Description
The inherent difficulties creation of profit centers may cause and advantages possible.
Generated by Unregistered Batch DOC & DOCX Converter 2010.2.406.1388, please register! Q.5. a) Describe the inherent difficulties creation of profit centers may cause and advantages possible? Ans: When a responsibility center’s financial performance is measured in terms of profit (i.e. the difference between the revenue and expenses), the centers is called a Profit Center. Profit is a particularly useful performance measure since its allows senior manager to use one comprehensive indicator rather than the several (some of which may be pointing in different directions). Difficulties in creation of Profit Centers: • Decentralized decision making will force top management to rely more on management control reports than on personal knowledge of an operation, entailing some loss of control. • If headquarters management is more capable or better informed than the average
profit center manager, the quality of decisions made at the unit level may be reduced. • Friction may increase because of arguments over the appropriate transfer price, the
assignment of common sales, and the credit for revenues that were formerly generated jointly by two or more business units working together. • Organization units that once cooperated as financial units may now be in the
competition with one another. An increase in profits for one manager may mean decrease to another. In such situations, manager may fail to refer sales leads to another business unit better qualified to pursue them; may hoard personnel or equipment that, from the overall company standpoint, would be better of used in another unit; or may make production decision that have undesirable cost consequences for other units. • center. • Competent general managers may not exist in a functional organization because there Divisionalization may impose additional cost because of the additional management,
staff personnel, and record keeping required, and may lead to task redundancies at each profit
may not have been sufficient opportunities for them to develop general management competence. • There may be too much emphasis on short run profitability at the expense of long run
profitability. In the desire to report high current profits, the profits center manager may skimp
Generated by Unregistered Batch DOC & DOCX Converter 2010.2.406.1388, please register! on R & D, training programs or maintenance. This tendency is especially prevalent when the turnover of profit center managers is relatively high. In these circumstances, managers may have good reason to believe that their actions may not affect profitability until they have moved to other jobs. • There is no completely satisfactory system for ensuring that optimizing the profits of
ach individual profit center will optimize the profits of the company as a whole. Advantages of profit centers: • The quality of decisions may improve because they are being made by managers closest to the point of decision. • The speed of operating decisions may be increased since they do not have to be
referred to corporate headquarters. • Headquarters management, relieved of day-t0-day decision making, can concentrate
on broader issues. • Managers, subject to fewer corporate restraints, are freer to use their imagination and
initiative. • Because profit centers are similar to independent companies, they provide an
excellent training ground for general management. Their managers gain experience in managing all functional areas, and upper management gains the opportunity to evaluate their potential for higher – level jobs. • Profit consciousness is enhanced since managers who are responsible for profits will
constantly seek ways to increase them. (A manager responsible for marketing activities, for example, will tend to authorize promotion expenditures that increase sales, whereas a manager responsible for profits will be motivated to make promotion expenditures increase profits.) • Profit centers provide top management with ready-made information on the
profitability of the company’s individual components. • Because their output is so readily measured, profit centers are particularly responsive
to pressures to improve their competitive performance.
Generated by Unregistered Batch DOC & DOCX Converter 2010.2.406.1388, please register! Q.5.b) Under which situations creation of profit centers is not advisable. Ans: The creation of profit centers is not advisable under the following situations: One of the main problems occurs when profit units deal with one another. It is useful to think of managing profit center in terms of control over three types of decisions: 1. 2. The product decision (what goods and services to make and to sell) The marketing decision (how, where and for how much are these goods and services
to be sold) 3. The procurement or the sourcing decision (how to obtain or manufacture the goods
and services). If a profit center manager control all three activities, there is usually no difficulty in assigning profit responsibility and measuring performance. In general, greater degree of integration within a company, the more difficult it becomes to assign responsibility to a single profit center for all three activities in a given product line; that is, if the production, procurement, and marketing decision for a single product line are split among two or more profit centers, separating the contribution of each profit centre to the overall success of the product line may be difficult. The constraints imposed by the corporate management can be grouped into three types: 1. 2. 3. Those resulting from the strategic considerations Those resulting because uniformity required Those resulting from the economies of centralization. Most of the companies retain certain decisions, especially financial decisions, at the corporate level, at least for domestic activities. Consequently, one of the major constraints on profit centers results from corporate control over new investments. Profit centers must compete with one another for the share of the available funds. The maintenance of the proper corporate image may require constraints in the quality of the products or in the public relations activities. Companies impose some constraints on profit centers because for the necessity for uniformity. One constraint is that profit centre must confirm to the corporate accounting management control systems. This constraint is especially troublesome for units that have
Generated by Unregistered Batch DOC & DOCX Converter 2010.2.406.1388, please register! been acquired from the another company and that have been accustomed to using different systems. Corporate headquarters may also impose uniform pay and other personnel policies, as well as uniform policies on ethics, vendor selection, computers and communication equipment, and even the design of the business unit letterhead. The major problems seem to resolve around corporate service activities. Q.6) Which management control practices, if followed, in performance measurement of Investment Centers are likely to induce Goal Congruence, in respect of following assets
a) i) Idle ii) Intangible iii) Leased (b) i) Cash ii) Receivables iii) Inventories Ans: The following is the explanation of the terms: Q.6.(a)
1.
