ASSIGNMENT ON

RESPONSIBILITY

ACCOUNTING

INTRODUCTION

Responsibilty accounting is one of the basic components of a good control system. The main characteristic feature of this control system is that it is relevant to measurement of performance of divisions of an organization while other control systems are applicable to the organization as a whole. Budgeting and variance analysis are thus part of the responsibility accounting process.

Responsibility accounting has no scope in a small organization because in such a business all decision making is centralized at one place and one individual. However, in big and diversified companies like ITC ltd. , which produces and sells a wide variety products/services, responsibility accounting proves extremely useful. Because of the complexity of operations in such companies,it is very difficult for the head office to directly control the operations of all divisions of business. It is therefore, appropriate to divide the company into separate self contained divisions and to allow all divisional managers to operate with a great deal of independence. Take the case of ITC ltd, which is in cigarette and other businesses and is also running a chain of hotels all over India . in applying responsibility accounting to such a business model, each hotel manager may be asked to run the hotel as an independent unit like a small business. Each hotel will then be treated as a responsibility centre. In this way , a number of responsibility centres will be created which should promote the long term interest of the larger organisatin and coordinate their activities with other responsibility centres of the company.

MEANING & DEFINATION

Responsibility accounting is a method of accumulating and reporting both budgeted and actual costs and revenues by divisional managers responsible for them. It means in responsibility accounting, business activities are identified with persons rather than products or functions and responsibility is assigned to the manager best placed to effect control. The idea of responsibility accounting is that managers will be held responsible only for those items over which they can exercise a significant amount of control. Horngern has defined responsibility accounting “ a system of accounting that recognizes various responsibility centres through the organization and reflects the plans and actions of each of these centres by assigning particular revenues and costs to the one having the pertinent responsibility”

Responsibility accounting is also defined as “ that segregates revenues and costs into areas of personal responsibility in order to assess performance attained by persons to whom authority has been assigned”

PRE-REQUISITES FOR RESPONSIBILITY ACCOUNTING

It should be a big company with divisionalised arganisational structure and where areas of responsibility are well defined at different levels of the organization.

There are clearly set goals and targets for each responsibility centre. Managers actively participate in establishing the budgets against which their

performance is measured Accounting system generates correct and dependable information for each

responsibility centre. The managers are held responsible only for those activities over which they

exercise significant degree of control. Managers must try to attain the goals and objectives. Goals for each area of responsibility should be attainable with efficient

performance. Performance reporting should be timely and should contain significant

information relating to the responsibility centre.

SIGNIFICANCE OF RESPONSIBILITY ACCOUNTING

The significance of responsibility accounting for management can be explained in the following way:

Easy Identification: It enables the identification of individual managers responsible for satisfactoryOr unsatisfactory performance.

Motivational Benefits :

If a system of responsibility accounting is implemented, considerable motivational benefits are assured.

Data Availability

A mechanism for presenting performance data is provided. A framework of managerial performance appraisal system can be established on that basis, besides motivating managers to act in the best interests of the enterprise.

Ready-hand Information:

Relevant and up to the minutes information is made available which can be used to estimate future costs and or revenues and to fix up standards for departmental budgets.

Planning and Decision Making:

Responsibility accounting helps not only in control but in planning and decision making too.

Delegation and Control:

The twin objectives of management are delegating responsibility while retaining control are achieved by adoption of responsibility accounting system

PROBLEMS IN RESPONSIBILITY ACCOUNTING

While implementing the system of responsibility accounting, the following difficulties are likely to be faced by the management:

Classification of costs:

For responsibility accounting system to be effective a proper classification between controllable and noncontrollable costs is a prime requisite. But practical difficulties arise while doing so on account of the complex nature and variety of costs.

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.

Delay in Reporting:

Responsibility reports may be delayed. Each responsibility centre can take its own time in preparing reports.

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.

Complete Reliance will be deceptive:

Responsibility accounting can’t 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.

OBJECTIVES OF RESPONSIBILITY ACCOUNTING

Responsibility accounting is a method of dividing the organizational structure into various responsibility centers to measure their performance. In other words responsibility accounting is a device to measure divisional performance measurement may be stated as under:

To determine the contribution that a division as a sub-unit makes to the total

organization.

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.

To motivate the divisional manager to operate his division in a manner consistent with the basic goals of the organization as a whole.

PRINCIPALS OF RESPONSIBILITY ACCOUNTING

The main features of responsibility accounting are that it collects and reports planned and actual accounting information about the inputs and outputs of responsibility accounting.

