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MANAGEMENT CONTROL SYSTEM

An Integrated Framework to drive an organization on a Growth track.


Recommended Text Book : Management Control Systems Robert Anthony & Vijay Govindrajan (Tata-McGrawHill/11th /12th Edition.)
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Learning Objective : What is the scope of Management planning control system ? How does a corporate enterprise function ? What needs to be controlled ? Who should be responsible for management planning & control ?

What is the scope of Management planning & control system in an organization ? 1. Build necessary internal control measures at financial & non financial matters to create Value for share holders. 2. Create a management culture to deliver the best performance rater than mediocre output. 3. when a business environment is at its worst , every strategy, action & expenditure is questioned & need to be justified to the share holders. 4. A universal truth is that no business is steady, hence management planning & control help to sustain its commitments to shareholders during peak & trough situation of business. 3

Management of an organization is responsible for creating wealth for its shareholders. All management action & strategies to meet financial goal are guided by SVC . Corporate managers of contemporary business are expected to focus on SVC. Companies adopt different methods to measure shareholder's value . Shareholder Value Creation can be explained as excess of market value over book value.

Market Value Added = Market value of the firm Market value of debt.
Market value of a firm is the value of its assets reflected in capital market
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When MV is in excess of invested capital , MVA is said to be positive . Hence firm is said to have created value for its shareholder. The inherent drawback of MVA is that it ignores cash flow received by share holders in the form of dividend & shares buyback. Alternative measure is market to book value ( M/B ) Market value per share = Book value per share = Market value of equity Number of shares outstanding Invested equity capital Number of shares outstanding

M/B > 1 Firm is creating value for share holders M/B = 1 Value maintenance M/B < 1 Value destroyed.
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Management Control Focuses primarily on Strategy Implementation. Three distinct systems/activities that require planning and control can be defined:

Strategy Formulation Management Control Task Control

Goals, Strategies, Policies

Implementation of Strategies

Performance of specific Tasks

Management control does not necessarily require that all actions are per the previously determined Plan; It, however, requires inducing people to act in pursuit of own goals in ways that organizations goal are also met: 6 Goal Congruence.

Starting Point: strategy formulation

Internal Analysis Technology/Marketing/ Manuf./Supply Chain

Environmental Analysis Competitor/Customer/ Supplier/Laws/Political

S.W O.T. K.S.F.


And its financial impact: Number crunching

Strategy

Steps for Strategy Formulation


Strategic Plan Financial budget Responsibility centers Reward Superior performance Take corrective action on Inferior performance Performance Standard

Corrective Action

Process of Measurement Plan Vs Actual


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An organizations long term and short term vision & goal are translated quantitatively in terms of its financial objective. The management of closely held or publicly held organization is directly responsible & accountable for creating shareholders value. Management formulates strategy & action plan to meet the financial goals given the internal & external constraint to meet the expectation of the shareholder.
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MANAGEMENT CONTROL SYSTEM


Its not enough for any business to focus on building assets, but must control it in short term & long term perspective to achieve sustained growth & visibility in line with shareholders expectation.

What is being controlled?


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CONTROL OF ASSETS
TANGIBLE ASSETS FINANCIAL ASSETS INTANGIBLE ASSETS KNOWLEDGE ASSETS EMPLOYEE ASSETS

CUSTOMER & SUPPLIER ASSETS

BRAND ASSETS

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Management control is the process by which managers at all levels ensure their team align themselves to the goal of the BU, division or organization referred as Goal congruence or Goal alignment Challenges of building good control system are:
1. Unlike the simpler systems, the standard is not pre-set , keep changing in dynamic market. 2. Control requires coordination amongst individuals. 3. The link between need for action and determining the action is not always clear. 4. Much of control is self control.
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Framework to support
Management Control System
(Management) Controls Organization Structure Culture H. R. Management

Performance

Org. Structure specifies creating roles, reporting relationships, responsibilities that shape decision making; Culture refers to the set of common beliefs, attitudes that guide management actions; HR Management drives performance related career progression , compensation which enable people to execute strategy more efficiently.
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Strategy

Conceptual model of Management Control Systems


Elements of Control
Assessor:

Control Device
Detector:

Effector: Behaviour Alteration, if needed.

Controlled Entity

Desired performance by the management

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McKinsey 7-S Framework to support control system Of an organization.

STRUCTURE STRATEGY SHARED VALUES SKILLS STYLE SYSTEMS

STAFF
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What Is Internal Control ?


A process effected by an entitys board of
directors, management and other personnel, designed to provide reasonable assurance regarding the achievements of objectives in the following categories:

Effectiveness & efficiency of operations. Reliability of financial reporting. Compliance with applicable laws and regulations.
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What Internal Control Can Do..???


It can help achieve performance & profitability targets.( Financial Guideline ) It can help prevent loss of resources. It can help ensure reliable financial reporting. It can help ensure compliance with laws.

It can help an entity get to where it wants to go, and avoid pitfalls and surprises along the way.
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Internal control is a process. It is a means to an end, not an end in itself. Internal control is effected by people.Its not merely policy manuals and forms, but people at every level of an organization. Internal control can be expected to provide only reasonable assurance, not absolute assurance, to an entitys management and board. Internal control is geared to the achievement of objectives in one or more separate but overlapping categories.
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Components Of Internal Control


Control Environment. Risk Assessment. Control Activities. Information & Communication. Monitoring.

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Control Environment
Sets the tone of the organization. The foundation for all other components. It includes the integrity,ethical values and competence of the people. Reflects managements philosophy & operating style,the way management assigns authority and responsibility and organizes and develops its people, and the attention and direction provided by the board of directors.

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Risk Assessment
Every entity faces internal &external risks. Every entity sets objectives. Risk assessment is the identification and analysis of relevant risks to achievements of the objectives.

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Control Activities
The policies and procedures that help ensure management directives are carried out. They help ensure that necessary actions are taken to address risks. Control activities occur throughout the entity at all levels and in all functions. They include activities such as approvals, authorization, reconciliations and segregation of duties.
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Relevant information must be identified , captured and communicated in a form & timeframe that enables people to carry out their responsibilities. Information systems produce reports containing operational, financial and compliance related information that make it possible to run and control the business. Effective communication must occur in a broader sense, flowing-down, across and up the organization.
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Information & Communication

Monitoring
Internal control systems need to be monitored. Types of monitoring: - ongoing during the course of operations. - evaluation for which the scope and frequency will depend primarily on an assessment of risks and the effectiveness of ongoing monitoring procedures.

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What Internal Control Cannot Do


Internal controls ,no matter how well designed and operated,can provide only reasonable assurance to management regarding achievements of an entitys objectives.

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Formal Management Process.

Goals & Strategies

Other Info.

Task Control Safeguards

Rules

Periodic Review

Management decision
Reward

Y
Strategic Resp Center Reports: Budgeting Performance A vs P Planning
Revision Analysis/ Actions

OK?

Measurement

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Management planning & Control requires to be done in 3 areas.


