An organization’s accounting staff prepares financial statements for use by outsiders, and cost analyses for use by line managers and senior management.1 The accounting staff also undertakes ad hoc analyses of cost and revenue data—usually of a differential nature—for internal use in making alternative-choice decisions. These analyses frequently are done in conjunction with senior management and line managers, so that they meet their needs.
Preparation of both routine reports and ad hoc analyses are accounting activities that help managers to assure the profitability of the organization. However, a third kind of information is necessary to assist in ongoing management. This is the information that is generated and provided to managers via the management control system. Its focus is on the distinction between cost that are controllable by a manager and those that are not.
In its broadest sense, a management control system is concerned with planning and controlling, rather than measuring the resources used in an organization. Clearly measurement is important to planning and control, so the two cannot be completely divorced. Nevertheless, our focus in this Note will be on planning and control. To discuss these topics, we must consider both the structure of an organization’s management control system as well as the process followed in its use. These terms will be defined and expanded upon in the Note.
ORGANIZATION OF THE NOTE
The Note begins with an analysis of the relationship between cost accounting and management control systems, which allows us to explore the distinction between measurement and control. We then look at the various factors that must be considered in the design and use of a good management control system.
We then turn to the management control structure, which consists of an organization’s network of responsibility centers. We discuss the different types of responsibility centers, and assess the rationale for choosing one type over another. We also relate the management control structure to the incentives of managers, arguing that one of the principal objectives in designing a management control system is to attain congruence between senior management’s goals for the organization, and the personal goals of operating managers. We examine this in a number of different areas, but especially in the context of transfer prices and investment decisions.
Next, the Note turns to the topic of the management control process, breaking it into four separate phases: programming, budgeting, operating and measuring, and reporting and evaluation. We look at each phase separately, discussing its characteristics and its relationship to the other phases.
The Note concludes by emphasizing the contingency notion of management control systems, i.e., that there is no one right management control system. Rather, a management control system must fit with the organization’s strategy and structure. The learning objectives for the Note are contained in Exhibit 1.
Exhibit 1. LEARNING OBJECTIVES
Upon completing this Note, you should know about:
- The relationship between cost accounting and management control.
- The definition of a responsibility center, the different responsibility center options, and the basis for choosing the most appropriate type of responsibility center.
- The relationship between the management control structure and managers’ incentives.
- The definition of a transfer price and its role in a management control system.
- The meaning of the term residual income, and its use in a management control system.
- The four phases of the management control process and the characteristics of each.
1 Senior management are people at the top of the organization’s hierarchy. They are responsible for seeing that the organization accomplishes its objectives. They generally formulate the organization’s overall strategic directions, sometimes with assistance from line management. Line managers are those persons who are responsible for the day-to-day operations of the organization’s programs and responsibility centers. They are the persons whose judgments are incorporated into the organization’s plans, who must see to it that those plans are implemented, and whose performance is measured by the management control system. They sometimes are called operating managers. Staff, includes individuals who collect, summarize, and present information that is useful in the management control process. Although they may be large in numbers, they do not make significant decisions for the organization.