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Q.1 ) Explain the benefits accrued to the top management by the

internal audit?

Ans : Major advantages Having An Internal Audit Department

• It dispenses the need to employ external consultants to act as internal auditors hence saving
large sum of money. This is even especially true when an internal audit department is
properly run with well trained and experienced internal auditors;
• The internal auditors are intimately acquainted with the business as they are continuously
employed in the same concern and have access to much confidential information and to all
levels of management. Hence, they really are “special” personnel who have very in depth
inner knowledge which can then contribute to the company;
• The Internal Audit maintains a group of highly skilled people available to cope with non-
recurring and exceptional jobs which no many employee could deal with efficiently and
effectively;
• It ensures that the organization detailed standard policy and procedures are running
smoothly. This compared to the external auditors’ primary role of the ability to express the
true and fair view of the clients’ financial statements audit;
• Internal auditors are invaluable in areas like operational audits, constant examination of
internal check controls, the detailed application of normal auditing method and detailed review
of the various type of management reporting;
• Last but not least, it provides an excellent training ground for future executives. Trainee
personnel obtain intimate knowledge of the business which they can study problems of all
kinds at different levels.

The following categories of function may be carried out by an internal audit department:

1. Advisory- meaning that the internal auditor may recommend improvements and changes in
the system in operation and in the setting up of new systems
2. Executive-the internal audit department may actually deise and install changes and
improvements to existing systems and set up new systems
3. Reporting-the internal audit department prepares routine report on the company’s activities
either on a comprehensive, or on an exception basis

4. Routine testing-the department routinely monitors the performance of the company’s

system,eg. by examining and testing controls such as those over buying procedure and by
cash counts or stock counts

Q. 1 a. Explain the considerations involved in performing the function of R&D by top

management in view of the challenges of the globalization?

Ans :
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Globalization means no barriers of trade between the countries across the

globe. Anyone can freely trade the goods and services among the countries in
the globe. This results into stiff competition in the global market, in this
competitive market if the firm has to survive then it must be updated and the
products of the firms must have the latest technology in it.

In the situation like this if the R&D department is functioned by top

management then this will be useful for the future of the organization
because, top management can make decisions very quickly due to powers in
their hand and the experience that they earn.

If R&D decisions made quickly and effectively then one can expect always
updated and latest quality product of the firm in the market.

Due to the influence of trips (trade related intellactual property rights) the
competition in global scenario bacame very tough before the top
management there are various patents, copyrights acts available in these
provisions to protect the R&D findings of one company that’s why there is
heavy expenditure is required in R&D activities by the corporates.

Also due to intense copetition it is indeed to corporates to udate their

products and services with their rivals products and services.

Socio cultural differences among the market territories influence the direction
of R&D activities for e.g. incase of Annapurna iodized salt invented by HLL
made an intensive research on preserving the iodine content in food cooked
by indian receipies for that they have introduced stable iodine salt which has
been patented in 80 countries which encapsulates iodine in aluminium and
magnatium hydroid.

Thus, these are the considerations involved in regulating R&D function by the
top management especilly in view of challenges faced on account of
globalization.

Q. 2 a. Explain subtle difference among the Management audit, Quality audit and Technical
audit?

Ans :

Management Audit –

• A management audit may be described as a systematic and objective appraisal of the

quality of management, aimed both at individual managers and toward the
management team as an interlocking system of decision makers.
• Management audit concerned with the ways and means to perform specific task.
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• For e.g. it involves the decision taken by the management, reporting and follow up
procedures, direction given by the management to the company, leadership etc are
examined in the management audit.

Quality Audit –

• A systematic and independent examination to determine whether quality activities and

related results comply with planned arrangements and whether these arrangements are
implemented effectively and are suitable to achieve the stated objectives.

• A quality audit is concerned with the quality of results of specific

tasks which involves various products and services.

• For e.g. it involves the quality testing of the final output of the plant
whether it is goods or services.

Technical Audit –

• Technical audit can be described as systematic and independent

examination of technical facilities of the company.

• It is concerned with the exmining the technical specifications of the

various entities of the company

• For e.g. factory layout, production or manufacturing facilities,

locations, machineries, processes etc. comes under technical audit.

Q.7 Explain responsibility centre and map the process of evaluation thereof from one
stage to another, with the help of illustrations – cum – experience of the corporates?

Answer:

Introduction –

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
centers, each of which is represented by a box on the organization chart. These
responsibility centers from a hierarchy, at the lowest level are the centers for sections,
work shifts, and other small organization units. Departments or business units comprising
several of these smaller units are higher in the hierarchy. From the standpoint of senior
management and the board of directors the entire company is a responsibility center,
though the term is usually used to refer to units within the company.

