Responsibility Centres

A responsibility center is an organization unit that is headed by a manager who is responsible for its activities and results. In Responsibility Accounting, revenues and costs information are collected and reported by responsibility centers. A decentralized environment results in highly dispersed decision making. As a result, it is imperative to monitor and judge the effectiveness of each manager.

Nature of responsibility centers A responsibility center exist one or more purpose are its objectives. The company as a whole has goals, and senior management has decided on a set of strategies to accomplish these goals. The objectives of responsibility centers are to help implement these strategies. Because the organization is the sum of its responsibility centers, if the strategies are sound and if each responsibility center, if the strategies are sound and if each responsibility center meets its objectives the whole organization should achieve its goals. A responsibility center uses inputs, and a variety of services. Its work with these resources and it usually require working capital, equipment, and other asset to do this work. As a result of this work the responsibility center produces output which is classified either as goods if they are tangible or as services if they are intangible. Every responsibility center has output that is it does something. In a production plant, the outputs are goods. In staff units, such as human resources, transportation, engineering, accounting, and administration, the output s are services. For many responsibility centers, especially staff units, outputs are difficult to measure; nevertheless, they exist. The products produced by a responsibility center or to the outside marketplace. In the first case, the product are inputs to the other responsibility center in the latter case, they are output s of the whole organization.

Objectives of Responsibility Accounting: Responsibility accounting is a method of dividing the organizational structure into various responsibility centres to measure their performance. In other words responsibility accounting is a device to measure divisional performance measurement may be stated as under: 1. To determine the contribution that a division as a sub-unit makes to the total organization. 2. To provide a basis for evaluating the quality of the divisional managers performance. Responsibility accounting is used to measure the performance of managers and it therefore, influence the way the managers behave. 3. To motivate the divisional manager to operate his division in a manner consistent with the basic goals of the organization as a whole.

There are four types of responsibility centres, according to the nature of the control over the inputs and outputs:

1. Cost Center A cost center is an organizational sub-unit such as department or division, whose manager is held accountable for the costs incurred in that division. For example, a Power and Airco Department can can be defined as a cost center within the Operation and Maintenance Department in United Telecommunication Company. Manager of a cost center is responsible for controllable costs incurred in the department, but is not responsible for revenue, profit or investment in that center. A cost center is a responsibility center in which inputs, but not outputs are measured in monetary value.

2. Revenue Center A manager of a revenue center is held accountable for the revenue attributed to the sub-unit. Revenue centers are responsibility centers where managers are accountable only for financial outputs in the form of generating sales revenue. A revenue center's manger may also be held accountable for selling expenses such as sales persons' salaries, commissions, and order receiving costs. 3. Profit Center Profits are the excess of revenue over the total expenses. Therefore, the manager of a profit center is held accountable for the revenues, costs, and profits of the centre. A profit center is a responsibility center in which inputs are measured in terms of expenses and outputs are measured in terms of revenues.

Profit centers have been used as a major management control tool. The major advantages of profit centers are:

These help in increasing the speed of making operating decisions as they do not have to be

referred to corporate headquarters.

As the decision-making authority lies with the managers they can make better decisions

related to the task they are performing, because they can understand the nature of the work better.

Since profit centers make their day-to-day decisions themselves headquarters can

concentrate on broader issues of the organization.

Managers are motivated to perform more effectively, as they are responsible for

increasing the profit of their unit.

Managers use their imagination, take initiatives to perform more effectively, to increase the profit of their unit. However, there are certain difficulties associated with the creation of profit centers. The management cannot have considerable control over the different profit centers when decisions are centralized. The top management has to depend on management control reports which may not be as effective as the personal knowledge of an operation. There may be no place for competent general managers in a functional organization because of lack of opportunities for them to develop creative management skills.

