Responsibility Accounting
INTRODUCTION One of the fundamental functions of management accounting is facilitating managerial control. Various devices are used by the management in performing this important function. Responsibility accounting is one of the most recent developments in this field. It has assumed great significance and is rightly described as modern approach to managerial control and reporting. The growth of responsibility accounting is attributed to the realisation that the results of operations must be regarded as human responsibilities and not as abstract concepts. While the other control techniques, available under conventional accounting, are directed towards determining the total and unit product cost for the organisation as a whole, responsibility accounting lays emphasis on performance of individuals where responsibilities are fixed for persons and divisions accountable for the same. The concept of responsibility accounting is closely related to the systems of budgetary control and standard standard costing. According According to Schaltke, R.W. and Johnson, H.G., "the management accounting system that ties budgeting and performance perfor mance reporting to a decentralised organisation is called responsibility accounting."
MEANING AND DEFINITION OF RESPONSIBILITY ACCOUNTING The systems of costing like standard costing and budgetary control are useful to management for controlling the costs. In those systems the emphasis is on the devices of control and not on those who use such devices. Responsibility Accounting is a system of control where responsibility is assigned for the control of costs. The persons are made responsible for the control of costs. Proper authority is given to the persons so that they are able to keep up their performance. In case the performance is not according to the predetermined standards then the persons who are assigned this duty will be personally responsible for it. In responsibility I accounting the emphasis is on men rather than on systems. For example, ifMr. A, the manager of a department, 1 prepares the cost budget of his department, then he will be made responsible for keeping the budgets under control. A will be supplied with full information of costs incurred by his department. In case the costs are more than the budgeted costs, then A will try to find out reasons and take necessary corrective measures. A will be personally responsible for the performance of his department. Charles, T. Horngreen,' "Responsibility accounting is a system of accounting that recognizes various responsibility centres throughout the organisation and reflects the plans and actions of each of these centres by assigning particular revenues and costs to the one having the pertinent responsibility. It is also called profitability accounting and activity accounting". According to this definition, the organisation is divided into various responsibility centres and each centre is responsible for its costs. The performance of each responsibility centre is regularly measured. Anthony and Reece\ "Responsibility accounting is that type of management accounting that collects and reports both planned actual accounting information in terms of responsibility centres". The emphasis in this definition is on setting the
objectives of responsibility centres and then recording the actual performance so that the persons incharge of various activities are able to assess their performance. Institute of Cost and Works Accountants of India. 3 Responsibility accounting is "a system o! management accounting under which accountability is established according to the responsibility delegated t< various levels of management and a management information and reporting system instituted to give adequat feedback in terms of the delegated responsibility. Under this system divisions or units of an organisation und« a specified authority in a person are developed as responsibility centres and evaluated individually for the performance." According to this definition the organisation is divided into different cost centres. These cost centn are put under certain persons and adequate authority is delegated to them for completing the work assigned them. A system of management reporting is used to assess the performance of cost centres. Kohler E.L.4 It is "the classification, management, maintenance, review and appraisal of accoui serving the purpose of providing information on the quality, quantity and standards of performance attain by persons to whom authority has been assigned." Responsibility accounting, according, to Kohler, is I maintaining of accounts in such a way that the performance and level of achievement of various pers< responsible for different works is studied". "Responsibility accounting is the name given to that aspect of managerial process dealing with the reporting of information to facilitate control of operations and evalual of performance." Charles T. Horngren. "Responsibility accounting is a system of accounting that recognises vari decision centres throughout an organisation and traces costs to the individual managers who are primj responsible for making decisions about the costs in question."
Schaltke, R.W. & Jonson, H. G7. Responsibility accounting "is a system of accounting in which c and revenues are accumulated and reported to managers on the basis of the manager's control over these ( and revenues. The managerial accounting system that ties budgeting and performance reporting to a decentra organisation is called responsibility accounting." This is a system of accounting in which cost data are reported to managers who are in-charge of var: cost centres. In this system, budgets are prepared and actual performance is recorded and reported. According to this definition, responsibility accounting is used as a controlling device by top management for controlling the performance of other executives. The executives' decisions are judged on the basis of their performance and they are made responsible for the outcome of their actions. Responsibility accounting focusses main attention on responsibility centres. The managers of different activity centres are responsible for controlling the costs of their centres. Information about costs incurred for different activities is supplied to the persons incharge of various centres. The performance is constantly compared to the standards set and this process is very useful in exercising cost controls. Responsibility accounting is different from cost accounting in the sense that the future lays emphasis on cost control whereas the latter lays emphasis on cost ascertainment.
