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An accounting system that provides information . . .

Relating to the responsibilities of individual managers.

To evaluate managers on controllable items.

Responsibility accounting involves the creation of responsibility centres. A responsibility centre may be defined as an organization unit for whose performance a manager is held accountable. Responsibility accounting enables accountability for financial results and outcomes to be allocated to individuals throughout the organization. The objective is to measure the result of each responsibility centres. It involves accumulating costs and revenues for each responsibility centre so that deviation from performance target (typically the budget) can be attributed to the individual who is accountable for the responsibility centre.

A subunit in an organization whose manager is held accountable for specified financial results.

Revenue Center
Segment is responsible for the revenue of a unit.
Inputs Activity performedd The Reservations Department of an airline.


production department

Inputs are not related with output

Revenue Center mangers are not made accountable for the cost of the goods and services that they sell. They are held responsible for selling & distribution expenses such as salesperson salaries, commissions and order getting costs. It generally happens in those organizations where revenue centers acquire finished goods from a manufacturing division

The performance of Revenue Center is measured by comparing budgeted figures of sales with actual sales. While making evaluation, costs are not related to output. In such a situation where managers are evaluated solely on the basis of sales revenue, there is a danger of that they may concentrate on maximizing sales revenue at the expense of profitability. Though main focus is on revenue, necessary attempts are made to control costs also.

Cost Center Segment has control over the incurrence of costs.

Inputs Activity performedd Optimal relation can not be established Cost center

The Paint Department in an automobile plant.


Sales department

(a) The performance of the manager of expenses center is judged on the basis of cost incurred in his division and what is done in the division(output or revenue) is of no consequence. The analysis of performance is restricted to the consumption of resources in the division regardless to what the division has achieved as a result of consuming those resources. The actual inputs are compared with the budgeted inputs(costs) to find out variances which would be indicative of efficiency or inefficiency of the divisional manager. (b) While fixing responsibility, it is taken into consideration that managers will be accountable only for those costs which are under their control, it means that the relevant costs to be measured are the incremental or avoidable costs of operating such division/centers. Here the incremental cost would include both fixed and variable costs but would exclude common costs which are allocated to several divisions on same arbitrary basis.

Standard cost center

Discretionary cost center

Administration and support centre Marketing Research & centres development centre

Administrative centres :- administrative centre's include the business units which are related with formulation of policy, directing the organization controlling and managing the operations of an undertaking. The example of such units are human resource department, accounting department legal section etc. Support centre's :- support centre's are the units that provide services to other responsibility centre's. Units for maintenance, transportation, engineering, customer services and similar support activities come under the purview of such centre's often charge other responsibility centre's for the services they provide with the financial objective of equating their revenues with the expenses.

The activities of R &D centre's include basic research at one end and product testing at the other. Here basic research means unplanned efforts in the general areas and there is often a signification time lapse between the initiation of research and the introduction of a successful product. On the other end product testing refers to the testing of required features of the product so that if a product will ultimately turn out to be unprofitable; it should be terminated as early as possible. The activities of R&D centre are continuous in nature and may involve several years of effort. Due to the factor of uncertainity. R&D function may defeat managements attempt to measure efficiency. A brilliant efforts may end up in mere wastage where as a mediocre efforts, by luck, may result in bonanza..

Marketing centres are the units which are responsible for (a) Order getting activities which take place before an order has been received and (b) Order filling activities which take place after an order has been received. Units for advertising, publicity and other similar activities come under the perview of marketing centres

Profit Center Segment has control over both costs and revenues.

Company-owned restaurant in a fastfood chain.

In a profit center, performance is measured by the numerical difference between revenues (outputs) and expenditures (inputs). The managers in the profit center are responsible for both revenues and costs. For measuring performance of profit center, all the data is required from expense center as well as revenue center. The term profit as performance measure, is based on revenues and expenses, which are directly traceable to the division and avoidable if the divisions were closed down. The concept of divisional profits is before tax margin of a natural profit center. The reason being that taxes are assessed on the basis of the income of the entire company but it is not necessary that the total profits of all divisions will be equal to the profit of entire firm. The difference would arise from the fact that costs not attributable to any single division are excluded from the computation of the profit of the organisation as a whole.

Natural or constructive profit centers

Profit centers in divisionalised and non divisionalised organization

(1)Natural or constructive profit centers :

(a) A profit center which uses inputs (costs) and produces outputs (revenue) is called natural profit center. For example, a product division is a type of natural profit center (b) A constructive profit center is that which uses inputs (costs) but it does not provide tangible output(revenue). However it may be considered as an expense center but management has an alternative to treat it as profit center. For example a computer department in an organization, uses inputs but it produces no revenue as it renders services to other departments and does not sell its products/services. This is logically an expense center. However if mgt wants to consider it as a profit center, they will make a comparison of (a) cost incurred on inputs in computer department (b) the cost of services if borrowed from outside the firms. the cost avoided by owing a computer department will be considered as constructive profit

