Chapter3

Management Control System

Structure and Process

3.1 MANAGEMENT cONTROL sYSTEM

Management Control System consists of a 'structure' and a 'process'.

System

Structure Process
(i.e. What is it?) (i.e. What it does?)

The structure can be described in terms of units and sub-units in the organization, through
which information flows among the units. Each unit and sub-units are headed by a manager
who remains responsible for the activities as well as results of such activities of the
respective unit or sub-unit. Each unit or sub-unit, thus, becomes a responsibility centre.
The process is what the managers do with the information. It involves communication
of information and interactions arising out of them. It is, therefore, essential to have well-
nit organization structure so that an effective and efficient control system can be installed.

3.2 STRUCTURE

Organization structure provides the management with control environment. The structure is
made up of a number of responsibility centres, each being headed by a respònsible manager
or officer. In an organization chart, each responsibility centre is shown in a box as indicated
in Diagram 3.1.
19
20 MANAGEMENT CONTROL SYSTEMS

Managing Director

Technical Marketing Finance Secretary

Director Director Director

Diagram 3.1 The organization chart showing responsibility centre.

In the above chart. only four responsibility centres are shown below the Head of
the
organization Each of them is controlling some defined activities or functions such as
Technical DirectorManufacturing activities,
Marketing DirectorSelling and distribution activities,
Finance DirectorFinance and accounting and
SecretaryCorporate, legal and administrative functions.
Again. each one of them are assisted by a number of executives, managers, officers,
and supervisors representing top to bottom
as the responsibility of each
hierarchy, indicating the lines of authority as well
of the unit-heads in the organization. For
example, the Technmcal
Director is assisted by four Divisional General
authority down the
Managers, while each of them delegates their
l1ne. The chart in Diagram
3.2 below indicates the hierarchy of wo
ievels from the Technical
Director
Technical Director

General Manager General Manager

Nasik Plant
General Manager General Manager
Pune Plant Service H.R.D.

Factory Manager
Office Manager

Purchase Manager
Personai Manager
Quality Control Manager
Production Planning Manager
Diagram 3.2 The chart showing the hierarchy of the levels c' Tochn c

nd Divisional
 MANAGEMENT CONTROL SYSTEM-STRUCTURE AND
PROCESS 21
Each of the six managers
reporting to the General Manager, Nasik Plant are being
assisted by managers, officers, foreman and
supervisors, as will be evident from the
following, chart, where only those who are reporting to the
subordinates are included. Factory Manager and his
In the same way, the entire
organization from the top management to the shop-floor
level is broken down into several
responsibility centres with an official a (with
given
designation) managing each centre. He is responsible for the resources used and the results
obtained. Authority flows from top to bottom, while
results obtained
accounting
for resources used and
moves from bottom to the top. The
diagram 3.3 shows the factory management.

Factory Manager-Nasik Plant

Manager Manager Manager Works Stores Ware House Security

making mixing packing engineer in and dispatch officer
dept. dept. dept. charge In charge

Shift in Shift in Shift in Maintenance Machine shop

charge charge charge Engineer in chargge

Supervisor Supervisor Supervisor Maintenance

Supervison
Diagram 3.3 The organization chart showing factory management.

3.2.1 Essential Elements of Responsibility Centres

If we analyse the responsibility centres as indicated above, it will be evident that each one
of them serve some specific purpose which are indicated in the objective of the organization.
Objectives are derived from strategic planning, which is prepared by the top management,
keeping the organization's goals in view. Thus, the goals of the organization can be achieved,
if the responsibility centres accomplish their objectives because the sum of all the responsibility
centres is nothing but the organization itself.
centres are not the same. Some
However, nature of all the responsibility the centres of
earn revenue along with the expenses while most of them incurs only expenditure and some
of them earn only revenue. However, each responsibility centre utilizes resources such as

