Chapter 10 : Responsible Accounting

Chapter 10
Responsibility Accounting

TABLE OF CONTENTS
• Summary
• Understand the meaning and essential and features of responsibility
accounting.
• Steps involved in responsibility accounting.
• Responsibility centres-cost ,profit and investment centres.
• Transfer prices.
• Advantages of responsibility accounting

SUMMARY
Responsibility accounting is a system of dividing an organization into
similar units, each of which is to be assigned particular responsibilities.
These units may be in the form of divisions, segments, departments,
branches, product lines and so on. Each department is comprised of
individuals who are responsible for particular tasks or managerial
functions. The managers of various departments should ensure that the
people in their department are doing well to achieve the goal.
Responsibility accounting refers to the various concepts and tools used by
managerial accountants to measure the performance of people and
departments in order to ensure that the achievement of the goals set by
the top management.
Responsibility accounting, therefore, represents a method of measuring
the performances of various divisions of an organization. The test to
identify the division is that the operating performance is separately
identifiable and measurable in some way that is of practical significance to
the management. Responsibility accounting collects and reports planned
and actual accounting information about the inputs and outputs of
responsibility centers.

SUMMARY
A responsibility center is a part or subunit of a company for which a
manager has authority and responsibility. The company's detailed
organization chart is a logical source for determining responsibility
centers. The most common responsibility centers are the departments
within a company.
When the manager of a responsibility center can control only costs,
the responsibility center is referred to as a cost center. If a manager
can control both costs and revenues, the responsibility center is known
as a profit center. If a manager has authority and responsibility for
costs, revenues, and investments the responsibility center is referred
to as an investment center.

SUMMARY
Steps in Responsibility Accounting:
To make responsibility accounting effective and efficient, the following
steps are suggested:
(i) Targets are set and should be communicated to each manager Or
executive.
(ii) A continuous appraisal of actual performance is to be made and
actual results are to be conveyed to each manager of concerned
responsibility centre.
(iii) The variances are to be reported to the higher management
together with the names of managers of responsibility centres.
(iv) The corrective measures are to be suggested or taken and
communicated to the concerned manager of each responsibility
centre.

SUMMARY
Transfer pricing is the method used to sell a product from one subsidiary to
another within a company. It impacts the purchasing behavior of the subsidiaries,
and may have income tax implications for the company as a whole.
Here are the key issues:
Revenue basis. The manager of a subsidiary treats it in the same manner that he
would the price of a product sold outside of the company. It forms part of the
revenue of his subsidiary, and is therefore crucial to the financial performance on
which he is judged.
Preferred customers. If the manager of a subsidiary is given the choice of selling
either to a downstream subsidiary or to outside customers, then an excessively low
transfer price will lead the manager to sell exclusively to outside customers, and to
refuse orders originating from the downstream subsidiary.
Preferred suppliers. If the manager of a downstream subsidiary is given the choice
of buying either from an upstream subsidiary or an outside supplier, then an
excessively high transfer price will cause the manager to buy exclusively from
outside suppliers. As a result, the upstream subsidiary may have too much unused
capacity, and will have to cut back on its expenses in order to remain profitable.

SUMMARY
1. Responsibility accounting delegates decision making. Line managers,
department heads, and supervisors are entrusted with operational
decisions. The top management (executives) could then focus on
strategic or long-term organizational objectives.
2. It provides a guide to the evaluation of performance. It helps to
establish standards which are used for comparison with actual results.
3. It promotes management by objectives and management by
exception.

UNDERSTAND THE MEANING AND ESSENTIAL AND FEATURES OF
RESPONSIBILITY ACCOUNTING
Section 1

MEANINGAND DEFINITION OF
REPONSIBILITYACCOUNTING
• Responsibility accounting is a system of accounting that
recognizes various responsibility centres throughout the
organization 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.
Charles, T.Horngreen
• Responsibility accounting is that type of management
accounting that collects and reports both planned actual
accounting information in terms of responsibility centres.”
Anthony and Reece

FEATURES OF RESPONSIBILITY ACCOUNTING
1. INPUTS AND OUTPUTS OR COST AND
REVENUE: The implementation and
maintenance of responsibility accounting
system is based upon information relating
to inputs and outputs. Inputs expressed In
the monetary term are known as cost and
output expressed in monetary terms are
called revenue.
2. PLANNED AND ACTUAL INFORMATION
OR USAGE 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 budget
that responsibility for implementing the
plans is communicated to each level of
management.
Inputs And Outputs Or Cost And
Revenue
Planned And Actual
Information Or Usage Of
Budgeting
Identification Of
Responsibility Centres
Relationship Between
Organisation Structure And
Responsibility

