Accounting, Finance and Control (Maccarrone) by Cremaschi

Accounting, Finance &

Control

ACCOUNTING,

FINANCE &

CONTROL 1

Sommario

1.0 Introduction .................................................................................................................................................................. 3

1.1 The CFO ............................................................................................................................................................. 3

1.2 Organization and duties ........................................................................................................................................... 4

1.3 Introduction to external accounting ........................................................................................................................ 6

1.4 Internal accounting .................................................................................................................................................. 6

1.4.1 Decision making ................................................................................................................................................ 6

1.4.2 Behavioural aspects .......................................................................................................................................... 8

2.0 Financial accounting ................................................................................................................................................... 10

2.1 Fundamental accounting principles ....................................................................................................................... 12

2.2 Balance sheet ......................................................................................................................................................... 14

3.0 Consolidated financial statements ............................................................................................................................. 20

3.1 Consolidation process and examples ..................................................................................................................... 22

4.0 Financial Indicators ..................................................................................................................................................... 26

4.1 Overview of corporate performance measurement .............................................................................................. 26

4.2 Profitability Analysis ............................................................................................................................................... 27

4.3 Innovative financial indicators ............................................................................................................................... 30

4.4 Liquidity analysis .................................................................................................................................................... 33

5.0 The budgeting process ................................................................................................................................................ 34

5.1 Master budget ........................................................................................................................................................ 36

5.2 Organisational issues .............................................................................................................................................. 45

6.0 The control phase ....................................................................................................................................................... 45

6.1 Control phase ......................................................................................................................................................... 45

6.2 Management reporting .......................................................................................................................................... 46

7.0 Control of responsibility centres: part I ...................................................................................................................... 47

7.1 Transfer prices ........................................................................................................................................................ 49

7.2 Corporate cost allocation ....................................................................................................................................... 52

8.0 Control of responsibility centres: Part II ..................................................................................................................... 54

8.1 Cost centres ............................................................................................................................................................ 54

8.2 Revenue centres ..................................................................................................................................................... 56

8.3 Expense centres...................................................................................................................................................... 58

8.4 Innovative approaches for cost/revenue centres .................................................................................................. 59

9.0 Non-financial KPI ......................................................................................................................................................... 60

9.1 Characteristics of non-financial performance and resource indicators ................................................................. 67

10.0 Strategic KPIs, dashboards, balanced scorecards ..................................................................................................... 67

10.1 Balanced Scorecards ............................................................................................................................................. 70

11.0 Budgeting and risk management .............................................................................................................................. 79

2

1.0 Introduction

1.1 The CFO

Activities and processes regarding accounting are performed by an organisational unit usually

called “Administration, Finance and Control” or A, F&C. The head of this unit is named “Chief

Financial Officer” or CFO which reports directly to the Chief Executive Officer (CEO). Sometimes he

In modern companies

is considered so important that the CFO is regarded as important as the CEO.

there is a new figure who specializes in optimizing long term performances called Chief Performance

Officer (CPO), which can completely take the place of the CFO in some cases.

<<Senior-most executive responsible for financial control and planning of a firm. He or she is in charge of

all accounting functions including (1) credit control, (2) preparing budgets and financial statements, (3)

coordinating financing and fund raising, (4) monitoring expenditure and liquidity, (5) managing investment

and taxation issues, (6) reporting financial performance to the board, and (7) providing timely financial data

to the CEO >>

www.businessdictionary.com

<<A Chief Financial Officer (CFO) is the senior executive responsible for managing the financial actions of a

company. The CFO's duties include tracking cash flow and financial planning as well as analysing the

company's financial strengths and weaknesses and proposing corrective actions. The CFO is similar to a

treasurer or controller because he is responsible for managing the finance and accounting divisions and for

ensuring that the company’s financial reports are accurate and completed in a timely manner >>

www.investopedia.com 3

(1) Credit control means recovering commercial credits in due time and trying to reduce payment

periods. (3) Coordinating finances and fund-raising means dealing with banks and investors, they

try to reduce as far as possible the interest rates and risk rates. (4) Monitoring expenditure and

liquidity means checking all cash flows in and out of the company. (5) They work on acquisitions

valuing companies and trying to obtain them at the best possible conditions. On the other hand, if

the company wants to divest on a business area they will value it and try to sell it at the highest

possible value. (6) The board is interested about the month to month evolution of the company.

