Responsibility centers

MCS

MCS

CENTARLISATION & DECENTRALISATION

Why should we have decentralised system?(1/1)

Quality of decision making improves Speed of decision making improves H.Q. is relieved of day to day decision making Managers at decentralised units get exposure to decision making in functional areas and the managers at H.Q. get exposure in evaluation and supervision areas Managers at decentralised units become more aware of the differences in personal goals and the organisation goals.

Why should we not have decentralised system?(1/2)

Top management has to rely on the management control reports H.Q. managers are more capable or better informed and therefore can take better quality decisions Frictions arise on the issues like transfer price, overhead charges and the credit for the success The decentralised units instead of cooperating start competing with each other

Why should we not have decentralised system?(2/2)

Decentralisation may impose additional costs because of additional management, staff, record keeping etc. Competent persons to head the decentralised units may not be available Emphasis is placed on short run achievements rather than long run goals

Delegation (1/1)
Delegation without authority is of no consequence. It is like tying the hands and feet of a person and asking him to run. Delegation of the powers to the manager of the decentralised unit is the soul of decentralisation. Authority must be delegated commensurate to the activities / goals and the capability of the manager in charge.

Efficiency and Effectiveness(1/2)

These are the measures of the performance

Efficiency:
It is a comparative, rather than absolute measure of performance we say that one is more efficient than the other or one is more efficient now than in the past or one is more efficient than the standards/ideal etc. It is mostly quantitative measure between the input and the output

Efficiency and Effectiveness(2/2)

Effectiveness:
It is a measure of the contribution of the one to the overall objective of the whole Since the objectives of the whole and the contribution to the objectives are both difficult to quantify , this measure is mostly qualitative

Epitome:
In other words one is efficient if one does the things right, and one is effective if one does the right things.

Responsibility Centers
Definition: A responsibility center is an organisation unit that is headed by a manager who is responsible for its actvities.

Types of Responsibility Centers

1. Revenue Centers 2. Expense Centers
i. Engineered Expense Center ii. Discretionary Expense Center

3. Profit Centers 4. Investment Centers

Revenue Centers(1/3)

In a revenue center, output (i.e. revenue is measured in monetary terms, but no formal attempt is made to relate input (i.e. expense or cost) to output.

Efficiency of the Revenue Centers(2/3)

Efficiency of these centers is measured against the budgets or quotas. Managers are held responsible for the direct expenses incurred in the center. They are however not charged with the cost of the goods they market or sell. Primary efficiency measurement is revenue.

Revenue Centers(3/3)
Inputs are not related to outputs

Inputs (only for costs directly incurred)

work

Outputs in monetary terms

Examples: Marketing, Sales and Distribution, Counselors in academic or financial products etc.

Expense centers(1/7)
Expense centers are responsibility centers whose inputs are measured in monetary terms, but whose outputs are not. There are two types of the expense centers: Engineered Expenses Center:
These are those centers for which the costs can ascertained with precision. For example, raw material cost, wages, power, fuel etc.

Discretionary Expenses Center: (also called as managed costs centers)

Here no precise estimate of the costs is feasible Costs depend upon the managements judgment

Engineered Expense Centers (2/7)

Engineered Expense have the following charecteristics:
Their inputs can be measured in monetary terms. Their output can be measured in physical terms. Optimum cost incurred per unit of output can be determined The following are the examples: manufacturing operations, warehousing, distribution, trucking etc.

Efficiency of the EEC (3/7)

Standard cost is calculated from the historical data or the standards already set. Actual cost is calculated. These costs are then compared and the efficiency or otherwise is determined. Besides this managers are responsible for the activities such as training, employee development, that are not related to the current production The overhead costs are however determined by the HQ.

Engineered Expense Centers (4/7)

Optimal relationship Can be established Inputs in monetary terms work Outputs in physical terms

Example: factory expenses, manufacturing expenses,

Discretionary Expense Center (5/7)

These type of centers include the following activities:
Administrative unit Support unit Legal services Industrial relations and human resources Public relations Research and development Marketing and advertisement

Efficiency of the DEC (6/7)

Difference between the budgeted and the actual expense is NOT the efficiency measure for DEC. it is difficult to assess the efficiency of these centers.

Discretionary Expense Centers (7/7)

Optimal relationship cannot be established

Inputs in monetary terms

work

Output in physical terms

Examples: Research and Development department, Advertisements etc.

Profit Centers (1/11)

When the responsibility centers financial performance is measured in terms of profit (i.e. difference between the revenues and the expenses), the center is called as Profit Center. All SBUs are profit centers but all profit centers are not SBUs. All organisations take step in creating the profit centers at the lowest point in an organisation where the following two conditions are met.
The manager should have access to the relevant information needed for making such a decision. There should be some way to measure the effectiveness of the trade-offs the manager has made.

