responsibility accounting 158

8/9/2019 Responsibility Accounting 158

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Tata McGraw Tata McGraw--Hill Publishing Company Limited, Management AccountingHill Publishing Company Limited, Management Accounting 2121--11

ResponsibilityResponsibility

AccountingAccounting


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RESPONSIBILITY ACCOUNTING

Meaning and Objectives

Types of Responsibility

Centres


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Responsibility AccountingResponsibility Accounting

Responsibility accounting is a device to measure divisional

performance. Division includes any logical segment/

component/sub-component of an organisation.

Features of responsibility accounting

(i) Inputs and Outputs

(ii) Planned and Actual

(iii) Responsibility Centres


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The financial information included is both actual and planned. For

planning and control, it not only contains historical information

about cost/revenues, but also estimated future cost and revenue

data..

Responsibility accounting is based on information relating to inputsand outputs. The resources used are called inputs.

The resources used by an organisation are essentially physical in

nature, such as quantity of materials consumed, hours of labour,

and so on.

Responsibility centre is the unit of an organisation that is separable

and identifiable for operating purposes and its performance

measurement should be possible.

(ii) Planned and Actual

(i) Inputs and Outputs

(iii) Responsibility Centres


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Example 1

The following information is available relating to the cost of

production of the Hypothetical Ltd:

Cost item Amount

Direct material

Direct labour

Overheads

Total

Rs 40,000

26,000

28,000

94,000

It may be assumed that the firm has four departmentstwo

production and two service. Assuming an imaginary division

of the cost between the four departments (responsibilitycentres), show the cost allocation.


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Solution

The allocation of the costs to the four responsibility centres is illustrated in Table

Table 1: Allocation of Costs to Responsibility Centres

Total

Responsibility Centres (Departments)

A B C D

Direct material Rs 40,000 Rs 36,000 Rs 4,000 Rs Rs

Direct labour 26,000 8,000 18,000

66,000 44,000 22,000

Overheads:

Supervision 7,600 1,400 1,800 1,600 2,800

Indirect labour 13,200 1,200 1,600 4,200 6,200

Supplies 2,400 1,000 800 200 400

Other costs 4,800 600 1,600 1,000 1,600

28,000 4,200 5,800 7,000 11,000

Total 94,000 48,200 27,800 7,000 11,000

Thus, responsibility accounting is a method for dividing the organisation structure into various

responsibility centres to measure the performance of each of the responsibility centres. In other

words, responsibility accounting is a device to measure divisional performance.


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ObjectivesObjectives

1) Determination of Contribution of a Division

The performance of a responsibility centre can be measured in terms of its

efficiency and/or in terms of its effectiveness. Efficiency measures the

relationship of inputs to outputs; and the relationship between output andthe goals of the organisation is called effectiveness.

2) Evaluation of Quality of Performance

Responsibility accounting is used to measure the performance of managers

and it, therefore, influences the way the managers behave. In discussing

responsibility accounting, we must take behavioural considerations intoaccount.

3) Motivation Consistent with Organisational Goals

As observed earlier, any performance measurement system can be

expected to influence the behaviour of the managers affected by it.


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TYPES OF RESPONSIBILITYTYPES OF RESPONSIBILITY

CENTRESCENTRES

(1) Expense/Cost Centre(1) Expense/Cost Centre

(2) Profit Centre(2) Profit Centre

(3) Investment Centre(3) Investment Centre


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Expense/Cost CentresExpense/Cost Centres

Expense/cost centre is a segment of an organisation whose financial

performance is measured in terms of cost. The expense centre can be

employed in three situations.

In the first place, in several cases, the output (revenue) of a responsibility

centre cannot be reliably measured in financial terms. Their outputscannot obviously be expressed in monetary terms. The onlymeasurable performance measure is their efficiency in the use of inputs.Thus, such divisions can be evaluated only as expense centres.

Secondly, if a production centre/unit/segment is producing one singleproduct, its performance can be measured as expense centre in

terms of efficiency and effectiveness. Although, the output cannot beexpressed in monetary terms, the number of units produced can reasonablyrepresent output.

Thirdly, an expense centre can also be suitably employed to measureperformance if the responsibility of the departmental manager is to producea stated quantity of outputs at the lowest feasible cost.


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Profit CentresProfit Centres

Profit centre is a segment of an organisation in which financialperformance is measured on the basis of profit.

Segment profit contribution is the best direct measure of profit

performance attributable to, and controllable by a segment.

Segment net income may also be a useful measure as it

emphasises the long-run ability of a segment to contribute to theprofits of an organisation. Segment profit contribution and segment

net income may be used for

(i) Evaluating segment performance in relation to pre-determined

objectives,

(ii) Competitive ranking of segments,

(iii) Decisions relating to the expansion, contractions, additions or

discontinuation of segments.


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LimitationLimitation

Although the profit centre basis is superior to expense

centre, as a criterion for divisional performance

measurement, this approach suffers from certainoperational problems. These relate to

Criteria for Profit Centres

Measurement of Expenses

Transfer Prices


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Criteria for Profit Centres

One problem with profit centre is that it cannot be used for all

responsibility centres. The operational implication is that

unless these problems are overcome, the profit centre

technique would not serve its purpose and should,

therefore, not be used.

Measurement of Expenses

Another problem with profit centres may relate to the

measurement of certain types of expenses which have to be

included in the computation of profit centres. In view of thespecial nature of divisional profits, such expenses should not

be considered since, they are not the responsibility of the

division/divisional manager.