Inputs and outputs :

Responsibility accounting is based on information relating to inputs and outputs. The resources used are called inputs. The resources used by an organization are essentially physical in nature such as quantity of materials consumed, hours of labour, and so on. For managerial control, these heterogeneous physical resources are expressed in monetary terms they are called cost. Thus, inputs are expressed as cost. Similarly, outputs are measured in monetary terms as “revenues”. In other words, responsibility accounting is based on cost and revenue data or financial information.

RESPONSIBILITY CENTRE

The basic idea of responsibility accounting is that large diversified organizations are difficult, if not impossible, to manage as a single segment. Thus they must be decentralized or separated into smaller manageable parts. The parts or segments are reffered to as responsibility centres.

A responsibility centre “is a division for which a manager is held responsible”. CIMA , London has defined as “ a segment of the organization, where an individual manager is held responsible for its segment’s performance.”

In the words of horgren, “a responsibility centre is a part, segment or sub-unit of an organization whose manager is accountable for a specified set of activities”.example of a responsibility centre in a company running a chain of hotels may be one hotel whose manager will be accountable for its performance. A responsibility centre is like a small business to achieve the objectives of a large organization . for an organization to be successful, the activities of its responsibility centres must be coordinated. An important criterion for creating responsibility centre is that the unit of organization, should be separate and identifiable for the purpose of its performance evaluation. It should also be understood that for creating responsibility centre,it is not necessary that organization must be decentralized because responsibility centres can be found in both centralized and decentralized organizations. Responsibility centres are of four types namely:-

1. Cost centre

2. Profit centre

3. Investment centre

4. Revenue centre

Together they form the basis of responsibility accounting.

1. Cost Centre or Expense Centre:

An expense centre is a responsibility centre in which inputs, but not outputs, are measured in monetary terms. Responsibility accounting is based on financial information relating to inputs (costs) and outputs (revenues). In an expense centre of responsibility, the accounting system records only the cost incurred by the centre but the revenues earned (outputs) are excluded. An expense centre measures financial performance in terms of cost incurred by it. In other words, the performance measured in an expense centre is efficiency of operation in that centre in terms of the quantity of inputs used in producing some given output. The modus operandi is to compare actual inputs to some predetermined level that represents efficient utilization. The variance between the actual and budget standard would be indicative of the efficiency of the division.

2. Profit Centre:

A centre in which both the inputs and outputs are measured in monetary terms is called a profit centre. In other words both costs and revenues of the centre are accounted for. Since the difference of revenues and costs is termed as profit, this centre is called profit centre. In a centre, there are financial measures of the outputs as well as of the input, it is possible to measure the effectiveness and efficiency of performance in financial terms. Profit analysis can be used as a basis for evaluating the performance of divisional manager. A profit centre as well as additional data regarding revenues. Therefore, management can determine whether the division was effective in attaining its objectives. This objective is presumably to earn a “satisfactory profit”. Profit directly traceable to the division and voidable if the division were closed down. The concept of divisional profit is referred to as ‘profit contribution’ as it is amount of profit contribution directly by the division.

The performance of the managers is measured by profit. In other words managers can be expected to words managers can be expected to behave as if they were running their own business. For this reason, the profit centre is good training for general management responsibility .

Measurement of Expenses :

Another problem with profit centers may relate to the measure of certain type of expenses which have to be involved in the computation of profit centres. There is a scope for difference of opinion relating to the treatment of those type of expenses which are not traceable or attributable should be ignored in working out the profit of the division as a profit centre.

Transfer of Prices :

A transfer price is a price used to measure the value of goods and services furnished by a profit centre to other responsibility centers within a company. In other words, when internal exchange of goods and services takes place between the different divisions of a firm, they have to be expressed in monetary terms. The monetary amount for these interdivisional exchange transfers is called the transfer prices. The measurement of profit in a profit centre type or responsibility accounting is also complicated by the problem of transfer prices. The implication of the transfer price is that for the selling division it will be a source of revenue, where as for the buying division (the division which is receiving, acquiring the goods and services) it is an element of cost. It will therefore, have a significant bearing on the revenues, costs therefore, have a significant bearing on the revenues, costs and profits of responsibility centres. Hence, there is a need for correct determination of transfer prices. The determination is, however, complicated because of wide variety of alternative methods are available. They are explained as under

Types of Transfer Price :

There are two general approaches to the determination of a transfer price :

1. Cost based and

1. Market based, Based on these, there are five basic methods of transfer price :

a) Cost b) Cost plus a normal mark-up c) Incremental cost d) Market price, and e) Negotiated price

3. Investment Centres

A centre in which assets employed are also measured besides the measurement of inputs and outputs is called an investment centre. Inputs are accounted for in terms of costs, outputs is calculated on investment centre. Inputs are accounted for in terms of costs, outputs are accounted for interms of revenues and assets employed in terms of values. It is the broadest measurement, in the sense that the performance is measured not only interms of profits but also interms of assets employed to generate profits.

