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Accounting Notes > Management Accounting, Financial Mgmt & Organisations (AC310) Notes

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M1: Key to good control in creative setting is 'to let talented employees be unfettered in their ability to demonstrate themselves' What type of control is being referred to? How dependable is this type of controls, what are its advantages & disadvantages? What other control types would also be used and why? (2015 A1) Introduction

* Control Problem: Lack of direction, motivational problems, personal limitations

* Management Control: Process by which management ensures employees carry out organisational objectives - overcome control problem

* Statement refers to personnel controls - one of the 3 types of controls an organisation can use:
- Personnel & Cultural Control: Types of people employed and their shared value and norms
- Results Control: The results products
- Action Controls: The actions taken

* While personnel controls can be effective in facilitating firm to reach its desired goals, it does have it weaknesses - generally supplemented by actions and results controls Paragraph 1: Evaluation of Personnel & Cultural Controls

* Personnel Controls: (1) Selecting Employees (2) Training (3) Job Design/Provision of Resources
- Build on employees' tendencies to control/motivate themselves - encourage self-monitoring

* Primary Methods of Cultural Controls: (1) Codes of Conduct (2) Group Rewards (3) Tone at Top
- Encourages mutual monitoring

* Several advantages over results/action:
- Generally adaptable - usable to some extent in every setting
- Relative unobtrusive - unlikely to cause dysfunctional behaviour
- Low cost - economically efficient to implement

* However effectiveness varies significantly depending on context - generally supplemented with action and result controls Paragraph 2: Evaluation of Action Controls

* Types (1) Behaviour constraints (2) Pre-action Reviews (3) Action Accountability (4) Redundancy

* Can be classified by whether serve to prevent or direct behaviour - more valuable if prevent

* Several advantages:
- Most direct form of control
- Documentation of accumulation of knowledge as to what works best - organisation memory
- Efficient way of co-ordination - increase predictability of actions

* But only works for highly routing jobs; may discourage creativity/innovation/adaptation, costly, may cause negative attitude, operational delays

* Means-End Inversion: Pay attention to what they are doing but lose sight of end goal Paragraph 3: Evaluation of Results Controls

* Reward individuals for good results; punishes for bad - use of performance targets

* Several advantages:
- Behaviour can be influence while allowing significant autonomy
- Greater employee commitment motivation
- Inexpensive - performance measurement information often already collected for other uses

* However often less than perfect indicators of whether good actions have been taken, shifts risks to employees (risk premium), over-quantification, budget slack/falsified data

* Only can be used if conditions present - can determine desired results, employees have influence over what they are held accountable for, organisation measures results efficiently (precise, objective, timely, understandable) Conclusion

* Given the context, personnel controls are very applicable as does not put restriction on employees - have significant autonomy which is important in creative setting

* Given fast pace/changing nature of creative settings allows adaptability

* However may choose to supplement with other controls to ensure best result

M1: Accounting measures of profit often said to badly reflect economic income of firms; especially criticised for myopia - discuss nature and possible solutions (2013 A3) Introduction

* Economic Income: Change in value of entity over given period (value obtained by DCF)

* Myopia: Making decisions based on ST goals even if detrimental in the long run
- Investment Myopia: Reduce/postpone investments if payoffs in future measurement periods
- Operational Myopia: Destroying goodwill with customers, suppliers, employees, society

* Myopia problem stems from 2 problems with accounting measures: (1) Conservative bias - do not recognise gains until realised, recognise costs immediately (2) Ignoring of intangible assets with predominately future payoffs

* Addressing myopia problem usually involve 2 steps: (1) managers must understand how market reacts to earnings (2) implementing devices to offset accounting measures that cause myopia Paragraph 1: Measure Changes in Shareholder Value Directly

* Possibly remedy for myopia problem is to try to measure economic income or shareholder value creation directly by estimating future CF and discounting to PV

* Difference between beginning and ending value is direct estimate of value created

* Making accounting income more congruent with economic income e.g. mark-to-market accounting, use current/market value accounting - maintain productive capacity

* However lack measurement procession and objectivity Paragraph 2: Control Investment With Pre-action Reviews

* Distinguish between operating expenses necessary to produce current period revenues and development expense incurred in order to generate revenues in future periods

* If distinction made, profit centre managers maximise OI- good indicator of ST performance

* 2 major limitations: (1) No clear distinction exists between operating and developmental expenditure (2) Final decisions about which developmental expenditures to fund made by corporate management - less well informed than entity managers

* Lambrix & Singhvi (1984): Case Study: Armco - Pre-Approval Audit for capital budgeting Paragraph 3: Extend Measurement Horizon

