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Module 1 Lecture Notes

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

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MODULE 1: MANAGEMENT ACCOUNTING IN ITS ORIGINAL CONTEXT: FUNCTION OF MCS

Lecture 1 - The Control Function of Management (textbook readings incorporated) Management Control: Process by which management ensures people in organisation carry out organisational objectives -
encourages, enables, 'forces' employees to act in interest of firm
- Purpose: Influence desirable behaviour
- Benefit: Increase probability or firm's objective being achieved Objective Setting: Necessary prerequisite for any purposeful activities; without objective impossible to assess whether employees' actions purposive/assess firm's success
- Can be financial vs non-financial, quantified (explicit vs implicit), economic, social, environmental, societal Strategy Formulation: Defines how firm should use resources to meet goals - put constraints on employees to focus activities on competitive advantage
Management Control has behavioural orientation - encourages desirable actions Causes of Management Control Problems Lack of Direction

* Some employees perform poorly as do not understand what is expected of them - one function of MCS is to inform employees how to maximise contribution to fulfil objectives Motivational Problems

* Even if understand objectives may not perform as first want because of motivational problems - often because individual and organisational objectives do not coincide

* Lack of goal congruence, self-interested behaviour (prone to laziness)

* May engage in gamesmanship (e.g. earnings management) to make performance look good even if detrimental effects to organisation Personal Limitations

* Occur when understand direction/motivated but lack person-specific attributes (intelligence, training, experience, stamina, knowledge etc.) Management controls do not always involve a simple cybernetic (automatic) system - often doesn't focus on measuring performance; proactive rather than reactive
- Detector - measures behaviour
- Assessor - compare with pre-set standard
- Effector - take corrective action Control Problem Avoidance Activity Elimination

* Can sometimes avoid control problems by turning over potential risks (and associated profits) to 3rd party through subcontracts, licensing agreements, divestment

* Transaction Cost Economics: Focuses on whether specific activities can be controlled more effectively through markets or through organisational hierarchies Automation

* Use of computers, robots, expert system to reduce firms exposure to control problems

* Set to behave appropriately - consistent, eliminate human error/motivation problems

* However automation lacks feasibility (no machine can duplicate intuitive judgement) and cost (high investment required)

* Can increase control risks - elimination of source documents obscure audit trail, increase security risks, expose company to risk of programming errors Centralisation

* All key decision made at top management levels (e.g. major acquisitions/divestments, negotiation of pivotal sales contracts, organisation changes, hiring & firing executives)

* However in most organisations not possible to centralise all critical activities

MODULE 1: MANAGEMENT ACCOUNTING IN ITS ORIGINAL CONTEXT: FUNCTION OF MCS

Control Alternatives

* For problems that cannot be avoided managers must implement management controls collection of control known as management control system

* Can involve hiring reliable people, performance-based incentives, internal audit staff etc.

RESULTS CONTROLS

* Results Controls: Preventative-type controls that can address each major category of control problems - well defined results inform employees what is expected of them

* Can be effective in addressing motivational and person limitation problems

* Rewarding (punishing) individuals for good (bad) results - results accountability

* Commonly used for controlling behaviour of employees at many organisational levels
- Organisational architecture: decentralisation, design of incentive systems, franchising

* Often implemented under management-by-objectives (MBO) framework: superior &
subordinate managers jointly identify goals, define employee's responsibilities in terms of results expected and use them as guides for operating unit and assessing contribution Elements of Results Controls - 4 Steps: (1) Defining performance dimensions
- Must ensure defined correctly - what you measure if what you get (2) Measuring performance on these dimensions
- Lack of symmetry in uses of financial & operational performance measures between top and lower-level management creates pivotal point in hierarchy (hinge)
- If more than one result measure for given employee need to attach relative importance weightings to each measure so judgement can be aggregated
- Sometimes weightings implicit but blurs communication about what is important (3) Setting performance targets for employees to strive for
- Should be specified for every performance dimension measured
- Effect behaviour in 2 ways: (1) Simulate action by providing conscious goals for employees to strive for (2) Allows employees to interpret own performance (4) Providing rewards to encourage behaviours that will lead to desired results
- Anything employees value (pay rise, promotion, job security, freedom, power)
- Extrinsic rewards can be monetary or non-monetary, however results measures can be motivational without explicitly linked rewards (intrinsic motivation)
- Motivational strength of any reward can be understood using expectancy theory which postulates individuals' motivation force or effort is function of: (1) Expectancies that certain outcomes will result from their behaviour (2) Valences (strength) of their preference for those outcomes
- Preference of rewards varies between individuals, cultures, income tax laws

MODULE 1: MANAGEMENT ACCOUNTING IN ITS ORIGINAL CONTEXT: FUNCTION OF MCS

Conditions Determining Effectiveness of Results Control Work only when all of following conditions are present: (3) Organisations can determine what results are desired in areas being controlled (4) Employees whose behaviours are being controlled have significant influence for the result which they are being held accountable
- Controllability Principle: Person whose behaviours controlled must be able to affect results in material way in given time - if uncontrollable, result controls useless (3) Organisation can measure results efficiently
- Efficient if (1) precise (2) objective (3) timely (4) understandable i.e. what they are accountable for and how to influence it Pros

