Definition of Management Control in Specialized Organisations – Sectoral Applications

Service Organisations

Early in the 20th century, employment in the service sector overtook employment in the manufacturing sector. By 2005, service sector employment had grown to more than twice that of manufacturing.

Characteristics of Service Organisations

Management control in service industries is different from management control in manufacturing companies. The factors which apply to the management control of legal, research and development, and other service department in companies generally are discussed below.

Absence of Inventory Buffer

Goods can be held in inventory, which is a buffer that dampens the impact on production activity of fluctuations in sales volume. Services cannot be stored. The airplane seat, hotel room, hospital operating room, or the hours of lawyers, physicians, scientists, and other professionals that are not used today are gone forever. Thus although a manufacturing company can earn revenue in the future from products that are on hand today, a service company cannot do so. It must try to minimize its unused capacity. Moreover, the costs of many service organisations are essentially fixed in the short run.

For example, in the short run, a hotel cannot reduce its costs substantially by closing off some of its rooms. A key variable, therefore, in most service organisations is the extent to which current capacity is matched with demand.

Difficulty in Controlling Quality

A manufacturing company can inspect its products before they are shipped to the consumer, and their quality can be measured visually or with instruments. A service company cannot judge product quality until the moment the service is rendered, and then the judgements are often subjective. Restaurant management can examine the food in the kitchen, but customer satisfaction also depends on the way it is served.

Labour Intensive

Manufacturing companies add equipment and automate production lines, thereby replacing labour and reducing costs. Most service companies are labour intensive and cannot do this.

Multi-Unit Organisations

Some service organisations operate many units in various locations, each unit relatively small. These organisations are fast-food restaurant chains, auto rental companies, gasoline service stations, and many others. The information for each unit can be compared with system wide or regional averages, and high performers and low performers can be identified.

Historical Development

Cost accounting started in manufacturing companies because of the need to value inventories. Standard cost systems, separation of fixed and variable costs, and analysis of variances were built on the foundations of cost accounting systems. Until a few decades ago, most texts on cost accounting dealt only with practices of manufacturing companies.

Professional Service Organisations

Research and development organisations, law firms, accounting firms, health care organisations, engineering firms, architectural firms, consulting firms, advertising agencies, symphony and other arts firms and sports firms are examples of professional service organisations.

Special Characteristics

Goals

These organisations have relatively few tangible assets; its principal asset is the skill of its professional staff, which doesn’t appear on its balance sheet. Their financial goal is to provide adequate compensation to the professionals.

Professionals

Professional organisations are labour intensive, and the labour is of a special type. Professionals who are also managers tend to work only part time on management activities. They give inadequate importance to the financial implications of their decisions which affect the attitude of support staffs and non professionals which in turn leads to inadequate cost control.

Output and Input Measurement

The output of a professional organisation cannot be measured in physical terms, such as units, tons, or gallons. Revenues earned is one measure of output in some professional organisations, but these monetary amounts relate to the quantity of services rendered, not their quality. Furthermore, the work done by many professionals is non repetitive. This makes it difficult to plan the time required for a task, to set reasonable standards for task performance, and judge how satisfactory the performance was.

Small Size

With a few exceptions, such as some law firms and accounting firms, professional organisations are relatively small and operate at a single location. Senior management in such organisations can personally observe what is going on and personally motivate employees. Even a small organisation needs a budget, a regular comparison of performance against budget, and a way of relating compensation to performance.

Marketing

In professional organisation, the ethical code limits the amount and character of overt marketing efforts by professionals. Since marketing is an essential activity, if it can’t be conducted openly, it takes the form of personal contacts, speeches, articles, etc. These marketing activities are conducted by professionals who spend their time mostly in production work, i.e., working for clients.

Management Control Systems

Pricing

The selling price of work is set in a traditional way in many professional firms. If the profession is one in which members are accustomed to keeping track of their time, fees generally are related to professional time spent on the engagement. The hourly billing rate is based on the compensation of the grade of the professional, plus a loading for overhead costs and profit. In other professions, such as investment banking, the fee typically is based on the monetary size of the security issue. In some others, there is fixed price for the project. Prices vary widely among professions; they are relatively low for research scientists and relatively high for accountants and physicians.

Profit Centres and Transfer Pricing

Support units, such as maintenance, information processing, transportation, telecommunication, printing, and procurement of material and services, charge consuming units for their services.

Strategic Planning and Budgeting

In general, formal strategic planning systems are not as well developed in professional organisations as in manufacturing companies. Partly it is because professional organisations have no great need for such systems. The principal assets are people. The strategic plan of a professional organisation typically consists primarily of a long range staffing plan, rather than a full-blown plan for all aspects of the firm’s operation.

Control of Operations

Much attention is given to scheduling the time of professionals. The billed time ratio, which is the ratio of hours billed to total professional hours available, is watched closely. If engagements are billed at lower than normal rates, the resulting price variance warrants close attention. When the work is done by project teams, control is focused on projects. A written plan for each project is needed, and timely reports should be prepared that compare actual performance with planned performance in terms of cost, schedule and quality.

Performance Measurement and Appraisal

At the extremes the performance of professionals is easy to judge. Appraisal of the large percentage of professional who are within the extremes is much more difficult. For more professions, objective measures of performance are sometimes available. The recommendations of an investment analyst can be compared with actual market behaviour of the securities; the accuracy of a surgeon’s diagnosis can be verified by an examination of the tissue that was removed and the doctors’ skill can be measured by the success ratio of operations.

These measures are, of course, subject to appropriate qualifications, and in most circumstances the assessment of performance is finally a matter of human judgement by superiors, peers, self, subordinates, and clients.

Financial Service Organisations

Financial Service organisations include commercial bank and thrift institutions, insurance companies, non-banking financial institutions, mutual funds and securities firms. These companies are in business primarily to manage money. Some act as intermediaries (obtain money from depositors and lend it to individuals), some act as risk shifters (obtain money in the form of premiums, invest these them and accept the risk of occurrence of specific events) and still others as traders (buy and sell securities, either for their own account or for customers).

General observations about the financial services sector are:

Financial services firms accounted a major portion of the gross domestic product and constitute an important backbone to the economy.

Blurring of industry boundaries, globalization, and consolidation of financial services firms will accelerate in the 21st century.

Financial services firms have used the information technology revolution to innovate new products and discover new methods of trading.

The need for controls in the financial services sector has become paramount due to highly risky and bad loans which have lead to collapse of banks in the past.

New forms of financial instruments such as derivatives designed by financial services firms sometimes resulted in millions of dollars of losses for their clients.

Special Characteristics

The general principles and concepts of management control systems applied must be adapted to the following special characteristics of this industry.

Monetary Assets

Most of the assets of financial service firms are monetary. The current value of monetary assets is much more easily measured than the value of plant and other physical assets. Currency is the extreme example of a fungible commodity. At any time, rupees held by all companies have the same value, even though the purchasing power changes with time. Financial assets also can be transferred from one owner to another easily and quickly. In an electronic funds transfer, money moves almost instantaneously.

Time Period for Transactions

The ultimate financial success or failure of a loan or a security issue may not be known for 30 years or more. During this period, the soundness of the loan as well as the purchasing power of money will change. So, it means performance of financial personnel cannot be measured at the time the initial decision is made. It also means that control should be in the form of continued surveillance of the soundness of the transaction during its life.

Risk and Reward

Many financial services firms are in the business of accepting risks in return for rewards. Most business decisions involve a trade-off between risks and rewards. The greater the risk, the greater should be the anticipated reward. Interest rates on loans and premiums on insurance policies are based on assumptions about risk that may or may not turn out to be accurate.

Technology

Technology has revolutionized the financial services industry. Financial service firms have used information technology as a way to offer innovative services. The Automated Teller Machines of banks, electronic marketing of products and services through internet, cyber-payment systems and online brokerage services are such innovative examples.