An investment centre differs from a profit centre in that as investment centre is evaluated on the basis of the rate of return earned on the assets invested in the segment while a profit centre is evaluated on the basis of excess revenue over expenses for the period.

4. Revenue centre:-

A responsibility centre is a revenue centre in which manager controls revenues but does not control either the costs of products/services or the level of investment made in the responsibility centre. Revenue centre may control selling price, product mix and promotional activities to enhance revenues. The sales department of a hotel will be a revenue centre because it is responsible only for revenues.

MEASUREMENT OF DIVISIONAL PERFORMANCE

It has been stated earlier that in large companies, particularly those which produce and sell a wide variety of products, it is appropriate to divide the company into separate divisions and all the divisional managers to operate with a great deal of independence. By creating various divisions, a decentralized organization structure will be created and each division will be a responsibility centre. Where divisional manager has authority and responsibility for making capital investment decisions, the division will be a an investment cntre. But where the manager is responsible only for costs and revenues obtained from operations, the division will be a profit centre. In responsibility accounting, the profitability of each responsibility centre is measured. In the fig a divisionalised organization structure is shown, where the company is manufacturing & selling a number of products. For each product a division has been created under the charge of a divisional manager. each division is a responsibility centre of which performance will be separately measured and compared with other responsibility centres for managerial decisions.

Divisional organization structure

A functional organization structure has been shown for each division with separate departments forproduction,purchase, marketing and finance, . these departmental managers will be responsible for activities under their respective functions such a purchase, production etc. it may not be practicable to divisionalise the entire company. These may be certain common functions such as industrial relations, research and development , etc. which will be under the central administration of the corporate head quarters. The chief executive will have the responsibility of providing these central services to all the divisions.

Measurement

The basic objective of responsibility accounting is to measure divisional so as to determine the contribution of each division in the total performance of a company. This provides a basis for evaluation of performance of each division & fixation of responsibilities for various off the mark performances. Various techniques used for measurement of divisional performance are explained below.:-

1. VARIANCE ANALYSIS This is a technique where actual performance is compared with standard or budgeted performance and any variance between the two is analysis to know the causes so that responsibility can be established and corrective action taken. As applied to responsibility accounting, variance analysed should be undertaken for each cost centre and revenue centre to measure the performance of each such responsibility centre.

2 PROFIT

The absolute amount of profit revealed by a profit centre can also be used as a measure to judge its performance. However, this is not considered to be very reliable measure of performance because the costs charged for computing profit may include direct divisional costs plus apportioned fixed overhead. Such allocation beings in the element of subjectivity.

3.RETURN ON INVESTMENT

Instead of considering the absolute size of a division’s profit, most organizations prefer return on investment of a division as a measure of its performance. For example, if division A makes a profit of rs. 200000 and division B makes a profit of rs. 100000 , can it be calculated that division A is more profitable than B? The answer is no because it cannot be said without reference to the amount

of capital invested in each division. ROI expresses divisional profit as a percentage of

firm’s investment in the division. This is calculated as follows:-

ROI = DIVISIONAL PROFIT/DIVISIONAL INVESTMENT * 100

Also, ROI = profit/sales* sales/capital invested*100

Assuming further in above example, the capital invested in division A is Rs. 10 lakhs and that in division B is Rs 4 lakhs, the ROI will be:-

Division A – ROI = 200000/1000000*100 = 20%

Division B- ROI = 100000/400000*100 = 25%

ROI has reversed the conclusion because it proves that performance of division B is better than A as it’s ROI is 25% as compared to 20% of A .

4. RESIDUAL INCOME

Residual income may be defined as the profit of a division less cost of capital charge on the investments used by the division. It is also known as economic value added(eva) method where EVA is profit minus the cost of invested capital in the division.

The rate of interest at which cost of capital is calculated may be notional and not actual and such a rate is specified by the top management. Thus residual income may thus be calculated as follows;-

Residual income= divisional profit-(divisional investment* rate of charge)

Suppose, a division is Rs. 500000 and average capital invested is RS. 20,00,000 in the division for the year. If the cost of capital is 10% , residual income will be calculated as follows;-

Divisional profit 5,00,000Less; cost of capital(20,00,000*10%) 2,00,000 Residual income 3,00,000

Residual income tells how much a division’s profit exceeds its cost of capital.

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