Organizational units compete with one another, and this may, sometimes, result in conflict between different centers and reduction in cooperation between different units and sharing of resources. Types of profit centers Functional units can be classified as different types of profit centers. A multibusiness company can be divided into independent profit generating units such as marketing, finance, manufacturing etc. The decisions regarding whether a particular functional unit can be a profit center depends on the responsibility center manager's ability to influence, if not control, other activities that affect the company's bottom line. The different types of profit centers are discussed below: Marketing: A marketing activity becomes a profit center if it is charged with the cost of the products sold. A marketing activity can be given the responsibility of making profit when the marketing manager has the authority to make principal cost/revenue trade off in terms of marketing a product, spending on sales promotion, the appropriate time for this expenditure and on which media to spend. Manufacturing: This is an expense center and the management of activities here is based on performance against standard costs and overhead budgets. Problems in measurement may occur because of inadequate quality control, shipping of inferior quality products, and so on, to obtain standard cost credit. At times, there may arise the need to accommodate an order in-between production schedules, and the manufacturing managers may be reluctant to interrupt these schedules. In manufacturing units, when performance is measured against standards, there may be no incentives for manufacturing products that are difficult to produce. These factors may demotivate the managers, and eventually, they may not try to improve standards. Hence, while measuring the performance of manufacturing activities against standard costs, it is important to take into consideration quality control, production scheduling and the make or buy decisions. Measuring profitability: Profitability measurements in a profit center can be of two typesmanagement performance and economic performance. Management performance focuses on the managers performance while economic performance relates to how well a profit center is performing as an economic entity. Management performance is a measure used for planning, controlling and coordinating the day-to-day activities of the profit center. The performance

measures of profit centers can be different and hence, the necessary purpose for the information should not be obtained from a single set of data. For example, the management performance report can show excellent performance of a profit center manager. But the economic and competitive forces for that particular report can show poor economic performance. As a result, the center may run into losses and may even have to close shop. Types of profitability measures: The parameters that can be used for measuring the profitability of a profit center are contribution margin, direct profit, controllable profit, income before taxes and net income. Contribution margin: This performance measure is used on the premise that, since fixed expenses are not controllable by the manager, the focus should rest on maximizing the difference between revenues and variable expenses. The problems of using contribution margin is that since many of the centers expenses may vary according to the discretion of the profit center manager, focus on the contribution margin tends to direct the attention of the profit center manager away from the goals of the center. Direct profit: This measure helps in understanding the contribution of the profit center to the general overhead profit of the corporation. It encompasses all the expenses directly incurred by profit centers or related to profit centers, irrespective of whether the expenses are controllable by the profit center manager. However, it does not include corporate expenses. Controllable profit: The headquarters expenses in an organization can be divided into two categories-controllable and uncontrollable. Controllable expenses include expenses that are controlled by the business unit manager. The advantage of including such costs in the measurement system is that the profit will be calculated after the deduction of expenses that can be influenced by the profit center manager. Hence, these are controllable profits. As uncontrollable headquarters expenses are taken into consideration while calculating controllable profits, controllable profits cannot be compared directly with published data or with trade association data, which report the profits of other companies in the industry. Income before taxes: In this method, all corporate overhead profit is allocated to the profit center. The amount of expense incurred by each profit center forms the basis of allocation of profit. Such allotment has its own drawbacks. Firstly, the costs in departments like finance, and HR are not controllable by the profit center and hence, profit centers should not be held

accountable for such costs. Also, it is difficult to quantify the amount that has been spent on human resources in each profit center. However there are certain advantages in allocating costs. Corporate service units often have a tendency to spend lavishly to make their units as excellent as possible without paying due attention to the value they create for the company. Once such costs are allocated to profit centers, the profit center managers will try to keep a check on the expenditure. The performance of profit centers is easily comparable to that of competitors performance who pay for similar services. Since the profit center can earn profit only when it has recovered all its costs, including allocated corporate overhead costs, the profit center manager will be motivated to make long-term marketing decisions such as pricing, product mix, and so on, because the center will have to recover its share of corporate overhead costs. For profit centers to function with the allocated costs in mind, it is important that they are allocated budgeted costs, and not actual costs. This ensures that the profit center managers will perform without complaining about the arbitrariness of the allocated costs, since there would be no variances in the allocated overheads in the performance reports.

Net income: The performance is measured by taking into consideration the net income after the payment of taxes. The disadvantage of using this method is that many decisions that have an impact on the income taxes are made at headquarters, and profit center managers should not be judged by these decisions. If the income after tax payment is constant percentage of the income before tax payment, then there would be no need to measure performance based on this method. This method would be useful if profit centers influence decisions like installing credit policies or disposing of equipment. This method is also useful to motivate the manager to minimize taxes in case the taxable income differs from income, as measured by using generally accepted accounting principles. The performance of profit centers can be measured by comparing actual results with one or more of the measures discussed above with budgeted amounts. In addition, data on competitors and industry provide a good crosscheck on the appropriateness of the budget.

