MANAGEMENT ADVISORY SERVICES

RESPONSIBILITY ACCOUNTING

Decentralization – refers to the separation or division of the organization into more manageable units
wherein each unit is managed by an individual who is given decision authority and is held accountable
for his or her decisions.

Goal Congruence – is the term which describes the situation when the goals of different interest groups
coincide. A way of helping to achieve goal congruence between shareholders and managers is by
the introduction of carefully designed remuneration packages for managers which would motivate
managers to take decisions which were consistent with the objectives of the shareholders.  

Sub-Optimization – happens when one segment of a company takes action that is in its own best
interests but is detrimental to the firm as a whole.

Responsibility Center – is a segment of organization that is engaged in the performance of a single

function or a group of closely related functions. This segment is usually governed by a manager, who is
accountable and responsible for the activities of the segment.

Types of Responsibility Centers:

1) Cost Center – managers are held responsible for the costs incurred by the segment.
2) Revenue Center – managers are held responsible primarily for revenues of the segment.
3) Profit Center – managers are held responsible for both revenues and costs of the segment.
4) Investment Center – managers are held responsible for revenues, costs and investments. The
central performance is measured in terms of the use of the assets as well as revenues earned
and the costs incurred.

EXERCISES

I. IDENTIFICATION

Direction: Indicate how each of the business situations below is most likely to be organized: cost center,
revenue center, profit center, or investment center.

1. The Repair and Maintenance Department of Pascual Liner.

2. The Magnolia Product Division of San Miguel Corporation.
3. The Ayala Mall car park ticket outlets.
4. The Morayta branch of Starbox Coffee.
5. The Accounting Department of Banco De Orocan.
6. The College of Accountancy of University of Santo Tomas.
7. The Parts Department of Toyota Cars Corporation.
8. The convenience store that is owned by a chain organization. The head office supplies all the
goods to be sold and determines the selling prices.
9. Raw Materials Purchasing Department.
10. Telemarketing Department of a residential remodeling company.
11. The Asian Division of a multinational manufacturing organization.

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Responsibility Accounting – is a system of accounting that is implemented to an organization so that performance,
in terms of costs and/or revenues, are recorded and reported by levels of responsibility within an organization.

Financial Performance Measures for Responsibility Accounting

A. Cost Center – Variance analysis

B. Revenue Center – Sales Variance Analysis (Sales Volume, Market size, Market share)
C. Profit Center – Segment Margin, Return on Sales
D. Investment Center – Return on Investment, Residual Income, Economic Value-Added

Return on Investment (ROI) = Operating Income ÷ Operating Assets

= Return on Sales x Asset Turnover (DuPont formula)

Where: ROS = Operating Income ÷ Sales

Asset Turnover = Sales ÷ Operating Assets*

* Total Assets, excluding idle plant assets

Residual Income – encourages managers to maximize pesos of profit after a required ROI has been
achieved.
Residual Income = Operating Income – Required Income
Where: Required Income = Operating Assets x Minimum ROI

EXERCISES:

PROBLEM 1: Wolf Company had the following information pertaining to 2018:

Profit P 100,000
Sales P 1,000,000
Asset Turnover 2 times
Desired minimum rate of return 15%

Required: Compute for the following:

1. Return on investment
2. Return on sales
3. Amount of assets
4. Residual income

PROBLEM 2: For each of the following independent cases, the minimum desired Return on Investment
(ROI) is 20%.

DIVISION 1 DIVISION 2 DIVISION 3

Sales P400,000 (5) P700,000
Operating income (1) (6) P42,000
Operating assets (2) P300,000 (9)
Margin (Return on sales) 15% 8% (10)
Turnover (Asset turnover) (3) 3 times (11)
Return on investments 30% (7) (12)
Residual income (4) (8) P22,000

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Required: Compute for each division’s missing items.

Economic Value Added (EVA – is a more specific version of residual income that measures the
investment center’s real economic gains. It uses the weighted-average cost of capital (WACC) to compute
the required income.

