Q.

1 Short notes:
a. Impact of management style on management controls:
Ans: The internal factor that probably has the strongest impact on management control is
management style. Usually, subordinates attitude reflects that what they perceive their
superiors’ attitude ultimately stem them from the CEO. Managers come in all shapes and
sizes. Some are charismatic and outgoing, others are less ebullient. Some spend much time
looking and talking to people, others rely more heavily on written reports.
Examples: when Reginald Jones was appointed CEO of GE in the early 1970s, the company
was a large, multi-industry company that performed fairly well in a number of mature
markets. But the company did have its problems; price fixing scandals that sent several
executive in jail, coupled with GEs sound defeat in, and subsequent retreat from, the
mainframe company. Jones’ management style was well suited to bring more discipline to the
company. Jones awes formal, dignified, refined, bright, and both willing and able to delegate
enormous amounts of authority. He instituted formal strategist planning and built up one of
the first strategic planning unit in Major Corporation.
After Jones, jack Welch, outspoken, impatient, informal, entrepreneur. These qualities are
well suited in the era of 80s & 90s. In 2001, when jack Welch after 20 years at the helm, Jeff
Immelt was chosen as new chairmen an d CEO, Immelt plan to focus on GE’s customer
orientation, business mix, management diversity & technology.
GE has well-deserved reputation for producing sterling business managers who have very
different styles but a common ability to lead successfully.
b. . Free Cash Flow:
A measure of financial performance calculated as operating cash flow minus capital
expenditures. Free cash flow (FCF) represents the cash that a company is able to generate
after laying out the money required to maintain or expand its asset base. Free cash flow is
important because it allows a company to pursue opportunities that enhance shareholder
value. Without cash, it's tough to develop new products, make acquisitions, pay dividends
and reduce debt. FCF is calculated as:

 
It can also be calculated by taking operating cash flow and subtracting capital expenditures.
Free Cash Flow of the Firm is calculated as follows:-

A measure of financial performance that expresses the net amount of cash that is generated
for the firm, consisting of expenses, taxes and changes in net working capital and
investments.
Calculated as:

This is a measurement of a company's profitability after all expenses and reinvestments. It's
one of the many benchmarks used to compare and analyze financial health.

A positive value would indicate that the firm has cash left after expenses. A negative value,
on the other hand, would indicate that the firm has not generated enough revenue to cover its
costs and investment activities. In that instance, an investor should dig deeper to assess why
this is happening - it could be a sign that the company may have some deeper problems.

c. Management control process in organization:

Ans: Management control is the process by which managers influence other members of
the organization to implement the organization’s strategies. Management control process
involves informal interactions between one manger and another manager and his or her
subordinates. Informal communications occurs by means of memoranda, meetings,
conversations, and even by facial expression. The informal interactions take place within a
formal planning and control system. Such system includes the following activities:
1] Strategic planning,
2] Budget preparation,
3] Execution,
4] Evaluation of performance.
Each activity leads to next in a regular cycle.
1] Strategic planning: it is process of deciding on the major programs that organization
undertakes to implement its strategies and appropriate amount of resources that will be
devoted to each. The output of the process called as strategic planning. This is the first step
in management control cycle.
2] Budget planning: budget represent fine tuning of the strategic planning, incorporating
most current information. In budget, revenue and expenses are rearranged from programme to
the responsibility centre, thus budget shows the expenses that each managers expected to
occur. The process of budget preparation is essentially one of the negotiations between the
managers of each responsibility centre and their superior.
3] Execution: managers execute the programme or part of the programme for which they are
responsible and also report on what has happened in the course of fulfilling that
responsibility. Reports on responsibility centre may show budgeted and actual information,
financial and non-financial performance measures, internal & external information.
4] Evaluation of performance: the process of evaluation is comparison of actual expenses
and those that should have been incurred under circumstances. If the circumstances assumed
in the budget process are unchanged, the comparison between budgeted and actual amounts.
If circumstances have changed, these changes are taken into accounts. Ultimately, the
analysis leads to praise or constructive criticism of the responsibility centre managers.

d. Implication of differentiated strategies on controls:

Ans: Any organization, however well aligned its structures is to the chosen strategy, can
not effectively implement its strategies without a consistent management control system.
While organization structure defines the reporting relationship and responsibilities and
authorities of different managers, it needed an appropriately designed control system to the
function effectively.
Different corporate strategies imply the following differences in the context in which control
systems need to be designed:
1. As firms become more diversified, corporate level managers may not have significant
knowledge of, or experience in, the activities of the company’s various business units.
If so, corporate level managers for highly diversifies firms can not expect to control
the different businesses on the basis of intimate knowledge of their activities and
performance evaluation tends to be carried out at arm’s length.
2. Single industry and related diversified firms possess corporate wide core
competencies on which the business units are based. Communication channels and
transfer of competencies across business units. Therefore, are critical in such firms. In
contrast, there are low levels of interdependence among the business units of
unrelated diversified firms. This implies that as firm becomes more diversified, it may
be desirables to the change the balance in control system from an emphasis on
fostering cooperation to an emphasis on encouraging entrepreneurial spirit.

Q.2 Under which conditions Management is better advised not to create Profit
Centers? Explain the advantage of creation of Profit Centers?

