IGNOU MBA MS-43 Solved Assignment 2012

Course Code              :           MS - 43

Course Title               :           Management Control Systems 

Assignment Code      :           MS-43/TMA/SEM - I /2012

Coverage                    :           All Blocks

Note : Answer all the questions and submit this assignment on or before  April 30, 2012, to

     the coordinator of your study center.

1.      What are the characteristics of a project organization? Explain how these characteristics affect the control system design of a project. 

Solution: The choice of project organizational structure depends on the characteristics of the project, and external constraints, such as existing organizational policy. It is, therefore, difficult to be prescriptive about such structures, because what is effective (or even feasible) will depend very much on circumstance. The issues to be addressed are canvassed in Guidelines: Project Plan, which also present a default project structure that may be adapted to a project's particular needs. The default structure also suggests a mapping of (Rational Unified Process) roles to the organization's positions. The shape and size of the project organization will vary across phases, and the Software Development Plan, a living document, will be updated to reflect these changes.

The mission of the project organizations is to generate results in response to specific client demands by structuring projects around temporary assemblies of in-house specialist staff and executing business within a fixed time limit. The entire company can also be thought of as an assembly of project organizations where the routine business that goes on at a consulting firm is almost non-existent. A great deal of research has accumulated around project management and project organizations. A key point is that project-based organizations possess all internal and external resources, as well as individual functions such as development, production and sales, and established organizations are structured to execute business as individual projects. Another point is that in order for large companies to implement the most important themes, such as projects to enhance management efficiency or develop new products, an organizational structure should exist  to build the project after members of temporarily existing organizations have ended their participation, and to

have the project carried out by specialist members (see Midler, 1995; Keegan and Turner, 2002). A third characteristic is that a matrix form exists for members to participate in projects in addition to following their primary business in existing organizations (see Galbraith, 1969). The

fourth characteristic is that there are cases where members of existing organizations form informal project networks within and outside the

company. As you can see, the term “project-based organizations” has several meanings.

A project is a temporary organization to which resources are assigned to undertake a unique, novel and transient endeavor that involves managing the inherent uncertainty and need for integration in order to deliver beneficial objectives of change (Turner and Miller, 2003, p. 7).

Project organizations refer to a variety of organizational forms that involve the creation of temporary systems for the performance of project. Clearly, a project organization incorporates the meaning of an organizational structure specially formed for a temporary period to enable a project organization execute a specific task. The project companies of Japanese companies are not simply playing the role of organizations that execute temporary functions, but are also positioned as specialist, official organizations that execute specific function.

Project organization characteristics affect the control system design of a project in the following ways :

 Project management control systems are the modern tools for managing project scope, cost and schedule. They are based on carefully defined process and document controls, metrics, performance indicators and forecasting with capability to reveal trends toward cost overrun and/or schedule slippage. Identifying those trends early makes them more amenable to successful management.

Traditionally, management systems have utilized data about planned and actual costs. Modern systems further incorporate, in their analysis of projects and tasks, the monetary value earned for actual work accomplished. They analyze the Planned Value of work scheduled (PV), Actual Cost of work performed (AC), and Earned Value of work performed (EV). Forecasting includes cumulative and incremental trends in key indicators such as the Estimate at Completion (AC + Estimate to Complete), Cost Variance (EV – AC), Schedule Variance (EV – PV), Cost Performance Index (EV/AC), and Schedule Performance Index (EV/PV). Earned Value Management (EVM) is a systematic approach to the integration and measurement of cost, schedule and scope accomplishments on a project or task, providing managers the ability to examine cost data in the context of detailed schedule information and critical program and technical milestones. EVM systems are in use at CERN and by leading project delivery contractors in commercial industry and government service.

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2.      Explain the concept of Responsibility Accounting and describe its benefits.

