MS 07 RESPONSIBILITY ACCOUNTING & TRANSFER PRICING

Responsibility Accounting
- performance are recorded & evaluated by levels of responsibility within an organization
- an accounting information system
- a managerial control device
- works best in decentralized org
- basic purpose: Motivation

Steps in implementing Responsibility Accounting

1.
Costs and / or revenues be classified according to responsibility centers
2.
Cost are classified as either controllable or non-controllable
3.
Within controllable classification, cost are classified according to the nature of expense
4.
A performance report is furnished by each center & reported to the appropriate level of mgmt
Responsibility Centers
-segment or subunit of an org
1.

Cost center
- where manager has control over cost

variance analysis- best for evaluating mgmt. performance

2.

Revenue center
- manager has control over revenues

3.

Profit center
- manager has control over cost & revenue

4.

Investment center
- manager has control over cost & revenues as well as investments
- almost like an independent business

5.

Service center
- usually operated as cost center
- provide specialized support to the other segments of an org

Controllable cost

- costs that may be directly regulated at lower levels of mgmt

Non-controllable Cost
- costs that cannot be regulated at a particular mgmt. level other than the top level
Performance Report
- end product of responsibility acctg process
- shows & compares actual results with the intended (budget/std) results
- highlighting deviation that need corrective actions

Contribution approach
-usually used to measure performance
Sales
xx
VMC
MCM
xx
VS&A
(xx)
CM
xx
Controllable FC
(xx)
Short-run performance margin
Non-controllable FC
Segment Margin
Allocated common cost
Operating Income

(xx)

xx
(xx)
xx
(xx)
xx

Financial Performance Measure

1.
Return on Investments (RoI)
RoI = Operating Income / Operating Assets
= Margin x Turnover
= Income / Investment
= (Sls / Inv) x (Income / Sls)

Income EBIT
Net income
NI adjusted for Price level changes
Cash flow

Investments
Total assets
Total assets used by segment in its operation (excluding idle assets)
Working capital + Other Assets
SHE

RoI computation is based on DuPont Formula:

ROA = Asset TO x ROS
NI = Sales
x
NI
Assets Assets
Sales

2.

Residual Income
RI = Operating Income Required Income
*Required income = Operating Assets x Minimum RoI
= Income earned or expected income of an investment center Desired Income
* Desired Income = Investment x DRR
*DRR is usually the Cost of Capital

3.

Economic Value Added (EVA)

- more specific version of residual income that measures the investment center real economic
gains
EVA = Income after tax Required Income
*Required Income = (Total Assets CL) x WACC after tax
= Income after tax Desired Income

Equity Spread (ES)

- calculates equity value creation of shareholder value
ES = Beg Equity capital x (Return on Equity x % of cost of equity)

Total Shareholder Return (TSR)

TSR = Change in stock price + Dividend per share
Initial Stock Price

Market Value Added (MVA)

MVA = Market Value of Equity Equity supplied by shareholders
*MV of Equity = Shares outstanding x Market Price

4.

Delivery Cycle Time (Customer Response Time)

-length of time between receiving an order to the time when it was delivered to customer
- only the process time is value added time

5.

Throughput or Manufacturing Cycle Time

- time required to convert RM to FG
- composed of:
Process time
- amount of time in which work is actually done on the product

Inspection time
- amount of time spent to check if the product is not defective

Move time
- time required to move RM & WIP from 1 workstation to another

6.

Queue time
- amount of time a product spends waiting to be processed, moved, inspected & shipped

Manufacturing Cycle Efficiency (MCE)

- objective is to reduce or eliminate non-value added time in the delivery cycle time
MCE = Value Added Time or Process Time
Throughput Time

7.

If MCE < 1: non-value added time is present in the production process

*Ex: If MCE is 20% , 80% of the time of producing a unit is spent on non-value added
activities

Non-value added time = Lead time Production time

Delivery Cycle Efficiency (DCE)

DCE = Value Added Time
Delivery Cycle Time

Organizational Structure
1.

Centralized Organization
- top mgmt makes most decisions

2.

