Responsibility Accounting

Responsibility AccountingResponsibility Accounting Responsibility Accounting is a method of accounting Responsibility Accounting is a method of accounting

in which costs and revenues are identified with in which costs and revenues are identified with persons assigned to their control rather than with persons assigned to their control rather than with products or functions.products or functions.

Responsibility Accounting collects and reports Responsibility Accounting collects and reports planned and actual accounting information about the planned and actual accounting information about the inputs and outputs of responsibility centres. inputs and outputs of responsibility centres.

In Other words Responsibility accounting is based on In Other words Responsibility accounting is based on cost and revenue data for financial information.cost and revenue data for financial information.

Basis Principles of Responsibility Basis Principles of Responsibility AccountingAccounting

1. Objectives1. Objectives 2. Controllable Costs2. Controllable Costs 3. Explanation3. Explanation 4. Management by exception4. Management by exception

Responsibility CentreResponsibility Centre

Responsibility Centre is a unit of an organisation that Responsibility Centre is a unit of an organisation that is separable and identifiable for operating purposes is separable and identifiable for operating purposes and its performance measurement should be possible.and its performance measurement should be possible.

The important criterion for creating a responsibility The important criterion for creating a responsibility centre is that the unit of the organisation should be centre is that the unit of the organisation should be separable and identifiable for operating purpose and separable and identifiable for operating purpose and its performance measurement should be possible.its performance measurement should be possible.

Objectives of Responsibility Centre Objectives of Responsibility Centre

i) To Provide basis for evaluation of quality of i) To Provide basis for evaluation of quality of performance. (based on efficiency & performance. (based on efficiency & effectiveness)effectiveness)

ii) To Motivate, consistent with the basic goals ii) To Motivate, consistent with the basic goals of the organisation.of the organisation.

Responsibility Centre-SketchesResponsibility Centre-Sketches

Types of Responsibility CentresTypes of Responsibility Centres Cost CentreCost Centre Revenue CentreRevenue Centre Profit CentreProfit Centre Investment CentreInvestment Centre

Cost CentresCost Centres

Cost Centre or Expense centre is a segment of Cost Centre or Expense centre is a segment of an organisation whose financial performance an organisation whose financial performance is measured in terms of cost.is measured in terms of cost.

In this type of Reporting, Revenue is excludedIn this type of Reporting, Revenue is excluded

Cost in this case, includes fixed and variable Cost in this case, includes fixed and variable cost but excludes Common costscost but excludes Common costs

Cost Centre- SketchesCost Centre- Sketches

Suitability of Cost CentresSuitability of Cost Centres

i) In Places where output (revenue) cannot be i) In Places where output (revenue) cannot be reliability measured in financial terms such as reliability measured in financial terms such as legal department, accounting department & legal department, accounting department & Personnel departmentPersonnel department

ii) A Unit which is producing one single ii) A Unit which is producing one single productproduct

iii) To measure performance of departmental iii) To measure performance of departmental manager.manager.

Engineered expense centersEngineered expense centers

They have the following characteristics:They have the following characteristics: - Their inputs can be measured in monetary - Their inputs can be measured in monetary

terms.terms. - Their output can be measured in physical - Their output can be measured in physical

terms.terms. - The optimal Rupee amount of input required - The optimal Rupee amount of input required

to produce one unit of output can be to produce one unit of output can be established.established.

Engineered expense centers: Engineered expense centers: ExamplesExamples

Manufacturing operations. Manufacturing operations. Warehousing, distribution, trucking and Warehousing, distribution, trucking and

similar units in the marketing organization similar units in the marketing organization Accounts receivable account payable and Accounts receivable account payable and

payroll section in the controller department.payroll section in the controller department. Personnel record and cafeteria in the human Personnel record and cafeteria in the human

resource department.resource department.

Discretionary expense center:Discretionary expense center:

The output of discretionary expenses center The output of discretionary expenses center cannot be measured in monetary terms.cannot be measured in monetary terms.

They include administration and support units They include administration and support units research and development organization and research and development organization and most marketing activities. most marketing activities.

Performance is measured in terms of working Performance is measured in terms of working within the budgets. within the budgets.

Revenue CentreRevenue Centre

Revenue Centre is a segment of an Revenue Centre is a segment of an organisation whose financial performance is organisation whose financial performance is measured in terms of Revnue.measured in terms of Revnue.

In this type of Reporting, Cost is excludedIn this type of Reporting, Cost is excluded

For Eg: Sales DepartmentFor Eg: Sales Department

Profit CentreProfit Centre

Profit Centre is a segment of an organisation in Profit Centre is a segment of an organisation in which financial performance is measured on which financial performance is measured on the basis of Profit.the basis of Profit.

Profit CentreProfit Centre

Advantage of Profit CentreAdvantage of Profit Centre

i) Profit is a powerful tool for measurementi) Profit is a powerful tool for measurement ii) Profit Centre represents a business unitii) Profit Centre represents a business unit iii) Profit Centre makes decentralisation iii) Profit Centre makes decentralisation

possible.possible.

LimitationLimitation

i) Criteria for Profit Centre selectioni) Criteria for Profit Centre selection ii) Measurement of Expenses (allocated ii) Measurement of Expenses (allocated

expenses)expenses) iii) Transfer Prices (for Inter Departmental iii) Transfer Prices (for Inter Departmental

transfers)transfers)

Investment CentreInvestment Centre

Investment Centre is a responsibility centre Investment Centre is a responsibility centre whose performance is measured in relation to whose performance is measured in relation to revenues/ profits and the assets employed in revenues/ profits and the assets employed in the division.the division.

