Department of Accounting Education

Mabini Street, Tagum City

Davao del Norte
Telefax: (084) 655-9591, Local 116

Big Picture
Week 8 & 9: Unit Learning Outcomes (ULO): At the end of the unit, you are
expected to:
a. explain the concept and objective of responsibility accounting system.
b. describe the concept of cost of quality.

Big Picture in Focus: ULOa.explain the concept and objective of responsibility

accounting system.

Metalanguage
In this section, the most essential terms relevant to the topic and to demonstrate
ULOawill be operationally defined to establish a common frame of reference as to
how the texts work in your chosen field or career.
1. Responsibility accounting – is a specific unit of an organization assigned to
a manager who is held accountable for its operations and resources.

Please proceed immediately to the “Essential Knowledge”.

Essential Knowledge
Managers are vital in the organization’s success and survival. Manages were given
certain authority to decide for the attainment of the organization’s goal. Each
manager’s performance is judged by how well he or she manages those items under
his or her control. The manager is then held responsible for the deviations between
budgeted goals and actual results.

1. Responsibility center – is a specific unit of an organization assigned to a

manager who is held accountable for its operations and resources. Each
manager’s performance is judged by how well he or she manages those items
under his or her control.

2. Responsibility accounting – is central to any effective profit planning and

control system. It is a system that recognizes various decision centers throughout
an organization and traces cost, revenues, assets and liabilities where pertinent
by areas of responsibility. It operates on the premise that managers should be
held responsible for their performance, the activities of their subordinates and all
activities within their responsibility center.

Through responsibility accounting, managers will complied to set managerial targets

and formulate strategies to attain the firm’s overall objectives. Control mechanism
will be provided which will serve as the basis in evaluating actual results or
performance.

2.1. Advantages of Responsibility Accounting

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 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

 It facilitates delegation of decision-making.

 It helps management promotes the concept of management by objective
wherein managers agree on a common set of goals and their performance
evaluated on the basis of their attainment of goals.
 It aids in establishing standards of performance which are used in evaluating
the efficiency and effectiveness of the different units in the organization.
 It permits effective use of management by exception which provides that the
manager will maximize his efficiency by concentrating on those operational
factors which are deviations from plans.

2.2. Disadvantages of Responsibility Accounting

 The negative effect of some decision made in one subunit to the other subunit
or to the organization as a whole.
 Decentralization necessitates a more elaborate reporting system, hence the
costs of gathering and reporting data increases.
 The problems of job duplication or overlapping of functions are usually
encountered.

2.3. Prerequisites to the Initiation and Maintenance of an Effective

Responsibility Accounting System
1) A well-defined organization structure
This requires that the spheres of jurisdiction which are set forth in the
organization chart must be clearly established and that a manager’s financial
responsibility be defined in advance.

2) Well-defined and established standards of performance in revenues, costs

and investments.
This requires that an integrated plans for the control of operation, as well as
the necessary procedures to effectuate the plan should be established and
maintained.

3) A system of accounting that identifies any revenues, expenses and assets to

specific units in the organization.

4) A system that provides for the preparation of regular performance reports.

This requires that a system of preparing the regular reports showing the
planned results, actual results and the variances should be established.

2.4. Responsibility Centers and their Evaluation

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 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

The types of responsibility centers are cost center, profit center, investment
center and revenue center.

I. Cost Center
This is a unit within the organization wherein the manager is responsible for
minimizing costs or expenses subject to some output constraints. Example
are maintenance department of a manufacturing company, library section of
a school and accounting department of a trading concern.

Performance of a cost center is evaluated through responsibility cost

report based on standard costs and flexible budgets. To have a fair
evaluation of the cost center performance, the variance analysis report
should highlight those costs that are controllable by the manager of the
department concerned.
Types of Costs in Responsibility Cost Report
1. Controllable costs – are costs which may be directly regulated at a
given level of managerial authority.
2. Noncontrollable costs – are costs that may not be directly regulated at
a given level of managerial authority.
3. Direct costs – are costs that can be specifically identified to a certain
responsibility center. Thus, all controllable costs are direct costs, but not
all direct costs are controllable costs.
4. Indirect costs – are composed mostly of costs that are merely allocated
to the responsibility center under consideration. Therefore, are
noncontrollable by the manager of the segment to which the cost is
allocated.

Sample Problem:

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 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

Shown below is a comparison between the budgeted and actual costs data for the
mixing department headed by Mr. Roland Lopez.

