Page 206 - DCOM302_MANAGEMENT_ACCOUNTING

Unit 10: Responsibility Accounting and Transfer Pricing

Responsibility accounting is appropriate where top management has delegated authority to Notes
make decisions. The idea behind responsibility accounting is that each manager’s performance
should be judged by how well he or she manages those items under his or her control. This
approach allows responsibility to be assigned to the segment managers that have the greatest
amount of influence over the key elements to be managed. These elements include revenue for a
revenue center (a segment that mainly generates revenue with relatively little costs), costs for a
cost center (a segment that generates costs, but no revenue), a measure of profitability for a profit
center (a segment that generates both revenue and costs) and return on investment (ROI) for an
investment center (a segment such as a division of a company where the manager controls the
acquisition and utilization of assets, as well as revenue and costs).

10.1 Responsibility Centers

The concept of responsibility accounting has emerged to accommodate the need for management
information at a more specific level of detail than can be provided by financial accounting
procedures. Responsibility accounting attempts to report results (actual performance) in such a
way that:
1. significant variances from planned performance can be identified,
2. reasons for variances can be determined,

3. responsibility can be fixed, and
4. timely action can be taken to correct problems.
Under this approach, pertinent costs and revenues are assigned to various organizational units
– departments, bureaus, and programs – designated as responsibility centers. A decentralized
environment results in highly dispersed decision making. As a result, it is imperative to monitor
and judge the effectiveness of each manager. This is easier said than done. Not all units are
capable of being evaluated on the same basis. Some units do not generate any revenue; they only
incur costs in support of some necessary function. Other units that deliver goods and services
have the potential to be assessed on the basis of profit generation.
As a generalization, the part of an organization under the control of a manager is termed a
“responsibility center.” To aid performance evaluation it is first necessary to consider the specific
character of each responsibility center. Some responsibility centers are cost centers and others
are profit centers. On a broader scale, some are considered to be investment centers. The logical
method of assessment will differ based on the core nature of the responsibility center.

10.1.1 Cost Center

A cost center is the smallest segment of activity or area of responsibility for which costs are
accumulated. Obviously most business units incur costs, so this alone does not define a cost
center. A cost center is perhaps better defined by what is lacking; the absence of revenue, or at
least the absence of control over revenue generation.

Human resources, accounting, legal, and other administrative departments are expensive to
support and do not directly contribute to revenue generation. Cost centers are also present on the
factory floor. Maintenance and engineering fall into this category. Many businesses also consider
the actual manufacturing process to be a cost center even though a saleable product is produced
(the sales “responsibility” is shouldered by other units).

It stands to reason that assessments of cost control are key in evaluating the performance of cost
centers. This unit will show how standard costs and variance analysis can be used to pinpoint
areas where performance is above or below expectation. Cost control should not be confused with
cost minimization. It is easy to reduce costs to the point of destroying enterprise effectiveness.

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