Controlling the Financial Sector

These industries are severely controlled by legislation, as there is an understanding that neither of the two types of controls, - those internal to the organisations which is called as hierarchies, or the controls of markets, would be adequate to ensure that organisations perform up to the expectations of society. Nor are the problems of the finance sector fully captured by the concept of either the single or the dual focus of controls. The sector has been one of the most vulnerable, and like the keg of gunpowder, ever ready to explode. Trust is the key word for control systems in this sector. The locus of controls in the finance sector lies largely outside the organisation. They are heavily circumscribed by regulations made by the state. Even so, the sustainability of the sector has to rely on the cultivation of trust within the organisation and its relationship with the outside world. The organisation has also to make it feasible for hierarchical and market controls operate within the organisation, within an acceptable level of transaction costs.

The Banking Sector

Logical consequence of Flow of Transactions

The first step in constructing a management control system for an industry is to understand the skeleton of their flow of transactions. The flow chart is given in diagram below.

The Flow Chart of the Banking Industry

Flow of funds  in return of interest. Providing service Providing income for service rendered  Providing funds in return of dividend

The peculiarity in the banking sector is that the providers of capital provide usually a much smaller proportion of the total fund of the banks.

The Balance Sheet Concept

Definition: A Balance Sheet is a statement of the financial positionof a business which states the assets, liabilities, and owners’ equity at a particular point in time. In other words, the Balance Sheet illustrates business’s net worth.

It is a statement of the total assets and liabilities of an organization at a particular date, usually the last day of the accounting period. The first part of the statement lists the fixed and current assets and the liabilities, the second part shows how they have been financed; the totals for each part must be equal.

All accounts in the General Ledger are categorized as an asset, a liability or equity. The relationship between them is expressed in this equation: Assets = Liabilities + Equity. The Balance Sheet is divided into these three sections. It is also known as Statement of financial position.

Activity Based Costing (ABC)

Introduction

ABC was developed as a continuous improvement initiative of the accounting information system. Original, ABC was used as a product costing methodology, but is now being used as a cost management tool in many different functions of business. A couple of differences between ABC and traditional cost systems are 1) costs are traced to cost objects by identifying cost drivers and 2) costs are traced on the basis of the structural or hierarchical level at which costs are incurred. Therefore, ABC provides more accurate cost estimates of the product or service and the corresponding activities than traditional costing.

It is important to note that in traditional costing the assumption is that products consume resources. ABC contrasts traditional costing by assuming that products consume activities and activities consume resources. Once the product or service activities are identified, costs are allocated to the product or service according to the amount incurred by those activities. This method of allocating costs provides a benefit for making decisions regarding different types of profitability and project accounting.

There are two sets of costs related to the accuracy of ABC cost information, 1) cost of measurement and 2) cost of decision error. As the accuracy of measurement goes down the cost of decision error goes up. Detail is an important factor in the success of a ABC system, but the detail must be value add. It is important to control changes brought on by environmental factors (competition, volatility, profit margins, etc…) while still allowing for diversity throughout the life cycle of the product or service. So how can one ensure accuracy in measurements for better decision making? The key is to identify and analyze the most optimal cost drivers that trace the costs of the activities back to the product or service.

Activity Identification & Analysis in Activity Based Costing (ABC)

Cost drivers are linked to business process mapping and activity analysis in order to obtain rigid data for measurement analysis. Diagram depicts a two stage process that traces expenses through activities to costobjects.

The first stage traces expenses from the department or organizational level budget to activities that are assigned to resources (labor, space, materials, and suppliers). For example, a labor resource is allocated to an activity at 100% over a duration of time equating to a unit of work converted to an activity cost. In the second stage, activity costs are traced through the activity cost drivers to the cost objects, i.e. products and/or services. This stage is concerned with explaining the causes of work and what things cost. Managers that focus on process drivers and cost drivers have a more detailed understanding of activity costs and associated activity dependencies. Therefore, managers can make better decisions on areas in need for process improvement instead of shooting from the hip.

ABC provides a hierarchical structure of detail. The challenge for managers is to ensure an optimal amount of detail that achieves balance and accuracy.

Activity Based Costing (ABC) - Cost Driver Optimization

Managers chose cost drivers for planning and control purposes. Choosing too many cost drivers and the system is bogged down creating extra costs and inefficiency problems. Managers must strive to strike a balance between accuracy benefits and costs of data management. An optimal number of cost drivers generally discriminates and captures most of the incurred costs, and identify a priority order that specifies which low-priority and relatively insignificant activities will be combined to save costs without sacrificing much accuracy.

Use of ABC Information

ABC may provide useful insights. For example, it may show that complex products with many separate parts have higher design and production costs than simpler products, that products with low volume have higher unit costs than high-volume products, that products with many setups or many engineering change orders have higher unit costs than other products.

Information on the magnitude of these differences may lead to changes in policies relating to full-line versus focused product line, product pricing, make-or-buy decisions, product mix decisions, adding or deleting products, elimination of non-value-added activities, and to an emphasis on better factory layouts and simplicity in product design.

Examples. In 1992, Chrysler benefited from ABC analysis in a pilotproject that examined the designs for wiring harnesses for the company’s popular minivans. The harnesses yoke together bundles of wires. Nine departments, from design to assembly to finance, set out to reckon the optimum number of wiring harnesses. The assembly people favored using just one kind of harness; the design group wanted nine, and so on. When ABC was used to cost out activities across the entire production of the vehicles, everyone saw the optimum number was two.

Hewlett-Packard’s successful products, new models of HP 3000 and HP 9000 midrange computers, benefited from better cost information. When ABC showed that testing new designs and parts was extremely expensive, engineers changed their plans to favor components that require less testing, thus lowering costs.

By investing $100,000 and six months in its ABC implementation program, the Naval Air Depot in Jacksonville, Florida, saved about $200 million annually. Through utilization of ABC, the distance that aircraft parts were moved around was reduced by 80 percent, total number of steps was reduced by 91 percent, and total change in task ownership was reduced by 92 percent.

Other companies have realized significant cost savings as a result of reduced complexity.

Examples.Procter & Gamble had standardized product formulasand packages. P&G used just two basic packages for shampoo in the United States, saving $25 million a year.

General Motors had reduced the number of U.S. car models from 53 to 44 and combined its Pontiac and GMC division to simplify marketing.

Insurance Industry Overview

Insurance is a contract binding an insurance company to compensate a beneficiary for the loss of life or loss or damage to property of a person insured. Benefits accrue due to an individual due to statutory obligation of the benefit provider to compensate for the expenses involved in health care, retirement plans of the beneficiaries by entering into a contract with the provider either singly or in groups by paying a predetermined premium at predetermined intervals.

The process of Insurance and Benefit Management Business can be grouped under three main categories and shown in diagram 3. These are Products, Processes and People.

The processes involved in Insurance and Benefits Management Business are described below:

Publicity and Promotion of Products.

Product Evaluation.

Enrolment of Beneficiaries for the Plans.

Receipts and Accounting of Premiums.

Processing and Settlement of Claims.

Payments Processing and Settlement of Accounts with Vendors.

Payments Processing and Settlement of accounts with Agents/ Brokers.

Routine and Exception Reporting for Management Control.

Customer Relations Management with Beneficiaries and Vendors.

Accounting and Audit.

System Administration.

Publicity and Promotion of Products

Insurance and Benefit Product Vendors offer Perennial as well as Plan Year Based Products.

The Promotional Materials including Application Forms for Perennial Products should be made available on the Client’s Website.

Upon requests from individual, the CRM staff should be capable of dispatching hard copies by Surface Mail.

Insurance Agents also canvass for Products and their management for a specified Commission amount. The details of Agents are held in the database.

Insurance and Benefit Vendors also promote their Products through brokers for Corporate Clients on a specified brokerage. The details of brokers and Corporate Client Information are to be stored in the database.

For the Year Based Benefit Plans, the Promotional Materials and Application Forms are obtained from Vendors in advance and dispatched prior to the beginning of Plan Year. Corporate Client may employ its own representative or use the services of Broker or Agent for bulk enrolment. The materials are dispatched either through Bulk Email or by Surface mail as convenient to the Client. For the Individuals and Groups who wish to enrol or continue for the Year Based Benefit plans the promotional materials and application Forms are sent as per their requirement.