EVA = Operating Income after Tax – Required Income

Where: Required Income = (Total Assets – Current Liabilities) x WACC

Illustration: Economic Value Added, Weighted-Average Cost of Capital

The following data pertain to Dana Industries:

Interest rate on debt capital 9%
Cost of equity capital 12%
Before-tax operating income P35 million
Market value of debt capital P60 million
Market value of equity capital P120 million
Total assets P150 million
Income tax rate 30%
Total current liabilities P15 million

Required:
1. Compute Dana’s weighted-average cost of capital.
2. Compute Dana’s economic value added.

CONTROLLABLE vs. NON-CONTROLLABLE COSTS

Generally all costs are controllable. The key difference lies in the level of management who can control
the costs:

Controllable Costs – are those items of cost that may be directly regulated at lower levels of
management.

Non-controllable Costs – are costs that cannot be regulated at a particular management level other than
the top level.

Of most relevance in deciding how or which costs should be assigned to a responsibility center is the
degree of controllability.

Costs may also be classified into Direct (attributable to a particular segment) or Indirect (common to a
number of segments), the latter being subject to arbitrary allocation.

NOTE: All controllable costs are also direct costs, but not all direct costs are controllable.

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Illustration: CONTROLLABLE/NON-CONTROLLABLE COSTS, DIRECT/INDIRECT COSTS

The supervisor of Painting department of Honda Cars is in-charge of purchasing supplies, authorizing
repairs, and hiring labor for the department. Various costs are given:
1) Sales, salaries and commission P 18,200
2) Salary of supervisor of Painting Department 2,500
3) Factory heat and light 3,900
4) General office salaries 11,000
5) Factory depreciation 1,800
6) Supplies, Painting Department 1,500
7) Repairs and maintenance, Painting Department 1,400
8) Factory insurance 2,100
9) Labor costs, Painting Department 15,600
10) Salary of factory supervisor 2,700

Required: Compute for the following:

a. Total costs controllable by the supervisor of the Painting Department (Controllable).
b. Total costs directly identifiable with the Painting Department (Direct).
c. Total costs that will have to be allocated to the factory departments (Indirect).
d. Total costs that do not pertain to factory operations (Selling/Administrative).

Performance Report and Segmented Income Statement

A Performance Report is the end product of responsibility accounting process. It is a report that
shows and compares actual results with the intended (budgets or standards) results of a responsibility
center, thereby highlighting deviations that need corrective actions.

The “contribution format” to computing results of operations (income) is emphasized in

responsibility accounting. This income statement presentation highlights controllability of costs by
behavioral classification. In addition to the usual variable costs and fixed costs, a more detailed
classification of costs may be made. Consider the following illustrative example:

Sales xxx
Less: Variable manufacturing costs xxx
Manufacturing contribution margin xxx
Less: Variable selling and administrative costs xxx
Contribution margin xxx
Less: Controllable fixed costs:
Manufacturing xxx
Selling and administrative xxx xxx
Short-run performance margin xxx
Less: Non-controllable fixed costs:
Depreciation xxx
Rent and leases, insurance xxx xxx
Segment margin xxx

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 Less: Allocated/common costs xxx
Income xxx
Illustration: SEGMENTED INCOME STATEMENT

Fog City Retail operates a retail store in Phoenix, Las Vegas, and Portland. The following information
relates to the Phoenix facility:
 The store sold 65,000 units at P18.00 each, after having purchased the units from various suppliers for
P12.50. Phoenix salespeople are paid a 5% commission based on gross sales dollars.
 Phoenix’s sales manager oversees the placement of local advertising contracts, which totaled P54,000
for the year. Local property taxes amounted to P14,500.
 The sales manager’s P65,000 salary is set by Phoenix’s store manager. In contrast, the store manager’s
P134,000 salary is determined by Fog City’s vice president.
 Phoenix incurred P6,800 of other noncontrollable costs along with P10,000 of income tax expense.
 Nontraceable (common) corporate overhead totaled P68,000.

Fog City’s corporate headquarters is located in Portland, and the company uses responsibility accounting
to evaluate performance.

Required: Prepare a segmented income statement for the Phoenix store, being sure to disclose the
segment contribution margin, the segment profit margin, and net income.