material, manpower, machinery and equipments and other fixed assets, working capital etc.
which are its 'Inputs'. In the responsibility centre, the 'Inputs' are converted into 'Outputs',
which are classified either as "Goods' if they are tangible or 'Services' if they are intangible.
Goods', but in centres
in a
manufacturing centre like 'Mixing', the 'output' is Processed
are Service. In
ike Accounting, Payroll, Stores, Engineering, Time Office, the 'outputs'
centres like sales office, there is some expense in maintaining
the oftice, i.e. Input but
is its output.
centre and thus, revenue or income
nostly the same is a revenue earning
 MANAGEMENT CONTROL SYSTEMS
22
3.2.2 Measurement of Inputs and Outputs

centre measured in terms of physical units,

Inputs and outputs in a responsibility are such

labour-hour, machine-hour, that is in heterogeneous units.

as per kg, litre,
Outputs are processed materials, finished goods or services. Hence, to obtain a common
denominator, inputs are all expressed in monetary terms. "Cost is a monetary measure of
the amount of resources used by a responsibility centre". Diagram 3.4 outlines the essential

picture of a responsibility centre

Utilization

Input Responsibility Centre Output

Resources used in Capital-Assets and Goods or Service
monetary terms Working Capital
(in rupees)
Diagram 3.4 The functioning of a responsibility centre.

It is obvious that inputs can always be measured in monetary terms. The output of
various responsibility centres cannot be measured in monetary terms. Where output is
processed goods or finished goods, it is possible to evaluate them. But when it is a service,
it is very difficult to relate cost with revenue. For example, expenditure on advertising
cannot be related to the additional revenue earned out of that advertisement. Or the value
of work done by a Public Relation Department, or Legal Department cannot be measured
in monetary terms.

3.3 TYPES OF RESPONSIBILITY CENTRES

Viewed in terms of input-output relationship and the functions performed by them, the
responsibility centres can be divided into following types:
(a) Expense Centre, and
(b) Revenue Centre.

3.3.1 Expense Centre

Expense centres are responsibility centre where expenses are incurred and measured m
terms of rupees, but no attempt is made to measure the
output in terms of rupee valuc
Measurement of the output can be done in terms of physical units. Manufacturing cost
centres are examples of expense centres. Expense centres can be
divided into two categories-
Engineered expense centres and Discretionary expense centres.
 MANAGEMENT CONTROL
SYSTEM-STRUCTURE AND PROCESS 23

Engineered Expense Centre

Engineered expense centres are those where inputs or costs can be measured in advance
with reasonable accuracy. They are
usually formed in manufacturing
standard cost system is used. For example, in Britannia Industries Ltd., operations and
where
Mixing, Making
Packing are engineered expense centres. In mixing department, ingredients are mixed to
prepare 'dough", from which biscuits are made in making department and packed in packing
department. In all these three cost centres, the input cost is expressed in terms of rupee
value, while the 'output' is expressed in physical units such as 'dough' and 'biscuits' in kg
Their expense centres are termed as "engineered expense centres" because valid engineering
estimates can be made for each and every cost items.
Engineered expense centres do not necessarily relate to manufacturing activities alone.
It may be applicable to marketing functions like warehousing, distribution or even within
administration and support departments like accounts receivable, payroll, etc.

Discretionary Expense Centre

Discretionary expense centres include administration and support units such as Secretarial,
Financial, Accounting, Legal, Public Relations, HRD, R & D and Marketing. In these units,
but output cannot be measured in monetary
expenses are expressed in monetary terms
terms. Discretionary expenses are those expenses which are incurrèd as per organizations'

policies, derived from, strategic planning and its goals and objectives. to shift
If the company intends to spend more on advertising and sales promotion or
reason or to increase or
the corporate office from one city to the other for any justifiable
are al discretionary.
reduce the size of its corporate office staff, then the resulting expenses
of the management. The
The level of such discretionary costs vary as per perceptions
cannot be measured in monetary terms.
not be as per expectations, but
output may or may
are compared against their budgeted
Even if the actual amount of discretionary expenses
'out put' of the expenses
amount, the 'out put' i.e. the
actual expense is not the outcome or
The performance cannot be
but at best may be a revised budget expenditure.
incurred,
evaluated.

