notater accounting for management controlling

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Innhold Notater Accounting f or management contr olling ................................ ................................ ................ 3

Chapter 2, Contr olling Business ................................ ................................ ................................ ..... 3

2.1 Contr ol philoso phies................................ ................................ ................................ ............. 3

2.2 Or ganization and contr ol................................ ................................ ................................ ....... 3

2.3 Pr ofit Center s and Management Contr ol................................ ................................ ................ 4

2.4 Divisions as Formal Subsidiaries? ................................ ................................ ......................... 4

2.5 Consequences of Decentralized Contr ol................................ ................................ ................ 4

Chapter 3, Costing is the star ting point ................................ ................................ ........................... 5

3.1 Intr oduction ................................ ................................ ................................ .......................... 5

3.2 Cost Components................................ ................................ ................................ .................. 5

3.4 Methods of cost accounting: ................................ ................................ ................................ . 6

3.5 Activity based costing ................................ ................................ ................................ ........... 6

Usef ulness of the models ................................ ................................ ................................ ............ 7 Methods of assigning fixed costs: ................................ ................................ ............................... 7

Or ganization of decentralized units................................ ................................ ............................. 8

Chapter 4, Transfer Price calls the tune ................................ ................................ ........................... 9

4.1 Inter nal transfer pricing................................ ................................ ................................ ......... 9

4.2 Prices in Inter national Or ganizations................................ ................................ ..................... 9

4.3 Consequences of inter nal transfer pricing................................ ................................ .............. 9

Chapter 5, Planning and budgeting to set the goals ................................ ................................ ....... 11

5.1 Traditional private budgeting ................................ ................................ .............................. 11

5.2 Gover nment budgeting ................................ ................................ ................................ ....... 12 5.3 Zer o-based Budgeting................................ ................................ ................................ ......... 13

5.4 Criticizing budgeting ................................ ................................ ................................ .......... 13

5.5 Fr om budgeting to r olling f orecasts................................ ................................ ..................... 13

5.6 The balanced scorecard ................................ ................................ ................................ ....... 14

Chapter 7, Capital budgeting f or long-term pr ojects ................................ ................................ ...... 15

7.1 The impor tance of time ................................ ................................ ................................ ....... 15

7.2 The methods of Capital budgeting................................ ................................ ....................... 15

7.3 A real case of corporate Investment Analysis ................................ ................................ ...... 15

7.4 Summing u p Corporate Investment analysis................................ ................................ ........ 15

Chapter 8, Calculating depreciation and Interest ................................ ................................ ........... 16

8.1 An intr oduction to the capital cost area ................................ ................................ ............... 16

8.2 Nominal Interest is easy................................ ................................ ................................ ...... 16

8.3 Handling Inf lation ................................ ................................ ................................ .............. 16

8.4 Real depreciation or nominal, Summarizing the Methods................................ .................... 16

8.5 Setting depreciation period ................................ ................................ ................................ . 17

8.6 Choosing the Interest rate ................................ ................................ ................................ ... 17



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Chapter 9, Evaluating Divisons ................................ ................................ ................................ .... 18

9.1 Measuring pr ofita bility ................................ ................................ ................................ ....... 18

9.2 Retur n on Equity................................ ................................ ................................ ................. 18

9.3 Some common Inter nal ratios................................ ................................ .............................. 18

9.4 A bsoulte measurements ................................ ................................ ................................ ...... 19

Chapter 10, Decision Analysis when the f uture is unknown................................ .......................... 19 10.1 Risk and uncer tainty ................................ ................................ ................................ ......... 19

10.2 Systematic decisions under uncer tainity ................................ ................................ ............ 19

10.3 A simplified case to descri be decision analysis................................ ................................ .. 20

10.4 Assigning Pr oba bilities ................................ ................................ ................................ ..... 20

Chapter 11, Managing the contr ol system ................................ ................................ ..................... 20

11.1 The r ole of the contr oller................................ ................................ ................................ ... 20

Incentiver og systemer, Iver Bragelien................................ ................................ .......................... 21

How to r un a big company................................ ................................ ................................ ............ 23



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NotaterAccounting for management controlling

Chapter 2, Controlling Business

Leading a company involves creating a management control system in such way that ambitious

employees will solve the right problems while striving for the right goals.

2.1 Control philosophiesDirect contr ol In a small firm, the manager could have f ull contr ol. He knows how ever ything should be done, andgives order. But as the firm gr ows, he loses contr ol and has to begin tr usting his middle manager s.

Pr ogram contr ol The manager cannot contr ol ever yone, and creates manuals and instr uctions in how different tasks areto be solved.

Management contr ol In Management by objectives (MBO), detailed instr uctions are replaced by a clear statement of goals

and reasona ble amount of freedom f or each manager to decide in detail what needs to be done to reach the objectives. In firms these objectives of ten are related to economic sizes, lik e sales, pr ofit, mar gins etc. It is impor tant to monitor other parameter s as well, as safety, happiness, employees satisfaction etc. Freedom to choose your means of action does not mean freedom to do as you please.

Multidimensional contr ol In the beginning of the 21st centur y, many companies redefined their management system. Now, it¶s more BSC with many goals, both economic num ber s, but also quality of pr oducts, customer happiness etc.

2.2 Organization and controlFunctional or ganization

Each division has its own task . Of ten leads to pr oblems between the different division manager s. The pr oduction unit means that their quality is much better than their competitor s, and the sales divisons thinks that the price is way too high. Leads to pr oblems.

Division or ganization Each division has its own mar k ed. Lik e a high end user mar k et, and a low end. Each division includes the total value chain fr om pr oduction to mar k eting to sales. May lead to destr uctive competition between divisions.

Matrix Or ganizations Both geographical divisions and submar k ets mak es it necessar y to divide you or ganization into smaller par ts.

Pr ofit centres Each depar tment in your or ganization is a pr ofit center. The manager leads his pr oduction unit, andhas to answer f or his depar tments pr ofit and results. It is impor tant not to let the competition mak e themanager s to do things that will mak e a downside f or the or ganization as whole, to achieve goals f or his depar tment.