Solution: Responsibility accounting is the system for collecting and reporting revenue and cost information by areas of responsibility. It operates on the premise that managers should be held responsible for their performance, the performance of their subordinates, and all activities within their responsibility center. Responsibility accounting, also called profitability accounting and activity accounting, has the following advantages:

1. It facilitates delegation of decision making.

2. It helps management promote the concept of management by objective. In management by objective, managers agree on a set of goals. The manager`s performance is then evaluated based on his or her attainment of these goals.

3. It provides a guide to the evaluation of performance and helps to establish standards of performance which are then used for comparison purposes.

4. It permits effective use of the concept of management by exception, which means that the manager`s attention is concentrated on the important deviations from standards and budgets.

For an effective responsibility accounting system, the following three basic conditions are necessary:

(a) The organization structure must be well defined. Management responsibility and authority must go hand in hand at all levels and must be clearly established and understood.

(b) Standards of performance in revenues, costs, and investments must be properly determined and well defined.

(c) The responsibility accounting reports (or performance reports) should include only items that are controllable by the manager of the responsibility center. Also, they should highlight items calling for managerial attention.

A well-designed responsibility accounting system establishes responsibility centers within the organization. A responsibility center is defined as a unit in the organization which has control over costs, revenues, and/or investment funds. Responsibility centers can be one of the following types:

Cost center. A cost center is the unit within the organization which is responsible only for costs. Examples include production and maintenance departments of a manufacturing company. Variance analysis based on standard costs and flexible budgets would be a typical performance measure of a cost center.

Profit center. A profit center is the unit which is held responsible for the revenues earned and costs incurred in that center. Examples might include a sales office of a publishing company, and appliance department in a retail store, and an auto repair center in a department store. The contribution approach to cost allocation is widely used to measure the performance of a profit center. This topic is covered in Chapter 9 (Control of Profit Centers).

Investment center. An investment center is the unit within the organization which is held responsible for the costs, revenues, and related investments made in that center. The corporate headquarters or division in a large decentralized organization would be an example of an investment center.

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3.      What do you understand by transfer pricing? Explain the criteria used for establishing transfer price.

Solution: Transfer pricing refers to the setting, analysis, documentation, and adjustment of charges made between related parties for goods, services, or use of property (including intangible property). Transfer prices among components of an enterprise may be used to reflect allocation of resources among such components, or for other purposes. OECD Transfer Pricing Guidelines state, “Transfer prices are significant for both taxpayers and tax administrations because they determine in large part the income and expenses, and therefore taxable profits, of associated enterprises in different tax jurisdictions.”

Over 60 governments have adopted transfer pricing rules. Transfer pricing rules in most countries are based on what is referred to as the “arm’s length principle” – that is to establish transfer prices based on analysis of pricing in comparable transactions between two or more unrelated parties dealing at arm’s length. The OECD has published guidelines based on the arm's length principle, which are followed, in whole or in part, by many of its member countries in adopting rules. The United States and Canadian rules are similar in many respects to the OECD guidelines, with certain points of material difference. A few countries, such as Brazil and Kazakhstan, follow rules that are materially different overall.

The rules of nearly all countries permit related parties to set prices in any manner, but permit the tax authorities to adjust those prices where the prices charged are outside an arm's length range. Rules are generally provided for determining what constitutes such arm's length prices, and how any analysis should proceed. Prices actually charged are compared to prices or measures of profitability for unrelated transactions and parties. The rules generally require that market level, functions, risks, and terms of sale of unrelated party transactions or activities be reasonably comparable to such items with respect to the related party transactions or profitability being tested.

Most systems allow use of multiple methods, where appropriate and supported by reliable data, to test related party prices. Among the commonly used methods are comparable uncontrolled prices, cost plus, resale price or markup, and profitability based methods. Many systems differentiate methods of testing goods from those for services or use of property due to inherent differences in business aspects of such broad types of transactions. Some systems provide mechanisms for sharing or allocation of costs of acquiring assets (including intangible assets) among related parties in a manner designed to reduce tax controversy.