FUNDAMENTAL ASPECTS OR ESSENTIAL FEATURES OF RESPONSIBILITY ACCOUNTING An analysis of the definitions given above reveals the following important features or fundamental aspects of responsibility accounting : Inputs and Outputs or Costs and Revenues The implementation and maintenance of responsibility accounting system is based upon information relating to inputs and outputs. The physical resources utilised in an organisation; such as quantity of raw material used and labour hours consumed, are termed as inputs. These inputs expressed in the monetary terms are known as costs. Similarly outputs expressed in monetary terms are called revenues. Thus, responsibility accounting is based on cost and revenue information. Planned and Actual Information or Use of Budgeting. Effective responsibility accounting requires both planned and actual financial information. It is not only the historical cost and revenue data but also the planned future data which is essential for the implementation of responsibility accounting system. It is through budgets that responsibility for implementing the plans is communicated to each level of management. The use of fixed budgets, flexible budgets and profit planning are all incorporated into one overall system of responsibility accounting. Identification of Responsibility Centres. The whole concept of responsibility accounting is focused around identification of responsibility centres. The responsibility centres represent the sphere of authority or decision points in an organisation. In a small firm, one individual or a small group of individuals, who are usually the owners, may possibly manage or control the entire organisation. However, for effective control, a large firm is, usually, divided into meaningful segments, departments or divisions. These sub-units or divisions of organisation are called responsibility centres. A
responsibility centre is under the control of an individual who is responsible for the control of activities of that sub-unit of the organisation. This responsibility centre may be a very small sub-unit of the organisation, as an individual could be made responsible for one Relationship between Organisation Structure and Responsibility Accounting System. A sound [ organisation structure with clear-cut lines of authority— responsibility relationships is a prerequisite for [ estabilishing a successful responsibility accounting system. Further, responsibility accounting system must be so designed as to suit the organisation structure of the organisation. It must be founded upon the existing authority- responsibility relationships in the organisation. In fact, responsibility accounting system should parallel the organisation structure and provide financial information to evaluate actual results of each individual responsible for a function.
Assigning Costs to Individuals and Limiting their Efforts to Controllable Costs. Aftt identifying responsibility centres and estabilishing authority-responsibility relationships, responsibili! accounting system involves assigning of costs and revenues to individuals. Only those costs and revenui over which an individual has a definite control can be assigned to him for evaluating his performanc Responsibility accounting has an apeal because it distinguishes between controllable and uncontrollable cosl Unlike traditional accounting where costs are classified and accumulated according to function such manufacturing cost or selling and distribution cost, etc. or according to products, responsibility accountii classifies accumulated costs according to controllability. 'Controllable costs' are those costs which can controlled or influenced by a
specified person or a level of management of an undertaking. Costs which canr be so controlled or influenced by the action of a specified individual of an undertaking are known 'uncontrollable costs'. The difference in controllable and uncontrollable costs may only be in relation t< particular person or level of management. The following guidelines recommended by the Committee of I American Accounting Association in regard to assigning of costs may be followed : If the person has authority over both the acquisition and use of the services, he should be charged \» the cost of these services. If the person can significantly influence the amount of cost through his own action, he may be char] with such costs. Even if the person cannot significantly influence the amount of cost through his own direct action, he may be charged with those elements with which the management desires him to be concerned, so that he will help to influence those who are responsible. Performance Reporting. As stated earlier, responsibility account is a control device. A control system to be effective should be such that deviations from the plans must be reported at the earliest so as to take corrective action for the future. The deviations can be known only when performance is reported. Thus, responsibility accounting system is focussed on performance reports also known as 'responsibility reports', prepared for each responsibility unit. Unlike authority which flows from top to bottom, reporting flows from bottom to top. These reports should be addressed to appropriate persons in respective responsibility centres. The j reports should contain information in comparative form as to show plans (budgets) and the actual performance I and should give details of variances which are related to that centre. The variances which are not controllable ataparticular responsibility centre should also be mentioned separately in the report. To be effective, the reports
[should be clear and simple. Use of diagrams, charts, illustrations, graphs and tables may be made to make them [ attractive and easily understandable. A specimen of a performance report is given below Management by Exception. It is a well accepted fact that at successive higher levels of managei in the organisational chain less and less time is devoted to control and more and more to planning. Thus effective responsibility accounting system must provide for management by exception, i.e., it should f attention of the management on significant deviations and not burden them with all kinds of routine ma rather condensed reports requiring their attention must be sent to them particularly at higher leve management. The following diagram explains the flow and reporting details at different levels of manager! Human Aspect of Responsibility Accounting. "The aim of responsibility accounting is not to place blame. Instead it is to evaluate the performance and provide feed back so that future operations can be improved'. Goals and objectives are achieved through people and, hence, responsibility accounting system should motivate people. It should be used in positive sense. It should not be taken as a device to punish subordinates. It should rather help in improving their performance. Subordinates sometimes dislike control because they take them as restraints. The best responsibility accounting system enlightens employees about the positive side of control. To ensure the success of responsibility accounting system, it must look into the human aspect also by considering needs of subordinates, developing mutual interests, providing information about control measures and adjusting according to requirements.