IDLE ASSETS: If a business unit has idle assets that can be used by the other units,
it may be permitted to exclude them from the investment base if it classifies them as available. The purpose of this permission is to encourage business unit managers to realize underutilized assets to units that may have better use for them. However, if the fixed assets cannot be used by the other units, permitting the business unit manager to remove them from the investment base could result in dysfunctional actions. For example, it could encourage the business unit manager to idle partially utilized assets that are not earning a return equal to the business unit’s profit objective. If there is no alternative use for the equipment, any contribution form this equipment will improve the company profits.
2.
INTANGIBLE ASSETS: Some companies tend to be R&D intensive; others tend to
be marketing intensive. There are advantages to capitalizing intangible assets such as R&D marketing and then amortizing them over a selected life. This method should change how the business unit manager views these expenditures. By accounting for these assets as long terms investments, the business unit manager will gain less short term benefit from reducing outlays on such items. For instance, if R&D expenditures are expensed immediately, each dollar of R&D cut would be a dollar more in pretax profits. On the other hand if R&D costs are capitalized, each dollar cut will reduce the assets employed by a dollar; the capital charge is thus reduced only by one dollar times the cost of capital, which has a much smaller positive impact on economic valued added.
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3.
LEASED ASSETS: Many leases are financing arrangements – that is, they provide
an alternative way of getting to use assets that otherwise would be acquired by funds obtained from the debt and equity financing. Financial leases (i.e. long term leases equivalent to the present value of the stream of the lease charges) are similar to the debt and are so reported on the balance sheet. Financing decisions usually are made by corporate headquarters. For these reasons, restrictions usually are placed on the business unit manager’s freedom to lease assets. Q6(b)
1.
CASH: Most companies control cash centrally because central control permits use of
the smaller cash balance than would be the case if each business unit held the cash balance it needed to whether the unevenness of its cash inflows and outflows. Business unit cash balances may well be only the “float” between daily receipts and daily disbursements. Consequently, the actual cash balances at the business unit level tend to much smaller than would be required If the business unit were an independent company. Many companies then use a formula to calculate the cash to be included in the investment base. For example, General Motors was reported to use 4.5% of annual sales; Du Pont was reported to use two months cost of sales minus depreciation. One reason to include cash at higher amount than the balance normally carried by a business unit is that the higher amount is necessary to allow comparisons to outside companies. If only the actual cash were shown, the return by internal units would appear abnormally high and might mislead senior management. Some companies cash from the investment base. These companies reason that the amount of cash approximates the current liabilities. If this is so, the sum of accounts receivable and inventories will approximate the amount of working capital.
2.
RECEIVABLES: Business unit managers can influence the level of receivables
indirectly, by their ability to generate sales, and directly, by establishing credit terms and approving individual credit accounts and credit limits, and by their vigor in collecting overdue amounts. In the interest of simplicity, receivables often are included at the actual end of period balances, although the average of intraperiod balances is conceptually a better measure of the amount that should be related to profits. Whether to include accounts receivables at selling prices or at cost of goods sold are debatable. One could argue that the business unit’s real investment in accounts receivables is only the cost of goods sold and that
Generated by Unregistered Batch DOC & DOCX Converter 2010.2.406.1388, please register! a satisfactory return on this investment is probably enough. On the other hand, it is possible to argue that the business unit could reinvest the money collected from accounts receivable, and, therefore, accounts receivable should be included at selling prices. The usual practice is to take the simpler alternative – that is, to include receivables at the book amount, which is the selling price less an allowance of bad debts. If the business unit does not credits and collections, receivables may be calculated on the formula basis. This formula should be consistent with the normal payment period – for example 30 days’ sales where payment normally made 30 days after the shipment of the goods.
3.
INVENTORIES: They are ordinarily treated in an manner similar to receivables –
that is, they are often recorded at the end of period amounts even though intraperiod averages would be preferable conceptually. If the company uses LIFO for the financial accounting purposes, a different valuation method usually is used for business unit profit reporting because LIFO inventory balances tend to be unrealistically low in the periods of inflation. In these circumstances, inventories should be valued at standard or average cost, and these same costs should be used to measure cost of sales on the business unit income statement. If work in progress inventory is financed by advanced payments or by progress payments from the customers, as is typically the case with goods that require a long manufacturing period, these payments either are subtracted from the gross inventory amounts or reported as liabilities. Some companies subtract accounts payable from the inventory on the grounds that accounts payable represent financing of part of the inventory by vendors, at zero cost of the business unit. The corporate capital required for inventories is only the difference between the gross inventory amount and accounts payables. If the business can influence the payment period allowed by vendors, then including accounts payable in the calculations encourages the manager to seek the most favorable terms. In times of high interest on credit stringency, managers might be encouraged to consider forgoing the cash discount to have, in effect, additional financing provided by vendors. On the other hand, delaying payments unduly to reduce net current assets may not be in the company’s best interest since this may hurt its credit rating.
