition and market share in targeted segments. Major Dimension's
affecting customer response and profitability are product and service attributes, customer
relations and image and reputation.
4. The Financial Perspective These measures do not disregard the traditional need for
financial data. Timely and accurate financial data will always be a priority, and managers will
do whatever necessary to provide it. In fact, often there is more than enough handling and
processing of financial data. With the implementation of a corporate database, it is hoped that
more of the processing can be centralized and automated. But the point is that the current
emphasis on financials leads to the "unbalanced" situation with regard to other perspectives.
A Balanced Scorecard must be balanced. In this context, the internal auditor may prove
helpful to create and monitor the scorecard since he has access to company wide measure of
performance.
Performance measurement system: additional consideration

A performance measurement system attempt to address the need of the different stakeholders
of the organization by crating a blend of strategic measures: outcome and driver measures,
financial and no financial measures and internal & external measures.
Outcome and driver measures

Outcome measurements indicate the result of strategy(e.g. increased revenue). These
measures typically are “lagging indicators”; they tell management what has happened. By
contrast driver measures are “leading indicators” they show the progress of key areas in
implementing a strategy. Whereas outcome measures indicate only the final result driver
measures can be used at a lower level and indicate incremental changes that will ultimately
affect the outcome.
By focusing management attention on key aspect of the business driver measures
affect behavior in the organisation. If a business units desire is to improve time to market
focusing on cycle time allows management to track how well this goal is being achieved,
which in turn encourages employees to improve this particular measures.
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Outcome and driver measures are inextricably linked. if outcome measures indicate
there is a problem but the driver measures indicate the strategy is being implemented well
there is a high chance that the strategy needs to be changed.
Financial and no financial measures

Organization has developed very sophisticated system to measure financial performance.
Unfortunately as many U.S..Firm discovered, during the 1980s industries were being driven
by changes in nonfinanacial areas, such as quality and customer satisfaction, that eventually
impacted companies financial performance.
Even through they recognize the importance of nonfinanacial measures, many
organizations have failed to incorporate them into their executive –level performance reviews
because these measures tend to be much less sophisticated than financial measures and senior
management is less adept at using them.
Internal and External measures

Companies must strike a balance between external measures such as customer satisfaction
and measures of internal business processes, such as manufacturing yield. Too often
companies sacrifice internal development for external results altogether, mistakenly believing
that good internal measures are sufficient.
Measurements drive change

The most important aspect of the performance measurement system is its ability to
measure outcome and diverse in a way that causes the organisation to act in accordance with
its strategies. The organisation achieve goal congruence by linking overall financial and
strategic objective with lower levels. With these measures all employee can understand how
their action impact the company strategies.
Because these measures are explicitly tied to an organization’s strategies, the
measures in the scorecard must be strategy – specific and therefore organization – specific
and therefore organization-specific. While a generic performance measurement framework
exists, there is no such thing a generic scorecard.
The scorecard measures are linked from top to bottom and tied to specific targets
throughout the entire organization. Objectives can further clarify a strategy so that the
organization knows both what it needs to do how much.
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Finally the scorecard emphasis the idea of cause and effect relationship among
measures. By explicitly presenting the cause and effect relationships among measures. by
explicitly presenting the cause and effect relationship, an organization will understand how
nonfinanacial measures(e.g. product quality) drive financial measures (e.g. revenue) bellow
figure present an example of how the measures link to each other in a cause and effect
relationship. Better selection, training, and development of manufacturing employees
(measured in term of “manufacturing yield”) lead to better product quality(measured in term
of” first pass yield”) and better on time delivery (measured in term of “order cycle time”).
These improvements in turn lead to improved customer loyalty which leads to enhanced
sales.(measured in term of “sales growth”)
The scorecard must not simply be a laundry list of measures. Rather, the individual
measures in the scorecard must be linked together explicitly in a cause effect way, as a tool to
translate strategy into action.
Perspective Measures
Innovation and Manufacturing

learning skills
perspective
First – pass yield

Internal business order cycle time
perspective
Customer Customer
perspective satisfaction
survey.
Financial Sales revenue

perspective growth
Therefore balance scorecard is greater measure than performance appraisal.
Example Balanced Scorecard: Regional Airline
Mission: Dedication to the highest quality of Customer Service delivered with a

sense of warmth, friendliness, individual pride, and Company Spirit.
Vision: Continue building on our unique position -- the only short haul, low-fare,
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high-frequency, point-to-point carrier in America.z
Theme: Operating Objectives Measures Targets Initiatives

