Lesson 4.2 to 4.

3: Responsibility Accounting
MAC 406: PERFORMANCE MANAGEMENT SYSTEM
BS Management Accounting
 Learning Objectives:

1. Explain the concept and objectives of

responsibility accounting;
2. Enumerate the advantages of
responsibility accounting;
3. Describe the pre-requisites to initiate and
maintain an effective responsibility
accounting system; and
4. Describe and evaluate the different types
of responsibility centers.
Decentralized Organization
❑ It is one in which decision-making is not confined to few
top executives but rather is spread out throughout the
organization, with managers at various levels making key
operating decisions relating to their sphere of
responsibility.
Decentralized Organization
▪ Managers have found that segment reporting is of
greatest value in organizations that are decentralized.
▪ In segment reporting, costs and revenues are assigned to
segments to enable management to see where
responsibility lies for control purposes and to measure the
performance of segment managers.
Basic Concepts
▪ In a well-managed organization, responsibilities for
specific functions among its employees are clearly
defined.
▪ A 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/she managers those items under his/her control.
RESPONSIBILITY ACCOUNTING
❑ It is a system that recognizes various decision centers
throughout an organization and traces costs by areas of
responsibility.
▪ This system is also known as accounting and profitability
accounting.
▪ 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.
Objectives of Responsibility
Accounting
❑ Through responsibility accounting, managers will
be compelled 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 for evaluating the actual results
or performance.
Advantages of Responsibility
Accounting
1. It facilitates delegation or decision-making.
2. It helps the management promote the concept of
management by objectives wherein the
management agree on a common set of goals and
their performance evaluated on the basis of the
attainment of goals.
3. It aids in establishing standards of performance
which are used in evaluating the efficiency and
effectiveness of the different units in the
organization.
Advantages of Responsibility
Accounting
4. It permits effective use of management by
exception which provides that manager will
maximize efficiency by concentrating on those
operational factors which are deviations from plans.
Prerequisites of Effective
Responsibility Accounting System
1. A well-defined organization structure.
2. Well-defined and established standards of
performance in revenues, costs and other
investments.
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.
Responsibility Centers and their
Evaluation
▪ It is to determine the range of authority and
influence of manager to have control over
revenues, costs and investments.
▪A responsibility centers is a unit within the
organization which has control over costs,
revenues and/or investments.
▪Types of responsibility centers include cost
centers, profits centers and investment centers.
Business Segments Classified as Cost,
Profit and Investments
COST CENTER
▪ This is a unit within the organization wherein the
manager is responsible for minimizing costs
subject to some output constraints.
▪It has no control over generating revenue or the
use of investment funds.
▪The manager is responsible for making projection
or cost budget in his unit base on the expected
level of operation for the period.
▪When approved by the higher authorities (BOD),
the budgets will serve as the basis of transactions
or activities for the ensuing period.
Cost Center
▪ Performance of a cost center is evaluated by
using the performance reports or variance
analysis reports based on standard cost or
flexible budget.
▪The performance report will show the
comparison between the actual cost and the
budgeted cost incurred,
Cost Center
▪ The difference between the two costs if any,
if significant will be analyzed.
▪Responsibility for the incurrence will be
pinpointed and the manager concerned will
be required to explain or justify the variance.
▪The efficiency of the manager of the cost
center to control the cost in his unit will be
evaluated.
PROFIT CENTER
▪ This is a unit or segment within the
organization where in the manager is
responsible for the generation of revenues
and control of cost incurred in the center.
▪The manager of the profit center will likewise
be responsible for preparing the budget in his
unit.
Profit Center
● Performance of a profit center is measured
by preparing the income statements using
the contribution approach, presenting both
the actual results and budgeted figures. The
statement will show the comparative
revenue, direct costs and the profit center’s
contribution to indirect costs.
Profit Center
▪ The operating performance of the profit
center is generally considered satisfactory
if it is able to generate or even exceed the
expected contribution to indirect costs or
common costs of the company.
Pro-Forma Income Statement of a
Profit Center
INVESTMENT CENTER
● This is a unit or segment within the organization
where the manager is responsible for the control
of revenues, costs and investments made in that
center.
● Examples include corporate headquarters or
division of a large decentralized organization
such as (1) Magnolia Products Division of San
Miguel Corporation; (2) Pharmaceutical Division
of Novartis (Phils.) Inc.; (3) Subsidiary
companies
Objectives of Investment Center
● Motivate managers to exert a high level of
effort to achieve the goals of the firm
● Provide the right incentive for managers to
make decisions that are consistent with the
goals of top management
● Determine fairly the rewards earned by the
managers for their effort and skill
Return on Investment Formula
Return on Investment
● Net Operating Income – 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, PPE, etc. held for
productive use in the organization. Examples of
assets not to be included are land held for
future use, as investment in another company
or a factory building rented to someone else.
Advantage of ROI
● It is easily understood and has gained wide
usage.
● It is comparable to interest rates of returns
of alternative investments.
Limitations of ROI
● Although ROI is widely used in evaluating
performance, this method is subject to some
criticisms. One of these is that ROI tends to
emphasize short-run performance rather than
long-run profitability.
● Managers may be motivated to reject profitable
investment opportunities if the expected rate of
return is lower than the current ROI.
● ROI may not be fully controllable by the division
manager due to the presence of committed costs.
Limitations of ROI
● 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.
● It is therefore advisable to use multiple criteria in
evaluating performance rather than relying on ROI as
a sole measure.
● Other criteria include: growth in market share,
increase in productivity, product innovation, peso
profit, receivable and inventory turnover and ability to
venture into new and profitable areas.
Residual Income

● Residual income is the net operating income

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

● 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
● The firm can adjust the required rates of return
for differences in risk and types of assets
● It is possible to calculate different investment
charge for different types of assets
Limitations of Residual Income

● Since residual income is not a percentage, it

suffers the same problem of profit centers in
that it is not useful for composing units of
significantly different sizes.
● It forms larger unit that would be expected to
have larger residual income, even with
relatively poor performance.
Limitations of Residual Income

● It is not as intuitive as ROI.

● It may be difficult to obtain minimum rate of
return.
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