Materiale completo di

MANAGEMENT CONTROL
SYSTEMS - Cifalinò
(2020/2021)
Controllo di Gestione
Università Cattolica del Sacro Cuore - Milano
53 pag.

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 Management Control Systems

Chapter 1

Main concepts to be analysed designing management control systems

(input):

• Type of organization (manufacturing company, service organization, ...)

• External environment: competitors, sector of activity, market segments, life cycle, customers, distribution
channels, degree of uncertainty, ...
Need to know the specific feature of the environment in which the company is located.
If the environment changes, the management control system design needs to change. Company in a very
competitive sector, with high rate of change. Features of a well designed MCS: flexible, decentralized (high
knowledge of the specifics), ...
• Internal environment: complexity of the organizational structure (number of responsibility centres),
interdependencies between units, transfer pricing, ...
High complexity and interdependence: define some rules for exchanges (transfer pricing).

Designing MCS in specific settings

Imagine designing a new MCS for a consulting company, which are the main issues that you need to cope with when
you design a MCS, the components:
• Cost accounting
• Budgeting, reporting
• Responsibility centers
Design all these things to implement a MCS.

Focus on designing a responsibility center (responsibility accounting system):

• How many RC
• Which kind of RC

For each component of a MCS you need to define and to set the specific features of the item you are designing. But
then you need to put all these features together (cost accounting, budgeting…) à find out a holistic general model
that may inspire the design crossing the different tools (cost accounting, budgeting…). Design the specific tool but in
the meantime, you need to create a consistent overall MCS à define different features fitting each other. Issue of
consistence/coherence.
According to the book, when designing MCS, we need to take in account some input factor (uncertainty and
competitiveness of the external environment, complexity of internal structure, ...) and then it’s necessary to design a
coherent MCS that is fitting with input variables in order to find out desired output.
If the input variable changes, then the MCS needs some changes.

The main purpose is to reach a given output. General purposes (output):

• Mission;
• Value toward customers;

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 • Maximize the value (coherent with specific mission) and minimize the consumption of resources à
Increasing value through an effective using of constraint resources. Constraints and scarce resources in a
health-care organization: physicians à improve the value (level of care), doing the most effective use of
physicians. Another scarce resource is money, because drugs are very expensive.
This purpose can be reached through these:
o Efficiency;
o Good allocation of resources;
o Synergies, coordination, integration;
o Motivation.

Functions of MCS:

1) Provide effective information to decision making: we need information to improve the goal congruence, to
support goal setting so that we may assure goal congruence between organizational goals, team goals and
individual goals. We need information also to evaluate performance and to help the members of the
organization to understand which are the expected goals. Feedback and feed forward:
• Feedback = retrospective control, you focus on past results because when you apply feedback you
register the past resources, you compare actual result and budgeting objectives, so you compute
variances (distance between objective and results) and as a consequence you highlight possible actions
to be applied to improve your future actions. Information here are based on past resources.
• Feed forward mechanisms: immediately focus on future. You do not strictly compare budgeting and
actual results, but you try to find out some leading information that may anticipate future trends, future
events. Try to find out some information which may anticipate future issues/trends. It is a sort of
emerging control.
Example: working in a merchandise company in a mall (competitive environment), people may choose
among different stores and the important is to attract people within the store à customer attraction.
We are a family going to the store and we need to find out some items and, in this store, we see
different stocks out = we would like to buy something, but we cannot find the item. Probably the second
time you will change the store. The number of stock outs is a leading issue. You need to look also at
leading information which anticipate future revenues. Feedback is a variance between actual results and
budgeting objectives (look at past results), but in the meantime you need to anticipate future events,
prompt to trace possible future problems and opportunities. So, providing information is a first very
much important function to support decision-making, goal setting, performance evaluation (based on
feedback and feed forwards) but also to provide direction for the future and so on.
2) Coordinate the efforts of different responsibility centres (synergies): we need coordination because different
units have different goals à ensure coherence among different goals. Support both vertical and horizontal
integration. We need to assure coherence consistently congruence between the goals regarding different
hierarchical levels. Vertically: we need to assure that units positioned at different hierarchical level follow
coherent goals (vertical cascading of objectives, from top management to individual objective). Horizontal
coherence = objectives must be coherent with respect to two or more units positioned at the same
hierarchical level. If we combine in a coherent way the different goals both on vertically and horizontally à
result is increase synergies, allow people to converge the different prospective. Then each manager much
have specificity in terms of objectives, priorities and so on, but the specificity regarding each position must
converge to a common objective à push the converge toward the common objective of the organization
emphasizing the specific objectives.
3) Motivate people: if the MCS is focused on measures that aren’t motivating for employees, they aren’t
engaged in working in this organization (both on individual base and a team base).
To increase these three functions, it’s needed a designing of MCS in a coherent way with input variables.
Motivation can be intrinsic and extrinsic.

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 • Intrinsic: internal values and priorities that fit the ones of the organization. Professional
organizations (ex. hospital) should emphasize this kind of motivation. Improve the coherence
between the personal values and organizational context.
• Extrinsic: monetary or non-monetary like training.

Motivation is a sort of motus to actions, stimulate actions and behaviors à stimulate them between intrinsic and
extrinsic incentives. How can a MCS improve motivation to information and coordination? How to put together these
3? How MCS stimulate the right behavior? Through information. If we develop a participative budgeting process (goal
setting) we allow people to know and then understand the priority of the organization and then to reflect in a critical
way. Participation to budgeting and reporting information.

Three types of information needed for controlling any company, each serving a different purpose:

Þ Score-card questions (“Am I doing well or badly?”)

Þ Attention-directing questions (“What problems should I look into?”)
Þ Problem-solving questions (“Of the several ways of doing the job, which is the best?”)

These reference problems are useful as starting point in designing and implementing a concrete management control
system. The problems that controllers and consultants have to face in any specific company show that they need a
detailed framework of information.
Unfortunately, many of the attempts made to identify some kind of relation between company variables and control
tools have failed. Two likely explanations:

- company variables identified not the most relevant from a control perspective;
- description of control systems in terms of tool incorrect.

So, it’s needed to define appropriate independent variables (characteristic of the company and of its environment),
identify some distinctive features of MCS and then find significant relations.

Independent variables

• Company variables: degrees of structural complexity→ number

and articulation of responsibility areas (organizational units).
Two factors affecting the degree of structural complexity:
o External degree of structural complexity: number and
interconnections (interdependence) of result areas
(business units) is related to the way the company
works in the environment. (Complexity of the company toward the external environment.)
The control process is simpler in a company which produces and sells one or a few independent
products in a single market. In a university, result areas: number of services, like bachelor’s degrees,
Master of Science, executive master, national and international students, employed and non-
employed students. If we are big and articulate, it’s needed to increase the internal degree of
structural complexity. In a manufacturing company producing luxury goods (male and female
dresses), results area: types of customers, product line, distribution channels, geographical markets,
...

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 need to differentiate the design of the MCS in coherence with the situation of the company (current and
future).

To sum up:

Creation of a matrix with the two variables (degree of turbulence and structural complexity) in order to study how the
company changes in time.
Company D starts in a position in which there are low of both variables and changes into a position with high level of
both. To have an effective MCS is necessary taking into account these two variables, foreseen the changes and adjust
the designed MCS.

Question of exam
When you need to design a MCS, which input variables do you need to take into consideration? 2 degrees of structural
complexity, external environment (degree of turbulence) and then I need to combine both of them looking at current
position and future position.

Distinctive features (features related to input variables and they must be coherent)

1) Degree of details of information: a control system can be more or less detailed in relation to the number of
clusters (aggregations) in which raw financial data are collected and classified. In management accounting,
they break down the income statement. It’s not related to financial accounting. The degree of detail is less if
the control tool employed is the company financial accounting, where data are classified with reference to
type of counterpart and nature of costs of revenues.
The degree of detail must be higher when the company has a high external degree of complexity and if data
are classified with reference to products, organizational units, and variables like cost accounting.
2) Degree of relevance of information provided: an information is relevant in a specific situation if it is related to
factors that can be influenced by the decision taken.
Relevant information is additional knowledge on critical success factors that impact the decisions: relevant
information is directly related to manager’s prevailing decisional activity. We need to focus on the degree of
relevance when our company is characterized by rising turbulences: future is different from the past, so they
must do new decisions and for those they need additional information. The degree of relevance is also
related to the structural complexity because in order to take important decisions related to the structural
complexity additional information are needed (increasing structural complexity: new cost objects).
Direct cost accounting increases the system’s degree of relevance with respect to full cost accounting,
because the distinction between variable and fixed cost is relevant in many decisions. Working in a
merchandising organization that is opening new shops and the old cost accounting systems is divided for
products and not for shops. They need to know how to locate new shops.
3) Selectivity of information provided: the control system has a great degree of selectivity the higher the ratio is
between relevant and irrelevant information.
A selectivity is high when only relevant information is provided and irrelevant one is deleted, they are often
confused. The key economic variables greatly influencing the profitability of operations are clearly identified
and the managers are aware of them. The system operates as a filter for that information not actually useful
in the managerial activity.
The selectivity is very important in a turbulent environment.
4) Degree of formal responsibility: a control system has a high degree of formal responsibility if the system of
sub-goals is very well developed with respect to the business or the organizational structure.
Breakdown in a formal/explicit way in sub-goals, within the organizational hierarchy. It’s important when
decentralization is high and so there’s a high degree of internal structural complexity. In complex systems
control is passed on a process of the hierarchic subdivision. So each responsibility center has its own financial
target. A control system has a high degree of formal responsibility if the system of financial targets is very
well developed.

