Fundamentals of Cost Accounting 3rd Edition by William N. Lanen, Shannon W. Anderson, Michael Maher

Exercise 22

Evaluating Management Control Systems

SPG Company manufactures and sells metal products that are used in many manufacturing operations. The management at SPG believes strongly in decentralized decision making and using performance evaluation and compensation to encourage high-performing managers. Marilyn Conners is the manager of the manufacturing operations, which produces and transfers the product to the marketing division. Jack Schwartz is the manager of marketing. Marilyn is evaluated on manufacturing cost relative to a budget for good output. Marilyn makes all production decisions. Jack is evaluated on company profit relative to a target. If a manager meets his or her target, they receive a bonus equal to 100 percent of salary.

Information on performance last year follows:

Manufacturing Cost		Company Profit
Target cost per unit	$2.37	Target profit	$10,000,000
Actual cost per unit	2.25	Actual profit	9,232,000

Required

What recommendations would you suggest for changes to the SPG management control system, if any? Discuss the delegation of decision authority, performance evaluation and measurement, and compensation design in your response.

Step 1 of 2

Management control system

Management control system is needed to manage the complications arising out of decentralization like dysfunctional decision making. Owners of the organization use structure and procedures of management control system to influence the actions of its managers and other employees to ensure smooth implementation of organizational strategies. Management controls system comprises of three elements such as delegation fo decision making authorities, evaluation of performance and measurement systems and finally awarding compensation and rewards for performance.

Compensation system

Compensation system are made effective and attractive for managers in order to motivate for them for the best performance and achieve organizational objectives. Contingent compensation is part of compensation system where part of remuneration is based on performance. Paying commission to sales person based on sales revenue is part of compensation system that motivates sales teams to deliver their best, which eventually helps to achieve organizational objectives.

Contingent compensation may result in dysfunctional results also. Sales managers may take some decisions to meet their individual goals, that are not in the interest of organization. For example, sale managers may make false commitments or mislead customers about the benefits of sales schemes so that they can meet their sales targets.