RESPONSIBILITY ACCOUNTING

Concept of Responsibility Accounting

Decentralisation of authority is the essence of modern management. In the context of business organisations, it is generally perceived that profit-centre managers have a higher level of decentralised decision-making authority, as compared to the authority enjoyed by the cost-centre managers. However, this may not be true in all the cases. Delegation of powers or decentralisation of authority is the need of the hour, especially for the organisations of large size, because it is practically not possible for the top management to take each and every decision at their level. The authority and the responsibility are two most important aspects, which are taken into consideration during the process of designing a management control system.

 Meaning and Definition of Responsibility Accounting         

Under the system of responsibility accounting, the emphasis is laid on the responsibility of the persons handling costs- control tools. They are made accountable in case of any failure in the exercise of cost- control.

Responsibility accounting may be defined as a part of ‘Management Information System’ (MIS), which envisages compilation of data relating to revenue, cost, and profit in respect of an individual management personnel’ who is directly responsible for them. After compilation of such data, they are transmitted to the persons of next higher management level, who can

• Take necessary action, if any required, and
• Measure the performance of the concerned

According to Anthony and Reece, “Responsibility accounting is that type of management accounting that collects and reports both planned and actual accounting information in terms of responsibility centres”.

Features of Responsibility Accounting

1)    Inputs and Outputs or Costs and Revenues:

Information pertaining to the inputs and outputs (costs and revenues) are the two basic pillars of functioning of the system of responsibility accounting.

2)    Planned and Actual Information or Use of Budgeting:

Success of the system of responsibility accounting depends upon the availability of not only historical or past data but also upon the availability of budgeted financial data. Availability of the above two sets of data ensures the effectiveness of the system.

3)   Identification of Responsibility Centres:

The entire idea of responsibility accounting revolves around the responsibility centres; the places, where the required data are compiled and transmitted onwards to the management. Such a concept is missing in a business Organisation of smaller size, as all the decisions making is undertaken by the owners or a small group of individuals.

In other words, there is no decentralisation of authority in smaller organisations. On the other hand, in larger organisations, it is not possible to have centralised authority, and as such there are various departments, divisions, or Segments. The role of each division is well defined. The heads of these divisions are delegated certain authorities and are made responsible for the decisions taken at their level . Such divisions of a business Organisation are referred to as responsibility centres.

4)   Relationship between Organisational Structure and Responsibility Accounting System:

The basic pillars of a successful responsibility are:

1. A well-established organisational
2. Under a system of responsibility accounting compilation of data, their transmission to appropriate authority in a timely manner for taking suitable and a necessary action, and for evaluation of the division heads

5) Assigning Costs to Individuals and limiting their Efforts to Controllable Costs: 

Under the system of responsibility accounting, the heads of the various divisions are assigned costs and revenues. In other words, they delegate some level of authority and responsibility in respect of those costs and revenues. While deciding with regard to such assignments, it is ensured that such an individual exercises complete control over them, so that their performance evaluation may be undertaken in a logical and scientific manner.

6)   Transfer Pricing Policy:

In a decentralised division, generally the goods and services are transferred from one department to another. There is always a need to have an appropriate transfer pricing policy. So that there is a proper assignment of costs and revenues amongst the departments.

7)     Performance Reporting:

The system of responsibility accounting is a control mechanism, which may be considered as part of the overall Management Information System (MIS). For any successful control mechanism, it is necessary to have a reporting system in the case of deviations from the plan, so that necessary corrective measures should be taken by the appropriate authority. Under the system of responsibility accounting, such reporting system consists of performance reports, which are also known as responsibility reports. They are prepared in respect of each responsibility unit, whenever there is any deviation

8)     Participative Management:

The management of an organisation, wherein the system of responsibility accounting has been set up, functions in a democratic manner, is likely to be more successful. Democratic set up of an organisation shows the participation of all the stakeholders, starting from the process of budgeting, planning and takin g a final decision on the basis of mutual understanding. Democratic type of management is the biggest motivating force for the individuals to do their best.