Enrolment Management Staff is responsible for collection and dispatch of promotional materials, maintenance of the concerned web page(s), receipt and approval of Applications, maintenance of master data of Plans.

Product Evaluation

The selection of Products for promotion and management depends on the business yield, the popularity of the Product with benefits, the reliability of Vendors, and the business relationship with the Vendors, legal and statutory requirements.

To have an objective analysis of the Products, the Program will be using statistical tools to analyze the data on Plans, Premiums, Claims, Revenue Flows and Revenue earned.

To gauge the relative effectiveness of the Vendors, the lead-time for Claims Adjustment, Rejections, Net Rebate Earned, the total number of beneficiaries will be given by the program

The Enrolment Management will select the appropriate Vendors and Products in the best interest of the business and Clients for promotion.

Enrollment of Beneficiaries for the Plan

Applications for Enrolment in the Insurance / Benefit Plans will be obtained through:

Internet

Surface Mail

Bulk enrolment through

Brokers

Agents

TPA’s

Client Representative.

Its Own Representative.

The approved list will update in the Master list of affected tables.

The rejected list will be sent to the applicant / the forwarding agency for resubmission or rejection.

Where the applications are received through Internet a confirmation letter will be sent to the Applicant on hard copy for his /her authentication and return. The Plan becomes effective only after the receipt of the signed copy.

Receipts & Accounting of Premium

Premium may be received from Individual Beneficiary through Check, Demand Drafts, Money Order, Pay Order or Credit or Debit Card Authorization.

Corporate Clients may send the details of Premium Cutting as a separate file or as part of their combined Pay Roll.

Groups may send their Premium Payments through a separate file.

There will be a necessity to Import the above into the master files of the legacy database as each Client/ Group may have their own established data formats.

Import definitions for each of the Clients / Groups should be customized.

The Imported data will be reconciled for short, missing, invalid or overpayment against actual due and the Client notified accordingly.

After reconciliation, the premium payment will update individual running ledger entry.

Processing and Settlement of Claims

Individuals prefer Claims against Products.

These are required to be settled by the Carriers as per the entitlement.

Claims are validated by Program as well as by the Claims Staff who are trained Claims Settlers.

The Program does the validation for Effectiveness of the Claim, limits of liability.

The Settlers verify authenticity of the Beneficiary and the supporting documents. In case of Life, Property and Vehicle Insurance legal documents may be required to authenticate the claim and the claimant.

Once the Claim is processed, it is passed for Payment or Rejected.

The Payment Order would be generated and sent to the Beneficiary or the Rejection slip with reasons.

Payments Processing and Settlement of Accounts with Vendors

The records should be updated and prefer a claim on the Vendor. Based on the business relationship with the Vendor, reimbursement of the Claims passed will be by book adjustment against Vendor Payment or Imprest Account.

Then generate Payment advice, Payment Orders and Control Reports as per the needs of the management as well as Vendors.

Similarly when Premium Payments are received from Individuals, Groups and Corporate Clients by Carriers, the Processing Staff will calculate the amount payable to Vendors for their plans and credit the amount to the Vendor. They will also generate required reports for the information of Vendors.

Payments processing and Settlement of accounts with Agents/ Brokers

The Agents / Brokers / TPA’s canvass for enrolment into Insurance and Benefit Products. The commission amount to Agents / Brokers / TPA’s will be paid as per business rules and agreements. This may be fixed or based on a percentage of Premium amount. The periodicity of payment may be either onetime or periodic.

The Brokers can make use of custom developed software to promote both Software & Insurance / Benefit Providers for soliciting their Products. The software would calculate the amount due to Agents/ Brokers / TPA’s to cater for all types of payments. It will also Generate Pay orders, update Accounts and print needed control and information reports.

Routine and Exception Reporting for Management Control

Reports are required to have control on the activities outlined in each of the above processes. These reports will help the management for decision-making.

There will also be a list of FAQ’s for use by Management, Agents / Brokers / TPA’s, Individual beneficiary, Clients and Staff.

Customer Relationship Management

This process would enhance the relationship between Management, Staff, Agents / Brokers / TPA’s, Beneficiaries, Groups, Clients, Vendors.

The concerned departments of Carrier would be responsible for maintenance and updating of Information pertaining to CRM activities.

This process [CRM] includes Call / Request Registration, Call / Request Tracking and Call / Request Closure.

Control Reports will be generated for Pending, Open and Closed Calls / Request.

Accounting and Audit

The amount received as Premium will be validated against the expected and exception report will be generated for each client and plan.

The amount paid against Commission and brokerage will be based on type of payment and periodicity.

Carriers will carry out audit on percentage of approved and rejected Claims manually at random and an audit report will be made.

The payment dues towards service charges and rebate will be credited to Corporate Accounting.

The Commission and Brokerage will be calculated for payments to Agents and brokers.

The Premium Payments to Vendors will be calculated and payments made/ adjusted.

Receipts and Acknowledgements will be sent through appropriate media.

Summary and Individual Reports will be generated as needed by the Management.

Nonprofit Organisations

A non-profit organisation, as defined by law, is an organisation that cannot distribute assets or income to, or for the benefit of its members, officers or directors. The organisation can, of course, compensate its employees, including officers and members, for services rendered and for goods supplied. This does not permit an organisation from earning a profit; it prohibits only the distribution of profits. A non profitorganisation needs to earn a modest profit, on average, to provide funds for working capital and for possible “rainy days”.

Many such organisations are exempt from income taxes, property taxes and certain types of sales taxes.

In many industry groups, there are both non-profit and profit-oriented organisations. There are non-profit and for-profit hospitals, non-profit and for-profit schools and colleges and religious organisations.

Special Characteristics

Absence of the Profit measure

A dominant goal of all businesses is to earn a satisfactory profit; net income measures performance toward this goal. No such measure of performance exists in non-profit organisations. Many of them have several goals, and an organisations’ effectiveness in attaining its goals rarely can be measure by quantitative amounts. The absence of a satisfactory, quantitative, overall measure of performance is the most serious management control problem in this organisation.

The income statement is the most useful financial statement in a non-profit organisation, just as it is in a business. In a non-profit organisation, the net income should average only a small amount above zero. A large net income means that the organisation is not providing the services according to the expectations of the providers of resources. Net losses will lead to bankruptcy. So in order to survive, the revenues must bemore than its expenses.

Contributed Capital

One major difference between business and non-profit organisations relates to the equity section of the balance sheet. Non-profit organisation receives contributed capital in two forms: plant and endowment. Plant includes contributions of buildings and equipment, or contributions of funds to acquire these assets. Endowment consists of gifts whose donors intend that the principal amount will remain intact indefinitely.

These organisations have two sets of financial statements. One set relates to operating activities including an operating statement, a balance sheet, and a statement of cash flows. The second set relates to inflows and outflows of contributed capital during a period and a balance sheet that reports contributed capital assets and the related liabilities and equity.

Inflows of contributed are capital contributions received in theperiod and gains on the endowment portfolio. Outflows are the endowment income that is reported as operating revenue, losses on the endowment portfolio, and write-offs of plant.

Fund Accounting

Many non-profit organisations use an accounting system that is called “fund accounting”. Accounts are kept separately for several funds each of which is self-balancing (i.e., the sum of the debit balances equals some of the credit balances). Most organisations have

A general fund or operating fund, which corresponds closely to the set of operating accounts mentioned above.

A plant fund and an endowment fund, which account for the contributed capital assets and equities mentioned earlier.

A variety of other funds for special purposes.

Others are useful for internal control purposes. For management control purposes, the primary focus is on the general fund.

Governance

Non-profit organisations are governed by boards of trustees. Trustees are usually are not paid, and many of them are unfamiliar with business management. Therefore, they generally exercise less control than the directors of a business corporation. Moreover, because performance is more difficult to measure in a non-profit organisation than in a business, the board is less able to identify actual or incipient problems.