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5) Degree of procedural responsibility:
- If high, standard control system (ready defined and stable tools) with well-defined procedures (supposed to
be useful for solving the majority of problems that managers must face).
When the environment is stable.
- If low, ad hoc (contingency) control systems – without predefined procedures – to be tailored to the specific
problem to be solved at that specific moment.
Flash reports are very short reports including KPIs, which change months by months in order to communicate
only relevant information for this month and they change every month. Assuming that any company uses
both standard and contingency system to solve a problem, the relationship between these two is a matter of
judgement.
The degree of procedural rigidity is higher the greater the standard system’s predominance of the
contingency one.
Procedural rigidity is relevant in discontinuous environment. Standard systems, because of their procedural
rigidity, are difficult to shift accordingly. This means that the problem could remain uncovered or that
procedures are implemented to no actual purpose.
6) Style of control:
- Tight control: predominance of administrative (formal) control, low participation in goal setting, imposed
targets (impose budgeting goals), financial performance measurement. It’s coherent when the company has
a stable environment (standardized tools).
Related to an high degree of procedural rigidity.
- Loose control: awareness of the social and individual side of control, high participation in goal setting,
negotiated targets, multidimensional (financial and non-financial, like customer satisfaction; repeated
customers; number of sales units; organizational climate indexes→turnover, number of innovation provided;
... ) performance measurements. More motivating: both bottom up and top down. It’s useful when the
company is working in a discontinuous environment. Related to a low degree of procedural rigidity.
7) Quickness: period elapsing between the occurrence of an environmental event and its communication in an
appropriate way to managers that must in turn react. The shorter this period is, the higher the degree of
quickness.
It’s important when the company works in discontinuous environment.
It’s not so important in a stable environment. Times between a new competitor enters in the market and the
communication to the managers so that they could react. This time must be immediate.
8) Orientation: tendency to favour certain types of events, information or objectives with respect to others.

- Productive factor orientation (kind of costs like raw materials, taxes, depreciation, ...) vs Product
orientation (aggregate the productive factor into product/productive line)
The system is productive factor oriented if information is gathered mainly in accordance with
production input. The system is product oriented if emphasis is given to production outputs.
A productive factor orientation is present when the degree of details is low.
On the contrary, there’s orientation to product when the degree of details is high.
- Past orientation (management accounting system provide information related to the past, so to
finished events) vs Future orientation (anticipate in a proactive way future events) Past orientation
is coherent with a company working in a stable environment.
A system is oriented to the past if they focus on past events and on hypothesis and targets defined
in advance. They are, instead, future oriented if they concentrate on future events which are
explicitly considered in the system and towards which the entire system is geared.
Feedback: reaction on past events (variance analysis).
Future orientation is coherent with a company working in a discontinuous environment.
Feedforward: focus on future events, trying to find out proactive measures/indicators which
anticipates future events.

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Control tools: designing MCS means design control tools, creating a high coherence between distinctive features and
independent variables.

- Financial accounting
- Management accounting
- Responsibility accounting
- Standard costing
- Budget
- Reporting
- Etc.

Relate the different features with the different tools. Low degree of detail à financial accounting; high à
management accounting. If we need an orientation to productive factors à financial accounting; to product à
management accounting and standard costing.
If we need a high formal responsibility à invest in responsibility accounting a lot and so on…
To achieve the desire output we need to design a contingency based MCS = fits with the input variables and to find
out the links between the MCS and the input variable we need to associate the input variable with the features and
then the features with the control tools.
To do that we need a 3-step model:
- Identify our variables: how we position our company with respect to the variables in the matrix
- What are the distinctive features which fix with my position?
- Once I have selected my distinctive features for my MCS, which tools may assure these features?
It is an issue, a job of finding out coherence. Design a coherent MCS that fits with the input variables. This is a general
model that can be applied to any company.

Connection between independent variables and distinctive features

1) Stable environment
o The number of business units and
the connection between them is
directly related to a more detailed
system with an orientation toward
outputs.
o Complexity of organizational
structure is directly related to the
level of relevance and selectivity in
the decisional activity of the
business unit. The degree of details
must be high at the lower levels
and low at the top levels.
o Complexity of organizational structure is directly related to the degree of formal responsibility and
procedural rigidity and the tighter the style of control will be.

2) Turbulent environment: the connections suggested for a stable environment are to be adjusted to be the
turbulence as follows

o The more discontinuous the environment is, the more the system must be oriented to the future and
with a high degree of quickness.
o The less discontinuous the environment is, the more procedural rigidity should decrease and the style of
control change from tight to loose.

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 Chapter 2

Service organizations: organizations that provide intangible services, with particular attention to organizations that
provide professional services. Service organizations include hotels, restaurants, and other lodging and eating
establishments, but also banks, insurance companies etc.

Features of service outputs

Service outputs = final outputs delivered by a service organization.

• Intangibility: intangible service outputs

• Heterogeneity: even the same services provided within a business may differ, depending on the person who
serves you. (Classes, case study, feedback, ...) - heterogeneous service outputs
• Simultaneity: services are consumed as they are produced.
• Perishability: service capacity cannot be stored for sale in the future.

Given simultaneity and perishability there’s an impact in terms of capacity level.

If we can’t store the service outputs, we can’t use it as a buffer to regulate the level of production and also sales
(production of panettoni in august). You must level the capacity at the maximum you decide to work.
Production capacity of a hotel is the number of beds. If you want 1000 beds you need a huge structure.

In order to set customers you want to satisfy, you need to level the capacity to the level of sales you want to deliver. If
you decide not to lose customers. but to increase them, you maintain free capacity to be used when sales increase
and you also hire more people, so increase fixed costs.

Features of service organizations: Consequences of what seen before

o Absence of inventory buffer.

There’s no inventory, because services can’t be stored. If the service available today isn’t used today, the
revenue from these services is lost forever. The resources available for sale in many service organizations are
essentially fixed. The loss from unsold services is such an important factor that occupancy rates and similar
indications of success in selling available services are normally key variables in service organizations of all
types.
(A university or an hospital are service organizations.)
o Capacity levelling and cost structure: they are related, because capacity levelling influences the cost
structure
o Difficulty in controlling quality: consequence of intangibility. It’s measured after the service is sold, it’s
impossible to control before selling as in manufacturing organizations. The measurement, so, is
retrospective.
In automotive if the car has problem the car isn’t sold. If a professor explains in a bad way, it’s impossible to
know before.
o Labor intensive organizations.
The most important key success factor is HR (labor intensive), and in some kind of sectors is also important
technology (banks, , railway). If a company have talented employees, they reach better results.
It’s necessary to motivate people working in service organizations.
o Multi-unit organizations: organizations organized in a network of units of productions.
This impacts in designing MCS: need to decentralize a lot of responsibility, open new shops (profit or
investment centres), vertical cooperation, ...

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 Using the benchmarking, there’s no stress competition and increases organizational learning (but sometimes
they are used badly). Esselunga and Auchan are multi-unit organizations, because they grow if they open
new shops. A bank may grow if they open new agencies.
o They provide intangible services.
o Measurement of quantity. It’s not practical, but possible.
o Usually, manufacturing organizations are standardized. In the case of service organization, each service unit
is unique: not standardized.
Personalization impacts in management control system because there’s the need to create flexible and
decentralized control tools, based on lose control system.
o Size: usually service organizations are relatively small and operate in single locations. Top management in
such organization can personally observe what’s going on and personally motivate employees. Thus, there’s
less need for a sophisticated management control system, with profit centres and heavy reliance on formal
reports of performance.
o Performance measurement is more difficult in a service organization, than in a manufacturing one.
Performance measurements could be customer satisfaction, output values (in a university, number of
students be hired in a speed way than the number of students itself), ...
o Management control system. For both manufacturing and service organizations planning is done in terms of
programs and responsibility centres, including profit centres and investment centres for organization units.
The management control process in both involves the steps of programming, budgeting, the measurement
and the appraisal of performance and in both transfer pricing is important. Because of the difficulty of
measuring quantity and quality in service organizations, judgements about efficiency and effectiveness of
performance are more subjective.

Value chain in service organizations

The value chain is a set of linked processes or activities that begins acquiring resources and ends with providing goods
and services that customers value. It’s useful to assign costs to products and to provide other information to help
managers to manage resources and create value.

Upstream activities
Large-scale service providers (banks, insurance companies,
airlines, ...) undertake research and development activities
to identify potential new services or service production
process.
Smaller service firms are less likely to be involved in such
activities.
The existence of design activities (design of new services
and service production processes) also depends on the
nature of the service.
The service production process in a medical and legal practices involves discretion rather than conforming to a specific
design. In bus and rail companies there is more scope for design.

Downstream activities
The downstream area of the value chain involves marketing activities (focus on selling the services produced),
advertising and promotion, customer support activities (after the production/delivery processes, including customer
inquiry lines and ongoing information for customers about the service that they’ve purchased).