Nature –
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A responsibility centre exists to accomplish one or more purpose termed its objectives. If
each responsibility centre meets its objectives, the goals of the organization would have
been achieved.

The output of responsibility center could be tangible like product or intangible like service
or advice output of a responsibility center could be input to another responsibility center
or could be sold in market place to earn revenue.

Relationships between inputs and outputs –

Management is responsible for ensuring the optimum relationship between inputs and
outputs. In some centers, relationship is casual and direct. In production department
control focuses on using minimum input necessary to produce required output according to
correct specifications, quality standards and in right quantity.

In many situations inputs are not directly related to the outputs. Advertising expenses are
intended to increase sales revenue but since revenue is affected by many factors other
than advertising, the management’s decision to increase advertising budget is based on its
judgement rather than data. The value of R&D expenditure may not be known for many
years.

Measuring Inputs and outputs –

Inputs can always be measured in terms of cost. Inputs are the resources used by the
responsibility centers.

Calculating the value of output is much difficult to measure. Annual revenue may be an
important measure of output but did not express all that the organization did during the
year like R&D, training and advertising etc. It is not possible to measure value of output of
HR, PR, R&D etc. In non profit organizations there may be quantitative measures of
output. At best we may use surrogates.

Efficiency and Effectiveness –

Efficiency is the ratio of outputs to inputs or the amount of the output per unit of input.

Effectiveness is determined by the relationship between a responsibility centers output

and its objectives. Efficiently and effectiveness are not mutually exclusive. Every
responsibility centre should be both effective and efficient. In summary, a responsibility
centre is efficient if it does right things.

The role of profit –

A major objective of any profit oriented organization is to earn satisfactory profit. Thus,
profit is an important measure of effectiveness. Since profit is the difference between
revenue (a measure of output) and expenses (a measure of input), it is also a measure of
efficiency. Thus, profit measures both efficiency and effectiveness.

Types and flow of Responsibility centers –

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There are four types of responsibility centers, classified according to the nature of
monetary inputs and outputs that are measured for control process:

1. Revenue centers
2. Expenses centers
3. Profit centers
4. Investment centers
1. Revenue Centers –
In a revenue centre, output (i.e.revenue) is measured in monetary terms, but no
formal attempt is made to relate input (expense or cost) to output. Typically
revenue centers are marketing / sales unit that do not have authority to set selling
price and are not charged for the cost of goods they market.

2. Expense Centers –

Expense centers are responsibility centers whose inputs are measured in monetary
terms, but whose outputs are not. There are two types of expense centers.

I. Engineered Expense centers – It has following characteristics

i. Their inputs can be measured in monetary terms.

ii. Their output can be measured in physical terms.

iii. The optimum rupee value of input required to produce one unit
of output can be determined. Engineered expenses centers are
usually found in manufacturing operations. They could be
engineered expense centers in marketing like warehousing,
distribution, trucking in administration and support departments
also.

II. Discretionary Expense center – Discretionary expenses centers

include administrative and support units, research and
development, and most marketing activities. The output of these
centers cannot be measured in monetary terms. The term
discretionary means management exercise its judgement about
what the costs should be taking into account its strategy and
competitive environment.

General control consideration –

Budget preparation – Management formulates budget for a

discretionary expense center by determining the magnitude of the
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job that needs to be done. The work done by a discretionary expense

center falls into two categories continuing and special.

Continuing work is done consistently from year to year such as

preparation of financial statement by controller’s department.
Special work is a one slot project. E.g. developing and installing a
profit budgeting system in a newly acquired division. MBO is used for
budget preparation in a discretionary cost center, where in a budget
proposes to do specific jobs and suggest measures to be used in
performance evaluation.

The planning function for discretionary expense center is usually

carried out in two ways.

a. Incremental Budgeting – In this method current level of expenses is taken as

a starting point. This amount is adjusted for inflation, anticipated changes
in workload of continuing jobs, special jobs and if data are readily
available, and the cost of comparable jobs in similar units.
b. Zero Based Budgeting – A thorough review is made of each expense center.
This review attempts to ascertain de novo that is from scratch, the resource
actually required to carry out each activity. This analysis establishes a new
base; the annual budget simply tries to keep the cash in line with this new
base.

Cost variability – In most discretionary cost centers personnel cost centers

personnel cost is the predominated cost. This is insulated from short term
fluctuation in sales volume. If you try to adjust it with volume the cost of hiring
and training would increase. If we retrench moral of the people goes down.