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2.3 Profit Centers and Management ControlThe budget process contains different things, and in a pr ofit center it is impor tant to define objectives and limitations of authority. It has devoleped a trend where details is phased out, and f ormulations of local objectives tak e a lar ger r ole.Sound internal prices is impor tant to get the pr ofit center s to r un well.Still, it is impor tant to have a good product costing system that descri bes the costs of pr oducing andsu pplying pr oducts and services to customer s. Activity based costing has overr un the use of traditional

costing system. It¶s impor tant to have a good under standing of cost of capacity Capital budgeting analyses is impor tant in to mak e god long-r un-decisions.

2.4 Divisions as Formal Subsidiaries?Has in long time been used to clarif y economic res ponsi bility in lar ge complicated or ganizations.Divisions have also been used to eliminate pr oblems with same company o perating in different jurisdictions all over the wor ld.If you mak e a depar tment a subsidiaries, you can lose economics of scale.Can mak e pr oblems to get the different subsidiaries wor k together as on team.Ar guing a bout local pr ofits, who is the owner of the pr ofit?

2.5 Consequences of Decentralized Controlz Sub o ptimization z Small units may not aff ord exper ts z If cost-consciousness is over -emphasized, decisions could be shor t-sighted and inefficient.z The capital reserve is of ten small, so a small depar tment can¶t aff ord a long term deficit.z Sections that are not pr ofita ble over time will str uggle with motivation and feeling of job

security Will increase attention to economic outcome of each unit Will impr ove local communication Decentralization will impr ove cost contr ol Increase f lexi bility and a bility of adaption to mar k et develo pment Easier to close down un pr ofita ble units More decision mak er s and more motivation Efficiency will rise, faster decision mak ing More f un to wor k!



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Chapter 3, Costing is the starting point

3.1 IntroductionThere are different ways to find the pr ofita bility of an activity:

y Or ganization, the entire unit as a whole.y Inter nal transfer pricing, creating separate pr ofit center y Pr oduct cost analysis, all cost are divided onto pr oducts

o Full costing o ABC-costing, Activity based costing

Full costing is to allocate all your costs onto the pr oducts you sell.ABC-cost is based u pon that the mar k et is highly competitive, and that the consumer s only will by the

pr oducts if you offer the lowest price. The resources used to pr oduction is reckoned, and it¶s long termcost are put into the calculation.

Different Costs in different systems y Costs of financial accounting

o It could be the IRFS or GRS, (god regnsk apssk ikk )o Different fr om countr y to countr y, but AS should repor t in the same set of r ules.

y Tax accounting o Differ s fr om countr y to countr y. Could be lik e, land is not allowed to depreciate, but

machiner y and equipment can. The differences between IFRS and tax accounting creates the tax shields, which is perfectly legal.

y Management Accounting o On inter n analyses, used to calculate pr ofit and so on. Differ s fr om all over the wor ld,

in Eur o pe, a pr oduct is sold at ³f ull cost´ and this cover s interest rate at pr oduction gear and so on. In usa a pr oduct is sols at f ull cost + because the interest rate has not been covered by the cost of pr oduction.

y Economic analysis o When something unusual happens, it would be nescesarr y to do some extraordinar y

calculations. Here you tak e in alter nativkostnad if f or example you have a lot of resources that¶s not current any more.

3.2 Cost Components

Fixed and varia ble costs Most cost are varia ble in long r un, and most costs are fixed in shor t r un. Salaries is of ten treated as avaria ble cost, but in most Eur o pean countries, this is a fixed cost. It is noe easy to get rid of your wor k f orce. But in the long r un it is correct to treat this as a varia ble cost.

Direct and indirect costs A practical classification, dependent on bookk eeping r ules

Common costs and tracea ble costs A logical classification, su ppor ting management decision. Impor tant to get the pricing right

Committed costs and f lexi ble costs The most recent classification, clarif ying relations between time and cost behaviour

Comparing models and reality The traditional model of costs: with rapid develo pment in the beginning because of high fixed cost,and then a linear develo pment until you reach a high pr oduction volume. Then the firm looses f ocus on cost accounting, and you may see unexpected sudden losses.

How to impress peo ple that are not economists: Mak e a ta ble that shows differences between price and volume. What will needed volume be if weraise the price with 10%?



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Cost and decision mak ing: Common cost is costs associated with the pr oduction line of two pr oducts where the common cost involves pr oducing both units. This costs are of ten fixed. Sepera ble are almost varia ble, but of ten thesame ty pe of cost f or two pr oducts, but is possi ble to divided the use of resources to the two pr oducts.

3.4 Methods of cost accounting:

Traditional f ull cost, definition: T he sum of all costs for a product or a service until it has been delivered to a customer and paid for.

Fixed costs are assigned recording to f ollowing: Indirect costs to direct salar y Indirect Material cost to material cost Sales- and Administration to total cost of pr oduction included assigned indirect cost and indirect material.

Direct costing: Only the direct costs, included direct selling cost, used when the mar k et price is known or can bef orecasted.

Full costing (Full a bsorption costing): Af ter prime cost is accounted, add all indirect costs, and a share of general fixed cost of the company.Used when pr oduction are made to costumer order s, made f or pricing

Stepwise costing: To include all costs without allocations

Activity based costing: Identif ying activities and cost driver s

3.5 Activity based costingABC f ocus on the activities, not the cost center s. What are the cost driver s in ever y depar tment, andhow does t

his inf luence t

he price of your pr oduct? 1. Assign all costs to activities instead of cost center s

2. Assign activity cost to pr oducts or services a. According to cost driver s b. With accurate measurec. How each object exploits that activity

3. Thus impr oving pr oduct and activity cost inf ormation

Challenging par ts with ABC:

Fixed cost: Cost regarding heating, cleaning or IT don¶t have direct links to pr oducts or services. These costs should be assigned to pr oducts by their capacity or volume or any other reasona ble allocation.

Overcapacity: Instead of adding free capacity as a cost to your normal pr oduction, we mak e a new cost calledovercapacity. Your pr oducts get char ged the price it would have been if there was no overcapacity.

R&D: Should be treated as an investment in f uture pr oduction. If R&D is succeccsf ull it should be activatedin the balance, and depreciated until your patent or so went out. If the R&D was usless it should bewritten off as a windfall loss.