Significance/Advantages of Responsibility Accounting 

Responsibility accounting system is beneficial to a business organisation in following manners:

 1) Assigning of Responsibility:

Under the system of responsibility accounting, every individual employee of an organisation is entrusted with some responsibilities, which he/she has to shoulders. They are made accountable for negligence of the duties, if any, assigned to them. As the responsibilities of each individual are clearly spelt out, evaluation of their performance at periodical intervals is easy and convenient for the management. In case of any lapse, the offender can be easily traced out. Thus, it helps to distinguish between the performers and non-performers.

2)   Improves Performance:

As every individual is aware of their responsibilities, and that their performance is under the watchful eye s of the management, there is an effort on their part to perform their best. They are also aware that for a poor performance or performance at a lower level than they expected, they will be called upon to offer an explanation. This awareness, acts as an element that keeps them giving their best performance.

3)   Helpful in Cost Planning:

Cost planning of an organisation is facilitated by responsibility accounting, as relevant necessary information pertaining to costs and revenues is made available to the top management by the system. Such data are useful in (i) future planning in respect of costs and revenues, (ii) fixing standards, and (iii) preparation of budgets.

4)   Delegation and Control:

Responsibility accounting is helpful in achieving some of the basic objectives of the management, viz. delegation of power and exercising overall control. The basis of delegation of powers is as per the needs of the assigned job and the responsibilities are assigned accordingly. There is a system of regular reporting with regard to the performance of every individual and every cost centre. This ensures that the total control remains with the management.

5)   Helpful in Decision-Making:

The reporting mechanism under the responsibility accounting system ensures uninterrupted and prompt flow of relevant information in respect of various cost centres to the top management, which is the basic input for decision-making and future

Responsibility Centres

Under the responsibility accounting system, a business organisation is divided into various functional units referred to as the responsibility centre. A manager is entrusted with the responsibility of supervising the affairs of a responsibility centre, which includes, among others, preparation of Responsibility Accounting Reports (RARs). Such RARs are transmitted to the top management of the organisation for taking decisions with regard to various corrective measures.

The performance of a manager heading a responsibility centre is measured on the basis of the quality of RARs received from that centre. The inputs of a responsibility centre pertaining to a manufacturing organisation consist of raw materials, labour, overheads, etc., whereas the outputs are manufacture finished goods. Such outputs are measurable as against the inputs of responsibility centres engaged in services, e.g. accounts, finance, advertisements, human resources, etc., which are rather difficult to measure.

Different Responsibility Centres

Responsibility centres may be broadly categorised into three groups as indicated below:

•  Investment Centers
• Cost or Expense Centers
• Profit Centres 

1.) Investment Centres

The responsibility of an investment centre includes, in addition to cost management and revenue generation, investment in other assets used by the centre. The in-charge of an investment centre is entrusted with the additional responsibility with regard to the profits and the assets under the con trol of the centre. The head of an investment centre enjoys a higher level of authority and at the same time shoulders a higher level of responsibilities in comparison with the heads of a cost centre or a profit centre.

Measurement of an investment centre is carried out in terms of Return on Investments (ROI), which is computed with the help of following formula: 

 Return on Investments (%) = Profit of the Investment Centre/ Assets used in the Investment Centre x 100

Applying the similar formula, ROI with respect of each centre is measured separately with a view to evaluating performance of individual centres.

Managerial Implications of Investment Centre

For the purpose of evaluation of performance or level of contribution of a division or that of a di visional manager, an investment centre may be used in an effective manner. An investment centre’s performance is measurable on the basis of the relationship between the profit and the income of assets used in generating the profit. The relationship between income and assets can be expressed in the following manners:

1)   Return on Investment (ROI):

The profit of an investment centre is just one aspect of assessing the success of the centre; the other aspect being the amount of investment. The relationship between the above two is the ROI, which is calculated by applying the following formula:

Return on Investment = Income of the Investment Centre / Assets of the Investment Centre)

2) Residual Income (RI):

The excess of income beyond the required rate of return on investments is referred to as Residual Income (RI). The income is perceived to be more than the imputed cost of capital investment. Interest accrued on such investment is considered to be part of the cost. The idea of the opportunity cost is the underlying premise behind the estimation of required rate of return.