3. IDENTIFICATION OF RESPONSIBILITY
CENTRES : For effective control ,a large
firm isusually ,divided into meaningful
segments ,departments or divisions of
organization are called responsibility
centres . Responsibility centres are usually
classified under three categories : 1)cost
centres ; 2)profit centres ; 3)investment
centres
4. RELATIONSHIP BETWEEN
ORGANISATION STRUCTURE AND
RESPONSIBILITY
ACCOUNTING SYSTEM : A sound
organization structure with clear cut lines
of authority –responsibility relationship is a
prerequisite for establishing a successful
responsibility accounting system. Further
,responsibility accounting system must be
so designed as to suit the organisation
structure of the organisation.
Inputs And Outputs Or Cost And
Revenue
Planned And Actual
Information Or Usage Of
Budgeting
Identification Of
Responsibility Centres
Relationship Between
Organisation Structure And
Responsibility

5. ASSIGNING COST TO INDIVIDUALS
AND LIMITING THEIR EFFORTS TO
CONTROLABLE
COSTS : Only those costs and
revenues over which an individual has
a definite control can be assigned to
him for evaluating his performance
.Responsibility accounting has an
appeal because it distinguishes
between controllable and
uncontrollable cost
• CONTROLABLE COST : are those
costs which can be controlled or
influenced by a specified person or
a level of management of an
undertaking.
• UNCONTROLABLE COST : are those
which cannot be so controlled or
influenced by the action of
specified individual or undertaking.
Assigning Cost To Individuals And
Limiting Their Efforts To
Controllable
Transfer Pricing
Performance Reporting
Participative Management

6. TRANSFER PRICING POLICY: In
large scale enterprises having
decentralized divisions ,there is a
common practice of transferring of
goods and services from one
segment of the organization to
another .in such situation ,there is a
need to determine the price at
which the transfer should take
place so that cost and revenues
could be properly assigned .The
significance of the transfer price can
well be judged from the fact that
for transferring division it will be a
source of revenue , whereas for the
division to which transfer is made it
will be an element of cost .
Controllable
Transfer Pricing

7. PERFORMANCE REPORTING :As
responsibility account is a control
device .A control system to be
effective should be such that 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 focused on
performance reports also known as
‘responsibility reports’ ,prepared
for each responsibility unit.
Controllable
Transfer Pricing

8. PARTICIPATIVE MANAGEMENT:
The function of responsibility
accounting system becomes more
effective if participative or
democratic style of management is
followed, wherein ,the plans are
laid or budgets/standards are fixed
according to the mutual consent
and the decisions reached after
consulting the subordinates. It
provides motivation to the workers
by ensuring their participation and
self imposed goals.
Controllable
Transfer Pricing

9. MANAGEMENT BY EXCEPTION :
An effective responsibility
accounting system must provide for
management be exception, i.e., it
should focus attention of the
management on significant
deviations and not burden them
with all kinds of routine matters
condensed reports requiring their
attention must be sent to them
particularly at higher levels of
management.
Management By
Exception
Human Aspect
Of Responsibility
Accounting

10. 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
Management By
Exception
Human Aspect
Of Responsibility
Accounting

STEPS INVOLVED IN RESPONSIBILITY ACCOUNTING.
Section 2

STEPSINVOLVEDINRESPONSIBILITYACCOUNTING
1. The organisation is divided into
various responsibility centres each
responsibility centre is put under
the charge of responsibility
manager. The manger are
responsible for the performance of
their department.
2. 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 goal of the
responsibility centres are properly
communicated to them
The organisation is
divided into
responsibility centres
The targets of each
responsibility centre are
set in
The actual performance
is recorded
If actual performance is
than standard, the
variances will be used
Timely action are taken
for corrective measures

3. The actual performance of each
responsibility centre is recorded
and communicated to the
executives concerned and the
actual performance is compared
with goals set and it helps in
assessing the work of these centres.
4. 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.
The organisation is
divided into
The targets of each
set in
is recorded
than standard, the

5. 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 measure are
initiated at the earliest.
The organisation is
divided into
The targets of each
set in
is recorded
than standard, the

RESPONSIBILITY CENTRES-COST ,PROFIT AND INVESTMENT CENTRES.
Section 3

TYPES OF RESPONSIBILITY CENTRES
Responsibility
Centre
Cost/expense
centre
Profit centre Investment centre

1. Cost or Expense Centre: Cost centres
are segments in which managers are
responsible only for the cost incurred
but have no revenue responsibilities.
The performance of a cost centre is
measured in terms of quantity of inputs
used in producing a given level of
output. A comparison between the
actual input used and predetermined
budgeted inputs is made to determine
the variances which represent the
efficiency of the cost centre.
Cost centres can be further classified on
the basis of
• (a)Types of cost
• (b)Functions performed
Type of
cost
Functioned
performed
Cost/expense
centre

COST/EXPENSE CENTRE
(classification on basis of type of cost)
Cost/expense centre
(classification on basis of
type of cost)
Engineered expense
centres
Discretionary expense
centre

