RESPONSIBILITY ACCOUNTING
Responsibility Accounting a system of accounting wherein costs and revenues
are accumulated and reported by levels of responsibility or by responsibility centers
within the organization.
Responsibility center (also called accountability center)
- A clearly identified part or segment of an organization that is accountable for
a specified function or set of activities.
- Any part of the organization that a particular manager is responsible for
Types of Responsibility Centers :
A. Cost center (or expense center) a segment of an organization in which
managers are held responsible for the costs or expenses incurred in the
segment.
B. Revenue center where management is responsible primarily for revenues.
C. Profit center a segment of the organization in which the manager is held
responsible for both revenues and costs.
D. Investment center a segment of the organization where the manager
controls revenues, costs, and investments. The centers performance is
measured in terms of the use of the assets as well as the revenues earned
and the costs incurred.
Classifications of Costs in Responsibility Accounting
1. By responsibility center
2. By cost type, as to controllability
3. By specific cost item or cost elements within each classification in (1) and (2).
RESPONSIBILITY vs. ACCOUNTABILITY
Responsibility has two facets, (1) the obligation to secure results, and (2) the
obligation to report back the results achieved to higher authority.
Accountability denotes the obligation to report results achieved to higher authority.
THE CONCEPT OF DECENTRALIZATION
Decentralization refers to the separation or division of the organization into more
manageable units wherein each unit is managed by an individual who is given
decision authority and held accountable for his decisions.
Goal congruence all members of an organization have incentives to perform for a
common interest.
Sub-optimization occurs when one segment of a company takes action that is in
its own best interests, but is detrimental to the firm as a whole.
BENEFITS OF DECENTRALIZATION
1. Better access to local information
2. Cognitive limitations
3. More timely response
4. Focusing of central management
5. Training and evaluation
6. Motivation
7. Enhanced competition
COSTS OF DECENTRALIZATION
1. Some decisions made in one sub-unit may bring about negative effect to the
other sub-units or the organization as a whole.
2. Decentralization necessitates a more elaborate reporting system hence, the
costs of gathering and reporting of data increase.
3. Job qualification or overlapping of functions is usually encountered in a
decentralized set-up.
MEASURING THE PERFORMANCE OF INVESTMENT CENTERS
Performance measures for investment centers usually attempt to assess how well
managers are utilizing invested assets of the division to produce profits by relating
operating to assets.
Return on Investment (ROI) is the most common measure of performance for
investment centers.
ROI can be defined as follows:
ROI=Operating Income/Average Operating Assets
Operating income refers to earnings before interest and taxes. Operating assets
include all assets acquired to generate operating income, including cash,
receivables, inventories, land, buildings, and equipment.
The ROI formula can also be broken down into the product of margin and turnover.
MARGIN is the ratio of operating income to sales. TURNOVER is defined as sales
divided by average operating assets.
ROI = Margin x Turnover
Or ROI = (Operating income/sales) x (Sales/Average Operating Assets)
Three advantages of using ROI to evaluate the performance of investment centers:
1. It encourages managers to play careful attention to the relationships among
sales, expenses, and investment, as should be the case for a manager of an
investment center.]
2. It encourages cost efficiency.
3. It discourages excessive investment in operating assets.
Two disadvantages of using ROI are:
1. It discourages managers from investing in projects that would decrease the
divisional ROI but would increase the profitability of the company as a whole.
(Generally, projects with ROI less than a divisions current ROI would be
rejected.)
2. It can encourage myopic behavior, in that managers may focus on the short
run at the expense of the long run.
Residual income (RI) the difference between operating income and the
minimum peso return required on a companys operating assets. The equation for RI
can be expressed as follows:
RI = Operating Income (Minimum Rate of Return x Operating Assets)
ECONOMIC VALUE ADDED (EVA) a more specific version of residual income. It
represents the segments true economic profit because it measures the benefit
obtained by using resources in a particular way.
After-tax operating income
(EBIT x [1-tax rate])
xx
Less: desired income
(After-tax x WACC* x [Total assets Non-interest-nearing Current liabilities])
xx
Economic Value added (EVA)
xx
*WACC = Weighted average cost of capital
TRANSFER PRICING
Transfer Price the monetary value or the price charged by one segment of a firm
for the goods and services it supplies to another segment of the same firm.
OBJECTIVES OF TRANSFER PRICING
1. To facilitate optimal decision-making.
2. To provide a basis in measuring divisional performance.
3. To motivate the different department heads in improving their performance
and that of their departments.
APPROACHES FOR DETERMINING TRANSFER PRICE:
1. Negotiated transfer price
2. Cost-based transfer price
3. Market-based transfer price
General Rules in Choosing a Transfer Price
The maximum price should be no greater than the lowest market price at
which the buying segment can acquire the goods or services externally.
The minimum price should be no less than the sum of the selling segments
incremental costs associated with the goods or services plus the opportunity
cost of the facilities used.
A good should be transferred internally whenever the minimum transfer price
(set by the selling division) is less than the maximum transfer price (set by
the buying division). By using this rule, total profits of the firm are not
decreased by an internal transfer.