1.2 Organization and duties

The technostructure is formed by specialists in management and finance fields. The A, F&C

department isn’t cut off from the rest of the company; to explain the numbers and to have a

deeper understanding of the situation the CFO will ask reports from the head of sales, plant

managers and all other major heads of departments. Furthermore, controllers must check

expenditures for all the departments and if one of them goes out of budget the controllers should

evaluate granting more money or reducing costs.

Accountants often face a dilemma because they are called to fulfil two conflicting roles

simultaneously:

1) “Watchdogs” of top managers and scorekeepers with a focus on completeness and

“reliability” of financial data. They check if the CEO is taking the appropriate decisions from

a financial perspective. Often accountants will annoy managers asking for financial

information relating to their department and will nag them on expenditures and budgets. 4

2) Helper/supporter (or “partner”) of managers in the decision-making processes with an

attention-directing role. For example, a CFO has to identify opportunities and threats

stemming from an external strategical analysis. Another important trait is a positive

problems-solving attitude. Accountants predict the economic implications of managerial

decisions. Often managers, especially in sales, won't have an economic background and are

generally more interested in revenues than profits.

The duties of financial accountants are two:

1) Internal accounting (managerial accounting): Aids in strategical, managerial decision-

making processes and control; consists of financial and non-financial data.

2) External accounting (statutory reporting): mandatory (by law) reports to inform and

protect shareholders and stakeholders. Now more than ever non-financial data is given as

well even though it’s not required by law.

Accountants will try to be very accurate and complete, managers will often ask for TLDRs and

rough reports to take strategical decisions in a quick and timely manner. This creates a struggle.

Typically, data is organised by accountants and then presented in reports. Some of these are

periodically drafted (quarterly, management report). Others might be one-offs to support decision

making, which may require data that doesn’t exist in the information system because it hasn’t

been collected and stored yet. In these cases, it has to be gathered specifically to support that

decisional process.

In order to understand which data is relevant, a conceptual model has to be built (problem

setting). Ex: an outsourcing decision: which internal processes are impacted? What the impact on

resources? Which are the relevant (differential) costs?

As stated, nowadays CFOs complement the financial analysis with information which is non-

financial in nature. Old financial accountants had no idea of non-financial performances, but today

CFOs must be aware of them, how they are measured and what they refer to. (lead times, quality

rates...) 5

1.3 Introduction to external accounting

The key issue is disclosure. A company on one hand has to be transparent because shareholders

and stakeholders should be protected by wrongdoings. But on the other hand, there are a lot of

secrets that shouldn’t be reported because if these were to leak competitors would get free

strategic advantages.

Companies are asked (by its stakeholders) to communicate periodically financial and non-financial

information:

• Mandatory Financial Statements (ruled by national and supranational laws)

• Non-mandatory (but strongly suggested) social/sustainability/environmental reporting. It

should follow some rules if provided:

1) Information should be complete with reference to international or national reference

standards (ex: GRI – Global Reporting Initiative standards);

2) Information should be stable across time: changes in contents, measurement criteria

and other elements have to be justified.

3) Information should be transparent and understandable for readers

1.4 Internal accounting

When we talk about internal accounting we are referring to management control systems that

serve two main purposes and a one secondary purpose:

1) Support decision making (and thus contribute to the achievement of the company ultimate

goals)

2) Control/influence the behaviour of people working in an organisation: this is linked to the

decentralisation of decisional power (from top management down along the organisational

structure) and consequent identification of responsibilities. It basically underlines the

effort of people. This is encouraging to workers because good jobs are rewarded but, on

the other hand, it’s stressful because workers feel assessed.

