Responsibility centers MCS Why should we have decentralized ( ) system?

Quality of decision making improves Speed of decision making improves H.Q. is relieved ( )of day to day decision making Managers at decentralized units get exposure to decision making in functional areas and the managers at H.Q. get exposure in evaluation and supervision areas Managers at decentralized units become more a are of the differences in personal goals and the organization goals. Why should we not have decentralized system? !op management has to rely ( )on the management control reports H.Q. managers are more capable or better informed and therefore can take better "uality decisions #rictions ( )arise on the issues like $transfer price%& $overhead charges% and the $credit for the success% !he decentralized units instead ( )of cooperating start competing ith each other 'ecentralization may impose additional costs because of additional management& staff& record keeping etc. (ompetent persons to head the decentralized units may not be available )mphasis is placed on short run achievements rather than long run goals Delegation 'elegation ithout authority is of no conse"uence.( ) *t is like tying () the hands and feet of a person and asking him to run. 'elegation of the po ers to the manager of the decentralized unit is the soul of decentralization. +uthority must be delegated commensurate ( )to the activities , goals and the capability of the manager in charge. !!iciency and !!ectiveness "hese are the measures o! the per!ormance !!iciency# *t is a comparative& rather than absolute measure of performance e say that one is more efficient than the other or one is more efficient no than in the past or one is more efficient than the standards,ideal etc. *t is mostly "uantitative measure bet een the input and the output !!ectiveness# *t is a measure of the contribution of the one to the overall ob-ective of the hole Since the $ob-ectives of the hole% and the $contribution to the ob-ectives% are both difficult to "uantify & this measure is mostly "ualitative .

pitome# *n other ords one is efficient if one does the things right& and one is effective if one does the right things.

Responsibility Centers De!inition# A responsibility center is an organization unit that is headed by a manager who is responsible for its activities. "ypes o! Responsibility Centers $% Revenue Centers &% 'pense Centers i% ngineered 'pense Center ii% Discretionary 'pense Center (% )ro!it Centers *% +nvestment Centers Revenue Centers +n a revenue center, output (i%e% revenue is measured in monetary terms, but no !ormal attempt is made to relate input (i%e% e'pense or cost) to output% !!iciency o! the Revenue Centers )fficiency of these centers is measured against the budgets or "uotas. Managers are held responsible for the direct expenses incurred in the center. !hey are ho ever not charged ith the cost of the goods they market or sell. /rimary efficiency measurement is revenue. Revenue Centers

Inputs are not related to outputs Inputs (only for costs directly incurred) work Outputs in monetary terms

)xamples0 Marketing& Sales and 'istribution& (ounselors in academic or financial products etc. 'pense centers )xpense centers are responsibility centers hose inputs are measured in monetary terms& but hose outputs are not. !here are t o types of the expense centers0 )ngineered )xpenses (enter0 !hese are those centers for hich the costs can ascertained ith precision. #or example& ra material cost& ages& po er& fuel etc1. 2

 'iscretionary )xpenses (enter0 (also called as managed costs centers) Here no precise estimate of the costs is feasible (osts depend upon the managements -udgment ngineered 'pense Centers )ngineered )xpense have the follo ing characteristics0 !heir inputs can be measured in monetary terms. !heir output can be measured in physical terms. 3ptimum cost incurred per unit of output can be determined !he follo ing are the examples0 manufacturing operations& arehousing& distribution& trucking etc. !!iciency o! the C Standard cost is calculated from the historical data or the standards already set. +ctual cost is calculated. !hese costs are then compared and the efficiency or other ise is determined. 4esides this managers are responsible for the activities such as training& employee development& that are not related to the current production !he overhead costs are ho ever determined by the HQ. ngineered 'pense Centers

Inputs in monetary terms

Optimal relationship Can be established work

Outputs in physical terms

Example: factory expenses, manufacturing expenses,

Discretionary 'pense Center !hese type of centers include the follo ing activities0 +dministrative unit Support unit 5egal services *ndustrial relations and human resources /ublic relations 6esearch and development Marketing and advertisement

!!iciency o! the D C 7

'ifference bet een the budgeted and the actual expense is 83! the efficiency measure for ')(. *t is difficult to assess the efficiency of these centers. Discretionary 'pense Centers

Inputs in monetary terms

Optimal relationship cannot be established work Output in physical terms

)xamples0 6esearch and 'evelopment department& +dvertisements etc. )ro!it Centers 9hen the responsibility center%s financial performance is measured in terms of profit (i.e. difference bet een the revenues and the expenses)& the center is called as /rofit (enter. +ll S4:s are profit centers but all profit centers are not S4:s. +ll organizations take step in creating the profit centers at the lo est point in an organization here the follo ing t o conditions are met. !he manager should have access to the relevant information needed for making such a decision. !here should be some ay to measure the effectiveness of the trade;offs the manager has made. -usiness .nit or Strategic -usiness .nit (S-.) (ompanies create business units because they have decided to delegate more authority to the operating managers. 'egree of delegation may differ from company to company Ho ever the complete authority for generating profit is never delegated to a single segment of the business /dvantages o! )ro!it Centers Quality of decision making improves as they are nearest to the point of decision making. Speed of decision making is increased because the instructions are not sought ( )from the HQ. HQ is relieved of the day to day decision making for the petty issues involving the profit centers. Managers are freer to use their imagination and the initiative. /dvantages o! )ro!it Centers <

+s the profit centers are similar to the independent companies& they provide an excellent training ground for general management. !heir management gain experience in managing all functional areas& and the upper management gains the opportunity to evaluate their potential for higher level -obs /rofit consciousness is enhanced since the managers ho are responsible for profits ill constantly seek ays to enhance them.