Q10. Pritam engineering manufactures variety of metal products at many factories. Currently it is experiencing crisis. Management has therefore decided to install detailed expense control system including responsibility budgets for overheads expense items to each factory. from historical data controller developed a standard for each overheads
Generated by Unregistered Batch DOC & DOCX Converter 2010.2.406.1388, please register! exp. Item. Summarized expenses for Nov 2005. Given to concerned productions supervisor for comments is tabulated. Particulars Standard at normal volume (1) 720 12706 420 3600 14840 21040 2133.04 Budgeted at actual volume (2) 720 11322 361 3096 13909 21040 2103.39
Actual 582 12552 711 3114 17329 21218 2413.30
Management supervision Indirect Labour Idle time Material & Tools Maintenance & scrap Allocation exp. Total per tune
(a) Explain with justification which of the 2 standards 1 or 2 is more meaningful for expense control (b) Can the supervisor be held responsible for all overhead expenses included? Why / why not? Table 1 Table for total Expenses Particulars Management supervision Indirect Labour Idle time Material & Tools Maintenance & scrap Allocation exp. Total exp. Table 2 Total Exp. Per Ton. Unit Produce Unit Produce Table 3 If no of unit produce is same as 25000 Unit produce Total expenses Rupee in 000 Standard at normal Budgeted at actual volume (1) volume (2) 720 720 12706 11322 420 361 3600 3096 14840 13909 21040 53326 21040 50448
2133.04 56626/2133.04 25
2103.39 50448/2103.39 24
25000 53326 53326
25000 50448 * 25 / 24 52550
Generated by Unregistered Batch DOC & DOCX Converter 2010.2.406.1388, please register! If we consider total expenditure then obviously we select standard (2) because standard at normal volume (1) total exp. rupee 53326 and Budgeted at actual volume (2) rupees 50448 (from table 1) & if we consider individual expenses then we can say as under ,stander volume(1) expenses more than propagated actual volume(2) as shown as under. Indirect labor Idle time Material & Tools Maintenance & scrap Allocation exp. 12706 420 3600 14840 21040 > > > > > 11322 361 3096 13909 21040
If we consider relationship of expenses and output then we also select the standard (2) because output is more in the standard (1) is 25000 but expenses are also more as compare to budgeted actual volume. This can we understand from table 2 & table 3. In that total expense of standard (1) are Rs. 53326000 & standard (2) is Rs. 52550000 with same level of output. B) Supervisor be held responsible for overhead expenses because of following reason: 1. He is professional person who have knowledge and skill 2. Supervisor has responsibilities of optimum utilization of organizational resource 3. He is responsible to manage cost and increase efficiently 4. He is responsible to allocate proper recourses in each area where it require 5. If manage each presses properly then it can idle-time and increase production 6. It manage things properly in production area in it will reduce scrap. So supervisor play important role in manage each activity smoothly and effective Q.11 (a) Given Facts Turnover 225 crores – 2004-2005 Income Tax rate 40% Plan to install new machinery of Rs. 45 cr. Results Turnover rise by 6% = 238.5 cr. Variable expenses to turnover ratio Old = 225 = 1.5 180 New = 238.5 = 1.47 162.2
( 162.2 = new variable expenses ) 8.48% rise in fixed expenses Old fixed expenses = 49.5 cr. New = 53.7 cr. Net working capital = 36 cr. Rise by 1.8 cr. New working capital = 37.8 cr. Solution a)
Generated by Unregistered Batch DOC & DOCX Converter 2010.2.406.1388, please register! ____Profit____ Equity capital Profit = 225 – expenses = 225 – 150 – 49.5 = 25.5 ROE = _25.5_ turnover 51 = 0.5 Return on equity =
Up explored = Fixed Asset + Working Capital = 36 + 51 = 87 cr. b) Turnover Variable Expenses Fixed Expenses New W. Capital Pre Installation 225 cr. 150 cr. 49.5 cr. 36 cr. Post Installation 238.5 cr. 162.2 cr. 53.70 cr. 37.80 cr.
c) Parameters to be controlled for success of project 1. 2. 3. 4. 5. 6. Pre – installation statement obtain. Analysis of all expenses Post installation statement obtain Analysis of all expenses Comparison of both statements Turnover rise from 225 cr. To 238.5 cr. It means it rise by 6% but as compare to that variable expenses rise by 8% i.e. from Rs. 150 cr. To 162.2 cr. Still there is need to control variable expenses. 7. about fixed expenses it is rising by 8.48% If sales is rising by just 6% & expenses are increasing by 8.48% I should control. Q.12 For effective strategy implementation, Soniya Ltd. (SL) has been organized on product decentralization basis and each division is headed by GM (General Manager). GM is responsible for manufacturing, purchasing, finance and marketing activities for his divisional product group. Performance measurement is Return on Investment (ROI) of division. Annual budgets are split up into four quarters and at the beginning of each quarter, performance of previous quarter is reviewed and budget for following quarter may be revised in consultation with GM. Data for div P is as under. Figures in Rs. Crores Budget Quarter 2 7.5 Actual Quarter 1 8.5
Account receivable
Quarter 1 8
