1. What is a management control system? Explain in detail the basic elements of a control process.

(20 Marks)
Management control systems are methods of collecting information that are used to guide and direct the behavior of staff members and management in order to achieve a company's goals. A management control system may use a variety of techniques to evaluate various areas to improve performance and productivity. Some areas addressed by management control systems may include accounting methods, employee incentive programs and performance measurement. Accounting methods are often implemented and evaluated as part of a management control system. To control financial activities within a company, the area may be broken down into financial and managerial accounting. Financial accounting generally focuses on internal issues, such as reporting sales costs, while managerial accounting may focus on methods for determining product costs. While both areas cover business accounting issues, their methods of application generally differ, and separate systems implemented by a management control system may aid in ensuring reports remain accurate and impartial. Managerial accounting is typically responsible for providing management with information on controlling costs and improving the production process. Managerial accountants may also provide cost information on new products, make pricing decisions and monitor actual and budgetary costs. General financial accounting within management control systems aims to focus on a company's internal accounting issues. Financial accounting typically handles payroll and human resource issues affecting employees within the company. Accounts in this area may also manage employee costs and reimbursements under a control system.

. Basic Elements of Process Control In the process control, four basic elements are normally involved: process, measurement, evaluation (with a controller), and control element (Fig. 1).

Fig. 1: Basic control elements

PROCESS If we try to control the temperature during ladle furnace steel making, the ladle furnace steelmaking can be abstracted as a Process. Many dynamic variables may be involved in a process, and it may be desirable to control all those variables at the same time. There are single-variable processes, in which only one variable is to be controlled. However, most industrial processes are multivariable processes, in which many variables, perhaps interrelated, may require regulation. MEASUREMENT Control is in nature to effect control of a dynamic variable in a process. To perform control, we have to perform measurement, so that we can have information on the variable itself. In general, a measurement refers to the transduction of the variable into some corresponding analog of the variable, such as a pneumatic pressure, an electrical voltage, or current. A transducer is a device that performs the initial measurement and energy conversion of a dynamic variable into analogous electrical or pneumatic information. Further transformation or signal conditioning may be required to complete the measurement function. The result of the measurement is a transformation of the dynamic variable into some proportional information in a useful form required by the other elements in the process-control loop. EVALUATION The next step in the process-control sequence is to examine the measurement and determine what action, if any, should be taken. A controller is commonly used in this step to perform the evaluation. The evaluation may be performed by an operator, or by (electronic/pneumatic) signal processing, or by a computer. Computer use is growing rapidly in the field of process control because it is easily adapted to the decisionmaking operations and because of its inherent capacity to handle control of multivariable systems. The controller requires an input of both ameasured representation of the dynamic variable and a representation of the desired value of the variable, expressed in the same terms as the measured value. The desired value of the dynamic variable is referred to as the setpoint. Thus, the evaluation consists of a comparison of the controlled variable measurement and the setpoint and a determination of action required bring the controlled variable to the setpoint value. CONTROL ELEMENT The final element in the process-control loop is the device that exerts a direct influence on the process, that is, that provides those required changes in the dynamic variable to bring it to the setpoint condition. This element accepts an input from the controller, which is then transformed into some proportional operation performed on the process. In our previous example, the control element is the value that adjusts the outflow of fluid from the tank. This element is also referred to as the final control element.

2. Explain the scope of Management control system.

Scope of control

(10 Marks)

MANAGEMENT CONTROL SYSTEM is an important process in which accounting information is used to accomplish the organizations objectives. Therefore the scope of control is very wide which covers a very wide range of management activities. Policies control: Success if a business depends on formulation of sound policies and their proper implementation. Control over organization: It involves designing and organizing the various departments for the smooth running of the business. It attempts to remove the causes of such friction and rationalizes the organizational structure as and when the need arises. Control over personnel: Anything that the business accomplishes is the result of the action of those people who work in the organization. It is the people, and not the figures, that get things done. Control over costs: The cost accountant is responsible to control cost sets, cost standards, labour material and over heads. He makes comparisons of actual cost data with standard cost. Cost control is a delicate task and is supplemented by budgetary control systems. Control over techniques: It involves the use of best methods and techniques so as to eliminate all wastages in time, energy and material. The task is accomplished by periodic analysis and checking of activities of each department with a view to avoid an eliminate all non-essential motions, functions and methods. Control over capital Expenditure: Capital budget is prepared for the whole concern. Every project is evaluated in terms if the advantage it accrues to the firm. For this purpose capital budgeting, project analysis, study of cost of capital etc are carried out. Overall control: A master plan is prepared for overall control and all the departments of the concern are involved in this procedure.