EXERCISES
TRUE OR FALSE:

1. Decentralization is a transfer of authority from the top to the bottom of an organization. T

2. Decentralization can result in a lack of goal congruence among departments. T
3. Decentralization increases the time required for decision-making. F
4. A responsibility accounting system should include the revenues and costs under a division
manager’s control. T
5. Responsibility reports at lower levels of the organization are less detailed than reports at the
higher levels. F
6. A manager of a cost center is evaluated solely on the basis of how well costs are controlled. T
7. The manager of a revenue center has the authority to establish selling prices of product. F
8. A profit center is typically an independent organizational unit. T
9. The manager of an investment center is responsible for generating revenue as well as controlling
expenses. T
10. Suboptimization occurs when a manager of a cost center focuses on the goals of the cost center
rather than on the goals of the organization as a whole. T
11. An administrative department provides services that benefit other internal units of an
organization. F
12. An administrative department provides services that benefit the entire organization. T
13. A service department provides services that benefit other internal units of an organization. T
14. The most theoretically correct method of allocating service department costs is the algebraic
method. T
15. The direct method of service department cost allocation allows a partial recognition of reciprocal
relationships among service departments before assigning costs to revenue-producing areas. F
16. All controllable costs are direct by nature. Not all direct costs are controllable. T
17. Responsibility accounting system functions best in a decentralized organization. T

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 18. If the division’s ROI is equal to the minimum ROI, then the division’s residual income is positive.
F, it will be 0
19. The most straight-forward method of assigning service department costs to revenue-producing
areas is the direct method. T
20.Residual income incorporates a firm's cost of acquiring investment capital. T
21.Residual income is a percentage measure, not a dollar measure. F
22.If used correctly, residual income may result in division managers making decisions that are in their
own best interest and not in the best interest of the entire firm. F

MULTIPLE-CHOICE:

1. The sequence that reflects increasing breadth (level) of responsibility is

a. Cost center, investment center, profit center c. Profit center, cost center, investment center
b. Cost center, profit center, investment center d. Investment center, cost center, profit center

2. In responsibility accounting, the most relevant classification of costs is

a. Fixed and variable c. Discretionary and committed
b. Incremental and non-incremental d. Controllable and non-controllable

3. Which of the following techniques would be best for evaluating the management performance of
a department that is operated as a cost center?
a. Return on assets c. Payback method
b. Return on investment d. Variance analysis

4. The segment margin of the Division ABC of DEF Corporation should not include
a. Net sales of ABC c. Fixed selling expenses of ABC
b. Variable selling expense of ABC d. ABC’s share of president’s salary

5. Which of the following describes the computation of Return on Investment (ROI)?

a. Return on Sales x Investment c. Sales x Investment Turnover
b. Investment Turnover x Return on Sales d. Income – (Investment x Minimum ROI)

6. The best measure of the performance of the manager of a profit center is the
a. Rate of return on investment
b. Success in meeting budgeted goals for controllable costs
c. Amount of controllable margin generated by the profit center
d. Amount of contribution margin generated by the profit center.

7. If sales increase, while income and investment remain constant, which of the following is true?
a. Investment turnover decreases. c. ROI increases.
b. ROS decreases. d. ROI could increase or decrease.

8. Residual income
a. is always the best measure of divisional performance
b. is not as good a measure of performance as ROI
c. overcomes some of the problems associated with ROI
d. cannot be used by divisions that deal with others in the same company

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9. In order to promote goal congruence, a manager of an investment center is best evaluated using
a. standard variable costing income statements
b. return on investment
c. budgets and standard costs
d. residual income

10. If two divisions earn the same ROI and RI, which of the following is true?
a. Their managers must be about equally skillful.
b. Their incomes and investments must be the same.
c. Both divisions are doing as well as they should be.
d. All of the above.

11. Decentralization occurs when

a. the firm’s operations are located over a large geographic area to reduce risk.
b. authority for important decisions is delegated to lower segments of the organization.
c. important decisions are made at the upper levels and the lower levels of the organization are
responsible for implementing the decisions.
d. none of the given choices.

12. Which of the following is critically important for a responsibility accounting system to be
effective?
a. Each employee should receive a separate performance report.
b. Service department costs should be allocated to the operating departments that use the service.
c. Each manager should know the criteria used for evaluating his or her performance.
d. The details on the performance reports for individual managers should add up to the totals on
the report to their supervisor.

