Designing Managerial Control Systems

• Designing and Evaluating MCS are key for managerial accounting and control.

Designing Control Systems

• Two fundamental questions in designing control systems: What is desired and what is likely to happen?
• If a difference exists between what is desired and what is likely, two design questions arise: What controls should be used, and how tightly should each be applied?

Defining "Desired"

• Objectives and strategies guide expected actions, especially when specific (e.g., 15% ROI and 20% sales growth, instead of "Become a leader in the industry").
• Key Actions (KA) are actions that must be performed to provide a high probability of success.
• Key Results (KR) are the critical areas where things must go right for the business to flourish.

Determining "Likely"

• Three questions to consider: Do employees understand what is expected, are they properly motivated, and are they able to fulfill their desired roles?
• Gaps in understanding lead to a lack of direction.
• Lack of being properly motivated result in lack of motivation.
• In ability to fulfilling roles result in personal limitations.
• The difference between "desired" and "likely" dictates the choice and tightness of management control systems.

Choice of Controls

• Action, Results and People controls aren't equally effective in addressing control problems.
• Results accountability is effective for lack of motivation, personal limitations.
• Action controls, including behavioral constraints, preaction reviews, and action accountability, address lack of direction.
• People controls like selection/placement and training are effective for lack of direction, lack of motivation and personal limitations.
• Provision of resources and Group-based rewards are effective for lack of motivation and personal limitations.
• Strong culture addresses all of the listed problems.

Choice of Control Tightness

• Tight controls are most beneficial in areas critical to an organization's success.
• Potential costs and harmful side-effects must be considered.

Control System Change

• As firms grow, controls often evolve toward increased formalization of procedures for action accountability and/or towards more elaborate information systems for results control.

Behavioral Focus

• There is no universally "best" form of control.
• Focus on the people involved is important, because their responses to controls determine the control system's success or failure.
• The benefits of controls come only from their impact on behaviors.

Ethics

• Ethical principles guide employer and employee behavior.
• Both employers and employees should consider their actions’ impact on various stakeholders, including shareholders, employees, customers, communities, and society.
• Ethical issues are distinct from legal issues.

Codes of Conduct

• Corporate codes of conduct and operating principles make ethical behavior explicit.
• Virtues included are integrity, loyalty, objectivity, confidentiality and competence.
• The ethical tone at the top is also important.
• Many ethical issues are not clear-cut.

Creating Budgetary Slack

• On one hand, employees create budgetary slack by exploiting knowledge, increasing their likelihood of meeting the budget (costly to owners) and distorting resource allocation.
• On the other hand, they do so to protect themselves from uncertainty and evaluation unfairness, or simply because everyone else does it.

It Depends On

• Implementation depends on performance measure quality, budget target rigidity, employee intentions, superior awareness/encouragement, amount of "material" slack, and explicit codes of conduct.

Earnings Management

• Influencing reported earnings violates duty to disclose information fairly, undermines integrity, and is not transparent to users.
• Efforts can smooth meaningless perturbations, provide more informative performance signals, protect employees from unfair evaluations and prevent more damaging actions like layoffs.

Factors in Earnings Management Decisions

• These include manipulation direction, magnitude, timing (e.g., related to bond offering), method (e.g., deferring spending), employee intent, clarity of rules, and repetition.

Controls that are too good

• Computer surveillance programs, cameras, and location devices can provide congruent, accurate, and timely controls.
• These can impinge on employee autonomy, leading to "electronic sweatshops".

Further Implementation Considerations

• The use of controls should be disclosed.
• Employees should be involved in establishing the system to ensure fairness, and monitoring should be adjusted based on employee experience level.

Week 5 Readings

• Included are Chapter 7 on Financial Responsibility Centers, Chapter 10 on Financial Performance Measures and their Effects and supplemented with with Chapter 23 of Horngren’s Cost Accounting: A Managerial Emphasis 17th Edition ©2021 by Datar and Rajan.