Ans. When a responsibility centre`s financial performance is measured in terms of profit

(i.e by the difference between the revenue and expenditure) the centre is called the profit
centre. Profit is particularly useful performance measure since it allows senior management
to use one comprehensive indicator rather than several.

Many management decisions involve proposals to increase expenses with the expectations of
an even greater increase in sales revenue. Such decisions are said to involve expenses /
revenue trade off. Additional advertising expense is an example. Before it is safe to delegate
such a trade off decision to a lower level manager two conditions should exist. These are as
follows :
 i) The manager should have access to relevant information needed for making
such a decision.

ii) There should be some way to measure the effectiveness of trade offs the
manager has made.

A major step in creating profit centers is to determine. The lowest point in an

organization where these two conditions prevail.

Advantages Of Profit Centers:-

Establishing organization units as profit centers provides the following advantages:-

1. The quality of decisions may improve because they are being made by
managers closest to the point of decision.
2. The speed of operating decisions may be increased since they do not have
to be referred to the corporate head quarters.

3. Headquaters management, relieved of day-to-day decision making can

concentrate on broader issues.

4. Managers subject to fewer corporate restraints, are freer to use their

imagination and initiative.

5. 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.
6. Profit consciousness is enhanced since managers who are responsible for
profits will constantly seek ways to increase them.

7. Profit centers provide top management with ready-made information on

profitability of the company`s individual components.

8. Because their output is readily measured profit centers are particularly

responsive to pressures to improve their competitive performance.

Q.3 (a) Describe the features of cost based and market price based transfer pricing
methods?
Ans:- In divisionalised companies where profit or investment centers are created there is
likely to be interdivisional transfer of goods or services and this internal transfer create the
problem of transfer pricing. A transfer price is that notional value at which goods and
services are transferred between division in a decentralized organization. Transfer prices are
normally set for intermediate products which are goods and services that are supplied by the
selling division to the buying division. The goods that are produced by the buying division
and sold to the outside world are known as final product.

Broadly there are 3 bases available for determining transfer prices but many options
are also available within each bases.

1. MARKET BASED PRICES:-

Market price refers to a price in an intermediate market between independent buyer
and seller. When there is competitive external market for the transferred product, market
prices work well as transfer prices. When transferred goods are recorded at market prices
divisional performance is more likely to represent the real economic contribution of the
division to total company profit. If the goods cannot be brought from a division within the
company the intermediate product would have to be purchased from the current market price
from the outside market. Divisional profits are therefore likely to be similar to the profits that
would be calculated if the divisions were to be separate organizations. Divisional profits can
be compared directly with the profitability of similar companies operating in the same type of
business. No divisions can benefit at the expense of another division. The selling division can
sell all that it produces at the market price transferring internally at a lower price would make
that division worse off. Since the minimum transfer price for the selling division is the market
price and the maximum price for buying division is also the market price the only possible
transfer price is the market price.

The market price can be used to resolve conflicts among the buying and selling
division. Market price is optimal so long as the selling division is operating at full capacity.
Market price may change often. Internal selling expense may be less than would be incurred
if the products were sold to outside.

2. COST BASED PRICES:-

When external markets do not exist or are not available to the company or when the
information about external market prices is not readily available companies may decide to
use some form of cost based transfer pricing system. Under this method the transfer price is
based on the total product cost. It has three characteristics.

1. It provides a varying price since cost per unit keeps changing as use of
capacity changes.

2. It mixes short run and long run costs.

3. The concept is based on the equation of variable cost plus arbitrary mark up
to cover capacity related cost and a targeted profit margin.

Q.3. (b) Explain the problems faced in pricing corporate services furnished by
corporate services staff to business units in the company. Assume profit
centers decentralization.

Ans: There are some of the problems associated with charging business units for services
furnished by corporate staff units. Central accounting, public relations, administration these
are the costs of central service staff units over which business units have no control if these
costs are charged at all, they are allocated, and the allocations do not include a profit
component. The allocations are not transfer prices.

There remain two types of transfers:

1. For central services that the receiving unit must accept but can at least partially
control the amount used.

2. For central services that the business unit can decide whether or not to use.
Control over amount of service

Business units may be required to use company staffs for services such as information
technology and research and development. In these situations, the business unit manager
cannot control the efficiency with which these activities are performed but can control the
amount of the service received. There are three schools of thought:

 One school holds that a business unit should pay the standard variable cost of the
discretionary services. If it pays less than this, it will be motivated to use more of the
service than is economically justified. On the other hand, if business unit managers
are required to pay more than the variable cost, they might not elect to use certain
cervices that senior management believes worthwhile from the company’s viewpoint.
 This possibility is most likely when senior management introduces a new service,
such as a new project analysis program. The low price is analogous to the introductory
price that companies sometimes use for a new product.
 A second school of thought advocates a price equal to the standard variable cost plus a
fare share of the standard fixed costs-that is, the full cost. Proponents argue that if the
business units do not believe the services are worth at least this amount, something is
wrong with either the quality or the efficiency of the service unit. Full costs represent
the company’s long run costs, and this is the amount that should be paid.
 A third school advocates a price that is equivalent to the market price or to standard
full cost plus a profit margin. The market price would be used if available (e.g. costs
charged by a computer service bureau); if not, the price would be full cost plus a
return on investment. The rationale for this position is that the capital employed by
service units should earn a return just as the capital employed by manufacturing units
does. Also, the business units would incur the investment if they provided their own
service.
Optional use of Services

In some cases management may decide that business units can choose whether to use
central service units. Business units may procure the service from outside, develop their own
capability, or choose not to use the service at all. This type of arrangement is most often
found for such activities as information technology, internal consulting groups, and
maintenance work. These service centers are independent; they must stand on their own feet.
If the internal services are not competitive with outside providers, the scope of their activity
will be contracted of their services may be outsourced completely.

