Accounting: text and cases / Anthony, Robert N. Hawkins, David F & Merchant, Kenneth A. / McGraw-Hill 2011 13.

ed
part of ch. 22 pp 650-654

Chapter

Control: The
Management Control
Environment
In this and the next three chapters, we describe the nature of the management control
process and the use of accounting information in that process. This chapter describes the
environment in which management control takes place: the organization, the rules and
procedures governing its work, the organization's culture, and the organization's exter­
nal environment
Management control focuses on organization units called responsibility centers.
There are four types of responsibility centers that can be used: revenue centers, expense
centers, profit centers, and investment centers. Profit centers and investment centers
may require the use of transfer pricing, which this chapter also addresses.

Management Control

An organization has goals; it wants to accomplish certain things. It also has strategies for
attaining these goals, which are developed through an activity called strategy formula­
tion. Strategy formulation is not a systematic activity because strategies change when­
ever a new opportunity to achieve the goals-or a new threat to attaining the goals-is
perceived, and opportunities and threats do not appear according to a regular schedule.
Essentially, the management control process takes the goals and strategies as given
and seeks to assure that the strategies are implemented by the organization. Formally,
management control is defined as the process by which managers influence members
of the organization to implement the organization's strategies efficiently and effec­
tively. The word control suggests activities that ensure the work of the organization
proceed as planned, which is certainly part of the management control function. How­
ever, management control also involves planning, which is deciding what should be
done. The organization will not know how to implement strategies unless plans are de­
veloped that indicate the best way of doing so.
These plans have essentially two parts: (1) a statement of objectives, which are the
results that the managers should achieve in order to implement strategies, and (2) the
 Chapter 22 Control: The Management Control Environment 651

resources required in order to attain these objectives. (The words goals and objectives
are often used interchangeably. We use goals for broad, usually nonquantitative, long­
run plans relating to the organization as a whole, and objectives for more specific, often
quantitative, shorter-run plans for individual responsibility centers.)
Moreover, managers do not always seek planned results. If there is a better way than
the one indicated in the plan, managers ordinarily should employ that better way.
Therefore, the statement that management control seeks to assure desired results is
more realistic than a reference to planned results.
With respect to a machine or other mechanical process, we can say that the process
is either "in control" or out of control; that is, either the machine is doing what it is sup­
posed to be doing, or it is not. In an organization, such a dichotomy is not appropriate.
Although some organizations have been said to be "out of control," it is usually more
appropriate to judge an organization's degree of control along a continuum ranging
from excellent to poor.
Management control is a process (described in the succeeding three chapters) that
takes place in an environment. This chapter discusses some of the important character­
istics associated with this environment.

The Environment

Four facets of the management control environment discussed in this section are as
follows: the nature of organizations; rules, guidelines, and procedures that govern the
actions of the organization's members; the organization's culture; and the external
environment.

The Nature of A building with its equipment is not an organization. Rather, it is the people who work
Organizations in the building that constitute the organization. A crowd walking down a street is not
an organization, nor are the spectators at a football game when they are behaving as
individual spectators. But the cheering section at a game is an organization; its mem­
bers work together under the direction of the cheerleaders. An organization is a group
of human beings who work together for one or more purposes. These purposes are
called goals.

Management
An organization has one or more leaders. Except in rare circumstances, a group of peo­
ple can work together to accomplish the organization's goals only if they are led. These
leaders are called managers or, collectively, the management. An organization's man­
agers perform many important tasks, among these are the following:
Deciding what the organization's goals should be.
Deciding on the objectives that should be achieved in order to move toward these
goals.
Communicating these goals and objectives to members of the organization.
Deciding on the tasks that are to be performed in order to achieve these objectives
and on the resources that are to be used in carrying out these tasks.
Ensuring that the activities of the various organizational parts are coordinated.
Matching individuals to tasks for which they are suited.
Motivating these individuals to carry out their tasks.
652 Part 2 ManagementAccounting

ILLUSTRATION
22-1
Partial Organization
Chart
Staff

Manager,
Control

Manager,
F inance

Manager,
Personnel

Manager,
Legal

Manager, Manager. Manager,

Sect ion A Sect ion B Section C Manager,
Research

Etc.

• Observing how well these individuals are performing their tasks.

• Taking corrective action when the need arises.
Just as the leader of a cheering section performs these functions, so too does the chief
executive officer of General Electric Company.

Organization Hierarchy
A manager can supervise only a limited number of subordinates. It follows that an or­
ganization of substantial size must have several layers of managers in the organization
structure. Authority runs from the top unit down through the successive layers. Such an
arrangement is called an organization hierarchy.
The formal relationships among the various managers can be diagrammed in an
organization chart. Illustration 22-1 shows a partial organization chart. A number of
organization units report to the chief executive officer (CEO). Some of these are line
units; that is, their activities are directly associated with achieving the objectives of the
organization. They produce and market goods or services. Others are staff units,
which exist to provide various support services to other units and to the chief executive
officer. The principal liue units are called divisions in the illustration. Each division
contains a number of departments, and within each department are a number of
sections. Different companies and nonbusiness organizations use different names for
these layers of organization units. Also, in some companies, the chairman of the board
is the chief executive officer and the president is the chief operating officer (COO).