Production and delivery activities

The production and delivery segment covers the activities undertaken to produce and deliver the service. Because in
most service organizations services are consumed as they are produced, production and delivery occur simultaneously
(producing a service is the same as delivering a service). Direct costs could be the costs to use machines in order to

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produce the service and the cost of labor (salaries). Overhead costs could include depreciation of machines, insurance,
...
In many service firms, in which direct labor costs dominate, all other costs are classified as indirect or overhead costs.
The direct material classification isn’t often used, as material costs are relatively insignificant and might be included in
overhead as indirect material.
Cost in upstream or downstream areas may also be included as overhead costs, as costing of services isn’t influenced
by accounting standards.
Obviously, the cost classification, the approach to estimate service costs and the relevance of service cost in formation
vary with the type of services produced and the service production environment.

Service classification

In order to classify the service organizations, the

number of customers processed by a typical unit
per day is a good variable. Which kind of
classification criteria could we apply for service
classification?
1) Number of customers processed by a
typical unit per day (horizontal axis) –
independent criteria;
2) Competence required: like in
transportation service, technical
competences are required (vertical axis);
3) Customization: low in standardized mass
services, high in tailored services (ad hoc for customers) (vertical axis);
4) Contact time: how long does the service occur? (vertical axis)

1. Mass services
They have a huge number of customers, which one requires a limited staff time and little customization. Staff
are mainly non-professional. The service process involves equipment and the orientation is on product (what
is delivered more than how). Most of the value is created in the back office, while front office staff have
limited discretion to change the service provided. Mass service entities provide facilities rather than
customized services. Mass services (underground): the contact time is low (20 mins), the customisation also
and the discretion. ...
Railway companies, airline companies, post offices, electricity suppliers, telecommunication companies,
various public service organizations, ... In mass service, the key issue is economies of scale (we have a lot of
technologies) that has to be applied to different services. So, we have one cost: amortization cost, that can
be split in the different services. We have huge common fixed costs – technologies used by different service
lines.

In contrary, in the case of professional services (see below), like consulting companies, you construct a team
who deals with just one project. We have a lot of specific costs or direct costs, that are directly traced to the
cost object (service line) without the allocation base.

2. Professional services
Professional service firms are staffed by professional staff who provide individual services to customers. They
serve a low number of customers: this because staff spends a lot of time producing and delivering the service
to the customer and often adapting the service to meet individual needs (customization). Staff has a high
level of discretion in dealing with customers. The front office part (where there’s an interaction with
customers) is more important than the back office.
The orientation is on process (because is more important how the service is delivered rather than what is

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delivered) and involves people rather than equipment. Professional service (consultancy company): the
contact time is high (a consultancy project needs months/years.
Research/development organizations, law firms, accounting firms, medical clinics, health maintenance
organizations, engineering firms, architectural firms, consulting firms, investments firms, advertising
agencies, ...

o Organizational goals
In professional organizations the dominant success criterion isn’t return on asset employed as in
manufacturing or some service organizations. Because, in professional services, the amount of
tangible assets employed is relatively insignificant. The principal resource is the skills of professional
staff and return on assets employed provides neither a basis for measuring success nor a criterion
for decision making.
o Output measurement
Revenues earned are one measure of output, but these monetary amounts relate to the quantity of
services rendered, not to their quality, at least in the short run.
Being intangible it’s difficult to measure it in quantitative terms and also in qualitative terms.
o Production standard
The work isn’t repetitive, so it’s difficult to plan the time required for a task and to set reasonable
standards for task performance. This makes it difficult to judge how satisfactory the performance
was.
o Marketing
In most professional organizations no clear dividing line exists between marketing efforts and
production efforts.
Since marketing is essential in any organization, if it can’t be conducted openly, it takes the form of
personal contacts, speeches, articles, ... (by professionals).
In professions which permit explicit marketing efforts, the professional staff is responsible for
developing leads, preparing proposal and carrying on discussions with prospective clients, all of
which are activities that would be conducted by the marketing department in an industrial company.
Because marketing is not an identifiable function and because new business is generated by the
part-time activities of professional staff members who are primarily engaged in doing production
work, it’s difficult to assign appropriate credit to the person responsible for the generation of the
revenue.
In professions that frown on marketing, firms tend not to give much, if any thought to the marking
mix, the proper position of the product line and other fundamental marketing concepts.
o Professionals
Professionals often have motivations that are inconsistent with good resource utilization and their
success as perceived by their colleagues reflects these motivations. Professionals are motivated by
dual standard: those of their organizations and those of their professional colleagues. The rewards
for achieving organizational objectives may be less potent than those for achieving professional
objectives. Departmental managers tend to work part-time on management activities, they do the
same job of their subordinates.
o Differences among organizations
There are differences among professions and among the firms within a given profession that are
relevant for management control. In some organizations, professionals work as a team on an
engagement; in others, they tend to work as individuals with perhaps some temporary assistance
form colleagues. Organizations also vary in proportion of support personnel to professional
personnel.
o Pricing
It’s impossible to use the return on asset employed criterion.
Many professional firms are organized as partnerships, so that the compensation for individual
services plus profit winds up eventually as partnership compensation. Professional firms tend to

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 substantial and easily traceable to specific jobs.
The large number of services would make job costing unwieldy. Even if job costing could be used, the high
level of indirect costs that needs to be allocated to individual types of services may undermine the accuracy
of the service costs. The elements of customization and discretion in the production process make process
costing unreliable.

Capacity management

Two problems:

Þ installing the capacity, defining how much capacity do we need;

Þ once the capacity is installed, it’s impossible to change it, so they must use it.

Concerning capacity management, which are the tools that support the decision of how much capacity is installed and
how to use it?

• Capacity levelling (how much capacity?)

o BEP: point in which sales and revenues are equal, so profit is zero. BEP is a static analysis, which we
compute given the fixed costs the level of sales.
o What-if-analysis: what happens to BEP if profit increases? How many units to I have to sell if I
increase fixed costs by 50%? It is a dynamic analysis.
You have still invested, decide the capacity.
Cost-volume-profit analysis (break-even analysis): we estimate for the future variable and fixed costs
and we compute the break-even point in units and/or in sales.
Unit price * Volume of activity – Variable costs – Fixed costs = 0
The break-even point in units is given by Total fixed costs : Unit contribution margin
We compute the number of units to deliver in order to cover at least the fixed costs.
The cost-volume-profit analysis is useful to anticipate which will be the future fixed costs to be cover
by the future volume of sales (number of units to be sold to break-even).
It’s a simple tool in order to gain its purpose. Found an affordable situation, they decide to invest
the amount decided.
They study the marketing attractiveness to understand their credibility at break-even point.
• Capacity utilization (how to use the capacity installed?) Other two problems:
- being efficient (keep the costs under control);
- attract people in using pricing.
After capacity levelling, you need to attract customers. So improve capacity usage.
Take under control all the costs, be efficient in use install capacity.
Activity based costing and time driven ABC: techniques useful to improve capacity. Techniques to highlight
activities within each process and find out the level of efficiency to find out area of improvement.
Computation on costs and then keep them as lower as possible.
The problem is now to attract customer and the price is used to do that.
High competitiveness means high reaction on volume of activity after a little change in prices.

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 • Cost structure: ratio between variable and fixed cost. The higher is the ratio, the higher is the flexibility and
the operative risk is lower. The higher is the number of volunteers the higher if the flexibility. Many costs are
discretionary and the amount to be stent can vary widely depending on management’s decisions. Many of
these decisions are made during the budget formulation phase. (cost allocation: risk to underestimate the
cost of people, because volunteers are free)
• Revenue structure: mix of revenues coming from donations, funds, contributions, funds by the State, fees (in
public administration by taxes)
• Price differentiated by services and categories of users.
• Spending flexibility: flexibility in defining how much to spend (to deliver the non-profit activity) each year.
NPOs decide what to do each year, they work among programs of activities. The following year donations
reduce, so we decide flexible work in order to ensure a break-even point. We adapt the work taking into
account the revenue year after year.
Conditions in non-profit organizations are more stable and predictable than in for-profit organizations. So,
the operating budget is a fairly accurate statement of both the activities and resources to be used. It’s
important that significant time, including that of senior management be devoted to it.
• Contributed capital: asset donated to the company and this donation must be kept for many years, it cannot
be sold and used to finance the activity of just one year (long-term donation). There are two principal
categories of contributed capital:
o Plant: contributions of buildings and equipment or contributions of funds to acquire these assets, works of
art and other museum objects.
o Endowment: gifts whose donors intend that the principal amount will remain intact indefinitely (or for
many years); only the income on this principal will be used to finance current operations. Endowment assets
must be kept separate from operating assets. Capital contributions should be reported separately from
operating contributions, that is, from revenues from annual fund drives, grants, and other gifts intended to
finance current operations. Thus, a non-profit organization has two sets of financial statements: one relates
to operating activities (it includes an operating statement, a balance sheet and a statement of cash flows that
are the same as those found in business); the other relates to contributed capital (statement of inflows and
outflows of contributed capital during a period and a balance sheet that reports contributed capital during a
period and a balance sheet that reports contributed capital assets and the related liabilities and equities).
Inflows of contributed capital are capital contributions received in the period and gain 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: presence of different funds/accounting system. Management accounting only refers to
operating activities. Accounts are kept separately for several funds, each of which is self-balancing (sum of
debit balances = sum of credit balances). Different accounting system to calculate the contributed capital and
the income from it (the revenues).

