Management Control Systems: Chapter 7: Financial Responsibility Centers (And The Transfer Pricing Problem)

Management Control
Systems
Chapter 7: Financial Responsibility Centers (and
the Transfer Pricing Problem)
Merchant and Van der Stede: Management Control Systems © Pearson Education Limited 2003
Financial results controls ...
• Three core elements:
• Financial responsibility centers

• The apportioning of accountability for financial results within the organization.
• Formal management processes (planning & budgeting)

• To define performance expectations and standards for evaluating performance.
• Motivational contracts
• To define the links between results and various organizational incentives.
-2-
Definition ...
• Responsibility center ...
• Organization unit that is headed by a responsible manager;
• It denotes the apportioning of responsibility for a particular
set of inputs and/or outputs to an organization unit.
• Responsibilities can be expressed in terms of ...

• Physical units of outputs;
• Particular characteristics of the services provided;
• e.g., schedule attainment, customer satisfaction, etc.
• Quantities of inputs consumed;
• Financial indicators of sets of performance in these areas.
• Financial responsibility centers ...

• Responsibility centers in which the manager's responsibilities
are defined at least partially in financial terms.
-3-
Revenue centers ...
 Managers of revenue centers are held accountable for
generating revenues, which is a financial measure of outputs.
» e.g., Sales departments in commercial organizations;
» e.g., Fundraising managers in not-for-profit organizations.
 No formal attempt is made to relate inputs (measured as

expenses) to outputs.
» However, most revenue center managers are also held accountable
for some expenses (e.g., salespeople's salaries and commissions);
» But, still they are not profit centers because:
 These costs are only a tiny fraction of the revenues generated;
 Revenue centers are not charged for the costs of the goods
they sell.
-4-
Expense centers ...
 Managers of expense (cost) centers are held accountable
for expenses, which are a financial measure of the inputs
consumed by the responsibility center.
 Two types:
» Standard cost centers or engineered expense centers
 Inputs can be measured in monetary terms;
 Outputs can be measured in physical terms; and,
 Causal relationship between inputs-outputs is direct / stable;
– e.g., manufacturing departments, but also, warehousing,

distribution, personnel administration, catering.
» Managed cost centers or discretionary expense centers

 Outputs produced are difficult to measure; and,
 Relationship between inputs-outputs is not well known;
– e.g., R&D, PR, HR, marketing activities.
-5-
Control in expense centers ...
 Engineered expense centers
» Standard cost vs. actual cost
 i.e., the cost of inputs that should have been consumed in
producing the output vs. the cost that was actually incurred.
» Additional controls
 Volume produced; quality; training; etc.
 Discretionary expense centers

» Ensuring that managers adhere to the budgeted level of expenditures
while successfully accomplishing the tasks of their center.
» Subjective, non-financial controls
 e.g., quality of service as perceived / evaluated by users.
» Personnel controls
» Tools: benchmarking
-6-
Profit centers ...
 Managers of profit centers are held accountable for generating
profits, which is a financial measure of the difference between
revenues and costs.
 As a measure of performance, profit is ...
» Comprehensive
 i.e., it incorporates many aspects of performance;
» Unobtrusive
 i.e., the profit center manager makes the revenue/cost tradeoffs.
 Main question / problem in practice: Has the manager significant

influence over both revenues and costs?
» Charge standard cost of goods sold to sales-focused entities;
» Assign revenues to cost-focused entities;
» Pseudo profit centers.
-7-
Measuring profitability ...
Pusat Pusat Laba Pusat Laba Pusat
Laba Tidak Sebelum Laba
kotor Lengkap Pajak Lengkap
Pendapatan    
Harga Pokok Penjualan    
Laba Kotor    
Pengiklanan + Promosi   
Riset + Pengembangan  
Laba Sebelum Pajak  
Pajak Pendapatan 
Laba Setelah Pajak 
-8-
Investment centers ...
 Managers of investment centers are held accountable for
the accounting returns (profits) on the investment made
to generate those returns.
» Measures: ROI, ROE, ROCE, RONA, etc.
 In fact, managers have two performance objectives:

» Generate maximum profits from the resources at
their disposal;
» Invest in additional resources only when such an
investment will produce an adequate return.
-9-
Typical organization structure ...
Direktur
(IC)
Wakil Direktur
Administrasi dan
Keuangan
Wakil Direktur Wakil Direktur (D /ECC)
Grup Grup
(IC) (IC)
Manajer Divisi Manajer Divisi Manajer Divisi Manajer Divisi

(PC) (PC) (PC) (PC)
... ...
Divisi Staf Fungsi (D/ECC)
... ... ... ...
Pembelian Manufaktur Penjualan
(ECC) (ECC) (RC)
- 10 -

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Management Control

• Three core elements:

• Financial responsibility centers

• Formal management processes (planning & budgeting)

• Responsibilities can be expressed in terms of ...

• Financial responsibility centers ...

 No formal attempt is made to relate inputs (measured as

 Outputs can be measured in physical terms; and,

 Causal relationship between inputs-outputs is direct / stable;

– e.g., manufacturing departments, but also, warehousing,

» Managed cost centers or discretionary expense centers

 Relationship between inputs-outputs is not well known;

– e.g., R&D, PR, HR, marketing activities.

 Discretionary expense centers

 Main question / problem in practice: Has the manager significant

 In fact, managers have two performance objectives:

Manajer Divisi Manajer Divisi Manajer Divisi Manajer Divisi

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