Criticism of ABC:



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y There are some costs that are common costs, ty pical raising a cow which s plits in to different pr oducts.

y Not all activities are homogeneous so it is difficult to apply one par ticular cost driver.y It could be hard to reduce fixed capacity, so in the long r un, even if the pr oduct is pr ofita ble,

we will lose money.y We do not include pr oduct syner gies in ABC.

Usefulness of the models

Pricing ProductsIf possi ble, pr oducts should be priced according to the mar k et price. If there is no mar k et price, we had better price pr oducts by look ing at Full costing and Activity based costing at the same time. Full costing will give the correct price level and Activity Based costing will give the correct allocation between pr oducts. Direct Costing would be danger ous.

Long Term product mix decisionsABC was designed to solve this pr oblem.

Short term product mix decisions

Direct costing is su perior if you include the varia ble par t of over heads. ABC might be usef ul to su pply a more correct allocation of the varia ble over head than is normally done in direct costing. ABC alonewould not be efficient.

Valuation of inventoriesFor financial accounting, f ull costing is normally recommended and preferred. For managerial accounting, we would prefer ABC. Direct costing would underestimate the pr oba ble value of inventories.

Introducing new brandsABC was designed to solve this pr oblem.

Methods of assigning fixed costs:

y Normal cost according to budget, Budget decides the cost, not influenced by usage. o + Total cost is known in advanceo ± Actual volume will not inf luence allocation

y Standard average cost, T he standard cost is made on behalf of the budgeted amount. T he cost depends on actual usage o +Manager s known prices in advanceo ± Inf ormation on varia ble cost is not availa ble

y Actual average cost, T he fixed amount is divided with actual number, and spread out on behalf of actual usag e. o +Financial accounts lik e it o ± Prices are not known o ± Some body¶s volume changes will hit ever ybody

y Flexi ble budget cost, per unitcost is decided before the periode, actual volumes decides the total cost o +Char ging f or actual volume at varia ble cost o +Char ging f or capacity according to agreement

Criticism of assigning fixed costs: y Fixed cost should not be treated as varia bley If pr oducts are different, there will be cost subsidies between them, one pr oduct is paying f or

another(?)y There will be bias against the basis of allocation, peo ple will always disagreey Faulty f ormulas can create a ³s piral of death´, jmf the example with hos pital, one division had

pr oblems and had to ad just, this made the ³fixed cost´ in another division to excel



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erent centers.

y Standard cost center

o Where output can be measured, but someone else is selling, ma be because products

or markets are common to sever al units

y R evenue center o Where we sell out product/service. R es ponsi ble for market share, volume and

³dek ninsbidr ag ́

y Ex pense center

o For su ppor ting activities outside the main process, producing regulated by a year ly

budget. Ex penses could be assigned to other units, sold inter nally or remain

unassigned

y Prof it centres

o When managers are res ponsi ble for R evenue as well as ex penses.Possi bly created

through inter nal tr ansfer pr icing. Assets is not a big deal

y Investment centres

o When even investment decisions are made locally. Same as a bove, but managers isalso res ponsi ble for investments of production f acilities



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Chapter 4, Transfer Price calls the tune

4.1 Internal transfer pricingVer y of ten, strategies develo ped by company headquar ter fails if not the individual manager s has tak en par t in the pr ocess.Reasons f or inter nal pricing:

y Encourage economic think ing and rational behavior in employees when they mak e choices

with economic consequences.y Create in puts f or pricing final pr oducts to exter nal costumer s at the end of a long inter nal

pr oduction pr ocesses.y Measure pr ofita bility f or each of the pr ofit center s delivering goods or services to one another.y Facilitate the planning of taxes in lar ge business gr ou ps.

Methods f or Inter nal Pricing: T o create rational economic behavior for internal buyers and sellers, internal prices would need toreflect the full economic consequence of the trade, including opportunity costs.

Common practice of inter nal pricing: Market-based prices, Best way to do it

Cost-based prices, Could be f ull-cost, direct cost or ABC

Negotiated prices,

Double pricing of various kind, Different inter nal and exter nal prices.

Different ty pes of inter nal transfer s y Finished goods, traded between different divisions of a company y Unfinished goods, treaded inside a division or acr oss divisional boundaries.

o If mar k et price is known, use this, not cost based price. If the cost based price is a bove mar k et price, the u pper division should not have to pay f or this disadvantage.If the price is lower than the mar k et price, the pr oducer should receive the gain sincehe¶s res ponsi ble f or creating it.

y Managerial service, su pplied by headquar ter and bought by divisions y Fixed assets lik e building, machiner y and equipment, only occasionally traded between

divisions.

4.2 Prices in International OrganizationsBecause of different tax systems thr oughout the wor ld, there is esta blished an inter national code,called the arm¶s length principle. It goes lik e the f ollowing:

y Inter nationally well-known raw materials should be traded at the regular price in the wor ldmar k ets. Ad justments can be made to compensate f or differences in trans por t costs or selling costs.

y Unfinis

h

ed goods to be pr ocessed f ur th

er by th

e buyer should be traded at t

h

e f ull cost of th

eseller.y Finished goods to be re-sold without f ur ther pr ocessing should be traded at the mar k et price

of the destination countr y less a discount to allow f or the selling cost of the inter nal buyer.y Patent rights and know-how should be paid f or thr ough licensing agreements.y Central managerial services should be real and should be traded at the f ull cost of the seller.

4.3 Consequences of internal transfer pricingValua ble effects:

y Inf ormation gathering can be limited to transfer prices and local transactions y The value of inter nal services can be compared to costs, and maybe questioned



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y Pr ices will be negotiated between buyer and seller, information will im prove

y Prof it centers can be created without divisions. Motivation and prof its will im prove!

Diff iculties and dangers:

y Inter nal prof its may exagger ate perceived cost levels

y Tr ansfers Backwards will create problems witho Cost assignmentso Inventory evaluations

o Estimation of tur nover y R eactions to pr ices may be overstated and valua ble service may disappear

y Some managers s peciali

e in inter nal prof its, sub o ptimi

ation



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Chapter 5, Planning and budgeting to set the goals

5.1 Traditional private budgetingWhat will budgeting do?

1. A plan f or the total activities of the company 2. Develo p goals f or divisions and pr ofit center s 3. Create co-ordination and communication between pr ofit center s

4. Impor tant star ting point f or f ollow u p and variance analysis during and af ter the budget period.5. Develo p pr ofit f orecast f or the remainder of the budget year 6. Usef ul tool to prioritize between expenditure lik e lar ge investments in different areas when

shor tage on resources, distri bution of resources 7. Identif ying res ponsi ble manager s 8. Create motivation 9. Descri be revenue and expenditure f or each section of the company.10. To develo p incentives and bonuses.