13. Which of the following is not a disadvantage of the ROI performance measure?
A. It encourages managers to focus on the long run rather than the short run.
B. It discourages managers from investing in projects that would decrease divisional ROI but
increase the profitability of the company as a whole.
C. It encourages myopic behavior.
D. All of these are disadvantages of the ROI measure.

14. In calculating residual income, the variable set by top management is called the
A. average operating assets C. hurdle rate
B. operating income D. actual operating assets

15. Performance reports help managers:

A. use management by exception and effectively control operations.
B. decide whether a cost, profit, or investment center framework is appropriate.
C. design their organizational hierarchy.
D. pinpoint trouble spots.
E. use management by exception and effectively control operations and pinpoint trouble spots.

16. A segment’s contribution margin would reflect the impact of:

A. variable operating expenses.

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 B. fixed expenses controllable by the segment manager.
C. fixed expenses traceable to the segment but controllable by others.
D. common fixed expenses.

17. Distinguishing between controllable and non-controllable costs on a performance report may
result in:
A. an increase in the effectiveness of a cost management system.
B. a decrease in goal congruent behavior by managers.
C. an increase in the quality of performance information.
D. an increase in feelings of blame by managers.
E. an increase in the effectiveness of a cost management system and an increase in the quality of
performance information.

18. Consider the following statements about performance reports:

I. Performance reports provide feedback to managers and allow them to better control
operations.
II. Many performance reports have budget, actual, and variance data.
III. Performance reports are often structured around a firm's organizational hierarchy—that
is, data relating to lower-level units (e.g., departments) are combined and flow into higher-
level units (e.g., stores).

Which of the above statements is (are) true?

A. I only B. I and II C. I and III D. II and III E. I, II, and III.

19. Aloha Hotels owns numerous hotels on each of the Hawaiian Islands. The company's
performance reporting system is structured around the firm's organizational structure, with
information flowing from operating departments at a particular property and later respectively
grouped by individual hotel, island operation (i.e., division), and the company as a whole.
Which of the following best depicts the detail level of the information given to a department
manager versus that reported to a company vice-president?
Department Manager Company Vice-President
A. Somewhat detailed Somewhat detailed
B. Somewhat detailed Somewhat summarized
C. Somewhat summarized Somewhat detailed
D. Somewhat summarized Somewhat summarized

20. For a company that uses responsibility accounting, which of the following costs is least likely to
appear on a performance report of an assembly-line supervisor?
A. Direct materials used. D. Repairs and maintenance.
B. Departmental supplies. E. Assembly-line facilities depreciation.
C. Assembly-line labor.

21. Harris Company is preparing a segmented income statement, subdivided into departments
(billing, purchasing, and telemarketing). Which of the following choices correctly describes the
accounting treatment of the firm's compensation cost for key executives (president and vice-
presidents)?

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 A. The cost is charged to the departments.
B. The cost is not charged to the departments because, although easily traceable to the
departments, it is not controllable at the departmental level.
C. The cost is not charged to the departments because, although controllable at the
departmental level, it is not easily traceable to the departments.
D. The cost is not charged to the departments because it is both easily traceable to the
departments and controllable by the departments.
E. The cost is not charged to the departments because it is neither easily traceable to the
departments nor controllable by the departments.

22. West Coast Electronics (WCE) operates 87 stores and has three divisions: California, Oregon, and
Washington. Which of the following costs would not appear on Oregon's portion of WCE's
segmented income statement?
A. Costs related to statewide advertising contracts, negotiated by Oregon's divisional manager.
B. Variable sales commissions paid to Oregon's salespeople.
C. Compensation paid to Oregon's chief operating officer, as determined by WCE's management.
D. Oregon's allocated share of general WCE corporate overhead.

23. The difference between the profit margin controllable by a segment manager and the segment
profit margin is caused by:
A. variable operating expenses.
B. allocated common expenses.
C. fixed expenses controllable by the segment manager.
D. fixed expenses traceable to the segment but controllable by others.

24. The profit margin controllable by the segment manager would not include:
A. variable operating expenses.
B. fixed expenses controllable by the segment manager.
C. a share of the company's common fixed expenses.
D. income tax expense.
E. items "C" and "D" above.