Most tax treaties and many tax systems provide mechanisms for resolving disputes among taxpayers and governments in a manner designed to reduce the potential for double taxation. Many systems also permit advance agreement between taxpayers and one or more governments regarding mechanisms for setting related party prices.

Many systems impose penalties where the tax authority has adjusted related party prices. Some tax systems provide that taxpayers may avoid such penalties by preparing documentation in advance regarding prices charged between the taxpayer and related parties. Some systems require that such documentation be prepared in advance in all cases.

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4.      What is performance measurement? List the various types of metrics used for performance measurement and identify the purpose for which they are being used.

Solution: Performance measurement is a process for collecting and reporting information regarding the performance of an individual, group or organizations. It can involve looking at process/strategies in place, as well as whether outcomes are in line with what was intended or should have been achieved.

1. To Evaluate how well a public agency is performing. To evaluate performance, managers need to determine what an agency is supposed to accomplish. (Kravchuk & Schack 1996). To formulate a clear, coherent mission, strategy, and objective. Then based on this information choose how you will measure those activities

2. To Control How can managers ensure their subordinates are doing the right thing.

Today managers do not control their workforce mechanically (measurement of time-and-motion for control as during Taylor) However managers still use measures to control, while allowing some space for freedom in the workforce. (Robert Kaplan & David Norton) Business has control bias. Because traditional measurement system sprung from finance function, the system has a control bias.

Organisations create measurement systems that specify particular actions they want execute- for branch employess to take a particular ways to execute what they want- branch to spend money. Then they want to measure to see whether the employees have in fact taken those actions. Need to measure input by individual into organisation and process. Officials need to measure behavior of individuals then compare this performance with requirements to check who has and has not complied.

Often such requirements are described only as guidelines. Do not be fooled. These guidelines are really requirements and those requirements are designed to control. The measurement of compliance with these requirements is the mechanism of control.

3. To Budget Budgets are crude tools in improving performance. Poor performance not always may change after applying budgets cuts as a disciplinary action. Sometimes budgets increase could be the answer to improving performance. Like purchasing better technology because the current ones are outdated and harm operational processes. So for decisions highly influenced by circumstance, you need measures to better understand the situation.

4. To Motivate Giving people significant goals to achieve and then use performance measures- including interim targets- to focus people’s thinking and work, and to provide periodic sense of accomplishment.

Performance targets may also encourage creativity in developing better ways to achieve the goal (Behn) Thus measure to motivate improvements may also motivate learning.

5. To Celebrate Organisations need to commemorate their accomplishments- such ritual tie their people together, give them a sense of their individual and collective relevance. More over, by achieving specific goals, people gain sense of personal accomplishment and selfworth (Locke & Latham 1984).

6. To Promote How can public managers convince political superiors, legislators, stakeholders, journalists, and citizens that their agency is doing a good job.

(National Academy of Public Administration’s center for improving government performance- NAPA 1999) performance measures can be used to: validate success; justifing additional resources; earn customers, stakeholder, and staff loyalty by showing results; and win recognition inside and outside the organisation.

Indirectly promote, competence and value of goverement in general.

7. To Learn Learning is involved with some process, of analysis information provided from evaluating corporate performance (identifying what works and what does not). By analysing that information, corporation able to learn resons behind its poor or good performance.

However if there is too many performance measures, managers might not be able to learn anything.

8. To Improve What exactly should who- do differently to improve performance? In order for corporation to measure what it wants to improve it first need to identify what it will improve and develop processes to accomplish that.

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5.      Explain in detail the risks faced by the banks and how management control system can contain these risks.

Solution: Bank Deposits generally have a much shorter contractual maturity than loans and liquidity management needs to provide a cushion to cover anticipated deposit withdrawals. Liquidity is the ability to efficiently accommodate deposit as also reduction in liabilities and to fund the loan growth and possible funding of the off-balance sheet claims. The cash flows are placed in different time buckets based on future likely behaviour of assets, liabilities and off-balance sheet items. Liquidity risk consists of Funding Risk, Time Risk & Call Risk.