3) Another objective (or side-effect) consists in learning (and continuous improvement of the

control model)

1.4.1 Decision making 6

This is the primary role of an MCS: help management to reach the target goals of a company. It

can be seen as a type of cybernetic cycle. Two main phases can be identified:

1) Planning

2) Control, which, in turn, can be split into three sub-phases:

a) Measurement of actual results

b) Analysis, formalization and communication of actual results

c) Identification of corrective actions

The company will try to keep score of performances (Ex: net profit, EBIT, EBITDA, ROE, etc...) and

set target values. The internal accounting department completes the following tasks:

• Calculate costs of the investments needed for plan execution

• Risk assessment regarding other possible strategic decisions

• Assessing performances once they unfold and delta (Expected - actual) calculation

• Give feedback to the decision-making team, that in turn will take minor adjustments to

close eventual gaps

The planning phase aims at defining a plan of action

Considering: objectives, resources, risks

Input data required: prices (historical, predicted), product costs (material, labour, other costs), …

A model is required: Ex. how to estimate the impact of an investment in a new technology (on

efficiency and then on costs and/or revenues)?

During or after the plans execution, managers want to know the outcome therefore, they measure

results periodically, the control phase. This would be useless if:

• We were able to predict the exact value of each variable in the planning phase

• Models were perfect

Actual results differ from budgeted (or target) ones because of:

1) Change in value of external (or “exogenous”) variables (e.g. lower or higher demand,

increase in the cost of raw materials, higher or lower interest rates, etc)

2) Change in value of internal (or “endogenous”) variables (Ex. productivity turns out to be

lower/higher than expected, change in the mix of resources used to perform a process, …)

3) The model is not perfect

Variance analysis consists in the thorough analysis of the differences between actual and

budgeted performances. The quality of the model is essential to detect the inner validity of the

variances. Ex: non-respect of budgeted production costs (to produce a certain amount of finished

goods) is a problem of inefficiency/over-efficiency or is it because standard unitary costs are

inaccurate?!

The final step after the analysis of variances is the implementation of corrective actions which can

affect both plans and objectives. 7

1.4.2 Behavioural aspects

A company is a very complex «system». It is very hard to model because it’s hard to correlate

inputs with outputs. Moreover, companies are different from electronic/mechanical systems: the

human component! Human beings tend to adapt their behaviour according to the «control»

mechanisms in place, AKA the way the business measures and evaluates performance. An

excessive control could be counterproductive, but generally people will adapt their behaviour to

match a certain set of requirements.

Example: people are not assessed by how clean their desk is; in some companies this is considered

important. To achieve order in the working space they create indicators on the cleanness of desks.

At the end of the year employees which have a positive score will receive a bonus. The same thing

might happen with electricity consumption, etc...

Motivation: it refers to pushing individuals working in an organization to provide the maximum

effort in order to achieve organization goals. The following framework shows critical nodes related

to the motivation process:

THE ACTION THEORY:

They have to do with the EFFORT provided by an individual within an organisation. The most

recognized among action theories is Maslow’s one (about the hierarchy of needs):

1) Primary needs: physiological (related to survival - including food and other “basic” needs),

linked to safety and physical protection, …

2) Secondary needs: social (acceptance and friendship), related to personal ego (self-respect,

autonomy, status, self-fulfilment, …)

According to Maslow, these needs form a hierarchy of priority for action: once primary needs are

satisfied, employees’ behaviours are driven by secondary needs or in our case the implicit

motivational role of Management Control Systems (even with no explicit incentives). More recent

studies highlight that the effort provided by an employee within an organization depends also

upon social relationships with peers and superiors. Individuals are motivated to increase their

effort when:

1) They are part of a hardworking team (socialization is improved)

2) They know that they are being evaluated (formally or informally) by their bosses. This issue

points out the need for a timely managerial control system that is capable of providing

quick feedbacks to employees regarding their behaviour and performance.

3) The time period of analysis of performances is short. People might at first think that the

goal can be reached later in time, and once it’s too late to achieve they give up. 8

THE CHOICE THEORY:

Individuals usually have personal objectives which may be not consistent with those of