The need for a strong governing board in a non-profit organisation is greater than in a business because the vigilance of the governing board may be the only effective of detecting when the non-profit is in difficulty. In a profit oriented organisation, a decrease in profits signals this danger automatically.

Management Control Systems

Product pricing

Many non-profit organisations give inadequate attention to their pricing policies. Pricing of services at their full cost is desirable.

A “full-cost” price is the sum of the direct costs, indirect costs and a small allowance for increasing the organisation’s equity. This principle applies to services that are directly related to the organisation’s objectives. Pricing for peripheral activities should be market-based. Thus a non-profit hospital should price its health care services at full cost, but prices in its gift shop should be market-based.

Management control is facilitated when prices are established prior to the performance of service.

Strategic Planning and Budget preparation

In non-profit organisations that must decide how best to allocate limited resources to worthwhile activities, strategic planning is a more important and more time consuming process. Absence of a profit measure makes program decisions more subjective.

Non-profit industries know before the budget year begins the approximate amount of their revenues. They do not have the option of increasing revenues during the year by increasing their marketing efforts. They budget expenses so that the organisation will at least break even at the estimated amount of revenue. They require that managers of responsibility centres limit spending close to the budget amounts. Therefore, the budget is the most important management control tool for financial activities.

Operation and Evaluation

In non-profit organisations there is no way of knowing what the optimum operating costs are. Therefore, responsibility centre managers tend to spend whatever is allowed in the budget, even though the amount is higher than is necessary. Conversely, they refrain from making expenditures that have an excellent payoff simply because the expenditure was not included in the budget.

Legal Environment

The important aspects of the legal environment in India are:

There are restrictions on foreign funding under Foreign Contribution Regulation Act.

Their governance structure is laid down by the Society’s Registration Act and Charities Act. These provide for trustees, management committees, board of directors and so on. But legal provisions of governance only cover the don’ts. The proactive features cannot be legislated

Difficulties of Management Control in Service and Non-profit Organisations

Most service, government, and non profit organizations have more difficulty implementing management control systems than do manufacturing firms. Why?

The main problem is the outputs of service and non profit organizations are more difficult to measure than are the cars or computers that are produced by manufacturers. As a result, it may be more difficult to know whether the service provided is, for example, of top quality until long after the service has already been delivered.

The key to successful management control in any organization in proper training and motivation of employees to achieve goal congruence and effort, followed by consistent monitoring of objectives set in accordance with critical processes and success factors, but it is even more important in service-oriented organisations. For example, MBNA America, a large issuer of bank credit cards, identifies customer retention as its primary key success factor. MBNA trains its customer representatives carefully.

Each day it measures and reports performance on 14 objectives consistent with customer retention and rewards every employee based on those 14-objectives. Measures include answering every call by the second ring, keeping the computer up 100% of the time, and processing credit-line requests within one hour. Employees have earned bonuses as high as 0% of their annual salaries by meeting those objectives. Non profit and government organisations also have additional problems designing and implementing an objective that is similar to the financial ‘bottom line’ that often serves as a powerful incentive in private industry.

Furthermore, many people seek positions in non-profit organisations primarily for other than monetary rewards. For example, volunteers in the Peace Corps receive very little pay but derive much satisfaction from helping to improve conditions in underdeveloped countries. Thus, monetary incentives are generally less effective in non profitorganisations. Control systems in non profitorganisations probably will never be as highly developed as are those in profit-seeking firms because

Organizational goals and objectives are less clear. Moreover, they are often multiple, requiring difficult trade-offs.

Professionals (for example, teachers, attorneys, physicians, scientists, economists) tend to dominate non-profit organisations. Because of their perceived professional status, they have been lessreceptive to the installation or improvement of formal control systems.

Measurements are more difficult because

There is no profit measure.

There are heavy amounts of discretionary fixed deposits, which make the relationships of inputs to outputs difficult to specify and measure.

There is less competitive pressure from other organisations or “owners “ to improve management control systems. As a result, for example, many cities in the United States are “privatizing” some essential services such as sanitation by contracting with private firms.

The role of budgeting is often more a matter of playing bargaining games with sources of funding to get the largest possible authorization than it is rigorous planning.

Motivations and incentives of individuals may differ from those in for-profit organizations.

Government and Cooperative Business

Introduction

Contrary to popular impression, a substantial proportion of market based transaction, which we may describe as business, whether in capitalist, socialist, or welfare economic systems are in the hands of the state and cooperatives. A large number of business managers, therefore, work in organisations run by the government and cooperatives. Therefore understanding this segment is very important. Cooperatives also are the more explicit form of the dual focus control systems.

Government and Business

Many analysts have gone to great lengths on the rationally and impact of the legal structures regarding the business and government. These are spread across in various forms: railways are a government department, electricity boards have been form under an act of parliament, Food Corporation of India was established under a separate enactment.

Mother Dairy was formed under the Society Registration Act and the bulk of businesses are registered under the Company’s Act.

Some of that work under the Indian Company’s Act could also use the concept of holding companies functioning as an umbrella for several companies. This is the position of the steel giant, SAIL, and the coal giant coal India, which were created in the image of Italian Public Sector organisations by Mohan Kumaramangalam, the then Minister for steel and mines of the government of India. Public sector organisation working under the company’s act would have the patterns of control as the private sector and would be in the level playing field. S.S.Khera was a distinguished member of the Indian Civil Service who was the cabinet secretary, the most civilian position in the Government of India.

This over simplified approach is not useful in understanding government and business. It would see that these legal structures are largely irrelevant, but could affect operations albeit in trivial matters. The over-riding styles are driven by the nebulous accountability of ministers in the government to the people at last, their constituencies, and their hangers-on, the dependence of managers on ministerial favours and penalties. Legal structures are quite unable to change substantially and permanently. They can at best be used as tools as advocacy and manipulation and in meeting the opponents down in sparring matches.

Process of Setting of Strategy and Objectives of Government Business.

Government in business could owe much of its inspiration to the features of the Soviet Union formality in its analytic frame work, focus on internal controls, and connection to the economics of the classical approach, but its rationale is hardly based on profitability and is vague, as in the procedural approach. It does not grow from within by learning from local conditions, as in the system approach, or evolutionary approach.

Are Multiple Objectives a Necessary Feature of Government in Business?

No current day organisation can avoid having multiple objectives, therefore making it necessary to use balanced score cards that can balance these objectives. Government in business has these features more pronounced than in the purely private sector organisation. We will see

how this feature would require evolution of instrument of control which could go even beyond balanced score card.

Origins of Opportunistic Behaviour in Government Business

Due to reasons of fuzziness of accountability, opportunistic behaviour is more extensive in government in business. Let us see typical example. A well known example involves HUDCO. It paid for the telephone calls of a minister and his cook, which ran to astronomical figures. There was a public outcry.

A more recent example was when a minister stayed in an expensive hotel in Goa and appeared to be palming off the bill to a public undertaking under him. A public outcry followed and the payment was, thankfully, ultimately made by the minister from his personal account.

These examples are some of the more trivial incidence seen in the backdrop of the overall performance of the government organisation in business. But they may be indicated of greater malaise and massive failures in the control system. We will look for most strategic solution to take care of the more major issues. But irritants are perhaps more directly controlled by greater transparency which private sector operators do not need.

Monitoring and Controlling Performance

The simplest way of controlling and monitoring public sector performance is watching profits. But this makes nonsense of all long term objectives. AmartyaSen, Nobel laureate and well known economist says

“ having a well formulated system of social profits based on shadow crises may therefore save the purpose of giving management a clear perception of interest of the respective public enterprise. “

But this somewhat starry-eyed vision of control system using measurements with hypothetical adjustments for social cause could be quite convoluted, subject to serious biases and totally useless for concurrent controls, even if it may have some remote use in evaluation in decision making. No wonder the systems of control which came to the practically evolved all over the world were totally different.