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Transfer Prices

Transfer price is a critical aspect of profit centre

performance evaluation. The choice of transfer pricing

system has to reconcile the requirements of managerial

decision-making, on the one hand, and performanceevaluation, on the other.

Transfer price is the monetary amount of inter-

divisional exchanges/transfer of goods and services.


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Types of Transfer Prices

(1) Cost-Based (2) Market-Based

Based on these, there are six basic types of transfer prices:

1) Cost

2) Cost plus a normal mark-up

3) Incremental cost

4) Market price

5) Negotiated price6) Dual (two-way) prices


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Example 2

The Hypothetical Ltd employs a budgetary control systemand measures performance on segmented basis of its

product line divisions, A and B. The budgeted and actual

sales figures for the month of March are as follows:

Division Unit sales Sales revenue

Budgeted Actual Budgeted Actual

A 20,000 24,000 Rs 2,00,000 Rs 2,40,000

B 40,000 40,000 2,00,000 2,40,000


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Solution

Since, the basis of divisional performance measurement is the profit centre, the performance

evaluation report should be compiled in the form of a segment income statement. These are

illustrated sequence-wise in Table.2.

Table.2 Performance Evaluation Report

(Figures are in 000)

Particulars Product Line A Product Line B Product Line C

Budget Actual Varian

ce

Budge

t

Actual Varian

ce

Budge

t

Actual Varian

ce

Sales

revenue

Rs 200 Rs 240 Rs 40F Rs 200 Rs 240 Rs 40F Rs 400 Rs 480 Rs 80F

Less

controllable

variable

costs

80 84 4A 80 96 16A 160 180 20A

Controllable

contribution

margins 120 156 36F 120 144 24F 240 300 60F

Less

controllable

fixed costs 20 22 2A 20 26 6A 40 48 8A


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Controllable

segment

margin 100 134 34F 100 118 18F 200 252 52F

Less

attributable

segment

costs

40 44 4A 60 64 4A 100 108 8A

Segment

profit

contribution 60 90 30F 40 54 14F 100 144 44F

Less

common

firm-wide

costs

24 24 24 24 48 48

Net income 36 66 30F 16 30 14F 52 96 44F

*F = Favourable, A = Adverse.

Contd.


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Investment CentresInvestment Centres

The investment centre approach is an extension of the

profit centre approach. The measure of performance

in an investment centre is based on the relationship

between the segment profit contribution and segmentassets. There are two ways to relate segment profit

contribution to segment resources:

1) Segment Rate Of Return On Investment

2) Segment Residual Income


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Segment Rate Of Return

On Investment (SROI)

Segment return on investment is the segment profit

contribution divided by the segment

assets/resources.

SROI = Segment profit contribution (SPC) Segment resources/assets

SROI = SPC before interest Segment total assets

SROI (net) = SPC after interest Segment net assets

SROI Segment profit contribution (SPC) x Segment sales revenueSegment sales revenue Segment assets


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Advantages

ROI is the generally accepted measure of overall performance. As ameasure of divisional performance, it is consistent with a firm-wise

rate of return analysis.

ROI analysis is a relative, and not absolute measure. It is, in fact, a

ratio/percentage. It, therefore, serves as a common denominator sothat a comparison can be made between the performance of different

divisions.

ROI is conceptually easy to understand and interpret.

ROI analysis can provide incentive for optimum utilisation of the

assets of a firm.


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Limitations

1) Determination of investment base

Investment base is the measurement of the value of divisional

investment. The measurement of the divisional investment baserequires: (i) A precise definition of all elements that should be

included and (ii) The value that should be assigned to them. The

problems of measuring investment in assets in connection with the

investment centre analysis fall into two categories:

(i) Problems of allocation/apportionment

These arise out of the possibility of different treatment of assets that

are pooled/shared among the different divisions. The most common of

such assets are cash, receivables, and inventories.

The second aspect of the allocational problem relates to the treatment

of assets that are currently idle. If such assets are excluded as they

presumably do not generate income, the ROI would be actually a

return on capital employed rather than on the total

investments/assets/available invested capital. This approach would

tend to raise the ROI.


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(ii) Problems of valuation

Apart from the problem allocation/traceability of items of assets, the

measurement of investment base is complicated by the difficulty ofassigning values to the assets of a division. There are variety of

methods to value assets for purpose of ROI analysis. They include: (i)

Book value, (ii) Gross book value (original costs), and (iii) Current

replacement cost.

2) Determination of net incomeThe second element in the computation of ROI is the net income/profit

of a responsibility centre. The determination of divisional net income

also involves some problems.

First, as an extension of the profit centre, the investment centre

analysis encounters all the problems of the profit centre analysis.

In addition, there are some special problems of income measurement

as a rate of return is to be calculated. These relate to the treatment of

(a) tax (b) interest.


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Segment Residual Income (SRI)

Segment residual income is the difference between

the actual operating income of a division and

the required expected income.

SRI = SPC (SROI SR)

Where,

SRI = Segment residual incomeSPC = Segment profit contribution

SROI = Desired segment ROI

SR = Segment resources


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Example 3Assume the budgeted investment of a firm is Rs 10 lakh. Assume

further, a budgeted net income of Rs 2 lakh. The required rate of

return (cost of capital) may be assumed to be 15 per cent. The

residual income of the division would be:

Divisional income Rs 2,00,000

Required income (0.15 Rs 10

lakh) (1,50,000)

Segment residual income 50,000

responsibility accounting 158

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