Types of Financial control – The main purpose of the discretionary expense

budget is to control cost by allowing the manager to participate in the
planning, sharing in the discussion of what tasks should be undertaken, and
what level of effort is appropriate for each. Thus financial control is exercised
at the planning stage before the costs are incurred.

Measurement of Performance – The primary job of a discretionary expense

centers manager is to obtain the desired output. Spending an amount that is
“on Budget” to do this is considered satisfactory spending more than that it is
cause for concern, spending less may indicate that the planned work is not
being done.
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The financial performance report is not a means of evaluating the efficiency of

the manager.

3. Administrative and support centers – Control problem of administrative expenses

is especially difficult.
I. The problem inherent in measuring output, and
II. The frequent lack of goal congruence between the goals of
departmental staff and the company as a whole.

Difficulty in measuring output – The principal output in administrative center is Advice

and Service – functions that are virtually impossible to quantity much less evaluated.
Since output cannot be measures, it is not possible to set cost standards against which
to measure financial performance. Thus, a budget variance cannot be interpreted as
representing efficient or inefficient performance and which to discontinue. These
decisions, of course are highly subjective but they are within the policy limits on total
research spending.

4. Annual Budgets – if a company has decided on long range R&D program, and has
implemented this program with a system of project approval, the preparation of
the annual R&D budget is mainly the calenderization of the expenses for the
budget period. If the budget is in line with the strategic plan, approval is routine
and primarily serves to assist cash and personal planning.

5. Marketing Centers –

Marketing activities are those undertaken to obtain orders for company’s products.
These activities include test marketing, the establishment, training and supervision
of sales force, advertising and sales promotion – all of which have characteristic
that present management control problem. When it is possible to measure a
marketing department’s output evaluating the effectiveness of marketing effort is
much more difficult. It is because that the factors beyond the marketing
departments control may invalidate the assumption on which sales budget were
based.

There are two types of Marketing Activities.

i. Order tilling or Logistic activities – which takes place after an order

has been received.
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ii. Order getting activities or true marketing activities.

Flow of one stage to another stage

Manufacturing Function

Engineered
Expense Centers Optimal
relationship can
be established

Output
Inputs
s
Work
Dollar Physical
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Research & Development Function

Discretionary
Expense Centers Optimal
relationship cannot
be established

Output
Inputs
s
Work
Dollar Physical

Marketing Function
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Revenue Centers
Inputs are not
related to outputs

Output
Inputs
s
Work
Dollar only
Dollar
for costs
Revenue
directly
incurred

Business Units

Profit Centers
Inputs are related
to outputs

Output
Inputs
s
Work
Dollar
Dollar Costs
Profits
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Business Unit

Investment
Centers Inputs are related
to capital employed

Output
Inputs
s
Capital Employed
Dollar
Dollar Costs
Profits

Q.10 Mane jay LTD ,engaged in diversified activities consisting of 9 independent profit
centres decided to sell one of its division profits centre to a group of its managers .narrate the
changes that are needed in control system ,practice and procedure ,giving the reasons.

Answers
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There is no guiding principle declared that certain types of units are inherently profits centres
and others are not. Management decisions as to whether a give units should be profits centre is based
on the amount of influence(even if not control) the units managers exercise over the activities that
affect the bottom line.

Marketing

A marketing activity can be turned into profit century charging it with the cost of the
production sold. this transfers price provide the marketing managers with the relevant information to
make a optimum revenue /cost trade offs, and the standard practice of measuring a profits centres
managers by centre profitability provides a cheque on how well these trade offs. Have been made the
transfer priced charged to the profit cater should be based on the standard cost. Rather than the actual
cost. Of the product being sold. Using the standard cost has is separated .the marketing cost
performance from that the manufacturing cost performance.

When should a marketing activity be given profit responsibility? when the marketing
managers is in the best position to make the principle cost revenue trade off .this often occurs where
different conditions exist in different geographical areas –for example a foreign marketing activity ,in
such an activity ,it may be difficult to control centrally such decision as how to market product. How
to set the price, how much to sends on sales promotions, when to spends it ,and on which media ,how
to train salespeople or dealers ,where and when to established new dealers.

Manufacturing

The manufacturing activity is usually an expenses centre, with management being judged on
performance versus costs and overhead dudgets.this measure can cause problems however since it
does not necessarily indicate how the manager is performing all aspect of his job.

Example

• A manager may skimp on quality control, shipping products of inferior quality in order to
obtain standards cost credit.

