Chap 022

Chapter 22 - Control: The Management Control Environment

CHAPTER 22 CONTROL: THE MANAGEMENT CONTROL ENVIRONMENT

Changes from the Twelfth Edition

All changes were minor. Approach

This chapter and the following one provide a distinct distinct change of pace from the preceding chapters because they present few numbers. There are no numerical techniues or procedures to be learned. !nstead" the chapters establish a framewor# and describe concepts that are essential to an understanding of the chapters that follow. !t is probably desirable to alert students to this change so that they will #now what to e$pect. %ince the te$t e$pands on material that was introduced in Chapter &'" it may be desirable to as# students to reread Chapter &' at this point. point. (oints that were obscure obscure when Chapter Chapter &' was first assigned assigned shou should ld now be clearer. Although the topic has come up several times previously" it probably is desirable to emphasi)e again the fact that there are three types of management accounting information" each of which is appropriate to certain certain types of problems problems but not to others" others" and that mista#es mista#es are made when the wrong type of data is used. !llustration 22-* is designed to ma#e this point" particularly with reference to the differences  between responsibility responsibility accounting and full cost accounting. accounting. !t may be well to discuss this e$hibit e$hibit in detail. There is sometimes a tendency to play down the importance of full cost accounting because it is not useful in the control of responsibility centers" but this reflects an erroneous +either-or, attitude. !t is not a case of choosing either one approach or the other" each approach is needed in a company" and each has its own uses. Cases

shows ws stude students nts that that  Behavioral Implications of Airline Depreciation Accounting Policy Choices sho companies measurement choices vary widely and motivates a discussion as to whether these choices affect managers decisions" and if so how. Shuman Automobiles Inc . introduces the concepts of responsibility centers and transfer prices in a setting that students can easily understand.  Zumwald AG is a transfer pricing case" with the emphasis on the behavioral effects of the transfer pricing alternatives.  nager Industries! Inc ." is a case on the introduction of an /! measurement scheme for business divisions. !t can be used to discuss discuss almost any aspect of investment investment centers.  Piedmont "niversity  deals with several management control issues in a nonprofit organi)ation" especially the use of profit centers.

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Chapter 22 - Control: The Management Control Environment

Problems

Problem 22-1: Arbia Company

elevant Costs a. 0or financial statements1full costs of epartment 3: 4'5"665" or 4'5.66 per unit for units sold or left in inventory.  b. ecisions to ma#e or buy (art 7o. &5'1differential costs: (urchase cost............................................................................................................................................................................ 4*&.55 per unit Materials and labor cost if ma#e..............................................................................................................................................  26.82 per unit %avings if ma#e........................................................................................................................................................................ 4&.&8 9assuming no fi$ed costs are differential c. Assessing performance of manager of epartment 3: Costs for which the manager is responsible are the variable and fi$ed costs of epartment 3" 4*;"355. Costs allocated to epartment 3" 4&ect whose pro>ected /! is higher than the cost of capital but lower than the investment center=s overall targeted /!. This ! concept could also be raised earlier in the conte$t of how to define +profit", since ! essentially corresponds to the economist=s view of what constitutes profit. %ince it is the  presence of AA(-valued fi$ed assets in the formula that causes either /! or ! to increase solely with the passage of time" ! favor for managerial evaluation what ! call +partial !", which is profit e$cluding interest less holding-cost rates applied to receivables and inventories. &&.  -ew pro5ect proposals in an +.I system . This is the +lead-off, issue in Enager. !f your students have  been e$posed to capital budgeting techniues" they uic#ly will point out that a discounting techniue should be used to evaluate Ms. Mc7eil=s new product proposal. espite the normative truth of that statement" it is nevertheless uite conceivable that a manager might feel that a pro>ect that will improve E(% 9and accounting /!I should be acceptable. Another aspect of capital budgeting in an investment center setting 9or companywide setting" for that matter that often pu))les students is this: Fhy is the +hurdle rate, used in evaluating a new pro>ect higher than the division=s /! targetG /ne reason is that a significant portion of a company=s capital  budget funds must be used for pro>ects that will not 9in any obvious way increase profits   e.g."  pollution control euipment. Thus" pro>ects that will improve profits have +to carry more than their fair share of profitability contribution, in order to compensate the nondiscretionary 9necessity investments that tend to lower /!. /ther reasons include allowance for ris#Kuncertainty and the desire to improve /! fairly rapidly. &2. .verall 0moral$1   /! is conceptually simple" but comple$ to implement 9if one recogni)es the  pitfalls" as ?ubbard and andall did not. %tudents should not be left with the feeling that /! necessarily should be avoided" but rather that its implementation should be approached with +great care. &ssues #pecific to Enager

&. 6hat is the incremental +.I on the proposed pro5ect  G The case numbers are +rigged, so that the incremental E@!T percentage at any of the three prices is &* percent 94&*5"555 K 4&"555"555. A variation on this calculation is to say that" at least in an accounting sense" the average plant and euipment investment over the life of the pro>ect is only 42'5"555" giving an /! of &3.* percent 94&*5"555 K 43'5"555. Fe do not #now the potential life of this pro>ect its paybac# period is less than < years 9we can=t tell how much less: cash flow per year will be greater than the 4&*5"555 income because the 4&35"555 fi$ed costs include depreciation.