Most organizations have:

- A general fund or operating fund, which corresponds closely to the set of operating accounts; (primary focus
of MCS)
- A plant fund and an endowment fund, which account for contributed capital assets and equities;
- A variety of other funds for special purposes: pension fund (also found in business), other used for internal
control purposes, ...

1. General fund or operating fund > correspond to operating accounts

2. Plant fund and endowment fund > contributed capital assets and equities
3. Variety of other funds

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 Decision making : decision mainly characterise non profit decision. The most important are the
pricing policy, decision like make or buy , adding service g and product line since they are a
mean to reach the final end to reach the final mission . Each year you need to decide to keep
existing line or drop or add line. The flexibility mentioned before requires a continuous
decision process regarding which activity to deliver. Useful to analyse which are the economic
consequences related to this flexible activity. If we add a new service line , what are the new
cost ? Also make or buy is a very important decision. Ancillary activities pursue the social
Implications for management control systems mission. Even though make or buy regard the ancillary activity giving relevance to reach a
break even point it is also important to analyse the cost effects when we decide to for example
outsourcing production , maybe you will save money. The meaning of this decision is peculiar
Decision making but then the techniques presents the traditional features . How to identify a differential revenue
and cost ? Meaning on the implication of this decision in a not for profit environment.

The decision-making process in NPOs is very specific. Given the previous features, also the decision-making process is
very specific and unique.
Simulation of the economic impact is possible in profit MCS. In NPOs they should maximize the social wellness (best
social outcome for the users).

Information needed to compare the options and choose the best:

- break-even point as a constraint;
- identification of the unsatisfied needs.
Examples of short-run decisions in NPOs: in a primary school number of classes, morning/afternoon/weekend
activities, cover variable/full costs, earn something and reinvest, ...

We need to understand the decisions and why we are focusing on those and speak with board of trustee.

1. Identify the decisions to support and fitting of decisions with our mission.
2. Multidimensional information (revenues, costs and other associated with social needs).
3. Even though we decide to accord a social criterion, we identify the option that maximize the social purpose,
we still need to be conscious of the economic impact, associated with our decision. Efficiency is important. -
à Better use the allocation of resources.

Also, in NPOs, we may need economic information to support:

• Product pricing
• Make or buy
• Adding or dropping product lines

Management control system

Þ Product pricing
Normal pricing: full cost plus margin – estimating the margin – the pricing unit Variations from normal prices:
cost plus pricing, market-based prices, subsidized prices, free services
- Free from service (poor people: very basic users that can’t pay) = 0 price,
- Price to cover just the variable costs (quite poor people),
- Price to cover full costs (not so poor people)→most desirable for services directly related to the
organization’s objectives,
- Market price/Cost plus mark-up and we use the revenues to reinvest and finance other activities (rich
people)→peripheral activities.
Product pricing is important because it influences the behaviour of clients (or third party on behalf of a
client), provides a measure of output, influences the behaviour of managers and service providers.
The smaller and the more specific the unit of service that is priced, the better the basis for decisions about
the allocation of resources.
Management control is facilitated when prices are established prior to the performance of the service. If an
organization is able to recover its incurred costs, management is not motivated to worry about cost control.
o Strategic planning and budget preparation
In non-profit organizations that must decide how best to allocate limited resources to worthwhile activities,
strategic planning is a more important and more time-consuming process than in the typical business.
(Similar process to profit organizations, except the absence of a profit measure makes program decision

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 more subjective.)
The budget is the most important management control tool, at least with respect to financial activities.
o Operation and evaluation
In most non-profit organizations, there’s no way of knowing what the optimum operating costs are.
Responsibility centre managers tend to spend whatever is allowed in the budget, even though the budgeted
amount may be higher than is necessary. Although non-profit organizations had a reputation of operating
inefficiently, this perception has been changing in recent years, far good reasons. Many organizations have
had increasing difficulty in raising funds, especially from government sources.
For example in hospital costs there was the introduction of reimbursement on the basis of standard prices for diagnostic related groups.

Budget formulation

Unique and peculiar.

1. Programming and budgeting

In the language of NPOs a program is a long-term strategic initiative (action). It includes the types of
programs we plan to deliver in the long-run (3-5 years). The decisions (of programming) involve investments
in assets that senior managers expect will be used over some future period of time and that will result in a
payback of some sort to the organization. Often, the result is a capital budget.
Non-profit hospital: over the next 5 years I will work on paediatrics.
Budgeting is a short-run tool. In the short run (1 year) you need to translate the long-term objective into
short-run goals. Given the long-run program the expected activities are defined, and revenues and costs are
associated. Usually revenues are a constraint and they have to reach the break-even. In this phase, managers
sets outs plans for the upcoming year, attach monetary amounts to various activities and programs, and, if
feasible, establishes appropriate output and performance measurement targets. If an unexpected profit is
found, it’s possible to try to increase the activity. Budgeting formulation stops when unexpected results are
found. It’s useful to think about these two activities separately as they have different characteristics.
Programming proposals generally include rough estimates of the associated revenues and expenses for
several years into the future.
Budgeting, by contrast, ordinarily is for one year only and requires more careful expense estimates. Senior
managers must be certain that it corresponds to individual responsibility centres. It then provides a basis for
measuring the performance of each responsibility centre manager. If a program is to be used as the basis of
performance measurement, it must be designated as a responsibility centre. Responsibility for many of a
program’s elements may be too diffused throughout the organization to permit the measurement of the
performance of any given manager.
Objectives:
- volume of activities
- revenues
- costs
Given the donation, contribution, ... they understand what they’re able to do.
Total sales = total costs à Break-even point
Programming defined by the board of trustees. If they are visionary people with a lot of passion, they tend to
introduce a lot of program in the long-run and then they translate in the short-run with budgeting. It is also a
communication, negotiation process.
2. Behavioural aspects of budget formulation (managerial context for operating budget)

o Environment: an organization’s environment governs much of what happens in the budget formulation
phase. Considering an environment that is a lot regulated (public utility like health-care, universities, ...),
NPO must respect the rules, the budget must be geared in part to the need of the regulatory agencies
and the constraints they place on decision- making. The creativity in budgeting proceeding is reduced. If,
instead, some of an organization’s programs operate in a competitive environment (municipal parking

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 lot) the budget formulation phase will need to eliminate as much slack as possible. All the people must
be trained with respect to the regulations.
o Strategy: in many NPOs there’s no clearly defined and formalized strategy. Strategy can be
operationalized in terms of the organization’s programs, the markets where they operate and their
sources of financing.
(Different budgetary process for organizations with significant grant funding and only a few fee-based
programs and for organizations with many fee-based programs and little or no grant funding.)
o Values: very often they are professional organizations with strong values. Senior manager’s values also
will have an influence on the budget
o Organizational structure: board of trustees is the governance with some possible organizational models
that could be programs (like university) or departments. It’s needed to understand how to design
responsibility centres around programs. The chief of the program is often a professional. Some
organizations are highly authoritarian, while others are more collegial. These factors will influence how
the budget is structured and who plays a role in its formulation.
The way an organization is structured will influence how it goes about formulating its budget.
o Programmatic goals and objectives: some organizations specify their programmatic goals and objectives
clearly, while others don’t. When these goals and objectives are specified, managers who are responsible
for attaining them soon begin to develop relationships between their attainment and the associated
costs. When this happens, a non-profit organization has the opportunity to budget for both
programmatic goals and objectives as well as revenues and expenses. It can begin to make tradeoffs
among them.
o Motivation system: which are the motivational drivers of performance? More intrinsic motivation. It’s
needed to define a package of tools and combine them in order to be coherent in a holistic vision. Some
non-profits have reward system that pay bonuses to key operating managers, other encourage managers
to behave in an entrepreneurial way and provide extra budgetary resources to those who are successful.
There’s a link between these kinds of motivation systems and the way the budget is formulated and
monitored.
o Critical success factors: it depends, but very often professional only look at technical professional factors,
loosing managerial issues. Managerial aspects may be highlighted. Usually, each program has two or
three activities that are essential to its success. These critical success factors influence the budget and
variations of these have a major impact on the budget. Managers can incorporate these factors into a
budget in such a way that “what if?” scenarios can be tested for their budgetary implications.
o Cost structure: influence the budget.
o Budgetary game playing: game play is an opportunistic behaviour. You try to underestimate the volume
of activity (the costs), so a decision mistaken is approved but then the costs arise, and you lose.
Opportunistic simulation for the future.
Overestimation of donation: donation will be lower.
The negotiation phase of the budget tend to be zero-sum in many organizations, with each budgetee
attempting to obtain a larger share of the fixed budget pie (where resources are not abundant, such an
arrangement can produce a great deal of conflict and game playing by budgetees).
Conflicts and game playing can be mitigated if there’s a culture with norms that include: - trust between
supervisors and subordinates;
- goodwill and honesty;
- recognition that disagreements don’t mean threats;
- spirit of openness and sharing information;
- willingness to allow subordinates to develop their own solution to budget-related problems;
- confidence in the computation and other work of staff analyst.
o Role of professionals: critical. Professionals are oriented in the mission of the organization, instead
administrators are more interested in costs.
o Behavioural issues: the formulation of the budget is more than purely a mechanical exercise, with
arbitrary reductions across line items when the first pass leads to unacceptable results.