Generated by Unregistered Batch DOC & DOCX Converter 2010.2.406.1388, please register! Cash 4 4 2.0 Inventory 18 16.5 21.50 Fixed assets 20 20 20 Factory cost 21 19 17 Marketing Cost 7 6 3 Freight 1 0.90 0.80 Administrative 3 2.60 3.20 exp. Sales 40 36 34 (a) Review the first-quarter performance on the basis of computation of various Parameters. (b) Would you suggest any revisions for the second quarters? why/why not.Justify. Solution: a) The first-quarter performance on the basis of computation of various parameters are as follows: 1) Turnover of investment =__ Sales ___ Total Investment = 40 50 = 0.8 times = Profit*100 Sales = 08*100 40 = 20%
2) Profit Margin
3) Return on Investment = Operating profit Total investment = 08 *100 50 = 16% Working note: Calculation of operating profit Particulars Sales Less expenses: Factory cost Marketing cost Freight Administration expenses Operating profit Calculation of Total Investment Particulars Account Receivable Amount (Rs.) 8 Amount(Rs.) 40 21 7 1 3
(32) 8
Generated by Unregistered Batch DOC & DOCX Converter 2010.2.406.1388, please register! Cash Inventory Fixed Assets Total Investment 4) Factory cost as percentage to sales 4 18 20 50 = Factory cost * 100 Sales = 21 / 40 *100 = 52.5% = Marketing cost *100 Sales = 7/40 *100 = 17.5% = Freight *100 Sales =1/40 * 100 =2.5%
5) Marketing cost as percentage to sales
6) Freight as percentage to sales
7) Administration exp. as percentage to sales = Administration exp. *100 Sales =3/40 *100 =7.5% 8) Turnover of Fixed Asset = Sales Fixed Asset = 40/20 = 2 times Sales Inventory =40/18 =2.22times =
9) Turnover of Inventory
b) Suggestion for review for second quarter budget. 1) Turnover of investment = __ Sales ___ Total Investment Budgeted Particulars Quarter I Quarter II Turnover of investment 40/50 = 0.8 times 36/48 = times
Actual Quarter I 0.75 34/52 = times
0.65
2) Profit Margin
= Profit*100 Sales
Generated by Unregistered Batch DOC & DOCX Converter 2010.2.406.1388, please register! Budgeted Quarter I Quarter II 08/40 * 100 = 7.5/36*100 20% 20.83% Actual Quarter I = 10/34*100= 29.41
Particulars Profit Margin
3) Return on Investment = Operating profit Total investment Budgeted Particulars Quarter I Quarter II Return on Investment 8/50 *100= 16% 7.5/48*100= 15.63%
Actual Quarter I 10/50*100 19.23
=
Working note: Calculation of operating profit Budget Quarter I Particulars Sales Less expenses: Factory cost Marketing cost Freight Administration expenses Operating profit Budget Quarter II Particulars Sales Less expenses: Factory cost Marketing cost Freight Administration expenses Operating profit Actual Quarter I Particulars Sales Less expenses: Factory 17.00 Marketing cost Freight Administration Amount(Rs.) 40 21 7 1 3
(32) 8 Amount(Rs.) 36
19.00 6.00 0.90 2.6
28.5 7.5 Amount(Rs.) 34
cost 3.00 0.80 expenses 24
Generated by Unregistered Batch DOC & DOCX Converter 2010.2.406.1388, please register! 3.20 Operating profit 10
Calculation of Total Investment Budgeted Quarter I Quarter II Amount (Rs.) Amount (Rs.) 8 7.5 4 4 18 16.5 20 20 50 48 = Factory cost * 100 Sales Budgeted Quarter II *100= 19/36*100= 52.77% Actual Quarter I Amount (Rs.) 8.5 2.0 21.5 20 52
Particulars Account Receivable Cash Inventory Fixed Assets Total Investment
4) Factory cost as percentage to sales
Particulars Factory cost percentage to sales
Quarter I as 21/40 52.5%
Actual Quarter I 17/34*100= 50%
5) Marketing cost as percentage to sales
Particulars Quarter I Marketing cost as % to 7/40*100 sales 17.5% 6) Freight as percentage to sales
= Marketing cost *100 Sales Budgeted Quarter II = 6/36*100 =16.67%
Actual Quarter I 3/34*100 =8.82%
Particulars Quarter I Freight as percentage 1/40 * to sales =2.5%
= Freight *100 Sales Budgeted Quarter II 100 0.90/36* =2.5%
Actual Quarter I 100 0.80/34*100=2.35%
7) Administration exp. as percentage to sales = Administration exp. *100 Sales Budgeted Actual Particulars Quarter I Quarter II Quarter I Administration exp. as 03/40*100 =7.5% 2.6/36*100 =7.22% 3.2/34*100 percentage to sales =9.41%
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8) Turnover of Fixed Asset
= Sales Fixed Asset Actual Quarter I 34/20 =1.7times
Particulars Turnover of Asset
Budgeted Quarter I Quarter II Fixed 40/20 =2times 36/20 =1.8times
9) Turnover of Inventory
Particulars Turnover of Inventory
Sales Inventory Budgeted Quarter I Quarter II 40/18= 2.22times 36/16.5= 2.18times
=
Actual Quarter I 34/21.5= 1.58times
Return on Investment of Budgeted quarter I was less than Actual quarter I. ROI is multiplication of Profit margin and turnover of Asset There was difference in budgeted Quarter I and actual Quarter I due to: Increase in profit margin. Though sales have been reduced from budgeted but there is reduction in marketing cost and freight. Quarter II sales have been increased from actual Quarter I. So there should be decrease in cost as compared to actual. So this will lead to increase in profit margin. Fixed asset invest is same in Quarter II but in turnover there is difference due to sales. But inventory budgeted in Quarter I was less than actual quarter I. so instead of increasing inventory it has reduced than actual. So there should be increase in inventory.
doc_831082627.pdf
The inherent difficulties creation of profit centers may cause and advantages possible.
