Responsibility Accounting and

Transfer Pricing
Module 7
INTENDED LEARNING OUTCOME
• Explain the concept of decentralization, segment reporting, and costs
related to segment reporting.
• Determine the type of responsibility centers
• Prepare segmented income statement
INTRODUCTION
CENTRALIZED VS
✓ Only one person who MAKES ✓
ALL DECISIONS.
✓ It is usually the manager who is ✓
the owner of the business.
✓ It is the owner who is solely
responsible for the attainment ✓
of the organization’s objective.
✓ “one-man” team
DECENTRALIZED
Several persons makes the
decision for the firm.
Usually, managers, who are not
the owner of the business can
make decisions for the firm.
“teamwork”
Centralized Decentralized
organization organization
CENTRALIZATION
✓A form of organization or management style where the firm requires
“top management” to make most decisions and controls most of the
activities of the organization.

✓Example
✓A sole proprietor who owns a small grocery store in the barangay.
DECENTRALIZATION
✓A form of organization where the firm is divided into smaller units,
such as departments, segments, and divisions.
✓Each unit has an assigned responsible officer or employee who does
managerial functions.
✓Here, there are delegations of duties from the top management to
the subordinate managers.
✓Subordinate managers have a significant degree of autonomy and
independence in operating and making decisions relating to their
sphere of responsibility.
✓Here, there is this so-called “employee empowerment”.
ADVANTAGES OF DECENTRALIZATION
✓ENHANCED SPECIALIZATION.
✓TRAINING
✓MOTIVATED MANAGERS
✓DEFINED SPAN OF CONTROL
✓FASTER DECISION-MAKING
DISADVANTAGES OF DECENTRALIZATION
✓NEED FOR COMPETENT PEOPLE
✓MEASUREMENT SYSTEM
✓SUB-OPTIMIZATION
RESPONSIBILITY ACCOUNTING
➢It is a system of accounting wherein costs and revenues are
accumulated and reported by levels of responsibility or by
responsibility centers within the organization.
➢It will make a decentralized form of organization operate effectively.
➢It provides information to top management about the performance
of the units and subunits.
➢It is designed primarily for cost control and performance evaluation.
BASIC CONCEPTS: RESPONSIBILITY
ACCOUNTING
➢It is the system that recognizes various decision centers throughout
an organization and traces costs by areas of responsibility.
➢This is also known as activity accounting or profitability accounting.
➢It links to authority and control.
➢Managers plan for their areas of responsibility and exert control over
tasks.
➢It is focused on financial reporting by segment, or division, or work
center.
GUIDELINES IN DESIGNING A RESPONSIBILITY
ACCOUNTING SYSTEM:
➢A reward and punishment structure should be included in the system
and its objectives should be clearly stated.
➢Management should be allowed to participate in the setting of goals
that will be used as the basis for performance evaluation.
➢The goals to be established should be attainable with efficient and
economic performance.
➢Managers should clearly understand the rationale behind the system
so they would strive to attain the goals and objectives established for
them and for their responsibility centers.
➢Submission of performance reports and feedback to managers should
be timely.
ADVANTAGES OF RESPONSIBILITY
ACCOUNTING
➢It facilitates decision-making.
➢It helps the management promote management-by-objectives.
➢It adds in establishing standards of performance.
➢It permits effective use of management-by-exception
PURPOSES OF RESPONSIBILITY ACCOUNTING
1. Goal Congruence
2. Managerial Effort
GOAL CONGRUENCE
✓It is a condition where employees working on their own personal
interests or the interests of their responsibility center, make decisions
that help meet the overall goals of the firm.
MANAGERIAL EFFORT
✓The exertion of effort by the decision-makers to reach a common goal
or objective.
✓This includes all conscious actions, such as planning and supervising.
How can GOAL CONGRUENCE and
MANAGERIAL EFFORT be achieved?
✓Employees must be properly motivated.
✓MOTIVATION – it is a drive toward a goal that creates action and
effort to achieve that goal.
OTHER CONCEPTS IN RESPONSIBILITY
ACCOUNTING
1. AUTHORITY – the power to direct and exact performance from
others, particularly the subordinate, including the right to prescribe
the means and methods by which work must be done.
2. RESPONSIBILITY – refers to the obligation to perform.
3. ACCOUNTABILITY – the duty to report performance to one’s
superior and the physical means for reporting or being able to
substantiate performance.
OTHER CONCEPTS IN RESPONSIBILITY
ACCOUNTING
4. CONTROLLABILITY – the extent to which the manager can influence
activities, cost, revenues, or capital.
5. MANAGEMENT BY OBJECTIVES (MBO) – a behavioral,
communications-oriented, responsibility approach where a
manager and his/her subordinates agree upon obejctives and the
means on how such objectives can be attained.
RESPONSIBILITY CENTERS
➢Also called “accountability center”, is a clearly identified part or
segment of an organization that is accountable for a specified
function or set of activities.
RESPONSIBILITY CENTERS
1. COST CENTER
2. PROFIT
3. REVENUE CENTER
4. INVESTMENT CENTER
COST CENTER
✓This is sometimes called as the expense center.
✓A segment of an organization in which managers are held responsible
for the costs or expenses incurred in the segment.
✓EXAMPLE?
✓Maintenance department
SERVICE CENTER
✓This usually operates as a cost center.
✓It exists primarily and sometimes solely to provide specialized
support to the other segments or subunits of the organization.
EVALUATION OF COST CENTERS’
PERFORMANCE
✓Evaluation should be based on the objectives set for the cost center.
✓Submit performance reports on various types of services rendered to
other departments as well as the cost incurred for such services.

