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ACC3602

Managerial Planning and Control


Semester II, AY 2014/15
Instructor:Dr.ZhuZinan
Email:bizzz@nus.edu.sg
Office:BIZ1#724

Lecture 2
Responsibility Centers
RelevantChapters:

MerchantandVanderStede,ManagementControlSystems:
PerformanceMeasurement,Evaluation,andIncentives,
Chapters7

AdditionalreadingmaterialspostedinIVLE(2files)
LearningObjectives:
1.
Responsibilitycenters
2.
Allocationofservicedepartmentcosts:3methods
3.
Allocationofservicedepartmentcosts:dualcostallocation

1. Financial responsibility centers

Resultscontrols Financialresultscontrols
Whyarefinancialresultscontrolsystemssowidely
usedinpractice?(Alternatively,wemayaskwhywe
focusonfinancial results?)
Financialobjectivesareparamountinforprofitfirms.Managers
ofnotforprofitorganizations,too,mustmonitorfinances
closely.(cashflow)
Financialmeasuresprovideasummarymeasureof
performance.
Mostfinancialmeasuresarerelativelypreciseandobjective.
Corefinancialresultscontrolmeasurementelementsarelargely
inplace.
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1. Financial responsibility centers

Financialresultscontrolsystemshavethreecore
elements:
Financialresponsibilitycenters
Theapportioningofaccountabilityforfinancialresultswithinthe
organization

Planningandbudgeting
Todefineperformanceexpectationsandstandardsforevaluating
performance

Motivationalcontracts(incentivecontracts)
Todefinethelinksbetweenresultsandvariousorganizational
incentives/rewards

1. Financial responsibility centers

Responsibilitycenter
Anorganizationunit(entity)headedbyamanagerwith
responsibilityforaparticularsetofinputsand/oroutputs

Financial responsibilitycenter
Aresponsibilitycenterinwhichthemanagers
responsibilitiesaredefinedprimarilyinfinancialterms
Fourbasictypes:revenuecenters,costcenters,profit
centers,andinvestmentcenters.

1. Financial responsibility centers: Revenue centers

Managersofrevenuecentersareheldaccountablefor
generatingrevenues(afinancialmeasureofoutputs)

E.g.,salesdepartmentsincommercialorganizations,fundraising
managersinnotforprofitorganizations

However,mostrevenuecentermanagersarealsoheld
accountableforsomeexpenses(e.g.,salespeoples
salariesandcommissions)
Advantages/disadvantages

1. Financial responsibility centers: Cost centers

Managersofcost(expense)centersareheld
accountableforexpenses(afinancialmeasureofthe
inputsconsumedbytheresponsibilitycenter)
Standardcostcenters(engineeredcostcenters)
E.g.,manufacturingdepartments
Inputsandoutputscanbemeasuredinmonetaryterms
Thereisacausalrelationshipbetweeninputsandoutputs

Discretionarycostcenters(managedcostcenters)
E.g.,R&Ddepartments,humanresourcesdepartments
Outputsproducedaredifficulttomeasure
Relationshipbetweeninputsandoutputsishardtoestablish

1. Financial responsibility centers: Cost centers

Standardcostcenters(engineeredcostcenters)
Standardcostvs.actualcost
Analysisofthecostofinputsthatshouldhavebeen
consumedinproducingtheoutputvs.thecostthatwas
actuallyincurred

Additionalcontrols
Volumeproduced,quality,etc.

Discretionarycostcenters(managedcostcenters)
Ensuringthatmanagersadheretothebudgeted
expenseswhilesuccessfullyaccomplishingthetasksof
theircenter
Subjective,nonfinancialcontrols

Forexample,qualityofserviceprovided

1. Financial responsibility centers: Profit centers

Managersofprofitcentersareheldaccountable
forgeneratingprofits(afinancialmeasureofthe
differencebetweenrevenuesandcosts)
Indecidingwhetheranentityisaprofitcenter,

Doesthemanagerhavesignificantinfluenceoverboth
revenuesandcosts?
itisnotimportanttoconsider

Whethertheentitysgoalistomaximizeprofits
Whetheranyrevenuesaregeneratedfromoutsidethe
organization

1. Financial responsibility centers: Profit centers

Revenue
Cost of goods sold
Gross margin
Advertising + promotion
Research + development
Profit before tax

Gross
Margin
Center

Incomplete
Profit
Center

Before-tax
Profit
Center

Complete
Profit
Center

Income tax
Profit after tax
Note: signifies that the responsibility center manager is held accountable for that financial statement line item.

