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CHAPTER 14. Management control systems. 14 .1a. Different types of controls • Action (or behavioural) controls • Personnel and cultural (or clan and social) controls • Results (or output controls) Action (or behavioural) controls • Consist of: • Behavioural constraints
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CHAPTER 14 Management control systems
14.1a Different types of controls • Action (or behavioural)controls • Personnel and cultural (or clan and social)controls • Results (or output controls) Action (or behavioural)controls • Consist of: • Behavioural constraints • Preaction reviews • Action accountability • Focus should be on prevention rather than detection controls.
14.1b Social,personnel and cultural controls • Social controls involve selection of people who have beensocialized into adopting particular norms of behaviour. • Personnel controls build on employees natural tendenciesto control themselves (emphasis is on selection, trainingand job design). • Cultural controls represent a set of values, social norms andbeliefs that are shared by members of an organization andthat influence their actions. • In recent years there has been a greater emphasis oncultural controls in the form of employee empowerment.
14.2 Results or output controls • The focus is on reporting informationabout the outcomesof work effort. • Results controls involve the following stages: 1. Establishing performance measures thatminimize undesirable behaviour. 2. Establishing performance targets. 3. Measuring performance. 4. Providing rewards or punishments. Cybernetic control systems (see above diagram) • Results controls resemble a cybernetic(mechanical) control system. • Cybernetic systems involve feedback controls (actionsafter the events) but ideally control should be based on control actions before the events.
14.3 Harmful side-effects of controls 1. Occurs when controls motivate employees to engage inbehaviour that is not organizationally desirable (i.e. systemleads to a lack of goal congruence). 2. Results controls: • Encourages individuals to focus only on what ismeasured, regardless of whether it is organizationallydesirable (see sheet 4). • Focuses mainly on quantifiable and easily measurableitems. • Subject to data manipulation. • Can lead to negative attitudes towards the controlsystem. 3. Action controls: • May discourage creativity. 4.Cultural controls: • Lack of goal congruence where group goals do notcoincide with firm goals.
14.4 Figure 2 The measurement reward process with imperfect measures (Source: Otley (1987)
14.5 Advantages and disadvantages of different types of controls Personnel/cultural controls • Few harmful side-effects. • Inexpensive to operate. • Appropriate only in certain circumstances. Action controls • Direct link between control mechanism and the action. • Measurement problems do not apply. • Not feasible where cause-and-effect relationships are not well understood or easily observable. • Best suited to stable situations. Results controls • Can be applied where knowledge of what actions are desirable is lacking. • Focus is on outcomes (individual autonomy is not restricted). • Subject to limitations described on sheet 3.
14.6 Management accounting control systems (MACS) • Tend to be the predominant controls in most organizations because: 1 Monetary measure provides a means of aggregating results from dissimilar activities. 2. Profitability and liquidity are essential for company survival. 3. Financial measures enable a common decision rule to be applied. 4. Measuring results in financial terms enables managers to be given more autonomy. Responsibility accounting • Responsibility accounting is a fundamental part of the MACS. • Four types of responsibility centres: 1. Cost or expense centres (two types: standard cost centres and discretionary cost centres). 2. Revenue centres 3. Profit centres 4. Investment centres.
14.7a Management control systems The nature MACS • Two core elements: 1. Formal planning processes (e.g. budgeting and long-term planning) for establishing performance expectations. 2. Responsibility accounting • Responsibility accounting assigns differences from the performance target to the individual who is accountable for the responsibility centre.
14.7b • MACS process involves: 1. Setting performance targets. 2. Measuring performance. 3. Comparing performance against target. 4. Analysing variances and taking remedial actions. • Responsibility accounting is implemented by issuing performance reports similar to that on sheet 8. • Issues that must be addressed by responsibility accounting include: 1. Distinguishing between controllable and non-controllable items (i.e. the controllability principle). 2. Determining how challenging the targets should be. 3. Determining how much influence managers should have in the setting of targets.
14.9a The controllability principle • Principle advocates that it is appropriate to charge to a responsibility centre only those costs that can be influenced by the manager of the responsibility centre. • Implemented by either eliminating uncontrollables or reporting controllable and uncontrollable items separately. •Types of uncontrollable factors: 1. Economic and competitive factors (because managers can respond to some of these changes most MACS do not shield managers completely from them). 2. Acts of nature (managers normally protected from them). 3. Interdependencies where outcomes are affected by other units within the organization: • Pooled interdependencies • Sequential interdependencies • Reciprocal interdependencies.
14.9b • Adjustments for the distorting effects of uncontrollables can be made either before or after the measurement period. • Adjustments before the measurement period: 1. Specify which budget line items are uncontrollable (eliminate or report separately in performance report). 2. Insurance. • Adjustments after the measurement period: 1. Variance analysis 2. Flexible performance standards (e.g. flexible budgeting and ex postbudget adjustments) 3. Relative performance evaluations 4. Subjective performance evaluations.
14.10 An example of flexible budgeting Budgeted activity = 20,000 units Actual activity = 24,000 units Budgeted unit variable cost =£5 Actual variable costs = £105,000 Original fixed budget Flexible budget Actual Reported cost variance 20,000 × £5 =£100,000 24,000 × £5 =£120,000 £105,000 £15,000F • Ensures that managers are accountable for the conditions applyingduring the period and not those envisaged when the budget was set.
14.11a Guidelines for applying the controllability principle • Price and quantity of service controllable = Controllable expense • Quantity controllable but not price = Manager accountable for difference between (actual quantity × budgeted price) and (budgeted quantity × budgeted price) • Quantity and price not controllable = Non-controllable expense • General principle = Hold managers accountable for performance areas you want them to pay attention to.
14.11b Determining how challenging the targets should be • A clearly defined quantitative goal is likely to motivate higher levels of performance. • Level of budget difficulty should be related to task uncertainty. • Targets must be accepted to motivate managers to achieve higher levels of performance. • Literature identifies a theoretical relationship between budget difficulty, aspiration levels and performance (see slide 12). • Hypothesized relationships suggest that budget level that motivates best performance is unlikely to be achieved most of the time (do not adopt punitive approach for adverse variances).
14.12 The effect of budget difficulty on performance
14.13a Arguments in favour of setting highly achievablebudgets • Conflict between planning and motivational purposes. • Psychological benefits (e.g. achievement and self-esteem). • Shields managers from adverse impact of environmentalchanges. • Alleviates harmful side-effects of controls. Determining how much influence managersshould have in setting standards • Advantages of participation in the setting of performance standards: 1. Targets more likely to be accepted. 2. Reduces the information asymmetry gap. 3. Reduces negative attitudes and dysfunctional behaviour.
14.13b • Empirical studies provide conflicting evidence on the effectiveness of participation. • Factors influencing the effectiveness of participation: 1. Personality variables: 2. Work situation 3. Job difficulty. • Limitations on the positive effects of participation: 1. Budgetee has the opportunity to negotiate lower targets. 2. Depends on personality traits and work situation. 3. A top down approach may be preferable where a large number of similar units exist.