The Environment focusing on the characteristics of organizations and individual behaviour; organizing for control and generic responsibility and control devices in the behavioural context; The Process how control is effected within organizations; interactions, formal and informal, to effect control and systems: Strategic planning for goal setting; Budget preparation; Execution & budgetary control; Evaluation and start of next cycle of control; The Developments variations to the theme of Control.
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Responsibility centres for Management Control


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Responsibility centres
Decentralization, the corner-stone of contemporary Management Systems which leads to Responsibility Centres.
A Responsibility Centre is an organizational unit that is headed by a centre head or business head responsible for planning & controlling of its assets to meet organizational goal in terms of revenue & profit maximization, cost effectiveness, process efficiency & people effectiveness.

Revenue, profit, cost management & control People accountability & responsibility Responsibility Centre Process Alignment & control
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BUSINESS GOAL ATAINMNET

Objective of responsibility centre include planning & control of : Cost /Profit /Revenue : Monetary measure of the amount of resources used by a responsibility centre. Efficiency: which is the ratio of outputs to inputs, or the amount of output per unit of input; i.e. least sacrifice of resources for obtaining the required output. Effectiveness: is determined by the relationship between the responsibility centres output and attainment of its objectives; i.e. how well is the centre achieving its objectives.

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Types Responsibility Centres:


1. Revenue Centres: Outputs in monetary terms, inputs non-monetary ( MANAGER ACCOUTABLE FOR REVENUE OBJECTIVE ) 2. Expense Centres: Outputs non-monetary, inputs monetary (as costs) 3. Profit Centres: Inputs & Outputs monetary (as expenses & revenues) 4. Investment Centre: Profit centre + Investment made in them.

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Revenue Centre

Traditional ( Sales Department ) view

Inputs not related to Outputs

Input (money only for direct Costs incurred)

Revenue Centre

Output (money revenue)

Contemporary view : Profit center : Since its performance is measured on revenue generated, profit earned , cost control. Management control on : Cost of sale :- sales return , in effective recovery management Low customer retention 32

Expense Centres ( Manufacturing function)


Optimal Relationship can be established
Engineered Expense Centre

Input (money)

Output (physical)

Planned expense on RM Inventory: Capital expenditure planned on long term assets. Management control through : Monitoring planned production targets Rejection cost Down time cost Low productivity ( Benchmark standard versus actual ) High production cost : Excess overtime.

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Expense Centres
e.g. R & D Function & other service function Optimal Relationship cannot be established

Input (money)

Discretionary Expense Centre

Output (physical)

Monitoring & Evaluation of asset is relatively difficult : Long gestation period . No direct correlation Cost allocation under common overhead .

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Expense Centres: Control Characteristics


Budget Preparation: For Engineered expense Centre, a proposed operating budget focuses on efficiently performing the task; For discretionary expense Centre, budget itself is the start of the financial control process. There are two approaches: o Incremental Budgeting & o Zero-based Reviews. Input Costs tend to be structural (semi-variable) in nature, so short-term control is difficult;.
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Profit Centre
A department /division in an organization responsible for generating specified quantum of profit form the activities it performs. The performance of the department is judged in terms of the profit it booked and cost it incurred. The divisional managers performance are measured on the profit objective they achieve. ( Profit target ) In an organization all products / category are treated as independent profit centre.
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Profit & Investment Centre ( Independent BU)


Inputs are related to Outputs
Profit Centre

Input (money as costs)

Output (money in profits)

Inputs are related to Capital Employed


Investment Centre

Input (money as costs)

Strategic Business Unit

Output (money in profits)

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Profit Centres: General Considerations


General Characteristics of Companies are:

At operating levels, all organizations are functionally structured. Divisional managers are delegated the responsibilities of cost benefit decisions and trade-off. Delegating responsibility to profit centre requires trade-offs between expenses & revenues, therefore prerequisites are: relevant information for effecting the trade-offs a device for measurement of effectiveness of decisions.
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Benefits of a Profit centre are:


increased

speed & quality of decision making;

greater delegation, better focus all around; increased profit orientation: consciousness & measurement; increased HR pool: specializations and training; specific information on performance of diverse parts; better service to target Customers & markets.
Currently, >70% of multi-product Companies have adopted the Profit Centre format within the BU structure, with a focus on financial control as the primary method for strategy implementation;
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However, there are difficulties with Profit Centres: some loss of top-management control at operational end; Competencies of Staff staffing dilemma; loss of cohesion within Organization: Sibling Rivalry; increased short-term profit focus unbalanced, tactical; poor and uncertain linkages between sub & overall optimization; additional costs due to redundancies. BUs autonomy limitations stem from synergy & control trade-off: Product/Market independence/interdependence; Financing/company-structure issues Share-holding, legal entity, global fit etc. PR, Brand-building, restructuring etc. Economies of consolidation; Constraints on long-term issues: R&D, Investments, Systems Sibling rivalry , silos operation , redundancy at multiple level
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Measurement of Profitability of profit center P/L statement: Revenue 1000


less Cost of Sales 780 ( Variable Cost
Control-level Possibilities Most elementary form of Profit with no control responsibility for Fixed Costs. More integral form of Profit with control responsibility for Fixed Costs in profit centre More integral form of Profit add discretionary responsibility for shared services. More integral form of Profit add limited responsibility for shaping Corporate structure Integrated form of Profit 41 highest level of responsibility.

Contribution Margin 220 less Fixed Exp.


90 Direct Profit

130

less Controllable Corp Charge 10

Controllable Profit 120


less Corp. allocation

Profit Centres:

The Marketing Function:


Considered as a Profit Centre if charged with the cost of products sold as input; Authorized as such when cost/revenue trade-offs are best assessed at the front-end viz., International Operations:
conditions and circumstances diverse for different centres act local - strategies difficult to assess centrally;

Convenient when sourcing from different centres for diverse products e.g. Transnational operations;

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Profit Centres:

The Manufacturing Function:


Usually, an expense centre: but for a more balanced approach (Quality, on-time delivery etc.) and for aggressive standard setting, converted to Profit Centre by affixing a price to transfer (internal sale) goods; Though imperfect, the transfer price mechanism is pragmatic tool; Convenient when it has more than one customer;

Service & Support units:


Current trends are to make service providers profit centres to support make/buy decisions; Allows for competitive functional excellence build-up through aggressive standard setting; Allows for revenues (Outside Customers) if worldclass levels of performance achieved.
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Human Behaviour & Management Control

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Organizational Behaviour & Management Control


Human Behavior must create a favorable organizational climate for Management control to influence employees towards achieving a firms Strategic Objectivee, i.e. Goal Congruence: Employees are led to take in their perceived self-interest are also in the interest of the firm:
Actions to motivate people to take in their own self interest? Actions in the best interest of the Organization?

Organizations Vision/Objective

Define KRA SBU Objective Define & Measure through KPI

Define KRA Employee Objective Define & 45 Measure through KPI

Formal and Informal processes influence human behavior in organizations. Informal processes need to be recognized since they are ill-defined and are both intrinsic and extrinsic to an Organization. Extrinsic Work Ethic: norms of desirable behavior that exist in the society of which the Organization is a part of.