25. A segment contribution margin would reflect the impact of:

A. variable operating expenses.
B. fixed expenses controllable by the segment manager.
C. fixed expenses traceable to the segment but controllable by others.
D. common fixed expenses.

26. Gathersburg Retail has three stores in Maryland. Which of the following costs would likely be
excluded when computing the profit margin controllable by store no. 3's manager?
A. Hourly labor costs incurred by personnel at store no. 3.
B. Property taxes attributable to store no. 3.
C. The salary of Gathersburg's president.
D. The salary of store no. 3's manager.
E. Items "B," "C," and "D" above.

27. Which of the following would be the best measure on which to base a segment manager's
performance evaluation for purposes of granting a bonus?

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 A. Segment sales revenue.
B. Segment contribution margin.
C. Profit margin controllable by the segment manager.
D. Segment profit margin.

28. The criteria for evaluating the performance of responsibility centers should be carefully selected
because
a. the responsibility center’s managers may find out what they are.
b. they must be approved by the BIR.
c. stockholders require an explanation about such criteria.
d. the managers’ behavior can be affected by such criteria that are used to judge their (the
managers’) performance.

29. A segment of an organization is referred to as a service center if it has

a. responsibility for developing markets and selling the output of the organization.
b. responsibility for combining the raw materials, direct labor, and other factors of production
into a final output.
c. authority to make decisions affecting the determinants of profit including the power to choose
its markets and sources of supply.
d. authority to provide specialized support to other units within the organization.

30. The term "management by exception" is best defined as: 

a. choosing exceptional managers.
b. controlling actions of subordinates through acceptance of management techniques.
c. investigating unfavorable variances.
d. devoting management time to investigate significant variances.

31. Return on investment (ROI) is a performance measure used for investment centers. Which of the
following statements about ROI is incorrect?
a. ROI is computed by dividing a segment’s income by the invested capital.
b. ROI is subject to numerous possible manipulations of the income and investment amounts, so
that a manager may decide not to invest in a project that will yield less than the desired rate of
return, or he/she may defer necessary expenses just to improve his/her center’s ROI.
c. ROI is superior to the residual income method.
d. The use of ROI may not be appropriate when the average age of assets differs substantially
across segments of a business.

32. Residual income as used in evaluating the performance of investment centers is the excess of the
return on an investment over a targeted amount equal to an imputed interest charge on invested
capital. The imputed interest rate used is ordinarily the
a. target return on investment set by the company’s management, but is often equal to the
weighted-average cost of capital.
b. average lending rate during the period under consideration.
c. average ROI for the investment center over the last several accounting periods.
d. internal rate of return on the invested capital in the investment center.

33. Hitchcock Corporation is in the process of overhauling the performance evaluation system for its
Los Angeles manufacturing division, which produces and sells parts that are popular in the

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 aerospace industry. Which of the following is least likely to be chosen to evaluate the overall
operations of the Los Angeles division?
A. Cost center C. Profit center
B. Responsibility center D. Investment center

34. A cost center manager:

A. does not have the ability to produce revenue.
B. may be involved with the sale of new marketing programs to clients.
C. would normally be held accountable for producing an adequate return on invested capital.
D. often oversees divisional operations.

35. If the head of a hotel's food and beverage operation is held accountable for revenues and costs,
the food and beverage operation would be considered a(n):
A. cost center B. revenue center C. profit center D. investment center

36. Which of the following would have a low likelihood of being organized as a profit center?
A. A movie theater of a company that operates a chain of theaters.
B. A maintenance department that charges users for its services.
C. The billing department of an Internet Services Provider (ISP).
D. The mayor's office in a large city.
E. Both "C" and "D" above.

