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12
Fundamentals of Management Control Systems
Solutions to Review Questions
12-1.
12-2.
12-3.
The advantages of decentralization include:
• Better use of local knowledge;
12-4.
Dysfunctional decision-making is the situation in which local managers make decisions in
their interests, which can differ from the interests of the organization.
12-5.
The three elements of a management control system are:
1. Delegated decision authority
12-6.
The five basic kinds of decentralized units in a responsibility accounting system are:
1. Cost centers;
12-7.
12-8.
12-9.
12-10.
12-11.
12-12.
Separation of duties helps prevent financial fraud because it limits the opportunity to
commit the fraud. When a separation of duties exists, two or more individuals must
Solutions to Critical Analysis and Discussion Questions
12-13.
Local managers often have better information about local conditions. This information is
12-14.
12-15.
12-16.
12-17.
There is a strong incentive to “find” $100,000 in income. The manager might defer
12-18.
Although there are well-developed standards for many accounting transactions,
12-19.
Frequently managers will wait until near the end of the budget period to make
discretionary expenditures. Sometimes managers will use "excess" funds from one period
12-20.
The service costs are being allocated on the basis of use when, in fact, some of the costs
were incurred to provide capacity. Dual rates might be established so that the capacity
12-21.
The allocation method affects the costs (and profits in a profit center) of the different units.
12-22.
Large divisions are, all other things being equal, more likely to rank in the upper half.
12-23.
12-24.
Answers will vary. There are many reasons for pay not to reflect performance. In some
cases, the reasons are because of collusion or other unethical or illegal reasons. Some
other reasons, which might be defensible for business reasons include a desire to keep
12-25.
In many cases managers are content to take a stated salary and perform optimally.
However, in other organizations managers appear to perform better when given profit
12-26.
The Treadway Commission listed the pressures to achieve unrealistically high, short-term
12-27.
Two explanations for the existence of unrealistic profit objectives for division managers are
that upper management might be uninformed about the division, and that they might be
12-28.
Committing financial fraud in the current period might seem to outweigh future problems
Solutions to Exercises
12-29. (15 min.) Evaluating Management Control Systems: Chama Car Detailing.
b. The management control system at Chama is possibly flawed. The low actual wages
might indicate that the quality of employees hired is below the level needed to achieve
12-30. (20 min.) Evaluating Management Control Systems – Ethical Considerations:
Magnolia Manufacturing.
b. Income with the new technique will be $10.2 million (= $8.5 million x 1.20) or 20%
above target. Kevin’s bonus will be 5% (the maximum) of salary, or $9,000 (= 5% x
d. Kevin should not consider his bonus when deciding whether to employ the technique.
e. Kevin is responsible for manufacturing and has little direct control over sales. One
recommendation would be to evaluate Kevin based on costs relative to a budget based
12-31. (15 min.) Management Control Systems and Incentives: DC.
This problem represents part of the incentive plan of a U.S.-based international
conglomerate. This part of the incentive system was designed to focus managers on
maximizing short-term earnings.
a. This plan creates the following incentives for division managers:
• Short-term orientation.
b. Is this a good plan? Would you want to be a division manager?
• It’s a good plan if the company wants a short-run, financial focus, which it does.
12-32. (15 min.) Management Control Systems and Incentives: Heavy.
This problem represents the change in an incentive plan at a company that
manufactures machinery and engines. In negotiating a wage contract with the
employees’ union, the company offered and the union agreed to a profit-sharing
12-33. (15 min.) Alternative Allocation Bases: Bartolo Delivery.
a. Number of calls basis.
Air Express
b. Time on Network
Air Express
12-34. (10 min.) Single versus Dual Rates: Bartolo Delivery.
Air Express
Fixed
350,000
x $5,200,000 =
$1,300,000
350,000 + 1,050,000
12-35. (20 min.) Single versus Dual Rates—Ethical Considerations.
a. Gigabytes of Storage Basis
Corporate
b. Number of Consultants Basis
Corporate
12-36. (25 min.) Single versus Dual Rates.
Corporate
Fixed
135
x $7,000,000 =
$3,150,000
12-37. (20 min.) Alternative Allocation Bases: Thompson Aeronautics.
a. Number of Purchase Orders Basis
Defense
b. Dollar Amount of Purchases Basis
Defense
c. Because the government contracts are cost-plus, the allocation basis will affect the
12-38. (20 min.) Tone at the Top – Ethics.
This case refers to an incident reported by NBC’s Dateline. The news group
committed fraud (not financial fraud) when it rigged the GM trucks to blow up. The
executive in this case set a tone that the behavior was not the problem, but getting
caught was. The news group believed that the GM trucks would explode upon
12-39. (20 min.) Incentives and Ethics.
The situation in this question is based on an actual case. In the actual case, the
fraudulent activities were discovered by people who worked in the accounting
department who discovered the invoices and shipping documents tucked away in the
12-40. (20 min.) Internal Controls.
a. The internal control is separation of duties between producing the sandwich and the
financial transaction of recording the sale and taking the money. This separation of
b. A better internal control is to separate ringing up the sale from taking the money. The
12-41. (20 min.) Internal Controls.
a. The internal control is separation of duties. Because the most senior member pays for
Solutions to Problems
12-42. Evaluating Management Control Systems: SPG Company.