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Intrinsic:
Culture: the set of common beliefs/attitudes/norms/links & relationships, implicitly or explicitly accepted. (Management) Style: The most dominant influencer, particularly the attitude of the (managers) superior to the Control system. Informal Organization: power distance & centres realities! Communication & Perceptions: Cooperation & Conflict:
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Organization Culture Managers, especially top managers, create the climate for the enterprise; their values influence the direction of the firm:

Values are fairly permanent beliefs about appropriateness and guides behaviours & actions towards goal attainment; Changing a culture, thus, can be time consuming (5~10 years) since understanding the deep biases take time.
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Increase Sociability by:


Promoting sharing of ideas, interests & emotions by recruiting like-minded people; Increase social interactions by organizing casual gatherings; Reducing formality between employees; Limiting hierarchical differences; Leader acting like a facilitator, setting example of kindness and caring for those in trouble.

Increase Solidarity by:


Developing awareness of competitors through briefings, mails, memos etc. Creating a sense of urgency a quasi-crisis; Stimulating a will to win spirit; Encouraging commitment to shared corporate goals.
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Management style the power of expectation


What managers expect of their subordinates and the way they treat them largely determine their performance and career progress; A unique characteristic of superior managers is the ability to create high performance expectations that subordinates fulfill; Subordinates, more often than not, appear to do what they believe they are expected to do!
You see, really and truly, apart from anything one can pick-up, the difference between a lady and a flower girl is not how she behaves but how she is treated. I shall always be a flower girl to Prof. Higgins because he always treats me as a flower girl and always will. But I know I can be a lady to you because you always treat me as a lady and always will. Eliza Doolittle from G.B.Shaws Pygmalion.
( reference: J.Sterling Livingston Pygmalion in management)
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Formal System: Influence of Organization Types

Strategy radically influences Organization Structure. This, in turn, significantly affects design of the Control System and its roll-out. Commonly encountered Organization structures are:
Strategic Business Units: Developed

to negate the ills and focuses onlines of Business with some limitations to autonomy, leading to closeness to Market. Generally, speed and effectiveness outweigh the cons of some redundancies and lower functional excellence.

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Matrix:

Currently popular for larger organizations to capture the advantages of both systems i.e. Functional excellence (traditional) and Effectiveness (BUs). Thus, organizations can: Avail of relevant (skill & experience) functional staff Drive for higher levels of functional excellence (Value Chain) Meet rapid shifts in relative needs of specialization, Without sacrificing the nimbleness of BU operations. However, suffers from: loss of clarity (unity of command) and complexity (multiple controls).

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If ease of control (profitability, unity of command etc.) were to be the only criterion, Companies would be organized into BUs whenever feasible. This is often an over-weighted factor, without considering: benefits of economies of scale from the functional structure; availability of mature managers with general management disposition; Thus in designing systems, the appropriate structure (driven by the environment) takes precedence over nature of control systems.

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Transfer pricing, issues of TP & management control system.

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Transfer Pricing
A business practice for satisfactorily (with profit) accounting of the transfer of goods & services between profit centers in a Company. It focuses on :

relevant trade-off between in-company costs and revenues for economic performance of individual profit centres; towards better goal congruence i.e. designed system must support better SBU profit & accountability in a simple to understand and easy to administer way.
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Benefit of T.P to the organization: Identify the unit contribution to the total profit. Encourage profit consciousness among managers Measure management performance. Maximize operating unit profitability Identify the areas of inefficiency Build value addition Facilitate & maximize de centralized decision making process Exercise effective management control.

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Transfer Pricing Policy


Transfer pricing practices adopted by the companies could be a possible tool for corporate abuse. A transfer pricing cases, causing transfer of economic resources to the related party at less than the comparable price necessitates for host of reasons like : evasion/avoidance of tax liability to siphon-off the resources. Transfer of resources to and from the related party should comply to arms length and at arms length price. Any exception to this should be a subject matter of close scrutiny, proper disclosure and effective accountability.
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Transfer pricing transactions, at present, are to be addressed through Accounting Standards, (AS) 18. The AS-18 came in the effect for the accounting periods commencing on or after 1st April, 2001. The Standard provides for disclosure of related party relationships, and certain particulars of transactions with the related parties, in case of listed companies, and companies whose turnover exceeds Rs. 50 crores.

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The application of Transfer Pricing . Under the Relevant rules, cost statement of each service (segment-wise and elements of cost) is Required to be given. The cost statement is also required to be submitted to the Audit Committee under Section 292A of the Companies Act, 1956. Separate audit of record of transactions (related party) and expression of opinion thereon. The record of transactions in the prescribed format to form part of the audit report. 1. Verification of the report on implementation on transfer pricing, by the separate auditor. 2. Disclosure in Directors Report/Annual Report: 3. Record of Transactions as per Schedule A. 4.Transfer Policy Statement (a comprehensive and detailed one).

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5.The aforesaid disclosure are to be given in the Directors Report along with those required under Accounting Standard 18 (disclosures as per AS 18 form part of accounts and, therefore, would require to be re-disclosed in the Directors Report.) 6.Directors certificate of compliance on Transfer Pricing

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Prominent issues of T.P are Divisional mangers tend to become more divisional profit centric than corporate profit centric. Lengthy disagreements on the T.P policy . Whenever the market prices are not available to bench mark , the decision process of convincing the T.P is difficult . De motivation arises when personal performance of a division gets affected due to improper T.P
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Transfer pricing- International business Multinational enterprises (MNEs) carry on business in more than one country either directly, through branches, or indirectly through subsidiaries. Whatever the form, the activities of an MNEs SBUs perform financial transactions between these units. The price at which goods, services or capital are exchanged between the related parties, the transfer price is determined by the transferpricing policies used within the related group.
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The transfer price received or charged for goods, services or financing will be included in the income of supplier, and the corresponding cost or payments will be deducted from the profits of the legal entity benefiting from the transaction and making the payments. Often the amount of these charges represents one of the largest inclusions or deductions in computing the income of one or both of the related parties.

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Governments, through their tax systems, have a vested interest in ensuring that appropriate profits are reported in their jurisdiction. Government concerns are high when one of the parties to a related-party transaction is subject to tax at a rate that is considerably less than that applying in the other related partys country. In addition to tax-rate pressures, other government pressures can be brought to bear on the transfer-pricing decision, including heavy penalties or restrictive measures dealing with related-party transactions.
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From a business perspective, following dimensions influence the decision what to charge for the inter company exchange of goods or services. 1. Compensation and performance may push in one direction . 2. Demand may push in another direction. 3. Tax considerations may push in a third.

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Types of transactions between MNEs that come under the scope of TP are : 1 Charges for administrative or management services . 2 Royalties and other charges for intangibles. 3 Transfer pricing for goods for resale. 4 Financing transactions. 5 Charges for technical services.
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Under an agreement of Organization for Economic Co- operation & Development (OECD) , 25 worlds leading industrialized countries, have stated their acceptance of the arms-length standard for setting inter-company transfer prices and have set out guidelines for methods that should be used in adhering to the standard.