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 Budgetary process is to be useful for managers at all levels in the organization, it must assist them in
making a commitment to achieving a set of agreed-upon results.
Because the bottom line in a non-profit organization doesn’t fully measure performance, these results
need to be both programmatic and financial. In most instances, if managers are to commit themselves to
achieving these two aspects of the budget, they must have some degree of participation in setting the
targets. It’s essential for managers to be held accountable only for those items they can control and not
for those outside their control. The budget phase must structure revenues and expenses in a way that
helps program and department managers to understand their commitment and managers need to assess
their subordinates’ budgets in terms of the scope of their responsibilities.
3. Operating budget formulation: mechanical aspects
In all but the simplest of organizations, the operating budget is prepared in light of senior management’s
decisions about the structure of the organization’s responsibility centres.
o Type of programs: the budget is the yearly translation of the strategic long-term programs. In designing
the program structure, senior management typically focuses its attention on several different types of
programs.
Most basic division:
§ Mission programs: relate to the organization’s objectives and usually are focused on
clients. Management usually focuses its attention on mission programs.
§ Support programs: provide services to more than one other program but usually don’t
work directly with clients. Within limits, the amount of resources required for support
programs is roughly dependent on the size and character of the mission programs.
o Need to highlight the components of a program structure and sub programs to have a map of activities.
In a large non-profit organization it consists of several layers. At the top are a few major programs (pre-
elementary school service, elementary and secondary school service, ....) and at the bottom re a great
many program elements, that are the smallest units in which information is collected in program terms
(language instruction, music instruction, ...) and in the middle there are program categories or
subcategories (kindergarten, primary or elementary school education, secondary or high school
education, ...). A program element is a definable activity or related set of activities that the organization
carries out, directly to accomplish its objectives or indirectly to support other program elements. In a flat
organization there no need for program categories and in a more hierarchical organization there may be
several levels of program categories.
o For each component/program, estimation of revenues and expenses.
Þ The purpose of a non-profit organization is to provide as much service as it can with available resources. In
many NPOs, the total amount of revenue in a budget year has quite narrow limits. The goal in preparing the
operating budget is to decide how best to spend it. The basic approach should be to first estimate available
revenue. Most managers agree to this policy of estimating revenue first and then budgeting expenses below
or equal to it is fiscally sound. In many NPOs application of this principle requires managers to make careful
estimates of the level of funds that a government agency is likely to appropriate. It also requires a judgment
as to taxation (in public sector) and other revenues. In other organizations, it requires estimating the
revenues to be derived from a variety of sources, ranging from the basic, such as client fees, to the more
significant, such as annual giving and endowment earnings. Carrying out a revenue-first policy requires
considerable discipline in two respects:
1. Careful and prudent estimate of total revenues from all sources (including taxes, fees, grants, contracts
and third-party payments).
2. Commitment to engage in cost cutting if the first approximation to the budget indicates a deficit. Although
the least painful course of action is to anticipate additional sources of revenue to eliminate the forecasted
deficit, this is a highly dangerous course of action. The safer course of action is to take whatever steps are
necessary to reduce expenses so as to bring them into balance with revenues.
Þ Two formats for expense portion of the budget:
1. Line-item budget (traditional form): focuses on expense elements (wages, fringe benefits, supplies, ...).

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 2. Program budget: focuses on programs, program categories and program elements. The second permits a
decision maker to judge the appropriate amount of resources for each activity and to match spending with
measures of each activity’s planned outputs. In program budget, there always is a line-item listing.
o Taking into account short-run fluctuations due to environment. Putting together all the program, the short
fluctuation should compensate. When managers expect short-term revenue or expense fluctuations around a
mean, it’s appropriate to budget for the average amount, rather than for a specific level anticipated in a
given year. In some year, the amount will exceed the budget and in some it will fall below it. Over time, the
two should net to.
o Link to the capital budget: frequently, the operating budget will contain expenditures as well as expenses.
Expenditures for minor capital items, often will be in the operating budget, even though their economic lives
extend over several years. It’s important for senior management to make a clear distinction between
expenditures (even small ones) and expenses. Otherwise, there’s a temptation to balance the operating
budget by moving some items from it into the capital budget, rather than by reducing expenses
o Output measures: it consists in process and results measures. Some organizations commit themselves to
specific targets for each as part of the budgetary process.
Number of users, number of services provided, frequency of services, ...
4. Operating budget formulation: steps
It’s needed to link programs and yearly budget. Writing the main long-term programs which are expected to
be delivered.
a) Disseminating guidelines: distributing a set of guidelines for managers to follow in preparing their
budgets. The guidelines include dates when various documents are due. If approved programs exist,
one guideline usually is that the budget be consistent with them. Desirable innovation coming may
come to light if managers are permitted to propose activities that are not part of approved
programs. These improved activities should be distinguished from approved programs. There are
some constraints, like the one that the budget mustn’t be more than 105% of the prior year’s
budget. The budget must be consistent with planned changes, senior management’s assumptions
(wage rates and other input prices), conditions under which new employees may be recruited,
number of employees who may be promoted, expected productivity gains and services to be
provided by support centres and the corresponding transfer prices. There often are guidelines about
the format and the content of the proposed budget to facilitate analysis and comparisons.
b) Revenue budgets
Then donations and revenue constraints should be included. All the rules according to which a
budget in process should be prepared have to be included.
Doing so provides the organization with some reasonable assurance that anticipated revenue is
based on market conditions. Sometimes revenue estimates are reviewed and evaluated by senior
management’s staff to assure that they are realistic in light of general economic conditions,
competitive forces, service delivery capabilities and so forth.
Larger is the complexity of the organization, more is the level of detail.
(If expenses are estimated first, there’s a tendency in assume that revenue will be high enough to
cover them, that might be unrealistic.)
c) Expense budgets for profit and standard expense centres
Then, expenses for mission centres are added (foresee profit and expenses centres → responsibility
centres which deliver the mission programs, the social activity).
Each program’s expense budget usually is constructed by beginning with the volume and mix
estimates used for the revenue budget and attaching variable cost elements to the units. The results
are multiplied to give total variable costs, after which the appropriate step-function and fixed costs
are included.
In case of standard expense centre, although no revenue is received, the manager till must estimate
expenses by beginning with the anticipated volume and mix of its outputs.
In a welfare office, if the number of cases can be predicted, the budget for social worker salaries can
be obtained by using a standard workload factor (cases per social worker) multiplied by the average

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 Discretionary cost : or called avoidable cost, are cost or capita, expenditure that can be curtailed or even eliminated in
the short term without having an immediate impact on the short term profitability of a business. ( example ,
advertising cost or maintenance cost)
salary. If there are different levels of social workers, a mix of factors will be needed. To this total can
be added the fixed costs of the office.
d) Expense budgets for discretionary expense centres
Then there are discretionary or support centre (library in the school).
Since these expenses are unrelated to the volume of outputs, the budget is a fixed amount, based
on assumptions about the kinds and amounts of activities that staff will need to engage in during the
year.
e) Budget income statement (master budget)
Then all the programs (all the profit centres) are put together and the income statement should be
closed in the break-even, to determine the forecasted contribution to standard and discretionary
expense centres for the year. Standard and discretionary expense centres budgets are then
subtracted to give the overall surplus. The master budget needs an approval by the governing body
and sometimes is reworked.
f) Non-financial results
Then, non-financial results should be added. These results can include process measures (amount of
time needed for a restaurant inspection), output measures (the number of secondary school
graduates) and outcome measures (number of homicides).
When these measures are included in the operating budget, responsibility centre managers must
think about both what they wish to accomplish and the cost of doing so.

There are several important features of this mechanical side of budgeting:

Ø The budget is taken seriously by senior management.

Ø The timetable remains roughly the same each year.
Ø Staff analyses are used as a check: verify forecasts by responsibility centre managers and their staffs. When
staff analyses contradict a forecast, neither is allowed to dominate the decision-making process. Instead,
areas of disagreement are identified, discussed and resolved.
Ø There’s a negotiation phase: between responsibility centre managers and senior managers.
Ø The final budget represents a serious commitment.