✓Cost center is evaluated through variance analysis based on standard

costs and flexible budgets.
✓The use of budgets in Cost Evaluation. “difference between
budget and actual amount
Format of Variance report for Cost Center
CLASSIFICATION OF COSTS IN RESPONSIBILITY
ACCOUNTING
1. By RESPONSIBILITY CENTER;
2. By COST TYPE AS TO CONTROLLABILITY;
3. By SPECIFIC COST ITEMS OR COST ELEMENTS WITHIN EACH
CLASSIFICATION IN (1) AND (2).
CONTROLLABLE COSTS
✓Controllable costs are costs that may be directly regulated at a given
level of managerial authority.
GUIDELINES TO DETERMINE CONTROLLABILITY
OF COSTS:
1. A cost is controllable if he has authority over both the acquisition
and the use of the services for which the cost is incurred.

2. A cost is controllable by a person if that person can significantly

influence the amount or the incurrence of cost through his own
action.

3. A cost is considered controllable by a person if, though he cannot

directly influence the incurrence of such cost, the management
wishes him to be concerned with the cost items involved so he can
help to influence those who are responsible.
IMPORTANT NOTES REGARDING
CONTROLLABILITY OF COSTS
1. It refers to a specific responsibility center.
2. It results from a significant influence and not from a complete
influence.
CONTROLLABLE COSTS AND DIRECT COSTS
1. Direct costs – these are costs that can be specifically identified to a
certain responsibility center.
✓Therefore, controllable costs which must be charged directly to a specific
business segment must be direct cost.
2. Indirect costs – these are costs that are merely allocated to the
responsibility center.
✓Therefore, indirect costs are non-controllable costs since these are costs
allocated to a specific responsibility center.
NOTE:
“ Not all direct costs are controllable cost”
FORMULA: Responsibility Cost Center
Actual Budget Variance
Controllable Costs:
- Expense Account
- Expense Account
TOTAL CONTROLLABLE COSTS

Uncontrollable Costs
-Expense Account
- Expense Account
TOTAL UNCONTROLLABLE COSTS
TOTAL COSTS (CONTROLLABLE +
UNCONTROLLABLE
August 2021

August 2021
Cont.
✓During August 2021, the Maintenance Department incurred a total
cost of P50,000.00, composed of salaries and wages - P25,000.00;
supplies – P8,000.00; PT & T – P3,000.00; light and water – P3,000.00;
and depreciation – P11,000.00.

✓Salaries and wages expense includes P5,000.00 representing the

department manager’s own salary.