Efficiency
Financial
Profitability •Profitability •Market •25% per year •Optimize
•Fewer planes Value •20% per year routes
Lower costs •Increased •Seat •5% per year •Standardize
revenue Revenue plans
Increase •Plane Lease
Revenue cost
Customer
•Flight is on •FAA On •First in •Quality
On-time -time Time industry management
flights •Lowest Arrival •98% •Customer
More prices Rating Satisfaction loyalty
Customers •More •Customer •% change program
Customers Ranking
•No.
Customers
Lowest
Prices
Internal
•Fast ground •On Ground •25 •Cycle time
Improve turnaround Time Minutes optimization
Turnaround •On-Time •93% program
Time Departure
Learning •Ground crew •% Ground •yr. 1 70% •Stock

alignment crew yr. 4 90% ownership
Align stockholders yr. 6 100% plan
Ground •% Ground •Ground crew
Crews crew trained training
Q8) what are the different types of strategies mission at SBU level? How do these
missions affect strategic planning process and budgeting at SBU level?
Ans:-
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Business unit strategies deal with how to create and maintain competitive advantage
in each of the industries in which a company has chosen to participate. The strategy of
business unit depend on two interrelated aspect: 1) its mission (what are its objective) and
2) its competitive advantage (“how should the business unit compete in its industry to
accomplish its mission”) .
Business unit mission

