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Types Objectives and Determinants

INTRODUCTION Planning & control are essential for achieving good results in any business. Firstly, a budget is prepared and, secondly, actual results are compared with budgeted ones. Any difference is made responsibility of the key individuals who were involved in (i) setting standards, (ii) given necessary resources and (iii) powers to use them. This is called as responsibility accounting. Responsibility accounting is the system for collecting and reporting revenue and cost information by areas of responsibility. It operates on the premise that managers should be held responsible for their performance, the performance of their subordinates, and all activities within their responsibility center. Responsibility accounting, also called profitability accounting and activity accounting, has the following advantages: 1. It facilitates delegation of decision making: . 2. It helps management promote the concept of management by objective. Inmanagement by objective, managers agree on a set of goals. The manager`s performance is then evaluated based on his or her attainment of these goals. 3. It provides a guide to the evaluation of performance and helps to establish standards of performance which are then used for comparison purposes. 4. It permits effective use of the concept of management by exception, which means that the manager`s attention is concentrated on the important deviations from standards and budgets. For an effective responsibility accounting system, the following three basic conditions are necessary: (a) The organization structure must be well defined. Management responsibility and authority must go hand in hand at all levels and must be clearly established and understood. (b) Standards of performance in revenues, costs, and investments must be properly determined and well defined. (c) The responsibility accounting reports (or performance reports) should include only items that are controllable by the manager of the responsibility center. Also, they should highlight items calling for managerial attention.


A well-designed responsibility accounting system establishes responsibility centers within the organization. In accounting, a responsibility centre refers to an organizational subunit in a corporation. It is charged with a well-defined mission and headed by a manager accountable for the performance of the centre. "Responsibility centres constitute the primary building blocks for management control." For instance, a large corporation may consist of numerous smaller business groups or divisions, some or all of these organizational subunits could be set up as responsibility centres. The manager of a responsibility center is responsible for the activities of the organizational subunit and for the results of specified financial and non-financial performance measurements. The concept of the responsibility center as an organizational subunit in a larger corporation is a part of the larger concept of a responsibility accounting system.

TYPES OF RESPONSIBILITY CENTRES There are four different types of responsibility centers. These different types include cost

centers (sometimes divided into regular cost centers and discretionary cost centers), revenue centers, profit centers, and investment centers. Cost centers In business, a cost centre is a division that adds to the cost of an organisation, but only indirectly adds to its profit. Typical examples include research and development, marketing and customer service. There are some significant advantages to classifying simple, straightforward divisions as cost centres, since cost is easy to measure. However, cost centres create incentives for managers to underfund their units in order to benefit themselves, and this underfunding may result in adverse consequences for the company as a whole (for example, reduced sales because of bad customer service experiences). Because the cost centre has a negative impact on profit (at least on the surface) it is a likely target for rollbacks and layoffs when budgets are cut. Operational decisions in a cost centre, for example, are typically driven by cost considerations. Investments in new equipment, technology and staff are often difficult to justify to management because indirect profitability is hard to translate to bottom-line figures. Business metrics are sometimes employed to quantify the benefits of a cost centre and relate costs and benefits to those of the organization as a whole. In a contact centre, for example, metrics such as average handle time, service level and cost per call are used in conjunction with other calculations to justify current or improved funding Revenue Centre A revenue centre is a division that gains revenue from product sales or service provided. The manager in revenue centre is accountable for revenue only.
The revenue centre represents the organizational link in which the activity is appreciated as value according to the revenue acquired, such as the sales department within an organization. The revenue is planned on the basis of the accomplishments in the previous year and of their anticipation for the year on course. The management periodically analyses the revenue budget and that of anticipation, and intervenes in the case of deviations.