Generated by Unregistered Batch DOC & DOCX Converter 2010.2.406.1388, please register! Q.5. a) Describe the inherent difficulties creation of profit centers may cause and advantages possible? Ans: When a responsibility center’s financial performance is measured in terms of profit (i.e. the difference between the revenue and expenses), the centers is called a Profit Center. Profit is a particularly useful performance measure since its allows senior manager to use one comprehensive indicator rather than the several (some of which may be pointing in different directions). Difficulties in creation of Profit Centers: • Decentralized decision making will force top management to rely more on management control reports than on personal knowledge of an operation, entailing some loss of control. • If headquarters management is more capable or better informed than the average
profit center manager, the quality of decisions made at the unit level may be reduced. • Friction may increase because of arguments over the appropriate transfer price, the
assignment of common sales, and the credit for revenues that were formerly generated jointly by two or more business units working together. • Organization units that once cooperated as financial units may now be in the
competition with one another. An increase in profits for one manager may mean decrease to another. In such situations, manager may fail to refer sales leads to another business unit better qualified to pursue them; may hoard personnel or equipment that, from the overall company standpoint, would be better of used in another unit; or may make production decision that have undesirable cost consequences for other units. • center. • Competent general managers may not exist in a functional organization because there Divisionalization may impose additional cost because of the additional management,
staff personnel, and record keeping required, and may lead to task redundancies at each profit
may not have been sufficient opportunities for them to develop general management competence. • There may be too much emphasis on short run profitability at the expense of long run
profitability. In the desire to report high current profits, the profits center manager may skimp
Generated by Unregistered Batch DOC & DOCX Converter 2010.2.406.1388, please register! on R & D, training programs or maintenance. This tendency is especially prevalent when the turnover of profit center managers is relatively high. In these circumstances, managers may have good reason to believe that their actions may not affect profitability until they have moved to other jobs. • There is no completely satisfactory system for ensuring that optimizing the profits of
ach individual profit center will optimize the profits of the company as a whole. Advantages of profit centers: • The quality of decisions may improve because they are being made by managers closest to the point of decision. • The speed of operating decisions may be increased since they do not have to be
referred to corporate headquarters. • Headquarters management, relieved of day-t0-day decision making, can concentrate
on broader issues. • Managers, subject to fewer corporate restraints, are freer to use their imagination and
initiative. • Because profit centers are similar to independent companies, they provide an
excellent training ground for general management. Their managers gain experience in managing all functional areas, and upper management gains the opportunity to evaluate their potential for higher – level jobs. • Profit consciousness is enhanced since managers who are responsible for profits will
constantly seek ways to increase them. (A manager responsible for marketing activities, for example, will tend to authorize promotion expenditures that increase sales, whereas a manager responsible for profits will be motivated to make promotion expenditures increase profits.) • Profit centers provide top management with ready-made information on the
profitability of the company’s individual components. • Because their output is so readily measured, profit centers are particularly responsive
to pressures to improve their competitive performance.
Generated by Unregistered Batch DOC & DOCX Converter 2010.2.406.1388, please register! Q.5.b) Under which situations creation of profit centers is not advisable. Ans: The creation of profit centers is not advisable under the following situations: One of the main problems occurs when profit units deal with one another. It is useful to think of managing profit center in terms of control over three types of decisions: 1. 2. The product decision (what goods and services to make and to sell) The marketing decision (how, where and for how much are these goods and services
to be sold) 3. The procurement or the sourcing decision (how to obtain or manufacture the goods
and services). If a profit center manager control all three activities, there is usually no difficulty in assigning profit responsibility and measuring performance. In general, greater degree of integration within a company, the more difficult it becomes to assign responsibility to a single profit center for all three activities in a given product line; that is, if the production, procurement, and marketing decision for a single product line are split among two or more profit centers, separating the contribution of each profit centre to the overall success of the product line may be difficult. The constraints imposed by the corporate management can be grouped into three types: 1. 2. 3. Those resulting from the strategic considerations Those resulting because uniformity required Those resulting from the economies of centralization. Most of the companies retain certain decisions, especially financial decisions, at the corporate level, at least for domestic activities. Consequently, one of the major constraints on profit centers results from corporate control over new investments. Profit centers must compete with one another for the share of the available funds. The maintenance of the proper corporate image may require constraints in the quality of the products or in the public relations activities. Companies impose some constraints on profit centers because for the necessity for uniformity. One constraint is that profit centre must confirm to the corporate accounting management control systems. This constraint is especially troublesome for units that have
Generated by Unregistered Batch DOC & DOCX Converter 2010.2.406.1388, please register! been acquired from the another company and that have been accustomed to using different systems. Corporate headquarters may also impose uniform pay and other personnel policies, as well as uniform policies on ethics, vendor selection, computers and communication equipment, and even the design of the business unit letterhead. The major problems seem to resolve around corporate service activities. Q.6) Which management control practices, if followed, in performance measurement of Investment Centers are likely to induce Goal Congruence, in respect of following assets
a) i) Idle ii) Intangible iii) Leased (b) i) Cash ii) Receivables iii) Inventories Ans: The following is the explanation of the terms: Q.6.(a)1.