3. What is the concept of free cash flow as applied organization. Explain process of computation? (10 Marks)

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We define net cash flow as net income plus non cash adjustment which typically means net income plus depreciation though that cash flows cannot be maintained over time unless depreciated fixed assets are replaced. So management is not completely free to use its cash flows however it chooses. Therefore we define the term free cash flows.

Free cash flow is the cash flow actually available for distribution to investor after the company has made all the investment in fixed assets and working capital necessary to sustain ongoing operation. When we studied income statement in accounting the emphasis was probably on the firms net income, which is accounting profit. However the value of companys operation is determined by the stream of cash flows that the operations will generate now and in the future. To be more specific, the value of operation depends on all the future expected free cash flows, defined as after- tax operating profit minus the amount of new investment in working capital and fixed assets necessary to sustain the business. Therefore the way for managers to make their companies more valuable is to increase their free cash flow.

Uses of FCF: 1. Pay interest to debt holders, keeping in mind that the net cost to the company is the after tax interest expense. 2. Repay debt holders, that is, pay off some of debt. 3. Pay dividends to shareholders. 4. Repurchase stock from shareholders. 5. Buy marketable securities or other non operating assets. In practice, most companies combine these five uses in such a way that the net total is equal to FCF. For example, a company might pay interest and dividends, issue new debts, also sell some of its marketable securities. Some of these activities are cash outflows (paying interest and dividends) and some are cash inflows (issuing debt and selling marketable securities), but the net cash flow from these five activities is equal to free cash flows. Computation of free cash flows: Eg: Suppose the company had a 2001 NOPAT of $170.3million and depreciation is only the non cash charge which is $100million then its operating cash flow in 2001 would be NOPAT plus any non cash adjustment on the statement of cash flows. Operating cash flow =NOPAT +depreciation (non cash adjustment) = $17.03 + $100 = $270.3 Company has $1,455million operating assets, at the end of 2000, but $1,800 at the end of 2001.it made a net investment in operating assets of Net investment in operating assets = $18, 00 - $1,455 = $345million If net fixed assets rose from $870million to $1000million however company reported $100million of depreciation. So its gross investment in fixed assets would be Gross investment = net investment + depreciation = $130 + $100 = $230million Company free cash flows in 2001 was

FCF = operating cash flow gross investment in operating assets = $270.3 - $445 = - $174.7million An algebraically equivalent equation is FCF = NOPAT - Net investment in operating assets = $170.3- $345 = - $174.7million Even though company had a positive NOPAT, its very high investment in operating assets resulted in a negative free cash flow. Because free cash flow is what is available for distribution to investor, not only was there nothing for investors, but investor actually had to provide additional money to keep the business ongoing. A negative current FCF not necessarily bad provided it is due to the high growth or to support the growth. There is nothing wrong with profitable growth; even it causes negative free cash flow in the short term

4. Write Short Notes on

1. Zero Based Budgeting 2. Internal Control

(20 Marks)

1. Zero Based Budgeting:

Zero-based budgeting is a technique of planning and decision-making which reverses the working process of traditional budgeting. In traditional incremental budgeting, departmental managers justify only increases over the previous year budget and what has been already spent is automatically sanctioned. No reference is made to the previous level of expenditure. By contrast, in zero-based budgeting, every department function is reviewed comprehensively and all expenditures must be approved, rather than only increases.[1] Zero-based budgeting requires the budget request be justified in complete detail by each division manager starting from the zero-base. The zero-base is indifferent to whether the total budget is increasing or decreasing. The term "zero-based budgeting" is sometimes used in personal finance to describe the practice of budgeting every dollar of income received, and then adjusting some part of the budget downward for every other part that needs to be adjusted upward. It would be more technically correct to refer to this practice as "active-balanced budgeting". Advantages of Zero-Based Budgeting: 1. Efficient allocation of resources, as it is based on needs and benefits. 2. Drives managers to find cost effective ways to improve operations. 3. Detects inflated budgets.