Profit Centre Decentralization :

Management style and culture influence concept of decentralized operation which top
management chooses to run the organization. It is concerned with how control over divisional
operations is exercised by top management through personal interactions, policies and
procedures, including planning system. The chief executive of a company has to distribute
the responsibility for profit earning among the top executives, keeping the control with him.
In a big company with diversified products manufactured and distributed through number of
units scattered over wide geographical locations-there is danger of responsibility for profit
being diffused.
 Under functional structure, the management of profit becomes a very hard task and
may even cut into the efficiency of the firm. Decentralization is surely an effective means to
overcome this diffusion of profit responsibility.

Q.4 What is a responsibility center? List and explain different types of Responsibility
Centres in organizations.
ANS: A responsibility centre may be defined as an area of responsibility which is
Controlled by an individual. A responsibility centre is an activity such as department over
which a manager exercises responsibility. Responsibility areas may be departments ( drilling
or maintenance department), product lines ( chemicals or fertilizers), territories (North or
South) or any other type of identifiable unit or combination of units. The specific types of
responsibility areas depend on the nature of the firm and its activities. It is relatively easy to
identify activities with specific managers. A plant manager is in charge of a plant and is
usually responsible for producing budgeted quantities of specific products within budgeted
cost limit. A sales manager is responsible for getting orders from customers, and so on. A
responsibility center exists to accomplish one or more purposes, termed its objectives. The
objectives of the company’s various responsibility centers are to help implement these
strategies.
Types of Responsibility Centres
Responsibility centres can be classified by the scope of responsibility assigned and
decision-making authority given to individual managers. The following are four common
types of responsibility centers.
1) Cost Centre
A cost or expense centre is a segment of an organization in which the mangers are
held responsible for the cost incurred in that segment but not for revenues. Responsibility in a
cost center is restricted to cost. For planning purposes, the budget estimates are cost
estimates; for control purposes, performance evaluation is guided by a cost variance equal to
the difference between the actual and budgeted costs for a given period. Cost center managers
have control over some or all of costs in their segment of business, but not over revenues.
Cost centres are widely used forms of responsibility centers. In manufacturing organizations,
the productions and service departments are classified as cost centre. Also, a marketing
department, a sales region or a sales representative can be defined as a cost centre. Cost
center may vary in size from a small department with a few employees to an entire
manufacturing plant.
In addition cost centres may exist within other cost centres. For example, a manager
of a manufacturing plant organized as a cost centres, with the department with a few
employees to an entire manufacturing plant organized as a cost centre may treat individual
departments within the plant as separate cost centres, with the department managers
reporting directly to plant manager. Cost centre managers are responsible for the cost that are
controllable by them and their subordinates. However, which costs should be charged to cost
centres, is an important in evaluating cost centre managers.
 2) Revenue Centre
A revenue centre is a segment of the organization which is primarily responsible for
generating-sales revenue. A revenue centre manager does not possess control cost,
investment in assets, but usually has control over some of the expense of the marketing
department. The performance of a revenue centre is evaluated by comparing the actual
revenue with budgeted revenue and actual marketing expenses. The Marketing manager of a
product line, or an individual sales representative are examples of revenue centres.
For eg In 1999 two companies, Servico and Impac Hotel Group, merged to create
Lodgian, Inc., one of the largest owners and operators of hotel in the United States. Lodgian
reorganized itself into six regions, each with a Regional Vice-president, a regional
operational manager, and a regional Director of sales and marketing. The sales and marketing
functions were constituted as revenue centres, with the goal to significantly improve market
share.
In the highly competitive call centre industry environment of 2004, some companies
successfully differentiated themselves by converting their services centres into revenue
centres. The revenue streams were generated through “after service sales”. The call centre
agents would address the calling customer’s needs and requests, provide the necessary
service, and then offer some type of new product or service that would meet the customer
needs.
3) Profit Centre
A profit centre is a segment of an organization whose manager is responsible for both
revenues and costs. Managers of profit centres have control over both costs and revenues. In
a profit centre the manager as the responsibility and the authority to make decisions that
affect both costs and revenues for the department or division. The main purpose of a profit
centre is to earn profit. Profit centre managers aim at both the production and marketing of a
product. The performance of the profit is evaluated in terms of whether the centre has
achieved its budgeted profit. A division of the company which produces and markets the
products may be called a profit centre. Such a divisional manager determines the selling
price, marketing programmes and production policies. Profit centres make managers more
concerned with finding ways to increase the centre’s revenue by increasing production or
improving distribution methods. The manager of a profit centre does not make decisions
concerning the plant assets available to the centre. For e.g., the manager of the sporting goods
department does not make the decisions to expand the available floor space for the
department.
Mostly profit centres are created in an organization in which they sell products or
services outside the company. In some cases, profit centres may be selling products or
services within the company. For example, repairs and maintenance department in a company
can be treated as a profit centre if it is allowed to bill other production department in a
company can be treated as a profit centre if it is allowed to bill other production department
for the services provided to them. Similarly, the data processing department may bill each of
company’s administrative and operating departments for providing computer related services.
An example of a profit centre in a departmental store having different retail
department is displayed in Fig
 Store Manager

