Responsibility Accounting

“Responsibility Accounting collects and reports planned and actual accounting information about the inputs and outputs of responsibility centres”. Responsibility Accounting is based on information pertaining to inputs and outputs. The resources utilised in an organisation which are essentially physical in nature and refer to quantities of materials consumed, hours of labour and so on, are termed as inputs. These heterogeneous physical resources are converted into a common denominator called the monetary measure, for the purpose of managerial control. When they are expressed in monetary terms, they are fermed as “costs”. In a similar way, when outputs are measured in monetary terms, they are termed as “revenues”. More precisely, responsibility accounting is based on cost and revenue data or financial information. Responsibility Accounting must be so designed as to suit the existing structure of the organisation. Responsibility should be coupled with authority. A person is obliged to perform his duties only when he is conferred with adequate powers to do so. A sound organisation structure, with clear-cut assignment of authorities and responsibilities should exist for the successful functioning of the responsibility accounting system. When the organisation is not in order, it will miserably fail to work. Responsibility Accounting system mainly depends on the assigned responsibilities and authorities such that the performance of each manager is evaluated in terms of such factors. Responsibility Centres: The main focus of responsibility accounting is on the responsibility centres. A responsibility centre is a sub-unit of an organisation under the control of a manager who is held responsible for the activities of that centre. The responsibility centres, for control purposes, are generally classified into: (1) Cost Centres, (2) Profit Centres and (3) Investment Centres. Cost Centres: When the manager is held accountable only for costs incurred in a responsibility centre, it is called a cost centre. More precisely, it is the inputs and not outputs that are measured in terms of money. In a cost centre of responsibility, the accounting system records only costs incurred by the centre/unit/division, but the revenues earned (output) are excluded from the purview. This only means that a cost centre is a segment whose financial performance is measured in terms of cost. The costs are the planning and control data in cost centres, since managers are not made responsible for profits and investments in assets. The performance of the managers is evaluated by comparing the costs incurred with the budgeted costs. The management focuses on the cost variances for ensuring proper control.The performance of a cost centre is measured by cost alone, without taking into consideration, its attainments in terms of “output”. A cost centre does not serve the purpose of measuring the performance of the responsibility centre, since it ignores the output (revenues) measured in terms of money. A common feature of production departments is that they are usually multiple product units. There must be some common basis to aggregate the dissimilar products to arrive at the overall output of the responsibility centre. If this is not done, the efficiency andl

Investment Centres: When the manager is held responsibility for costs and revenues as well as for the investment in assets of a responsibility centre. The following are the criteria to be considered for making a responsibility centre into a profit centre. it is called a Profit Centre. a profit centre will not prove to be more beneficial than a cost centre. The return on investment which is usually referred to as ROI.(2) effectiveness of the responsibility centre cannot be measured. the performance is measured not by profit alone. the revenue represents a monetary measure of output emanating from a profit centre during a given period. For evaluating the performance of a profit centre. In consonance with the above objective. Hence. A profit centre will gain more meaning and significance only when the divisional managers of responsibility centres have empowered adequately in their decision making relating to quality and quantity of outputs and also their relation to costs. The relevant profit to facilitate the evaluation of performance measurement of a profit centre is the pre-tax profit of a responsibility centre. are excluded from the computation of the department's profits and the same are adjusted while determining the profits of the whole organisation. Profit Centres: When the manager is held responsible for both cost (inputs) and revenues (output) and thus. there will be continuous friction among the centres arresting the growth and expansion of the whole organisation. the manager of the profit centre is highly motivated in his decision-making relating to inputs and outputs so that profits can be maximized. The profit centre approach cannot be uniformly applied to all responsibility centres. since the manager of an investment centre is always interested to earn a satisfactory return. In an investment centre. cement). revenues are recognised only when sales are made to external customers.it cannot be made a profit centre. The underlying principle is that a department has output representing goods and services which are capable of monetary measurement..g. A profit centre must maintain additional record keeping to measure inputs and outputs in monetary terms. In a Profit Centre. As the profit provides more effective appraisal of the manager's performance. for profit of a responsibility centre. The variance will arise because costs which are not attributable to any single department. internal audit. serves as a criterion for the performance evaluation of the manager of an investment . e. The profit of all the departments so calculated will not necessarily be equivalent to the profit of the entire organisation. When a responsibility centre renders only services to other departments at the instance of the management. by creating more profit centres in an organisation. The term “revenue”with reference to responsibility accounting is used in a different sense altogether. it is the divisional profit which is required for the purpose of managerial control. irrespective of whether the revenue is realised or not. but it is related to investments effected. The difference between revenues and costs represents profit where the former exceeds the latter and loss when it is vice versa. decentralisation of activities can be easily effected. due to intense competition prevailing among different profit centres.g. According to generally accepted principles of accounting. A profit centre will generate too much of interest in the short-run profit to the detriment of long-term results. If the output of a division is fairly homogeneous (e. Again. it is called an Investment Centre. both inputs and outputs are measured in terms of money..

