Page 87 - DMGT514_MANAGEMENT_CONTROL_SYSTEMS

Management Control Systems

Notes as reported on the financial statements, as constituting the “name of the game”.
Consequently, they do not favour an internal system that uses a different method of
“keeping score”, regardless of its theoretical merits.
7. Long-term debts: Ordinarily, a business unit receives its long-term/permanent capital
from the corporate pool of funds. The corporates obtain these funds from long-term debts,
from equity investors and from retained earnings. To the business unit, the total amount
of these funds is relevant, but the sources from which they are obtained are irrelevant. In
unusual situations, however, a business units financing may be peculiar to its own situation.
8. The capital charge: The rate used to calculate capital charge is set by corporate office. It
should be higher than the corporate rate for debt financing because funds involved are a
mixture of debt and higher cost of equity. Usually, the rate is set somewhat below the
company’s estimated cost of capital so that residual income of an average business unit
may be above zero.
In theory, we can use different rates for business units with different risk characteristics,
though in practice, this is rarely done. Some companies use a lower rate for working
capital than for fixed assets. This is based on the judgement that working capital is less
risky than fixed assets since the funds are committed for a shorter time period. In other
cases, the lower rate is used since company is including inventory and receivable in the
investment base at the gross amount without a deduction for accounts payable (which has
zero interest).

Self Assessment

Multiple Choice Questions:

12. In measuring the performance of profit centres ................................... helps in understanding
the contribution of profit centre to the general overhead profit of the corporation.
(a) Direct profit measure (b) Controllable profit measure

(c) Income before taxes (d) Contribution margin
13. A method used to understand the appropriate level of spending in a discretionary expense
centre is ................................. .

(a) Productivity analysis (b) Efficiency analysis
(c) Effectiveness analysis (d) Sensitivity analysis

4.10 Multiple Performance Measures

ROI and EVA have been employed with some success by many large sized undertaking which
have resorted to divisionalisation. However, exclusive reliance on a single profitability measure
may lead to manipulation of the system and consequent distortion in decision making. Managers
of business units may delay a potentially profitable investment in a bid to enhance short-term
return on income at the cost of long run consequences.

In order to overcome the limitation of “sole dependence in a single measure”, many firms have
developed multiple goal structures.

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