The Policy States that a specific transfer pricing methods to be used for different classes of transactions with different parties with special emphasis on those transactions where a Comparable Uncontrolled Price/Transaction (CUP/CUT) method could not be adopted.
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There are three methods for determining T.P Market based TP. Top management of the company choose to follow the price for the product or service in accordance with the publicly listed price information. Cost based TP. It is determined on the basis of the cost of producing the product or service. Full cost of the product is assessed upon calculating all variable & fixed cost . It may use actual cost or budgeted cost & include markup ( margin ) as return on subunits investment. Negotiated T.P : Subunits are given the freedom & autonomy to negotiate the price in line with the ability to earn profit. In a highly volatile market , such practice is common in large enterprises. 68

Division A manufactures certain item and transfers it to div B which in turn add value and sell it in open market at Rs 200 per unit. The variable cost incurred by division B is Rs 30 per unit. It buys semi finished goods from A at Rs 120 per unit. As the competition dropped the price price for the finished goods in the market to Rs 180 , Division B initiated a negotiation with division A for Rs 100 per unit. The competition of B meanwhile approached division A and were ready to pay Rs 115 for per unit. The cost details of Div A is as follows : Fixed cost : Rs 5 lac VC per unit Rs 15 Production capacity : 10000 units If div A decides to sell to Bs competition , sales and distribution overhead estimated is Rs 10 per unit . Competition has assured to take all the output of division A. As a profit center head of Division A what decision would you take . At what TP will you sell items to division B ?

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What action will you initiate from the point of view of SBU head to ensure the corporate objective is being met ? What TP methodology will you recommend. ?

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Illustration: Hindustan Petroleums ( H.P) refinery & transportation unit operates as independent profit center. Transport unit supplies crude oil to refinery unit, which is processed & transformed in to gasoline by refinery unit. It takes two barrels of crude to convert one barrel of gasoline. Variable cost is computed for each division & fixed costs are based on budgeted annual output of each division. Transportation Unit : Purchase cost of crude oil from oil field: Rs 120/barrel VC /barrel Rs 10.00 FC/barrel Rs 30.00 Pipeline capacity to transport crude oil/day is 40,000 barrels .

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Refinery Unit : Refinery units selling price is Rs 580/barrel. VC /barrel Rs 80.00 FC/barrel Rs 60.00 Operating capacity /day = 30000 barrels ( Consumes an average of 10000barrels /day supplied by transport division & 20000 barrels /day bought from outside @ R210/barrel locally. Using all three methods calculate TP, & compare the operating income of H.P Suggest what should be an appropriate managerial decision .

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Operating Income of HP with 100 barrels under alternative T.P Methods. @ Market Price Transport unit Revenue Purchase cost
VC ( 10X100) F.C 30 x100 210X100=21000 120x100= 12000 1,000 3000 5000

@ full cost with 10% margin


17,600 12000 1000 3000 1,600

@ Negotiated Price
19200 12000 1000 3000 3,200 29000 19200 4000 3000 2800
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(120+10+30)x1.1

Unit operating income Refining Unit Revenue (580 x 50) Transferred in cost
VC

FC Operating Income

29000 21000 4000 3000 1000

29000 17600 4000 3000 4400

When market price of crude oil fluctuates( upward or downward) , it will have an impact on the operating income of transportation unit. In such a given market situation, both division would like to negotiate an acceptable & stable long term TP. price . The price per barrel of crude oil drops to Rs 160.

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Operating Income of HP with 100 barrels under alternative T.P Methods. @ Market Price Transport unit Revenue Purchase cost
VC ( 10X100) F.C 30 x100 210X100=21000 120x100= 12000 1,000 3000 5000

@ full cost with 10% margin


17,600 12000 1000 3000 1,600

@ Negotiated Price
19200 12000 1000 3000 3,200 29000 19200 4000 3000 2800
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(120+10+30)x1.1

Unit operating income Refining Unit Revenue (580 x 50) Transferred in cost
VC

FC Operating Income

29000 21000 4000 3000 1000

29000 17600 4000 3000 4400

Methods Of Computation T.P shall be determined by any of the following methods, being the most appropriate method, having regard to the nature of transaction or class of transaction, namely :(1) Comparable Uncontrolled Price Method (2) Resale Price Method (3) Cost Plus Method (4) Profit Split Method (5) Transactional Net Margin Method (6) Any other basis approved by the Central Government, which has the effect of valuing such transaction at arms length price.
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Comparable Uncontrolled Price (CUP) Method : ( Negotiated Transfer price.) The price charged or paid in a comparable uncontrolled transaction or a number of such transactions shall be identified , between the related party transaction and the comparable uncontrolled transactions or between the enterprises entering into such transactions, which could materially affect the price in the open market. The adjusted price shall be taken as arms length price.
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The resale price method would normally be adopted where the seller adds relatively little or no value to the product or where there is little or no value addition by the reseller prior to the resale of the finished products or other goods acquired from related parties. This method is often used when goods are transferred between related parties before sale to an independent party.

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Cost based Method : The total cost of production incurred by the enterprise in respect of goods transferred or services provided to a related party shall be determined. The amount of a normal gross profit mark-up to such costs arising from the transfer of same or similar goods or services by the enterprise or by an unrelated enterprise in a comparable uncontrolled transaction or a number of such transactions, shall be determined. The total cost of production referred to above increased by the adjusted profit mark-up shall be taken as arms length price. 79

The cost plus method would normally be adopted if CUP method or resale price method cannot be applied to a specific transaction or where goods are sold between associates at such stage where uncontrolled price is not available or where there are long term buy and supply arrangements or in the case of provision of services or contract manufacturing.

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Profit Split Method : The combined net profit of the related parties arising from a transaction in which they are engaged shall be determined. This combined net profit shall be partially allocated to each enterprise so as to provide it with a basic return appropriate for the type of transaction in which it is engaged with reference to market returns achieved for similar types transactions by independent enterprises. The residual net profit, thereafter, shall be split amongst the related parties in proportion to their relative contribution to the combined net profit.
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This relative contribution of the related parties shall be evaluated on the basis of the function performed, assets employed or to be employed and risks assumed by each enterprise and on the basis of reliable market data which indicates how such contribution would be evaluated by unrelated enterprises performing comparable functions in similar circumstances. . The profit so apportioned shall be taken into account to
arrive at an arms length price . This method would normally be adopted in those transactions where integrated services are provided by more than one enterprise or in the case multiple inter-related transactions which cannot be separately evaluated.
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Transactional Net Margin Method : The net profit margin realised by the enterprise from a related party transaction shall be computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base. The net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions, shall be computed having
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regard to the same base. This net profit margin shall be adjusted to take into account the differences, if any, between the related party transaction and the comparable uncontrolled transactions or between the enterprises entering into such transactions, which could materially affect such net profit margin in the open market .
This method would normally be adopted in the case of transfer of semi finished goods.; distribution of finished products where resale price method cannot be adequately applied; and transaction involving provision of services.