The budget period has to be develo ped when it suits the company. If you are in a seasonal business,there is no point in mak ing a budget that r uns a calendar year.

What is bad a bout budgeting?

1. Fak e pillow, mak es employees lean back . When budget is reached, we are satisfied.2. The budget is not a ble to handle unf oreseen things 3. Waste of resources, too time consuming 4. Not tr ustwor thy in the long r un 5. Wor ks against new think ing, always looks back at the old budget 6. Mak es management contr ol subordinate to financial accounting 7. Quar ter ly revising mak es shor t sighted manager s.8. Appr o priations are always s pent!

Four different types of budgets:Fixed budget:The budget is made in advance, of ten f or a year. Forecasts are added to the budget in intervals, but

manager s are judged by the original budget.Revised and rolling budgets:Revised budget r outine: You revise the budget ever y quar ter, but just f or the remaining year. Theref ore, each periode gets shor ter than the last one. But same as bef ore, you don¶t know anything a bout the f uture, so there will be no confirmed budget f or the immediate f uture.R olling budget: The r olling budget always has the same length, but you mak e a new one each quar ter f or example. But there are some practically pr oblems:

y The budget lose some of its status because there is a new budget so of ten.y Also pr oblems implementing the new budget, f or the f ollowing period, should you use the old

one or the new one? y You need a good intranet and easily u pdated s preadshits.

Variable budgetsIf sales is volatile, you would need a f lexi ble budget that allows you to ad just f or changes.

Danger s: Forecasting is of ten made of manager s who care f or their employees and their division. They couldgive wr ong f orecasts to prevent the HQ and lead management to cut their resources. They could also claim that they need more money, just to be cur tain not to r un out bef ore the year is over.

Budgetary planning: There are two ways to build u p a budget:



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Build up budgeting:

Board and CEO will build assumptions a bout the f ollowing period. Instr uctions are made to descri behow the f ollowing budget period will r un. When these things are ready, the budgetar y planning

pr ocess will star t fr om the below. Ever y section will mak e its own budget. Upon completing, the budget will be sent to middle manager s, and may correct budgets together with the sections. This continues to the to p, depending on how big the company is. Then it will be analyzed by the to pmanagement.

Pr os: Democratic, owner ship to your own budget Cons: Time consuming, may not be a good ³overall´ budget. If lar ge pr oblems are seen in the end,when things are put together, may not be enough time to do ma jor changes. Of ten ver y difficult to dithis changes. Break down budgeting:CEO and budget management mak es a suggestion f or the entire company. Then its passed down to thelowest management level, and corrections are made if this is necessar y.Pr os: Time efficient, reach the goals of the company, to p management will mak e decisions.Cons: Lack of motivation, low management will not give necessar y changes because they don¶t believe that the goals are realistic.Ver y effective in given circumstances;

In an economic crises, the employees know that by acting together they will be a ble to savethe company.

When to p management obviously is better inf ormed than local employees and under stands thetr ue needs of the wor k .

Finding alternative methods of budgetary planningCombining the methods:Develo p a high-level budget in to p management. This should be used to create instr uctions to divisions. In this way, you k eep the inf luence fr om the to p and the motivations and realistic goals fr om the lower manager s. Its impor tant to get inf luence fr om lower levels when creating the goals andinstr uctions, ver y of ten it is at this levels the develo pment and innovative ideas is created. I terative budgeting

The pr ocess, normally build u p, is repeated several times. The pr ocess will give a better and morerealistic budget, but is time consuming and costly. Manager s at lower levels may get unmotivated because the get the feeling that they hand in the same budget over and over again.

5.2 Government budgetingBudget rule or market ruleThe budget can be inf luenced by the budget or by the mar k et. The fir st is a gover nment budget.Income does not inf luence the budget, the money will be s pent anyhow. Of ten made by break down fashion.The mar k et r ule applies f or or ganizations or companies where income occur s because of ongoing activities and relations to customer s. Nowadays, we of ten se gover nment bodies where budget is affected by perf ormance, par example in hos pitals. The public is seen as a customer, not a cost driver.

Program budgetingInstead of cost items, you let pr ograms or other goals contr ol the budget. The activities is decided by

gover nment, but the allocation and actions needed (and so on costs) are decided by the peo ple who arein char ge of the activity. The manager s can move money fr om one activity to another if this is necessar y to accomplish the pr ogram.

Diagnosis-Related Groups (DRGs)By classif ying patients, hos pital can sor t their services in different ty pes. Each classification can get a budget (ABC), and the gover nment can ³ buy´ different ty pes of medical treatment. Is it reasona ble to s pend 1 million in treating cancer f or peo ple over 60, or should this million be given to 10 000 k ids who needs braces? The hos pital gets paid an amount f or each ³patient´ and the gover nment can pay different to mak e hos pitals change their allocation of treatment. If something has a ³high price´,



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hos pitals would prefer to do this ty pes of patients. These ³prices´ has to be under continually observation, suddenly you get a new treatment that can do the same as an old to the third of the price.

5.3 Zero-based BudgetingCriticizing traditional budgetingRegular budgeting has been criticized because of lack of renewal. Things are done the same way ever y

year without any renewing.

Zer o-based budgeting: You identif y different ty pes of activities in your depar tment. The fir st ³decision pack age´ contains all activities that are esta blished because of legal conditions or because they are totally necessar y f or theor ganization. Next ³decision pack age´ contains cost related to last year s o perations, and is consideredimpor tant. The third ³decision pack age´ contains cost related to activities that may be esta blished if the budget allows it. These activities are considered so impor tant that head management should look at them, but not so impor tant that they were included in ³decision pack age´ two.

How to mak e a decision pack age and what it should contain: y A written document descri bing a set of activities y Outcomes of different activities

y Alter native ways to reach similar outcomey Consequences of not perf orming those activities at all y A standardized set of schedules to be filled out by all decision unit manager s

When this is done, manager s will rank the different pack ages unit to unit, and see how long the budget holds.

