Responsibility Accounting

Presented by:

Md. Nazmul Islam, ACMA
Assistant Professor
Department of Accounting & Information
Systems
Faculty of Business Studies
Jagannath University, Dhaka, Bangladesh.

Relating to the
responsibilities of
individual managers.
To evaluate
managers on
controllable items.
An accounting system that
provides information . . .
Responsibility Accounting
An accounting system that
provides information . . .
Decision Making is Pushed Down
Supervisor Supervisor
Middle
Management
Supervisor Supervisor
Middle
Management
Top
Management
Decentralization
often occurs as
organizations
continue to grow.
Decentralization
Decentralization
Promotes better
decision making.
Allows upper-level management to
concentrate on strategic decisions.
Improves
productivity.
Develops
lower-level
managers.
Improves
performance
evaluation.
Advantages
Responsibility Reports
Responsibility
Reports
Prepared for each
individual who has
control over
revenue or expense
items
Responsibility Reports
Prepare budgets for
each responsibility center.
Prepare timely performance reports
comparing actual amounts with budgeted amounts.
Measure performance of
each responsibility center.
Successful implementation of responsibility
accounting depends on clear lines of authority and
clearly defined levels of responsibility.
Vice President
of Finance
Department Manager
Store Manager
Vice President
of Operations
Vice President
of Marketing
President
Board of Directors
The Controllability Concept
Amount of detail varies according
to level in organization.
Department
manager receives detailed
reports.
Store manager receives summarized
information from each department.
Management by Exception and
the Degree of Summarization
Management by Exception and
the Degree of Summarization
The vice president of operations receives
summarized information from each store.
Management by exception
Upper-level management does not receive
operating detail unless problems arise.
Amount of detail varies according
to level in organization.
To be of maximum benefit,
responsibility reports should . . .
Be timely.
Be issued regularly.
Be understandable.
Compare budgeted
and actual amounts.
Qualitative Reporting Features
Responsibility Centers
A responsibility center is the point in
an organization where the control over
revenue or expense is located, e.g.
division,department or a single
machine.
A responsibility center may be divided
into three categories
cost
profit
investment
Types of Responsibility Centers
Cost Center
A business segment
that incurs
expenses but does
not generate
revenue.
Profit Center
A part of the
business that has
control over both
revenues and
expenses, but no
control over
investment funds.
Revenues
Sales
Interest
Other
Expenses
Manufacturing
Commissions
Salaries
Other
Types of Responsibility Centers
Investment Center
A profit center
where
management also
makes capital
investment
decisions.
Corporate Headquarters
Types of Responsibility Centers
Measuring Managerial
Performance
Return on investment (ROI)
Residual income (RI)
Cost
Center
Cost control
Quantity and quality
of services
Profit
Center
Investment
Center
Evaluation Measures
Profitability
Return on investment is the ratio of
income to the investment used to
generate the income.
ROI =
Net Income
Investment
Return on Investment
ROI =
Net Income
Investment
ROI =
Net Income
Sales

Sales
Investment
Margin Turnover
Return on Investment
Cola Company reports the following:

Net Income $ 30,000
Sales $ 500,000
Investment $ 200,000
Lets calculate ROI.
Return on Investment
ROI = 6% 2.5 = 15%
Return on Investment
ROI =
Net Income
Sales

Sales
Investment
ROI =
$30,000
$500,000

$500,000
$200,000
Improving R0I
Three ways to improve ROI
Increase
Sales
Reduce
Expenses
Reduce
Investment
Cola Companys manager was able to
increase sales to $600,000 which
increased net income to $42,000.
There was no change in investment.
Lets calculate the new ROI.
Improving R0I
Cola Company increased ROI from 15% to 21%.
ROI = 7% 3 = 21%
ROI =
Net Income
Sales

Sales
Investment
ROI =
$42,000
$600,000

$600,000
$200,000
Improving R0I
ROI - A Major Drawback
As division manager at Cola Company,
your compensation package includes
a salary plus bonus based on your divisions
ROI -- the higher your ROI, the bigger your bonus.
The company requires an ROI of 20% on all new
investments -- your division has been producing an
ROI of 30%.
You have an opportunity to invest in a new project that
will produce an ROI of 25%.
As division manager would you
invest in this project?
ROI - A Major Drawback
As division manager,
I wouldnt invest in
that project because
it would lower my pay!
Gee . . .
I thought we were
supposed to do what
was best for the
company!
Residual Income
Earned Income
Investment charge
= Residual income
Investment
Desired ROI
= Investment charge
Investment centers
cost of acquiring
investment capital
Residual Income
Cola Company has an opportunity to
invest $100,000 in a project that will
earn $25,000.
Cola Company has a 20 percent
desired ROI and a 30 percent ROI on
existing business.
Lets calculate residual income.
Residual Income
Investment = $100,000
Desired ROI = 20%
= Investment charge = $ 20,000
Investment centers
cost of acquiring
investment capital
Residual Income
Earned Income = $25,000
Investment charge = 20,000
= Residual income = $ 5,000
Investment = $100,000
Desired ROI = 20%
= Investment charge = $ 20,000
Investment centers
cost of acquiring
investment capital
Residual Income
As a manager at Cola
Company, would you
invest the $100,000 if
you were evaluated
using residual income?
Would your decision be
different if you were
evaluated using ROI?
Residual Income
Residual income encourages managers to
make profitable investments that would
be rejected by managers using ROI.
Transfer Pricing
Lets change topics!
Transfer Pricing
Batteries
The amount charged when one division
sells goods or services to another division.
Battery Division Auto Division
Transfer Pricing
Battery Division Auto Division
A higher transfer
price for batteries
means . . .
The transfer price affects the profit measure for
both the selling division and the buying division.
lower profits for
the auto division.
greater profits for
the battery division.
The ideal transfer price allows
each division manager to make
decisions that maximize the
companys profit, while
attempting to maximize the
divisions profit.
Transfer Pricing
Market-based transfer prices are
preferred because they promote
efficiency and fairness.
Setting Transfer Prices
When market prices are not available,
companies may use . . .
Cost-based prices
Negotiated prices
Negotiated Transfer Price
A system where transfer prices are arrived at
through negotiation between managers of
buying and selling divisions.
Excessive management
time may be used in the
negotiation process.
May not be in the
best interest of
the company.
Cost-Based Transfer Prices
When used, cost-based transfer prices . . .
Are either variable cost or full cost.
Should use standard rather than actual costs.
Cost-based transfer prices are the
least desirable because the incentive
to control cost is diminished.
Conflicts may arise between the companys
interests and an individual managers
interests when transfer-price-based
performance measures are used.
Setting Transfer Prices
End of Chapter
Lets transfer some of
your capital to me so
that my rate of return
will be higher!