In a diversified firm one of the important task of senior management is resource
deployment. Make decision regarding the use of the cash generated from some business
unit. Several planning model have been developed to help corporate level manager of
diversified firms to effectively allocate resource. These models suggest that a firm has
business unit in several categories, identifies by their mission the appropriate strategies for
each category differ. Together the several unit make up a portfolio, the component of which
differ as to their risk/ reward characteristic just as the component of investment portfolio
differ. Both corporate office and business unit general manager are involved in identified
the mission of individual business unit.
Of the many planning model two of the most widely used are Boston consulting
group two by two growth share matrix and general electric company / mc Kinsey &
company three-by three industry attractiveness –business strength matrix while these model
differ in the methodology they use to develop the most appropriate mission for the various
business unit, they have same set of mission from which to choose: Build, hold, harvest, &
divest.
Build
This mission implies an objective of increased market share, even at the expense of
short term earning and cash flow.
Hold
This strategic mission is geared to protection of the business unit market share and
competitive position. (IBM Computer)
Harvest
This mission has the objective of maximizing short term earning and cash flow , even at the
expense of market share.
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Divest
This mission indicates a decision to withdraw from the business either through a process of
slow liquidation or outright sale.
The mission for existing business units could be either build , hold, or harvest .These
mission constitute a constitute a continuum with “pure build” at one end and “pure harvest”
at the other end. To implement the strategy effectively there should be congruence between
the mission chosen and the type of control used. we develop the control mission “fit” using
the following line of reasoning”
• The mission of the business unit influences the uncertainty that general managers
face and the short term versus long term trade off they make.
• Management control system can be systematically varied to help motivate the
manager to cope effectively with uncertainty and make appropriate short term
versus long –term tradeoffs.
• Thus different mission often require systematically different management control
system.
Strategic planning
While designing a strategic planning process, several design issue need to be
considered. A business unit responds to these issues tend to depend upon the mission its
perusing.
When the environment is uncertain the strategic planning process is especially
important. Management need to think about how to cope with the uncertainties and this
usually requires a longer range view of planning than is possible in the annual budget. If the
environment is stable there may be no strategic planning process at all or only a broad brush
strategic plan. Thus , the strategic planning process is more critical and more important for
build as compare with harvest , business unit s. nevertheless some strategic planning of the
harvest business units may be necessary because the company overall strategic plan must
encompass all of its business to effectively balance cash flow.
In screening capital investment and allocating resources the system may be more
quantitive and financial for harvest units. A harvest business unit operates in mature industry
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and does not offer tremendous new investment possibilities. Hence the required earning rate
for such a business unit may be relatively high to motivate the manager to search for project
with truly exceptional returns. Since harvest units tends to experience stable environment
analysis often can be used more confidently. The required information used to evaluate
investment from harvest units is primarily financial.
A build unit is positioned on the growth stage of the product life cycle. Since the
corporate office wants to take advantage of the opportunities in a growing market senior
management may set a relatively low discount rate , thereby motivating build managers to
forward more investment ideas to corporate office. Given the product/market uncertainties
financial analysis of some project , no financial data are more important.
Budgeting
Implication for designing budgeting system to support, varied mission is shown in figure.
The calculation of variance analysis comparing actual result with the budget identifies
variances as either favorable or unfavorable. However a favorable variance neither imply
favorable performance nor does an unfavorable or unfavorable variance, one the one hand
and favorable or unfavorable performance, on the other hand, depend upon the strategic
context of the business unit under evaluation.
The following additional differences in the budget process are likely to exist between build
and harvest units.
• In contrast to harvest units, budget revisions are likely to be more frequent for build
units because their product/market environment changes more frequently.
• Build unit managers may have greeter input and influence than harvest unit managers
in formulating the budget. This because build managers operate in rapidly changing
environment and have better knowledge than senior management of these changes.
For harvest units with stable unit with stable environment, thus manager knowledge
less important.
Q.11
Kamal Enterprises (KE) is a medium sized company with Rs.225 Crores
turnover for the year 2004- 2005, during which the corporate income tax rate was 40%.
KE is planning to install a new equipment worth Rs.4.5 Crores which is expcted to
improve quality resulting in increased turnover over current by 6% and reduce
variable expenses to turnover ration by 2%. However, 8.48% increase in fixed expenses
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would also result and networking capital would increae by Rs.1.8 crores over current
level. Currently the variable expenses are Rs.150 crores; fix expenses Rs. 49.5 crores;
interest Rs.3 crores; net working capital Rs.36 crores; fixed asssets Rs.51 crores.
Borrowing Rs.36 crores : equity Rs.51 Crores. Return is measured pre-interest and
taxes on capital employed.
a. What is the present return on equity and capital employed?
b. Compare these figures to respective figures post installation
c. Explain the process by which Gautam-Fianancial controller may determine
relative importance’s of parameters to be controlled to ensure project success.
Ans:
Particular present Future
Sales 225 225+ 6% = 238.5
(-) Variable 150 154.23
(-) Fixed Cost 49.5 53.70
(-) Interest 3 (42.3 x 8.33%)=
03.52 22.5
27.05
(-) Tax(40%) 9 10.82
13.5 16.23
Comparison between present & future

Particular present future
ROE= PAT/Equity Capital * 100= 13.5/51 * 100 16.23/51* 100
= 26.47% = 31.8%
ROI= PAT/Total Capital*100= 13.5/87*100 16.23/93.3*100
=15.52% =17.38%
Q 12 Suresh Ltd has two divisions.Div A manufactures an intermediate product for

which no external market exists.Div B incorporates the intermediate product in to final
product (in the ratio of oneunit to one unit ) and sells in the market .Estimated number
of units which Div. B can sell at various prices is tabulated:-
Selling Price (Rs.) Expected Sales(Units)
90 2000
80 3000
50 6000
Costing Div A Div B

