Responsibility Center & Responsibility Accounting

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The Concept of Responsibility Accounting

Involves accumulating and reporting costs on the basis of the manager who has the authority to make the day-today-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 Concept of Responsibility 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 Concept of Responsibility Accounting Levels of responsibility for controlling costs .

The Concept of Responsibility 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 not-forProfit entities: maximize net income Not-forNot-for-profit: minimize cost of providing services .

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

´ Lower-level manager¶s objectives may not be those of the organization. . May be a lack of coordination among autonomous managers.Decentralization in Organizations Lower-level managers may make decisions without seeing the ³big picture. Disadvantages of Decentralization May be difficult to spread innovative ideas in the organization.

Noncontrollable Revenues and 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 Vs.

Controllable Vs.costs incurred directly by a level of responsibility that are controllable at that level Noncontrollable costs ² costs incurred indirectly which are allocated to a responsibility level . Noncontrollable Revenues and Costs All costs controllable by top management Fewer costs controllable as one moves down to lower levels of management Controllable costs .

Responsibility Reporting 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 Reporting System Example .

Responsibility Centres A responsibility centre is an organisation unit that is headed by manager who is responsible for its activities. ‡ motivation of the level of management to which a certain task has been delegated. . ‡ measurement of the achievement of specified objectives. ‡ delegation of responsibility for specific to successive lower levels of organisation.

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 .

and Investments Centers Cost Center A segment whose manager has control over costs.Cost. but not over revenues or investment funds. Profit. .

Cost Center Inputs (Money spent on production) RC s TASK Output (Physical units Produced) ‡ Decision Rights ± ‡ Input Mix ± Labor. Supplies ‡ Performance Measures ± ‡ Minimize total cost for a fixed output ‡ Maximize output for a given ³cost 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 . Material.

and his own monthly salary of $4. property taxes.000 LO 5: Indicate the features of responsibility reports for cost centers. .Responsibility Accounting for Cost Example ² Fox Manufacturing Company Centers Assumes department manager can control all manufacturing overhead costs except depreciation.

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

such as sales Manager controls all variable costs incurred by the center because they vary with sales .Responsibility Accounting for Profit Centers Based on detailed information about both controllable revenues and controllable costs Manager controls operating revenues earned.

‡ Can be a Business Division or any of the functional unit ‡ Demands highest freedom/autonomy than any other RCs¶ Output (Money-profit Earned out of sales) Inputs (Money spent for earning profits) RC s TASK Relationship can be established .Profit Center ‡ Profit is most comprehensive measure of performance ‡ Function/Activity having highest influence on Bottom Line suits best for Profit Center.

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 ««««« .Profit Center ‡ Decision Rights ± ‡ Input Mix ± Labor.

Bath Soaps division. Wipro. 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 . Coca-Cola. 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.g. Colgate. e.g. Dabur-Cosmetics division etc. Foreign Marketing Center e. IBM. Microsoft.g. ± When centralized control is infeasible e.3.

g. Engineering Design Divisions Given greater autonomy.3.g. Customer Service. Service and Support Center ± » e. helps them to cut cost and make its operations more efficient . 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. Transportation. Nirama Detergent ‡ To convert a Production Division in to Profit Center ‡ Credit selling price less marketing expenses to production division ‡ 3. Maintenance.

Direct Profit Less Controllable Corporate Expenses 3. 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 2. Contribution Margin Less Fixed Expenses 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 . & Marketing 1. Profit Center ± Performance Measures Performance Measure Justification Revenue Less VC of Mfg.3. e. Net Profit .g. Net Profit Before taxes Less Income tax 5. Controllable Profit Less Other Corporate Allocations 4.

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. Profit Center . Enhances profit consciousness with every expense made. it evokes competition. Ensures better motivation and evokes commitment. Since output is clear cut evident.3. . as RC s acts as mini Cos . Ensures better and safer delegation of authority. mgr. Provides best performance indicators of Co s individual component. will tend to authorize promotional expenditure which increases the sales). (mktg.

Divisionalisation may impose additional cost of admn/support units. Decentralization makes top mgt. 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. Profit Center ± Dis-Advantages Caliber of RC mgr. Functional set up may not have competent of GM to manage RC.(as profit of one is loss to another). Functional units once cooperated may now be in competition with one another. Incase of more integrated company there may be problems of cost sharing. transfer pricing.3. sharing credit for revenue. may hamper the decision. to rely more on MC reports .

Responsibility Accounting for Profit 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 LO center because responsibility reports for profit centers. the 6: Identify the content of they vary with sales .

Pertain to a company's overall operating activities Incurred for the benefit of more than one .Responsibility Accounting for Profit Centers Direct and Indirect Fixed Costs ² 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 LO 6: Identify the content of responsibility reports for profit centers.

Responsibility Accounting for Profit Centers Responsibility Report 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 LODo Identify the content of responsibility reports for profit centers. 6: not report noncontrollable fixed costs .

000 indirect fixed costs not controllable by manager LO 6: Identify the content of responsibility reports for profit centers.Responsibility Accounting for Profit Example ² MantleCenters Manufacturing Company $60. .

. and investments in operating assets.Investments Centers Corporate Headquarters Investment Center A segment whose manager has control over costs. revenues.

efficiency of assets employed.Responsibility Centers Investment Centers Inputs (Money spent for Starting & running the business) Objective Output RC s TASK (Money/net profit Earned on account of investment) Make sound investment decision It compares Business units profits with assets employed to earn that profit i. It satisfies both the goals of business organizations i.e.e. to earn the profit and to achieve optimal relationship in profits earned and assets employed .

Investment Center ‡ Decision Rights ± ‡ ‡ ‡ ‡ Input Mix ± Labor. Supplies Product Mix Selling Price Capital Investment ‡ Performance Measures ± ‡ Actual ROI ‡ Actual Residual Income i. 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 .e. Material.

) RC s TASK Generate Sales Output (Sales Generated in money terms) RC has no authority to decide price. Mktg. 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.e. . Marketing center TOPLINE Inputs (Money directly spent on achieving sales i. Exp.Responsibility Centers Revenue Center Prime concern of the REVENUE CENTER e.g.

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 .Revenue Center .

Responsibility Report Format Budget Actual Variance Sales Less variable costs Contribution margin Less controllable fixed costs $xxx $xxx $xxx $xxx $xxx $xxx $xxx $xxx $xxx $xxx $xxx $xxx .

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