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Birch paper company Case 6.2


Divisions :Thomson Div Northern Div Southern Timber Div Div RM

Custom made boxes & label. Liner board & corrugated box

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Northern Division Price : $480/ Th Thomson $430/Th West paper $432/Th Eire paper 90 30 164.5 ( 254.4 - 90 (comparable internal cost ) 284.5

Cost material 280 cost ( 70%) Label 25 Other cost 95 Total cost $ 400

Loading 20% margin on cost , Thomson division can be much more competitive than the prevailing market price , if it is able shed the excess unproductive cost. Using market price as a bench mark , 430- 284.5 = 145.5 is the 86 potential market opportunity for Thomson division.

ACTIVITY BASED COSTING & PROFIT CENTER

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Traditional financial reporting does not reveal a separate profits and losses of products or customers for three reasons: (1) It examines and reports department-level expenses but not the work-efforts within a department that matter . (2) The in-direct product and non-base-service costs are usually allocated using broad averaging approach ( Peanut Butter costing ) but not traced to respective products or base services . (3) Customer-related activity costs are rarely isolated and directly charged to the specific customer segments causing these costs. As business units have been restructured in profit center & product , service & customer diversity increased, above approach proved to be inaccurate method of assigning .
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Today, selling, merchandising, and distribution costs are no longer trivial coststhey are sizable. For example, it now costs General Motors more to sell its trucks and cars than to make them! A high-tech semiconductor manufacturer discovered that it was making roughly 90 percent of its profits from 10 percent of its customers. That alone is not unusual, but it was losing money on half of its customers. Upon discovering this, this manufacturer could alter their own approach to lessen the loss so that a fair profit could be attained.

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Traditional financial reporting does not reveal the separate profits and losses of products or customers for three reasons: 1) It examines and reports department-level expenses but not the work-efforts within a department that matter. 2) The in-direct product and non-base-service costs are usually allocated but not traced to products or base services. 3) Customer-related activity costs are rarely isolated and directly charged to the specific customer segments causing these costs.
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Therefore , in financial accounting terms, the costs for selling, advertising, marketing, logistics, warehousing, and distribution are immediately charged to the time period in which they occur. Consequently, the accountants are not tasked to trace them to channels or customer segments. As selling, merchandising, and distribution costs are sizable, a firm must allocate the expenses to the respective head to analyze the true profit generated by the product line. As an example, For General Motors it costs more to sell its trucks and cars than to 91 make them!

As an example, a high-tech semiconductor manufacturer performed ABC/M and discovered it was making roughly 90 percent of its profits from 10 percent of its customers. That alone is not unusual, but it was losing money on half of its customers. Upon discovering this, this manufacturer explained to some of its unprofitable customers how those specific customers could alter their own behavior to lessen the workload on the manufacturer so that a fair profit could be attained. The remaining unprofitable customers were fired, asked to take their business elsewhere because it was evident their was little hope their sales would cover their costs. Thus manufacturers sales levels dipped, but profits tripled.
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The lesson from this example is that there is a quality of profit associated with sales volume and product mix. There should be a focus on the customer contribution margin devoid of simplistic cost allocations. There is a red-flag warning from this: Two traditionally popular measures market share and growthcan potentially be dangerous in the new order of competition. This is because organizations now realize that there can be a sizable unprofitable segment of products, service lines, and customers in the mix.

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Products Category Lifebuy Liril Lux Dove

Cost ( Rs) Selling sales Reverse packaging Total overhead promotion logistics 270 110 0 40 120 200 150 140 80 40 40 140 80 60 120 145 165 540 415 405

Over costing Under costing

Total 600 160 320 550 1630 Average 150 + 40 + 80 + 137.5 = 407.5 Cost allocation Cost analysis revels that average apportion of cost leads to cross subsidization. Lirils cost getting heavily subsidized by 94 lifebouy.

Profit center cost Management Peanut butter costing to Activity based costing Bill of Cost activities Profit /Loss of profit center = incurred in profit center 1. Identify the direct & indirect cost associated to product , service , staff & cost involved in serving specific customer of the division. ( Cost Pool) 2. Identify cost allocation bases for allocating indirect cost to cost base. 3. Identify total indirect costs associated to each base. 4. Compute cost per unit of product or service.
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Revenue of a Profit center -

Revenue of a Bill of Cost activities Profit center - of profit center ( Price X Volume )

Profit /Loss = incurred at profit center

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Direct Costs In Direct Cost Pool Cost Allocation Bases Total Hrs X Hrly production Rate no. of trips X Cold chain transport Cost Specialized material handling equipments hired

Total Direct Costs + Bill of activities cost

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See Vision has been a pioneer in cosmetic contact lenses. The produce simple lens called S3 & cosmetic contact lens called CCL 5. Company has historically simple costing system . Annual production of lenses are as follows : 60000 S3 & 15000 CCL5 . As a practice , total material & manufacturing costs are divided by total budgeted production volume. Cost elements for : S3 ( Rs) Cost elements for CCL5 ( Rs) Material : 1,12,50,000 67,50,000 Manufacturing 60,00,000 19,50,000 Labour To allocate the following costs to S3 & CCL5 , company uses manufacturing labour- hour as an allocation base. Estimated manufacturing labour hour is 39750 Hrs. ( 30000 ML Hr for S3 & 9750 M-L-Hr for CCL5 )
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Total budgeted cost for salary , Administration, Sales , distribution Customer service , promotion, adds to Rs 2,38,50,000. SeeVisions selling price for S3 is far more than that offered by its immediate rivals price of Rs 530. Management countered it by saying that the technology & process are inefficient in manufacturing & distribution. However management is not convinced as they have years of experience in S3 . They often make process improvement . Kaizan initiative is used to drive manufacturing process. However management has less experience in CCL5 as it started it recently . Management is surprised to know that the market finds its CCL5 prices fairly competitive. At its price point , organization earns large profit margin on CCL5. Ever since See Vision restructured its business as profit center units, business managers of S3 are de 99 motivated & has low morale.

Revenue breakup from S3 & CCLS5 is s follows : S3 Rs 3,78,00,000 & CCL5 Rs 2,05,50,000 Business unit head is less certain about the accuracy of the costing system & measuring the overhead resources used by each type of lens. The finance manager of the division has been empowered with any system of cost control to improve the profitability of the division. 1. As a finance manger of the division , how would you approach the issue. 2. What additional inputs are required by you to convince CFO & Business unit head. 3. At what operating margin is S3 currently doing their business.
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S3 Lens Volume : 60000 Units Per unit Material 1,12,50,000 187.5 Manufacturing 60,00,000 100 labour Total 287.5 Indirect cost 1,80,00,000 300. Total cost 3,52,50,000 587.5

CCL5 Lens 15000 Units 67,50,000 19,50,000 58,50,000 1,45,50,000 Per unit 450 130 580 390 970

Indirect cost rate = 2,38,50,000/ 39750= Rs 600 For S3 : 600 X 30000= 1,80,00,000/60000=300 For CCL5 :600 X 9750 = 58,50,000/15000=390