Responsibility Centers
All the units in Illustration 22-1 are organization units. Thus, Section A of Depart­
ment I of Division A is an organization unit. Division A itself, including all of its de­
partments and sections, is also an organization unit. Each of these units is headed by
 Chapter 22 Control: The Management Control Environment 653

a manager who is responsible for the work done by the unit; each unit, therefore, is
called a responsibility center. Managers are responsible in the sense that they are held
accountable for the activities of their organization units. These activities include not
only the work done within the responsibility center but also its relationships with the
external environment (described below). A description of how responsibility centers
work and how responsibility choices should be made is provided later in the chapter.

Rules, An organization has a set of rules, guidelines, and procedures that influence the way its
Guidelines, and members behave. Some of these controls are written; others are less formal. They vary,
Procedures depending in part on the size, complexity, and other characteristics of the organization
and in part on the wishes of the organization's senior management. These rules, guide­
lines, and procedures exist until the organization changes them. Ty pically, such change
comes slowly.
Some of these controls are physical, such as security guards and computer pass­
words. Others are written in manuals, memoranda, or other documents. Still others are
based on the oral instructions of managers. Some may even involve nonverbal com­
munication, such as feelings developed about the appropriate mode of office attire:
Since the boss wears casual clothes, you do too. An important set of rules is the writ­
ten and unwritten rules relating to the rewards the organization offers for good perfor­
mance or the penalties for substandard performance and prohibited activities.

Culture Each organization has its own culture, with norms of behavior that are derived in part
from tradition, in part from external influences (such as the norms of the community
and of labor unions), and in part from the attitudes of senior management and the board
of directors. Cultural factors are unwritten, and they are therefore difficult to identifY.
Nevertheless, they are important. For example, they explain why one entity has much
better actual control than another, although both have seemingly adequate formal man­
agement control systems.
An important aspect of culture is the attitude of senior management, particularly on
the part of the chief executive officer and the chairman I of the board, toward control.
This has an important influence on the organization's control environment. Some top
managers prefer tight controls; others prefer loose controls. Either can work well in
appropriate circumstances.

External The external environment of an organization includes everything that is outside of the
Environment organization itself, including customers, suppliers, competitors, the community, regu­
latory agencies, and others. The organization is continually involved in a two-way in­
teraction with its external environment.
The nature of the environment in which an organization operates affects the nature
of its management control system. Differences in environmental influences on the or­
ganization can be summarized in one word: uncertainty. In an organization having rel­
atively certain revenues and whose technology is not subject to rapid change (e.g.,
pulp-making), management control is considerably different from management control
in an organization that operates in a fiercely competitive marketplace and whose prod­
ucts must be changed frequently in order to take advantage of new technological break­
throughs (e.g., computers). An organization that operates in a relatively uncertain

1 The authors fully realize that the position of chairman of the board may be held by a woman. We
use the term chairman because it is almost universally used in business practice irrespective of the po­
sition holder's gender (unlike in some universities and other nonprofit organizations, where the titles
chairperson, chair; and chairwoman are also used).
654 Part 2 ManagementAccounting

environment relies more on the informal judgment of its managers than on its formal
management control system. Also, managers at all levels in such an organization need
prompt, accurate information about what is going on in the outside world.

Responsibility Centers and Responsibility Accounts

Illustration 22-2 provides a basis for describing the nature of responsibility centers. The
top section depicts an electricity generating plant, which in some important respects is
analogous to a responsibility center. Like a responsibility center, the plant (1) uses in­
puts to (2) do work, which (3) results in outputs. In the case of the generating plant, the
inputs are coal, water, and air, which the plant combines to do the work of turning a tur­
bine connected to a generator rotor. The outputs are kilowatts of electricity.

Inputs and As shown in part B of Illustration 22-2, a responsibility center also has inputs: physi­
Outputs cal quantities of material, hours of various types of labor, and a variety of services.
Usually, both current and noncurrent assets also are required. The responsibility center
performs work with these resources. As a result of this work, it produces outputs:
goods (if tangible) or services (if intangible). These products go either to other respon­
sibility centers within the organization or to customers in the outside world.
Part C of the illustration shows iuformation about these inputs, assets, and outputs.
Although the resources used to produce outputs are mostly uonmonetary things such

ILLUSTRATION A. Analogy to a generating plant

22-2
Nature of a Respon­
sibility Center

Inputs
•
Coal, Air, Water
Output
•
Electricity

B. In reality
Inputs t9 other
reSponsibil�ty
I nputs: Outputs:
centers
Labor, Goods
Material ;:', $eiVices
orto
ServiCes
Things, people Outside world

C. As depicted by infor mation

inp��':':":,-'::,,;:' "" ':': ;'

"
: " Outputs:
1'. Cos'r and <"'-"' ": : ,:<: " < 1. Revenues
,
2:/No n:in
onet�ry ?ata' 2: NonrriOll_etaty
, information
Assets