1. Internal Control Systems
An organization uses resources to create a product or service
Question: How to use accounting systems to make the most important resource --- people --- more efficient?
Managing people
People in interpersonal vs. organizational settings
Accounting systems and numerical data
Your personal relationship to numbers

2. What is a Firm?
Liability
Assets
Owners’
Equity

3. Nexus of Contracts
Where is the product? The raw material? The financing?
Explicit or Implicit?
Who are the parties?
Financers, suppliers, employees, consumers
Collectively called “stakeholders”
The notion of “impersonal” leadership
How long does it take a student to grasp the nexus?
The role of theater

4. Strategy as a Nexus of Contracts
Your strategy is as good as its execution
Your competitors, customers, etc., will not be central to execution
Your organization will be central
Your organization is a Nexus of Contracts
Explicit or Implicit
Financers, suppliers, employees, consumers
Role of Management Accounting Systems in enabling the Nexus

5. Valuation as a Nexus of Contracts
Hedge funds and private equity funds
Valuation
Control
More money in control
Locate the firm with
Good assets
Bad Nexus of Contract
Get a controlling share somehow (debt, equity, etc.)
Improve its Nexus of Contracts
Sell the firm

6. Designing a Nexus of Contracts
Decision Rights & Control
Managerial Evaluation &
Capital Investments
Performance Metrics

7. Crucial Glue Managerial Evaluation & Decision Rights & Control
Capital Investments
Performance Metrics
FINITE
Communication

8. The Pedagogy of the Class
Primrose path
I teach how to take a Nexus and figure out the accounting
Linear rule-based teaching
You learn nothing
The steep and thorny way
You learn to uncover the Nexus underlying an accounting statement
I will help you but that will work only if you put in effort

9. First topic: Budgeting
Costs are driven by Resources
Resources are used by Products
Costing Concepts
Understand how Resource Costs map into Product Costs
Organizations need to compute Product Costs in advance
Planning and pricing cannot wait till actual costs are realized
Resource acquisition decisions must also be made in advance

10. Budgeting
Budgeting:
Process of developing a forecast of business activities in future periods
Budgets:
Result from the budgeting process
Expressed in financial measures (sales, expenses, income)
Primary uses of budgets:
Planning (e.g., resource acquisition decisions)
Performance measurement: Actual results are compared to budget

11. The Budgeting Process
Run the production or the business model in reverse
Forecast sales
Forecast production volume
Forecast various resource commitments and purchases

12. Budgeting Example Ross Jewelers currently has 10 rings in inventory
Forecast sales for next month is 20 rings
Production target is set for 15 rings (5 rings safety stock)
Producing this volume requires committing to $300 in factory resources
In addition, producing each ring is forecast to
Require $50 in raw material
Require $10 in labor
Budgeted Product Cost = [$300 + ($50 + $10) x 15] ÷ 15 = $80 per ring

13. Budgeting Challenges Key challenge:
Information that is important for developing budgets is spread throughout the organization.
E.g., managers of foreign divisions have superior knowledge about local market trends.
→ Top management can’t prepare budgets by themselves.
What is the best way to collect all the information?
Which employees should make forecasts?
Are employees going to report their “true” forecasts?

14. Budgeting Summary
The budgeting process runs the business model in reverse:
Forecast: Sales  Production Volume  Input Resources
Budgets typically have a dual role:
Planning
Performance evaluation
Key challenge:
Information is spread throughout the organization

15. Performance Measures Goal of the firm is to maximize value (or profit)
Easier said than done
Giving the manager a profit based bonus contract
Assumes the manager knows how to improve profits
What actions to take?
Will these actions really be effective in improving profits?
We need to decompose the problem
Smaller and more focused goals and actions
These goals and actions combined generate profits

16. Budgeting with non-financial measures
Idea is to consider a system of multiple measures (both financial and nonfinancial)
Four “perspectives”
Owners (financial)
Customers
Internal processes
Innovation and learning (or growth)
For each perspective, goals are linked to measures

17. Scorecard Perspectives
Financial
Goals
Measures …. ….
Customer
Internal
Goals
Measures
Goals
Measures …. …. …. ….
Innovation
Goals
Measures …. ….
Source: Kaplan and Norton (1991)

18. Financial Perspective
Ultimate goal is financial performance
Focus here is on for-profit firms
Example Goals
Example Measures
Profitability
Return on Investment
Growth
EPS growth (1, 5, 10 year)
Survival
Cash flow

19. Customer Perspective Customer experience is important for firms
Example Goals
Example Measures
Satisfaction
Satisfaction index
Delivery
% late deliveries
Improved service
Year-over-year complaints

20. Internal Perspective Efficiency (productivity) important to firms
Lean initiatives
Example Goals
Example Measures
Quality
Defects
Lean operation
Inventory turnover
Responsiveness
Cycle time

21. Innovation Perspective
Organization learning can be important for growth of the firm (and employees)
Example Goals
Example Measures
Innovative
New products
Leading edge
Patents
Knowledge
Employee competencies

22. Strategy Mapping Financial Grow revenues Control costs Customer
Satisfy customers
Add customers
Internal
Improve quality
Improve processes
Innovation
Develop skills
Innovate

23. The Balanced Scorecard
Identify key actions to generate profits
Measure these actions using the most appropriate financial and non-financial measures
Set goals for these measures
Link these goals and measures to each other by a “strategy map”
Main uses of Balanced Scorecard Information:
A guide to better planning and investment decisions
A compensation tool to evaluate divisional performance
Google Oxygen

24. After Budgeting Divisional Manager and CEO Compensation
Analysis of Variances from Budgets
Analysis of Transfer Pricing
Control in the Financial Services Industry
The seamless move from Internal  External
Corporate Finance
Financial Markets