Investment Centre-SketchesInvestment Centre-Sketches

A simple summary of the A simple summary of the responsibility centersresponsibility centers

Revenue CenterOutput measured in monetary terms

Input measured in monetary terms

Output measured in monetary terms

Output measured in monetary terms

Expense/Cost Centers

Profit Centers

Investment Centers

Performance EvaluationPerformance Evaluation

Type of Type of Responsibility Responsibility CentreCentre

Manager has Manager has control overcontrol over

Principal Principal Performance Performance MeasurementMeasurement

Cost CentreCost Centre Costs (only Costs (only controllable)controllable)

Variance Variance AnalysisAnalysis

Revenue CentreRevenue Centre Revenue Revenue Budgets Budgets

Variance Variance AnalysisAnalysis

Profit CentreProfit Centre Costs & RevenueCosts & Revenue ProfitProfit

Investment Investment CentreCentre

Cost, Revenue & Cost, Revenue & InvestmentInvestment

ROIROI

Residual IncomeResidual Income

What did we learn from these What did we learn from these control system illustrations?control system illustrations?

All responsibility centers evolve from the concept of All responsibility centers evolve from the concept of ““controllability.” controllability.”

Controllability principle states a manager should be assigned Controllability principle states a manager should be assigned responsibility for the revenue, costs, or investment that he/she responsibility for the revenue, costs, or investment that he/she could control.could control.

Revenues, costs, or investments that do not fall under a Revenues, costs, or investments that do not fall under a manager’s control must be excluded when evaluating the manager’s control must be excluded when evaluating the manager or his/her center.manager or his/her center.

Problem with this concept: In most organizations, many Problem with this concept: In most organizations, many revenues and costs are jointly earned or incurred and revenues and costs are jointly earned or incurred and differentiation the controllable from the uncontrollable is differentiation the controllable from the uncontrollable is difficult.difficult.

An alternative to An alternative to “Controllability”“Controllability”

Some argue that performance measures should be Some argue that performance measures should be chosen to influence decision-making behavior.chosen to influence decision-making behavior.

For example, if market prices for raw material is For example, if market prices for raw material is increasing, what can a manager do?increasing, what can a manager do?

Perhaps, enter into long term contract for fixed Perhaps, enter into long term contract for fixed prices for raw materials.prices for raw materials.

If electricity consumption cost is going up, find If electricity consumption cost is going up, find out how consumption can be economized (better out how consumption can be economized (better machines, lighting, reduce waste).machines, lighting, reduce waste).

Benefits of Responsibility Benefits of Responsibility AccountingAccounting

1. Clear defining and communicating the 1. Clear defining and communicating the corporate objectives and individual goals.corporate objectives and individual goals.

2. Compels management to set realistic plans 2. Compels management to set realistic plans and budgets.and budgets.

3. Delegation of Decision Taking3. Delegation of Decision Taking 4. Exception reporting4. Exception reporting 5. Closer control.5. Closer control. 6. Measures Performance of Individual in 6. Measures Performance of Individual in

objective mananerobjective mananer

Difficulties in ImplementationDifficulties in Implementation

1. Management may find it difficult to fix 1. Management may find it difficult to fix responsibility.responsibility.

2.The traditional way of classification of 2.The traditional way of classification of expenses should be subjected to a further expenses should be subjected to a further analysis which comes difficultanalysis which comes difficult

3. Managers may need additional clarification 3. Managers may need additional clarification because of the design of responsibility report because of the design of responsibility report being different from routine reports.being different from routine reports.

Return on Investment (ROI)Return on Investment (ROI)

Most common form of Performance evaluationMost common form of Performance evaluation ROI = Profit Margin ROI = Profit Margin ---------------- X 100---------------- X 100 InvestmentInvestment

RO I = RO I = Sales RevenueSales Revenue X X Profit MarginProfit Margin X 100 X 100 Investment Sales RevenueInvestment Sales Revenue

Advantages of ROIAdvantages of ROI

It relates return to level of investmentIt relates return to level of investment ROI can be analysed into other ratios which ROI can be analysed into other ratios which

are useful for analytical purpose.are useful for analytical purpose. It can be used for inter firm comparisonIt can be used for inter firm comparison

DisadvantagesDisadvantages

1. Problem of defining Profit & Investment1. Problem of defining Profit & Investment 2. For Inter firm comparison, Co may not 2. For Inter firm comparison, Co may not

follow common accounting policies & follow common accounting policies & practices for Assets & Profits.practices for Assets & Profits.

3. Manager may only select investment with 3. Manager may only select investment with high ROI and reject projects which increase high ROI and reject projects which increase the value of the business unitthe value of the business unit

Residual Income MethodResidual Income Method

In case of Residual Income Method, Capital In case of Residual Income Method, Capital Charge of use of Capital (Investment) is Charge of use of Capital (Investment) is deducted from the Divisional Profits.deducted from the Divisional Profits.

Residual Income = Div. Profits - Interest Residual Income = Div. Profits - Interest

Non Financial Control MeasuresNon Financial Control Measures

Market PositionMarket Position ProductivityProductivity Product LeadershipProduct Leadership Personnel DevelopmentPersonnel Development Employee AttitudeEmployee Attitude Public ResponsibilityPublic Responsibility