Business Unit or Strategic Business Unit (SBU)(2/11) Companies create business units because they have decided to delegate more authority to the operating managers. Degree of delegation may differ from company to company However the complete authority for generating profit is never delegated to a single segment of the business

Advantages of Profit Centers(3/11)

Quality of decision making improves as they are nearest to the point of decision making. Speed of decision making is increased because the instructions are not sought from the HQ. HQ is relieved of the day to day decision making for the petty issues involving the profit centers. Managers are freer to use their imagination and the initiative.

Advantages of Profit Centers(4/11)

As the profit centers are similar to the independent companies, they provide an excellent training ground for general management. Their management gain experience in managing all functional areas, and the upper management gains the opportunity to evaluate their potential for higher level jobs Profit consciousness is enhanced since the managers who are responsible for profits will constantly seek ways to enhance them.

Advantages of Profit Centers(5/11)

Profit centers provide top management with ready made information on the profitability of the companys individual components. Because their output is so readily measured, profit centers are particularly responsive to pressures to improve their competitive performance.

Difficulties with Profit Centers(6/11)

Decentralised decision making will force top management to rely on management control reports than on personal knowledge of an operation, entailing some loss of control. If HQ management is more capable or more informed than the profit center manager, the quality of the decision makingat unit level may be reduced.

Difficulties with Profit Centers(7/11)

Friction may increase because of arguments over the appropriate transfer price, the assignment of the common costs, and the credit for the revenues that were formerly generated jointly by two or more business units working together. Organisation units that once cooperated with each other as functional units may now be in competition with each other.

Difficulties with Profit Centers(8/11)

Decentralisation may impose additional costs because of additional management, staff and record keeping required, and may lead to task redundancies at each profit center. Competent managers may not exist in a functional organisation because there may not have been sufficient opportunities for them to develop general management competence.

Difficulties with Profit Centers (9/11)

There may be too much emphasis on short run profitability at the expense of long run profitability. In the desire to report high current profits, the profit center manager may skimp on R & D, Training programe or maintainence There is no completely satisfactory system of ensuring that optimising the profits of each individual profit center will optimise the profit of the company as a whole.

Measuring the efficiency of the Profit Centers(10/11)

1. Contribution margin (spread between revenue and variable expenses) 2. Direct profit (profit centers contribution to the general overhead or the profit of the company) 3. Controllable profit (non controllable expenses of the HQ are subtracted from the total expenses while calculating profit) 4. Income before tax (PBT) 5. Net income (PAT)

Profit Centers (11/11)

Inputs are related to outputs Inputs in monetary terms

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Outputs are in monetary terms

These are business units (with some modifications or amendments functional units can be converted as business units)

Investment centers (1/5)

This is a special type of profit center In such type of centers profit is compared to the assets employed to earn it. The sum of assets employed in the investment center is called as investment base. Profit is related to this investment base in the following two ways:
The percentage of return on investment referred to as ROI Economic Value Added (EVA) also known as residual income.

ROI and EVA (2/5)

ROI, Return on Investment is a ratio, the numerator of which is income as reported in the income statement and the denominator is the assets employed. Assets employed are total assets less current liability which corresponds to shareholders equity plus the non current liability. EVA on the other hand (not being a ratio) is the quantity in monetary terms. It is found by subtracting a capital charge from the net operating profit

Measuring the Assets (3/5)

Cash Receivables Inventories Working capital in general Property, Plant and Equipment Acquisition of new equipment Gross block value

Measuring the assets(4/5)

Disposition of assets Annuity depreciation Other valuation methods for the assets Leased assets Idle assets Intangible assets Noncurrent liabilities The capital charge

Investment Centers (5/5)

Profits are related to the Capital employed Inputs in monetary terms

Capital Employed

Outputs in monetary terms

These are business units

Questions so far asked by the university on this topic.

1. What is responsibility center? List and explain different types of responsibility centers with sketches. 2. Every SBU is a profit center but every profit center is not SBU? What are the conditions that must be fulfilled for an organisation unit to be converted into a profit center? What are different ways to measure the performance of a profit center? discuss their relative merits and demerits.

Questions so far asked by the university on this topic.

3. Briefly describe Engineered Expense Centers and Discretionary Expense Centers. How is budget prepared in each and how is performance evaluated in each? 4. What is a Strategic Business Unit? What are the conditions required for creating SBU? How is performance of SBU measured? What are the advantages and disadvantages of creating SBUs?

Questions so far asked by the university on this topic.

5. How is investment center different from a profit center? What are the different methods of judging their performance? Which is better method? 6. Briefly describe Responsibility center, engineered Expense center, Discretionary Expense Center, Revenue Center, Profit center. How is the performance of the head of these centers evaluated?

Questions so far asked by the university on this topic.

7. Every SBU is a profit center but every profit center may not be SBU. Explain. Under what conditions Production, Marketing and Service Departments are converted into profit centers? 8. What do you understand by Investment Center? Explain two different methods by which the performance of these centers are measured? Also discuss their relative merits and demerits.