MMm
Men’s Women’s Children’s Toy’s Shoe Medicines Photograp
Clothing clothing clothing departm Depart department hy
Department Departme departme ent ment departmet
nt nt n

4) Investment Centre
An investment centre is responsible for both profits and investments. The investment
centre manager has control over revenues, expenses and the amount invested in the centre
assets. He also formulates the credit policy which has a direct influence on debt collection,
and the inventory policy which determines the investment in inventory. The manager of an
investment centre has more authority and responsibility than the manager of either a cost
centre or a profit centre. Besides controlling costs and revenues, he has investment
responsibility too. Investment on asset responsibility means the authority to buy, sell and use
divisional assets.
For example division of a large multinational companies. The division is assessed in
terms of it’s contribution to overall profits.

Q.5 a. What are interactive controls ?

Interactive control is a subset of the management control information that has a
bearing on the strategic uncertainties facing the business becomes the focal point.
In industries that are subject to very rapid environmental changes, management
control information can also provide the basis for thinking about new strategies. In a rapidly
changing and dynamic environment, creating a learning organization is essential to corporate
survival. Learning organization refers to the ability of organization employees to learn to
cope with environmental changes on an ongoing basis. An effective learning organization is
one in which employees at all levels continuously scan the environment, identify potential
problems and opportunities, exchange environment information candidly and openly and
experiment with alternative environment. The main objective of interactive control is to
facilitate the creation of a learning organization.
Interactive control

Todays

Management

Control system
 Tomorrows

Strategy

Interactive controls alert management to strategic uncertainties, either troubles ( e.g.,

loss of market share, customer complaints) or opportunities ( e.g., opening a new market
because certain governmental regulations have been removed ). These become the basis for
managers to adopt to a rapidly changing environment by thinking about new strategies.
Interactive control has the following characteristics:
1) A subset of the management control information that has a bearing on the strategic
uncertainties facing the business becomes the focal point.
2) Senior executives take such information seriously.
3) Managers at all levels of the organization focus attention on the information
produced by the system.
4) Superiors, subordinates and peers meet face-to-face to interpret and discuss the
implications of the information for future strategic
5) The face-to-face meetings take the form of debate and challenge of the underlying
data, assumptions, and appropriate actions.
Strategic uncertainties relate to fundamental, nonlinear shifts in the environment that
potentially can create new business models. Firms should monitor the following
technological discontinuities:
1. Internet and e-commerce growth have potential implication for many firms. Some
of the particular items to monitor include :

 Growth in the number of internet users.

 Roll-out of broadband communications.
 Emergence of ubiquitous point-and-click interfaces that are based on open standards,
cheap to set up and run, and global.
 Increasing power of computing and communication technologies.
 Growth in mobile communications for both voice telephony and internet access.
 Development and deployment of speech recognition and machine based language
translation technologies that may make it possible for people speaking or writing
different languages to communicate with each other in real time.
2. converging technologies will have the following effects:

 Convergence of voice, data, and image has implications for firms operating in
consumer electronics (Phillips), telecommunications (British Telecom), and computer
(IBM) industries.
 Integration of chemical and digital technologies has impact on firms such as Eastman
Kodak.
 Blending of hardware and software has impact on firms such as Sony.
 Merging of plant engineering and biotechnology opens up opportunities for firms I
life sciences (Novartis, Merck, Pfizer).
4. Shift from physical goods to services is rapidly transforming the automobile industry
(Ford) and consumer durable goods business (General Electic).
Interactive controls are not a separate system; they are an integral part of the
management control system. Some management control information helps managers think
about new strategies. Interactive control information usually, but not exclusively, tends to be
nonfinancial. Since strategic uncertainties differ from business to business, senior executives
in different companies might choose different parts of their management control system to
use interactively.
Q. 5 b Discuss the features of management control system in nonprofit
organization.
Ans: A nonprofit organization was define by law, is an organization that cannot
distribute assets or income to, or for the benefit of, its member, its officers, directors. The
organization can, of course, compensate its employees, including officers and members, for
services rendered and for goods supplied,. This definition does not prohibit an organization
from earning a profit, on average, to provide funds for working capital and for possible “rainy
days”.
Characteristics of nonprofit organization
o Absence of the Profit Measure
o Contributed capital
o Fund Accounting
o Governance

