Acctg 205: Management Science

Responsibility
Accounting
 1. Responsibility Accounting
and Decentralization
Definitions, Key Concepts, Advantages and Disadvantages,

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 Responsibility
Accounting

□ Responsibility accounting is a system of accounting

wherein costs and revenues are accumulated and
reported by levels of responsibility or by responsibility
centers within the organization.

□ Responsibility accounting system is designed primarily

for cost control and performance evaluation.

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 Key Concepts
Authority
The power to direct and
exact performance from
others, particularly the
subordinate, including the
right to prescribe the means
and methods by which work
must be done.
Responsibility
Refers to the obligation to
perform.
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Accountability
The duty to report
performance to one’s
superior and the physical
means for reporting or being
able to substantiate
performance.
Controllability
The extent to which a
manager can influence
activities, cost, revenues,
or capital.
Management by
Objectives
(MBO)
A behavioral,
communications-
oriented, responsibility
approach where a
manager and his/her
subordinates agree upon
objectives and the means
on how such objectives
can be attained.
 Decentralization

□ Decentralization refers to the separation or division of

the organization into more manageable units wherein
each unit is managed by an individual who is given
decision authority and held accountable for his
decisions or by responsibility centers within the
organization.
□ A responsibility accounting system works best in a
decentralized organization.

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 Decentralization
Advantages Disadvantages
 Greater awareness of needs of the  Negative effect of some decisions
people involved in the subunit made in one subunit to the other
 More timely decisions subunits or to the organization as
a whole
 Faster management development
 Cost of gathering and reporting
 Greater initiative on the part of data increases
the management, as well as on the
subordinate  Job duplication and overlapping
of duties
 Improvement of employee’s
morale
 Sharper management focus
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 Key Concepts

Goal Congruence Sub-Optimization

All units of organization have
incentives to perform for a common
interest. The purpose of responsibility
system is to motivate management
performance that adheres to company
overall objectives.
This happens when one division of
a company takes action that is in its
own best interests but is
detrimental to the firm as a whole.

Aside from its control function, responsibility accounting is designed to

achieve goal congruence and to discourage sub-optimization within an
organization.

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 2. Responsibility Centers and
Performance Measures
Types of responsibility centers and their respective performance measures

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 Responsibility Centers

Responsibility center is a segment of an entity engaged in performing a single

function or a group of related functions and is usually governed by a manager,
who is accountable and responsible for the activities of the segment.

Cost Center Revenue Profit Center Investment

Managers are Center Managers are Center
held responsible Managers are held responsible Managers are
for the costs held responsibe for both revenues hed responsibe
incurred by the primarily for and costs. for both
segment. revenues of the revenues, costs
segment. and investments.

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 Responsibility Typical financial responsibility centers in a divisionalized organization

Centers President
(IC)

Administrative and
Group Group
Financial
Vice President Vice President
Vice Presidents
(IC) (IC)
(CC)

Division Division Division Division

Manager Manager Manager Manager
(PC) (PC) (PC) (PC)

Other
Marketing
Functional
Manager
Managers Source: K. A. Merchant, Modern Management Control Systems: Text and Cases (Upper Saddle
(RC)
(CC) River, NJ: Prentice Hall, 1998), p. 309.

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 Performance
Evaluation
Variance Variance
Analysis Analysis
Cost Revenue
Center Center

Profit Investment
Center Center
Variance • ROI
Analysis • RI
• EVA

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 Performance
Evaluation

= Operating Income ÷ Operating Assets

Return on = Margin x Turnover
investment (ROI) Where: Margin = Operating Income ÷ Sales
Turnover = Sales ÷ Operating Assets

Residual Income = Operating Income - Required Income

(RI) Where: Required Income = Operating Assets x Minimum ROI

Economic Value = Operating Income after tax - Required Income

Where: Required Income = (Total Assets – Current Liabilities) x
Added (EVA) WACC

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 ROI vs. RI
Coca-Cola Company has an opportunity to invest $100,000 in a project
that will earn $25,000. Coca-Cola Company has a 20 percent desired ROI
and a 30 percent ROI on existing business.
a) As a manager of Coca-Cola Company, would you invest the $100,000,
if you were evaluated using residual income?
Yes, the project’s return of 25% exceeds 20% and the residual income is P50,000.
b) Would your decision be different if your bonus was based on your
division’s ROI (i.e., the higher your ROI, the bigger your bonus)?
I will not accept the project because it will decrease the overall business’s ROI.
Residual income encourages managers to make profitable investments that
would be rejected by managers using ROI.