Advantages of Investment Centre

Investment centres play an important role in adding to the benefit of a business organisation as eviden t from the following:

1. l) The investment centres may be used as a tool to assess the performance or measure the contribution of a division and its manager;

• Income as well as the amount of assets employed to get that profit is taken into account by the investment centres;

• Analysis of ROI at an investment centre acts as an incentive for proper use of assets owned by a business organisation; and
• Analysis of ROI at an investment centre argues well with the philosophy that one of the objectives of investments is to have a desired rate of return.

Disadvantages of Investment Centre

Investment centres suffer from the following disadvantages:

1. l) For the measurement of performance, the concept of ROI analysis is appropriate in principle. However, there are certain limitations in its operational applications. due to availability of a number of methods to compute it’.

• As the assignment of value to the assets of an investment centre is not an easy job, measurement of the investment base becomes a complex process; and
• Some Of the assets, which are shared by more than one division, are likely to get varied treatment.

2. Cost or Expense Centres

Assessment of costs is the responsibility of either the cost centres or cost units or both. The cost centre of an enterprise may be defined as an item of equipment, an individual or a location. It may also be a combination of any two or more of the above. Cost is assessed in respect of a cost centre with an objective of having a cost-control mechanism.

Types of Cost Centres

Cost centres may be classified in terms of various parameters as follows:

• From the definition of a cost centre, they may be categorised as

(i) Impersonal cost centres, which includes a location or an equipment or a group of the above, and (ii) personal cost centres, which includes an individual or a group of individuals;

• Manufacturing organisation, may be broadly categorised as
• Production cost centres, and
• Service cost

Production cost centres may be sub-divided into (a) operation cost centres, which contain machines and men involved in the process of operations, and (b) process cost centres, which are regarded a sequel of operations.

• A cost centre may consist of a specific machine or a group of machines carrying out similar kind of operations; and
• Cost centres may also be classified according to the place where they are located, g. a specific division, sales area, tool room, stockyard, administrative office, etc. Costs in respect of an individual employee of the organisation (viz. sales manager, works manager, purchase manager, finance manager, personnel manager, store keeper, foreman, etc.) are also added .

 Managerial Implications of Cost Centre

In order to have an effective cost control mechanism in place, it is necessary that all the expenditure made by the organisation as a whole and those made by individual cost centres is carried out in a transparent manner. This involves

• a proper assessment of a functional division in terms of expenses incurred by it and its share of contribution towards the profitability of the organisation, and

• Transmission of necessary data to the management for undertaking decision-making The prerequisite for the above is an assignment of costs as per their source, which is rather a challenging job, particularly in the case of overhead costs. Assignment of costs to a cost centre shows an effort to charge to that cost centre all the costs directly pertaining to it.

Advantages of Cost Centre

A cost centre is an asset for an organisation, as following benefits accrue from it:

l) Helpful in Case of Centres having Conceptually Identifiable Output:

There are many cost centres, whose outputs may be identified conceptually, e.g. legal department (providing expert opinions in legal matters), public relations department (maintaining good public relationship), etc. However, it is difficult to measure such outputs in financial terms (which are not material as in a cost centre only inputs need to be measured in financial terms and not outputs).

 2) Measurement of Cost per Unit:

The cost per unit measured by a cost centre reflects the efficiency  as well as the effectiveness of the concerned division.

3) Measurement at the Lowest Feasible Cost:

With the help of financial budget, it is possible to measure the performance, both in financial and non – financial terms, which indicates through the efficiency as well as effectiveness at the lowest feasible cost.

Disadvantages of Cost Centre

Advantages of a cost centre notwithstanding, there are certain disadvantages also, which are discussed in the following points

• It does not take into account the output measurement in financial terms;
• With a view to ascertaining the overall output of a cost centre, a common basis is required to aggregate the dissimilar products of the production Such a common basis is altogether absent; and
• Determination of an appropriate level of relationship between the inputs and outputs is rather a daunting task.