Budget Actual
Salaries & Wages P20,000 P20,000
Supplies 8,000 12,000
Postage & Telephone 2,500 3,700
Repairs & Maintenance 4,000 2,500
Depreciation 3,000 2,000
Light & Water 2,000 2,800

The decrease in depreciation cost is due to the disposal of equipment during the
period. The disposal was approved by the Vice President for Production when Mixing
Department reported that the equipment was not functioning efficiently. The increase
in light and water cost is due to the adjustment in power rates imposed by the DLPC.

Required: Determine the net amount of cost variance that must be considered in
evaluating the performance of the Mixing Department.

SOLUTION:
Budget Actual Variance Remarks
Direct Costs:
Controllable Costs:
Salaries & Wages P20,000 P20,000 -
Supplies 8,000 12,000 4,000 unfavorable
Postage & Telephone 2,500 3,700 1,200 unfavorable
Repairs & Maintenance 4,000 2,500 1,500 favorable

Non-controllable Cost:
Depreciation 3,000 2,000 -

Indirect Costs:
Light & Water 2,000 2,800 -
TOTAL P3,700 unfavorable

II. Profit Center

This is a unit or segment within the organization wherein the manager is

responsible for the generation or revenues and control of cost incurred in the
center. Examples are loans and discounts department of a commercial
banks, ladies wear section of a department store and college department of a
university.

Performance of a profit center is measured by using the contribution

approach to cost allocation or the determination of the profit center’s
contribution to indirect costs of the company. The operating performance of
the profit center is generally considered satisfactory if it is able to generate or

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 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

even exceed the expected contribution to indirect cost or common costs of

the company.

III. Investment Center

This is a unit or segment within the organization where the manager is

responsible for the control of revenues, costs and investment made in that
center. Examples include corporate headquarters or division of a large
decentralized organization such as:
 Branch offices of commercial banks
 Pharmaceutical division
 Subsidiary companies

In addition to performance reports, the performance of an investment center is

also measured with the determined of its return on investment, residual
income and economic value added.

The objective of an investment center or business unit are:

a) Motivate managers to exert a high level of effort to achieve the goals of
the firm.
b) Provide the right incentive for managers to make decisions that are
consistent with the goals of top management.
c) Determine fairly the rewards earned by the managers for their effort
and skill

Return on Investment (ROI)

ROI is a performance measure used to evaluate the efficiency of an

investment or compare the efficiency of a number of different investment.

Advantages of ROI:
1) It is easily understood and has gained wide usage.
2) It is comparable to interest rates of returns of alternative investments.

Limitations of ROI:
1) Although ROI is widely used in evaluating performance, this method is
subject to some criticisms.
2) It results to disincentive for high ROI units to invest in projects with ROI
greater than the minimum rate of return but less than unit’s current
ROI.

Formula of ROI:

Net Operating Income

ROI =
Average Operating Assets

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 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

Alternative Formula for ROI:

Net Operating Income Sales
ROI = X
Sales Average Operating Assets

Operating Profit Margin X Asset Turnover (Return on

ROI =
sales)

Net operating income (sometime referred to as Earnings before interest and

taxes or EBIT) – is generally used because it is consistent with the base to
which it is applied, that is, operating assets.

Operating assets – include cash, accounts receivable, inventory, plant and

equipment (net) and all other assets held for productive use in the
organization.

Residual Income

Residual income is the net operating income that an investment center is bale
to earn above some minimum return on the operating assets. Generally,
larger the residual income figure, the better is the performance rating received
by the division’s manager.

Advantages of Residual Income:

1) A unit pursues an investment opportunity costs as long as the return
from the investment exceeds the minimum rate of return set by the
firm.
2) The firm an adjust the required rate of return for difference in risk and
types of assets.
3) It is possible to calculate a different investment charge for different
types of assets.

Limitations of Residual Income:

1) It is not as intuitive as ROI.
2) It may be difficult to obtain a minimum rate of return.

Formula of Residual Income:

Operating Income P XXX
Less: Minimum required return XXX
(Operating Assets*rate of return)
Residual Income XXX

Economic Value Added (EVA)

EVA is a business unit’s income after taxes and after deducting the cost of
capital. The cost of capital is usually obtained by calculating a weighted
average of the cost of the firm’s two sources of funds – borrowing and selling
stock.