5. Budgeting misfits

o The cost structure and the budget formulation phase

Budget formulation frequently is not built around the organization’s cost structure. Although the payment
rate is designed to cover three types of costs (fixed, step-function and variable). Since fixed costs and part of
step-function costs are time-based, there’s a misfit between the cost structure and the reimbursement
system.
Resolution: distinguishing between fixed and variable costs. Fixed costs exist because the organization must
be ready to serve and they will exist even if no units of service are provided. By contrast most variable costs
and some step-function costs are related to the volume of activity, so a program manager can be asked to
control variable costs per unit and not variable costs, because variable costs are affected by the volume, that
is outside the control of him/her.
o The cost structure and the monitoring phase
In the budget monitoring phase, a misfit happens when the management control reports don’t specify the
reasons underlying a difference between budgeted and actual results. Resolution: use of variance analysis
(distinguish among different causal factors). If it’s not used managers find it difficult to determine the reason
underlying a deviation between budgeted and actual results.
o Critical success factors and the budgetary process Critical factors come from the environment ( local supporters, donators )
Serious misfits can occur when the critical success factors are excluded from the budgeting phase.
o Programmatic objectives and the budgetary process
NPOs that engage in program budgeting have an opportunity to be explicit about a lack of congruence

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 The forth problem is the coherence between long and short term objectives . The solution is that when we start with
the budgeting guidelines they must be written in coherence with the long term priorities and if the monitoring phase
highlight long term priorities.also when in the monitoring phase we may discover the need of some revision
priorities , there may be a cluster of users not relevant, they have to be considered and we need to be open to their
revision.
between programmatic objectives and financial constraints. They can make tradesoffs as needed during the
budget formulation phase.
Imbalances between financial and programmatic objectives may be resolved by default, as happens when
budget cuts are necessary but managers haven’t sufficient information to determine most successful
programs in meeting the organization’s overall goals. Resolution: revising the budget formulation phase to
include a component in which responsibility centre manager are asked to specify programmatic objectives
and to commit themselves to their attainment in the same way as they commit themselves to the financial
objectives of the budget.
o The budget formulation and the budget monitoring phase (reporting)
(misfit within management control process)
The reporting phase in many NPOs operates with such long time-lags that the information is of little
managerial use when it arrives. Many reports don’t provide sufficient detail on the reason underlying a
budget variance. Managers thus find it difficult to assess the action that should be taken to correct a
problematic situation. It’s essential for managers to be held accountable only for those items they can
control.
The most useful way to structure information is in terms of the variances between budgeted and actual
results.

Performance measurement

It must be expanded, in order to measure different things. A perfect synthetic performance measurement doesn’t
exist. So, more than one is used.
(What to measure? How to measure? Who is involved?)
The goals of non-profit organizations are usually complex and often intangible, and their outputs are difficult or
impossible to measure. Output information is needed: to measure efficiency (ratio of outputs to inputs) and to
measure effectiveness (extent to which actual output corresponds to the organization’s goals and objectives). In a
NPO no monetary measure exists, so, in absence of this, analyses of efficiency and effectiveness require adequate
substitute measures of output.

Ø Categories of measures
o Social measures: broad measure of output that reflects the impact of an organization’s work on
society at large. Unfortunately, few social indicators can be related to the work of a single
organization because in almost all cases they are affected by external forces. Those than can be
collected fairly easily are likely to be of dubious validity. Cause-and-effect relationship between the
action of the organization and the change in a social indicator isn’t demonstrable. Social indicators
can be useful in strategic planning in that they can help guide senior management’s decisions about
the overall directions the organization should take and because of this, social indicators are often
stated in broad terms (expectation of healthy life free of serious disability and institutionalization).
For MCS a more specific objectives is needed, preferably measurable (infant mortality rates).
(Crime rate, mortality rate, percentage of registered citizens voting, ...)
o Output (results) measures: expression of output in terms that are related to an organization’s
objectives. They tend to avoid some difficulties of social indicators.
Ideally, objectives are stated in measurable terms and output measures are stated in these same
terms. When it’s no feasible to express objectives in measurable terms, the result measure
represent the closest feasible way to the management has to both specify the objectives and
measure the organization’s progress toward them.
A result measure related to an organization’s success in attaining its goals.
(Client oriented→result measure related to what it did for its clients). The closer a result measure
comes to indicating an organization’s impact on society, the more difficult is to establish valid cause-
and-effect relationships.
It’s ends oriented.

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Social measures represent the social long term outcome from the activity produced by the company. Represents
th medium long term effects impact in the organisation. The word impact focused on the idea that this impact
are impacted by many factors. The results si strictly affect by the activity of the company (short effect), on the
contrary impacts are medium long term impacts affected by issues among which the activity produced by the
organisation (clinical outcomes which measure the level of health achieved by a patient is a social measure)
The output measures include the volume of activity of output produced and the quality (patients satisfaction
indexes) by the organisation (ex. Number of patients threat) . PREM MEASURES (IN HEALTHCARE
PATIENT ARE REPORTED IN EXPECTED MEASURES, trace the perceived experience by patient. They are
relevant since the patient engagement is a driver of life expectancy. For example in a museum they may be the
number of visitors and the customer satisfaction indexes . In school number of extracurricular activities.
Process measure the volume of the input used and cost measure present the monetary value of the input used.
The difference between th activity and the results. The activity represents the mean through which you achieved
an end point (results). Process measures not focus on the finding produced in the end , on the contrary they
focus on the path way through which you will reach the output result is end oriented. (Ex. Teaching methods
produced within a not for profi university, means with which your learning is affected or adopt or not innovative
clinical procedure )
Resources measures focused on the volume and quality of input provided (tangible and intangible resources , the
competences of workers and volonteers). This resources can be measured in terms of volume and quality (level
of competences ). Used to provide activities and how they are delivered. We measure in terms of quality and
volume. At the end we have short term results.
Since we pursue a final social purposes we have to identifying if we are able to face social impacts affected by
exogenous issue and environmental issues , we need to affects in some way this medium and long run impacts
 person or it may be derived from data that aren’t dependent on human judgement.
A judgment made by a qualified person can be a better measure of the quality of performance than any
objective measure, because it includes the effects of circumstances and nuances of performance into their
judgment.
On the other hand, a subjective measure may be affected by the prejudices, attitudes, physical and
emotional state of the person who judges.
An organization’s output measure should include both.
(Users’ satisfaction is subjective)

➔ Quantitative vs non-quantitative (/qualitative): a quantitative information is easily summarized and

compared. Even some subjective information can be measured quantitatively. Non-quantitative information
can be valuable in some instances. (quantitative: grades in school, performance in sports ranked along a
numerical scale; qualitative: narrative statements of social workers)

➔ Discrete vs scalar: discrete is dichotomy (yes/no, satisfactory/unsatisfactory, ...), scalar has many shapes
along a scale. Scalar measures are preferable to discrete ones. But there are some situations where discrete
measures are appropriate.

➔ Actual vs surrogate measures: whenever actual output can’t be measured; surrogate measures can be
useful. In this case, surrogate measure should be closely related to an objective, but a surrogate doesn’t
correspond exactly to an objective and managers should keep this limitation in mind. Surrogate measures to
measure in quantities terms a qualitative phenomenon. (The number of non-attending students. Why
students aren’t attending? Maybe they are employed students.)
(A city used “number of complaints” as a surrogate performance measure for the agency that managed low-
cost rental housing units.)

➔ Quantity vs quality: performance has both a quantity (more feasible to measure) and a quality dimension
(shouldn’t be overlooked).
It’s frequent that quantity measures imply some quality standards.
(Number of lines typed per hour usually carries with it the implication that the lines were typed satisfactorily;
number of students graduated implies that the students have met the standards of quality that are necessary
for graduation.) In some situations, judgments about quality are limited to discrete measures; in these
situations. (Graduated: yes/no)

Quality measures of output

Ø Importance of quality: measure of quality is more important in non-profit than in for-profit organizations,
where the market mechanisms provides an automatic quality check (if a pair of shoes isn’t good, people
won’t buy, so the company has to raise quality). Similar market mechanisms exist for some non-profit
organizations (a university that gives poor quality education will lose students to other universities). However,
in other non-profits there’s no this mechanism for consumer reaction to output (hospitals). Because of the
absence of market-oriented client checks on quality in non-profit organizations, it’s usually worthwhile for an
organization to devote considerable effort to developing quality measures. If possible, these measures would
be linked to the individuals responsible for attaining them.
Ø Measuring quality: during the past years, many NPOs have begun programs in Total Quality Management or
Continuous Quality Improvement. One of the dilemmas faced by the organizations is measuring
improvement in quality which is inherently subjective. There are three approaches that managers generally
take to measure quality: crude measures, estimates and surrogates.
Ø Crude measures of quality: the absence of quality measures may lead to an emphasis on quantity. Thus,
managers should make every effort to find acceptable quality measures, even if they are crude ones. Even

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 though these measures are crude and may not even contain the proper attribute of quality, they may serve
as good motivators for the program’s management and service delivery personnel. This assumes that there’s
a clear relationship between inputs and quality.
Ø Estimates of quality: in the absence of objective data, estimates of quality can be useful.
Ø Surrogates of quality: surrogates for the quality of service provided, in some NPOs, are important indicators
of quality (response time). Often, objective measures of such surrogates are readily obtainable.