(a) In divisionalised organizations, each division is completely responsible for its own product line and separate division are considered profit center. As divisional managers take all the decisions relating to technology and marketing strategies, they influence both revenues and expenses. The revenues derived from that divisions all products are added and then the total expenditures of that division are deducted from total revenues. The net result is the measure of that divisions profitability (b) In non- divisionalised organizations, individual departments may be made profit centers by crediting them for revenue and charging them for expenses. A manufacturing department would normally be considered as a cost center. Allowing the manufacturing department to sell its products at an agreed upon prices called transfer pricing to sales dept, would be a method of making it a profit center. The diff b/w transfer price and the manufacturing cost per unit will represent the depts profit

Division net income Revenue

Common firm costs

Controllable variable costs

Controllable contribution margin

Attributable division costs Controllable fixed cost

Division profit contribution

(1) Profit center to be a powerful tool for measuring how well the profit center manager has performed. (2) Managers feel motivated to take decisions about inputs and outputs in such a way that profit can be maximized. Profit center can provide a good training ground (3) As profit center make decentralization effective, so top mgt can safely delegate the authority to the divisional managers (4) The speed and quality of operating decisions may be improved because many decisions do not have to be referred to top mgt. and also the top mgt can concentrate on broader issues by relieving itself from day to day operations.

Investment Center
Segment has control over profits and invested capital.
Inputs Activity performedd Net incomes are related with assets invested output

A division of a large corporation.

Organisatinal unit

As a responsibility center, the performance of a unit would be measured in relation to the revenues or profits and the assets employed in a division. Measurement of investment center performance can be viewed as the evaluation of an aggregation of past and present capital projects as opposed to the evaluation of each project individually. Such a measurement also provide an incentive for division managers to monitor capital investments carefully while managing their operations.

Return on investment

Residual income or economic value added

This is most common measure for making evaluation of an investment center. This measure takes into consideration two elements :(a) Net income before taxes and (b) Invested assets (assets employed) Symbolically : NET INCOME ROI = X 100 INVESTED ASSETS The two major ingredients of ROI are : NET INCOME ROI = INVESTED ASSETS





For example, if total assests invested in a division are Rs 2,50,000 and net income before taxes is Rs 25,000/Its ROI will be : ROI = 25,000 2,50,000 X 100 = 10 %

(1)It is generally accepted measure of overall performance because it is objective in nature by having its base on historical accounting (2) It serves as a better basis for camparing the performance of different division because ROI analysis is a ratio or percentage and not an absolute measure (3) While evaluating the overall corporate profitability, this measure encourages goal congruence between the division and the firm. (4) ROI also shows whether the company s borrowings policy was wise economically and whether the capital had been employed fruitfully (5) ROI may also be calculated on equity shareholders capital. In that case the profit after deduction for interest,income tax and prefrence dividend will have to be compared with equity shareholders fund. It would not indicate operational efficiency but merely the maximum rate of dividend that might be declared (6) The business can survive only if ROI is more than cost of capital employed in business.

(1) Manipulation possible (2) Different bases for computation of profit and investments (3) Emphasis on short term profits (4) Poor measure (5)Undue significance to capital resources (6)Limits initiative (7)Change factor

Both the terms EVA and RI have effectively the same meaning. The concept of EVA or RI is used as an alternative for measuring divisional performance as it avoids some of the problems associated with ROI measures. Economic value added is the residual income with the company after charging for the cost of capital provided by lenders and shareholders. This measure represents the value added to shareholder equity by generating operating profits in excess of the cost of capital employed in the business. This measure plays an important role in knowing whether the divisional managers are really increasing the net worth of the organisation or whether they are killing it gradually. RI (EVA) is the diff b/w actual income earned by the division on an investment and the desired income on the investment as specified by minimum rate of return. If RI is +tive the business is taken to have generated wealth in excess of what is expected by the shareholders. But if figure drops to zero or turns tive this indicates that the company has not met with the shareholderss expectations

RI(EVA) = actual income desired income Where Desired income = maximum desired x invested resources Calculation of RI (EVA) : Let the budgeted investment of a firm is Rs 5,00,000 and net income is Rs 1,00,000. if the required rate of return (cost of capital) is assumed to be 15 %, the residual income of division will be : Net income of division = Rs 1,00,000 Less Desired income = Rs 75,000 (5,00,000 x 15 %) Rs 25,000 RI (EVA)

(1) It encourages capital ivestment as a divisional manager can earn more than the required rate of return (2) RI measure is more flexible as it allows different rate of returns for different divisions. For example, higher rates for risky and lower rates for less risky projects. (3) It helps in achieving the goal congruence objective while evaluating various division.

(1) It is an absolute measure and it is not deflated by the size of the center. A large division can earn the given amount of residual income very easily as compared to small division. (1) For example : take two division, one with investment of Rs 2,00,000 and other with Rs 4,00,000 and both have a cut off rate of 10 %. To earn a residual income of Rs. 10,000 the first division will require to earn Rs. 30,000(15 % return) and second division will require to earn Rs. 50,000 (12.5 %) return only.

(2) It is difficult to select a fair and equitable cutoff rate (cost of capital)

Advantages of responsibility accounting

Helpful in decision making

Assigning of responsibility Delegation and control Helpful in cost planning Improves performance