Week 2: Organisational Structure and

Responsibility Accounting
Topic 2 Objectives

• Understand two aspects of organisational structure that

are relevant to the design of MAS’s
– Centralisation and Decentralisation
– Work units, Sub-units or Responsibility Centres

• Work Units
– Be able to recognise different types of work units and
understand when they are most appropriate
– Understand the role of work units in management control

• Understand the meaning of responsibility accounting

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Topic 2 Objectives

• Decentralisation
– Understand the concept of decentralisation and the
creation of responsibility centres or sub-units
– Understand the link between decentralisation and
responsibility accounting
– Understand the role of decentralisation and responsibility
accounting in management control

• Understand the relationship between management

accounting system design and organisational
structure
• Be able to identify appropriate management accounting
system attributes for different organisational structures
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What is organisational structure?

The way in which an organisation groups its employees

together to......
• Co-ordinate, manage and control the elements of an
organisation
– Resources
– People
– Activities
• Focus attention towards particular objectives and
activities that support organisational strategy

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Types of work units

CEO

CEO
Design Supply Mftg Mktg Sales

↑Functional work units SBU #1 SBU #2 SBU #3

Supply Supply Supply

Mftg. Mftg Mftg

Mktg Mktg Mktg

Sales Sales Sales

→Business (market-based) work units

Management Accounting and Business 5
Types of work units

Work units are:

• Groups of individuals who perform specific tasks or functions
• Can be small (a team) or large (a business)
• Are supervised by a manager

• Functional work units

– Focus of work unit is on a specific function
• Business (Market-based) work units
– Focus of work unit is a specific market
o Defined by either geography, customer or product
• A hybrid of both

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Organisational structures and work units

• Matrix Structures (complex market-based work units)

CEO

Europe Oceania Americas

Diamonds

Petroleum

Coal

Management Accounting and Business 7

Organisational structures and work units

CEO

Design Supply Mftg Europe Oceania

Back-end Front-end
Organised by function Organised by
or product client, region

Hybrid example: Front-End/Back-End

When are functional structures appropriate?

• Common technologies for all products

– Standardised products

• Presence of large economies of scale

• Similarities amongst product markets

• Managers are functionally skilled

• When efficiency in undertaking value chain functions

is a KSF

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When are market-based structures appropriate?

• Diversity of product lines

• Diversity in product technologies

• Dissimilar markets

• Capable managers

• When market responsiveness to customers is a KSF

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Business strategy and organisational structure
• Each type of work unit has its own benefits and limitations
• These benefits/limitations allow different means of
competitive advantage to be matched to different work
unit types
– Differentiation – tend to be market based work units
– Cost Leader – tend to be functional work units
• When interdependencies between work units are
important, horizontal information flows are important
• A well designed structure should provide incentives to
share information with other divisions or work units
o Fosters collaboration and avoids silo mentality

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Benefits of market-based responsibility centres

• Co-ordination of value chain activities is easier

– Most/all activities are within one work unit

• Managers tend to become more widely trained

– Breadth of skills

• Employees are dedicated to one product/line/service

– Understand customer needs

Therefore responsiveness to
customers is enhanced

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Limitations of market-based work units

• Duplication of non-production staff

– Each business unit has marketing/production function etc.
• Functional economies of scale are limited

• Management of work unit becomes more complex

– If managers don’t have a breadth of knowledge/skills -
o Information asymmetry may occur between work unit
manager and employees (within the same work unit)

• Can encourage competition between work units

– Each are a “Mini Business” effecting a “Silo mentality”

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Benefits of functional work units

• Limits attention to one function

– focused performance objectives

• All employees specialise in one function

– Allows employees develop expertise

• Manager is able to supervise/teach all employees

– All have similar skills

• Economies of scale

Therefore efficiency of the function is enhanced

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Limitations of functional work units

• Functions of the value chain are separated

– Co-ordination/integration of independent functions can be
difficult for organisation s to achieve

• Information flows/communication (vertically) are often

restricted
– Specialised knowledge gives power and may create
information asymmetry between work units
– If horizontal information flows are impeded with poorly
designed MAS, then silo mentality is also an issue

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 Limitations of functional work units

• Focus is often on efficiencies of operations at the expense of

– creativity and learning,
– customer value,
– customer responsiveness

• Performance measurement is problematic

– Often no unambiguous way of determining individual
contribution to final output (product/service)
o How do you measure the contribution of a “marketing”
function?

• Not as suitable for firms with diversified products/services

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A Decentralised Organisational Structure

Decentralisation refers to the way decision-making is

delegated to responsibility centre managers and employees

• The distinction between centralised and decentralised

organisations depends on the degree of decision-making
power/delegation within responsibility centres
• Centralised firms
– Little delegation of decision-making to lower management
– Small organisations may not necessarily have sub-units

• Decentralised firms
– Work units are generally necessary
– Work unit managers have decision making power

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Why do firms decentralise?

Decentralisation isn’t costless so why decentralise?