Profit Centre A profit centre is a section of a company treated as a separate business. Thus profits or losses for a profit centre are calculated separately A profit centre manager is held accountable for both revenues, and costs (expenses), and therefore, profits. What this means in terms of managerial responsibilities is that the manager has to drive the sales revenue generating activities which leads to cash inflows and at the same time control the cost (cash outflows) causing activities. This makes the profit center management more challenging than cost centre management. Profit centre management is equivalent to running an independent business because a profit centre

business unit or department is treated as a distinct entity enabling revenues and expenses to be determined and its profitability to be measured. Business organizations may be organized in terms of profit centres where the profit centre's revenues and expenses are held separate from the main company's in order to determine their profitability. Usually different profit centres are separated for accounting purposes so that the management can follow how much profit each centre makes and compare their relative efficiency and profit. Examples of typical profit centers are a store, a sales organization and a consulting organization whose profitability can be measured. Peter Drucker, who originally coined the term profit center around 1945, later asserted that The only profit center is a customer whose cheque hasnt bounced. Investment Centre An investment centre is a classification used for business units within an enterprise. The essential element of an investment center is that it is treated as a unit which is measured against its use of capital, as opposed to a cost or profit centre, which are measured against raw costs or profits. In other words the investment centre is held responsible for the costs, revenues, and related investments made in that center. The advantage of this form of measurement is that it tends to be more encompassing, since it accounts for all uses of capital. It is susceptible to manipulation by managers with a short term focus, or by manipulating the hurdle rate used to evaluate divisions. The corporate headquarters or division in a large decentralized organization would be an example of an investment center.

The scheme of the synthesis of different types of responsibility centers can be represented as

follows: Table no. 1 the synthesis of different types of responsibility centers

Centre type Discretionary expense Centers Turnover centers Examples Administrative services Sales departments Responsibility Using the budgets to obtain the best services (not measurable directly) Sticking to the objective of the turnover or maximising the amount of sales Minimising deviations between consumption done and consumption Proposed Maximising the overall result by making the best correlation between costs and turnover. Maximising profitability of the capital used. Objective No profit objectives No profit objectives

Profit centers

Production units

Maximising profit

Profitability centers

Some production units

Capital profitability


The main objectives of a responsibility centre are: self-stabilization- the characteristic of the centre to maintain itself in a specific state by adjusting to the changes that influence it; self-organisation- the characteristic of the centre to create stable structures for new situations.

Figure 1 illustrates the manners in which responsibility accounting can be used within an organization and highlights profit and cost centers. FIGURE 1 Responsibility Centers

The advantages of responsibility centers are as follows: They facilitate the control of some financial factors by specialists in budgets who do not need to know technological details; They allow identification of the contribution from each responsibility centre towards the entitys profit.
In a big, multi-productive company, spread upon a large geographical area, with advanced hierarchies and typical of modern business - a miniature economy, the managers must decide who inside the organization is responsible for making a certain decision and how this will be evaluated and rewarded. The central objective information and organizational planning is that of creating a balance between benefits and costs in making the decision, by a decentralized system. Alfred Chandler, in his studies on the development of the American industrial enterprises,

presented in a very expressive way his request for decentralization of the organizations, supporting this process with the role of responsibility centers, mainly including the following:


Christie, Joye and Watts (2003) have concluded that more decentralized firms are more diversified than more centralized firms. The main factors that influence the activity of responsibility centers are: owner: influences the strategy and the obj ectives of the organization and, implicitly, the of the responsibility centers. He/ she influences the amount of resources. the general management of the company : establishes the strategy and the objectives of the organization leading to the objectives of the centre. They negotiate the system of rewards and the control procedures. the size and complexity of the enterprise : influences by the amount of resources of the enterprise, according to which the budget can be established and the number of centers. It influences the acceptance or refusal of the change represented by the reorganization of the activity in responsibility centers,. the technical endowment: performance; sticking to the budget. the human resources: professional training, age, motivation, working capacity. the economic-financial status: the amount of funds on the level of each centre; success in business; the strategy of responsibility centers. the culture and behaviour of the enterprise : the behaviour norms of the employees; measuring performance and establishing rewards.