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 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

The main advantage of using EVA is that it focuses manager’s attention of

creating for shareholders by earning profit greater than the firm cost of capital.
Formula of EVA:
EVA = Net operating income after taxes - (Invested capital*WACC)

Alternative formula:
Operating Income after tax P XXX
Less: desired income XXX
[(Total assets – Current Liabilities)*WACC]

EVA XXX

Sample Problem:
Image Company’s Printing Division incurred the following costs and expenses in
2018:
Direct materials P 400,000
Direct labor 300,000
Factory overhead (37.5% is fixed) 224,000
Selling & administrative (60%fixed) 156,000
Total P 1,080,000

During the year, the division was able to print 400,000 copies. It charged an average
of P4.00 per copy. Digital’s investment in the division amounted to P2,000,000 on
January 1, 2018. This amount increase by P800,000 at the end of the year. Digital
normally computes interest on investments at 18% of average invested capital.

Required:
A. Rate of return on average investment for the year 2018.
B. Residual income (loss) for the year ended December 2018.
C. If the weighted average cost of capital (WACC) is 10% and a tax rate of 30%,
what is the division’s economic value added?

Solution:
A. Return on average investment (ROI)
P520,000
ROI = = 21.67%
P2,400,000

Sales (400,000 cps.*P4.00) P1,600,000

Less: Variable Costs:
Direct materials 400,000
Direct labor 300,000
Factory overhead (224,000*62.5%) 140,000
Selling & administrative (156,000*40%) 62,400

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 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

Total variable costs 902,400

Contribution margin P 697,600
Fixed Costs:
Factory overhead 84,000
(224,000*37.5%)
Selling & administrative 93,600
(156,000*60%)
Total fixed costs 177,600
Operating Income P520,000

(P2,000,000+2,800,000)
Average Operating Assets =
2
= P 2,400,000

B. Residual Income
Operating Income P 520,000
Less: Minimum required return 432,000
(2,400,000*18%)
Residual Income 88,000

C. Economic Value Added

EVA = P364,000 - (P2,400,000*10%)
= 364,000 - 240,000
= P 124,000
*P520,000*(1-.30)

IV. Revenue Center

This us a unit or segment within organization where the manager us
responsible for selling budgeted quantities of various products or services at
budgeted price. Examples of manager of revenue center are:
 A sales representative selling bread to supermarket
 A sales manager distributing automobile to dealers in specific
geographic areas
 A manager of the toys department in a local department store.

Managers of revenue centers use variance in sales price and sales mix to
monitor or control their operations. Managers of revenue centers are
responsible for achieving budgeted levels of contribution margin by controlling
the number of unit sold, product mix and selling prices.

Three types of variance and their formulas are useful to revenue center
manager in meeting their goals:

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 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

1) Sales Price Variance

SPV = (Actual Sales Price – Master budget Actual

X
sales price) unit sales

This variance shows how much of the difference between actual and
budgeted contribution margin is caused by the difference between
actual and budgeted sales prices.

2) Sales Volume Variance

SVV = (Actual unit sales – Master X Master budget

budget unit sales) average contribution
margin per unit*

*Master budget Master budget total contribution margin

average
=
contribution
Master budget sales
margin per unit

This variance measures the difference between actual unit sales and
budgeted unit sales.

3) Sales Mix Variance

Flexible Master
budget budget
Actual
average average
SMV = - X unit
contribution contribution
sales
margin per margin per
unit ** unit

**Flexible Flexible budget total contribution

budget margin
average =
contribution Actual unit sales
margin per unit

This variance is a measure of the change in contribution margin

caused by selling products in proportions (mix) different from those that
were budgeted.

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 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

Sample Problem:
Chips Galore sells two RISC chips to small machine tool manufacturers: R66 and
R100. Pertinent data for 2018:
BUDGETED ACTUAL
R66 R100 R66 R100
Selling price per chip P 50 P 160 P 55 P 155
Variable cost per chip 40 90 43 95
Contribution margin P 10 P 70 P 12 P 60
Fixed cost per chip 6 30 5 25
Operating income P4 P 40 P7 P 35
Sales in units 1,200 400 1,000 1,000

Required:
A. Sales price variance
B. Sales volume variance
C. Sales mix variance

Solution:
A. Sales Price Variance
SPV = (Actual Sales Price – Master budget Actual
X
sales price) unit sales
For R66:
SPV = (P55 – P50) X 1,000
= P5,000 favorable

For R100:
SPV = (P155 – P160) X 1,000
= P5,000 unfavorable

B. Sales Volume Variance

SVV = (Actual unit sales – Master X Master budget
budget unit sales) average contribution
margin per unit*