Management control System and its features in nonprofit organization

Product Pricing
Many nonprofit organizations give inadequate attention to their pricing policies.
Pricing of services at their full const is desirable.
A “full-cost” price is the sum of direct costs, indirect cost, and perhaps a small
allowance for increasing the organization’s equity. This principle applies to services that are
directly related to the organization’s objectives. Pricing for peripheral activities should be
market-based. Thus a nonprofit hospital should price its health care services at full const, but
prices in its gift shop should be market based.
In general, the smaller and more specific the unit of service that is priced, the better
the basis for decisions about the allocation of resources. For example, a comprehensive daily
rate for hospital care, which was common practice a few decades ago, masks the revenues for
the mix of services actually provided. Beyond a certain point, of course, the cost of the paper
work associated with pricing units of service outweighs the benefits.
As a general rule, management control is facilitated when prices are established prior
to the performance of the services. If an organization is able to recover it’s incurred costs,
management is not motivated to worry about cost control.
Strategic planning and budget Preparation
 In nonprofit organizations that must decide how best to allocate limited resources to
worth-while activities, strategies planning is a more important and more time-consuming
process than in the typical business.
Colleges and universities, welfare organizations, and organization in certain other
nonprofit industries know before the budget year begins, the approximate amount of their
revenues. They do not have the option of increasing revenues during the year by increasing
their marketing efforts. They budget expense so that organization will at least break even at
the estimated amount of revenue. They require that managers of responsibility centre limit
spending close to the budget amounts. The budget is, thereof, the most important
management control tool, at least with respect to financial institution.
Operation and Evaluation
In most nonprofit organizations, there is no way of knowing what the optimum
operating costs are. Responsibility centre managers, therefore, tend to spend whatever is
allowed in the budget, even though the budgeted amount may be higher than is necessary.
Conversely, they may refrain from making expenditures that have an excellent payoff simply
because the expenditure was not included in the budget.
Although nonprofit organizations have has a reputation for operating inefficiently,
this perception has been changing for good reasons. Many organization have had increasing
difficulty in raising funds, especially from government resources. This has led to belt-
tightening and to increased attention to management control. As mention above, the most
dramatic change has been in hospital costs, with the introduction of reimbursement on the
basis of standard prices for diagnostic-related groups

Q.8 Explain various features of Financial, Operational and Management Audit (all of
which are forms of Internal Audit). Illustrate with one example.

Internal auditing is a profession and activity involved in helping organisations achieve their
stated objectives. It does this by utilizing a systematic methodology for analyzing business
processes, procedures and activities with the goal of highlighting organizational problems and
recommending solutions. Professionals called internal auditors are employed by
organizations to perform the internal auditing activity.

The scope of internal auditing within an organization is broad and may involve topics such as
the efficacy of operations, the reliability of financial reporting, deterring and investigating
fraud, safeguarding assets, and compliance with laws and regulations.

Internal auditing frequently involves measuring compliance with the entity's policies and
procedures. However, Internal auditors are not responsible for the execution of company
activities; they advise management and the Board of Directors (or similar oversight body)
regarding how to better execute their responsibilities. As a result of their broad scope of
involvement, internal auditors may have a variety of higher educational and professional
backgrounds.
Publicly-traded corporations typically have an internal auditing department, led by a Chief
Audit Executive ("CAE") who generally reports to the Audit Committee of the Board of
Directors, with administrative reporting to the Chief Executive Officer.

The profession is unregulated, though there are a number of international standard setting
bodies, an example of which is the Institute of Internal Auditors ("IIA").

Best Practices in Internal Auditing

Measuring the internal audit function

The measurement of the internal audit function can involve a balanced scorecard approach.
[10] Internal audit functions are primarily evaluated based on the quality of counsel and
information provided to the Audit Committee and top management. However, this is
primarily qualitative and therefore difficult to measure. “Customer surveys” sent to key
managers after each audit project or report can be used to measure performance, with an
annual survey to the Audit Committee. Scoring on dimensions such as professionalism,
quality of counsel, timeliness of work product, utility of meetings, and quality of status
updates are typical with such surveys.

Quantitative measures can also be used to measure the function’s level of execution and
qualifications of its personnel. Key measures include:

Plan completion: This is a measure of the degree to which the annual plan of engagements is
completed, measured at a point in time. This may be measured using the number of projects
completed, weighted by the planned size of each project, with estimates for projects in-
progress. Measured throughout the year, it is compared against the percentage of the year
elapsed.

Report issuance: This is a measure of the time elapsed from completion of testing to issuance
of the final audit report, including management’s action plans. This can be measured in
average days or percentage of reports issued within a certain standard, such as 30 days.
Establishing expectations for the timing of management’s response to report
recommendations is critical. In addition, the scope and degree of change involved in the
report’s action plans are key variables. For example, a report for a single retail store requiring
only the store manager’s action might take 3-5 days to issue. However, a report consolidating
findings from 20 retail stores, with action plans with national implications determined by top
management, may take 30-60 days in complex organizations.

Issue closure: Reported audit findings are often called “issues” or “deficiencies.” Professional
standards require audit functions to track reported findings to resolution, which effectively
requires the maintenance of an issues follow-up database. The number of days that reported
issues remain open, or open after their agreed-upon closure date, are key measures. In
addition, reporting database statistics such as the number of issues open (unresolved), closed
(resolved), and issues opened/closed during a given period are useful statistics.
Staff qualifications: This can be measured through the percentage of staff with professional
certifications, graduate degrees, and overall years of experience.

Staff utilization rate: This is measured as the percentage of time spent on projects, as opposed
to administrative time such as training or vacation. Many internal audit departments track
time by audit project. This is typically captured in a database or spreadsheet.

Staffing level: The number of positions filled relative to the authorized staffing level. Due to
the challenge of finding qualified staff, departments may have rotational programs to bring in
management to complete tours in the function or be "guest" auditors. Audit departments also
"co-source," meaning they obtain contract auditors from service providers.