3.3.2 Revenue Centre

but no attempt is
the is measured in terms of revenue earned,
In a revenue centre, output revenue is earned by
cost. For example, in a sales office, the
made to relate to its input maintenance cost such as
of sales office relate to its
the
selling the products, but expenses
etc. but not to the expenses
incurred in manufacturing
office rent, taxes, staff salaries, security becomes a Profit Centre,
which
then it
latter is considered,
and selling the products. If the
1S a separate Responsibility Centre,
explained later. for the cost or profit
no responsibility
Revenue Centres are in
effect selling units, having Centre, so far
as it is
centre is also an Expense
each revenue
O the products sold. But
cost as indicated earlier.
related to the maintenance
 IAI

Again a Revenue Centre manager has nothing to do with the fixation of selling price.
Normally, a revenue centre manager does not enjoy power to set even selling prices.

3.4 BUSINESS UNIT AS A RESPONSIBILITY CENTRE

When a business unit is considered as a Responsibility Centre, then the criteria is normally
to measure the profit-earning capacity of each unit. This occurs in multiunit giant organizations
with profit orientation as an important objective. Since the profit is the difference between
revenue (a measure of output) and expense (a measure of input), it is also a measureof
efficiency. Thus, the profit measures both effectiveness and efficiency. There are, however,
two types of responsibility centres where profit is considered as outputs, viz.

(i) Profit Centre, and

(11) Investment Centre.

In the Profit Centre, the expenses are matched against the revenues of the unit. That
15, the revenue eamed from the sale of products is related to the cost of the goods sold of
the same products by the same unit concerned in a
given period, and profit is ascertained
for the period.
In an Investment Centre, the profits so calculated are related to the
capital employed
during the period and the return on investment is calculated to ascertain the efficiency of
the business unit. Profit Centre and Investment Centre are used to measure the
concepts
performance of Divisional Managers, who head these responsibility centres.
From the above discussion, it is
apparent that no good quantitative measurement of the
output exists in most of the non-profit organizations.
All of the four types of
responsibility centres discussed above are summarized in the
diagram 3.5.

3.5 PROCESs

Management control process involves communication of information to

various levels of hierarchy and their the managers a
interactions arising out of them. These
aim towards attaining the communications
organization's goals. But individual
managers have their personal
goals also. For example, a young manager with
good education,
like Britannia Industries or experience, personality
social background joins a ana
him fit for the
company Reliance. The company fnds
position as per job specifications, appoints him and
the company
expects of him. The young manager sets his makes him aware of wna
for his career
progress besides adequate goals of gaining rich experience
be directed towards compensation packages. Naturally, his actions WIu
achieving his own
Thus, his self-interest and the best objectives and goals while serving the
interest of the company
the best results can be
achieved by perfectly organization are
apparently conflict. Du
in
goal congruence' matching the two interests and this is calieu
 EM-STRUCTURE AND PROCESS 25
Expense Centre

Engineered Expense Centre Discretionary Expense Centre

(Proper amount of the cost can be
[No engineered estimate is feasible-
established with reasonable degree of
depends on judgement of management
accuracy, e.g. material, labour, etc. policy, e.g. advertising, legal, etc.]
as in standard cost]

Revenue Centre

Basically earns revenue It has expenses also for running

such as sales office the office, payments to
salesmen, etc.

Profit Centre
A business unit having

Revenue/income
Expenses From the sales of product)
(For converting inputs into
output effecting sales]
Investment Centre

A Business Unit having

Revenue/income
Expenses sales of product]
IFrom the
[For converting inputs into
output effecting sales]

Resulting in Profit

divisional performance
employed for measuring
Compared with the capital
centres.
responsibility
The four types of
Diagram 3.5
individual and the
between the goals of the
the main
it is quite apparent thatperfect congruence can n e v e r happen. Yet,
organization's goals interest
Organization individual's goals and the between the
is to a s s u r e goal
congruence
control system
of a management
Purpose as far as practicable.
organization
oI the individual and the
26 MANAGEMENT CONTROL SYSTEMs