SVV = (2,000 – 1,600) X 25

= P10,000 favorable

*Master budget average (P10*1,200) + (P70*400)

=
contribution margin per unit 1,600
= P25.00

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 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

C. Sales Mix Variance

Flexible Master
budget budget
Actual
average average
SMV = - X unit
contribution contribution
sales
margin per margin per
unit ** unit

SMV = (P40 – P25) X 2,000

= P30,000 Favorable

**Flexible budget average (P10*1,000) + (P70*1,000)

contribution margin per =
unit 2,000
= P40

3. Transfer pricing – is the value of goods or services transferred by one segment

to another segment within the company, therefore, a transfer price is an internal
price that is charged by one responsibility center to another responsibility center
for goods and services.

The transfer price of interdivisional sales will affect the selling division’s sales and
the buying division’s costs but will not have any direct effect on the company’s
profit. However, the transfer price policy of the company can have an indirect
effect on company profit by influencing decisions of the division manager.

3.1. Transfer Pricing Methods

1) Minimum transfer price – the price set by transfer pricing formula is equal to
the differential costs (generally the variable costs) of the goods being
transferred, plus the contribution margin per unit that is lost to the selling
division as a result of giving up outside sales.
Transfer price = differential costs per unit + lost contribution margin per unit

2) Market based transfer price – the price at which the goods are sold in the
outside market. This is the best transfer price in the sense that it will maximize
the profits of the company as a whole provided that a competitive market
exists, and divisions are independent of each other.

3) Cost based pricing – this is based on either the variable costs or full cost of
the product. It includes the following:
a. Variable cost transfer price– is based only on variable or differential
costs. But when fixed costs increase because of a transfer of goods

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 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

between segments, they are differential costs and therefore should be

included in the transfer price.
b. Full cost transfer price – includes all manufacturing costs (variable and
fixed) plus portion of marketing and administrative costs.
c. Full absorption cost based transfer price –only the manufacturing costs
(variable and fixed) should be included in determining the transfer
price.
d. Cost plus transfer – these method generally apply a normal markup to
costs as a substitute for market prices when intermediate market prices
are not available.

4) Negotiated transfer price – managers are permitted to negotiate the price

for internally transferred goods and services. The negotiated price is an
attempt to stimulate an arm’s length transaction between supplying and
buying segment.

3.2. Standard costs in Transfer pricing

When a firm uses the standard cost accounting system, it is advisable to use
standard costs instead of actual costs in the determination of transfer prices. This
is to avoid passing on to another division the inefficiencies or efficiencies
(variances) in the manufacturing operations of the selling divisions.

Sample problem:
The Teens Division of Mike’s RTW produces teens’ wear which it sells to the
company’s Sales Division. Cost and production data for the past year are presented
below:
Production in units 5,000
Direct materials P100,000
Direct labor 75,000
Factory overhead (60% fixed) 125,000
Selling & administrative (10% variable) 150,000

Required:
A. Full costs
B. Full costs plus 20%
C. Full production costs plus 40%
D. Variable costs
E. Variable manufacturing costs plus 60%

Solution:
A. Full costs
Direct materials P100,000
Direct labor 75,000
Factory overhead (60% fixed) 125,000
Selling & administrative (10% variable) 150,000
Total costs P 450,000
Divided by: Production in units 5,000

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 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

Transfer price P90.00

B. Full costs plus 20%

Direct materials P100,000
Direct labor 75,000
Factory overhead (60% fixed) 125,000
Selling & administrative (10% variable) 150,000
Total costs P 450,000
Divided by: Production in units 5,000
Cost per unit 90.00
Add: Markup (90*20%) 18
Transfer price P108.00

C. Full production costs plus 40%

Direct materials P100,000
Direct labor 75,000
Factory overhead (60% fixed) 125,000
Total costs P 300,000
Divided by: Production in units 5,000
Cost per unit 60.00
Add: Markup (60*40%) 24.00
Transfer price P84.00

D. Variable costs
Direct materials P100,000
Direct labor 75,000
Factory overhead (125,000*40%) 50,000
Selling & administrative (150,000*10%) 15,000
Total variable costs P 240,000
Divided by: Production in units 5,000
Transfer price P48.00

E. Variable manufacturing costs plus 60%

Direct materials P100,000
Direct labor 75,000
Factory overhead (125,000*40%) 50,000
Total variable manufacturing costs P 225,000
Divided by: Production in units 5,000
variable manufacturing costs per unit P45.00
Add: Markup (45*60%) 27.00
Transfer price P72.00

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