IDLE ASSETS: If a business unit has idle assets that can be used by the other units,
it may be permitted to exclude them from the investment base if it classifies them as available. The purpose of this permission is to encourage business unit managers to realize underutilized assets to units that may have better use for them. However, if the fixed assets cannot be used by the other units, permitting the business unit manager to remove them from the investment base could result in dysfunctional actions. For example, it could encourage the business unit manager to idle partially utilized assets that are not earning a return equal to the business unit’s profit objective. If there is no alternative use for the equipment, any contribution form this equipment will improve the company profits.
2.
INTANGIBLE ASSETS: Some companies tend to be R&D intensive; others tend to
be marketing intensive. There are advantages to capitalizing intangible assets such as R&D marketing and then amortizing them over a selected life. This method should change how the business unit manager views these expenditures. By accounting for these assets as long terms investments, the business unit manager will gain less short term benefit from reducing outlays on such items. For instance, if R&D expenditures are expensed immediately, each dollar of R&D cut would be a dollar more in pretax profits. On the other hand if R&D costs are capitalized, each dollar cut will reduce the assets employed by a dollar; the capital charge is thus reduced only by one dollar times the cost of capital, which has a much smaller positive impact on economic valued added.
Generated by Unregistered Batch DOC & DOCX Converter 2010.2.406.1388, please register!
3.
LEASED ASSETS: Many leases are financing arrangements – that is, they provide
an alternative way of getting to use assets that otherwise would be acquired by funds obtained from the debt and equity financing. Financial leases (i.e. long term leases equivalent to the present value of the stream of the lease charges) are similar to the debt and are so reported on the balance sheet. Financing decisions usually are made by corporate headquarters. For these reasons, restrictions usually are placed on the business unit manager’s freedom to lease assets. Q6(b)
1.
CASH: Most companies control cash centrally because central control permits use of
the smaller cash balance than would be the case if each business unit held the cash balance it needed to whether the unevenness of its cash inflows and outflows. Business unit cash balances may well be only the “float” between daily receipts and daily disbursements. Consequently, the actual cash balances at the business unit level tend to much smaller than would be required If the business unit were an independent company. Many companies then use a formula to calculate the cash to be included in the investment base. For example, General Motors was reported to use 4.5% of annual sales; Du Pont was reported to use two months cost of sales minus depreciation. One reason to include cash at higher amount than the balance normally carried by a business unit is that the higher amount is necessary to allow comparisons to outside companies. If only the actual cash were shown, the return by internal units would appear abnormally high and might mislead senior management. Some companies cash from the investment base. These companies reason that the amount of cash approximates the current liabilities. If this is so, the sum of accounts receivable and inventories will approximate the amount of working capital.
2.
RECEIVABLES: Business unit managers can influence the level of receivables
indirectly, by their ability to generate sales, and directly, by establishing credit terms and approving individual credit accounts and credit limits, and by their vigor in collecting overdue amounts. In the interest of simplicity, receivables often are included at the actual end of period balances, although the average of intraperiod balances is conceptually a better measure of the amount that should be related to profits. Whether to include accounts receivables at selling prices or at cost of goods sold are debatable. One could argue that the business unit’s real investment in accounts receivables is only the cost of goods sold and that
Generated by Unregistered Batch DOC & DOCX Converter 2010.2.406.1388, please register! a satisfactory return on this investment is probably enough. On the other hand, it is possible to argue that the business unit could reinvest the money collected from accounts receivable, and, therefore, accounts receivable should be included at selling prices. The usual practice is to take the simpler alternative – that is, to include receivables at the book amount, which is the selling price less an allowance of bad debts. If the business unit does not credits and collections, receivables may be calculated on the formula basis. This formula should be consistent with the normal payment period – for example 30 days’ sales where payment normally made 30 days after the shipment of the goods.
3.
INVENTORIES: They are ordinarily treated in an manner similar to receivables –
that is, they are often recorded at the end of period amounts even though intraperiod averages would be preferable conceptually. If the company uses LIFO for the financial accounting purposes, a different valuation method usually is used for business unit profit reporting because LIFO inventory balances tend to be unrealistically low in the periods of inflation. In these circumstances, inventories should be valued at standard or average cost, and these same costs should be used to measure cost of sales on the business unit income statement. If work in progress inventory is financed by advanced payments or by progress payments from the customers, as is typically the case with goods that require a long manufacturing period, these payments either are subtracted from the gross inventory amounts or reported as liabilities. Some companies subtract accounts payable from the inventory on the grounds that accounts payable represent financing of part of the inventory by vendors, at zero cost of the business unit. The corporate capital required for inventories is only the difference between the gross inventory amount and accounts payables. If the business can influence the payment period allowed by vendors, then including accounts payable in the calculations encourages the manager to seek the most favorable terms. In times of high interest on credit stringency, managers might be encouraged to consider forgoing the cash discount to have, in effect, additional financing provided by vendors. On the other hand, delaying payments unduly to reduce net current assets may not be in the company’s best interest since this may hurt its credit rating.