History of International Control Systems in Public Sector

The basic structure of control systems of a sample from fifty countries of the world is that they are converging towards, what is described as performance contracting. Performance contracting as a concept is based on the government entering into contract with a state owned enterprise (SOE), wherein several parameters of achievement are contracted for and in return for which the SOE gets autonomy and help from the government in a contingency. The contract can also provide for a sharing of profits. The monitoring is focused on the parameters contracted, which is reflected in the internal control systems too.

Performance contracting as a devise started in France and is now used all over the world, including countries like China, Korea, Sri Lanka, Pakistan, Morocco, Australia, New Zealand, Columbia and India. Its extension to socialized medicine is a striking application and is a centre of political debate in Great Britain and Europe.

The Socialized Medicine of UK and Europe

The great divide between the Great Britain and Europe on the one hand, and the United States on the other is that of the dominance of socialized medicine in the former. Medical attention is treated as a fundamental right in these countries. It, however, coexists with market systems. Concepts of market systems continue to be used by them for ensuring both allocative efficiency(Y efficiency) and operational efficiency(X efficiency)

The National Health Scheme of Great Britain was born with the blazing idealism of Aneurin Bevan, the fiery Labour partisan from Wales. Modelled on the health system of the Soviet Union to begin with, it evolved somewhat differently thereafter. Its example spread rapidly to Europe and the systems prevailing in Italy, France, Netherlands, Finland, and Germany bear its imprint. Its control system is a combination of the several features of the Whitting on classification.

Medical facilities are distributed across the countries as trusts. These trusts are autonomous and are allotted funds from the pool of central taxation as per a formula based on population covered and the existing record of morbidity. In return for the funds and the autonomythey are given, they are obliged to achieve certain levels of performance on a set of parameters. Typically, the waiting time for operations, for fatality from critical ailments like heart problems and cancer are boundaries within which they will have to operate. But the trust has the freedom to hire services in a market to enable them to fulfil these parameters.

Each trust can develop its own strategy to fulfil its obligations. Each of them can have a mechanism for surveying the environment and making business plans. Has this resulted in optimum achievement? The answer is yes and no.

The costs have been kept low but even then cannot be obtained within feasible taxation limits.

Productivity is effectively controlled and the factors affecting it and the adjustments required for prescribing realistic norms have been evolved. But several cases are reported in which the excessive adherence to performance measures result in manipulation to achieve scores for the means and sacrificing the ultimate outcomes. Thus to show lower waiting time at the dispensaries, patients were not taken off the ambulance to delay registration at the waiting line.

Waiting time in some areas is abnormally high, for example, in dental treatment.

The system hardly ever throws up great innovation in surgery and medicine.The doctors are exceptionally considerate to their patients even ifthe cadres are racked with frustrating rivalry due to bureaucratic appraisal systems that have great difficulty in recognizing true merit usually more easily visible in totally market driven systems. This rivalry results in manipulation of the type described in the second point.

In brief, the control systems in socialized medicine is a great improvement over the capitalist market driven systems in United States, in many respects, but have severe draw backs in other respects which need to be corrected over time.

The MOU System in India: A Success StoryThe culmination of the performance contract system is the memorandum of understanding (MOU) followed in India over the past decade. The MOU is evolved in consultation the highest authority in the government so that the replacement of profit criterion does not result in too soft a target as feared by some. A typical MOU with MarutiUdyog and its comparison with the actual is indicated in the exhibit 1 below:

It may be seen that the net resultant source of 1.52 would evaluate MarutiUdyog as between ‘excellent’ (1) and ‘very good’ (2).

By the same logic some organisations having losses could still be graded excellent by these criteria. Is this hypocrisy? The answer is ‘No’.

This system has enabled public sector units to consistently improve over the weighed indices. Also, incidentally, profits have also gone up. Autonomy has certainly been enhanced and the haziness in accountability has been considerably reduced,. Would this eliminate the trivial cases of opportunism? The routes to eliminate them would be transparency.

Distinction between Balanced Score Card and MOU

There are many similarities between the balanced score cards and the MOU. But there are three distinct differences:

A BSC ultimately aligns all measurement to long term profitability, whereas MOU ultimately aligns everything to the social objective of which profit is only one, even if it is not the most important criterion.

A MOU concentrates more on outcomes, whereas BSC concentrates a lot on processes.

A MOU is externally determined, whereas a BSC is a product of internal participative discussion.

Cooperatives

Hansmann’s Concept of the Rationale of Cooperatives

Cooperatives are forms of organisation wherein the strategic and management controls are not in the hands of shareholders or the government but in the hands of producers of goods and services external to the organisation, which are sold to the organisation, or the consumers of the goods and services of the organisations or the workmen who produce the goods and services within the organisation. These organisations have an optimum of the dual focus of control.

A very large number of organisations are cast in the cooperative model. The reason for the preference could be twofold:

Where a particular stake holder has less option to deal with outside the organisation, it would be worthwhile for them to spend their energy and time deciding things in the organisation, both allocative and operational, to make sure it functions effectively.

Where transaction cost would decrease if we have better trust relationship between the buyer and the seller. Decision making could be shared between them without interference with providers of capital, that is, the shareholders.

Cooperatives in Business and in Non-Business

Co-operatives as prevalent in India are not all in business. Typically, house building cooperatives do not have to indulge in a continuous stream of producing, buying and selling. Their control systems are, therefore, more akin to non profitorganisations.

Government Regulators of Cooperatives

For the reason that the marginal costs incurred by the members to effectively control cooperative organisations may be singly much higher than marginal gains, individual effort may not often be forthcoming. The state may see this as, what is known in economics, the problem of the common or the tragedy of the common in which if there are no regulators free riders would destroy common property. The government may offer tocontrol this common property externally on behalf of all the members. So goes the theory. But such control by those without any direct stake, except that which is available from opportunistic behavior makes nonsense of cooperatives as viable organisations.

Contours of Control Systems in Indian Cooperatives in Business

Control systems have been described in cooperatives and other village level organisations as overall strategic governance, revolving round belief systems in leadership and operational decisions, revolving around continuous consultation with the users of the cooperative. This combination enables minimizing marginal transaction costs of participation, a factor worrying economic theorists of co-operation.

Thus in Amul Milk Co-operative, product mix decisions could be strategically decided at the top but the location of milk routes, and milk collection centers, cattle feed distribution, bonus decisions could be participative. In sugar cooperatives, scheduling the cutting of cane could be participative. They also note that contrary to public pronouncements and much of the academic research carried out the in west, caste did not affect control mechanisms in Indian village level institutions once the democratic principles took root.

Control in Projects

Nature of Projects

“A project is a set of activities intended to accomplish a specified and result of sufficient importance to be of interest to management”.

Projects include construction projects, the production of a sizeable unique product (such as turbine), rearranging a plant, developing and marketing a new product, consulting engagements, audits, acquisitions and divestitures, litigation, financial restructuring, research and development work, development and installation of information systems and so on.

A project begins when management has approved the work to be done and has authorized the amount of resources to be spent, and the project ends when its objective when its objective has been accomplished or when it has been cancelled.

Construction of a building is project and routine maintenance of the building is an ongoing operation. The completion of a project may lead to an ongoing operation, as in the case of a successful development project.

At one extreme, a project may involve one or a few persons working for a few days or weeks, performing repetitive tasks. For example, an annual financial audit conducted by a public accounting firm. At the other extreme, a project may involve thousands of people working for several years, performing unlike work that ever done before. For example, project to land the first men on moon.

Difference between management control of projects and ongoing operations

The characteristics of projects that make the management control of projects different from the management control of ongoing activities are discussed below.

Single objective

A project has a single objective whereas ongoing operations have multiple objectives like ordering equipments, planning marketing campaigns training new employees. Project performance can be judged in terms of the desired end product and operating performance should be judged in terms of all results achieved by the manager.

Organization Structure

The project organization is superimposed on an ongoing operating organization. Its management control system is superimposed on the management control system of that organization. These problems do not exist in an ongoing organization.