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S3 Lens ( 6000units) Revenue: Cost Operating Income Profit margin%

CCL5 Lens ( 15000 units) per unit per unit 3,78,00,000 630 2,05,50,000 1370 3,52,50,000 587.5 1,45,50,000 970 25,50,000 42.5 60,00,000 400 6.74 29.19

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Activity based costing approach for See Vision. Manufacturing labour hour has little effect on overhead resources . Identifying indirect cost pool : Set up activity at production for manufacturing each type of lens . Resources required for CCL5, like molding machines , cleaning time , small batch production adds to more resources per setup. Set up data for : S3 CCL5 Volume 60000 15000 Output/batch 240 50 No of batch 250 300 Setup time 2 hr 5hr Per batch Total Hr 500 1500
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Set up data for : S3 Volume 60000 Output/batch 240 No of batch 250 Setup time 2 hr Per batch Total Hr 500

CCL5 15000 50 300 5hr 1500

Total cost of set up comprises of cost of process engineers , quality engineers , supervisors , & equipment used adds to Rs30,00,000 . (30,00000/2000) x 500= 750,000 (30,00,000/2000) x 1500= 22,50,000 Other cost drivers identified having impact are packing & shipment cost , distribution cost , administration cost .
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S3 Lens Volume : 60000 Units Per unit Material 1,12,50,000 187.5 Manufacturing 60,00,000 100 labour Mold cleaning 12,00,000 20.00 & Maint Total dir cost 1,84,50,000 307.5 Indirect cost Design 13,50,000 22.5 Setup 7,50,000 12.5 Mold 45,00,000 75 Operation Shipping 4,05,000 6.7 Distribution 26,10,000 43.5 Admin 19,24,530 32.1 Total cost 2,99,89,530 499.8

CCL5 Lens 15000 Units 67,50,000 19,50,000 15,00,000 Per unit 450 130 100

1,02,00,000 680 31,50,000 390 22,50,000 150 18,75,000 125 4,05,000 13,05,000 6,25,470 198,10,470 27 87 41.7 1320.7

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Budgeting & Budgetary Control.


Budgets are integral part of management control system . When administered systematically , budgets Promote Coordination & communication among sub units with the company. Budget estimates the profit potential of a BU . Provides framework for judging the performance Creates motivation & involvement within managers .

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It provides monetary & non monetary indicators to the managers for effective decision making in line with the goal of the BU. It is reviewed periodically by the concern managers for necessary action & strategy. It forms the basis for Financial budgets like :

Capital expenditure budget Budgeted balance sheet Cash Budget Budgeted cash flow statement .
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An operating budgets is prepared for a fiscal year . It is split in to half yearly, quarterly, or monthly for easy administration & control. If the business is highly driven by seasonality , it is desired that the budgets are made for peak & lean season. Once approved , it is only changed under specific conditions. Budgets are compared with the actual financial performance achieved during the period for taking necessary financial control.

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Revenue Budget Inventory Budget Production Budget

Direct Manufacturing labor, Material cost , Manufacturing overhead COG Sold Budget R&D , Marketing , Distribution , Customer Service Administrative cost Budgeted Income Statement Financial Capital Budget Cash Budget Budgeted cash flow 109

Preparation of master budgets : operation Budget, created after taking & having debated sufficiently with the line managers & functional managers are used for preparing master budget . Outcome of operation budgets is budgeted income statement for the fiscal year. Cash budget is prepared from this statement , which is used for planning capital expenditure budget , Cash flow statement & budgeted balance sheet . The decision of the organization as how much to source fund ( Source of fund : External equity , Debt, Reserve fund ) for capital expenditure can only be known form budgeted income statement .
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Operational budgets include : I. Revenue budgets : Projected Sales Projected volume ( Non Financial )
FY08-09 Product 1 Product 2 Vol Av selling price Revenue X Y XxY A B AxB ___________________________

Total Since input for revenue budgets is drawn form sales forecast, an in accurate sales forecast leads to upset the budget plan of the BU. Control : Measured periodically by revenue center head ( Sales & Marketing Head ) . BU finance head reports the variation in plan Versus actual to the profit center head for necessary action. Action : Revise overhead budgets , non financial budgets etc.
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Flexible budgets must help the mangers to evaluate & control variances in price & efficiency with respect to cost measures. Management by Exception is the practice of concentrating on areas not operating as expected. Information gained out of variances are used for reallocating resources & seek manager explanation for early correction. Budgeted revenue & budgeted costs are compared against the actual in the same budget period. On the basis of this, a deviation statement ( flexible budget statement ) is prepared & reported to the concern managers. This also forms a basis for variable compensation component of the managers & his team popular in industry as MPLC.
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If budgeted selling price is Rs 1200 /unit & budgeted variable costs are Rs 880 & budgeted Fixed costs are 2,60,000. for planned volume of 12,000 units. At the end of the month sale is 10000, the variance analysis can be as follows: Direct Material cost = Rs 600/unit Direct labour = Rs 160/ unit Overhead = Rs 120 /unit

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Sales- Volume Variance analysis report for Q1 April 2008 .


flexible Sales Vol Static budget Variance budget ___________________________________________________________ 10000 0 10000 2000U 12000 5,00,000F 2,16,000U 3,80,000U 1,05,000 U 7,01,000U 2,01,000 U 1,20,00,000 60,00,000 16,00,000 24,00,000U 12,00,000F 3,20,000F 1.44 Cr 72 L 19.2 L 14.4 L 38.4 L
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Actual

Variance

Units sold Revenue 1,25,00,000 Dir Mat D-M-L 62,16,000 19,80,000

Mfg O/H 13,05,000 Total 95,01,000 1,05,60,000 Cont 29,99,000 Margin

12,00,000 2,40,000 F 88,00,000 17,60,000F 32,00,000 6,40,000U

Ratios are most powerful tool financial analysis & control. It helps to know the divisions ability to meet current obligation. Firms ability to use long term solvency b borrowing funds. Efficiency with which the firm is utilizing its asset in generating sales revenue Overall operating efficiency & performance of the firm. Control role of ratios: Ratio analysis raise pertinent questions on a number of managerial issues. It provides basis for to investigate such issues in micro detail. To prevent from being misled by ratio , managers must do trend analysis & competitive analysis before arriving at any conclusion.
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What mangers should focus while using Ratios : Profitability analysis : Is return on equity due to ROI , Financing mix or capitalization for reserves. What is the trend of profitability & compare it with like market factors . Is it improving because of better utilization of resources or curtailment of expenses. Asset utilization : How effectively the company utilize the assets in generating sales. Are the levels of debtors & inventories relative to sales acceptable ,given the competitive environment & operating efficiency.
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Liquidity analysis : What is the level of CA relative to CL . Is it acceptable , given the nature of the business. How fast it converts it current asset in to cash. What is the desired mix of debt & equity . Accordingly , the managers may use : Liquidity ratio Leverage ratio Activity Ratio Profitability ratio