/dvantages o! )ro!it Centers /rofit centers provide top management ith ready made information on the profitability of the company%s individual components. 4ecause their output is so readily measured& profit centers are particularly responsive to pressures to improve their competitive performance. Di!!iculties with )ro!it Centers 'ecentralized decision making ill force top management to rely on management control reports than on personal kno ledge of an operation& entailing some loss of control. *f HQ management is more capable or more informed than the profit center manager& the "uality of the decision making at unit level may be reduced. Di!!iculties with )ro!it Centers #riction may increase because of arguments over the appropriate transfer price& the assignment of the common costs& and the credit for the revenues that ere formerly generated -ointly by t o or more business units orking together. 3rganization units that once cooperated ith each other as functional units may no be in competition ith each other. Di!!iculties with )ro!it Centers 'ecentralization may impose additional costs because of additional management& staff and record keeping re"uired& and may lead to task redundancies at each profit center. (ompetent managers may not exist in a functional organization because there may not have been sufficient opportunities for them to develop general management competence. Di!!iculties with )ro!it Centers !here may be too much emphasis on short run profitability at the expense of long run profitability. *n the desire to report high current profits& the profit center manager may skimp on 6 = '& !raining program or maintenance !here is no completely satisfactory system of ensuring that optimizing the profits of each individual profit center ill optimize the profit of the company as a hole. Measuring the e!!iciency o! the )ro!it Centers .. (ontribution margin (spread bet een revenue and variable expenses) 2. 'irect profit (profit center%s contribution to the general overhead or the profit of the company) 7. (ontrollable profit (non controllable expenses of the HQ are subtracted from the total expenses hile calculating profit) <. *ncome before tax (/4!) >

>. 8et income (/+!)

)ro!it Centers

Inputs are related to outputs Inputs in monetary terms work Outputs are in monetary terms

!hese are business units ( ith some modifications or amendments functional units can be converted as business units)

+nvestment centers !his is a special type of profit center *n such type of centers profit is compared to the assets employed to earn it. !he sum of assets employed in the investment center is called as investment base. /rofit is related to this investment base in the follo ing t o ays0 !he percentage of return on investment referred to as 63* )conomic ?alue +dded ()?+) also kno n as residual income. R0+ and 1/ 63*& 6eturn on *nvestment is a ratio& the numerator of hich is income as reported in the income statement and the denominator is the assets employed. +ssets employed are total assets less current liability hich corresponds to shareholders e"uity plus the non current liability. )?+ on the other hand (not being a ratio) is the "uantity in monetary terms. *t is found by subtracting a capital charge from the net operating profit Measuring the /ssets (ash 6eceivables *nventories 9orking capital in general /roperty& /lant and )"uipment +c"uisition of ne e"uipment @ross block value

Measuring the /ssets A

'isposition of assets +nnuity depreciation 3ther valuation methods for the assets 5eased assets *dle assets *ntangible assets 8on current liabilities !he capital charge

+nvestment Centers

Inputs in monetary terms

!hese are business units

Profits are related to the Capital employed Outputs in monetary Capital terms Employed

2uestions so !ar as3ed by the university on this topic% .. 9hat is responsibility centerB 5ist and explain different types of responsibility centers ith sketches. 2. )very S4: is a profit center but every profit center is not S4:B 9hat are the conditions that must be fulfilled for an organization unit to be converted into a profit centerB 9hat are different ays to measure the performance of a profit centerB 'iscuss their relative merits and demerits. 7. 4riefly describe )ngineered )xpense (enters and 'iscretionary )xpense (enters. Ho is budget prepared in each and ho is performance evaluated in eachB <. 9hat is a Strategic 4usiness :nitB 9hat are the conditions re"uired for creating S4:B Ho is performance of S4: measuredB 9hat are the advantages and disadvantages of creating S4:sB >. Ho is investment center different from a profit centerB 9hat are the different methods of -udging their performanceB 9hich is better methodB A. 4riefly describe 6esponsibility center& engineered )xpense center& 'iscretionary )xpense (enter& 6evenue (enter& /rofit center. Ho is the performance of the head of these centers evaluatedB C. )very S4: is a profit center but every profit center may not be S4:. )xplain. :nder hat conditions /roduction& Marketing and Service 'epartments are converted into profit centersB D. 9hat do you understand by *nvestment (enterB )xplain t o different methods by hich the performance of these centers is measuredB +lso discuss their relative merits and demerits.