Financial Audit:

A financial audit, or more accurately, an audit of financial statements, is the review of the
financial statements of a company or any other legal entity (including governments), resulting
in the publication of an independent opinion on whether or not those financial statements are
relevant, accurate, complete, and fairly presented. Financial audits are typically performed by
firms of practicing accountants due to the specialist financial reporting knowledge they
require. The financial audit is one of many assurance or attestation functions provided by
accounting and auditing firms, whereby the firm provides an independent opinion on
published information.

Features:

Instant information access and sharing for everyone

Unified auditing methods

Automated report generation

Less labour intensive and time-saving during report review meetings

Operational Audit:

An Operational Audit Process understands the responsibilities and risks faced by an auditable
faculty, department, unit or process (Hierarchy of Concerns for Audit and assess the level of
control) exercised by management; identify, with management participation, opportunities for
improving control.

This includes:

Reliability and integrity of financial and operational information;

Effectiveness and efficiency of operations;

Safeguarding of assets;

Compliance with laws , regulations and contracts.

Normally, this involves the following six phases:

1) Pre-audit process

The process normally begins with an introductory meeting to inform the unit's senior
management that an audit will take place, to explain the process, and to gather background
information.

Following the introductory meeting, the auditor performs a preliminary gathering of

information using various sources of information (for example, the unit's web site) to identify
the possible components and concerns. At the end of this stage, a binder is prepared and is
used in the risk assessment meeting with the auditees.

2) Risk assessment meeting with auditee

The risk assessment meeting involves the key managers of the department or faculty or unit
to be audited. One objective of the risk assessment meeting is to obtain confirmation of the
components and major concerns of the unit . The key managers also perform an assessment
of the importance of each concern (low, medium or high) for each component. They are also
requested to perform a voting exercise to compare and rank the components and concerns.
This step is preferably completed during the meeting, but may be completed separately with
each manager. The result is a risk template. The high-risk areas identified by management
will then provide the focus for the audit project.

3) Control matrix

The auditor meets with the managers of the high-risk areas to identify the key management
objectives and the key control activities performed. After these meetings, the auditor
documents the key management objectives and the key controls. The lack of key controls
identified, referred to as control design issues, is also documented in the matrix. Once the
first draft of the control matrix is completed, it is sent back to the managers for confirmation
and validation. The lack of key controls (control design issues) is also discussed with
management. The key controls identified in the matrix represent the controls to be tested in
the next phase.

4) Test design

Once the matrix has been agreed upon with management, the auditor designs the test
procedures for the identified key controls. The auditor prepares a test design for each key
control activity identified in the matrix. The testing plan is reviewed before the testing phase
begins. The testing phase usually requires the auditor's presence in the department to conduct
interviews, examine documents, and obtain explanations. The auditor documents the results
of the tests, the conclusion, and any proposals. During testing, the auditor also discusses
preliminary findings with individual managers. The test results become the basis for the first
draft of the audit report.

5) Report drafting

After the previous stages have been completed, the auditor can produce a draft report to be
presented and discussed with management. The draft report uses the following standard
structure:

Memo

Conclusion

Background information

Scope

Objectives

Proposals

Risk template and key controls as an appendix

Other appendices

The report review and discussion process is designed to arrive at agreed action plans to
resolve identified issues. Any management-accepted risks and differences of opinion are also
reported. The report drafting process involves meetings with increasingly senior levels of the
management hierarchy until the report has both the moral and monetary (if needed) support
for the issues raised.

6) Final audit report

The final report is distributed to all managers of an audited unit, the relevant members of
senior management, the Vice-Principal, (Administration and Finance), the Chair of the Audit
Committee of the Board, and the external auditors.

Managerial Audit:

Q.9 Investment base used in performance evaluation of investment centres consists of

various elements. Explain general practices used in organisation in treatment of each
element and the likely response induced by the treatment of each of these elements in
managers.

PERFORMANCE MEASURES FOR INVESTMENT CENTERS

Rate of Return on Investment (ROI)

A performance measure used to evaluate the efficiency of an investment or to compare the
efficiency of a number of different investments. To calculate ROI, the benefit (return) of an
investment is divided by the cost of the investment; the result is expressed as a percentage or
a ratio. 

The return on investment formula:

Return on investment is a very popular metric because of its versatility and simplicity. That
is, if an investment does not have a positive ROI, or if there are other opportunities with a
higher ROI, then the investment should be not be undertaken.

Advantages:

1) ROI allows management to assess both profitability and efficiency in using assets.

2) Divisions of unequal size can be com-pared.

3) Management is provided with information to make decisions on where to invest

additional company funds. The company knows where it is getting "the most
bang for its buck."

Disadvantage:

If a manager is evaluated based on ROI, he or she will not invest in any project that will
lower the division's ROI, even if it would increase the company's profitability.

Residual Income

The amount of income that an individual has after all personal debts, including the mortgage,
have been paid. This calculation is usually made on a monthly basis, after the monthly bills
and debts are paid. Also, when a mortgage has been paid off in its entirety, the income that
individual had been putting toward the mortgage becomes residual income.

Advantages:

1) It considers a company's minimum rate of return.

2) Any project that increases residual income will be pursued by division management.

Disadvantage:

The relative size of the divisions is not considered.