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The total sales of cement division of India Cement is Rs 6,40,000 & its gross profit margin is 15% . The division is operating at sustained current ratio of 2.5 . Its Current liabilities: Rs 96000 Current asset 1 Inventories Rs 48000 II Cash Rs 16000 Average inventory carried by the division : Rs 1,20,000 Inventory turnover : 5 Opening balance of debtors is 80,000 & competitive analysis by ETIG shows that average collection period for cement business is 60 days . BUH has a guideline for maximizing he profit . While there is much scope to increase the price , he feels division should operate more efficiently & eliminate operating inefficiency. You have been asked to analyze & prepare a financial report .
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Inventory turn over = Average collection Period =

COG Sold / Av Inventory (Av Debtors / Credit sales )x 365

Av debtors = (OP Debtor + Cl Debtors) / 2 For closing balance of debtor , find Current asset . Less Inventory & Cash

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Investment center Decisions

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ROI Problems
Feed the Dogs ( Over Investment ) Starve the Stars ( Under Investment )
High STAR Relative Market Growth Low High Market Share Low
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PROBLEM CHILD DOG

CASH COW

EVA Basic Premise Managers are obliged to create value for their investors Investors invest money in a company because they expect returns There is a minimum level of profitability expected from investors, called capital charge Capital charge is the average equity return on equity markets; investors can achieve this return easily with diversified, long-term equity market investment Thus creating less return (in the long run) than the capital charge is economically not acceptable (especially from shareholders perspective) Investors can also take their money away from the firm since they have other investment alternatives

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EVA is the gain or loss that remains after assessing a charge for the cost of all types of capital employed. What an accountant calls profits in an income statement includes a charge for the debt capital employed which is commonly referred to as interest expense. However, an income statement does not include a charge for the equity capital that was employed during the accounting period. Therefore, EVA goes beyond conventional accounting standards by including a provision for the cost of equity capital. The cost of equity needs to be factored into business investment decisions in order to enhance shareholder value.

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Although EVA is couched in financial analysis, its primary purpose is to shape management behavior. EVA can be used as a performance measure to evaluate an overall company, a division within a company, a location within a division, or an individual manager. By setting goals, EVA can become a motivational tool at various levels of management. EVA can also be used in downsizing decisions.

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EVA and Corporate Culture Paying managers for performance is a backward-looking practice, but the capital markets assign value on a forward-looking basis. Therefore, companies that pay for past performance may be unwittingly paying their managers to undermine value creation. When EVA-related performance measurement process is implemented throughout your company, all affected employees need to understand the goal, as well as how their actions contribute to meeting it. In this respect, the EVAs popularity parallels the 1980s total quality management trend. Like quality, value is every employees responsibility. To this end, management and employee training programs are a crucial component of any EVA plan.
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What is Needed to Calculate Companys Economic Value Added (EVA)? Only following the information is needed for a calculation of a companys EVA: Companys Income Statement Companys Balance Sheet

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Illustration: Income Statement Net Sales 2,600.00 Cost of Goods Sold 1,400.00 SG&A Expenses 400.00 Depreciation 150.00 Other Operating Expenses 100.00 Operating income Interest : Income Before Tax Income Tax (40%) 550.00 200.00 350.00 140.00

Net Profit After Taxes 210.00 Add Interest 200.00 NOPAT 410.00

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Illustration: Balance Sheet


Current Assets Cash 50.00 Receivable 370.00 Inventory 235.00 Other Current Assets 145.00 Total current Assets 800.00 Fixed Assets Land 650.00 Equipment 410.00 Other Long Term Assets 490.00 Total Fixed Assets 1,550.00 TOTAL ASSETS 2,350.00 Current Liabilities Accounts Payable Accrued Expenses Short-Term Debt

100.00 250.00 300.00

Non Interest Bearing Liabilities

Total Current Liabilities 650.00 Long-Term Liabilities Long-Term Debt 760.00 Total Long-Term Liabilities 760.00 Capital (Common Equity) Capital Stock 300.00 Retained Earnings 430.00 YTD Profit/Loss 210.00 Total Equity Capital 940.00 TOTAL LIABILITIES 2,350.00
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CCRDebt = [Debt/(Debt+Equity)](1-t) Where t represents the


companys tax rate.

+
CCREquity = Equity/(Debt+Equity) Capital Cost Rate (CCR) will be : Assume owners expect 13 % return* for using their money because less are not attractive to them, therefore, company has 940/2350 =40% (or 0.4) of equity with a cost of 13%. Company has also 60% debt and assume that it has to pay 8% interest for it. So the average capital costs would be: CCR ** = Average Equity proportion * Equity cost + Average Debt proportion * Debt cost = 40% * 13% + 60% * 8% = 0.4 * 13% + 0.6 * 8% = 10%
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** Note: if tax savings from interests are included (as they should if), then CCR would be: CCR = 40% * 13% + 60% * 8% *(1- tax rate) = 0.4 * 13% + 0.6 * 8% * (1 - 0.4) = 8.08 % (Using 40 % tax rate)

Companies paying high taxes and having high debts may have to consider tax savings effects, by adding the tax savings component later in the capital cost rate (CCR)

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Identify Companys Capital (C) Companys Capital (C) are Total Liabilities less Non-Interest Bearing Liabilities: Total Liabilities 2,350.00 less Accounts Payable 100.00 Accrued Expenses 250.00 ---------------------------------Capital : 2,000.00

[ No interest cost incurred on these Liabilities. ]

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EVA = NOPAT - C * CCR = 410.00 - 2,000.00 * 0.10 = 210.00 This company created an EVA of 210. Note: this is the EVA calculation for one year. If a company calculates & reports EVA in its quarterly report ,then its capital costs will be : Q1 Capital costs for 3 months: 3/12 * 10% * 2,000 = 50 Capital costs for 4 months: 4/12 * 10% * 2,000 = 67 Q2 Capital costs for 6 months: 6/12 * 10% * 2,000 = 100 Q3 Capital costs for 9 months: 9/12 * 10% * 2,000 = 150

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To estimate the cost of capital for a small company, a method derived from the WACC estimation and the CAPM( capital Asset Pricing ) model is called cost of capital cost rate CCR . . The CCR for a small company can be estimated as follows: CCRDebt = Prime Rate + Bank Charges

Where the average Bank Charges for small companies vary between one to two percent per year. CCREquity can be estimated as follows: CCREquity = RF + RP Where RF is the risk free investment rate and RP is the risk premium investment rate. RF can be estimated using a yieldto-maturity rate for government bonds. In contrast, RP reflects the risk resulting from investing in a companys equity. The riskier the investment, the higher the RP.
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General Guide line for RP 6 % and less Extremely low risk, established profitable company with extremely stable cash flows. 6 % - 12 % 12 % - 18 % Low risk, established profitable company with relative low fluctuation in cash flow. Moderate risk, established profitable company with moderate fluctuation in cash flow 18 % and more High business risk

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Income statement

Balance Sheet

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Cost of Capital Rate (CCR) Assume that the current Prime Rate is eight percent and that Pitt Products is paying one percent by borrowing new money, independent if they ask for short-term or long term debt.