4. Investment Center The manger of investment centre is held accountable for the division's profit and the invested capital used by the centre to generate its profits. Investment centres consider not only costs and revenues but also the assets used in the division. Performance of an investment centre are measured in terms of assets turnover and return on the capital employed. Expense centers: Expenses center are responsibility centers for which input or expenses are measured in monetary terms, but for which outputs are not measured in monetary terms. There are two general types : engineered expense center and discretionary expense center. They correspond to two types of costs : Engineered costs are elements of cost for which the right or proper amount of costs that should be incurred can be estimated with a reasonable degree of reliability. Costs incurred in factory for direct labour direct material component supplies and utilities are examples.

Engineered expense centers: Engineered expense center have the following characteristics: 1. Their inputs can be measured in monetary terms. 2. Their output can be measured in physical terms. 3. The optimal dollar amount of input required to produce one unit of output can be established Engineered expense center usually are found in manufacturing operations. Warehousing, distribution, trucking and similar units in the marketing organization also may be engineered expense center and so many certain responsibility center within administrative and support department. Examples are accounts receivable account payable and payroll section in the controller department personnel record and cafeteria in the human resource department shareholder record in the corporate secretary department and the company motor pool. Such units perform repetitive task for which standard cost can be developed In an engineered expense center the output multiplied by the standard cost or each unit produced represents what the finished product should have cost. When this cost is compared to actual

costs, the difference between the two represents the efficiency of the organization unit being measured. We emphasize that engineered expense centers have other important tasks not measured by cast alone. The effectiveness of these aspects of performance should be controlled. For example expenses center supervisor are responsible for the quality of good and for the volume of production in addition to their responsibility for cost efficiency. Therefore the type and amount of production is prescribed and specific quality standards are set so that manufacturing costs are not minimized at the expense of quality. Moreover manager of engineered expense center may be responsible for activities such a training that are not related to current production judgment about their performance should include an appraisal of how well they carry out these responsibilities. There are few if any responsibility center in which all cost items are engineered. Even in highly automated production department the amount of indirect labour and of various services used can vary with management discretion. Thus, the term engineered costs center refers to responsibility center in which engineered cost predominate but it does not imply that valid engineering estimates can be made for each and every cost item. Discretionary expense center: The output of discretionary expenses center cannot be measured in monetary terms. They include administration and support units research and development organization and most marketing activities. The term discretionary does not mean that management judgments are capricious or haphazard. Management has decided on certain policies that should govern the operation of the company. One company may have a small headquarter staff another company of similar size and in the same industry may have a staff that is 10 time as large the management of both companies may be concerned that they made the correct decision on staff size but there is no objective way judging which decision was actually better manager are hired and paid to make such decision after such a drastic change the level of discretionary expenses generally has a similar pattern from one year to the next. The difference between budgeted and actual expense is not a measure of efficiency in a discretionary expense centre it is simply the difference between the budgeted input and the actual input. It in no way measures the value of the output, if actual expense do not exceed the budget amount, the manager has lived within the budget however ,because by definition the budget does not purport to measure the optimum amount of spending we cannot say that living within the budget is efficient performance .

Administrative and support centers Administrative centers include the senior corporate management, the business unit management and the managers responsible for their staff units. Support centers provide services to other responsibility centers. Problems related to control in administrative and support centers include difficulty in measuring output, as they basically provide service and advice to the responsibility centers. Therefore, it becomes difficult to set cost standards. Hence, their performance cannot be branded as efficient or inefficient. Secondly there is lack of congruence between goals of staff units and responsibility centers. The suggestions that staff departments may provide regarding the development of systems, programs or functions may be too costly when one thinks of the additional profits that these would generate. The severity of the problems is also related to the organizational level. At the operational level, the staff activity is controlled by the plant manager, and at the business unit level, by the business unit manager. When compared to the plant level, there is more discretion of tasks at the business unit level. Support centers charge a particular price for the services they provide to other responsibility centers.

Research and development centers Control problems in research and development: The problems in research and development are: Difficulty in measuring quality: The inputs for an R&D activity can be measured whereas the outputs are difficult to measure. For R&D activities, the time taken for a particular research cannot be estimated as it may take months or sometimes years for a particular activity. Also the output is difficult to measure because of its technical nature.