Answers will vary. It is important to discuss all three elements of control systems
(delegation of decision authority, performance measurement, and compensation
systems) to ensure that recommended changes result in an efficient control system.
12-43. (40 min.) Analyze Performance Report for Decentralized Organization: Hall
O’ Fame Products.
a. An evaluation of the performance of James Davenport for the nine months ending
September Year 3 would appear favorable if only the divisional performance measure
figure were considered. The actual performance measure is well above the nine-month
budgeted figure. However, closer examination of the report reveals that overall
performance cannot be considered satisfactory for the following reasons:
• Variable cost of sales (direct materials and labor) has increased significantly as a
percentage of sales.
12-43. (continued)
b. A performance evaluation system should reflect the division manager’s (D.M.)
responsibilities (i.e., those things that are specifically controllable by the D.M. and
for which the D.M. is held accountable). A good division performance measurement
should present the performance of the manager unobscured by extraneous items
that are not subject to the D.M.’s control. In this instance, Hall O’ Fame’s divisional
management is solely responsible for the production and distribution of corporate
products.
Specific features of the performance measurement reporting and evaluation system,
which should be revised, are as follows:
12-44. (40 min.) Divisional Performance Measurement—Behavioral Issues: Paulista
Corporation.
a. The proposed Achievement of Objectives System (AOS) would be an improvement
over the current measure of divisional performance for the following reasons:
• There appears to be greater participation in the establishment of objectives by
divisional managers.
b. Specific performance measures for the criterion “doing better than last year” could
include total sales, contribution margin, controllable costs, net income, net income as a
12-44. (continued)
c. The motivational and behavioral aspects of the achievement of objectives system
depend upon the level of acceptance of the system by top management and the
divisional managers.
• Divisional managers could have a sense of participation in the role of goal setting
and budget development, which could encourage goal congruence.
Programs that might be instituted to promote morale and give incentives to divisional
managers in conjunction with the achievement of objectives system include the
following:
• Intrinsic motivators can be provided by allowing the manager to assess his/her own
achievements and his/her own worth.
CMA adapted
12-45. (40 min.) Cost Allocations—Comparison of Dual and Single Rates: Pacific
Hotels.
a. Allocations based on time usage:
(1)
Department
Proportion of
Total Time
Allocated Cost
Luxury ................................................................
.20a
$298,000b
(2) Dual allocations
(1)
Proportion
of Time
Usage
(2)
Allocated
Time Cost
(3)
Proportion of
Reservations
(4)
Allocated
Equipment
Cost
(5)
Total
Allocated
Cols. 2 + 4
Luxury ................................................................
.20a
$168,000b
.08c
$52,000d
$220,000
12-45. (continued)
b. Dual rates should be used. If a single rate (time usage) is used, there might not be a
12-46. (30 min.) Cost Allocation for Travel Reimbursement.
a.
(1) Since the round-trip cost of the Chicago-Paris portion (2 x $3,650 = $7,300) is less
12-47. (30 min.) Incentives, Illegal Activities, and Ethics.
This situation is based on the alleged fraud at the company, Leslie Fay.
a. Invoice backdating records revenues in periods earlier than they should be recorded.
The dressmaker would have reported revenues and cost of goods sold for Year 1 that
excuses to commit fraud.
c. Distant locations are more difficult to monitor than those close by. If he desired, the
CEO could have made frequent visits to the nearby location to observe activities. If he
opposed the fraudulent activities, he could have had a personal hand in preventing
them if he were personally observing the operations. Here is a real example. An
Solutions to Integrative Cases
12-48. (60 min.) River Beverages Case.
Note: It is important to understand the regional structure of the organization (Exhibit
12.3) as well as the production plant structure for the company’s Noncarbonated
Drinks plant in St. Louis (Exhibit 12.4). Instructors might want to present an
overview of this case before assigning it to students.
a. Sales projections are made at three levels:
• Division managers submit a report to the vice president for the region that includes
After the sales budget is approved by top management, it is separated into a sales
budget for each plant. Since the sales budget is already established, plant managers
12-48. (continued)
• The final budgets are fine tuned by the vice presidents and CEO and submitted to
b. The question is should the plants be treated as profit centers (responsible for sales
and costs), or as cost centers (responsible only for costs)?
The plant managers have very little control (if any) over sales projections. As shown in
Exhibit 12.4, the division and district sales managers report separately to the division
budgeting process.
c. The primary question is what behavior is top management trying to promote with the
budgeting process? In general, River Beverages’ management wants its employees to
maximize production efficiency (thus minimizing production costs), and maximize
profits.
12-49. (60 min.) Pepsi and Old Bottles
Here are some of the factors contributing to the fraud.
• Pepsi had strong incentives to perform well.
• The company was decentralized, which reduced oversight by top management.
12-50. (60 min.) Business Environment, Performance Measures, Compensation, and
Ethics: Kidder, Peabody (GE)
c. The percentage of salary that can be earned as bonus differs greatly from industry to
industry. There are (at least) two reasons for this:
d. (1) Apparently the managers have some money in the budget that could be used for
investment or other opportunities that had not been used and, as a result, could