3. Profit Centres

A profit centre cover a large area of operation and its responsibility includes cost control (inputs) as well as revenue generation (outputs), which ultimately lead to enhanced profitability. Through the proper monitoring of inputs and outputs, profit centres are supposed to generate substantial revenues on the assets deployed by them. The performance of the individuals heading such profit centres is judged on the basis of their capabilities to generate revenues.

Managerial Implications of Profit Centre:

Following are the managerial implications of a profit centre:

l: ) Evaluation and Ranking of Profit Centres

Performance of a profit centre is evaluated and a ranking is assigned to it on the basis of its level of achievement with regard to profit targets, viz. controllable contribution margin, controllable segment margin, segment profit contribution, contribution margin ratio, segment profit contribution rate. Etc. It is also necessary to look into the aspect of achievement of objectives by individual segments.

 

2) Decisions to Modify Operations of Profit Centres:

Evaluation of a profit centre acts as a guiding factor with regard to the requisite modifications (if any) in the operations of that profit centre. Such modifications may be in the form of decision for the expansion, contraction, addition or closure of the centre. Any of such modifications, when executed, bring about an improvement in the profitability of the organisation. Expansion or contraction of process at a profit centre, in the short run, impacts the controllable contribution margin, provided all attributable segment costs remain unchanged. In the long run, changes in direct fixed costs and attributable segment costs also need to be considered. As regards the decision of adding or closing the entire segment, the same depends upon the likely impact it may have on its contribution in the overall profit of the organisation.

Advantages of Profit Centres

Profit centres are advantageous to an organisation in the following manners:

• It is an effective and potent technique to measure and evaluate the performance of a profit centres.
• Profit centres are allowed autonomy in their operational Their profits are arrived as if they are independent business entities. Their managers are encouraged by providing monetary benefits, to take major decisions with regard to inputs and outputs with a view to maximising profit. Profit centres are considered suitable training centres in the area of overall general management.
• Profit centres may be considered a typical example of the phenomenon of decentralisation of a business Due to the presence of a robust and effective information system in place, through which close monitoring is Possible, the top management feels comfortable in delegating adequate authority to the heads of profit centres.
• Performance measurement of a Profit Centre manager may be carried out in a better manner, in comparison with the expense centre manager, due to the fact that the authority and responsibility of a profit centre manager is well defined and he is responsible for revenue as well as cost aspects. It also makes the measurement of the contribution of a profit centre (and its manager), in achieving the overall organizational goal, easy and convenient.

Disadvantages of Profit Centres

The profit centre approach suffers from certain disadvantages, some Of which are as follows:

l) Cannot be used for All Responsibility Centres:

In view of the following points, a profit centre approach cannot be used in respect of all responsibility centres:

1. Calculation Of inputs (costs) and outputs (revenue) in monetary terms necessitates the need for additional record-keeping;
2. Appropriate level of authority is required to be delegated to the divisional managers of a responsibility centre, so as to enable him / her to take important decisions with regard to quality and quantity of outputs, relation of output costs, Otherwise, the use of a profit centre as a tool for monitoring and controlling would be limited;
3. If a responsibility centre is asked by the management to extend its services to another responsibility centre, it cannot be treated as a profit centre, g. internal audits;
4. A profit centre with more or less uniform output (e.g. cement) is of little use; and
5. Some of the profit centres are tempted to give short-term positive results at the cost of losing a long- term It may lead to an unhealthy competition (or friction) amongst the various profit centres.

2)   Measurement of Expenses: 

Apportionment of expenses, incurred for the business organisation as a whole, amongst various profit centres, which impacts their performance evaluation, is not an easy task and leaves a room for varying views.

3)   Transfer Prices:

Determination of the value of goods and services’ transferred from one profit centre to another within the same organisation (transfer price mechanism), involves a complex process. It also poses a big challenge in view of a number of methodologies available for the purpose. Its implication l ies in the significant impact it may have on the selling profit centre as well as on the buying profit centre; for the former, it is a source of revenue, while for the latter, it is a part of the cost. The transfer price mechanism may affect the profitability of buying as well as selling profit centre, either in a positive manner or in a negative manner.