4. Municipal planning departments are exempt from this budgeting practice. 5. Useful for service departments where the output is difficult to identify. 6. Increases staff motivation by providing greater initiative and responsibility in decision-making. 7. Increases communication and coordination within the organization. 8. Identifies and eliminates wasteful and obsolete operations. 9. Identifies opportunities for outsourcing. 10. Forces cost centers to identify their mission and their relationship to overall goals. Disadvantages of Zero-Based Budgeting: 1. Difficult to define decision units and decision packages, as it is time-consuming and exhaustive. 2. Forced to justify every detail related to expenditure. The R&D department is threatened whereas the production department benefits. 3. Necessary to train managers. Zero-based budgeting must be clearly understood by managers at various levels to be successfully implemented. Difficult to administer and communicate the budgeting because more managers are involved in the process. 4. In a large organization, the volume of forms may be so large that no one person could read it all. Compressing the information down to a usable size might remove critically important details. 5. Honesty of the managers must be reliable and uniform. Any manager that exaggerates skews the results

2. Internal Control:
Internal control is defined as a process affected by an organization's structure, work and authority flows, people and management information systems, designed to help the organization accomplish specific goals or objectives.[1] It is a means by which an organization's resources are directed, monitored, and measured. It plays an important role in preventing and detecting fraud and protecting the organization's resources, both physical (e.g., machinery and property) and intangible (e.g., reputation or intellectual property such as trademarks). At the organizational level, internal control objectives relate to the reliability of financial reporting, timely feedback on the achievement of operational or strategic goals, and compliance with laws and regulations. At the specific transaction level, internal control refers to the actions taken to achieve a specific objective (e.g., how to ensure the organization's payments to third parties are for valid services rendered.) Internal control procedures reduce process variation, leading to more predictable outcomes Describing Internal Controls: Internal controls may be described in terms of: a) the objective they pertain to; and b) the nature of the control activity itself. Objective categorization Internal control activities are designed to provide reasonable assurance that particular objectives are achieved, or related progress understood. The specific target used to determine whether a control is operating effectively is called the control objective. Control objectives fall under several detailed categories; in financial auditing, they relate to

particular financial statement assertions,[5] but broader frameworks are helpful to also capture operational and compliance aspects: 1. Existence (Validity): Only valid or authorized transactions are processed (i.e., no invalid transactions) 2. Occurrence (Cutoff): Transactions occurred during the correct period or were processed timely. 3. Completeness: All transactions are processed that should be (i.e., no omissions) 4. Valuation: Transactions are calculated using an appropriate methodology or are computationally accurate. 5. Rights & Obligations: Assets represent the rights of the company, and liabilities its obligations, as of a given date. 6. Presentation & Disclosure (Classification): Components of financial statements (or other reporting) are properly classified (by type or account) and described. 7. Reasonableness-transactions or results appear reasonable relative to other data or trends. Activity categorization Control activities may also be described by the type or nature of activity. These include (but are not limited to): Segregation of duties - separating authorization, custody, and record keeping roles to limit risk of fraud or error by one person. Authorization of transactions - review of particular transactions by an appropriate person. Retention of records - maintaining documentation to substantiate transactions. Supervision or monitoring of operations - observation or review of ongoing operational activity. Physical safeguards - usage of cameras, locks, physical barriers, etc. to protect property. Analysis of results, periodic and regular operational reviews, metrics, and other key performance indicators (KPIs). IT Security - usage of passwords, access logs, etc. to ensure access restricted to authorized personnel. S

5. Explain briefly various stages of management control process citing salient features of each. (20 Marks)
Management control process involves communication of information to the managers at various levels of hierarchy and their interactions arising out of them. These communications aim towards attaining the organization's goals. But individual managers have their personal goals also. For example, a young manager with good education, experience, personality and social background joins a company like Britannia Industries or Reliance. The company finds him fit for the position as per job specifications, appoints him and makes him aware of what the company expects of him. The young manager sets his goals of gaining rich experience for his career progress besides adequate compensation packages. Naturally, his actions will be directed towards achieving his own objectives and goals while serving the company.