• Essentially, organisations become too large

– Information flows become too complex

– Co-ordination of people, resources, activities becomes

more complex
– Specialist knowledge/skills become critical to quality
decision making and therefore organisational success
– Therefore effective and timely decisions cannot be made
centrally

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Decentralisation

• Potential benefits of delegating decisions to lower

management (decentralising)
– Improves decision-making timeliness

– Improves access to relevant decision information

– Provides opportunities to gain experiences and skills

– Empowers employees

– Tends to improve managerial motivation

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Decentralisation

• In a centralised organisation, decision making authority

and responsibility resides with top management
• In a decentralised organisation, decision making
authority and responsibility is given to lower levels of
management

• Usually, top management has general knowledge about

the operations of business segments
• However, decision making often requires specific
knowledge which is more likely to reside with business
segment managers

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Decentralisation

• Potential problems

– Communication of strategic objectives may be difficult

– Control over decision-making may be problematic

o Information asymmetry

– Lack of goal congruence

– Performance measurement and evaluation difficult

The role of an MAS is to provide

information to minimise these problems

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Requirements for successful decentralisation

• Clear identification and communication of boundaries of

responsibility between work units and managers

• Ability to measure accurately the performance of individual

work units

• Limitations on the interference of central management in

local decision making

• The MAS supports the establishment of these

requirements through:
– Development of Responsibility Centres
– Use of Responsibility Accounting

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Responsibility accounting

• Responsibility centres are decentralised sub-units or

work units in which managers are accountable for specific
types of operating activities
• They are important part of management control
o Activities and performance should be clearly defined

o Activities and performance should be limited

o Managers should have decision-making power over

activities and performance for which he/she is responsible

• Responsibility accounting assigns authority and

responsibility to managers of sub-units and then
measuring and evaluating their performance

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Performance measurement in decentralised units

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Types of Responsibility Centres

• Cost centre
– Two types
o Engineered or
o Discretionary

• Revenue centre

• Profit centre

• Investment centre

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Cost centres

• Manager is responsible for costs associated with work

unit responsibility centre

• Cost centres tend to be functional work units

• Two types of cost centres

– Engineered
– Discretionary

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Engineered cost centres

Examples
• Manufacturing units, some data entry and administration
units

Characteristics
• Input /output relationships are well understood
– optimal amount of input required to produce one unit of
output can be determined
• Once desired output is known, inputs can be determined
• Performance measurement is relatively easy
– Use of standards, flexible budgets, variance analysis
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Discretionary costs centres

Examples

• R & D, Marketing, Staff Training

Characteristics
• Difficult to measure output – it’s often qualitative

• Even if outputs can be measured, the input-output

relationship is difficult to observe
– Sometimes a lag between inputs and outputs

• Costs incurred are often caused by management

discretion

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Discretionary cost centres continued

• Performance measurement and control in

discretionary cost centres is difficult

– No standards can be determined

– Input-output relationships cannot be identified

– No “optimal” level of expenditure can be determined

– Performance evaluation requires judgement

o Qualitative measures

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Profit centres

• Managers given control of both inputs (costs) and outputs

(revenue)
• Manager evaluated in terms of effectiveness in controlling
costs and revenues
• Often used in business work units – Why?
• Performance measures tend to be quantitative

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Investment centres

• Managers of investment centres are held responsible for

the revenues, costs and investments under their control.
• Because investment centres include revenues, costs and
investment, performance measures need to address all of
these factors.
• Objectives emphasise generation of profit, for a given
level of assets– i.e. profitability, not just profit is important

• Most common performance measures

– ROI or ROA
– Residual income
– Economic Value Added (EVA)

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Choice of responsibility centre
• Choice of types of responsibility centres depends on:
– size of organisation
– nature of organisation
– organisational structure.
• Functional work units tend to be?
– Cost or revenue centres
o Production department
o Sales department

• Business (market-based) work units tend to be?

– Profit or investment centres
o “mini businesses”

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Responsibility centre and management control

• Ideally, responsibility centres should reduce agency costs

by holding managers accountable for their decisions
• However, responsibility centre accounting may lead to
suboptimal decision making because managers act in
their own best interests rather than for the entity as a
whole.
• To address agency problems, appropriate performance
measures and reward systems must be implemented

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Influencing behaviour

• Organisational structure directly provides a form of

management control as it determines a manager’s:
– Span of control
– Span of accountability
– Span of attention

• These “spans” define a manager’s role and behaviours

• These “spans” influence individual behaviour by providing

direction for behaviour and decision-making

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 Controlling management actions

ort Span of attention

p
pp? Domain of activities that are within a manager’s field of view
u
f S to he
Span of attention is Intrinsically determined by:
l work unit – focus on specialization/responsiveness;
o
nWho ab
le control – focus on needs of subordinates;

a i s accountability - what gets measured gets managed

Sp

Work unit design

Functional specialisation or Market responsiveness designs
Generally tradeoffs between efficiency and responsiveness
(Matrix structure aims for both)

Span of control
ce Resources (people & work units) directly under a managers control

e n who is accountable to whom but not what they are accountable for

f u
l with?
f n
I nteract
o
nWho c nI
i

a a
Span of accountability
Sp Range of performance measures to evaluate achievements
(i.e. quality, cost, profit & loss, investment responsibility etc.)

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306-664 Strategic Management Accounting