STEPS INVOLVED IN RESPONSIBILITY ACCOUNTING Responsibility accounting is used as a control device. The aim of responsibility accounting is to help management in achieving organisational goals. The following steps are involved in responsibility accounting : The organisation is divided into various responsibility centres. Each responsibility centre is put under the charge of a responsibility manager. The mangers are responsible for the performance of their departments. The targets of each responsibility centre are set in. The targets or goals are set in consultation with the manager of the responsibility centre so that he may be able to give full information about his department. The goals of the responsibility centres are properly communicated to them. The actual performance of each responsibility centre is recorded and communicated to the executive concerned and the actual performance is compared with goals set and it helps in assessing the work of these centres. If the actual performance of a department is less than the standard set, then the variances are conveyed to the top management. The names of those persons who were responsible for that performance are also conveyed so that responsibility may be fixed. Timely action is taken to take necessary corrective measures so that the work does not suffer in future. The directions of the top level management are communicated to the concerned responsibility centre so that corrective measures are initiated at the earliest.
RESPONSIBILITY CENTRES "A responsibility Centre is like an engine in that it has inputs, which are physical quantities of material, hours of various types of labour, and a variety of services ; it works with these resources usually ; working capital and fixed assets are also required. As a result of this work, it produces output, which are classified either as goods, if they are tangible or as services, if they are intangible. These goods or services go either to other responsibility centres within the company or to customers in the outside world"9. Responsibility accounting is used to measure both inputs and outputs. The inputs of materials in quantity and labour in hours are expressed in monetary terms. The total of various inputs is called 'cost'. The output can be expressed either in goods produced or services rendered. If the output is meant for outsiders, then it is easy to measure the monetary value of the output but if the output is used for other departments of the centre, then it will have to be valued objectively. The total of output is called 'revenue'. So responsibility accounting is used in measuring costs and revenues. The responsibility centres represent the sphere of authority or decision points in an organisation. For effective control, a large firm is usually divided into meaningful segments, deprartments or divisions. These sub-units or divisions of an organisation unit are called responsibility centres. In the words of Deakin and Maher, "a responsibility centre is a specific unit of an organisation assigned to a manager who is held responsible for its operations and resources." □
TYPES OF RESPONSIBILITY CENTRES For the purposes of evaluating financial performance and control, the responsibility centres are generally classified into three categories :
Cost or Expense Centres "Cost centres are segments in which the managers are responsible for costs incurred but have no revenui responsibilities." As observed earlier, responsibility accounting is used to measure both inputs and outputs However, when we can measure only the expenses or costs incurred and not the revenue earned from responsibility centre, it is known as cost or Expense Centre. The contribution of accounting department to the company cannot be measured in monetary terms; s we will call it an expense centre. Generally, a company has production and service departments. The outputc production departments can be measured whereas service departments incur only expenses and their output not measured. It may not be either feasible or necessary to measure the output of some service departments. Sue centres are, therefore, called expense cost centres. The performance of a cost centre is measured in terms of quantity of inputs used in producing a givf output. A comparison between the actual input used and the predetermined budgeted inputs is made determine the variances which represent the efficiency of the cost centre.