Thus, his self-interest and the best interest of the organization are apparently in conflict. But the best results can be achieved by perfectly matching the two interests and this is called 'goal congruence'. It is quite apparent that perfect congruence between the goals of the individual and the organization individual's goals and the organization's goals can never happen. Yet, the main purpose of a management control system is to assure goal congruence between the interest of the individual and the organization as far as practicable. Management control systems Formal and Informal Communication As mentioned earlier, all the communication of information may be either formal or informal. The formal communication system involves strategic plan, budgets, standards and reports whereas the informal communication is made through letters and memos, verbally or even by facial expression. Formal communications are all 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. 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 behavior as indicated in the hierarchy and thereby, moving away from superior/subordinate relationship. However, such relations depend on the personal capabilities of the manager such as education, 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 attending a Training Course, he meets other 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 organization chart, he should inform his General Manager, but it depends on his own perception of the situation, and he mayor may not report to the General Manager. Work Ethics, Management Style and Culture External factors like work ethics vary from place to place. Therefore, organization work culture depends on the general behavior of the people in the society where the organization situates. Work culture generally differs because of the life style and the attitude towards the work. For example, people of Mumbai lead very fast life. Time has more value at Mumbai as compared to Kolkata, where people take things easily and leisurely. Japanese and Korean people have reputation for their excellent work culture. However, the most important internal factor is the organization's culture and climate. The culture refers to the set of common beliefs, attitudes, norms, relationships and assumptions that are explicitly or implicitly accepted and evidenced throughout the organization. The writer joined Union Carbide as an Assistant just three days before Christmas Eve. On the very second day, when he attended Christmas lunch, his table was shared by none other than the General Sales Manager Dr. W.R. Correa. He kept us amused with various stories of his recent tour abroad and recited Urdu 'shairies', even sharing jokes. Such a situation was unthinkable in Jessop & Co., where sharp differences were maintained at every level of hierarchy. Management control systems

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, and reward, constrain and find out about each other. It influences moral-the attitude of the individual towards his/her work and environment. Culture differs between the organizations, but cultural norms are extremely important. They are not written like formal communication. But the existence of a good culture can be felt from the behavior of the members of the organization. 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 in the culture, unless the new Chief follows the footsteps of his predecessor and maintains it. Generally, if higher positions are filled in through promotion of internal executives, the culture remains unchanged and the traditions are maintained. The other important internal factor which influences management control system is management style-that is the attitude of the superior to his subordinates and the latter's reaction through their perception of the attitude of their superiors. Again, the attitude ultimately stems from the temperament of the Chief Executive, who controls the entire organization. That is why R. W. Emerson said "an institute is the lengthened shadow of a man".

Importance of Informal Communication An organization indulges in informal control process when encountering non-routine decision-making or when seeking new information to increase understanding of some problem areas. During a very critical period in an organization, the writer found that the Chief Executive used to call managers informally at his residence or club to extract information in a relaxed manner rather than in a tense situation prevailing in the factory. Formal Control Process Formal communication system is structured as per the 'hierarchy outlined in the organization chart. The system has the following four components: (a) Strategic plan and programme (b) Budgeting (c) Operations and measurement in responsibility centers (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 centers. Expenses and revenues are marked for each responsibility centre period wise, say monthly, quarterly, half yearly, and annually. (c) Operations and Measurement Responsibility centers operate within the framework of the budget, established standards, standing instructions, practices and operating procedures embodied in 'rules', and 'manuals'. Thus, besides budget, the responsibility centers are 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 centers for performance measurement. (d) Reporting Actual performance is analyzed, measured and reported against plan, indicating variances and highlighting areas of weaknesses. If the performance is satisfactory, feedback information is sent to the responsibility centre concerned for praise or reward. If the same is unsatisfactory feedback communication is sent to the responsibility centre concerned for corrective action. If such action requires to be included in the budget, then the latter is revised to give effect to the changed position. If required, then the plan itself can be revised and a new basis of control may be established. The aforesaid formal control process has been presented in the following diagram:

6. Describe differences in budgeting perspective of engineered and discretionary expense centre. (10 Marks)
1.Expense centers: Expenses center are responsibility centers for which input or expenses are measured in monetary terms, but for which outputs are not measured in monetary terms. There are two general types: engineered expense center and discretionary expense center. They correspond to two types of costs.. Engineered costs are elements of cost for which the right or proper amount of costs that should be incurred can be estimated with a reasonable degree of reliability. Costs incurred in factory for direct labour direct material component supplies and utilities are examples.

2.Engineered expense centers: Engineered expense center have the following characteristics: 1. Their inputs can be measured in monetary terms. 2. Their output can be measured in physical terms.