COST/EXPENSE CENTRE (classification by
functional basis)
Cost/expense (classification by
functional basis)
Production cost
centre
Service cost
centre
Ancillary cost
centre
Administrative
and support
centre
Research and
development
centre
Marketing
centre

ENGINEERED AND DISCRETIONARY EXPENSE CENTRE

2. Profit centre: Responsibility
centres may have both inputs and
outputs. The inputs are taken as
cost and outputs are revenues. The
difference between the revenue
and cost gives the profit. When a
responsibility centre gets revenue
from output, it will be called a
profit centre .When the output is
meant for outsiders ,then the
revenue will be measured from the
price charged from customers and if
the output is meant for other
responsibility centre ,then the
management takes a decision
whether to treat it as profit centre
or not.

2. Profit centre:
Establishment of profit centre may
be suitable if the following
conditions are satisfied:
• There exist a decentralized form
of organization.
• The divisional manager has
access to all relevant information
needed for decision making.
• The divisional manager is
sufficiently independent.
• Internal transfer of output from
one division/centre to another
division are not significant.
• A definite measure of
performance is available.

ADVANTAGES OF PROFIT CENTRE
Establishment of profit centre offers the
following advantages
• It encourages initiative as a manager of
profit centre is subject to a lesser
degree of control of the top
management.
• It may improve the quality of decisions.
• It quickens the decision making process
as these need not be referred to top
management.
• It saves time of the top management.
• It enhances profit consciousness in the
entire organization.
• It promotes competition amongst
managers of various profit centres and
improves their performance.
• It helps in training divisional managers
for top management responsibilities.

DISADVANTAGES OF PROFIT CENTRE
Loss of top management control
over different divisions.
• Faulty decision at divisional level
• Conflict among individual
interests of divisions and the
organization as a whole.
• Too much emphasis on short
term profitability
• Increased cost due to multiple
requirement of facilities and
personnel at each profit centre.
• Transfer pricing problems
amongst profit centres

3. Investment centre: “An investment
centre is an entity segment in which a
manager can control not only revenue
and cost but also investment ”.The
manager is made responsible for
properly utilizing the assets used in his
centre and earn fair return on the
amount employed in assets in his
centre. The performance of an
investment centre can be measured by
relating profit to the investment base.
The two commonly used methods are as
follows:
• Return On Investment/Capital
Employed
• Economic Value Added/Residual
Income Approach

RETURN ON INVESTMENT/CAPITAL EMPLOYED
• It establishes the relationship between profits and capital
employed. The term capital employed refers to the total
investment made in the investment centre/business .
RETURN ON CAPITAL EMPLOYED= NET PROFIT(BEFORE TAX)/CAPITAL EMPLOYED X100
OR
ROI= NET PROFIT/SALES x SALES/CAPITAL EMPLOYED x 100
OR
ROI= NET PROFIT RATIO x CAPITAL TURNOVER RATIO
(Where , Net Profit = Total Assets – Current Liabilities)

ECONOMIC VALUE ADDED/RESIDUAL INCOME APPROACH
Economic value added is a measure of performance evaluation the was
originally employed by Stern Stewart and Co . It is a popular method used to
measure the surplus value created by an investment or portfolio of
investments . It is considered to be a better measure of divisional performance
as compared to return on investment or assets.
EVA= NET OPERATING PROFIT AFTER TAX – COST OF X CAPITALCAPITAL INVESTED
OR
EVA = CAPITAL EMPLOYED (Return on investment- cost of capital)
According to this approach an investment can be accepted if surplus(EVA) is
positive . It is only the positive EVA that will add value and enhance the wealth
oF shareholders.
EXAMPLE:
Suppose an investment generates net operating profit after tax of $20 millions
and cost of financing investment is $16 millions. The value added by the
investment shall be $4 millions and hence it should be accepted.

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”. It is necessary for
managerial evaluation within the
company through profit centres in
the cases where various profit
centres exchange goods and services,
Hence it is required to determine the
monetary values , called transfer
prices at which the transfer should
take place so that cost and revenue
could be properly assigned.