Profit Centres. Responsibility Centres may have both inputs and outputs. The inputs are taken as costs and outputs a revenues. The difference between the revenue earned and costs incurred will be profit. When a responsibili centre gets revenue from output, it will be called a profit Centre. The output of a centre may be undertaken eitr for outside consumers or for other centres in the same organisation. When the output is meant for outsiders, th the revenue will be measured from the price charged from customers. If the output is meant for otl responsibility centre, then management takes a decision whether to treat the centre as profit centre or not. I example, if a business has a number of processes and the output of one process is transferred to the next proce When the transfer from one process to another is only on cost, then these processes will not be profit centi On the other hand, if management decides to transfer the output from one process to the other at a profit (o a price at which the output is available in the market), then the process will become profit centre. Inter transfers at profit do not increase company's assets whereas sales to outsiders will increase assets of company (in the shape of Cash, Debtors, Bills receivables, etc.) The income statement of a profit centre is u as a control device. The profits of a responsibility centre will enable in evaluating the performance of manager of that centre.
Investment Centres. "An investment centre is an entrty segment in which a manager can control not only revenues and c but also investment."10 The manager of a responsibility centre is made responsible for properly utilising the assets used ir centre. He is expected to earn a fair return on the amount employed in assets in his centre. Measuremer
TRANSFER PRICES "A transfer price is a price used to measure the price of goods or services furnished by a profit centre to other responsibility centres within a company." As observed earlier, the evaluation of managerial performance within the company through profit centres is impossible without determining transfer prices in case various profit centres of the company exchange goods and services. In such situations, there is a need to determine the monetary values, called transfer price, at which the transfer should take place so that costs and revenues could be properly assigned. The implication of the transfer price is that for the transfering division/centre it will be a source of revenue, whereas for the division to which transfer is made it will be an element of cost. Thus, there is a need to determine proper transfer price for the successful implementation of responsibility accounting. There are various transfer pricing methods in use. These methods are generally based on either (a) cost, or (b) market price. The following are the important types or methods of intracompany transfer price : Cost Price Cost Plus a Normal Mark-up. Incremental Cost Shared Profit Relative to the Cost Market Price Standard Price Negotiated Price. Dual or Two-way Price.
Cost Price. According to this method, goods and services are transfered from one segment of the company to another on the basis of unit cost of production of the transferring division. The cost could either be taken to be the actual cost of production or the standard cost of production. The advantage of this method of transfer pricing is that it is very simple and convenient to operate. But, it distorts the profit figures of the various responsibility centres in the sense that the profit of the transfering centre shall be understimated and that of the centre to which transfer is made would be over estimated. In fact, this method of transfer pricing is inappropriate for profit centre analysis.
Cost Plus a Normal Mark-up. To overcome the shortcomings of the simple cost price method, many companies add to the cost a margin of profit, say 15% of the cost, to determine the transfer price. Thus, in this method, the buying division is charged the actual unit cost of production of the transfering department, whatsoever it may be, plus a mark up for the profit. The merit of this method is again simplicity and convenience ; but this method is also not an appropriate method for profit centre analysis as the inefficiencies of one department alongwith their costs are transfered to another department.
Incremental Cost. Another method of transfer pricing in use by certain companies is the incremental ' cost of the transfering division. Incremental cost can be computed in two ways depending upon the circumstances. In case entire production is transfered to another division within the same company, the incremental cost will be the total of variable cost of transfering centre plus any fixed costs which are directly attributable to that centre/division. The incremental cost so calculated suffers from the same defects as that of cost price method. The second approach may be used when goods and services are sold to outside customers as well as transfered within the same company. In such a case, incremental cost may be taken as the opportunity cost in the form of loss of revenue which the transfering division would have charged from the outside customers. The second approach is similar to the market price basis and is more useful for profit-centre analysis.