Pr os: Systematic, imper sonal appr oach mak es it easier to get rid of unnecessar y activities. Drills management in activity based management, in analogy of the moder n appr oach to ABC. Involves a lot of peo ple in ever y decision, ever yone has to be on their toes to get money when to p management is to choose activities. Easy to under stand consequences of using company resources in alter nativeways.The system will look f or cheaper ways to do traditional o perations.

Cons: Lots of paperwor k , different rank ing pr ocess between different areas. Middle manager s may get ver y disappointed if to p management chooses differently than they expected. Disregard company histor y and this might f ool us. When manager s get used to ZBB the lear n to cheat the system.

5.4 Criticizing budgetingBudgeting tak es to much time and resources. Not value f or money.Mak es peo ple think that they will have to s pend to money placed in the budget, par example the army with guns. In the end of the year, all tr oo ps are sent to the shooting range to get rid of ammunition.You would not risk to be given less ammunition next year.Budget will reduce company efficiency because of f ollowing:

y Not easily changed if unf oreseen things happen y When appr oved by the board, it becomes too inf lexi bley Basic f orecast will be correct f or a shor t period of time

5.5 From budgeting to rolling forecastsUpdate several times a year and don¶t give the budget an end date, locating and minimize budget driver s.Mak e f ore quar ter planning ever y quar ter, five in October so that the board will have the whole newyear bef ore the next year begins.

The planning pr ocess:



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Time is shor t, so the pr ocess is designed in a way that mak es it go ver y fast, per haps just a week .Manager s on lowest levels hands in their f orecasts.This could be done long time in advance of their submission date. Middle level manager s review the material, f orm their own o pinions, and pass theaggregated f orecast to the next level. So on so on. In an esta blished pr ocess, there should not be to much ar guing and conf licts. The latest f orecast has been discussed and the changes three quar ter s ahead should not be totally unexpected.

Pr os: y We can s peed u p the planning pr ocess significantly y We can ad just much more quickly to changes in the envir onment y We can better f oresight towards the end of the year y We will under stand that the board cannot decide a bout the f uture envir onment y Planning will be more realistic

Ma jor difference in pr ocess; ever y manager can do his task whenever he wants. The or ganization doesn¶t need a ma jor meeting to discuss the budget.

Cons: y Quite possi bly, the total wor k load of planning might increasey The year ly co-ordination of pr ofit center s will decreasey The f ollow u p of management decisions will be more difficult than bef ore, difficult to do an

analysis of last periody Weak manager s may f ool us f or a period of timey Demands on individual manager s will increase, possi bly beyond their capacity

What to choose? Budget or f orecasting: If freedom of action is high and cer tainty of f orecasting is low, go f or r olling If freedom of action is low and cer tainty of f orecasting is high, go f or budget and long term planning.

Criticism:

y Management contr ol has become subordinate to financial accounting because the last one is regulated by lawy Financial accounting looks back , gives no f orecasting valuey Traditional repor ting over look customer ¶s needs and other qualitative areas y Quar ter ly financial repor ting creates shor t-sighted manager s that wor k mainly to o ptimize the

next repor t.y Manager s look to their company too much instead of being o pen to changes in their

surr oundings. To impr ove decision mak ing they need to be motivated to f ollow inf ormation a bout the outside wor ld much more closely.

5.6 The balanced scorecardInstead of f ocusing on financial repor ting, Harvard Pr ofessor s Kaplan and Nor ton suggested f ollowing f our per s pectives, in hierarchy line:

1. A financial and owner per s pective, f ocus on pr ofita bility, sales, gr owth etc2. A customer per s pective, how does customer s feel 3. A pr ocess develo pment per s pective, how do manager s wor k to impr ove company r outines 4. A lear ning and gr owth per s pective, how does the company manages its pr oducts and its

human resources

Artikkel: ³Balanced Scorecards, 12 years after´There are six impor tant factor s to mak e a successf ul BSC:

1. Strategy map



Side 15 av 24

2. Dialogues, its necessar y to s peak with peo ple involved3. R oles, get some ³evangelist´, some extra dedicated per sons 4. Interfaces, have dialogue meeting between different depar tments with similar scorecards to be

sure lear ning is s pread.5. Incentives, Its better to have bonuses with no reward at all f or ³ better -than- perf ormed´

perf ormance, than individual bonus related to each measure. Then there is no chance of employees choosing the ³easy way out ́

6. IT-solutions, don¶t put much money in expensive IT-solutions. Hand written or excel will do.

Chapter 7, Capital budgeting for long-term projectsRemem ber always:!: Real interest rate � Nominel Real * Inf lation = Nominel

7.1 The importance of time

7.2 The methods of Capital budgetingPay-back How long time will it tak e bef ore the investment is paid back? Initial investment / year ly cashf low

Don¶t ad just f or inf lation or capital cost.NPV:Erdetkødd? To discuss a positive NPV, you also need to calculate Pr ofita bility ratio. NPV/Initial investment.When comparing to pr ojects with similar NPV and same size, use PR to decide.

Finding annuities:If the pr oject gives ancashf low, how much would this be compared to the cost of investing, seen with annuities? With 5%, and 3 year s of CF, the annuity factor is 2,723. Tak e the investment, divided by 2,723 and see if this gives net positive annuity.

The inter nal rate of retur n:

Inter nrente,hurra!

7.3 A real case of corporate Investment AnalysisWhat a bout inf lation? Add the gr owth to sales, materials etc. This gives us a gr owth in FCF. But there is an easier way, tak ethe gr owth away, Gordons f ormula.

7.4 Summing up Corporate Investment analysisWor k ing pr ocedure in evaluating an investment

1. Find the initial investment, and the year ly cash consequences over time, use the real annuity depreciation.

2. Estimate the pr oject life time and calculate the salvage value of the equipment at the end of the pr oject.

3. Subtract all taxes fr om year ly payments, fr om inf lows as well as outf lows.4. Calculate weighted average cost of capital (WACC) considering tax savings and interest

payments.5. Calculate the net present value of all payments, not f or getting the tax shield fr om depreciation

of the initial investment.

What could possi ble go wong? 1. Book values might be included in the analysis, wr ongly being interpreted as cash payments.2. Sales values of buildings or land we already know might be disregarded or f or gotten.



