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• Companies’ emphasis on short-term results motivates managers to take a chance on the
future to make the current period look good.
• A large and widely decentralized organization depends on local managers for their
superior local knowledge and may prevent top management from gaining information
about local activities which are fraudulent.
LO 12-8 Understand how internal controls can help protect assets.
♦ At a general level, internal controls provide management with reasonable assurances that their
company’s assets are protected and that the company’s accounting is reliable.
• Internal control is a process designed to provide reasonable assurance that an
organization will achieve its objectives in the following categories:
(1) Effectiveness and efficiency of operations.
(2) Reliability of financial reporting.
(3) Compliance with applicable laws and regulations.
• The top management and the board of directors are responsible for providing an
adequate system of internal controls.
• The Sarbanes-Oxley Act of 2002 requires that management of publicly traded
companies report on the adequacy of their internal controls over financial reporting. It
also requires the company’s external auditors attest to the effectiveness of the internal
controls in place.
• One key control is separation of duties, which means that no one person has control
over an entire transaction (e.g., make the sale, prepare the invoice, deposit the cash
payment, and reconcile the bank statement to the company’s books).
• Employees can collude to beat the internal control systems.
• Companies use many types of internal controls besides separation of duties, such as
(1) Setting limits on the amount of expenditures,
(2) Requiring management authorization for the use of a company’s assets,
(3) Reconciling various sets of books,
(4) Prohibiting particular activities or behavior, and
(5) Rotating personnel and requiring employees to take vacations.
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• Internal controls are not just good business practice but also are legally required for
publicly traded companies by, for example, the Foreign Corrupt Practices Act of 1977 to
reduce bribery to foreign government officials.
• Internal auditors, as the first line of defense against fraud, monitor internal controls to
ensure that they are working.
Matching
A.
Behavioral congruence
G.
Dysfunctional decision making
B.
Contingent compensation
H.
Internal control
C.
Cost center
I.
Investment center
D.
Decentralization
J.
Local knowledge
E.
Discretionary cost center
K.
Profit center
F.
Dual-rate method
L.
Separation of duties
_____ 1. The delegation of decision-making authority in the organization’s name to
subordinates.
_____ 2. Knowledge about local conditions, markets, regulations, etc.
_____ 3. Local managers may make decisions that are in their own interests, but not in the best
interests of the organization.
_____ 4. Exists when individuals behave in the best interest of the organization regardless of
their own goals.
_____ 5. An organization subunit responsible only for the cost of an activity for which a well-
defined relationship exists between inputs and outputs.
_____ 6. An organization subunit responsible for profits and thus responsible for revenues,
costs, production, and sales volumes.
_____ 7. Allocates costs by separating a common cost into fixed and variable components and
then allocating each component using a different allocation base.
_____ 8. The amount of compensation that is paid based on measured performance.
_____ 9. A process designed to provide reasonable assurance that an organization will achieve
its objectives.
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_____ 10. No one person has control over an entire transaction.
_____ 11. An organization subunit responsible for profits and for investment in assets.
_____ 12. An organization subunit whose manager is held responsible for costs when the
relationship between costs and outputs is not well established.
Answers
Chapter 12 – Fundamentals of Management Control Systems
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Multiple Choice
1. Which of the following represent a principal-agent relationship?
a. Patient and dentist.
b. Worker A and worker B.
c. Client and lawyer.
d. Both a and c.
2. The management control system includes
a. Delegation of decision rights.
b. Commitments.
c. Pricing decisions.
d. Capital budgeting.
3. An advantage of decentralization is that it
a. Pays attention to the company as a whole.
b. Does not waste any of corporate resources.
c. Improves employee morale.
d. Benefits smaller, regulated companies.
4. Decentralization
a. Takes advantage of local knowledge.
b. Delays response to local problems.
c. Reduces dysfunctional decision-making.
d. Gives top management more control.
5. Delegation of decision authority
a. Is the essence of decentralization.
b. Is followed by performance evaluation and compensation.
c. Is part of management control system.
d. All of the above.
6. A manager in charge of research and development is likely to be heading a
a. Revenue center.
b. Profit center.
c. Standard cost center.
d. Discretionary cost center.
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7. The manager of a profit center is responsible for all of the following except
a. Sales revenue.
b. Corporate overhead.
c. Production costs.
d. Marketing costs.
8. Which of the following statements is correct?
a. When diverse centers exist, management frequently establishes the same target level of
performance for all centers.
b. It is safe to assume that, if the manager is willing to work for the organization, he or she
should be paid more.
c. Managers should be held responsible for costs or profits over which they have decision
making authority.
d. The compensation system cannot be used to align better the risk preferences of the
manager and the firm.
9. Which of the following represents an example of relative performance evaluation?
a. Actual vs. budgeted divisional income.
b. Division A income vs. Division B income.
c. This year’s income vs. last year’s income.
d. Actual vs. standard costs.
10. A dual rate method
a. Allocates costs by separating a common cost into fixed and variable components.
b. Each cost component has a different allocation base and an allocation rate.
c. Transforms variable cost into fixed cost for decision making purpose.
d. Both a and b.
11. If high-pressure performance evaluation systems are adopted,
a. The pressure motivates employees to perform.
b. The pressure is concentrated in middle managers.
c. Fraudulent financial reporting is less likely to occur.
d. There is a desire to stick with the accounting standards.
12. Internal control
a. Is designed to provide absolute assurance of achieving organization’s goals.
b. Is the responsibility of factory foremen.
c. Helps protect a company’s assets.
d. Is optional for publicly traded companies.
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Answers