Focus on the project

Project control focuses on the project, whose objective is to produce a satisfactory product, within a specified time period, andat an optimum cost. In contrast, control in ongoing organizations focuses on the activities of a specified time period, such as a month, and on all the products worked on in that period.

Need for Trade-Offs

Projects usually involve trade-offs between scope, schedule and cost. Costs can be reduced by decreasing the scope of the project and the schedule can be shortened by incurring overtime costs. Similar trade-offs occur in ongoing organizations, but they are not typical of the day-to-day activities in such organizations.

Less-Reliable Standards

Performance standards are less reliable for projects than for ongoing organizations. Project design is used only once. But the standards for repetitive project activities can be developed from past experience or from engineering analyses of the optimum time and costs.

Frequent Changes in Plans

Plans for projects tend to be changed frequently and drastically. Unforeseen environmental changes on a construction project may lead to changes in plans.

Different Rhythm

Most projects start small, build up to a peak activity and then taper off as completion nears and only cleanup remains to be done. Ongoing activities tend to operate at the same level of activity for a considerable time and then change from that level to another.

Greater Environmental Influence

Projects tend to be influenced more by the external environment than is the case with operations in a factory. If the project involves excavating, conditions beneath the earth’s surface may cause unexpected problems, even for a simple project as building a house.

Project Control Environment

Project Organization Structure

A project organization is a temporary organization. A team is assembled for conducting the project, and the team is disbanded when the project has been completed. Team members may be employees of the sponsoring organization, may be hired for the purpose, or some or all of them may be engaged under a contract with an outside organization.

Matrix Organizations: If members of the project team are employeesof the sponsoring organization, they have two bosses – the project manager of the functional department to which they are permanently assigned. Such an arrangement is called matrix organization. In overhauling a ship, craftspeople such as electricians, pipe fitters, etc. are drawn from various functional departments in the shipyard, and they work on the project when their skills are needed. However, their basic loyalty is to their functional department. The project manager has less authority over personnel than the manager of a production department, whose employees have an undivided loyalty to that department.

Contractual Relationships

If the project is conducted by an outside contractor, an additional level of project control is created by the sponsoring organization which has its own control responsibilities. The contractor may bring its own control system to the project, and this system may need to be adapted to provide information that the sponsor needs

The form of the contractual arrangement has an important impact on management control. Contracts are generally of two types:

Fixed-Price Contracts

Here, the contractor agrees to complete the specified work by a specified date at a specified price. Usually, there are penalties if the work is not completed to specifications or if the scheduled date is not met. If the sponsor decides to change the scope of the project, a change order is issued. The parties must agree on the scope,schedule, and cost implications of each change order. If the change orders involve increased costs, then it must be borne by the sponsor. For example, the construction of a conventional house may involve a dozen or so change orders. If the change orders are in thousands, the final price of the work is actually not fixed in advance.

Fixed-price contracts are appropriate when the scope of the project can be closely specified in advance and when uncertainties are low. If the contractor signs a contract that does not include adequate provisions for adjustments caused by changes in scope or by uncontrollable uncertainties, he will resist the sponsor’s requests to make desirable changes, and he may even be unwilling to complete the project.

Cost-reimbursement Contracts

Here, the sponsor agrees to pay reasonable costs plus a profit. In such a contract, the sponsor has considerable responsibility for the control of costs and therefore needs a management control system and associated control personnel. Cost-reimbursement contract is appropriate when the scope, schedule, and cost of the project cannot be estimated reliably in advance.

In this contact, the profit component, or fee, usually should be a fixed monetary amount. If it is a percentage of costs, the contractor is motivated to make the costs high and thereby increase his profit.

Variations

Within these two types of contracts, there are many variations. In an incentive contract, completion dates or cost targets, or both, are defined in advance, and the contractor is rewarded for early completion of the project (a completion bonus that is set at an amount per unit of time saved) or for incurring less cost (a cost bonus that is set as a percentage of the costs saved). This type of contract is appropriate when moderately reliable estimates of completion and cost can be made.

Different contract types may be used for different activities on the project. For example, direct costs may be reimbursed under a cost-reimbursement contract because of the high degree of uncertainty, whilethe contractor’s overhead costs may be covered by a fixed-price contract, either as an amount for the total project or for each month.

If unit costs can be estimated reasonably well, but the quantity of work is uncertain, the contract may be for a fixed price per unit applied to the actual number of units provided. For example, in a catering activity, reimbursement is often a stated amount per meal served (plus a fixed monthly amount for overhead).

Information Structure

Work Packages

In a project control system, information is structured by elements of the project. The smallest element is called a work package, and the way in which these work packages are aggregated is called the work breakdownstructure.

A work package is a measurable increment of work, usually of fairly short duration of a month or so. It should have an unambiguous, identifiable completion point, which is called a milestone. Each work package should be the responsibility of a single manager.

If the project has similar work packages (for example, a separate work package for the electrical work on each floor of an office building), each should be defined in the same way so that cost and schedule information can be compared with similar work packages.

Indirect Cost Accounts

Apart from work packages for direct project work, cost accounts are established for administrative and support activities. Unlike the work packages, these activities have no defined output. Their estimated costs usually are stated as per unit of time, such as a month.

The chart of accounts, the rules for charging costs to projects, and the approval authorities and their specific signing powers are also developed in advance. If during the project it turns out that the workbreakdown structure or the accounting system is not useful, it must be revised. This may require recasting much information; both already collected information as well as information describing future plans.

Steps in Project Conrol Process

Project Planning

In the planning phase, the project planning team takes the rough estimates that were used as the basis for the decision as a starting point to undertake the project. It refines these estimates into detailed specifications for the product, detailed schedules, and a cost budget. It also develops a management control system and underlying task control systems, and an organization chart.

There is a plan for planning, that is, a description of each planning task, which is responsible for it, when it should be completed, and the interrelationships among tasks. The planning process is itself a subproject within the overall project. There is also a control system to ensure that the planning activities are properly carried out

Nature of the Project Plan

The final plan consists of three related parts: scope, schedule, and cost.

The scope part states the specifications of each work package and the name of the person or organization unit responsible.

The schedule part states the estimated time required to complete each work package and the interrelationships among work packages, that is, which work package must be completed before another can be started. The set of these relationships is called a network.

Costs are stated in the project budget, usually called the controlbudget. Unless work packages are quite large, monetary costs are shown only for aggregates of several work packages. Resources to be used for individual work packages are states as non-monetary amounts, such as person-days or cubic yards of concrete.

Network Analysis

The important tools for constructing the time schedule for the project are PERT (Program Evaluation and Review Technique) and CPM (Critical Path Method). These are techniques for network analysis. Each technique has three basic steps:

estimating the time required for each work package,

identifying the interdependencies among work packages – which must be completed before another can be started, and

Calculating the critical path.

A network diagram consists of

A number of nodes i.e., milestones, each of which is a sub goal that must be completed to accomplish the project, and

Lines joining these nodes to one another; these lines represent activities.

The estimated time to carry out each activity is shown on the network diagram. An activity connecting two events, say, A and B, indicates that the activity leading to B cannot be started until event A has happened. These activities are work packages. Thus, a network diagram shows the chronological sequence in which events must be completed to complete the whole project.

Critical Path and Slack

Project networks can be analyzed using computer programs. Theyidentify the critical path, which is the sequence of events that has the shortest total time to complete the project. The nature of the critical path is shown in the above figure.

To complete event B, event A must first be completed which requires two weeks. A-B requires an additional five weeks. Then B-C which requires an additional three weeks is done to complete the project. This is the critical path, and it is ten weeks long. To complete event B, activity X-B also must be undertaken, with an estimated time of four weeks. However, activity B-C cannot be started until both A-B and X-B have been completed. X-A and A-B require a total of seven weeks; and X-B, which requires only four weeks, can be performed at any time during this seven-week period. Activity X-B is said to have three weeks of slack.

