Responsibility Accounting

Responsibility accounting involves accumulating and reporting costs on the basis of individual manager who has authority to make day-to-day decisions. Under responsibility accounting the evaluation of manager’s performance is based only on matters directly under the manager’s control. It is also called as profitability accounting.

In this system, accountability is established based on the responsibility delegated to various levels of management, and they are held accountable for providing adequate feedback in accordance with the delegated responsibility. The main notion underlying responsibility accounting is that each manager’s success should be measured by how he or she handles those things and only those items within his/her authority.

The greatest strategy to inspire managers to attain the required level of performance is to assess their performance in contrast to budgeted outcomes. Periodic comparisons of the actual costs, revenues and investments with the budgeted costs, revenues and investments relating to individual managers can help management in ascertaining their performance.

Essential Features of Responsibility Accounting:

• Information for both production and input of resources, i.e., based on cost and income data for financial information.
• Information about planned and actual performance.
• Identification of responsibility centre.
• Transfer pricing policy.
• Performance reporting
• To report reasons for deviation from original plan and to what extent.

Advantages of Responsibility Accounting: (i) Establishes a sound control system by allowing top management to delegate authority to responsibility centers while maintaining overall control.

(ii) It forces the management to consider the organisational structure to result in effective delegation of authority and placement of responsibility. It will be difficult for individual manager to pass back unfavorable results. Thus, it facilitates decentralisation of decision making.

(iii) It encourages budgeting for comparison of actual achievements with the budgeted figures. It compels management to set realistic budget.

(iv) It increases interest and awareness among the supervisory staff as they are called upon to explain about the deviations for which they are responsible.

(v) It simplifies the structure of reports and facilitates the prompt reporting because of exclusion of those items which are beyond the scope of individual responsibility.

(vi) It is helpful in following management by exception because emphasis is laid on reporting exceptional matters to top management and consequently top management is not burdened with all kinds of routine matters.

Features of Responsibility Accounting:

The main feature of responsibility accounting is to define the cost centers at the initial stage which we earlier referred to as responsibility centers.

For each center, there should be a fixed target which the department has to achieve in the defined deadline, so setting targets for the center is very crucial.

Then, we must track the performance of each responsibility center and also compare the actual performance with the target performance.

The variance between the actual performance and target performance is analyzed and post that the responsibility of each center should be fixed.

Then corrective action has to be taken by the management and it should be individually communicated to the concerned person taking care of the responsibility center.

Characteristics:

(i) Requirements of recipient. First point in the direction is to focus the attention on the requirements of the recipient of report.

(ii) Reporting in conformity with organised chart. This is essential to promote accountability and discipline. There should be individual report for each organisation level.

(iii) Number of reports would be kept to a minimum because a number of reports breed confusion, duplicity of efforts and uncalled for wastage.

(iv) Reports should be made timely, i.e., daily, weekly or monthly depending on the need of the management.

(v) Reports should be designed to motivate manager to initiate connective action.

(vi) Reports should pinpoint responsibility.

(vii) Reports should be standardized as far as possible. Style of presentation should be consistent. Conventional form, size and paper should be used as far as possible.

(viii) Facts should be stated concisely and in logical manner.

(ix) Comparison ratio and trend should be shown.

(x) Reporting should be based on management by exception principle.

(xi) Duplication of contents should be avoided and variances should be shown as favourable or adverse.

(xii) Reports should be revised when conditions warrant special report should be made if there is need for the same.

(xiii) Visual presentation is more effective and communicative and these aids should be extensively used.

(xiv) The distribution of reports should be properly controlled.

Types of Responsibility Centres:

The following are the main types of responsibility centres for management control purposes:

(i) Cost (or Expense) Centres: These are segments in which managers are responsible for costs incurred but have no revenue responsibilities. The performance of each cost centre is evaluated by comparing the actual amount with the budgeted/standard amount. Such centres may be made according to location or person or service or type of product.

It is essential to differentiate between controllable costs and uncontrollable costs while judging the performance of such centres. A manager responsible for a particular cost centre will be held responsible for only controllable costs.

(ii) Revenue Centres: It is a centre mainly devoted to raising revenue with no responsibility for production. The main responsibility of managers of such centres is to generate sale revenue. Such managers have nothing to do with the cost of manufacturing a product or in the area of investment of assets. But he is concerned with control of marketing expenses of the product.

(iii) Profit Centre: This is a centre whose performance is measured in terms of both expenses it incurs and revenue it earns. Thus, a factory may constitute a separate profit centre and sell its production to other departments or the sales department. Even within the factory, the service departments (as maintenance department) may sell their services to the production department.

This is the practice in large undertakings where each divisional manager is given a profit objective and his performance is measured accordingly. The main problem in designing control system on the basis of profit centre arises in fixing transfer pricing.

(iv) Contribution Centre: It is a centre whose performance is mainly measured by the contribution it earns. Contribution is the difference between sales and variable costs. It is a centre devoted to increasing contribution. The main responsibility of the manager of such a responsibility centre is to increase contribution. Higher the contribution, better will be the performance of the manager of a contribution centre.

A manager has no control on fixed expenses because these expenses are constant and depend on policy decisions of the higher level of ‘management. He can control contribution by increasing sales and by reducing variable costs. The manger of such a centre is to see that his unit operates at full capacity and contribution is maximum.

(v) Investment Centre: It is a centre in which a manager can control not only revenues and costs but also investments. The manager of such a centre is made responsible for properly utilising the assets used in his centre. He is expected to earn a requisite return on the amount employed in assets in his centre. Return on investments is used as a basis of judging and evaluating performance of various people. Many large undertakings in the U.S.A. like General Motors etc. follow this system of management control.

In calculating return on investments, beginning-of-period investment, end of period investment or average investment may be taken. However, the choice seems to be between beginning-of-period investment arid average investment. Divisional investment is equal to net fixed assets of the division + current assets of the division – current liabilities of the division.

Return on Investment (ROI) = Net Profit of the Division/Investment of the Division x 100

As an alternative to return on investment, the performance of the responsibility centre can be measured by another method known as residual income method. Under this method a charge for the use of assets (i.e., cost of capital) is deducted from the divisional or responsibility’s centre profit and the surplus remaining after the deduction of cost of capital or imputed interest is the residual income. Residual income method is favoured in those cases where managers of responsibility centres are autonomous and accountable for their performances and make their own investment decisions.