Q10. Pritam engineering manufactures variety of metal products at many factories. Currently it is experiencing crisis. Management has therefore decided to install detailed expense control system including responsibility budgets for overheads expense items to each factory. from historical data controller developed a standard for each overheads
Generated by Unregistered Batch DOC & DOCX Converter 2010.2.406.1388, please register! exp. Item. Summarized expenses for Nov 2005. Given to concerned productions supervisor for comments is tabulated. Particulars Standard at normal volume (1) 720 12706 420 3600 14840 21040 2133.04 Budgeted at actual volume (2) 720 11322 361 3096 13909 21040 2103.39
Actual 582 12552 711 3114 17329 21218 2413.30
Management supervision Indirect Labour Idle time Material & Tools Maintenance & scrap Allocation exp. Total per tune
(a) Explain with justification which of the 2 standards 1 or 2 is more meaningful for expense control (b) Can the supervisor be held responsible for all overhead expenses included? Why / why not? Table 1 Table for total Expenses Particulars Management supervision Indirect Labour Idle time Material & Tools Maintenance & scrap Allocation exp. Total exp. Table 2 Total Exp. Per Ton. Unit Produce Unit Produce Table 3 If no of unit produce is same as 25000 Unit produce Total expenses Rupee in 000 Standard at normal Budgeted at actual volume (1) volume (2) 720 720 12706 11322 420 361 3600 3096 14840 13909 21040 53326 21040 50448
2133.04 56626/2133.04 25
2103.39 50448/2103.39 24
25000 53326 53326
25000 50448 * 25 / 24 52550
Generated by Unregistered Batch DOC & DOCX Converter 2010.2.406.1388, please register! If we consider total expenditure then obviously we select standard (2) because standard at normal volume (1) total exp. rupee 53326 and Budgeted at actual volume (2) rupees 50448 (from table 1) & if we consider individual expenses then we can say as under ,stander volume(1) expenses more than propagated actual volume(2) as shown as under. Indirect labor Idle time Material & Tools Maintenance & scrap Allocation exp. 12706 420 3600 14840 21040 > > > > > 11322 361 3096 13909 21040
If we consider relationship of expenses and output then we also select the standard (2) because output is more in the standard (1) is 25000 but expenses are also more as compare to budgeted actual volume. This can we understand from table 2 & table 3. In that total expense of standard (1) are Rs. 53326000 & standard (2) is Rs. 52550000 with same level of output. B) Supervisor be held responsible for overhead expenses because of following reason: 1. He is professional person who have knowledge and skill 2. Supervisor has responsibilities of optimum utilization of organizational resource 3. He is responsible to manage cost and increase efficiently 4. He is responsible to allocate proper recourses in each area where it require 5. If manage each presses properly then it can idle-time and increase production 6. It manage things properly in production area in it will reduce scrap. So supervisor play important role in manage each activity smoothly and effective Q.11 (a) Given Facts Turnover 225 crores – 2004-2005 Income Tax rate 40% Plan to install new machinery of Rs. 45 cr. Results Turnover rise by 6% = 238.5 cr. Variable expenses to turnover ratio Old = 225 = 1.5 180 New = 238.5 = 1.47 162.2
( 162.2 = new variable expenses ) 8.48% rise in fixed expenses Old fixed expenses = 49.5 cr. New = 53.7 cr. Net working capital = 36 cr. Rise by 1.8 cr. New working capital = 37.8 cr. Solution a)
Generated by Unregistered Batch DOC & DOCX Converter 2010.2.406.1388, please register! ____Profit____ Equity capital Profit = 225 – expenses = 225 – 150 – 49.5 = 25.5 ROE = _25.5_ turnover 51 = 0.5 Return on equity =
Up explored = Fixed Asset + Working Capital = 36 + 51 = 87 cr. b) Turnover Variable Expenses Fixed Expenses New W. Capital Pre Installation 225 cr. 150 cr. 49.5 cr. 36 cr. Post Installation 238.5 cr. 162.2 cr. 53.70 cr. 37.80 cr.
c) Parameters to be controlled for success of project 1. 2. 3. 4. 5. 6. Pre – installation statement obtain. Analysis of all expenses Post installation statement obtain Analysis of all expenses Comparison of both statements Turnover rise from 225 cr. To 238.5 cr. It means it rise by 6% but as compare to that variable expenses rise by 8% i.e. from Rs. 150 cr. To 162.2 cr. Still there is need to control variable expenses. 7. about fixed expenses it is rising by 8.48% If sales is rising by just 6% & expenses are increasing by 8.48% I should control. Q.12 For effective strategy implementation, Soniya Ltd. (SL) has been organized on product decentralization basis and each division is headed by GM (General Manager). GM is responsible for manufacturing, purchasing, finance and marketing activities for his divisional product group. Performance measurement is Return on Investment (ROI) of division. Annual budgets are split up into four quarters and at the beginning of each quarter, performance of previous quarter is reviewed and budget for following quarter may be revised in consultation with GM. Data for div P is as under. Figures in Rs. Crores Budget Quarter 2 7.5 Actual Quarter 1 8.5
Account receivable
Quarter 1 8