The management control implications in CPM are:

First, in the control process, special attention must be paid to those activities that are on the critical path, and less attention needs to be paid to slack activities.

Second, in the planning process, attention should be given to possibilities for reducing the time required for critical path activities; if possibilities exist, the overall time required for the project can be reduced.

Third, it may be desirable to reduce critical path times by increasing costs, such as incurring overtime, but additional money should not be spent to reduce the time of slack activities.

PERT

PERT is a method to analyze the involved tasks in completing a given project, especially the time needed to complete each task, and identifying the minimum time needed to complete the total project.

PERT was developed primarily to simplify the planning and scheduling of large and complex projects. It was able to incorporate uncertainty by making it possible to schedule a project while not knowing precisely the details and durations of all the activities. It is more of an event-oriented technique rather than start- and completion-oriented, and is used more in projects where time, rather than cost, is the majorfactor. It is applied to very large-scale, one-time, complex, non-routine infrastructure and Research and Development projects.

Optimistic time (O):the minimum possible time required toaccomplish a task, assuming everything proceeds better than is normally expected

Pessimistic time (P):the maximum possible time required toaccomplish a task, assuming everything goes wrong (but excluding major catastrophes).

Most likely time (M):the best estimate of the time required toaccomplish a task, assuming everything proceeds as normal.

Expected time (TE):the best estimate of the time required toaccomplish a task, assuming everything proceeds as normal (the implication being that the expected time is the average time the task would require if the task were repeated on a number of occasions over an extended period of time

Estimating Costs

Cost estimates are made as an aggregate incorporating several work packages. Resources used on individual work packages are controlled in terms of physical quantities, rather than costs. Cost estimates tend to be less accurate because projects are less standardized and cost information accumulated is therefore not a valid basis for comparison. Nevertheless, if a contractor has performed similar work in the past, the costs incurred on these work packages provide a starting point in estimating the costs of the new project. For some work, industry norms, or rules of thumb, have been developed that are useful in estimating costs.

Since no knows what will happen in the future and what future costs will actually be, two types of unknown must be taken into account. The first type is the known unknowns. These are estimates of the cost of activities that are known to be going to occur, such as digging the foundation for a house. The nature of the task is known, and the costs, although known, often can be estimated within reasonable limits on the basis of past experience.

The other unknowns are the unknown unknowns. For these activities, the estimator does not know that they are going to occur and obviously, therefore, has no way of estimating their cost. Work stoppages, destruction caused by storms or floods, delays in receiving materials, accidents and failure of government inspectors to act in a timely manner are examples. A fixed price contract usually states that costs caused by such events are added to the fixed price.

The impossibility of estimating the cost of unknown unknowns must be recognized. Their actual costs may range from zero up to any amount whatsoever. There is no definable upper limit. If the contract does not provide that all these costs are added to the fixed price, the estimator should include a contingency allowance for them.

Preparing the Control Budget

The control budget is prepared at the time of inception of the work allowing just enough time for approval by decision makers prior to the commitment of costs. For a lengthy project, the initial control budget may be prepared in detail only for the first phase of the project, with fairly rough cost estimates for later phases. Detailed budgets for later phases are prepared just prior to the beginning of the work on these phases. Delaying preparation of the control budget until just prior to the start of work ensures that the control budget incorporates current information about scope and schedule, the results of cost analysis, and current data about wage rates, material prices and other variables.

Therefore, it avoids making budget estimates that are based on obsolete information. This is a waste of effort. The control budget is an important link between planning and control of performance. It represents both the sponsor’s expectations about what the project will cost and also the project manager’s commitment to carry out the project at that cost

Project Execution

At the end of the planning process, there exists for most projects a specification of work packages, as scheduled and a budget; also, the manager who is responsible for each work package is identified. The schedule shows the estimated time for each activity, and the budget showsestimated costs of each principal part of the project. This information often is stated in a financial model. If resources to be used in detailed work packages are expressed in nonmonetary terms, such as the number of person-days required, the control budget states monetary costs only for a sizeable aggregation of individual work packages. In the control process, data on actual cost, actual time, and actual accomplishment are compared with these estimates. The comparison may be made either when a designated milestone in the project is reached or at specified time intervals, such as weekly or monthly.

Basically, both the sponsor and the project manager are concerned with these questions.

Is the project going to be finished by the scheduled completion date?

Is the completed going to meet the stated specifications?

Is the work going to be done within the estimated costs?

If at any time during the course of the project the answer to one of these questions is no, the sponsor and project manager need to know why and they need to know the alternatives for the corrective action.

It is sometimes desirable to make trade-offs among time, specifications and cost, using the financial model and other available information. For example, overtime might be authorized to assure completion on time, even though this would add to costs; or some of the specifications might be relaxed to reduce costs.

Nature of Reports

Managers need three types of reports

Trouble reports report both on trouble that has already happenedsuch as delay resulting from any of a number of possible causes and also anticipated future trouble. Critical problems are flagged. It is essential that these reports get to the appropriate quickly, so corrective action can be initiated.

Progress reports compare actual schedule and costs with plannedschedule and costs for the work done, and they contain similar comparisons for overhead activities not directly related to the work. Variances associated with price, scheduled delays, and similar factors may be identified and measured quantitatively, using techniques for variance analysis that are similar to those used in the analysis of ongoing operations.

Financial reports are accurate reports of project costs that mustbe prepared as a basis for progress payments if there is a cost-reimbursement contract; and they usually are necessary as a basis for financial accounting entries for fixed-price contracts.

Much of the information in management reports comes from detailed records collected in task control systems. These include such documents as work schedules, time sheets, inventory records, purchase orders, requisitions and equipment records.

Quantity of reports

To make certain that all needs for information are satisfied, management accountants sometimes create more than the optimum number of reports. An unnecessary report, or extraneous information in a report incurs extra cost in assembling and transmitting the information. Therefore, a review of the set of reports often is desirable and this may lead to the elimination of some report and the simplification of others. This paperwork problem, often referred as information overload is not necessarily serious.

Percent Complete

Some work packages will be only partially completed at the reporting date, and the percentage of completion of each such work package must be estimated as a basis of comparing actual time with scheduled time and actual costs with budgeted costs.

Summarizing progress

In addition to determining the percentage of completion of individual work packages, a summary of progress on the whole project is useful. Progress payments

Often are made when specified milestones are reached. Thus, the system usually contains some method of aggregating individual work packages, which provides an overall measure of accomplishment. A simple approach is to use the ratio of actual person-hours on work packages completed to date to total person-hours for the project; but this is reliable only if the project is labour intensive.

Punch list

Close to the end of a construction project, the sponsor prepares a list of items yet to be accomplished, including defects that need to be corrected. This “punch list” is negotiated with the project manager. Final payment is held up until the agreed-upon work has to be done.

Use of reports

Trouble reports

Managers spend much time dealing reports of trouble. The typical projects have many such reports, and one of the manager’s tasks is to decide which ones have the highest priority. In the limited number of hours in a day, the manager of a large project cannot possibly deal with all the situations that have caused, or that may cause, the project to proceed less than smoothly. The manager therefore has to decide which problems will get his or her personal attention, which will be delegated to someone else, and which will be disregarded on the assumption that operating personnel will take the necessary corrective action.

Progress reports

Not only do managers try to limit the number of trouble spots to which they give personal attention, they also try to avoid spending so much time solving immediate problems that no time remains for careful analysis of the progress reports. Such an analysis may reveal potential problems that are not apparent in the reports of trouble, and the manager needs to identify these problems and plan how they are to be solved. The temptation is to spend too much time on current problems and not enough time identifying problems that are not yet apparent.

The approach to analyzing progress reports is the familiar one of “management by expectation”. If progress in a particular area is satisfactory, no attention needs to be paid to the area. Attention is focused on those areas in which progress is, or may become unsatisfactory.

The analyses of reports that show actual time compared with the schedule, and actual cost compared with the budget, are relatively straight forward. In the interpretation of the time report, the usual presumption is that if a work package was completed in less than the estimated time, the responsible supervisor is to be congratulated; if more than estimated time was spent, questions are raised.