3. The optimal dollar amount of input required to produce one unit of output can be established Engineered expense center usually are found in manufacturing operations. Warehousing, distribution, trucking and similar units in the marketing organization also may be engineered expense center and so many certain responsibility center within administrative and support department. Examples are accounts receivable account payable and payroll section in the controller department personnel record and cafeteria in the human resource department shareholder record in the corporate secretary department and the company motor pool. Such units perform repetitive task for which standard cost can be developed In an engineered expense center the output multiplied by the standard cost or each unit produced represents what the finished product should have cost. When this cost is compared to actual costs, the difference between the two represents the efficiency of the organization unit being measured. We emphasize that engineered expense centers have other important tasks not measured by cast alone. The effectiveness of these aspects of performance should be controlled. For example expenses center supervisor are responsible for t he quality of good and for the volume of production in addition to their responsibility for cost efficiency. Therefore the type and amount of production is prescribed and specific quality standards are set so that manufacturing costs are not minimized at t he expense of quality. Moreover manager of engineered expense center may be responsible for activities such a training that are not related to current production judgment about their performance should include an appraisal of how well they carry out these responsibilities. There are few if any responsibility center in which all cost items are engineered. Even in highly automated production department the amount of indirect labour and of various services used can vary with management discretion. Thus, the term engineered costs center refers to responsibility center in which engineered cost predominate but it does not imply that valid engineering estimates can be made for each and every cost item.

3.Discretionary expense center: The output of discretionary expenses center cannot be measured in monetary terms. They include administration and support units research and development organization and most marketing activities. The term discretionary does not mean that management judgments are capricious or haphazard. Management has decided on certain policies that should govern the operation of the company. One company may have a small headquarter staff another company of similar size and in the same industry may have a staff that is 10 time as large the management of both companies may be concerned that they made the correct decision on staff size but there is no objective way judging which decision was actually better manager are hired and paid to make such decision after such a

drastic change the level of discretionary expenses generally has a similar pattern from one year to the next. The difference between budgeted and actual expense is not a measure of efficiency in a discretionary expense centre it is simply the difference between the budgeted input and the actual input. It in no way measures the value of the output, if actual expense do not exceed the budget amount, the manager has lived within the budget however ,because by definition the budget does not purport to measure the optimum amount of spending we cannot say that living within the budget is efficient performance . 4.Differences in budgeting perspective of engineered and discretionary expense centre Budget preparation The decision that management make about a discretionary expense budget are different from the decisions that it makes about the budget for an engineered expense center. For the latter, management decides whether the proposed operating budget represent the cost of performing task efficiently for the coming period. Management is not so much concerned with the magnitude of the task because this is largely determined by the actions of other responsibility centers, such as the marketing departments ability to generate sales. In formulating the budget for a discretionary expense center, however management principal task is to decide on the magnitude of the job that should be done. Incremental budgeting: Here the current level expenses in a discretionary expense center is taken as a starting points this amount is adjusted for inflation for anticipated changes in the workload of continuing tasks for special tasks and if the data are readily available for the cost of comparable work in similar units. There are two drawbacks to incremental budgeting. First because managers of these centers typically want to provide more service they tend to request additional resources in the budgeting process and if they make a sufficiently strong case these request will be granted. This tendency is expressed in Parkinsons second law: overhead costs tend to increase period. There is ample evidence that not all this upward creep in cost is necessary. This problem is especially compounded by the fact that the current level of expenditure in the discretionary expenses center is taken for granted and is not reexamined during the budget preparation process. Second when a company faces a crises or when a new management takes over overhead costs are sometimes drastically reduced without any adverse consequences. Despite this limitation most budgeting in discretionary expense centers is incremental. Time does not permit the more thorough analysis described in the next section.

 Zero based review: An alternative approach is to make a thorough analysis of each discretionary expense center on a schedule that will cover all of them over a period of five year or so. That analysis provides a new base. There is a likelihood that expenses will creep up gradually over the next five years and this is tolerated at the end of five years, another new base is established. Such an analysis is often called a zero base review. In contrast with incremental budgeting which takes the current level of spending as the starting point this more intensive review attempts to build up de now the resources that actually are needed by the activity. Basic question are raised;(1) should use customer?(2) what should the quality level be ?are we doing too much(3)should the function be performed in this way (4) how much should it cost? Cost variability: In discretionary expense center costs tend to vary with volume from one year to the next but they tend not to vary with short run fluctuation in volume within a given year. By contrast costs in engineering expense center are expected to vary with short run changes in volume. In part this reflect the fact that volume changes do have an impact throughout the company even though their actual impact cannot be measures the ; in part this reflect the fact that volume changes do have an impact throughout the company even though their actual impact cannot be measured in part this result from a management personnel and personnel related costs are by far the largest expense item in most discretionary expense center the annual budget for these center tend to be a constant percentage of budgeted sales volume.