3.5.1 Formal and Informal Communication

As mentioned earlier, all the communication of information may be either formal or informat
The formal communication system involves strategic plan, budgets, standards and repore
orts
whereas the informal communication is made through letters and memos, verbally or ven
by facial expression.
Formal communications areall documented and addressed to the responsible
managers
for their information and actions, if necessary. However, the actions depend on the
perception
of the individual managers. This subject of behaviour in organ1zation will be
discussed in
detail in chapter 6.
Informal communication, on the other hand, relates to some external factors-work
ethics, management style and culture. Added to these factors is the existence of an
informal
organization within the structured formal organization.
Informality refers to the relaxation of sharp differentiation and explicit description of
behaviour asindicated in the hierarchy and thereby, moving
away from superior/subordinate
relationship. However, such relations depend on the personal capabilities of the
such as education, manager
experience, expertise, trust and cooperation. For example, Accounts
Manager of Nasik Plant (see the organization chart in the diagram 3.2)
reports to the General
Manager of the Plant. While visiting the Corporate Office for
he meets other attending a Training Course,
colleagues, parallel officers and even the Finance Director. The latter
communicates some important matter to him
verbally and wants action thereon. Accounts
Manager carried out the instructions so given. As per the
inform his General Manager, but it organization chart, he should
depends on his own
perception of the situation, and he
may or may not report to the General
Manager.
3.5.2 Work Ethics, Management Style and Culture
External factors like work ethics
vary from place to place. Therefore, organization wOTk
culture depends on the
general behaviour of the people in the society where the
situates. Work culture
generally differs because of the organization
life style and the attitude towards
work. For example, the
people of Mumbai lead very fast life. Time has
compared Kolkata, whore people take more value at
as to
things Mumba
people have reputation for their excellent work culture.easily and leisurely. Japanese and Korean
However, the most important internal
factor is the
The culture refers to the set
of common organization's culture and climac
that are explicitly or beliefs, attitudes, norms, relationships and
implicitly
writer joined Union Carbide accepted and evidenced throughout the assumptions
as an Assistant
just three days before Christmas organization. Ine
very second day, when he Eve. On
than the General Sales
attended Christmas lunch, his
table was shared by none ounet u
of his recent tour Manager Dr. W.R. Correa. He kept us
abroad and recited Urdu amused with various
was unthinkable in 'shairies', storic
Jessop Co., where sharp differences
&
even
sharing jokes. Such a
situatioO
of hierarchy. were maintained at
every ievc
 MANAGEMENT CONTROL SYSTEM-STRUCTURE AND PROCESS 27

Climate is used to designate the quality of the internal environment that conditions the
quality of cooperation, the development of individuals, the extent of members dedication or
commitment to organizational purpose and the efficiency with which that purpose is translated
into results.Climate is the atmosphere in which individuals work help. judge, reward,
find
constrain and out about each other.
towards his/her work and environment.
It influences moral--the attitude of the individual

Culture differs between the organizations, but cultural norms are extremely important.
They are not written ike formal communication. But the existence of a good culture can
be felt from the behaviour of the members of the orgarnization. Once the writer landed up
with his family at Hyderabad in the early morning to discover that nobody had come to
receive them at the station. His visit was arranged through non other than the Director of
the company himself. His unit being new, telephone directory did not include any number
of his unit, but the parent organization's telephone number was located. When an executive
of the parent company was contacted, he immediately sent an officer of the company with
a car to pick us up to their Guest House, entertain with coffee and then put up in a Hotel
What subsequently happened is a different matter, but the attitude and treatment of that
member of organization speak volumes about their excellent culture
In any organization, the culture remains unchanged as long as the Chief Executive
remains in position. When a new executive replaces him, there is likelihood of some change
and maintains
in the culture, unless the new Chief follows the footsteps of his predecessor
internal executives, the
it. Generally, if higher positions are filled in through promotion of
culture remains unchanged and the traditions are maintained.
is
The other important internal factor which influences management control system
the superior to his subordinates and the latter's
management style-that is the attitude of
their superiors. Again, the attitude
reaction through their perception of the attitude of
the Chief Executive, who controls the entire
ultimately stems from the temperament of
said "an institute is the lengthened shadow of a
organization. That is why, R.W. Emerson
man.