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In this case, the pre-tax CCRDebt will be : CCRDebt = Prime Rate + Bank Charges = 8% + 1% = 9% Assume that the yield-to-maturity of 10-year government bonds is five percent. Pitt . Products management, believe that RP of seven percent is adequate because its business . CCREquity = RF + RP = 5% + 7% = 12% CCR = 9 % (600/(600+600))(1- 0.4) + 12 % (600/(600+600)) = 2.7% + 6% = 8.7%
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Assume that in Pitt Products case that all financing will be made using owners equity. Thus, no interest expenses will be incurred. However, with this financing approach, tax savings are lost. Therefore ,its profit will increase by the interest savings component, less the tax shield on interest expenses. Tax shield, or tax savings, on interest expenses can be estimated by multiplying the interest expenses by the tax rate. In addition, owner-managers stated that they regard approximately 50,000 of their salaries as a kind of compensation for their investment in the company. Because Pitt Products income statement does not show categories, such as Research & Development, marketbuilding outlays, employee training, unusual write-offs or gains, there were no further adjustments needed. Hence e NOPAT is NOPAT = (Net Profit after Tax + Total Adjustments) Tax Savings on Adjustments = 192 + (42 +50) (42 +50) x 0.4 = 248.4

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Calculation of EVA is must for internal reporting for all investment centers.
Permanent EVA improvement has to be the main management objective EVA has to be calculated periodically (at least every three months) Changes in EVA have to be analyzed EVA development is the basis for a companys financial and business policy Try to improve returns with no or with only minimal capital investments . Invest new capital only in projects, equipment, machines able to cover capital cost while avoiding investments with low returns Identify where capital employment can be reduced Identify where the returns are below the capital cost; divest those investments when improvements in returns are not feasible .

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Creating an EVA-based Compensation Plan The four primary factors in creating a compensation plan are: 1. Align management performance and shareholder value. 2. Create strong wealth leverage, so employees work hard and make difficult decisions. 3. Employee retention risk, particularly in bear markets or industrial slumps, when performance-based compensation may decrease through no fault of the employee. 4. Cost of the compensation plan to shareholders.

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Like other financial performance measures, such as return on investment (ROI), EVA, on its own, is inadequate for assessing a companys progress in achieving its strategic goals and in measuring divisional performance. Other more forward-looking measures, often non-financial in nature, should be included in regular performance reports to provide early warning signs of problem areas . Another problem of EVA is that it is distorted by inflation, with the result that it cannot be used during inflationary times to estimate actual profitability. A superior measure, the adjusted EVA, corrects for inflationary distortions .
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INVESTMENT CENTER MANAGEMENT MILESTONES.


Enjoy leadership in business

Integrate Long term Financial goal With key process Initiative

Initiate necessary changes at business operation process & people level.

Control & Compliance Track , Measure & audit Financial and operational Performance

Drive internal Process using IT

Clearly define expectation Set role models , examples Within the business

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1. Creates a bridge between Strategy, KPIs, operational

measures and outcome measures. 2. Includes non-project Investments. 3. Focuses on organizational affordability and aggregate risk. 4 . Brings together the process disciplines of integrating Finance, operational efficiency and outcome measures linked to business objectives and Change Management . 5. Assists Executives to make choice and trade-offs between competing and non competing options to align with business goals.

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Monetary Value Added 1. Accounting Value 2. Economic Value Added 3. Market Value Added Non-Monetary Value Added 1. Human Resource Value Added 2. Intellectual Value Added Customer Satisfaction 1. Price 2. Satisfaction Index 3. Quality 4. Service Learning & Growth 1. Technology Leadership 2. Research and Development 3. Market Leadership 4. Cost Leadership

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Concept of Balance Score Card.

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Competence and Learning perspective.

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Audit : Compliance & Control Why Audit ? For Compliance & Control . What is to be audited ? 1.Financial performance Audit 2. Process Audit 3 People Audit 4 Knowledge Audit

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The Audit Committee is created by the Board of Directors of the Company to assist the Board in maintaining the integrity of the financial statements and internal controls of the Company, the qualifications, independence and performance of the Companys independent auditor, the performance of the Companys internal audit function, compliance by the Company with legal and regulatory requirements; prepare the audit committee report that Securities and Exchange Commission rules require to be included in the Companys annual statement.

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Financial Statements; Disclosure and Other Risk Management and Compliance Matters 1. The Audit Committee shall review and discuss with management: (a) the annual audited financial statements, including the Companys disclosures under Managements Discussion and Analysis and Analysis of Financial Condition and Results of Operations, prior to the filing of the Companys quarterly financial statements. (b) any analyses or reports prepared by management, the internal auditors and/or the independent auditor setting forth significant accounting or financial reporting issues and judgments made in connection with the financial statements, including critical accounting estimates analyses of the effects of alternative GAAP methods on the financial statements
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(c) the effect of regulatory and accounting initiatives or actions, off-balance sheet structures and related party transactions on the financial statements of the Company; and any major issues regarding accounting principles and financial statement presentations, including any significant changes in the Companys selection or application of accounting principles .

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With regard to material non-listed subsidiary companies Clause 49 stipulates the at least one independent director of the holding company to serve on the board of the subsidiary. The audit committee of the holding company should review the subsidiarys financial statements particularly investment plans. The minutes of the subsidiarys board meetings should be presented at the board meeting of the holding company and the board members of the latter should be made aware of all significant (likely to exceed in value 10% of total revenues/expenses/assets/liabilities of the subsidiary) transactions entered into by the subsidiary.

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Internal Audits : Compliance with management controls System and process improvements Financial impropriety and fraud audits Due diligence for acquisitions and investments

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The areas where Clause 49 stipulates specific corporate disclosures are: (i) related party transactions; (ii) accounting treatment; (iii) risk management procedures; (iv) proceeds from various kinds of share issues; (v) remuneration of directors; (vi) a Management Discussion and Analysis section in the Annual report discussing different heads of general business conditions and outlook; (vii) background and committee memberships of new directors as well as presentations to analysts. In addition a board committee with a non-executive chair should address shareholder/investor grievances. .
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The CEO and CFO or their equivalents need to sign off on the companys financial statements and disclosures and accept responsibility for establishing and maintaining effective internal control systems. The company is required to provide a separate section of corporate governance in its annual report with a detailed compliance report on corporate governance. It should also submit a quarterly compliance report to the stock exchange where it is listed. Finally, it needs to get its compliance with the mandatory specifications of Clause 49 certified by either the auditors or practicing company secretaries.
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The system of internal control An internal control system encompasses the policies, processes, tasks, behaviors and other aspects of a company that, taken together: facilitate its effective and efficient operation by enabling it to respond appropriately to significant business, operational, financial, compliance and other risks to achieving the companys objectives . This includes the safeguarding of assets from inappropriate use or from loss and fraud, and ensuring that liabilities are identified and managed; help ensure the quality of internal and external reporting. This requires the maintenance of proper records and processes that generate a flow of timely, relevant and reliable information from within and outside the organization; help ensure compliance with applicable laws and regulations, and also internal policies with respect to the conduct of business.
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