Generated by Unregistered Batch DOC & DOCX Converter 2010.2.406.1388, please register! Cash 4 4 2.0 Inventory 18 16.5 21.50 Fixed assets 20 20 20 Factory cost 21 19 17 Marketing Cost 7 6 3 Freight 1 0.90 0.80 Administrative 3 2.60 3.20 exp. Sales 40 36 34 (a) Review the first-quarter performance on the basis of computation of various Parameters. (b) Would you suggest any revisions for the second quarters? why/why not.Justify. Solution: a) The first-quarter performance on the basis of computation of various parameters are as follows: 1) Turnover of investment =__ Sales ___ Total Investment = 40 50 = 0.8 times = Profit*100 Sales = 08*100 40 = 20%
2) Profit Margin
3) Return on Investment = Operating profit Total investment = 08 *100 50 = 16% Working note: Calculation of operating profit Particulars Sales Less expenses: Factory cost Marketing cost Freight Administration expenses Operating profit Calculation of Total Investment Particulars Account Receivable Amount (Rs.) 8 Amount(Rs.) 40 21 7 1 3
(32) 8
Generated by Unregistered Batch DOC & DOCX Converter 2010.2.406.1388, please register! Cash Inventory Fixed Assets Total Investment 4) Factory cost as percentage to sales 4 18 20 50 = Factory cost * 100 Sales = 21 / 40 *100 = 52.5% = Marketing cost *100 Sales = 7/40 *100 = 17.5% = Freight *100 Sales =1/40 * 100 =2.5%
5) Marketing cost as percentage to sales
6) Freight as percentage to sales
7) Administration exp. as percentage to sales = Administration exp. *100 Sales =3/40 *100 =7.5% 8) Turnover of Fixed Asset = Sales Fixed Asset = 40/20 = 2 times Sales Inventory =40/18 =2.22times =
9) Turnover of Inventory
b) Suggestion for review for second quarter budget. 1) Turnover of investment = __ Sales ___ Total Investment Budgeted Particulars Quarter I Quarter II Turnover of investment 40/50 = 0.8 times 36/48 = times
Actual Quarter I 0.75 34/52 = times
0.65
2) Profit Margin
= Profit*100 Sales
Generated by Unregistered Batch DOC & DOCX Converter 2010.2.406.1388, please register! Budgeted Quarter I Quarter II 08/40 * 100 = 7.5/36*100 20% 20.83% Actual Quarter I = 10/34*100= 29.41
Particulars Profit Margin
3) Return on Investment = Operating profit Total investment Budgeted Particulars Quarter I Quarter II Return on Investment 8/50 *100= 16% 7.5/48*100= 15.63%
Actual Quarter I 10/50*100 19.23
=
Working note: Calculation of operating profit Budget Quarter I Particulars Sales Less expenses: Factory cost Marketing cost Freight Administration expenses Operating profit Budget Quarter II Particulars Sales Less expenses: Factory cost Marketing cost Freight Administration expenses Operating profit Actual Quarter I Particulars Sales Less expenses: Factory 17.00 Marketing cost Freight Administration Amount(Rs.) 40 21 7 1 3
(32) 8 Amount(Rs.) 36
19.00 6.00 0.90 2.6
28.5 7.5 Amount(Rs.) 34
cost 3.00 0.80 expenses 24
Generated by Unregistered Batch DOC & DOCX Converter 2010.2.406.1388, please register! 3.20 Operating profit 10
Calculation of Total Investment Budgeted Quarter I Quarter II Amount (Rs.) Amount (Rs.) 8 7.5 4 4 18 16.5 20 20 50 48 = Factory cost * 100 Sales Budgeted Quarter II *100= 19/36*100= 52.77% Actual Quarter I Amount (Rs.) 8.5 2.0 21.5 20 52
Particulars Account Receivable Cash Inventory Fixed Assets Total Investment
4) Factory cost as percentage to sales
Particulars Factory cost percentage to sales
Quarter I as 21/40 52.5%
Actual Quarter I 17/34*100= 50%
5) Marketing cost as percentage to sales
Particulars Quarter I Marketing cost as % to 7/40*100 sales 17.5% 6) Freight as percentage to sales
= Marketing cost *100 Sales Budgeted Quarter II = 6/36*100 =16.67%
Actual Quarter I 3/34*100 =8.82%
Particulars Quarter I Freight as percentage 1/40 * to sales =2.5%
= Freight *100 Sales Budgeted Quarter II 100 0.90/36* =2.5%
Actual Quarter I 100 0.80/34*100=2.35%
7) Administration exp. as percentage to sales = Administration exp. *100 Sales Budgeted Actual Particulars Quarter I Quarter II Quarter I Administration exp. as 03/40*100 =7.5% 2.6/36*100 =7.22% 3.2/34*100 percentage to sales =9.41%
Generated by Unregistered Batch DOC & DOCX Converter 2010.2.406.1388, please register!
8) Turnover of Fixed Asset
= Sales Fixed Asset Actual Quarter I 34/20 =1.7times
Particulars Turnover of Asset
Budgeted Quarter I Quarter II Fixed 40/20 =2times 36/20 =1.8times
9) Turnover of Inventory
Particulars Turnover of Inventory
Sales Inventory Budgeted Quarter I Quarter II 40/18= 2.22times 36/16.5= 2.18times
=
Actual Quarter I 34/21.5= 1.58times
Return on Investment of Budgeted quarter I was less than Actual quarter I. ROI is multiplication of Profit margin and turnover of Asset There was difference in budgeted Quarter I and actual Quarter I due to: Increase in profit margin. Though sales have been reduced from budgeted but there is reduction in marketing cost and freight. Quarter II sales have been increased from actual Quarter I. So there should be decrease in cost as compared to actual. So this will lead to increase in profit margin. Fixed asset invest is same in Quarter II but in turnover there is difference due to sales. But inventory budgeted in Quarter I was less than actual quarter I. so instead of increasing inventory it has reduced than actual. So there should be increase in inventory.
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