Responsibility Center &

Responsibility Accounting
Syndicate: 10
 The
TheConcept
Conceptof
ofResponsibility
ResponsibilityAccounting
Accounting

Involves accumulating and reporting

costs on the basis of the manager
who has the authority to make the
day-to-day decisions about the items

Means a manager's performance is

evaluated on the matters directly
under the manager's control

Is based on the concept that managers should

not be held accountable for revenues and
costs over which they have no control.
LO 4: Describe the concept of
responsibility accounting.
 The
TheConcept
Conceptof
ofResponsibility
ResponsibilityAccounting
Accounting

Conditions for using responsibility accounting:

 Costs and revenues can be directly associated with the specific
level of management responsibility
 The costs and revenues can be controlled by employees at the
level of responsibility with which they are associated
 Budget data can be developed for evaluating the manager's
effectiveness in controlling the costs and revenues
 The
TheConcept
Conceptof
ofResponsibility
ResponsibilityAccounting
Accounting

Levels of responsibility for controlling costs

 The
TheConcept
Conceptof
ofResponsibility
ResponsibilityAccounting
Accounting

Two differences from budgeting in reporting costs and

revenues:
 Distinguishes between controllable and noncontrollable
costs
 Emphasizes or includes only items controllable by the
individual manager in performance reports
Applies to both profit and not-for-profit entities
Profit entities: maximize net income
Not-for-profit: minimize cost of providing services
 Decentralization in Organizations

Benefits of
Top
Top management
management
Decentralization freed
freed to
to concentrate
concentrate
on
on strategy.
strategy.
Lower-level
Lower-level managers
managers
gain
gain experience
experience in
in
decision-making.
decision-making. Decision-making
Decision-making
authority
authority leads
leads to
to
job
job satisfaction.
satisfaction.
Lower-level decision
Lower-level decision
often
often based
based on
on
better
better information.
information.
Lower
Lower level
level managers
managers
can
can respond
respond quickly
quickly
to
to customers.
customers.
 Decentralization in Organizations

May
May be
be aa lack
lack of
of
coordination
coordination among
among
autonomous
autonomous
Lower-level
Lower-level managers
managers managers.
managers.
may
may make
make decisions
decisions
without
without seeing
seeing the
the
“big
“big picture.”
picture.”
Disadvantages of
Lower-level
Decentralization
Lower-level manager’s
manager’s
objectives
objectives may
may not
not
be
be those
those of
of the
the
organization.
organization. May
May bebe difficult
difficult to
to
spread
spread innovative
innovative ideas
ideas
in
in the
the organization.
organization.
 Controllable
ControllableVs.
Vs.Noncontrollable
Noncontrollable
Revenues
RevenuesandandCosts
Costs

Can control all costs and revenues at

some level of responsibility within the
company
Critical issue under responsibility
accounting:

Whether the cost or revenue is controllable

at the level of responsibility with which
it is associated
 Controllable
ControllableVs.
Vs.Noncontrollable
Noncontrollable
Revenues
RevenuesandandCosts
Costs

All costs controllable by top management

Fewer costs controllable as one moves down to lower levels of

management

Controllable costs - costs incurred directly by a level of responsibility

that are controllable at that level

Noncontrollable costs – costs incurred indirectly which are allocated to

a responsibility level
 Responsibility
ResponsibilityReporting
ReportingSystem
System

Involves preparation of a report for

each level of responsibility in the
company's organization chart
Begins with the lowest level of
responsibility and moves upward to
higher levels
Permits management by exception at
each level of responsibility
Each higher level can obtain the
detailed report for each lower level
Responsibility
Responsibility Reporting
Reporting System
System --
Example
Example
 Responsibility Centres

A responsibility centre is an organisation unit

that is headed by manager who is
responsible for its activities.
• delegation of responsibility for specific to
successive lower levels of organisation.
• motivation of the level of management to
which a certain task has been delegated.
• measurement of the achievement of
specified objectives.
The key consideration in determining the
responsibility centre is
• ability to control cost or revenue
• determining the question of controllability

• evaluation of responsibility centre as per

predetermined criteria
The responsibility centres may be classified
as
• Revenue Centres
• Expense Centres
• Profit Centres
• Investment Centres
 Cost, Profit, and Investments
Centers

Cost Center
A segment whose
manager has control
over costs,
but not over revenues or
investment funds.
 Cost Center
Inputs RC’s Output
(Money spent on (Physical units
TASK
production) Produced)