METHODS USED FOR DETERMINING THE TRANSFER PRICES
1. COST PRICE : Under this method
goods and services are transferred from
one segment of the company to another
on the basis of unit cost of production
of transferring division . Cost can be
taken to be either the actual cost of
production or the standard cost of
production.
• Advantage : It is very simple and
convenient.
• Disadvantage : Profit of the
transferring centre shall be
underestimated and that of the
centre to which it is transferred is
over estimated.
Cost Price
Cost Plus A
Normal Mark-up
Incremental Cost
Shared Profit
Relative To The
Cost

2. COST PLUS A NORMAL MARK-UP: To
overcome the shortcomings of the first
method ,companies add
to the cost a margin of profit to
determine the transfer price. So the
transferring department charges
the actual unit cost of production plus a
mark up for profit.
• Advantage : It is very simple and
convenient
• Disadvantage :Inefficiencies of one
department is transferred to another
department.
Cost Price
Cost Plus A
Normal Mark-up
Incremental Cost
Shared Profit
Relative To The
Cost

3. INCREMENTAL COST : Incremental cost
can be computed in two ways depending
upon the circumstances. In case entire
production is transferred to another
division within the same company, the
incremental cost will be the total of
variable cost of transferring 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 transferred
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 transferring 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.
Cost Price
Cost Plus A
Normal Mark-up
Incremental Cost
Shared Profit
Relative To The
Cost

4. 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 aggregate 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.
Disadvantage :inefficiencies are not
evaluated, and hence, it is not an
appropriate methodfor profit centre
analysis
Share of profit of a
particular centre =
Profit of the company
cost of a centre
Total
cost X 100

5.MARKET PRICE: In this method , the
prices charged for intra-company
transfers are determined on the basis of
market price and not on the cost basis.
There are three ways of computing the
market price . Firstly , the prevailing
market price , after making adjustment
for discounts and other selling costs ,
may be taken as transfer price if there is
an active market for goods and services
transferred between division of the
same company. The main advantage of
this method is that it protects the
profitability
Market Price
Standard
Price
Negotiated
price
Dual Or Two-
way Price

6. STANDARED PRICE: Transferred prices
can also be fixed on predetermined
standard price basis. The standard price
may be determined on the basis of cost
of production and the prevailing market
conditions. Thus, division working at less
than the desired efficiency will show
lesser profits as compared to the
efficient divisions. However, difficulties
may arise infixing the standard price
agreeable to the different divisions.
Market Price
Standard
Price
Negotiated
price
Dual Or Two-
way Price

7. NEGOTIATED PRICE: The intra-
company transfer price can also be
determined on the basis of negotiations
between the buying and the transferring
division. The price arrived at after
negotiations will be mutually agreed
price. Such a pricing method will be
advantageous to both the divisions as
well as the company as a whole.
However, this method could be used
only when both the buying as well as
transferring divisions have alternative
choices available with them.
Market Price
Standard
Price
Negotiated
price
Dual Or Two-
way Price

8. DUAL OR TWO-WAY PRICE: According
to this method, the transferring division
is allowed to give credit at one price,
whereas, the buying division is charged
at a different price. It enables better
evaluation of profit centres and avoids
conflict among them on account of
transfer prices. However, the total
profits of the various segments would
differ from the actual profit of the
company as a whole. But, it poses no
problems for the company as transfer
prices are meant for internal purposes
of performance evaluation only.
Market Price
Standard
Price
Negotiated
price
Dual Or Two-
way Price

SELECTION OF TRANSFER PRICING METHOD
• The study of the various transfer
pricing methods reveals that
there is no particular method
which could be termed as the
best method for all situations.
The selection of a particular
method will depend upon the
particular circumstances which
may differ from case to case.
However, the following general
criteria should be kept in mind
while determining the transfer
price
Transfer
pricing
reveals that
no best
method for
all situation
It will
depends
upon case to
case situation

SELECTION OF TRANSFER PRICING METHOD
• the transfer price should be
objectively determinable;
• the transfer price should
compensate the transferring
division and charge the buying
division commensurate with the
value of the goods/services
exchanged;
• it should contribute to
congruence between the goals
of the divisions and the goals of
the organization;
• it should provide for profit
centre evaluation; and
• it should maximize the efforts
towards achievement of
organizational goals.
Objectively
determinable
Provide for profit
centre evaluation
Should
compensate and
charge the buying
commensurately
Congruence with
goals of division
and organisation
Maximize the
effort of
achievement

ADVANTAGES OF RESPONSIBILITY ACCOUNTING
Section 5

1. Assigning of Responsibility: Each and
every individual in the organization is
assigned some responsibility and they
are accountable for there work.
Everybody knows what is expected of
him. The responsibility can easily be
identified as satisfactory and
unsatisfactory performances of various
persons are known. Nobody can shift
responsibility to anybody else if
something goes wrong. So, under this
system responsibility is assigned
individually.
Assigning of responsibility
Improves Performance
Helpful in Cost
Planning
Delegation and Control
Helpful in Decision-Making

2. Improves Performance: The assigning
of tasks to specific persons acts as a
motivational factor too. The persons in
charge 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

3. 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.
Helpful in Cost
Planning

4. 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
remains with top management because
performance of every cost centre is
regularly reported to it. So management
is able to delegate authority and at the
same time to retain control.
Helpful in Cost
Planning

5. 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.
Helpful in Cost
Planning

Chapter 10 : Responsible Accounting

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Chapter 10 : Responsible Accounting