Funding Risk: It is the need to replace net out flows due to unanticipated withdrawal/nonrenewal of deposit

Time risk : It is the need to compensate for nonreceipt of expected inflows of funds, i.e. performing assets turning into nonperforming assets.

Call risk : It happens on account of crystalisation of contingent liabilities and inability to undertake profitable business opportunities when desired.

The Asset Liability Management (ALM) is a part of the overall risk management system in the banks. It implies examination of all the assets and liabilities simultaneously on a continuous basis with a view to ensuring a proper balance between funds mobilization and their deployment with respect to their a) maturity profiles, b) cost, c) yield, d) risk exposure, etc. It includes product pricing for deposits as well as advances, and the desired maturity profile of assets and liabilities.

b) Interest Rate Risk

Interest Rate Risk is the potential negative impact on

the Net Interest Income and it refers to the vulnerability of an institution’s financial condition to the movement in interest rates. Changes in interest rate affect earnings, value of assets, liability off-balance sheet items and cash flow. Hence, the objective of interest rate risk management is to maintain earnings, improve the capability, ability to absorb potential loss and to ensue the adequacy of the compensation received for the risk taken and effect risk return trade-off. Management of interest rate risk aims at capturing the risks arising from the maturity and re-pricing mismatches and is measured both from

the earnings and economic value perspective. Earnings perspective involves analyzing the impact of changes in interest rates on accrual or reported earnings in the near term. Economic Value perspective involves analyzing the expected cash in flows on assets minus expected cash out

flows on liabilities plus the net cash flows on off-balance sheet items. The economic value perspective identifies risk arising from long-term interest rate gaps.

c) Forex Risk

Foreign exchange risk is the risk that a bank may suffer loss as a result of adverse exchange rate movement during a period in which it has an open position, either spot or forward or both in same foreign currency. Even in case where spot or forward positions in individual currencies are balanced the maturity pattern of forward transactions may produce mismatches. There is also a

settlement risk arising out of default of the counter party and out of time lag in settlement of one currency in one center and the settlement of another currency in anothertime zone. Banks are also exposed to interest rate risk, which arises from the maturity mismatch of foreign currency position. The Value at Risk (VaR) indicates the riskthat the bank is exposed due to uncovered position of mismatch and these gap positions are to be valued on daily basis at the prevalent forward market rates announced by FEDAI for the remaining maturities. Currency Risk is the possibility that exchange ratechanges will alter the expected amount of principal and return of the lending or investment. At times, banks may try to cope with this specific risk on the lending side byshifting the risk associated with exchange rate fluctuations to the borrowers. However the risk does not get extinguished, but only gets converted in to credit risk.By setting appropriates limits-open position and gaps, stop-loss limits, Day Light as well as overnight limits for each currency, Individual Gap Limits and Aggregate GapLimits, clear cut and well defined division of responsibilities between front, middle and back office the risk element in foreign exchange risk can be managed/monitored.

d) Country Risk

This is the risk that arises due to cross border transactions that are growing dramatically in the recent years owing to economic liberalization and globalization. It is the

possibility that a country will be unable to service or repay debts to foreign lenders in time. It comprises of Transfer

Risk arising on account of possibility of losses due torestrictions on external remittances; Sovereign Risk associated with lending to government of a sovereign nation or taking government guarantees; Political Risk when political environment or legislative process of country leads togovernment taking over the assets of the financial entity(like nationalization, etc) and preventing discharge of liabilities in a manner that had been agreed to earlier; Cross border risk arising on account of the borrower being a resident of a country other than the country where the crossborder asset is booked; Currency Risk, a possibility thatexchange rate change, will alter the expected amount ofprincipal and return on the lending or investment.In the process there can be a situation in which seller(exporter) may deliver the goods, but may not be paid orthe buyer (importer) might have paid the money inadvance but was not delivered the goods for one or the

other reasons.