Decentralized Organization
- there is employee-empowerment
-decentralized related concepts:
a. Goal Congruence
- all units of org have incentives to perform for a common interest
- purpose: motivate mgmt performace that adheres to company overall objectives
- sharing of goals by superiors & subordinates
- agreement on the goals
b. Managerial Effort
- exertion of effort by decision-makers to reach a common goal or objective
- extent to which manager attempts to accomplish a specific goal
- may include psychological & physical commitment to a goal
c. Motivation

combination of GC & ME
a drive forward a goal that creates action and effort
employees must be properly motivated to achieve GC & ME
desire to attain a specific goal & the commitment to accomplish the goal

d. Sub-optimization
- 1 segment take action that is in its own best interest but is detrimental to the firm as a
whole
*Responsibility accounting designed to achieved GC & to discouraged sub-optimization
e. Organizational Chart
- shows responsibility relationship among managers in an org
- sets forth principal mgmt position
- helps define authority, responsibility & accountability
f.

Autonomy
-extent to which managers have the authority to make decisions

Other key concepts in Responsibility Accounting

1.
Authority
-power to direct & exact performance
2.

Responsibility
-obligation to perform

3.

Accountability
-duty to report performance to ones superior

4.

Controllability
-extent to which managers can influence activities, cost, revenues, or capital

5.

Management by Objectives
-a behavioral, communications-oriented, responsibility approach
-where manager and subordinates agree upon objectives & the means on how such objectives
can be attained

Balanced Scorecards
- a goal congruence tool or a performance measurement system
- strikes a balance between financial & operating performance measures
- links performance to rewards
- gives explicit recognition to the diversity of interests of stakeholders
- its a strategic mgmt system that defines a strategic-based responsibility accounting system
4 different perspectives:
1.

Financial Perspective
-describes economic consequences of actions taken in customer internal business process and
learning & growth perspectives

2.

Customer Perspective
-identifies & defines the customer & market segments in which the firm will compete

3.

Internal Business Process Perspective

-describes the internal process that will provide value for the firms customers and owners

4.

Learning & Growth (Infrastructure) Perspective

-identifies & defines capabilities that an org needs to create long-term growth & improvement

Cycle time
-time required to produce a unit of output
CT = Time / Outputs
Velocity
-# of units of output that can be produced in a given period of time
V = Units produce / time
Productivity
-relationship between output & input
Productivity Ratio = Output / Input
1.

Partial Productivity
-ratio of output to the quantity of a single factor of production
a. Operational Partial Productivity
OPP = Qty of output produced
Qty of inputs used
b. Financial Partial Productivity
FPP = Qty of output produced
Cost of inputs used

2.

Total Productivity (Total Factor Productivity)

-ratio of qty of output produced to the cost of all relevant inputs used based on current period
prices
TP = Qty of output produced
Costs of all inputs used

Strategic Analysis of Operating Income

Strategy

-specifies how an org matches its own capabilities with the opportunities in the market place to
accomplish its objectives
2 Basic Strategies
1.
Product Differentiation
-ability to offer products & services perceived by customers to be superior & unique relative to
the products or service of competitors
2.

Cost Leadership
-ability to achieve lower cost relative to competitors
-best for company if engineering staff is more skilled at making process improvements than at
creatively designing new products
-to evaluate the success of its strategy:
a. Growth Component
-measures the change in revenue and cost from selling more or less units, assuming
nothing else has changed
Revenue effect of growth = (Yr2 units sold Yr1 units sold) x Yr1 selling price
Cost effect of growth for variable cost = (Units of input required to produce Yr 2
output in Yr1 - Actual units of input used to produce Yr1 output) x Yr1 input price
b. Price Recovery Component
-measures change in revenue & cost solely as a result of change in price of outputs &
inputs
Revenue effect of Price recovery = ( SP in Yr2 SP in Yr1) x Actual units of output
sold in Yr2
Cost effect of Price recovery for VC = (Input P Yr2 Input P Yr1) x Units of input
required to produce Yr2 output in Yr1
Cost effect of Price recovery for FC = (Price per unit of capacity in Yr 2 Price per
unit of capacity in Yr1) x Actual units of capacity in Yr1, because adequate
capacity exist to produce Yr2 output in Yr1
c. Productivity component
-measures decrease in costs from using fewer units, a better mix of inputs and reducing
capacity
Cost effect of productivity for VC = (Actual units of inputs used to produce Yr 2
output Units of input required to produce Yr2 output in Yr1) x Input Price in Yr2
Cost effect of productivity for FC = (Actual units of capacity in Yr 2 Actual units
of capacity in Yr1, because adequate capacity exist to produce Yr2 output in Yr1)
x Price per unit of capacity in Yr2