✓The manager does not have control over hiring of personnel in his
department. Salaries of all staff in the department are set with the
use of the company’s standard salary scheme for all employees.
Cont.
✓The department manager can influence the incurrence of supplies
and PT & T.
✓The department does not have its own meter to measure the
consumption of light and water. The cost, instead is computed for the
whole factory and allocated to all the departments concerned.
✓Acquisition and disposal of tools, equipment, and other fixed assets
are subject to approval by higher levels of management. Depreciation
of useful life and depreciation method is covered by the company’s
depreciation policy.
REQUIRED:
Prepare the Responsibility Cost Report for the Maintenance
Department.
Solution
REVENUE CENTERS and PROFIT CENTERs
PROFIT CENTER
- Here, the manager is held responsible for both revenues and costs.
- Example: Branch
REVENUE CENTER
- The manager has control over the revenues.
- Example: Sales Department
OBJECTIVES OF PROFIT CENTERS
1. To minimize cost and
2. To maximize profit.
CRITERIA TO CONSIDER AS PROFIT CENTER
1. The company has two or more units for which revenues and
expenses can be measured separately.
2. The managers of these units can considerably control the units’
revenues and expenses.
3. The profit of each unit must be regularly calculated and reported to
top management for use as a basis for evaluating each unit’s
performance.
EVALUATION OF PROFIT CENTERS’
PERFORMANCE.
1. It may be evaluated with the use of budgets and responsibility
accounting reports.
2. Budgeted income statements may be prepared for each profit
center. Actual results are compared with budgeted figures to
determine variances.

NOTE:
Variances, whether favorable or unfavorable, must be investigated so
that the necessary corrective actions may be immediately taken.
RESPONSIBILITY ACCOUNTING REPORT OF A
PROFIT CENTER (Format)
INVESTMENT CENTERS
- Here, the manager controls revenues, costs, and investments in plant
and equipment, receivables, inventory, and other assets.
OBJECTIVES OF INVESTMENT CENTERS
1. Earning as much as profit as they can possibly earn.
EVALUATION OF INVESTMENT CENTERS’
PERFORMANCE
1. It is evaluated not only on the profit figures per se, but on the profit
figures in relation to the investment in the center. In other words,
the evaluation emphasis shifts from the income figure to a measure
of the rate of return on investment.
2. Residual income
3. Economic Value Added
RETURN ON INVESTMENT
RETURN ON INVESTMENT =
(Income/investment)
Income amount may be the: The investment base may be the:
✓Operating income or earnings ✓Total assets
before interest and taxes (EBIT)
✓Net income ✓Total assets employed or used by
the segment in its operations
(excluding idle assets)
✓Net income adjusted for price Working capital (CA les CL) + other
level changes assets
✓Cash flow ✓Stockholder’s Equity
RETURN ON INVESTMENT
Du pont model – a model that indicates the return on investment as it
is affected by profit margin and asset turnover.

✓Profit Margin = NI / Sales

✓Asset Turnover = Sales / Asset
✓ROI = Profit Margin x Asset Turnover

Another way of computing:

✓ROI = (income / sales revenue) x (sales revenue / invested capital)
ILLUSTRATION

REQUIRED:
Compute for the ROI.
SOLUTION:
Other Bases used in computing the ROI
1. Total Gross Assets (all assets account without deducting contra
account)
2. Net Assets (all assets account less contra account)
3. Total Net Assets employed (assets used in the normal production
or operating activities)
4. Stockholder’s Equity (applicable to wholly owned subsidiaries with
separate capital and retained earnings accounts)
5. Assets stated at current market values (applicable when historical
costs are considered meaningless due to inflation and other
economic factors)
RESIDUAL INCOME
✓It is the excess income earned by an investment center over the
desired income or return in invested capital
✓Here, a target or desired rate of return is established for the
investment center.
✓Actual income figure is compared with the desired amount; any
excess of actual income over the desired or target figure is the
residual income.
✓NOTE: The higher the residual income, the better.
RESIDUAL INCOME
FORMULA:

Actual Net Income/expected income(investment center) P XXX

Less: Target Income (investment center) XX
(investment capital x desired rate of return)
Residual Income P XXX

NOTE: DRR = Cost of Capital

ILLUSTRATION
Assume that the desired rate of return established for Division X of C
company is 18%. Last year, division X earned a net income of
P480,000.00 when total assets amounted to P2,500,000.00.

Required:
Compute for the residual income.
SOLUTION:

How can you interpret the above computation?