Implementing output measures (principles)

1. Some measure of output is usually better than none (inputs as a measure of outputs). No measure is perfect,
so it’s useful to take in account the imperfections and qualify the results accordingly. In general, some output
data (however crude) are more useful than none. Rather than using imprecise indicators as absolute bases
for judgment, managers can use them as a basis for asking questions to determine if a problem really exist.
Although generally less desirable than a true output measure, inputs are often a better measure of output
than no measure at all.When inputs are used as surrogates, managers must be careful to avoid undue
reliance on them and they should continually try to develop usable measures of output.
2. Compare output measures to measures available from outside sources. Several professional associations
(hospitals, schools, colleges, universities, welfare organizations, ...) collect information from their members
and compile averages and statistics. These statistics may provide a valuable starting point in analysing the
performance of an organization.
o Problems with comparability: when a comparison between output information of an organization
and average of others is needed, the data must be comparable. This requires that the definitions
used in compiling the averages be studied carefully. Publishing statistics, an organization must be
sure that its data are prepared according to the same definitions and ground rules as those used by
the compiling organization. Comparability is especially important when data are reported for costs
per unit of output
o Problems with reliability: managers also should ensure that reliable data underlie the statistics. (If
costs per unit of output are desired, output measures must be comparable with expense measures.)
3. Use measures can be reported in a timely manner
If the manager needs information quickly as a basis for action, the controller’s staff must find a way to
compile the information quickly. For management control purposes a timely, but less accurate, output
measure is preferable to an accurate, but less timely, one.
o Reasons of timeliness problems: the problem of timeliness is different in NPOs than in for profit.
o Lack of prompt feedback: output often cannot be measured immediately after a program’s efforts
have taken place.
o Organizational hierarchy: reports on a program may have to work their way through several
organizational layers and thus be too old to be of use.
o Slowly changing circumstances: some data may describe a situation that is not likely to have
changed since the time of measurement, so old data may be useful.
4. Develop a variety of measures
There’s no such thing as a general-purpose report on output that is analogous to a general- purpose financial
statement. For most responsibility centres and organizations there are usually a few key results measures
that are important indicators of the quality and quantity of performance. In a given situation, opinions may
differ as to what these are, but it’s usually worthwhile to give careful thought to identifying them. When
there are several measures, each tends to be used for a different purpose.
o A continuum of output measures: when there are several output measures used, they tend to be
arranged along a continuum. It’s useful to think in this way because: higher- level output measures
generally are better indicators of program effectiveness than lower-level ones, which often are not
closely related to program goals and lower-level indicators are easier to specify and quantify than
are higher-level indicators.

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 Chapter 4
Healthcare organizations

In reality HCOs are the most complex organizations and they include a broad sector of organizations.
For instance, a hospital is very much complex because there are always emergency situations, that the organization
cannot fail.
The main purpose is about generating health. The health outcomes are very much important, because they regard
life of people.
Another complexity of an hospital is that customer needs are very different: emergency situation, scheduled
operation, preventative care (you feel well, but you want to avoid future diseases), ... Thinking about children, you
have the child and the family. For elderlies you have the elderly and the family. So, in this case the family is the care
giver.
For one disease you need many specialties.
For cancer: radiotherapy, chemotherapy, psychology, ...
Multidisciplinary care: team including different specialties in cancer.
Tumor board that discusses the specific case: personalized medicine.
They adapt in a flexible way the process of care. Different care path will impact into different expectancies. It
increases the possibility of life.

Resource constraints are huge, because health care processes are very much expensive (huge amount of money).
Money are needed for technology, like robotic surgery (very precise in cutting people).
And also research is very expensive (personalized medicine).

Revenues are constraints.

Sources of revenues: distinguish private and public hospitals.
Public hospitals à public foundation/money (depends on the state and on the region).
In Italy the taxation is divided into national taxation, and national taxation is divided in regional. Regions are
autonomous in manage the health care, with some national limitations.
Then from the region money go to the local health units, that are the commissioning organization (organization
responsible to assure health in his area; in Milan is ATS, ex ASL).
Commissioning means:

1. Analysing the needs: health care needs of the population living in the geographical area;
2. Organize the service in order to satisfy the needs: one decision is to deliver the service in the local unit
(organizational division in the local area);
3. Outsourcing: services coming from outside the boundaries of the area; suppliers may be private or public;
4. Check if the needs are satisfied.

Both in Emilia Romagna and in Tuscany, each local health unit owns a lot of the public production. In Emilia Romagna,
in Piacenza the local health unit produces almost the local care services inside. In Lombardy, there are some regional
laws which force the local health unit to outsource almost all. The ATS of Milan doesn’t produce almost anything, they
buy the health care services from public suppliers (public hospitals, like San Paolo) or from private hospitals
(Humanitas). It because in Lombardy, according to a regional policy, the region has established to separate the
planning and control function and the production. The ATS of Milan has the function of planning and control (many
contracts and control).

Revenues in local health units in Tuscany: they receive money and they produce inside (pay employees, drugs,
amortization of machines). If they outsource something, they need to pay the purchasing the service. In Milan, they

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receive the money from the region, and they pay some administrative and some clinical employees and the most
important expense is to pay the outsourced services.

How may a region deliver money to a local health unit?

Regional and national taxation are spread out through local health units.
Criterion to deliver money: number of citizens (not patients, because they have also preventive care). The region has
to finance the local health unit in proportion to the number of citizens living here.

In the USA there are health maintenance organizations (HMO) and are commissioning functioning. They are mainly
private, and they receive money from private insurances. They need to assure a level of health financed by private
insurances.
Usually HMOs are organized on a geographical basis. Then HMOs has to analyse the needs, organize the delivery and
purchase services from external suppliers (private hospitals).

Criterion to finance a hospital à definition of the fee for each patient: there are very different procedure from one
patient to another, even if the disease is similar.

Types of healthcare organizations

Health maintenance organizations – local health units, so aziende sanitarie locali (ATS) – they collect money from the
insurers (public or private) and then they analyze the need of the population, organize the services and delegate the
activities to the providers. Within the system of local heath units in Lombardy delegates the activities to other
providers, which may be private or public. Of course, they work for people belonging to their region. The key issue is
to avoid unneeded care, since the amount is given according to the population, so you can’t finance unneeded care,
just needed one.

• Local health units

• …

Health care providers (who produces a service):

• Acute care (one-time disease) – satisfy one need (cancer, tumors, stroke). It is a branch of secondary health
care where a patient receives active but short-term treatment for a severe injury.

o Hospitals
o Clinics
o ...

• Primary care (chronic illnesses) is the day-to-day healthcare given by a health care provider.

• Health districts
• Primary care groups
• Residential care services
• Ambulatory care services (of family doctors)
• Home care services
• …

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Health financing mechanism

Ø Capitation arrangements: capitation means per person. The local health unit receives an amount of money
per person/citizen living in the area. This amount, of course is an expected amount of money needed to
cover the expected utilization rate, it is not computed in accordance with the actual services used by people.
Of course, the region knows that an ancient man of 90 years old uses more services that a young man of 20.
The capitation is studied upon sex and age (ancient more than young, man more than woman).
In Sondrio they receive an amount of money per person higher than the average received in Milan, because
there are older people than in Milan. Financing mechanism applied to local health units (organization that
assure a commissioning function). Main financing mechanism in nations with commissioning functions.
With capitation arrangements extending beyond hospitals and into group practices, physicians must be
concerned about cost control at both the ambulatory and inpatient levels of care.
Ø DRGs: diagnosis related group. The hospital groups the patients with similar diagnostic needs. If they have a
similar disease, they need similar activities, so similar costs and similar revenues. The DRG doesn’t change if
the average length of stay (average number of days passed in the hospital). Patients are put into
homogeneous clinical groups. It’s used in case of hospitalization (people staying in the hospital for some
days). A patient passes three days in the hospital. The DRG was defined based on the group similar to the
needs.
Another patient passes five days in the hospital, maybe because it’s older and has also cardiological diseases.
The revenue is the same, because the cluster is based on the disease and the activity needed, not on the
number of days passed.
DRGs, as ambulatory fees, are paid on the basis of real patients, so when he is admitted in the hospital, he
stays there and when the hospitalization stops then the hospital will receive the revenue computed
according to DRG mechanism (by the maintenance organization through which the patient is enrolled in) –
DRG are held only for the admitted patients after the discharge.
The DRG is the amount of money paid from the local health unit to the hospital and it’s not related to the
length of stay. The length of stay isn’t considered, because hospitals are pulled to be efficient and to not
waste time. A bed in a hospital is very expensive, so they need to have a high rotation for the beds. Speed up
the process of care, so that people may stay within the hospital few days and when they are in the hospital,
they receive a lot of services in one day or few days.
The idea is to absorb a huge production capacity.
With very limited exceptions, payers that use a DRG approach pay a hospital the DRG rate for each patient
discharged and rarely adjust the payment for the costs a hospital actually incurs in proving care to the
patients.
Ø Ambulatory fees: amount received based on the actual ambulatory service – so the fee is applied after the
service is provided.
Patients don’t stay the night in the hospital. In this case there’s no the problem of hospitalization: this is the
reason because they apply a fee according to the number of services they deliver.
In the case of public ambulatory, the patient pays the ticket that is the co-payment. The ticket is paid by the
local health unit. In Milan, ATS buys also the ambulatory service.
But in Italy at a regional level (mainly) regions aim to increase the individual responsibility to reduce the
overconsumption of ambulatory services. (Need for the second, third, ... opinion) The ambulatory service is
enough one time, because the ambulatory services are for all the people. (If a person wants to go many times
to an ambulatory, pays more).
The co-payment is included in order to reduce overconsumption.
A private ambulatory accredited to the local health unit, receives money from the local health unit. If it is not
accredited to the local health unit, the patient pays.
To be accredited means that they signed an agreement of purchasing from that ambulatory a number of
services.
Sometimes the same hospital may work in part on accreditation (floor with accredited beds) and in part