1. Financial responsibility centers: Investment centers

Managersofinvestmentcentersareheldaccountablefor
theaccountingreturns(profits)andtheinvestmentsmade
togeneratethosereturns
E.g.,toplevelmanagersinmostorganizations
Objective=returnoncapital
Involvearatiooftheprofitsearnedtotheinvestmentcapital
used,e.g.,ROI
Absolutedifferencesinprofitsarenotmeaningfulifthevarious
organizationalentitiesusedifferentamountsofresources

Infact,managershavetwoperformanceobjectives
Generatemaximumprofitsfromtheresourcesattheirdisposal
Investinadditionalresourcesonlywhensuchaninvestmentwill
produceanadequatereturn

1. Financial responsibility centers

Controllabilityprinciple
Employeesshouldbeheldaccountableonlyforwhatthey
control.

Financialresponsibilitycenters(behavioralangle)
Holdemployeesaccountablefortheperformanceareas
thatmanagementwantsthemtopayattentionto.

Examples:
Chargingcorporateadministrative(overhead)coststo
segments
Howarethesecostsallocated?

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2. Allocation of service department costs

Operating
Departments

Carry out the central purposes


of the organization

Service
Departments

Do not directly engage in


Operating activities

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2. Allocation of service department costs


Service department costs are charged to operating
departments for a variety of reasons including:
Toencourageoperating
departmentstowisely
useservicedepartment
resources.

Toprovideoperating
departmentswithmore
completecostdatafor
makingdecisions.

Tohelpmeasurethe
profitabilityofoperating
departments.

Tocreateanincentive
forservice
departmentsto
operateefficiently.

2. Allocation of service department costs

Methods
Direct method
Step method
Reciprocal method
Difficulty
Service departments may
provide services to each other
(interdepartmental or reciprocal services)

2. Allocation of service department costs: Direct method

Cost of services
between service
departments are
ignored and all
costs are
allocated directly
to operating
departments.

Service
department
(Cafeteria)

Operating
department
(Machining)

Service
department
(Janitorial))

Operating
department
(Assembly)

DirectMethodExample
Departmental costs
before allocation
Number of employees
Square feet occupied

Service Departments

Operating Departments

Cafeteria

Janitorial

Machining

Assembly

$ 250,000
1,000

$ 160,000
20
-

$ 100,000
60
4,500

Service department

Allocation base

Cafeteria
Janitorial

Number of employees
Square feet occupied

60,000
20
4,500

DirectMethodExample
Departmental costs
before allocation
Cafeteria allocation

Service Departments

Operating Departments

Cafeteria

Janitorial

Machining

Assembly

$ 250,000

$ 160,000

$ 100,000

(250,000)

187,500

60,000
62,500

Janitorial allocation

Total after allocation

$250,000

20
60 + 20

= $62,500

Allocation base: number of employees

DirectMethodExample
Departmental costs
before allocation
Cafeteria allocation

Service Departments

Operating Departments

Cafeteria

Janitorial

Machining

Assembly

$ 250,000

$ 160,000

$ 100,000

(250,000)

Janitorial allocation

Total after allocation

$160,000

0
(160,000)
0

4,500
4,500 + 4,500

Allocation base: square feet occupied

60,000

187,500

62,500

80,000

80,000

$ 367,500

$ 202,500

= $80,000

2. Allocation of service department costs: Step-Down method

Service department
costs are allocated
to other service
departments and
to operating
departments, usually
starting with the
service department
that provides the
greatest amount of
service to other
departments.

Service
department
(Cafeteria)

Operating
department
(Machining)

Service
department
(Janitorial)

Operating
department
(Assembly)

StepMethod
Once a service
departments costs
are allocated,
other service
department costs
are not allocated
back to it.

Service
department
(Cafeteria)

Operating
department
(Machining)

Service
department
(Janitorial)

Operating
department
(Assembly)

StepMethod
Janitorial will
have a new
total to allocate
to operating
departments: its
own costs plus
those costs
allocated from
the cafeteria dept.