Marketing centers There are two types of marketing activities in every organization: order filling (logistics) and order getting. Order getting is an actual marketing activity. Order filling activities include transferring goods from the company to the customer, and receiving the appropriate pay from the customer. These are mostly engineered expense centers. Order getting activities include test marketing, training sales force, advertising, sales promotion, etc. Though the output of a marketing organization can be measured, it is difficult to evaluate the marketing effort, as the marketing department has no control over economic conditions or competitors actions. These actions may be different from what was expected when the sales budgets were established. In such situations, it is difficult to achieve management control. Also, it becomes difficult to measure the efficiency and effectiveness of these costs.

Differences in budgeting perspective of engineered and discretionary expense centre Budget preparation The decision that management make about a discretionary expense budget are different from the decisions that it makes about the budget for an engineered expense center. For the latter, management decides whether the proposed operating budget represent the cost of performing task efficiently for the coming period. Management is not so much concerned with the magnitude of the task because this is largely determined by the actions of other responsibility centers, such as the marketing departments ability to generate sales. In formulating the budget for a discretionary expense center, however management principal task is to decide on the magnitude of the job that should be done.

Incremental budgeting Here the current level expenses in a discretionary expense center is taken as a starting points this amount is adjusted for inflation for anticipated changes in the workload of continuing tasks for special tasks and if the data are readily available for the cost of comparable work in similar units. There are two drawbacks to incremental budgeting. First because managers of these centers typically want to provide more service they tend to request additional resources in the budgeting process and if they make a sufficiently strong case these request will be granted. This tendency is expressed in Parkinsons second law: overhead costs tend to increase period. There is ample evidence that not all this upward creep in cost is necessary.

This problem is especially compounded by the fact that the current level of expenditure in the discretionary expenses center is taken for granted and is not re-examined during the budget preparation process. Second when a company faces a crises or when a new management takes over overhead costs are sometimes drastically reduced without any adverse consequences. Despite this limitation most budgeting in discretionary expense centers is incremental. Time does not permit the more thorough analysis described in the next section. Zero based review An alternative approach is to make a thorough analysis of each discretionary expense center on a schedule that will cover all of them over a period of five year or so. That analysis provides a new base. There is a likelihood that expenses will creep up gradually over the next five years and this is tolerated at the end of five years, another new base is established. Such an analysis is often called a zero base review. In contrast with incremental budgeting which takes the current level of spending as the starting point this more intensive review attempts to build up de now the resources that actually are needed by the activity. Basic question are raised;(1) should use customer?(2) what should the quality level be ?are we doing too much(3)should the function be performed in this way (4) how much should it cost?

Cost variability In discretionary expense center costs tend to vary with volume from one year to the next but they tend not to vary with short run fluctuation in volume within a given year. By contrast costs in engineering expense center are expected to vary with short run changes in volume. In part this reflect the fact that volume changes do have an impact throughout the company even though their actual impact cannot be measures the ; in part this reflect the fact that volume changes do have an impact throughout the company even though their actual impact cannot be measured in part this result from a management personnel and personnel related costs are by far the largest expense item in most discretionary expense center the annual budget for these center tend to be a constant percentage of budgeted sales volume. Measurement of performance: The financial performance report of a discretionary expense center does not help in evaluating the efficiency of the manager, whereas in engineered expense centers the financial report helps in evaluating the efficiency of the manager. If the two centers are not properly distinguished, the management may consider the performance report of a discretionary center as an indication of its efficiency.

Problems in Responsibility Accounting While implementing the system of responsibility accounting, the following difficulties are likely to be faced by the management: 1. Classification of costs: For responsibility accounting system to be effective a proper classification between controllable and non controllable costs is a prime requisite. But practical difficulties arise while doing so on account of the complex nature and variety of costs. 2. Inter-departmental Conflicts: Separate departmental persuits may lead to inter-departmental rivalry and it may be prejudicial to the interest of the enterprise as a whole. Managers may act in the best interests of their own, but not in the best interests of the enterprise. 3. Delay in Reporting: Responsibility reports may be delayed. Each responsibility centre can take its own time in preparing reports. 4. Overloading of Information: Responsibility accounting reports may be overloading with all available information. This danger is inherent in the system but with clear instructions by management as to the functioning of the system and preparation of reports, etc., only relevant information flow in. 5. Complete Reliance will be deceptive: Responsibility accounting cant be relied upon completely as a tool of management control. It is a system just to direct the attention of management to those areas of performance which required further investigation