Variable cost (unit)Rs. 11 7
Fixed cost per annum Rs. 60,000 90,000
Transfer price to Division B for intermediate product is Rs.35 per unit.
(a)Define Profit in this case and prepare a statememnt for both Divisions and Overall
Company
(b) State the selling price which maximizes profits for Div.B and company as a whole
.Commnet on why the latter price is unlikely to be selected by Div.B
Solution:
A)Here profit can be calculated as
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Profit = A Div contribution + B Div contribution

Case I :
Selling price = Rs.90 Expected Sales = 2000 units
DIV A DIV B COMPANY
REVENUE/Unit 35 90 90
Finishing
Variable 7 7
Cost/Unit
Fixed Cost/Unit 45 45
Transfer 35
Price/Unit
Processing
Variable 11 11
Cost/Unit
Total Cost 41 87 93
Profit/Loss 6(loss) 3(Profit) 3(loss)
Case II :
DIV A DIV B COMPANY
Finishing
Variable 7 7
Cost/Unit
Transfer 35
Price/Unit
Processing
Variable 11 11
Cost/Unit
Total Cost 31 72 68
Profit/Loss 4(Profit) 8(Profit) 12(Profit)
Case III:
DIV A DIV B COMPANY
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Finishing
Variable 7 7
Cost/Unit
Transfer 35
Price/Unit
Processing
Variable 11 11
Cost/Unit
Total Cost 21 57 43
Profit/Loss 14(Profit) -7(Loss) 7(Profit)
B) From the above contribution calculation for different selling price with respective
volume sales,it is clear that when selling price is =Rs.80 with sales volume = 3000 units
result in positive contribution by both profit centers,which gives profit Rs 12 /unit,with Div
A’s contribution =Rs 4/Unit and Div B’s Contribution =Rs 8/Unit.There firm enjoy the profit
of Rs 12/Unit.While in other case say case I Div A incurred loss of Rs 6/unit which in turn
result in overall loss of Rs 3/unit for the firm.In case III Div A enjoys the profit of Rs
14/unit ,while Div B incurred a loss of Rs.7/Unit which results in overall loss of Rs.7/Unit for
the firm
OR
Q12. Two divisions A and B of satyam Enterprises operates as Profit Centers.Division A

normally purchases annually 10,000 nos.of required component from Division B ;which has
recently informed Division A that it will increase selling price per unit to Rs.1,100.Division
decided to purchase the components from open market available at Rs.1000 per
unit.Naturally ,Division B is not happy and justified its decision to increase price due to
inflation and added that overall company profitability will reduce and thae decision will lead
to excess capacity in Division B ,whose variable and fixed costs per unit are respectively
Rs.950 and Rs.1,100
(a)Assuming that no alternate use exists for excess capacity in Division B,will
company as a whole benefit id Division A buys from the market
(b)If the market price reduced by Rs.80 per unit.What would be the effect on the
company (assuming Division B still has excess capacity)if A buys from the market.
(c)If excess capacity of Division B could be used for alternative sales at yearly cost
savings of Rs.14.5 Lacs,should Division A purchase from outside?
Justify your answer with figures.
(a) Div A Buys from outside parties at Rs 1000

SP PER UNIT 1000
VC PER UNIT 950
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Contribution /Unit 50
Here if the division A buys the product at Rs 1000 from the outside parties instead of
division B, the company as whole will be loosing the contribution otherwise would have been
earned of Rs.50, because it can produce the said item at variable cost of 950 only. Therefore
Division A should not buy the product from outside at Rs.1000
(b)If the market price reduce by Rs 80 per unit , the new market price will be
Rs.920 per unit.
Price drops from 1000 to 920
SP per unit 920
VC per unit 950
Contribution per unit (30)
In this situation the revised prices reduces the division B’s contribution and it becomes -30
per unit, it will better if division A goes for outside purchase because to produce the
component Division B has to incur variable cost of Rs.950/ but the said component is
available at less than that so from B’s as well as from company’s point of view it is advisable
for A to go for outside purchase.
(c)A’s annual requirement is 10000 components