• Decision Rights –
• Input Mix – Labor, Material, Supplies
• Performance Measures –
• Minimize total cost for a fixed output
• Maximize output for a given “cost budget”
• Typically used when –
• RC manager can measure output & quality of output
• knows cost functions, optimal input mix
• can set optimal quantity and appropriate rewards
Responsibility
Responsibility Accounting
Accounting for for Cost
Cost
Example – Fox Manufacturing
Centers Company
Centers
Assumes department manager can control all
manufacturing overhead costs except depreciation,
property taxes, and his own monthly salary of $4,000

LO 5: Indicate the features of responsibility reports for cost centers.

 Profit Centers

Revenues
Profit Center Sales
A segment whose Interest
manager has control Other
over both costs and Costs
revenues, Mfg. costs
but no control over Commissions
investment funds. Salaries
Other
 Responsibility
ResponsibilityAccounting
Accountingfor
forProfit
ProfitCenters
Centers

Based on detailed information

about both controllable
revenues and controllable costs

Manager controls operating

revenues earned, such as sales

Manager controls all variable

costs incurred by the center
because they vary with sales
 Profit Center -
• Profit is most comprehensive measure of performance
• Function/Activity having highest influence on Bottom
Line suits best for Profit Center.
• Can be a Business Division or any of the functional unit
• Demands highest freedom/autonomy than any other
RCs’

Inputs Output
RC’s (Money-profit
(Money spent for
TASK Earned out of sales)
earning profits)

Relationship can be established

 Profit Center
• Decision Rights –
• Input Mix – Labor, Material, Supplies
• Product Mix
• Selling Price
• Performance Measures –
• Actual Profits
• Actual Profit in comparison with budgeted profits
• Typically used when –
• RC manager has knowledge about correct
price/quantity
• RC manager has knowledge to select optimal
product mix
CANDIDATES FOR PROFIT CENTER ……………
 3. Business Unit as Profit Center
• Business Units In a Decentralized Company
Best suited as Profit Center
• Marketing Center as Profit Center–
– Marketing Function having highest influence on
Bottom Line, e.g. Colgate, Coca-Cola, Wipro- Bath Soaps
division, Dabur-Cosmetics division etc.
– When centralized control is infeasible e.g. Foreign
Marketing Center e.g. IBM, Microsoft, Honda India
• To Convert Marketing Division into Profit Center
• Charge cost of production to revenue center
• Grant of maximum autonomy to the unit
• Delegate sufficient authority
• Treat the unit as a mini company
 3. Functional Unit as Profit Center
• Manufacturing Division –
– When Cost of production having highest impact on
Bottom Line and
– When Marketing Function is relatively insignificant
» e.g. Nirama Detergent
• To convert a Production Division in to Profit Center
• Credit selling price less marketing expenses to production
division
• 3. Service and Support Center –
» e.g. Maintenance, Customer Service, Transportation,
Engineering Design Divisions
Given greater autonomy, helps them to cut cost and make its
operations more efficient
 3. Profit Center – Performance Measures
Performance Measure
• Revenue
Less VC of Mfg. & Marketing
1. Contribution Margin
Less Fixed Expenses
2. Direct Profit
Less Controllable Corporate Expenses
3. Controllable Profit
Less Other Corporate Allocations
4. Net Profit Before taxes
Less Income tax
5. Net Profit
Justification
Fixed Cost is beyond control of PC
All Expenses incurred at the behest of PC
Some HQ expenses exclusively incurred
for given PC at HQ – IT services
Common unavoidable expenses
incurred to run a company ; e.g.
All administration, financing and tax
planning activities are carried at HQ
In some cases RC do have
impact on tax liability of the company -
Tax Heavens
 3. Profit Center - Advantages
• Improves quality of decision – RC Mgr are closest to the point of decision
• Improves speed of decision – less intervention by HQ
• HQ is relieved of day-to-day decisions making process – can
concentrate on more strategic decisions

• Provides training ground for general mgt. as RC’s acts as mini Cos’.
• Enhances profit consciousness with every expense made.
(mktg. mgr. will tend to authorize promotional
expenditure which increases the sales).

• Provides best performance indicators of Co’s individual component.

• Since output is clear cut evident, it evokes competition.
• Ensures better and safer delegation of authority.
• Ensures better motivation and evokes commitment.
3. Profit Center – Dis-Advantages
• Caliber of RC mgr. may hamper the decision.