Service
department
(Cafeteria)

Operating
department
(Machining)

Service
department
(Janitorial)

Operating
department
(Assembly)

StepMethodExample
Departmental costs
before allocation
Cafeteria allocation

Service Departments

Operating Departments

Cafeteria

Janitorial

Machining

Assembly

$ 250,000

$ 160,000

$ 100,000

50,000

150,000

(250,000)

60,000
50,000

Janitorial allocation

Total after allocation

$250,000

20
20 + 60 + 20

Allocation base: number of employees

= $50,000

StepMethodExample
Departmental costs
before allocation
Cafeteria allocation

Service Departments

Operating Departments

Cafeteria

Janitorial

Machining

Assembly

$ 250,000

$ 160,000

$ 100,000

50,000

150,000

(250,000)

Janitorial allocation

Total after allocation

(210,000)
?

60,000
50,000

New total in Janitorial = $160,000 (original Janitorial cost)


plus $50,000 (allocated from Cafeteria).

StepMethodExample
Departmental costs
before allocation
Cafeteria allocation

Service Departments

Operating Departments

Cafeteria

Janitorial

Machining

Assembly

$ 250,000

$ 160,000

$ 100,000

50,000

150,000

50,000

(210,000)

105,000

105,000

$ 355,000

$ 215,000

(250,000)

Janitorial allocation

Total after allocation

$210,000

4,500
4,500 + 4,500

Allocation base: square feet occupied

= $105,000

60,000

2. Allocation of service department costs: Reciprocal method

Recognizes all
interactions of
service
departments.
The usage of one
service department
by another is used
to determine the
total cost of each
service department.

Service
department
(Cafeteria)

Operating
department
(Machining)

Service
department
(Janitorial)

Operating
department
(Assembly)

ReciprocalMethodExample
Departmental costs
before allocation
Number of employees
Square feet occupied

Cafeteria

Janitorial

Machining

Assembly

$ 250,000
1,000

$ 160,000
20
-

$ 100,000
60
4,500

60,000
20
4,500

Proportion of Output Used by


Cafeteria
Janitorial
Machining
Assembly
Allocation ratios:
Cafeteria
Janitorial

--0.1

0.2
---

0.6
0.45

0.2
0.45

ReciprocalMethodExample
Specifyasetofequationsthatexpressthe
relationshipsbetweenthedepartments.
Cafeteria(CA)=dept.costs+ShareofJanitorialscost
=$250,000+0.1JA
(1)
Janitorial(JA)=dept.costs+ShareofCafeteriascost
=$160,000+0.2CA
(2)
SolveforCAandJA,
CA(Cafeteria)=$271,429
JA(Janitorial)=$214,286

ReciprocalMethodExample
Allocated to
Total Cost
Cafeteria
Janitorial
Total

Machining

Assembly

271,429

162,857

54,285

214,286

96,429

96,429

$ 259,286

$ 150,714

$271,429 0.6
$271,429 0.2

$214,286 0.45
$214,286 0.45

ComparisonofMethods
Direct Method
Departmental
cost before
allocation

Step Method

Reciprocal Method

Machining

Assembly Machining

Assembly Machining

Assembly

$ 100,000

60,000 $ 100,000

60,000 $ 100,000

60,000

Cafeteria
allocation

187,500

62,500

150,000

50,000

162,857

54,285

Janitorial
allocation

80,000

80,000

105,000

105,000

96,429

96,429

Total after
allocation

$ 367,500

$ 202,500

$ 355,000

$ 215,000

$ 359,286

$ 210,714

ComparisonofMethods
CostAllocationAccuracy
The Direct method does not consider
interactions among service departments.
The Step method considers some interactions
among service departments.
The Reciprocal method is more thorough in
considering interactions among service
departments.

3. Allocation of service department costs: Dual cost allocation

Variable
Costs

Fixed
Costs

Charge touser
departmentsata
budgetedratetimes
theactualusageof
theallocationbase.

Allocate
budgetedamounts
touserdepartments
inproportiontothe
capacitydemandedby
theuserdepartment.

DualCostAllocation
Maintenance Dept
Budgeted Costs FY10
Variable
Fixed
Total

$120,000
360,000
$480,000

DualRate:
VC:
FC:

Machine Hours Usage


Normal Budgeted FY10 Actual FY10

Machining 6,000
Assembly 4,000
Total
10,000

8,000
4,000
12,000

$120,000/12,000=$10perMH
Machining=$360,000x0.6=$216,000
Assembly=$360,000x0.4=$144,000

7,000
5,000
12,000

DualCostAllocation
DualRate

Machining Assem bly


Dept

Dept

VC allocation:
$107,000 MH $ 70,000
$105,000 MH

$ 50,000

FC allocation
60%x$360,000

216,000

40%x$360,000
Total cost

144,000
$286,000

$194,000

EndofLecture2

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