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 Performance
Evaluation Sales xx
Less variable manufacturing costs (xx)
Manufacturing contribution margin xx
Managerial performance
Less variable non-manufacturing costs (xx)
should be evaluated on
the basis of those factors Contribution margin xx
controllable by the Less controllable fixed costs (xx)
manager being evaluated. Short-run performance margin xx
To achieve this, it is best Less direct, non-controllable fixed costs (xx)
to use the contribution Segment margin xx
approach to performance Less common costs allocated to segment (xx)
measurement. Operating income xx

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 Control
□ Generally, all costs are controllable. The key difference
lies in the level of management who can control the
costs.
□ Controllable costs are costs which may be directly
regulated at a given level of managerial authority.
□ Controllable costs are direct costs (i.e., costs attributable
to a particular segment) but not all direct costs are
controllable costs.
□ Indirect costs (i.e., costs common to a number of
segment) are always non-controllable.

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 3. Transfer Pricing
Methods, Minimum and Maximum Transfer Price, Considerations

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 Transfer Pricing

Transfer price is the Selling Buying

amount charged by one
segment of the
organization for
Division
X
? Division
Y
goods/services
transferred/provided to
another segment of the
same organization. Transfer price directly affects the
revenue of the selling division and
the cost of the buying division.

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 Methods

• Market is perfectly competitive • Useful when market

• Transfer price may be prices are unavailable,
market price (regular selling inappropriate or too
price) or modified market Market- Cost- costly to obtain
price (selling price • May be based on full
adjusted for allowance
Based Based cost or variable cost,
for discounts) plus some mark-up

• Often used when market • Using two separate

prices are volatile Negotiated Dual transfer-pricing methods
• Represent the outcome e.g., selling division will
of a bargaining process
Transfer Transfer record sale at market
• May or may not bear Pricing Pricing price, and buying division
any resemblance to will record purchase at
cost or market data variable cost

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 Minimum and
Maximum
= Incremental cost + Opportunity cost
• Incremental cost is the additional cost of producing and transferring the
Minimum product or service
• Opportunity cost is the maximum contribution margin foregone by the
Transfer Price selling subunit of the product or service is transferred internally
(Seller’s POV) • When a company segment is operating at full capacity, the lost CM per
unit on outside sales is the opportunity cost of transferring products to
another company segment.

Maximum = Prevailing market price

• Strictly speaking, the maximum transfer price is the higher amount of:
Transfer Price • Cost of buying from outside suppliers, OR
(Buyer’s POV) • Selling price to outside customers

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 Transfer Pricing
Considerations

Goal Segmental Cost Capacity

Congruence Performance Structure Does the seller
Will transfer Will the transfer What portions have excess
price promote price promote of production capacity to
the goals of the the interest of costs are accommodate
company as a the segment variable or further inter-
whole? under the fixed, direct of segment
manager’s indirect? transfer?
responsibility?

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 Illustration

Central Lumber Corp. has a Raw Lumber Division and a

Finished Lumber Division. The variable costs are:
□ Raw Lumber Division: P100 per 100 board feet of raw
lumber
□ Finished Lumber Division: P125 per 100 board feet of
finished lumber
Raw Lumber can be sold at P200 per 100 board feet.
Finished lumber can be sold at P275 per 100 board feet.

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 Illustration
a) Should Central Lumber process raw lumber into its finished form?

Sell as raw lumber for P200 Sell as finished lumber for P275
Revenue P200 Revenue P275
Variable costs (100) Variable costs:
Contribution margin P100 Raw Lumber Div. P100
Finished Lumber Div. P125 (225)
Contribution margin P50

It would be more profitable for Central Lumber Corp. to sell raw lumber .