Cons

Behaviour can be influenced while allowing significant autonomy

Often less than perfect indicators of whether good actions have been taken

Greater employee commitment/motivation

Shift risk to employees (because of uncontrollable factors) - often require risk premium as employees risk averse

Inexpensive i.e. PM often collected for reasons unrelated to management control

ACTION, PERSONNEL AND CULTURAL CONTROLS Most direct form of control as involves taking steps to ensure employees act in firms best interest by making actions themselves focus on control Conditions Determining Effectiveness:

* Knowledge of desired actions

* Ability to ensure desired actions are taken 4 Basic Forms: (1) Behaviour Constraints
- Negative form of action control - less likely to engage in undesirable activities
- Physical Constraints: Locks, computer passwords, limited access to areas
- Administrative Constraints: Restriction of decision-making authority (e.g. can only approve spending up to PS1000)
- Separation of Duties: Dividing tasks for accomplishment of certain sensitive duties
- Poka-Yoke: Designed to make system foolproof - step built into process to prevent deviation from correct order of steps (2) Pre-action Reviews
- Scrutiny of action plans of employees being controlled - reviewers can approve/
disapprove/request changes (3) Action Accountability
- Holding employees accountable for actions they take, requires: (1) Defining what actions are acceptable and unacceptable (2) Communicating definitions to employees (3) Observing/tracking what happens (4) Rewarding good actions or publishing actions that deviate from acceptable (4) Redundancy
- Assigning more employees to a task than strictly necessary

MODULE 1: MANAGEMENT ACCOUNTING IN ITS ORIGINAL CONTEXT: FUNCTION OF MCS

Action Controls & The Control Problems

Prevention vs Detection

* Can be classified as whether they serve to prevent (most powerful if they work as because 0 cost of undesirable behaviour!) or detect undesirable behaviours

Pros

Cons

Most direct form of control

Only for highly routine jobs

Tend to lead to documentation of accumulation of knowledge as to what works best - organisational memory

May discourage creativity, innovation, adaptation

Efficient way of coordination - increase predictability of actions

May cause negative attitude (little opportunity for creativity)

Sometimes very costly

Personnel Controls

* Build on employees' natural tendencies to control and/or motivate themselves - ensure they understand role, possess required capabilities, increases likelihood will engage in self-monitoring (self-control, intrinsic motivation, ethics and morality, trust, loyalty)

* 3 Methods: (1) Selection & Placement of Employees (2) Training (3) Job Design & Provision of Necessary Resources Cultural Controls

* Encourage mutual monitoring - powerful form of group pressure on individuals who deviate from group norms and values

* Primary Methods: (1) Codes of Conduct (2) Group Rewards (3) Tone at the Top - Top management statements must be consistent with culture trying to create, and behaviours must be consistent with statements

* Other methods - inter-organisational transfers/employee rotation, physical arrangements (office plans, architecture, interior decor, social organisations etc.)

MODULE 1: MANAGEMENT ACCOUNTING IN ITS ORIGINAL CONTEXT: FUNCTION OF MCS

Personnel/Cultural Controls and the Control Problems

Effectiveness of Personnel/Cultural Controls

* Several advantages over results/action controls:
- Generally adaptable
- Relatively unobtrusive
- Usable to some extent in every setting
- Usually lower cost

* However effectiveness can vary significantly across individuals, groups, societies

* In most cases necessary to supplemented with actions and results controls CONTROL SYSTEM TIGHTNESS

* Good control if 'high' probability that firm's objectives will be achieved; 'low' probability that major unpleasant surprises will occur i.e. less unpredictability

* Achievement of tight results depends on: definition of desired results, congruence, specificity/timeliness, completeness, PM effectiveness, incentives link to performance Tight Action Controls

* Tight if highly likely that employees will engage consistently in all of the actions critical to the operation's success and will not engaging in harmful action (1) Behaviour Constraints
- Both physical and administrative constraints can be used to achieve tight control (2) Pre-action Reviews
- Tight if reviews frequent, detailed, performed by diligent/knowledgable reviewers
- Reviews do not automatically indicate tight controls - sometimes not examined sufficiently before approval (rubber stamp them) (3) Action Accountability
- Definitions of actions must be congruent, specific, well-communicated, complete (4) Action Tracking
- Employees who are certain that actions will be noticed quickly will be more responsive to action controls (e.g. constant direct supervision) (4) Action Reinforcement
- Tighter by making reward/punishment more significant to employees affected Tight Personnel/Cultural Controls

* Often unstable - impending divergence between individual & organisational objectives

* Personnel/cultural controls unlikely to affect tight controls alone unless strong culture Multiple Forms of Control