The balanced scorecard is a set of financial and nonfinancial measures that reflect multiple
performance dimensions of a business.
Transfer Pricing

The Price at which Divisions of a company transact with each other. Transactions may
include the trade of supplies or labor between departments. Transfer prices are used when
individual entities of a larger multi-entity firm are treated and measured as separately run
entities. 

Also known as " transfer cost "

In managerial accounting, when different divisions of a multi-entity company are in charge of

their own profits, they are also responsible for their own "Return on Invested Capital".
Therefore, when divisions are required to transact with each other, a transfer price is used to
determine costs. Transfer prices tend not to differ much from the price in the market because
one of the entities in such a transaction will lose out: they will either be buying for more than
the prevailing market price or selling below the market price, and this will affect their
performance.

Benefits of transfer pricing

1. Divisions can be evaluated as profit or investment centers.

2. Divisions are forced to control costs and operate competitively.

3. If divisions are permitted to buy component parts wherever they can find the best price
(either internally or externally), transfer pricing will allow a company to maximize its profits.

Few other Non - financial Performance Measurement Tool

1. Measures of product quality

2. Customer complaints and warranty experience

3. Customer satisfaction and retention rates

4. Product availability and on-time performance

5. New product time to market and market share

Q.10. Year and information about two expense centres in an organization

Providing services is tabulated below to be used for review and performance appraisal.
All figures are in Rs. : -
Centre Budget Actual Over Budget Under Budget
A 13,30,893 13,85,154 54,261 -
B 11,76,302 11,30,073 - 46,229

Total 25,07,195 25,15,227

Number of personnel:
A 46 46 - -
 B 26 24 - 2
Manager to whom the heads of these two centers report is not clear on how to use the
available information for evaluation. Assuming that any further information requested
would be available ( on proper justification), assistant
Manager in his task of evaluation.

Solution:

Center B = 11,76,302/26 = 45,242.38 per person

45,242.38* (actual employee) 24 = 1,085,817.12

This should have been the actual base in the budget.

(Amount overspent)Actual amount spent is = 1130073-1085817.12

= 44,255.88

1130073/24 = 47086.375- per person actual expense.

1176302/26 = 45242.38- per person actual expense.

47086.375-45242.38 =1843.995= 1844

Verification = 1844*24
= 44256 (Which is same as actual to be overspent as per budget.)
44265 over spent

For A budget = 1330893/46 = 28932.45

Actual = 1385154/46 = 30112.04

30112.04-28932.45 = 1179.59.

Therefore verification = 1179.59*46

= Rs. 54261(over budget)

Q 11 omega co. has divisions-M & N. products required by div N are currently being
outsourced at Rs.20/unit. Div M makes these products and can sell either to div N or to
outside markets. Current capacity of div M is 50,000 units. Div N sells its products at
Rs. 40/unit in the market. Income statement for both the divisions and the company is
as under-

Div M (Rs. Lacs) Div N (Rs. Omega co. (Rs.

Lacs) Lacs)
Sales
50,000 units @Rs 20/unit 10 - 10
20,000 units @Rs 40/unit - 8 8
Total 10 8 18
Expenses
Variable
50,000 units @Rs 10/unit 5 - 5
20,000 units @Rs 30/unit - 6 6
 Fixed expenses 3 1 4
Total expenses (8) (7) (15)
Gross income 2 1 3

Div M may be in a position to create an additional capacity of 20000 units at no additional

fixed expenses. However, it can only continue to sell 50000 units in the market.
(a) What should be done by the company as a whole? Justify with figures.
(b) What would be the approach of managers of div M & N towards the possible capacity
increase? What should it be? Why?
(c) If you are commend interunit sale, what would be the recommended price? Why?

Ans:
Income Statement with Production capacity: Unit M: 50000 * 20, Unit N 20000*40

Particulars Unit ‘M’ (In Lacs) Unit ‘N’ (In Lacs) Total (In Lacs)

Sales 10 8 18

- Variable Exp. 5 6 11

Contribution 5 2 7
-
- Fixed Cost 3 1 4

Profit 2 1 3

PV Ratio 50% 25% 38.88%

Income statement with production capacity of additional 20000 units in Unit M

Particulars Unit ‘M’ (In Lacs) Unit ‘N’ (In Lacs) Total (In Lacs)

Sales 14 8 22

- Variable Exp. 7 6 13

Contribution 7 2 9
-
- Fixed Cost 3 1 4

Profit 4 1 5

PV Ratio 50% 25% 40.90%

 a) What should be done by the company as a whole? Justify with figures.
Ans: as per figures given in two tables mentioned above. The company can increase its
production capacity with unit m. with no increase in Fixed cost for unit m the PV ratio
remained same at 50%. As per additional increase in production of units, we can see PV ratio
for entire company increased marginally from 38.88% to 40.90%. Looking at the increment
in profit volume Ratio Company can increase its production with unit m.
b) What would be the approach of managers of div M & N towards the possible capacity
increase? What should it be? Why?
Ans: the manager of div m should have positive outlook for additional increase in
capacity with no burden of additional fixed cost. The manager of m division can take
benefit of the leverage with increase in additional capacity. The manager of unit n should
not worry of additional increase in capacity of unit m. the manger can outsource the
additional capacity. The 70000 unit production capacity for unit n will bring the profit
volume ratio to 40%, which will be in the favor of company.