• Incase of more integrated company there may be problems of

cost sharing, transfer pricing, sharing credit for revenue.
• Divisionalisation may impose additional cost of admn/support units.
• Functional set up may not have competent of GM to manage RC.
• Functional units once cooperated may now be in competition with
one another- (as profit of one is loss to another).
• May encourage short term motive at the expense of Co’s overall goal.

• Optimization of RC’s profit not necessarily mean optimization of

company’s profits.
• Decentralization makes top mgt. to rely more on MC reports
 Responsibility
ResponsibilityAccounting
Accountingfor
forProfit
ProfitCenters
Centers

Based on detailed information

about both controllable
revenues and controllable costs

Manager controls operating

revenues earned, such as sales

Manager controls all variable

costs incurred by the center
because they vary with sales

LO 6: Identify the content of responsibility reports for profit centers.

 Responsibility
ResponsibilityAccounting
Accountingfor
forProfit
Profit Centers
Centers
Direct and Indirect Fixed Costs – both may be present
Direct fixed costs
Relate specifically to one responsibility center
Incurred for the sole benefit of the center
Called traceable costs since they can be traced directly
to one center
Most controllable by the profit center manager
Indirect fixed costs
Pertain to a company's overall operating activities
Incurred for the benefit of more than one profit center
Called common costs since they apply to more than one
center
Most are not controllable by the profit center manager

LO 6: Identify the content of responsibility reports for profit centers.

Responsibility
Responsibility Accounting
Accounting for
for Profit
Profit
Responsibility Report Centers
Centers
Shows budgeted and actual controllable revenues
and costs
Prepared using the cost-volume-profit income
statement format:
Deduct controllable fixed costs from the contribution
margin
Controllable margin - excess of contribution margin
over controllable fixed costs
best measure of manager’s performance in
controlling revenues and costs
Do not report noncontrollable fixed costs

LO 6: Identify the content of responsibility reports for profit centers.

Responsibility
Responsibility Accounting Accounting for for Profit
Profit
Centers
Example – Mantle Manufacturing
Centers Company
$60,000 indirect fixed costs not controllable by manager

LO 6: Identify the content of responsibility reports for profit centers.

 Investments Centers

Corporate Headquarters

Investment Center
A segment whose
manager has control
over costs, revenues,
and investments in
operating assets.
 Responsibility Centers
Investment Centers –
Inputs Output
(Money/net profit
(Money spent for RC’s
Earned on account
Starting & running TASK of investment)
the business)

• Objective – Make sound investment decision

• It compares Business units profits with assets employed to

earn that profit i.e. efficiency of assets employed.
• It satisfies both the goals of business organizations i.e.
to earn the profit and
to achieve optimal relationship in profits earned and
assets employed
 Investment Center
• Decision Rights –
• Input Mix – Labor, Material, Supplies
• Product Mix
• Selling Price
• Capital Investment
• Performance Measures –
• Actual ROI
• Actual Residual Income i.e. EVA
• Actual ROI & RI in comparison with budgeted ROI & RI
• Typically used when –
• RC manager has knowledge about correct price/quantity
• RC manager has knowledge to select optimal product mix
• RC manager has knowledge about investment opportunities
 Responsibility Centers -
Revenue Center -
Prime concern of the REVENUE CENTER – “TOPLINE”
e.g. Marketing center
Inputs Output
(Money directly RC’s (Sales Generated
spent on achieving TASK in money terms)
sales i.e. Mktg. Exp.)
Generate Sales

• RC has no authority to decide price.

• RC is charged with cost of Marketing and not with cost of
goods produced
• No formal relationship possible between I & O
• Performance Measure for the RC can be Revenue Budgets.
 Revenue Center - Issues
• Decision Rights –
• Promotion Mix –
• Performance Measures –
• Maximize total sales for a given promotion budget
• Actual sales in comparison with budgeted sales
• Typically used when –
• RC manager has thorough knowledge about market
• Promotion plays significant role in generating sales
• RC manager can establish optimal promotion mix
• He can set optimal quantity and appropriate rewards
Responsibility Report Format
Budget Actual Variance
Sales $xxx $xxx $xxx

Less $xxx $xxx $xxx

variable
costs
Contribution $xxx $xxx $xxx
margin
Less $xxx $xxx $xxx
controllable
Thank You

Questions?