RESPONSIBILITY ACCOUNTING
A responsibility accounting system facilitates decentralization by providing information
about the performance, efficiency, and effectiveness of organizational subunits and their
managers. Responsibility accounting is the key management control tool in a decentralized
organization.
A responsibility accounting system produces responsibility reports that assist each successively
higher level of management in evaluating the performances of subordinate managers and their
respective organizational units.
Decentralization is a transfer of authority, responsibility, and decision-making rights from the
top to the bottom of the organizational structure.
Advantages Disadvantages
Helps top management recognize and develop Can result in a lack of goal congruence or
managerial talent. suboptimization by subunit managers.
Allows managerial performance to be Requires more effective communication
comparatively evaluated. abilities because decision making is removed
from the home office.
Can often lead to greater job satisfaction and Can create personnel difficulties upon
provides job enrichment. introduction, especially if managers are
unwilling or unable to delegate effectively.
Makes the accomplishment of organizational Can be extremely expensive, including costs
goals and objectives easier. of training and of making poor decisions.
Reduces decision-making time.
Allows the use of management by exception.
Goal congruence exists when the personal and organizational goals of decision makers
throughout the firm are consistent and mutually supportive.
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.
PRINCIPLES IN CREATING RESPONSIBILITY ACCOUNTING REPORTS
1. A manager’s responsibility report should reflect his or her degree of influence and should
include only the revenues and/or costs under that manager’s control
2. A responsibility reporting system involves the preparation of a report for each level of
responsibility in the company’s organization chart.
3. Reports at the lowest-level units are highly detailed, whereas more general information is
reported to the top of the organization.
4. All costs are controllable by top management because of the broad range of its activity.
5. Fewer costs are controllable as one moves down to each lower level of managerial
responsibility because of the manager’s decreasing authority.
6. Noncontrollable costs are costs incurred indirectly and allocated to a responsibility level.
KINDS OF RESPONSIBILITY CENTERS
1.) Cost centers
A Cost Center is responsible only for the incurrence of costs. A cost center does not earn any
revenue and therefore generates no profit. For example, a company’s human resources and
accounting departments could be considered cost centers because these units do not generate
revenues or charge for services, but they do incur costs.
The key standard for evaluating a cost center is its efficiency of operations, which measures
whether or not the center has provided the required services within the budget. Example of this
include cost variances.
2.) Revenue Centers
A Revenue Center is responsible only for revenues. For example, a sales department is a revenue
center. For instance, in many retail stores, each sales department is considered an independent
unit and managers are evaluated based on their departments’ total revenues.
Managers in revenue centers are evaluated according to the level of revenue that the center
generates (Example: Sales Variances)
3.) Profit Center
A profit center is an organizational unit whose manager is responsible for generating revenues
and managing expenses related to current activity. Thus, profit centers should be independent
organizational units whose managers
• have the ability to obtain resources at the most economical prices.
• sell products at prices that will maximize revenue.
• have a goal of maximizing the center’s profit.
4.) Investment Center
An investment center is an organizational unit whose manager is responsible for managing
revenues and current expenses. In addition, the center’s manager has the authority to
acquire, use, and dispose of plant assets to earn the highest feasible rate of return on
the center’s asset base. Many investment centers are independent, freestanding divisions or
corporate subsidiaries.
METHODS OF EVALUATING INVESTMENT CENTER
1.) Return on Investment
Return on investment (ROI) is a ratio relating income generated by an investment center to the
resources (or asset base) used to produce that income. The return on investment formula is
ROI = Segment Income / Average Assets Invested
ROI Definitional Questions and Answers
Question Answer
Is income defined as segment or Segment income
operating income? Because the manager does not have short-run
control over unavoidable fixed expenses and
allocated corporate costs.
Is income on a before-tax or after-tax Before-tax
basis? Because investment centers might pay higher or
lower tax rates if they were separated from the
organization.
Should assets be defined as Total assets available for use
• total assets utilized; Because if duplicate or unused assets were
• total assets available for use; or eliminated from the formula, there would be no
• net assets (equity)? encouragement for managers to dispose of those
assets and gain additional cash flow that could be
used for more profitable projects. Alternatively, if
the objective is to measure how well the segment
is performing, given the funds provided for that
segment, then net assets should be used to
measure return on equity.
Should plant assets be included at Current value
• original cost; Because as assets age and net book value
• depreciated book value; or declines, an investment center earning the same
• current value income each year would show a continuously
increasing ROI. Although more difficult to obtain
and possibly more subjective, current values
measure the opportunity cost of using the assets.
Should beginning, ending, or average Average assets
assets be used? Because the numerator income amount is for a
period of time, the denominator base should be
calculated for the same time frame.
2.) Residual Income
An investment center’s residual income (RI) is the profit earned that exceeds an amount
“charged” for funds committed to the center. The “charged” amount is equal to a specified
target rate of return multiplied by the asset base and is comparable to an imputed rate of
interest on the divisional assets used. The rate can be changed to compensate for market rate
fluctuations or for risk. The residual income computation is as follows:
Residual Income = Income - (Target Rate of return X Average Assets)
3.) Economic Value Added
Conceptually similar to RI, EVA measures the profit produced above the cost of capital. However,
EVA applies the target rate of return to the market value of the capital invested rather than the
book value of assets that is used to calculate RI. Furthermore, EVA is calculated on net income,
or the after-tax profits available to stockholders. The EVA calculation is as follows:
EVA = After-Tax Profits - (Cost of Capital % X Market Value of Invested Capital)
Difference between Residual Income and Economic Value Added
Residual Income Economic Value Added
Based on pre-tax After-tax
Book Value Market Value
Target Rate Cost of Capital
SAMPLE PROBLEM
Household Products is a division of Delaware Electronics. The division had the following
performance targets for 2010:
Asset turnover 3.1
Profit margin 6%
Target rate of return on investments for RI 15%
Cost of capital 9%
Income tax rate 35%
At the end of 2010, the following actual information concerning the company’s performance is
available:
Total assets at beginning of year P24,800,000
Total assets at end of year 29,600,000
Average fair market value of invested capital for year 36,000,000
Sales 68,000,000
Variable operating costs 34,800,000
Direct fixed costs 27,440,000
Allocated fixed costs 2,700,000
Compute for the following :
a. Compute the 2010 segment margin and average assets for Household Products.
Sales P 68,000,000
Variable operating costs (34,800,000)
Direct fixed costs (27,440,0
00)
Segment margin P
5,760,000
Average assets (P24,800,000 + P29,600,000)/ 2 = P27,200,000
b. Compute for the ROI of Household Products
ROI = Segment Income / Average Assets Invested
P5,760,000 / P27,200,000 = 21.18%
c. Compute the residual income for Household Products.
Residual Income = Income - (Target Rate of return X Average Assets)
RI = P5,760,000 - (0.15 x P27,200,000)
= P5,760,000 - P4,080,000
= P1,680,000
d. Compute the EVA for Household Products using after-tax segment margin.
After-Tax Profits = Pre-tax Segment Income x Taxes
= P5,760,000 - (P5,760,000 x 0.35)
= P5,760,000 - P2,016,000
= P3,744,000
EVA = After-Tax Profits - (Cost of Capital % X Market Value of Invested Capital)
EVA = P3,744,000 - (P36,000,000 X 0.09)
= P3,744,000 - P3,240,000
= P504,000