Viewed from this angle. receivables and inventories. depends on the method of allocation/apportionment and the mode of valuation. ROI = Net Income Total Assets / Investment There are two components to the return on investment classification. ROI is generally accepted measure of overall performance. ROI provides the basis for optimum utilisation of the assets of a firm. ROI is a product of two elements as given below: ROI = Profit Margin × Investment Turnover = ROI = Net Income Sales × Sales Assets Net Income Assets From the above it is clear that the ROI can be increased by increasing the profit margin. As a divisional performance measurement. ROI analysis is a relative measure since it comprises a ratio/percentage. it is in conformity with the firm's rate of return analysis. the common assets . in turn. Firstly. suffers from certain limitations. This only represents an extension of the responsibility idea. by increasing the asset turnover or by some combination of the two. Thirdly. There are certain benefits of using ROI as divisional performance measurement. This serves as a common denominator and facilitates comparison between different divisions. outputs and investment. They are: (1) profit margin or margin on sales and (2) asset/investment turnover. This interdivisional comparison is of great value in the maximisation of profits of an organisation. One main drawback with the ROI analysis is that of determination of investment base. The determination or measurement of the value of investment is referred to as “investment base”.(3) centre. Secondly. investment centres may be considered as separate entities wherein the managers are entrusted with the overall responsibility of managing inputs. Symbolically. Return on Investment (ROI): A very popular tool for reporting performance of an investment centre of responsibility accounting is the rate of return on investment in assets or simply return on investment (ROI). The problem of measurement of investment in assets relating to an investment centre analysis. The most common examples are cash. Problem of Allocation: This arises on account of the difference in the treatment of assets that are shared in common among the different divisions. Thus. This enables the divisional manager to obtain or retain those assets yielding satisfactory return and to discard the rest. Alternatively. What is the method adopted for the allocation of such assets among different divisions? One method is to completely ignore such assets while computing the investment base of a division on the basis that only those assets which are exclusively used directly traceable to a division should be included. The ROI analysis which is sound and appealing.

The measurement of investment base is also affected by the problem of assigning of values to the assets of a division. besides. The adjustment of these items in the calculation of the divisional income is open to question. there are certain complications in the determination of the net income of a division. it is not a measure of the current economic values of the assets concerned. If such assets are included while computing the ROI. They are book value. the depreciation should also be based upon the same. the problem of allocation is further complicated by the existence of number of idle assets. There are different methods available for valuation of assets required for ROI analysis. holds a partial solution to the ROI analysis based on book values. The most readily available method of valuation of assets is the book value. The current replacement cost basis provides the best measure of the current performance. But the main drawback of this method is the declining investment base as a result of depreciation charges. In short. When the earnings remain constant. this approach will give a constant ROI over a period of year. This only means the original cost less accumulated depreciation. This results in some complications in the measurement of net income for ROI analysis. Residual Income . Whether depreciation should be based on historical cost or replacement cost is yet another ticklish issue. It is but logical that when the basis of valuation of assets adopted is replacement cost. Again. gross book value (original cost) and the current replacement costs. More precisely. The Gross Book value which represents the original cost without any deduction for the depreciation. they are to be excluded. the divisional ROI would show improving performance which is not really the case. the resulting figures would be a return on capital employed rather than the total investments/assets.(4) should be apportioned among the benefited division so as to facilitate proper measurement of their individual investments. the presence of idle assets would indicate the ineffective utilisation of resources. This approach would tend to raise the ROI. For. When the net income of the division remains constant or does not dechne as fast the book value of the division's assets. Apart from the above. The underlying problem is the determination of the replacement cost which becomes materially subjective assessment. an investment centre which is only an extension of a profit centre encounters all the problems of the latter. As per the incremental approach. Though it avoids the unnecessary rise in the ROI with the passage of time. the items having a bearing on net income can be treated in different ways. there are certain special problems connected with the income measurement. They devolve on the treatment of tax and interest which are outside the purview of the divisional managers. there is also the difficulty of identification of assets with separate divisions and reasonable allocation. Net Income: Another element involved in the computation of ROI is the net income/profit of a responsibility centre. since these items do not fall in the area of responsibility of a division. This would not eventually reveal the degree of effectiveness of the utilisation of the assets which alone forms the basic objective of the ROI analysis.

Residual income represents that amount which remains after deduction of “implied” interest charge from the operating income. Of the three types of responsibility centres. This measure of divisional performance avoids some of the problems encountered in the ROI analysis. the difference between the actual operating income and the required/expected income is residual income. Among the various approaches of performance measurement in investment centre analysis. can be considered to yield better results. The basis for computation of interest is the value of assets in each investment centre. . The rate of interest so calculated will be equivalent to the minimum rate on investment expected by the top management. Conclusion: In conclusion it can be stated that the responsibility accounting is relevant to divisional performance measurement. The implied interest charge refers to the opportunity cost. it encourages capital investment by a divisional manager whenever he expects to earn more than the required/expected cut-off rate.(5) Residual Income is yet another approach for measurement of financial performance in an investment centre. any new investment by the divisional manager will increase the residual income provided it yields a higher income than the required/expected cut-off percentage. though ROI is more popularly used in business circles. this allows different rates of return for different divisions/assets. Secondly. More precisely. an investment centre type of responsibility centre which is only an extension of a profit centre. In fact. Firstly. The residual approach has certain merits to its credit. residual income is evidently superior.

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