If B produce this requirement and transfer it to A it is incurring the additional cost of
Rs.14.5 Lacs, in other words it save on this cost if it goes for alternative sales. i.e. per unit of
this produce leads to cost of 14,50,000/10,000 i.e. Rs 145 per unit.So instead of producing
and earing Rs 50 as contribution it can save Rs145 per unit by going for alternative sales.
Therefore in this situation division C should go for purchase of the component from
outside parties at Rs 1000
Purchase cost 10,000*1000 1,00,00,000

Less Saving on VC 10000*950 95,00,000
Less Saving of B if its capacity used for 14,50,000
other activities
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Net Cost (benefit) to the company -(9,50,000)

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Generated by Unregistered Batch DOC & DOCX Converter 2010.2.406.

1. Their input can be measured in monetary terms

2. Their output can be measured in phisical terms

Incremental Budgeting; In this model, discretionary expense cente's current level of

4. Discretionary Expense Center. Staff units, including general and administrative

The workdone by discretionary expense center falls in to two general

A technique often used in preparing a discretionary expense center’s budget is

If these two types of responsibility centers are not carefully distinguished

Soln:- HAVE TO UPDATE THIS PART

Conditions for an organization unit to be converted into a profit center

Functional organization is one which each principal manufacturing or marketing

Different ways to measure performance of profit centers

The classification and establishment of responsibility center may help an organization

The possible disadvantages of treating divisions as profit centers are as follows :

3. It may lead to reduction in the company’s overall total profits.

5. Top management loses control by delegating decision marking to divisional

7. It may under utilize corporate competence.

8. It leads to complication associated with transfer pricing problems.

9. It becomes difficult to identify and define precisely suitable profit centers.

10. It confuses division’s result with manager’s performance.

- The system should be simple to understand and easy to administer

-How a define cost

Q.5 -What the different methods are of evaluate of the performance of an

2) 2-to measuring the performance of the business units as economic entity.

MERIT AND DEMERIT

1- it is a comprehensive measure in that anything that affects financial statement is

2- ROI is simple to calculate, easy to understand and meaningful in absolute sense.

3 -it is a common denominator that may be applied to any organizational unit

EVA has four districts advantages over ROI

3- Different interest rate may use for income.

When used as a performance metric EVA motivators to increase EVA by taking

EVA =net profit = capital charge

EVA =capital employed x (ROI-cost of capital)

4-increase in sales, profit margined or capital efficiency without effecting other

Q7) what do u understands by balance scorecard? Why is it considered superior to

The balanced scorecard approach provides a clear prescription as to what companies

Performance measurement system: additional consideration

Outcome and driver measures

Financial and no financial measures

Internal and External measures

Measurements drive change

Innovation and Manufacturing

First – pass yield

Financial Sales revenue

Therefore balance scorecard is greater measure than performance appraisal.

Example Balanced Scorecard: Regional Airline

Mission: Dedication to the highest quality of Customer Service delivered with a

high-frequency, point-to-point carrier in America.z

Theme: Operating Objectives Measures Targets Initiatives

Learning •Ground crew •% Ground •yr. 1 70% •Stock

Business unit mission

Comparison between present & future

ROI= PAT/Total Capital*100= 13.5/87*100 16.23/93.3*100

Q 12 Suresh Ltd has two divisions.Div A manufactures an intermediate product for

Costing Div A Div B

Profit = A Div contribution + B Div contribution

Profit/Loss 6(loss) 3(Profit) 3(loss)

Profit/Loss 4(Profit) 8(Profit) 12(Profit)

Profit/Loss 14(Profit) -7(Loss) 7(Profit)

Q12. Two divisions A and B of satyam Enterprises operates as Profit Centers.Division A

(a) Div A Buys from outside parties at Rs 1000

(c)A’s annual requirement is 10000 components

Purchase cost 10,000*1000 1,00,00,000

ROI= PAT/Total Capital100= 13.5/87100 16.23/93.3*100