c) If you are recommend interknit sale, what would be the recommended price? Why?
Ans: as far as inter unit sale concerns, we would be happy to recommend same price as
further reduction in the interunit price could hammer the PV ratio of unit m. It could also
affect profitability of the overall firm. The reduction in the inter unit sale can affect the
margins of the unit m. it could also affect margins of the outsource market.
or

Q11 . Document processing is the activity in which Div DP of an org. is involved. This is
the major activity of the org, which it, in fact, pioneered. However, between 1990 to
2000, market share of document products fell drastically by 40%. Competitive products
were being offered almost at prices equal to product costs of Div DP. Unfortunately for
the company, the other div are showing fluctuating financial performance.
Based on the information tabulated below and assuming that Div DP utilizes 70% of total
company assets:
(a) Compute ROA for Div DP for year 2001 and 2000.
(b) Assuming that market exits should the company divest divisions other than Div DP?
Why/why not?
(c) Where do u think financial discipline by top mgt is immediately necessary? Justify
one area.

Year 2001 2000

Sales (Rs. Cr)
Div DP 13.82 13.58
Total company 17.83 17.97
Net profit (Rs. Cr)
Div DP 0.54 0.55
Total company 0.45 0.24
Financial position (Total company)
Current assets (Rs. Cr) 21.77 20.18
 Total assets (Rs. Cr) 31.66 31.64
Long term debt (Rs. Cr) 3.25 7.15
Shareholders equity (Rs. Cr) 5.14 5.05
Eps (Rs.) 3.86 1.66
Dividend per share (Rs.) 3.0 3.0

Ans:
a) Compute ROA for Div DP for year 2001 and 2000.

Formula for return on asset: Net profit *100

Total asset

Particular 2001 2000

Net Profit 0.54 0.55

Asset utilized by DP Div i.e. 70% 22.162 22.148

Of total asset of the company

ROA 2.44% 2.48%

b) Assuming that market exits should the company divest divisions other than Div DP?
Why/why not?

ROA 2001 2000

Div DP 2.44% 2.48%

Company 1.42% 0.76%

After assuming the condition that market exits, the company should not divest its Div
DP. The answer for the question can be simply drawn from table mentioned above; locking at
the ROA the Div DP has given better performance for the company as compared to its entire
operations.
c) Where do you think financial discipline by top management is immediately
necessary? Justify one area.
Ans:
By observing financial data provided by the company, we think that Profitability or
Increase in the Profit or Bottom-line Growth of Div DP is the area where top management
should look into.

Net Profit Figure 2001 2000 Remark

Div DP 0.54 0.55 Profit down by 2% on year on

year basis
 Company 0.45 0.24 Profit up by 87% on year on
year basis

The top management should look into bottom-line growth of div DP. This is area of
concern for the company. The Div DP process constitutes major portion of he company’s
overall activity.
As mentioned in the problem Div DP utilize 70% asset out of the total asset of the
company this makes skidding bottom line of the Div DP as area of concern for top
management where they should look into.

Q.12) Vijay enterprises has three divisions. One of these manufactures Product A,
which is sold to another division as component of its Product B. Product B is in turn
sold to the third division which uses it as a component in its Product C. Product C is
sold in outside market. Company has a rule that when products/components are
transferred from one division to another standard cost plus 10% return on fixed assets
and inventory would be charged to the buying division. Transfer price of products A
and B as well as standard cost of Product C are required (to be used for performance
appraisal of division) on the basis of following information:-

STANDARD COST PER UNIT PRODUCT PRODUCT PRODUCT

“A” “B” “C”

Purchase of outside material (Rs.) 20 30 10

Direct Labour (Rs.) 10 10 20

Variable Overheads (Rs.) 10 10 20

Fixed Overheads Per Unit (Rs.) 30 40 10

Average Inventory (Rs.) 7 lacs 1.5 lacs 3 lacs

Net fixed Assets (Rs.) 3 lacs 4.5 lacs 1.6 lacs

Standard Production 1 lac 1 lac 1 lac

Sol:-

Transfer to Product B:-

7 lac + 3 lac = 10 lac
 10 lac * 10 % = 1 lac
1 lac =1
1 lac (units)
Transfer to Product C:-
1.5 lac + 4.5 lac = 6 lac
6 lac * 10% = 60,000
60,000 = 0.60
1 lac (units)

PARTICULARS PRODUCT PRODUCT PRODUCT

“A” “B” “C”

Purchase of outside material 20 30 10

+ Direct Labour (Rs.) 10 10 20

+ Variable Overheads (Rs.) 10 10 20

+ Fixed Overheads Per Unit (Rs.) 30 40 10

Total 70 90 60

+ Transfer Price 1 71 + 0.60 161.60

Total 71 161.60 222.06

Transfer price of product A=Rs.71 pu

Transfer price of product B=Rs. 161 pu

Final cost of product C=Rs.222.06 pu (220+1+0.6+0.46)

Comments:

1. The actual cost of the final product is only Rs.222, But the upstream margins added by
product A was rs.1 per unit. For product B was Rs.0.6 per unit and C was Rs.0.46 per
unit which increases the final cost to Rs.222.06
2. In a highly competitive market for eg. An export market it would be advisable for the
company to sell the product for the price above Rs.220 and allocate the actual profit
amongst the three divisions.