Shared Profit Relative to the Cost According to this method no price is charged for the intra company transfers. Rather out of the total sales revenue of the company the aggreegate cost of various divisions is deducted to find out the profit for the company as a whole; and then the profit is shared by the various profit centres relative to the cost basis of each centre Thus, in this method profit is shared according to the cost of each division. The drawback of this methoi is that inefficiencies are not evaluated, and hence, it is not an approproate method for profit centre analysis
Market Price. In this method, the prices charged for intracompany transfers are determined c the basis of market price and not on the cost basis. There are three ways of computing the market price. Firstl the prevailing market price, after making adjustment for discounts and other selling costs, may be taken transfer price if there is an active market for goods and services transfered between divisions of the sar company. The main advantage of this method is that it protects the profitability interest of both the divisic as the buying division is charged what it has to otherwise pay to the outsiders, and the transfering divisi gets the price which, in any case, it would have obtained from outsiders. Further, selling and distribution cc as well as costs of bad debts are reduced and the transfering department gets an assured market, whereas, buying division is assured of regular and timely deliveries. Secondly, where active market-does not exis where market price is not available, cost plus a normal profit may be taken as a reasonable market price. I then, inefficiencies of one division will be transferred to another division. Thirdly, the company could in bids from the market so as to determine the market price. The lowest bid may be accepted as the market p for the transfer. However, the problem may arise because of false bidding or no bidding at all.
Standard Price. Transfer prices can also be fixed on predetermined standard price basis. standard price may be determined on the basis of cost of production and the prevailing market conditi Thus, division working at less than the desired efficiency will show lesser profits as compared to the effn divisions. However, difficulties may arise in fixing the standard price agreeable to the different divisi
Negotiated Price. The intra-company transfer price can also be determined on the bas negotiations between the buying and the transferring division. The price arived at after negotiations w the mutually agreed price. Such a pricing method will be advantageous to both the divisions as well; company as a whole. However, this method could be used only when both the buying as well as transfi divisions have alternative choices available with them.
Dual or Two-way Price. According to this method, the transfering division is allowed to give at one price, whereas, the buying division is charged at a different price. It enables better evaluation of centres and avoids conflict among them on account of transfer prices. However, the total profits of the v segments would differ from the actual profit of the company as a whole. But, it poses no problems 1 company as transfer prices are meant for internal purposes of performance evaluation only.
SELECTION OF TRANSFER PRICING METHOD The study of the various transfer pricing methods reveals that there is no particular method whicl be termed as the best method for all situations. The selection of a particular method will depend u| particular circumstances which may differ from case to case. However, the following general criteria be kept in mind while determining the transfer price : the transfer price should be objectively determinable. the transfer price should compensate the transferring division and charge the buying i comensurate with the value of the goods/services exchanged ; it should contribute to congruence between the goals of the divisions and the goals of the organisation ; it should provide for profit centre evaluation ; and it should maximise the efforts towards achievement of organisational goals.
ADVANTAGES OF RESPONSIBILITY ACCOUNTING Management uses responsibility accounting as a control device. It is used to evaluate the performance of executives who are incharge of various cost centres. Their performance is compared to the targets set for them and proper action is taken for low results. So responsibility accounting is very important in every type of business. The following are some of the advantages of responsibility accounting : Assigning of Responsibility. Each and every individual in the organisation is assigned some responsibility and they are accountable for their work. Every body knows what is expected of him. The responsibility can easily be identified and satisfactory and unsatisfactory performances of various persons are known. Nobody can shift responsibility to any body else if something goes wrong. So, under this system responsibility is assigned individually. Improves Performance. The assigning of tasks to specific persons acts as a motivational factor too. The persons incharge for different activities know that their performance will be reported to the top management. They will try to improve their performance. On the other hand, it acts as a deterrent for low performance also because persons know that they are accountable for their work and they will have to explain for their low performance. Helpful in Cost Planning. Under the system of responsibility accounting, full information is collected about costs and revenues. This data is helpful in planning of future costs and revenues, fixing of standards and preparing of budgets. Delegation and Control. This system enables management to delegate authority while retaining overall control. The authority is delegated according to the requirements of the task assigned. On the other hand, responsibility of various persons is fixed which is helpful in controlling their work. The control remain: with top management because performance of every cost centre
is regularly reported to it. So management i able to delegate authority and at the same time to retain control. Helpful in Decision-Making. Responsibility accounting is not only a control device but also helpful in decision-making. The information collected under this system is helpful to management in planning its future actions. The past performance of various cost centres also helps in fixing their future targets. So this system enables management to take important decisions.
Illustration A Company has 10 cars in operation. The budget for the transport department based on 25,000 km of run for a month is Rs. 87,500 out of which a sum of Rs. 25,000 is fixed. During the last month, the total kilometres run by all the 10 cars were 22,400 and the costs incurred were Rs. 83,150. The cost of hiring a car would have been Rs. 4 per km. Evaluate the performance of the transport department on the basis of (a) Cost Centre, (b) Profit Centre.