Economic Value Added (EVA)
- It is a more specific version of residual income.
- It represents the segment’s true income profit because it measures
the benefit obtained by using resources in a particular way.
FORMULA
After-tax operating income ([EBIT] x [1-Tax Rate]) P XXX.XX
Less Desired Income after tax* XXX.XX
Economic Value Added (EVA) P XXX.XX

*DIAT = WACC x Investment^^

^^ investment = Total Assets Less Current Liabilities

WACC – Weighted-Average Cost of Capital

ILLUSTRATION
The following year-end date pertains to Bax Company:
EBIT P 800,000.00
Current Assets 800,000.00
Non-current assets 3,200.000.00
Current Liabilities 400,000.00
Non-current liabilities 1,000,000.00
Bax Company pays an income tax rate of 32%. Its WACC is 10%.

Compute for the EVA. (3 minutes)

SOLUTION
After-Tax operating Income [(800,000) x (1-32%)] P544,000.00
Less: Desired income after tax: 360,000.00
[WACC x Investment^]
*Investment = Total Assets – Current Liabilities
[10% x ([800K + 3.2M] less 400k)
(10% x 3.6M)
Economic Value Added P184,000.00
SEGMENTED INCOME STATEMENT
- It provides details of operations broken down into segments or
departments.
- Purpose or benefit?
- It helps management to identify segments or departments that did
not perform well during a particular period and look for a solution to
turn a segment into a performing one.
FORMAT: Segmented Income Statement
TOTAL SEGMENT A SEGMENT B
Sales
Less: variable Mfg. Cost
Manufacturing CM
Less: Controllable FC
Short-run performance margin
Less: direct, non-controllable FC
Segment Margin
Less: Common costs allocated to
segment
Operating Income
SEGMENTED INCOME STATEMENT
1. Manufacturing CM – Sales less Variable Mfg. Cost.
2. CM – Manufacturing Margin less Variable non-manufacturing costs
3. CM – Sales less ALL variable costs.
4. Short-run performance Margin – CM less controllable or
discretionary FC
5. Segment Margin – short-run performance margin less
direct/traceable, committed, non-controllable FC
6. Operating Income – segment margin less allocated common costs.
SEGMENTED INCOME STATEMENT
Segment Income = Profit Margin (segment) x Segment Sales
ILLUSTRATION
Agua Division is one of the operating units of World Treasure Hunters
Inc. some of this division’s operating results follow.
Sales P3,000.000.00
Profit Margin 10%
Target Return 15%
Residual Income P60,000.00
Required:
Segment Income of Agua Division.
ROI of Agua Division
SOLUTION:
Segment Income = Profit Margin x Sales
= 10% x 3,000,000.00
= P300,000.00

ROI = Segment Income / Assets

= P300,000.00 / 1,600,000.00
= 18.75%
Some important questions and terminologies
in a Responsibility Accounting and
Performance Evaluation of a Center:
1. Why is it likely that a subordinate manager would be more
attentive to certain performance measures than overall
corporate objectives to guide his/her decision-making?
➢Because they are evaluated based on their ACTUAL
performance/results as compared to the specific performance
measure.

➢Not all performance measures apply to every department since every

department in an organization is classified according to its function.

➢In sum, in responsibility accounting, the performances of every

department are the responsibility of its respective managers, they are
accountable for whatever the results of their department.
2. What are some of the major problems associated with
accrual-based accounting performance measures

➢It can be easily manipulated by managers.

➢Accounting measures cannot reflect or capture all corporate goals.
3. What distinct advantage does a Return on Investment
have over a Residual Income measure?

➢It facilitates the comparison of organizational subunits of differing

sizes.
4. How can ROI result in suboptimization when it is used as a
performance measure?

➢Because performance measures are used to reward performance,

managers use them as decision criteria when they evaluate courses of
action.
➢This is optimal if the overall organization would be better off by the
division manager’s investment in available projects with lower ROIs.
5. What are some common problems encountered in
determining ROI?

➢Different interpretations or evaluations could be concluded by the

evaluator.
➢WHY?
➢Net income and investment involved can be calculated in several
ways.
➢These multiple calculations are often presented to show the
different factors that affect ROI, changes in sales, expenses, and
capital investments.
6. What is a flexible budget? Why management use it as a
basis of performance measure?

➢FLEXIBLE BUDGET – planning document that presents expected

revenue or cost results at different levels of activity.
➢It provides the means to estimate costs at various levels of activity.
➢The control function is undertake to assure that actual operations
meet planned operations. Through these function, deviations are
determined and variances can be ascertained.
➢Evaluation is more meaningful with valid and accurate data to make
the process of evaluation beneficial to all involved.
Thank you