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3. Nominal and real prices get mixed u p in the analysis.4. Interest payments might be regarded as outlaysalthough we calculate net present value5. It is quite difficult to find the correct cost of capital 6. Necessar y side-order s might easily be f or gotten in the fir st decision 7. Tax rate might suddenly be changed so as to to pple even var y caref ully analysis 8. The inter nal rate of retur n might over state the pr ofita bility of cer tain pr ojects

Artikkel ³The discount rate and the present value method´Always use af ter tax calculations when calculating NPV. There is no such thing as af ter -tax-interest rate.

Chapter 8, Calculating depreciation and Interest

8.1 An introduction to the capital cost areaDepreciation in management accounting is not the same as in financial accounting. Here it is meant to assist the company in setting the right prices. Theref ore, also inf lation is tak en in count of. It is also impor tant that the money put in investment, needs a retur n. Theref ore we also tak e in account theretur n on capital invested.Year ly cost = Depreciation + Interest on financing

8.2N

ominal Interest is easyDepreciation with interest, depreciation, and a total capital cost, only wor ks well if the inf lation is low.With no inf lation at all, the amount ³nominally´ is enough to pay the amount, you don¶t need to ad just f or f uture payments. With ver y high inf lation, your merchandise will be relatively ³cheap´ near theend of the depreciation period, and rise to a new level when new pr oduction machines is purchased.

8.3 Handling InflationWor k ing with real interest: If there are inf lation, you have to add this to your investment. See page 272. The depreciated valuegr ows ever y year in the same pace as inf lation. You pay 20 % of value, and as the value gr ows year by year, the depreciation values gr ows.

8.4 Real depreciation or nominal, Summarizing the MethodsNominal approach: Linear:

Depreciation is based on historical cost, nominal interest is calculated on f ormal remaining value.

Annuities: Nominal annuity is calculated on historical cost in order to find a capital cost that is constant over timein a nominal sense.

Nominal lineardepreciation

Year 1 2 3 4 5

Starting capital 100 80 60 40 20

Depreciation 20 20 20 20 20

Interest 10 8 6 4 2

Total cost 30 28 26 24 22

PV of cost 27,3 23,1 19,5 16,4 13,7 100,0



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We need to be a ble to calculate three different ways of pr oduct cost regarding interest and capital cost: 1. For pricing and pr ofita bility analyses, we need pr oduct cost included required retur ns on

equity, and interest on borr owings.2. For financial repor ting, we need the pr oduct cost included interest cost, but without required

retur n on equity.3. To calculate ROI or ROCE, we need pr oduct cost without interest payments and equity cost of

capital.

Chapter 9, Evaluating Divisons

9.1 Measuring profitability Normal ratios used f or this purpose:

y Retur n on equity (RE) pr ofit af ter tax to equity capital y Retur n on investment (ROI) ear nings bef ore interest and tax compared to total capital in pr ofit

center.y Retur n on capital employed (ROCE), a ratio relating ear nings bef ore interest and taxes to

capital employed, i.e. to capital that needs to be paid thr ough interest, dividends or theappreciation of the value of shares.

Normal a bsolute measurement used f or evaluation:

y Residual income (RI) Ear nings remaining in a pr ofit center af ter all regular equity capital andloans are paid f or.

y Economic value added (EVA), showing what ear nings remaining in a pr ofit center af ter all equity capital and loans are paid f or af ter ad justing f or invisi ble capital and taxes.

The ratios is easy to manipulate with reduced investments, but easy to under stand.A bsolute measurements is hard to calculate, but gives a more accurate measure to economists. But it could be hard f or manager s to under stand.

o Remem ber to ad just results lik e in BUS425.

9.2 Return on Equityy Calculation af ter taxy Include tax savings due to depreciation y Pr ofita bility is over stated, the assets as it is shown in the balance, is always undervalued

o RE is not well defined f or par ts of a gr ou p such as subsidiaries or divisions, only f or awhole company.

9.3 Some common Internal ratiosReturn on investment (ROI)ROI = EBIT/ Total capital

Ver y of ten compared to what pr ofita bility should be, using WACC.

ROI = Pr ofit Mar gin * Capital tur nover

P/A = P/S * S/AOf ten called the DuPont-model

P=EBIT

Criticism of ROI; There are two ver y different ways of impr oving ROI,1. Impr oving total pr ofits 2. Reducing capital



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The fir st one is great, but second one not. If capital is reduced by shutting down pr ofita ble activities just because they pr ovide a somewhat lower retur n then other pr ofita ble activities, it is not a success.

Return on capital Employed (ROCE)ROCE= Pr ofit bef ore interest paid (EBIT) / Capital to be paid f or (ar beidsk apital)

Because of high interest rates in the late 70s, f unding of capital became an impor tant figure.

Undesired effects of ratiosMost impor tant, pr ojects with lower ratios then existing pr ojects will be tur ned down, even though they are pr ofita ble. Because depreciation is an impor tant factor in the ratios, manager s of ten don¶t reinvest and then things are great in shor t term, but not in the long r un.

Relating ratios to each otherGearing, Miller -Modligiani,RE = (1-t) * (RT + ( RT ± RD ) * D/E )RD= Interest on de bt

There are two different ty pes of risk in a company according to the f ormula a bove.

1. Business risk , creating variations on the RT2. Financial risk , descri bed by the D/E ratio

9.4 Absoulte measurementsRI = EBIT ± (capital * cost of capital)

EVA = Ad justed EBIT ± (ad justed capital * cost of capital ) ± taxes

1. The income statement is ad justed. Impr oved because R&D is not a expenditure, but investment, then reduced because R&D needs depreciation.

2. Balance sheet is ad justed to include those investments.

Cost of capital is calculated as a WACC, because it is difficult to distinguish between Equity capital

and borr owed capital.EVA shows pr ofit a bove shareholder expectations, creates a tr ue picture of pr ofita bility.

Artikkel ³The metric wars´CFROI (Cashf low retur n on investment)

y Cashf low based and inf lation ad justed. A new measure tool, po pular in the consultant business.