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 Illustration Sell as Sell as
_____
Raw Finished
b) Assume that internal Raw Lumber Division:
transfers are made at Revenues P200 P110
110% of variable. Will
Variable costs (100) (100)
each division maximize
Contribution margin P100 P10
its division operating
income contribution by Finished Lumber Division:
adopting the action Revenues P0 P275
that is in the best Transferred-in costs - (110)
interests of Central __-
Variable costs (125)
Lumber Corp.?
Contribution margin P0 P40

Finished Lumber Division will maximize operating income by selling finished

lumber which is NOT the best interest of the Company.
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 Illustration Sell as Sell as
_____
Raw Finished
c) Assume that internal Raw Lumber Division:
transfers are made at Revenues P200 P200
market prices. Will
Variable costs (100) (100)
each division maximize
Contribution margin P100 P100
its division operating
income contribution by Finished Lumber Division:
adopting the action Revenues P0 P275
that is in the best Transferred-in costs - (200)
interests of Central Variable costs __- (125)
Lumber Corp.?
Contribution margin P0 P(50)

Both divisions will maximize operating income by selling raw lumber which is also
the best interest of the Company. There is goal congruence.
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 4. Balance Scorecard
Definition, Perspectives, Operating Measures

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 Balanced Scorecard

□ A goal congruence tool or a performance

measurement system that strikes a balance
between financial and operating Customer
Financial
performance measures, links performance
to rewards, and gives explicit recognition to
the diversity of interest of stakeholders.
Learning
□ The balanced scorecard translates an Internal
and
organization’s mission and strategy into Business
Growth
operation objectives and performance
measures for four different perspectives.

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 Perspectives

Financial
• Describes the economic
consequences of actions taken
in the other three
perspectives.
• The customer perspective has
three strategic themes: (1)
revenue growth, (2) cost
reduction, and (3) asset
utilization
Customer
• Source of revenue component
for the financial objectives
• Identifies and defines the
customer and market segments
in which the firm will compete.

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 Perspectives
Internal Business Process
• Describes the internal process
that will provide value for the
firm’s customers and owners.
• Process value chain is made up
of three processes: (1)
innovation, (2) operations, and
(3) after-sales.
• Delivery time, throughput
(manufacturing cycle) time,
manufacturing cycle efficiency
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Learning and Growth
• Identifies and defines the
capabilities that an organization
needs to create long-term growth
and improvement
• Three major objectives: (1)
increasing employee capabilities,
(2) increasing motivation,
e0mpowerment, and alignment;
(3) and increasing information
systems capabilities.
 Operating Measures

□ Delivery Cycle Time is the total elapsed

time between when an order is placed by a
customer and when it is shipped to the
customer. Part of this time is wait time
that occurs before the order is placed into
production. The remainder od this time is
the throughput time, defined below.

□ Throughput (Manufacturing Cycle) Time is the total elapsed time between when an
order is placed into production and when it is shipped to a customer. It consists of
process time process time, inspection time inspection time, move time, and queue
time. The only element that adds value is processing time. Inspection, move time, and
queue time, and their associated activities do not add value and should be minimized.

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 Operating Measures
Illustration:
A company has the following average time
figures were recorded as follows:
□ Manufacturing Cycle Efficiency is the
ratio of value-added time (i.e., process Wait time 5 days
time) to total throughput time. It Process time 20 days
represents the percentage of time an
order is in production in which useful Inspection time 2 days
work is being done. The rest of the time Move time 1 day
represents non-value-added time (i.e.,
inspection time, move time, and queue Queue time 6 days
time).
Delivery Cycle = 5+20+1+6 = 34 days
𝑉𝑎𝑙𝑢𝑒 𝑎𝑑𝑑𝑒𝑑 𝑡𝑖𝑚𝑒 𝑜𝑟 𝑃𝑟𝑜𝑐𝑒𝑠𝑠 𝑇𝑖𝑚𝑒
𝑴𝑪𝑬 = Throughput = 20+2+1+6 = 29 days
𝑇ℎ𝑟𝑜𝑢𝑔ℎ𝑝𝑢𝑡 (𝑀𝑎𝑛𝑢𝑓𝑎𝑐𝑢𝑟𝑖𝑛𝑔 𝐶𝑦𝑐𝑙𝑒) 𝑇𝑖𝑚𝑒
MCE = 20/29 = 68.97%

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