• A managers may be reluctant to interrupt production schedule in order to produce a rush

corroder to accommodate a customer.

• Managers who are measured against standards may lack the incentive to manufacture
products that are difficult to produce-or to improve the standards themselves. some authors
maintain that manufacturing units should not be meet into profits centres unless they sell a
large pertain of their outputs to outside customers. the regards the units that sell primarily to
other business units as profit centre.

Service and supports units

Unit for maintained ,information ,technology ,transformations engendering ,consulting , customer

service and similar supports activities can all be made into profits center,these may operate out of
headquarters and service corporate division ,or they may fulfil similar function within business
units .they charge customer for service rendered ,with the finical objective of generating enough
business so that their revenues equal their expenses .the prevalence of such practices is shown (the
firms charge “based on usage “probably treat these units as profit centres ) usually ,the units
receiving these service have the option of procuring them from an outside vender ,provide the can
offer service of equal quality at a lower price.

Paper 2008

Q.11) ABC ltd has two division x and y. ROI and particulars of x and y are given below.
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PARTICULARS DIVISION X DIVISION Y

(RS) (RS)

ROI 28% 26%

Sales 100 Lakhs 500 Lakhs
Investment 25 Lakhs 100 Lakhs
EBIT 7lAKHS 20 Lakhs
Analyse and comment upon performance of both divisions.

Solution:-

Profit

Profit margin = ----------- *100

Sales

Div x div y

7 Lakhs 26 Lakhs

Profit margin ---------------- *100 -------------- *100

100 Lakhs 500 Lakhs

= 7% = 5.2%

Sales

Turnover of assets = ----------------

Investment (assets)

100 Lakhs 500 Lakhs

Turnover of assets -------------------- -----------------

25 Lakhs 100 Lakhs

= 4 times 5 times

Profit margin 7% 5.2%

Turnover of assets 4 times 5 times

RoI 28% 26%

Comment

Div x perform better than div y. Profit margin of x is 7% & of y is 5.2%. Though sales of x is
Rs 100 lakhs which is lower than of y i.e. 500 lakh. But efficiency of div x is more than div y because
it is earning more margin. About ROI it is 28% of x & 26% of y which means asset management of x
is proper (current assets such as debtors, receivable) is mismanaged working capital is mismanaged.
Turnover of y is good for which x have to work.
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OR

Q11. shandilya ltd has adopted Economic value Added.(EVA) technique for appraisal of
performance of its three division A,B,& c. company charges 6% for current assets and 8% for
fixed asset while computing EVA relevant data are given below.

Particular Division A Division B Division c

s
B* A** B* A** B* A**
profit 360 320 220 240 200 200

Current 400 360 800 760 1200 1400

assets
Fixed 1600 1600 1600 1600 2000 2200
assets

• budgeted ** Actual (Rs in carors)

On the basis data given below:-

1) Tabulate budgeted and actual Return on assets for each of the divisions.
2) Tabulate budgeted and actual Economic Value Added for each of divisions.
3) Comment upon both method based on result.
Solution:-

Profit

Profit margin = ----------- *100

Sales

Div A

Budget Actual

360 320

Profit margin ---------- * 100 -------------- *100

2000 1960

= 18% = 16%

Div B

Budget Actual

220 240

Profit margin ---------- * 100 -------------- *100

2400 2560

= 9% = 9.36%
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Div C

Budget Actual

200 240

Profit margin ---------- * 100 -------------- *100

3200 3600

= 6.25% = 5.55%

EVA = Profit – cost of op

OR

EVA = OP PROFIT – (Capital employee * WACC)

DIV A

Budget

EVA profit = 360

C.Asset = 400 *6% = 24

F.Asset = 1600* 8%= 123

-----------

152

360-158 = 208

EVA = 208

Actual

profit = 320

C.Asset = 360 *6% = 21.6

F.Asset = 1600* 8%= 128

-----------

149.6

320 -149.6 = 208

EVA = 170.4

DIV B

Budget

EVA profit = 220

C.Asset = 800 *6% = 48

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F.Asset = 1600* 8%= 128

-----------

176

220 - 176 = 44

EVA = 44

Actual

Profit = 240

C.Asset = 760 *6% = 45.6

F.Asset = 1800* 8%= 144

-----------

189.6

240 -189.6 = 208

EVA = 50.4

DIV C

Budget

EVA profit = 200

C.Asset = 1200 *6% = 72

F.Asset = 2000* 8%= 160

-----------

232

220 - 232 = -32

EVA = -32

Actual

Profit = 200

C.Asset = 1400 *6% = 84

F.Asset = 2200* 8%= 176

-----------
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260

200 – 260 = -60

EVA = -60

COMMENT

Negative EVA destroys value of company and positive EVA creates wealth for company.