Chapter 10, Decision Analysis when the future is unknown

10.1 Risk and uncertaintyThe f our most uncer tainties that are well known:

1. Man power, hiring the right num ber of peo ple bef ore you know the num ber of customer s

2. Inventories, place an order f or a num ber of units of perisha ble goods 3. Scrap allowance, pr oduce additional pieces to avoid setting u p f or a second r un 4. Capital investment, small or lar ge investment to pr oduce f or f uture sales 5. Mar k eting, Pricing or change of pack age design

10.2 Systematic decisions under uncertainityImpor tant issues to be descri bed in decision analysis:

1. What is our goal in this business activity? 2. What are the alter natives? 3. What events might occur during the pr ocess?



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4. What pr oba bilities inf luence our decision? 5. Calculating expected values to find a decision criterion 6. Finding the value of better inf ormation

10.3 A simplified case to describe decision analysisUse maximin or minimax regret solution on your decision matrix.

Maximin: Maximaize your pr ofit with

th

e assumption th

at wor st case scenario will h

appen.Minimax regret solution: Regard the pr ofit lik e what is lost if your best scenario gives 0. Choose thesolution that minimaize the potential loss.

10.4 Assigning ProbabilitiesAssign pr oba bilities by hear t, experience and common sense. Remem ber that peo ple in oneor ganisation has different valuation of money. The limit of potential loss f or a manager is much lower than the limit f or the company as a whole. Theref ore limits between division decisions and company decisions sometimes has to be reconsidered.

Chapter 11, Managing the control system11.1 The role of the controllerTasks f or a contr oller today:

y Or ganizing planning and repor ting activities y Continuously develo ping the system of planning, cost accounting and financial accounting y Watching and analysing the pr ofita bility of pr ofit center s, pr oducts, services and mar k ets y Perf orming ad hoc economic and financial analyses when needed to su ppor t to p management

decision mak ing

Artikkel:´ Why incentive plans cannot work´, Alfie Kohn

Incentives does not wor k

Artikkel ³Agency and performance management´There is a principal-agent pr oblem with measuring employees. Employees are risk-aver se and need acompensation if their actions involves risk , so there is a tradeoff between risk and incentives.Selecting between different measures involves trading off contr ol. Measures that includes all as pects of perf ormance will expose employees to considera ble risk , and this gives us that measuring is a tradeoff between gain and compensation.



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Incentiver og systemer, Iver Bragelien

Hvorf or har vi incentivordninger ? y De ansatte jobber hardere (rask ere och lengre)y De ansatte jobber smar tere (med de riktige tingene)y De ansatte tar bedre beslutninger (f or eksempel investeringsbeslutninger)y Bedrif ten tilltrekk er sig bedre k andidater ( som tr or på egne evner)y Bedrif ten beholder de bedste ansatte (mens de dår ligste slutter)

Fem ta bber med incentiver : Överdriven tro på ett operationellt måltal

Om man ger belöning f ör ett s peciellt måltal är det nästan säk er t att de anställda kommer att ar beta f ör att f ör bättra detta tal, of ta på bekostnad av något annat. Bragelien besk river ett eksempel där man ger bonus f ör k apacitetsutnyttjandet, men att detta i själva ver k et leder till att man ök ar pr oduktionen och att lager hållningen stiger med ök ade lager hållningskostnader som f öljd.

Det är också myck et vanligt att säljare, som får bonus på f ör säljningvolymen, ök ar f ör säljningen avlättsålda pr odukter, k ansk e sådana pr odukter som av någon anledning har f ör låga priser. Detta k an leda till att f ör säljningsvolymen stiger, men f öretagets resultat blir dåligare.

Överdriven tro på räntabilitetsmål

På f öreläsningen behandlade vi ett fall, där en stor koncer n betalade bonuus till de regionechefer somu ppnådde det högsta ROCE-talet i koncer nen. K onsek vensen av detta blev att en av chefer na i stor t sett u pphörde att genomf öra investeringar. På så sätt lyck ades han minsk a det bundna k apitalet inämnaren. Tr ots att resultatet minsk ade blev ROCE-k voten bättre f ör var je år tills han slutade vidf öretaget. Hans ef ter trädare blev tvungen att sna bbt åter ställa regionens anläggningsk apacitet genomstora investeringar, vilk et fick till f öljd att ROCE-talet sna bbt minsk ade till ett av de dåligaste ikoncer nen.

Uvettig bruk av Balansert målstyrning

Ef ter som vi nu vet att de två f ör sta bonusta bbar na k an vara far liga så k an det k ännas bättre att u ppmär ksamma ett stor t antal o perationella och finansiella indik atorer. Men utmaningen och

pr oblemen är egentligen densamma. Det som mäts o ptimeras och det som inte mäts får liten u ppmär ksamhet. Mät pr oblem gör att det är svår t att mäta många viktiga dimensioner. Då tvingas man att mäta det som är lätt att mäta, vilk et inte alls behöver vara det viktigaste i ver ksamheten. Dessutomfår man ett kom binations pr oblem med så många måltal. Hur sk all de vägas samman? Företagets strategisk a styr ning k an i vär sta fall över gå till en matematisk exercis och siffer o ptimering.

Manglende bruk av standardpriser

I dagens nummer av ´Dagens Næringsliv´ finner man en bild som besk river att bonus u ppfattas somvälmotiverat i Statoil tr ots att vem som helst k an räkna ut att större delen av resultatet bara ber or på

höga oljepriset och knappast alls på s peciella prestationer av f öretagets chefer eller anställda. Å andrasidan pr otesterar man i Nor sk Hydr o mot att aluminiumpriset sk all påver k a bonusen, f ör de anställdak an ju inte k ritiseras f ör att detta pris har fallit.

För att undgå sådana pr oblem borde man standardisera sådana priser som styr s av vär ldsmar knaden eller andra utomstående aktörer. Men om man standardiserar f ör många priser - även dem som k an styras av egen per sonal - k an man få en bristande u ppmär ksamhet mot att priser är viktiga beslutsvaria bler i många branscher.

Blandning av overskuddsdelning och incentiver



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Överrask ande många f öretag bygger bonus potten på f öretagets totala resultat. I goda tider blir det kyck et pengar att f ördela. Men i dåliga tider k an det inträffa att det inte finns något att f ördela även om både chefer och medar betare har gjor t en fantastisk insats.