* To tighten controls, management can use multiples control forms - reinforce each other
- fill gaps

MODULE 1: MANAGEMENT ACCOUNTING IN ITS ORIGINAL CONTEXT: FUNCTION OF MCS

DIRECT & INDIRECT CONTROL COSTS Out-of-Pocket Costs

* Direct, monetary costs of implementing an MCS - some easy to measure (cash bonuses, internal audit staff, recognition plaques), some harder (cost of time planning/budgeting) Behavioural Displacement

* Can subject organisations to significant indirect costs

* Occurs when MCS encourages behaviour inconsistent with organisation's objectives Behavioural Displacement and Results Control

* Occurs when organisation defines sets of results measures that are incongruent with organisation's true objectives Poor Understanding of Desired Results

* Due to incorrect understanding or incomplete specification

* Possible to maximise performance according to rules of the results control system without concurrently contributing towards organisational objectives

* Complete understanding of tradeoff required of employee being controlled is important when multiple indicators used to monitor different aspects of performance Overquantification

* Tendency to focus on information that can be quantified even if not most important -
need to develop indicators of intangible results areas that may be missing (e.g. # of defects as indicator for quality) Behavioural Displacement and Action Control

* Means-Ends Inversion: employees pay attention to what they do (means) while losing sight of what they accomplish (ends)

* Some action controls may have been useful as some points but discourage employees from thinking about how to do job better - rigid, non-adaptive behaviour

* Action control can be good in stable environment but can be dangerous in changing ones Displacement and Personnel/Cultural Controls

* Recruit wrong type of employees or provide wrong training

* Strong cultures can lead to displacement when behaviour norms group uses not aligned with organisational desires

* Sometimes control implemented in wrong environment - ineffective Gamesmanship

* Actions that employees take to improve their performance indicators without producing any positive economic effects for organisation; 2 major forms: (1) Creation of Slack Resources
- Negotiating highly achieve targets that are deliberately lower than what they expect
- Can have positive (less manager tension) & negative (obscures performance) effects
- Occurs when information asymmetry between seniors and juniors (very common!) (2) Data Manipulation
- Efforts by employee being controlled to look good by fudging control indicators
- 2 basic forms: (1) Falsification (2) Data Management - through accounting methods (earnings management) or operating methods (altering of operating decisions)
- Serious problem as renders entire control system ineffective

* Become more prevalent - more scrutiny of FS, legislation, stronger corporate governance Operating Delays

* Often-unavoidable consequence of pre-action review types of action control and some forms of behaviour constraints (e.g. limiting access to stockroom, require passwords etc.)

MODULE 1: MANAGEMENT ACCOUNTING IN ITS ORIGINAL CONTEXT: FUNCTION OF MCS

Negative Actions

* Even when control is well designed can sometimes cause negative attitudinal effects (job tension, conflict, frustration, resistance)

* Can encourage game-playing, lack of effort, absenteeism, turnover Negative Attitudes Produced by Action Controls

* Pre-action review can be frustrating as employees feel they are unnecessary

* Annoys lower-level personnel - demoralised workforce, high turnover Negative Attitudes Produced by Results Controls

* Lack of employee commitment to performance targets defined in MCS - not committed if too difficult, not meaningful, not controllable, unwise, illegal, unethical

* Can stem from problems in measurement system - unfair performance evaluation

* Can occur if employees feel rewards are unfair

* Some evidence poor performance react more negatively to better control systems however can also cause negative attitudes in good performers DESIGNING & EVALUATION MCS Understanding What is Desired and What is LIkely

* Cannot design/evaluate MCS without knowing objectives and strategies of firm

* Role demand specified in terms of actions to be performed or results are desired Understanding Desired Actions or Results

* Identify key actions that must be performed to provide greatest probability of success

* However most key actions for higher-level managers not well understood

* Can also understand role demands in terms of key results - defined as key areas where 'thing must go right' for business to succeed (consider ~6 - 8 factors)

* Result may not be stable - re-evaluated/adapted as necessary (strategic planing) Understanding Likely Actions or Results

* Managers should investigate potentials for each of the control problems - lack of direction motivation problems, personal limitation i.e. do employees understand what they are expected to do (actions) or accomplish (results) The discrepancy between what is desired and what is likely will determine the choice and the tightness of the management control systems Adapting to Change

* Most organisation emphasize one form of management control at given point but change emphasis from one form to another as needs, capabilities and environment change Keeping a Behavioural Focus

* Difficult to design MCS as benefits and side effects dependent on how employees react

* No one form on control is optimal in all circumstances - context matters!

* Important to keep focus on people involved because it is their responses that will determine success/failure Maintaining Good Control

* Bad control caused by:
- Imperfect understanding of setting and/or effects of MCS in that setting
- Management's inclination to subjugate the implementation of good MCS to other business demands

* Criticisms of MCS should be made with caution - loose control can have unseen benefits

* As firms grow evolve towards increased formalisation of behaviour and development of more elaborate information systems

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