37. Easy-to-Use Software operates stores within five regions. Regional managers are held
accountable for marketing, advertising, and sales decisions, and all costs incurred within their
region. In addition, regional managers decide whether new stores will open, where the stores
will be located, and whether the stores will lease or purchase the facilities. Store managers, in
contrast, are accountable for marketing, advertising, and sales decisions, and costs incurred
within their stores. Ideally, on the basis of this information, what type of responsibility center
should the software company use to evaluate its regions and stores?
Regions Stores
A. Profit center Profit center
B. Profit center Cost center
C. Profit center Revenue center
D. Investment center Profit center
E. Investment center Cost center

38. Decentralized firms can delegate authority by structuring an organization into responsibility
centers. Which of the following organizational segments is most like a totally independent,
standalone business where managers are expected to "make it on their own"?
A. Cost center B. Revenue center C. Profit center D. Investment center

39. A responsibility center in which the manager is held accountable for the profitable use of assets
and capital is commonly known as a(n):
A. cost center B. revenue center C. profit center D. investment center

40. Consider the following statements about goal congruence:

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I. Goal congruence is obtained when managers of subunits throughout an organization strive to
achieve the goals set by top management.
II. Managers are often more concerned about the performance of the entire organization rather than
the performance of the own segments.
III. Achieving goal congruence in most organizations is relatively straightforward and easy to
accomplish.

Which of the above statements is(are) true?

A. I only B. II only C. I and II D. II and III E. I, II, and III

41. Comparing budgeted and actual amounts is important in evaluating the performance of:
A. the manager of a cost center C. the manager of an investment center
B. the manager of a profit center D. any manager

42. Economic value added (EVA) analysis indicates:

A. the amount of income generated by each dollar of capital investment.
B. the number of sales dollars generated by each dollar of capital investment.
C. the percentage of each sales dollar that remains as profit after all expenses are covered.
D. the amount of increased capital generated by each dollar of income.
E. how much shareholder wealth is being created.

43. REB Service Co. is a computer service center. For the month of May 2015, REB had the following
statistics:

Sales P 450,000
Operating income 25,000
Net profit after taxes 8,000
Total assets 500,000
Shareholders’ equity 200,000
Cost of capital 6%

Based on the above information, which one of the following statements is correct? REB has a
A. ROI of 4% C. ROI of 1.6%
B. Residual income of P(5,000) D. Residual income of P(22,000)

44. Division A had the following information:

Asset base in Division A P 800,000

Net income in Division A 100,000
Operating income margin for Division A 20%
Target ROI 15%
Weighted-average cost of capital 12%

What is EVA for Division A?

A. P120,000 B. P96,000 C. P15,000 D. P4,000

45. Ralph, an investor, is interested in loaning money to a secure corporation. He always bases his
decision on the company with the largest economic value added (EVA). Ralph has narrowed his
choices down to four, and has collected the following information:
Operating

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 Income after Tax Equity Capital WACC Current
Liabilities
Company A P 50,000 P 200,000 12% P 10,000
Company B 60,000 150,000 20% 18,000
Company C 45,000 220,000 10% 30,000
Company D 55,000 250,000 15% 5,000

Based on largest EVA and assuming that none of the companies have any long-term liabilities,
which company should Ralph invest in?
A. Company A B. Company B C. Company C D. Company D

46. If the operating income margin of 0.3 stayed the same and the operating asset turnover of 5.0
increased by 10 percent, the ROI will
A. increase by 10 percent C. increase by 15 percent
B. decrease by 10 percent D. remain the same

47. Cost of capital is

A. The amount the company must pay for its plant assets.
B. The dividends a company must pay on its equity securities.
C. The cost the company must incur to obtain its capital resources.
D. The cost the company is charged by investment bankers who handle the issuance of equity or
long-term debt securities.

48. The cost of capital for a firm with a 60/40 debt/equity split, 8% cost of debt, 15% cost of equity,
and a 35% tax rate would be:
A. 7.02% B. 9.12% C. 10.80% D. 13.80%

49. Dobson Dairies has a capital structure that consists of 60 percent long-term debt and 40 percent
common stock. The company’s CFO has obtained the following information:

 The before-tax yield to maturity on the company’s bonds is 8 percent.

 The company’s common stock is expected to pay a P3.00 dividend at year end (D 1 = P3.00),
and the dividend is expected to grow at a constant rate of 7 percent a year. The common
stock currently sells for P60 a share.
 Assume the firm will be able to use retained earnings to fund the equity portion of its capital
budget.
 The company’s tax rate is 40 percent.

What is the company’s weighted average cost of capital (WACC)?

A. 12.00% B. 8.03% C. 9.34% D. 7.68%

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