Q.12) GBM Ltd , currently engaged in manufacture of medium engineering

products, takes over a company engeged in Telcom Sector. Design an
Integrated Management Control System for GBM Ltd. Assuming company
has merged into GBM Ltd.

Ans:- Any organisation,however well aligned its structure is to the choosen

strategy, cannot effectively implement its strategy without a consistent
management control system. While organisations structures defines the reporting
relationships & the responsibilities & the authorities of different managers, it need
an appropriately designed control system to function effectively.

Now we will discuss planning & control requirements of different

corporate strategies for GBM Ltd.,

Different corporate strategies imply the following differences in the context

in which control system need to be designed:

• As firms become more diversified , corporate level mangegers may not

have significant knowledge of, or experience in, the activities of the company’s
various business units.If so, corporate –level managers for highly diversified firm
cannot expect to control the different businesses on the basis of intimate
knowledge of their activities, and performance tends to be carried out at arm’s
length.
• Single-industry & related diversified firms posses corporatewide core
competancies on which the strategies of most of the business units are based.
Communication channels & transfer of competanciesacross business units,
therefore, are critical in such firms. In contrast, there are low levels of
interdependence among the business units of unrelated diversified firms. This
implies that as firms become more diversified, it may be desireable to change the
balance in control systems from an emphasis on fostering cooperation to an
emphasis on encouraging encouraging entrepreneurial spirit.
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Specific tendancies ,in design of control systems corresponding to variations in

corporate strategies for GBM Ltd., are given below…..
Strategic Planning :
Given the low level of interdependence, conglomerates of GBM Ltd, tend to use
vertical strategic planning systems- that is, business units prepare strategic plans &
submit them to senior management to review & approve. Because of the high level
of interdependencies, strategic plannig systems for releted diversified & single
industry firms tend to be both vertical & horizontal. The horizontal dimension
might be incorporated into strategic planning process in a number of different ways.
First, a group executives might be given the responsibilities to develop strategic
plans for the group as a whole that explicitly identifies synergies across individual
individual business units within the group. Second, strategic plans of individual
business unit could have an interdependence section, in which the general
manager of the business unit identifies the focal linkages with other business units
& how those linkages will be exploited. Third, the corporate office could require
joint strategic plans for intredependent business units. Finally, strategic plans of
individual business units could be circulated to managers of similar business units to
critique & review.
Budgeting :
In a single- industry firm, the chief executive officer may know the firm’s
operations intimately & corporate & business unit managers tend to have more
frequent contact. Thus, chief executive of single industry firms may be able to
control the operations of suborddinates through informal & personaly oriented
mechanism, such as frequent personal interactions. If so, this lessons the need to
rely as heavily on the budgeting system as the tool for control.
On the other hand in conglomerates like GBM Ltd,it is nearly impossible for the
chief executive to rely on informal interpersonal interactions as a control tool:
much of the communication & control has tobe achieved through the formal
budgeting system. This implies the following budgeting system characteristics in
GBM Ltd:
• Business unit managers have somewhat greater influence in developing their
budgets since they ,not the corporate office, possess most of the information about
their respective product or market environments.
• Greater emphasis is often placed on meeting the budget since the chief
executive has no other informal controls available.
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Transfer Pricing :
Transfer of goods & services between units are more frequent in single industry &
related diversified firms than in the conglomerates like GBM Ltd. The usual transfer
pricing policy in a conglomerate is to give sourcing flexibility to business units & use
arm’s length market prices, However, in a single-industry or a related diversified
firm, synergies may be important, & business units may not be given the freedom to
make sourcing decision.
Incentive Compensation :
The incentive compensation policy tends to differ across corporate strategies in the
following ways:
Use of formulas: Conglomerates, in general are more likely to use formulas to determine
business unit managers bonuses: that is , they may base a larger portion of the bonus on
quantitative, financial measures, such as X percent bonus on actual economic value added
(EVA) in excess of budgeted EVA. These formula-based bonus plans are employed because
senior management typically is not familiar with what goes on in a variety of disperate
businesses.
Profitability measures : In case of unrelated diversified firms, the incentive bonus of the
business unit managers tends to be determined primarily by the profitability of that unit,
rather than the profitability of the firm.
Thus by this way we can design the inegrated management control system for GBM Ltd.,
assuming the other company has merged into GBM Ltd.
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