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Provide the analysis to patient related cost to assure an effective and efficient use of organisation resources. The information needs to support responsability accounting healthcare must be focus on patient related cost since
costs are used to take care of them. We have to design the responsability accounting in order to motivate people working in hospital to sue resource in an effective way to improve the level of help of patient.
The most managerial way is according to control costs to motivate professional to sue resources in an efficient way. In any organisational healthcare setting the most relevant challenge is to use few scare resources to satisfy a
huge amount of patient needs.
Without a strong physician involvement we cannot improve efficiency an effectiveness in the use of resources. Physicians are controlling agents which means people who directly affect the usage of resources while the
management control team cannot control the usage. They may focus on the most supportive organisational model but at the end patients are cured by professional. A very much participative control process is relevant to
engage physicians.
Effectiveness > clinical outcome and efficiency > costs.
* Behavioural accounting : management tool used to influence the behaviour of professional in taking in mind the scarcity of resources when they prescribe diagnosis of patients.
either an ambulatory or inpatient setting.
Incentive a power responsibility concerning consumption of costs and attract patients. Outcome national plan (piano
nazionale esiti): plan in which the Italian ministry of health records a lot of information related to a lot of hospitals
(also private hospitals have to deliver information to the ministry).
The Italian ministry studies indicators for each disease à Incentive for hospitals to be efficient and effective, because
indicators on quality will be published.
Number of patients with a second surgery within six months for the same problem à If I’m with a second surgery it
means that the first operation wasn’t good.
Effectiveness→clinical outcome; Efficiencyàcosts.
Multidimensional responsibility accounting systems, that merge information about costs and about clinical outcomes.
From a cultural view point it’s easier to apply responsibility accounting in a private hospital, but it is useful also to
apply this in public hospitals.
Looking at mental diseases the DRG is low and costs are high, so they are more treated in public hospitals, that can’t
select patients.
From a legal viewpoint, every head of department should attend some managerial lessons.
At least, they should be aware on the economic and managerial issues. Sometimes, in private hospitals there are
consultants that help heads of departments à Multidisciplinary work.

Wide variety of management control systems in HCOs:

• Well-functioning or bad functioning of the system;

• Highly formal procedures and activities or quite informal and sporadic;
• Great deal of time for senior managers or senior managers quite marginally involved;
• Multi-speciality practice (great deal of decision-making autonomy delegated to clinical specialties) or the
head of the specialties have no authority/responsibility in decisions concerning the use of resources.

These differences arise because there’s no easy way to specify the precise characteristics of an organization’s MCS.
Management control principles are incomplete and occasionally contradictory.
Because they are concerned with the behaviour of people, the motivation of managers and healthcare professionals
and the role of information, these principles do not lend themselves easily to experiment or proof. They provide a way
of thinking about an important set of management problems.
In general, HCOs, including physician practices, have found management control principles useful for both resource
planning and control.
Although the presence of principles, there’s no correct way to design a management control system. It’s important
that the system firs with the organizational environment, its strategic thrust, its structure, its culture, the ways it
motivates its key personnel and how it manages patients and conflicts.
Relationships between:

Þ Motivation: recognizes and rewards individual behaviour that is in the organization’s best interest.
Þ Cultural maintenance: uses hiring, severance and training to help create a common culture and values.
Þ Management control: uses program adaptation budget formulation and measuring and reporting of financial
and programmatic results to help managers reach strategic goals.
Þ Strategy formulation: assess environmental opportunities and threats and organizational strengths and
weaknesses, and results in overall direction and goals.
Þ Conflict management: identifies conflict between and among responsibility centres and programs and creates
appropriate processes to resolve it.
Þ Client management: assures that the organization is attracting and working with clients in accordance with its
strategy.
Þ Authority and influence: include organizational structure, responsibility centre designand decision making
authority – both formal and informal.

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Management control process

As with the management control structure, the management control process must begin with the organization’s
strategy. This is true regardless of whether the organization is a large and complex integrated delivery system.
Much of the management control process is informal, even if in most organizations there also is a more formal
process. Formal control process mainly consists in regularly scheduled activities in which decisions are made about the
kinds and quantities of outputs the organization expects to provide during an upcoming period of time and the kind
and amount of resources it will to use to generate those outputs.

During any fiscal year, records usually are kept on actual results (outputs and inputs) and most organizations prepare
regular reports on these results that managers and providers can use to determine how thing are going and whether
corrective action is needed.

Ø Programming
Long-term (5-10 years) decisions, regarding all the programs and the kinds and amounts of resources to
devote. These decisions are made within the context of the organization’s overall strategy.
Formally or informally.
Ø Budgeting
Short-term (1 year). It accepts programs and determines the amount of revenues and expenses that will be
associated with each. Each organization must develop a budgeting process that meets its unique needs.
Formal process:
- standardized set of guidelines and timetable,
- participatory element for non-physicians as well as physicians,
- central staff that coordinates the activities,
- hierarchy of information that begins with the smallest responsibility centre and accumulates budget
information by successively larger responsibility centres,
- negotiation phase where each responsibility centre manager has an opportunity to defend his budget
against anticipated reductions,
- commitment at each level to carry out the agreed-upon budget.
Ø Operating and measuring
If some new programs have been approved, or if new funds have been made available for existing programs,
it’s likely that a variety of new or different types of operations also will commence at the beginning of a new
budget year.
Measure the actual results.
Ø Reporting and evaluating
Compare the actual results with budgeted objectives.→Variance analysis

Responsibility centres in HCOs

Before doing the management control process is necessary to understand which are the responsibility centres in
HCOs.
The structure of a management control system can be assessed in terms of groups of individuals working together
toward some common purpose and these groups are “responsibility centres”. They are generally led by a manager
who has overall responsibility for the group’s performance.

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Contribution margin variance analysis: for each cost drivers is computed its own variance – so the contribution margin
variance is break down for each cost drivers

- Case mix variance

- Volume variance
- Revenue price variance
- Resources per case variance
- Efficiency variance
- Price variance

EXERCISE: Cardiovascular disease

Important information:

Variable expenses per care are the sum of expenses per care per each section (radiology, laboratory, routine etc).
Expenses per case: number of cost driver x cost per cost driver. I.e. # of films per case x expenses per film
Cost drivers: number of cases and revenue per case

Acute MI
Budget Actual
Number of cases 150 175
Revenue per case $ 6.000 $ 5.700
Variable expenses per case $ 2.615 $ 2.782
Routine care
# of days per case 15 17
expenses per day $ 150 $ 140
expenses per case $ 2.250 $ 2.380
Radiology
# of films per case 5,00 6,00
expenses per film $ 25 $ 24
expenses per case $ 125 $ 144
Laboratory
# of tests per case 8 8
expenses per test $15 $ 21
expenses per case $ 120 $ 168
Pharmacy
# of units per case 40,00 45,00
expenses per unit $3 $2
expenses per case $ 120 $90
Unit contribution margin $ 3.385 $ 2.918

The question is: compute the contribution margin variance analysis

1) Total contribution margin variance

2) Break down this variance into second level variances

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 1) When you compute a total contribution margin variance, you compare a total budgeted value with actual
ones. We start always with actual – budget, since in the case of contribution margin and revenues, then we
have a positive value for a favorable situation and a negative one for an unfavorable situation.
For costs instead, you subtract actual costs from budgeted one (budgeted – actual).
2) Then we break down the contribution margin variance for each cost driver.

CONTRIBUTION MARGIN (Actual - Bdg) Check 1 Check 2

Tot CM variance =2.918 x 175 - 3.385 x 150 = $ 2.900 $ 2.900 $ 2.900
= (175 - 150) x 3.385 $ 84.625
Volume variance = $ 84.625 $ -81.725
Unit contr marg variance = (2.918 - 3.385) x 175 = $ -81.725

REVENUES (Act - BgT) $ 97.500

Tot rev variance =175 x 5.700 - 150 x 6.000 = $ 97.500
Volume variance = (175-150) x 6000 = $ 150.000
Price variance = (5.700 - 6.000) x 175 = $ -52.500

VAR COSTS (Bdg - Act) $ -94.600

Tot var cost variance = (150 x 2.615 - 175 x 2.782) = $ -94.600
Volume variance = (150-175) x 2.615 = $ -65.375 $ -29.225 $ -29.225
Unit var cost variance = (2.615 - 2.782) x 175 = $ -29.225

Breakdown of unit variable cost variance by operating units

Routine care = (2.250 - 2.380) x 175 = $ -22.750 $ -22.750
Radiology = (125 - 144) x 175 = $ -3.325 $ -3.325
Laboratory = (120 - 168) x 175 = $ -8.400 $ -8.400
Pharmacy = (120 - 90) x 175 = $ 5.250 $ 5.250

Breakdown of unit variable cost variance by operating units and drivers

Resources per case variance
Routine care = (15-17) x 150 x
175 = $ -52.500
Radiology = (5-6) x 25 x 175 = $ -4.375
Laboratory = (8 - 8) x 15 x 175
= $ -
Pharmacy = (40 - 45) x 3 x
175 = $ -2.625
Total $ -59.500
Price/efficiency variance
Routine care = (150 - 140) x 17 x
175 = $ 29.750
Radiology =(25 - 24) x 6 x 175
= $ 1.050
Laboratory = (15 - 21) x 8 x
175 = $ -8.400
Pharmacy = (3 - 2) x 45 x 175
= $ 7.875
Total $ 30.275

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