Communication
3.5.3 Importance of Informal
whenencountering non-routine decision-
An organization indulges in informal control process
to increase understanding of some problem areas.
making or when seeking new information
the writer found that the Chief Executive
During a very critical period in an organization,
club to extract information in a relaxed
used to call managers informally at his residence or
manner rather than in a tense situation prevailing in the factory.

3.5.4 Formal Control Process

the hierarchy outlined in the organization

rormal communicationsystem is structured as per
chart. The system has the following four components:

(a) Strategic plan and programme

(b) Budgeting
 MAT
28
centres
measurement in responsibility
(c) Operations and
(d) Reporting

(a) Strategic Plan and Programme

The foundation of management control process lies in the organization's goals and its
strategies for attaining these goals. A strategic plan is prepared in order to implement the
strategies, after carefully considering opportunities and threats in the external environment
as well as the strengths and weaknesses in the internal environment. Thus, a strategic plan
and programme is prepared as a guideline to budgeting

(b) Budgeting
The strategic plan is converted to an annual budget incorporating planned expenditure and
revenues for individual
responsibility centres. Expenses and revenues are marked for each
responsibility centre periodwise, say monthly, quarterly, half yearly, and annually. This
aspect is elaborated in Chapter 8.

(c) Operations and Measurement

Responsibility centres operate within the framework of the budget, established
standing instructions, practices and operating procedures embodied in standards,
Thus, besides budget, the responsibility centres are 'rules', and 'manuals'
also guided by a large number of rules.
They record the resources actually used and revenue
earned. They also classify the data by
programmes as well as by responsibility centres for
performance measurement.
(d) Reporting
Actual
performance is analysed, measured and reported
and highlighting areas of
is sent to the
weaknesses. If the performance is against plan, indicating variances
responsibility centre concerned for
feedback communication is sent to praise
satisfactory,
a feedback
information
or reward. If the is
If such action the
responsibility
centre concerned for
same unsatisfactory
requires to be included in corrective action.
to the
changed position. If required, then the budget, then the latter is revised to
control may be established. the plan itself can
be revised and a new
give effect
The aforesaid formal basis or
control process has
standing. been presented in
Diagram 3.6 for under
 MANAGEMENT CONTROL
SYSTEM-STRUCTURE AND PROCESS 29
Rules and
Other information
Goals and L Standing Instructions
Strategies
Reward (Feedback)
Yes

Was
Strategic Responsibility Report
performance
Planning Budgeting Centre Actual
Operations v/s Budget satisfactory?

Revision Revision Measurement

Corrective action No

Source: 'Management Control System by Robert N. Antony and Vijay Govindarajan, IRVWIN,
1995, p. 59.

Diagram 3.6 Formal control process.

SUMMARY
Management control system consists of a strueture and a process. The structure is described
in terms of units and sub-units in an organization through which information flows while
the process is what the managers do with the information.
The structure is made up of number of responsibility centres, each being headed by a
responsible manager or officer. The goals of the organization can be achieved if the responsibility
centres accomplish their objectives. Depending on the input-output relations and functions
performed by the responsibility centres, it can be divided into different types of responsibility
centres.
Management control process involves communication of information to the managers at
various. levels of hierarchy and their interactions arising out of them. All communication
system can be either formal or informal. Formal control system involves strategic plan,
letters
budgets, standards and reports whereas the informal communication is made through
control process is structured ass
and memos, verbally or even by facial expression. Formal
informal control process is useful tor
per hierarchy outlined in organization chart, whereas
non-routine decision-making.
culture and
Various other factors like management style, work ethics, organization
climate also influences the management control system.