It is important that actual costs be compared with the budgeted costs of the work done, which is not necessarily the same as the budgeted costs for the time period. The danger of misinterpretation would show actual and budgeted costs for a project. As of the end of September, actual costs were $345,000, compared with budgeted costs of $300,000, which indicates a cost overrun of $45,000. However, the budgeted cost of the work actually completed through September was only $260,000, so the true overrun was $85,000.

Reports on indirect costs are prepared separately. These reports measure costs in a different dimension than do reports on the direct costs of project work. In the case of direct costs, actual costs are compared with the budgeted costs for the work actually accomplished. In the case of indirect costs, the actual costs for a period, such as a month, are compared with the budgeted costs for that same period.

Cost to complete

In their progress reports, some organizations compare actual costs to date with budgeted costs for the work that has been done to date. Others report the current estimate of total costs for the entire project, compared with the budgeted costs for the entire project. The current estimate is obtained by taking the actual costs to date and adding an estimated cost to complete- that is, the additional costs required to complete the project. The latter type of report is a useful way of showing how the project is expected to come out, provided that the estimated cost to complete is properly calculated.

Informal Sources of Information

Because written reports are tangible, descriptions of management control systems tend to focus on them. In practice, these reports usually are less important than information that the project manager gathers from talking with people who actually do the work, from members of his or her staff, from regularly scheduled or ad hoc meetings, from informal memoranda, and from personal inspection of the status of the work. From these sources, the manager learns of potential problems and of circumstances that may cause actual progress to deviate from the plan. This information also helps the manager to understand the significance of the formal reports because these reports may not describe important events that affected actual performance.

In many cases, a problem may be uncovered and corrective action taken before a formal report is prepared, and a formal report does no more than confirm facts that the manager has already learned from informal sources. This is an illustration of the principle that formal reports should contain no surprises. Nevertheless, formal reports are necessary. They document the information that the manager has learned informally, and this documentation is important if questions about the project are raised subsequently, especially if there is controversy about the results.

RevisionsIf a project is complex or if it is lengthy, there is a good chance that the plan will not be adhered to one or more of its three aspects: scope, schedule, or cost. A common occurrence is the discovery that there is likely to be a cost overrun – that is, actual costs will exceed budgeted costs. If this happens, the sponsor might decide to accept the overrun and proceed with the project as originally planned, decide to cut back on the scope of the project with the aim of producing an end product that is within the original cost limitation, or decide to replace the project manager if the sponsor concludes that the budget overrun was unwarranted. Whatever the decision, it usually leads to a revised plan. In some cases, the sponsor may judge that the current estimates of the benefits is lower than the current cost-to-complete estimate and therefore decide to terminate the project.

The revised plan is presumably a better indication of the performance that is currently expected, but there is a danger that a persuasive project manager can negotiate unwarranted increases in budgeted costs or that the revised plan will incorporate, and thus hide, inefficiencies that have accumulated to date. In either case, the revised plan may be a rubber baseline – that is, instead of providing a firm benchmark against which performance is measured, it may be stretched to cover up inefficiencies.

It is better to compare actual cost with both the original plan and revised plan. The first section of such a summary report shows the original budget, the revisions that have been authorized to date, and the reasons for making them. Another section shows the current cost estimate and the factors that caused the variance between the revised budget and the current estimate of costs. The following exhibit 2is an example of such a report.

Project Auditing

The audit of quality must take place as the work is being done. If it is delayed, defective work on individual work packages may be hidden; they are covered up subsequent work (example, the quality of plumbing work on a construction project cannot be checked after walls and ceilings have been finished). In some projects, the audit of costs also is done as the work progresses; in others, the cost audit is not made until the project hasbeen completed. In general, auditing as the work progresses is preferable; it may uncover potential errors that can be corrected before they become serious. However, project auditors should not take an undue amount of the time of those who are responsible for doing the work.

In recent years internal auditors have expanded their function into what is called operational auditing. In addition to examining costs incurred, they call attention to management actions that they believe are substandard. Properly done, operational auditing can be useful. However, there is the great danger that the auditors, who, after all, are not managers, will second-guess the decisions that managers made in the light of all circumstances – as the managers understood them - at the time that decisions were made.

Project Evaluation

The evaluation of projects has two separate aspects: (1) an evaluation of performance in executing the project, and (2) an evaluation of the results attained from the project. The former is carried out shortly after the project has been completed; the latter may not be feasible until several years later.

Evaluation of performance

The evaluation of performance in executing the project has two aspects; (1) an evaluation of project management, and (2) an evaluation of the process of managing the project. The purpose of the former is to assist in decisions regarding project managers, including rewards, promotions, constructive criticisms, or reassignment. The purpose of the latter is to discover better ways of conducting future projects. In many cases, these evaluations are informal. If the results of the project were unsatisfactory and if the project was important, a formal evaluation is worthwhile. Also, formal evaluation of a highly successful project may identify techniques that will improve performance on future projects.

Cost Overruns

When actual costs exceed budgeted costs, there is said to be a cost overrun. To some, this implies that actual costs were too high. An equallyplausible conclusion, however, is that the budgeted costs were too low. If the higher costs resulted from changes in the scope of the project or from non controllable factors, the explanation is that there was an underestimate of costs, rather than excessive actual costs. Interpretation of the reports is complicated by the need to analyze both the budget and actual costs.Hindsight

In looking back at how well the work on the project was managed, the natural temptation is to rely on information that was not available at that time. Within insight, one can usually discover instances in which the “right” decision was not made.

Some positive indications of poor management may be identified. Diversion of funds or other assets to personal use of the project manager is one obvious example. If there were major specification changes or cost overruns, these changes should have been authorized, and cash flows should have recalculated to determine whether the return on the project was still acceptable.

Another example of poor management is a manager’s failure to tighten a control system that permits others to steal, but this is more difficult to judge because overly tight controls may impede progress on the project. Evidence that the manager regards cost control as much less important as an excellent product that was completed on schedule is another indication of poor management, but it is not conclusive.

The evaluation of the process may indicate that reviews conducted during the project were inadequate, or that timely action was not taken on the basis of these reviews. For example, the review may indicate that on the basis of information available at that time, the project should have been redirected or even discontinued, but this was not done.

The evaluation also may lead to changes in rules or procedures. It may identify some rules that impeded efficient conduct of the project. Conversely, it may uncover inadequate controls. As a part of the evaluation, suggestions for improving the process should be solicited from project personnel.

Evaluation of results

The success of a project cannot be evaluated until enough time has elapsed to permit measurement of its actual benefits and costs. This may take years. Unless the impact can be specifically measured, such an evaluation may not be worthwhile. To take extreme examples, the benefits of the introduction of a new product line usually can be measured because the revenues and expenses associated with that line will be known, whereas the benefits of installing a laboursaving machine will not be identifiable if the resulting costs are buried in a variety of product costs and not separately traced to the new machine. Furthermore, there is no point in attempting to evaluate a project unless an action can be taken based on this analysis.

For many projects, evaluation of results is complicated by the fact that the expected benefits were not stated in objective, measurable terms, and the actual benefits also were not measurable. In these cases, a quantitative benefit / cost analysis is not feasible, and reliance must be placed on judgements by knowledgeable people about the project’s accomplishments.

This is the situation in the majority of the projects undertaken by governments and non profitorganisations, many research and development projects undertaken by staff units, and projects whose subjective is to improve safety or eliminate environmental deficiencies.

Criteria for Selecting those that are to be Evaluated

The project should be important enough to warrant the considerable expenditure of effort that is involved in a formal evaluation.

The results usually should be quantifiable. Specifically, if the project was intended to produce a specified amount of additional profit, the actual profit attributable to the project should be measurable.

The effects of unanticipated variables should be known, at least approximately, and they should not swamp the effect of changes in the assumptions on which the project was approved. If the results of a new product introduction were unsatisfactory because the market for the product evaporated, not much worthwhile information can be learned from an evaluation.