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Chapter 22 - Control: The Management Control Environment

2. ! as# the students this uestion: %uppose Enager was committed to go ahead with this pro>ect   would you suggest a price per unit of 4;" 43" or 48G %tudents cannot choose on the basis of incremental  profit" which we have seen is the same 94*55"555 contribution less 4&35"555 fi$ed costs R 4&*5"555 at all three prices. %ome will say 4; because it gives the largest mar#et share 9a point of view which may have validity" if one believes the @oston Consulting roup=s e$perience curve hypothesis. /thers will say 48" since that has the lowest brea#-even volume however" in my opinion" one cannot choose based on brea#-even volume" since at each of the three prices the brea#-even volume is '; 2K*  percent of the estimated sales volume at that price" and profits are the same at the three estimated sales volumes. Eventually" a student will reali)e that the current asset investment should not be assumed to be the same at all three prices 9as ! have let them implicitly assume to this point in the discussion: certainly a volume of &55"555 units 94;55"555 revenues will reuire more cash on hand" receivables" and inventories than would a volume of ;5"555 units 94ected level of current assets seems e$cessive. !f volume R &55"555 units" average unit cost R 4or organi)ational change" and it=s no wonder that +there seems to be a lot more tension among our managers the last two years., (ersonally" ! feel Ms. Sraus has a good idea in the off-site retreat. ?owever" it appears that ?ubbard and andall first should engage a consultant to discuss /! and investment center implementation comple$ities with them and help them understand the causes of the current +tension, perhaps this same person could then be engaged to play a ma>or role in the retreat and subseuent training sessions.

Case 22-*: Pie$mont +niversity (ote: #his case is unchanged from the #welfth dition . Approach

The idea of profit centers in universities dates bac# many decades" probably to (resident A. Bawrence Bowell=s dictum to the ?arvard deans: +Every tub on its own bottom., Although he did not use the term +profit center, 9and for selling purposes this term may create resentment on the part of faculty and deans" he clearly meant that each school=s revenues should be adeuate to pay for its operating costs. This idea continues to influence the management control system at ?arvard and is increasingly being considered by other universities. The case provides an opportunity to discuss the principal problems that arise in implementing a profit center structure" and the situations described range from those for which a strong case can be made to those for which the results would be clearly dysfunctional. !n discussing the several issues" two uestions  provide a central focus: 9& ?ow would the recommended practice affect the motivation and attitude of the two parties: the party that receives the charge and the party that receives the revenueG 92 Are the  benefits greater than the boo##eeping costG The case also permits a discussion of certain behavioral problems in management control: the danger that management runs in accepting an offer from a well-meaning" but perhaps not s#illed" volunteer 9and the difficulty of finding a graceful way of declining such help the proper approach to gaining acceptance of ideas the indication that a strong-minded president can +turn an organi)ation around", especially during a honeymoon period when the seriousness of the situation is recogni)ed. %uestion & General administrative costs . Charging these costs to individual schools would result in an operating statement that would report the e$tent to which the school=s revenues were adeuate to pay for its own costs plus a fair share of the central costs. The sum of the net incomes reported for each school would be the net income of the university. This charge might get the deans to recogni)e that the university necessarily incurs costs on their behalf" which must be met from some source. The practice might also cause the deans to uestion whether the central costs were too high" which would be one way of e$ercising control. (erhaps the central administration would be reluctant to tolerate such uestions.

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Chapter 22 - Control: The Management Control Environment

An alternative is to not charge these costs" or to charge only those that can be specifically identified with a given school 9such as accounting" purchasing" personnel. This would reduce the technical and  behavioral problems associated with the allocation of indirect costs. Any basis of allocating indirect costs can be critici)ed because there is no +scientific, way of doing this"  by definition. The criticism that the administration probably spends more than a proportional amount of time on the undergraduate school is probably >ustified" but there does not seem to be a feasible way of correcting this ineuity. !f these costs are charged" the charge should probably be a budgeted amount" rather than the actual costs incurred. Allocating actual costs permits the central administration to pass costs that are greater than  budgeted to the individual schools. Gifts and endowment . The deans uite naturally would not favor giving the president authority to distribute 43 million as he chooses. Actually" the process would reuire that the schools put in their reuests and the president allocate the funds in a way that causes the minimum amount of dissatisfaction. The president could not allocate the funds in a way that is perceived to be grossly unfair he would lose the support of the deans if he did this. Moreover" the +each tub on its own bottom, idea can=t wor#  perfectly. The theological school" for e$ample" does not cover its costs by some 4*.& million 9E$hibit &" whereas the business school has a surplus of 4ob of developing a new proposal to someone in the administration 9or possibly to a committee so that the ne$t version would be given to the deans as coming from within the institution and ta#ing account of their concerns. !f handled properly" ! hope that the deans= reaction would be: we had an unrealistic proposal from a consultant which the president wisely re>ected we now have a practical one that is worth ta#ing seriously.

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