* Longer measurement period, accounting measures & economic income more congruent

* Approach can be expensive - to have motivation effects, payoffs must be quite lucrative

* Van der Stede (2009): UBS bonus structure - cash payouts restricted to 1/3 of bonus, other 2/3 rolled into manager's bonus bank changes depending on performance in subsequent year Paragraph 4: Reduce Pressure for ST Profit (i.e. restructure PMS)

* Tell managers not to worry about ST profits - lets them make LT discretionary investments

* Communicated in 2 ways (1) less weight on target (2) make target easier to achieve Paragraph 5: Use Set of Drivers of Future Financial Performance

* Incorporate non-financial PM, multiple dimensions - completeness
- e.g. BSC: 4 perspectives (1) Financial, Internal Business, Customer, Learning & Growth

* Ittner & Larcker (2003): However NFPM as susceptible as FPM to manipulation; must adapt to specific context; 4 common mistakes - not linking measure to strategy, not validating links, not setting right targets, measuring incorrectly Conclusion

* Use of accounting measures of profit can lead to myopia problem - managers must actively work to overcome it by changing focus of employees, incorporate non-financial measures etc.

M1: Firm proposing incentive reform proposals: (1) Implement bonus cap (2) LT performance incentives should be in form of company shares as financial incentives drive ST behaviour - discuss proposals and possible tweaks (2015 A3) Introduction

* Incentive packages encourage alignment of employees natural self-interest with organisational objectives - possess 2 management control benefits (Van der Stede, 2007) (1) Information - reminds employees of relative importance of competing result areas (2) Motivation - encourage employees to exert extra effort in areas being rewarded

* Academics have investigated different components of compensation packages and the behavioural impacts of changing them including incentive size (1) and incentive types (2) Paragraph 1: Evaluation of Proposal (1) - Bonus Size

* Proposal (1) suggests the implementation of a bonus cap

* Research has show that reward and results are linearly related but only over a certain range
- Lower Cutoff: To avoid paying bonuses for performance considered "mediocre" or worse
- Upper Cutoff: Vertical compensation, consistency, avoid myopic effect and windfall gains

* Van der Stede (2007): Motivation effects taper off quickly beyond meaningful amount

* Implementation of upper cutoff likely beneficial as motivational strength capped at certain points
- no improvement in results even if reward increases; additional benefits stated above

* Should also consider implementation of lower cutoff Paragraph 2: Evaluation of Proposal (2) - Incentive Horizon

* Compensation in the form of company shares help to align employees interest with organisations as when company stock price improves employees compensation increases

* Increased focus on LT incentive can help to prevent myopic behaviour

* Van der Stede (2009): UBS bonus structure - cash payouts restricted to 1/3 of bonus, other 2/3 rolled into manager's bonus bank changes depending on performance in subsequent year

* Implementation of proposal likely to be beneficial Paragraph 3: Proposed Tweaks - Use Weak Incentives

* Van der Stede (2007): When multitasking desired weak incentives for any of desired dimensions can be better e.g. to motivate garbage collectors to be quick, offered incentive scheme paid full even if came back early - garbage collectors consistently early but at expensive of safety (traffic accidents, over weight-limit), service (missed pick ups)

* Also weaker incentives may help to mitigate problem of attracting 'wrong sort' - detrimental as (1) those who come for money leave for money (2) PFP always leads to higher compensation

* Positive effects of PFP might be achieved with relatively low incentive intensity, motivation effects taper off quickly beyond meaningful amount Paragraph 4: Proposed Tweaks - Incorporate Benefits Related to Intrinsic Job Features

* Heath (1999): Extrinsic inventive bias - people overestimate other's concerns for extrinsic job features - firms overestimate employees desire for financial rewards; underestimate intrinsic job features (build reputation, decision authority, perform meaningful work, be appreciated)

* Beer & Katz (2003): Executives stated most important reason firms have bonus plans is top management's belief monetary incentives essential for motivation, however same executives reported they did not make decisions based on "calculation" of how decisions affect their bonus Paragraph 5: Proposed Tweaks - Incentive Types

* Van der Stede (2007): Should consider using subjective performance evaluation:
- Allows for rebalancing of incentives (e.g. improve multi-task incentives)
- Subjectivity can be used to reward (punish) employees for value-enhancing (destroying) efforts are too complex to quantify in formal bonus contract
- If done well/kept honest - helps to mute aggressive bonus culture that focus on ST Conclusion

* Implementation of both proposals likely to be beneficial to firm

* Should also consider other factors include incentive strength, incentive types and rewards using intrinsic features

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