Med sådana system vattnas incentieffekten ut och den ansatte blir inte lik a k raf tigt motiver t av bonusen om den mest styr s av konjunktur läget. De ansatte får också bära en del av den risk , somägar na egentligen borde ta ansvar f ör. Ordeningen blir matematiskt komplicerad och slutligen k an det,

sär sk ilt i dåliga tider, vara svår t att ver kligen behålla de bästa medar betar na, vilk et ju var ett avmotiven till att innf öra en bonusordning.



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How to run a big company

Our fir st and most impor tant point is changing the cost accounting system over to the more moder n activity based costing. This way, we can use cost driver s f or the various activities of pr oduction andadministration to show how pr oduct-line pr ofita bility can be under stood and enhanced.

The budgeting system also needs to be entirely revised. Using the same activities and cost drives as in

the ABC analysis, we would suggest consulting with our s pecialists in activity based budgeting. Thetr ue pr ofita bility of pr oducts and depar tments will stand out in great clarity with such a budget.

Since the pr ofita bility of pr oducts is now f ully known, we also need a dependa ble tool to find the real pr ofita bility of divisions. Theref ore, economic value added (EVA), should be calculated and regardedas the main inf ormation a bout divisional pr ofita bility. EVA is calculated the f ollowing way:

EVA = Divisional gr oss pr ofit ± Tax ± Real Assets*Cost of capital af ter taxes

This will hel p avoid dysf unctional investment behavior in divisions and thus increase the capital regeneration capacity of the entire gr ou p.

All o perational inter nal transfer s of goods or services should be priced at the real cost of pr oduction of

the inter nal seller. (Mar k et price if so is availa ble). This is the only way to avoid sub-o ptimization in alar ge decentralized or ganization.

Inter nal transfer s of building, machiner y or equipment should be priced at cost less accumulated

degressive depreciation. Then they will represent fair mar k et values while still based on cost. This way, cost accounting, financial accounting and tax accounting can easily be reconciled.

Capital budgeting should emphasize pay-back time as a percentage of project life af ter considering the time value of money. Since all pr ojects are risk ey, all income and expences should be evaluatedagainst a company utility function to be develo ped by our s pecialists in a conjunction with leading manager s at headquar ter s.

The real power in a company stays with the manager s contr olling the financial repor ting system.

Theref ore, all repor ting r outines should be centralized to headquar ter s. Division accounting controllers, subordinated only to the gr ou p contr oller, will su pply all necessar y inf ormation. If divisions heads feel that they need local business contr oller, the company contr oller s, the company contr oller may appr ove such position.

All units should be subsidiaries inside a two-dimensional matrix of the gr ou p. Business areas will handle wor ldwide business decisions, whereas legal subsidiaries emphasize pr ofita bility andres ponsi bility in a local mar k et. Real strategic decisions should be made at the business area level whereas HQ mainly should su pply staff service and the horizontal and ver tical transfer of inf ormation.



Slik kjører du et stor t selsk ap

Vår f ør ste og viktigste punktet er å endre kostnadsregnsk ap over til mer moder ne aktivitet baser t kostnadsk alkyle. På denne måten k an vi br uk e kostnadsdriver ne f or de ulik e aktivitetenetil pr oduksjon og administrasjon til å vise hvordan pr odukt-line lønnsomhet k an f or stås og f or bedret.

Budsjetteringssystemet må også være helt revideres. Br uk e de samme aktivitetene og kostnadenestasjoner som i ABC-analyse, ville vi f oreslår at du sjekk er med våre s pesialister i aktivitet baser t budsjettering. Den sanne lønnsomheten av pr odukter og avdelinger sk al sk ille seg ut i stor klar het medet slikt budsjett.

Siden lønnsomheten av pr oduktene er nå f ullstendig kjent, vi også trenger et pålitelig ver ktøy f or åfinne den vir k elige lønnsomheten av divisjoner. Derf or, la økonomisk verdi (EVA), sk al beregnes og regnes som den viktigste inf ormasjonen om avdelte lønnsomheten. EVA er beregnet på f ølgende måte:

EVA = Fa brikk direktør br uttof or tjeneste - Sk att - Real Eiendeler * k apitalkostnad etter sk att

Dette vil bidra til å unngå dysf unksjonelle investeringsatferd i divisjoner og dermed øk e k apitalen gjenf ødelse k apasiteten til hele gr u ppen.

Alle o perative inter ne overf øringer av varer eller tjenester sk al være priset til den reelle kostnaden ved pr oduksjon av den inter ne selgeren. (Bør skur s hvis så er tilgjengelig). Dette er den eneste måten åunngå sub-o ptimalisering i en stor desentraliser t or ganisasjon.

Inter n overf øring av bygg, mask iner og utstyr sk al være priset til kost pris fratr ukk et akkumuler tedegressive avsk rivninger. Da vil de representere vir k elig mar k edsverdi samtidig baser t på kost. Dennemåten, kostnadsregnsk ap, finansregnsk ap og sk atteregnsk ap k an lett bli f or sonet.

Capital budsjettering bør vektlegge pay-back tid som andel av pr osjektet livet etter vurdering avtidsverdien av penger. Siden alle pr osjekter er risikof ylte, bør alle inntekter og utgif ter bli vurder t mot et selsk ap nyttef unksjon å bli utviklet av våre s pesialister i f or bindelse med ledende ledere påhovedk var teret.

Den vir k elige makten i et selsk ap f or blir med leder ne kontr ollerer finansielle rappor teringssystem.Derf or bør alle rappor teringsr utiner bli sentraliser t til hovedk var teret. Seksjon regnsk ap kontr oller ne,ansvar lig bare til gr u ppen kontr olleren, vil levere all nødvendig inf ormasjon. Hvis divisjoner lederef øler at de trenger lok al vir ksomhet kontr olleren, selsk apet kontr ollere, k an selsk apet kontr olleren godkjenne slik stilling.

Alle enhetene sk al være datter selsk ap i en to-dimensjonal matrise av gr u ppen. Forretningsområder vil håndtere verdensoms pennende vir ksomhet beslutninger, mens juridisk e datter selsk aper under strek elønnsomhet og ansvar i et lok alt mar k ed. Real strategisk e beslutninger bør gjøres påf orretningsområdenivå mens HQ hovedsak bør gi service og en horisontal og ver tik al overf øring avinf ormasjon.

notater accounting for management controlling

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