Responsibility Accounting

An accounting system that

provides information . . .

Relating to the To evaluate

responsibilities of managers on
individual managers. controllable items.

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 Decentralization
Decentralization
often occurs as
Top organizations
Management
continue to grow.

Middle Middle
Management Management

Supervisor Supervisor Supervisor Supervisor

Decision Making is Pushed Down

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 Decentralization
Promotes better Improves
decision making. productivity.

Improves Develops
performance lower-level
evaluation. managers.

Advantages
Allows upper-level management to
concentrate on strategic decisions.
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Responsibility Reports

Responsibility
Reports
Prepared for each
individual who
has control over
revenue or
expense items

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 Responsibility Reports

 Prepare budgets for  Measure performance of

each responsibility center. each responsibility center.

 Prepare timely performance reports

comparing actual amounts with budgeted amounts.
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The Controllability Concept
Successful implementation of responsibility
accounting depends on clear lines of authority
and clearly defined levels of responsibility.

Board of Directors

President

Vice President Vice President Vice President

of Finance of Operations of Marketing

Store Manager

Department Manager
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Management by Exception and the
Degree of Summarization
Amount of detail varies according
to level in organization.

Department Store manager receives

manager receives summarized information
detailed reports. from each department.
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 Management by Exception and the
Degree of Summarization
Amount of detail varies according
to level in organization.
Management by exception
Upper-level management
does not receive operating
detail unless problems arise.

The vice president of operations

receives summarized information
from each store.
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Qualitative Reporting Features

To be of maximum benefit, responsibility

reports should:
– Be timely.
– Be issued regularly.
– Be understandable.
– Compare budgeted
and actual amounts.

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 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

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Types of Responsibility Centers

Cost Center
A business
segment that
incurs expenses
but does not
generate revenue.

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Types of Responsibility Centers

Profit Center
A part of the business
that has control over
both revenues and
expenses, but no
control over
investment funds.
Types of Responsibility Centers

Investment Center
A profit center
where management
also makes capital
investment
decisions.
 Introduction of Responsibility Accounting
• The establishment of responsibility with the help of accounting records
is called as Responsibility Accounting. R.A.is a system that concentrates
to establishes responsibility of a particular cost center and accumulates
cost of it to facility.
• Pre-requisite of successful Responsibility Accounting System are:
1. Support of Management.
2. Support and understanding of supervision i.e. the system
must be fully and thoroughly explained.
3. Accurate acceptable data. One should know it and must
be consulted in presence of some targets.
4. Give them job satisfaction.

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 Introduction of Responsibility Accounting
• 4. A progressive management climate. Responsibility is a means of
developing and motivating executives and supervisors through self discipline.
• 5. Classification of management levels, functional divisionalisation and
departmentalization.
• 6. Controllable and uncontrollable costs, variable and fixed costs.
• 7. Organization chart – who is responsible for what to whom he is
answerable.
• 8. Cost and benefit analysis.
• 9. Social responsibilities.
Three ways of controlling Business Activities:
• 1. By establishing administrative control, within a formal organization
structure Budgetary Control.
• 2. By building up a team spirit so that subordinates are motivated as a
group.
• 3. By encouraging the motivation of individuals, through the design of jobs
which

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 Benefits of Responsibility Accounting

• 1. Typing-in of accounting records and cost control system helps in

controlling costs.
• 2. Analysis of cost of production and related units of production and
services rendered.
• 3. Using a variable basis of allocating cost to various cost centers.
• 4. Responsibility Accounting provides a moral check upon the
supervisor to be alert for controlling expenses.
• 5. Managers’ moral and job satisfaction are higher because of their
participation in decision making.
• 6. Decisions are taken collectively and with mutual understanding at
right time.
• 7. Autonomy of given to managers to let them work independently
in the best interest of their department but keeping over all objectives
of the company in forefront all the time.

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Measuring Managerial Performance
Evaluation Measures
Cost control
Cost
Quantity and quality
Center
of services

Profit
Profitability
Center

Investment Return on investment (ROI)

Center Residual income (RI)
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 Return on Investment
Return on investment is the ratio of income
to the investment used to generate the
income.

Net Income
ROI =
Investment

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 Return on Investment

Net Income
ROI =
Investment

ROI = Net Income Sales

×
Sales Investment

Margin Turnover

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 Return on Investment

Cola Company reports the following:

Net Income $ 30,000

Sales $ 500,000
Investment $ 200,000

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 Return on Investment

ROI = Net Income Sales

×
Sales Investment

ROI = $30,000 $500,000

×
$500,000 $200,000

ROI = 6% × 2.5 = 15%

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 Improving R0I
 Reduce
Expenses
 Increase  Reduce
Sales Investment

Three ways to improve ROI

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 Improving R0I

ROI = Net Income Sales

×
Sales Investment

ROI = $42,000 $600,000

×
$600,000 $200,000

ROI = 7% × 3 = 21%
Cola Company increased ROI from 15% to 21%.
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 ROI - A Major Drawback
• As division manager at Cola Company,
your compensation package includes
a salary plus bonus based on your division’s
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?
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 Residual Income
Earned Income
– Investment charge
= Residual income

Investment
× Desired ROI
= Investment charge

Investment center’s
cost of acquiring
investment capital
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 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.

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 Residual Income

Investment = $100,000
× Desired ROI = 20%
= Investment charge = $ 20,000

Investment center’s
cost of acquiring
investment capital
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 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 center’s
cost of acquiring
investment capital
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Question #1
Division Y has reported annual operating profits of £40.2 million.
This was after charging £6 million for the full cost of launching a
new product that is expected to last three years. Division Y has a
risk adjusted cost of capital of 11% and is paying interest on a
substantial bank loan at 8%. He historical cost of the assets in
Division Y, as shown on its balance sheet, is £100 million, and the
replacement cost has been estimated at £172 million.

Answer:
Adjustment needed are:
For launch costs – spread over 3 years; and
Need to use replacement cost of net assets.
So EVA = (£40.2 million + £4 million) – (£172 million ā 11%) = £25.28
million.

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