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Management Control System

Responsibility Centers

Responsibility Centre:The entire organization should be divided into various responsibility centers. Each responsibility centre is held by a manager or head of the centre who has been assigned the responsibility. It is clearly understood that every organization is normally classified into various responsibility centers to the tune of different functions viz Marketing, Finance, Research and Development , Production and Human resources. The responsibility center is the department which is headed by responsibility person i.e. the manager of particular function. It is the part of the organization through which the information is processed and communicated at every position. The decision of responsibility center is taken by the head by considering the positional responsibility. The responsibility centre is classified into various categories 1. Revenue and expense center 2. Profit center 3. Investment center etc.

Expense Center: The responsibility center which incurs only expenses and measure them is known as expense center. The expense centers of the organization are mostly the service centre which only usually incur expenses. The contribution of service department and office and Administration department to the company cannot be denominated in the term of monetary terms, but instead in terms of quality or service to assist the entire organization. The output of the sales/production department are denominated in monetary term unlike others.

Cost Center: Cost center are division that add cost of the organization but only indirectly add to the profit of the company. Example:-Research and Development , Marketing and Customer Service. Companies may choose to

Responsibility Centre:The Chartered Institute of Management Accountants, UK has defined the responsibility center as a segment of the organization where an individual manager is held responsible for the segments performance. It is the department , function or unit of an organization headed by a manager who is directly answerable for its performance. Responsibility centers facilitates management control and help in implementing the strategies chosen to accomplish the organizations goals. Every responsibility center uses inputs (material, labor, etc.) and needs working capital , equipment and other assets to function effectively. While cost can be easily measured, output are not always easy to measure. The performance of a responsibility center can be judged using effectiveness and efficiency criteria.

Criteria to judge performance of RC Effectiveness Efficiency

Efficiency: it is the ratio of output and input. The lesser the input used to achieve a certain level of output or greater the output for given level of input , the higher will be the efficiency of the organization. Effectiveness : It is decided on the basis of a units outputs and its goals. The greater the contribution of t he outputs to the accomplishment of the organizational goals , the more effective the unit. According to the nature of monetary inputs and outputs , responsibility centers can be classified into four types:1. Cost center 2. Revenue center 3. Profit center 4. Investment center

Benefits of Responsibility centers 1. A way of managing large entities:- in large organization it is difficult for one manager or a small group of managers to understand every aspect of the business. So division of organization into different responsibility center helps to manage the large entities. Better decisions:-when the large organization is divided into smaller and more manageable units it achieves many of the advantages of small company. Because the decision makers responsible for each unit are closer to the problem in their environment, they are better able to make the relevant revenue/ cost decisions. Because decision making can also be speeded up, a decentralized organization can be more responsive to the environmental changes . Furthermore , because they are held responsible for all the activities , managers are far more aware of their ultimate impact and are extremely sensitive to what they are doing for the company. Motivation :- if responsibility is motivating and monetary measures are one means of establishing responsibility then the manager who is responsible for revenue and revenues / cost trade off will probable be more committed than a manager who is responsible for cost alone. Profit measure allow managers to focus on a familiar well understood goal and give them the feeling of being in the business for themselves. Frees top management:- decentralization frees top management . Top management is relieved of much day-to-day problem solving and is left free to concentrate on

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As they do not have to concentrate on all elements of the business, they can practice management by attending to those areas where a strong influence will be most beneficial . If one center begins to experience difficulty, management can then spend its time helping this center to correct its problems. Things should be kept in mind while dividing the whole organization into different responsibility centers. Top management must be committed to decentralization:-responsibility center system must have the wholehearted commitment to top management. They must be willing to relinquish some of their intimate knowledge of day to day operations and also some of their authority to their subordinates . Top management must allow the responsibility center managers to make the key operating decision . Although it may be difficult especially in a company with only one major business but they must do so if the system is to work efficiently. Adequate staff and information systems:-the cost of implementing a responsibility center may be quite high. A new management system will be necessary in order to provide top management with the data it need information to make decisions. Accounting reports will be primary source of information about a units performance so the management must provide these reports and must also know how to use them.. Capable profit center managers:-

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Capable profit center managers:- a company using responsibility center system must have managers capable of heading them. The implementation of responsibility center require a great deal of education to train managers up and down the line to understand and think in terms of Responsibility accounting. They must be made to understand that their performance is now being measured by their contribution to company profits and that they must now make decision based on profit contribution. Each responsibility manager must be made aware of the key variables of the organization as a whole, the managers strategic variables and the relationship between these so that he or she will not make decision to maximize his or her own welfare at the expense of the organization as a whole.

Classification of Responsibility Center Cost Center Revenue Center Profit Center Investment Center

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1. Cost Center:Cost centers are held responsible for the cost incurred but not for generating revenues. A cost centers can operate in two ways Either cost budget is specified and goal is to maximize the output or:- certain fixed budget is allocated to the cost center and it is expected to achieve the best possible result within the allocated budget.e.g. Public Relation Department The expected output is specified and goal is to minimize the cost:- the goal is to achieve the required level of output at minimum cost. The performance level depends on the cost incurred by that center.e.g. Maintenance Department. In order to control the cost the manager may ignore:Non financial indicators Quality of output Safety issue Ethical and environment

Type of Cost Centers Standard Cost Center It is referred to as Engineered Expense Center. It is usually in manufacturing organization and service Organization. The manager of this responsibility center is responsible for both the direct cost incurred per unit of output and overhead expenses. He is also responsible for quality and quantity of the outputs. The object of the manger is to prevent or reduce unfavorable variance between the actual and budgeted cost, while maintaining quality and quantity of output at the desired level. Discretionary Expense Center It is difficult to measure the output in monetary terms against a given level of input. Budget is decided upon for the chosen time period i.e. financial year. Responsibility center managers are expected to maximize the services offered while keeping within the budgeted limits. E.g. corporate functions such as accounting, human resources and corporate communication and departments involved in scientific research or new technology.

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Revenue Centers:-

Managers of revenue centers are held responsible for the Revenues ( Output). These centers are not directly responsible for the profits. Some revenue centers are incurring costs which are controllable to an extent e.g. cost incurred in providing customized services to boost sales. Any costs which are traceable to a revenue center are normally adjusted with the sales revenue to calculate the net revenue of the revenue center. in many organizations , the revenue centers are the closet points of contact with the existing and potential customers. The main objective of revenue centers is to maximize net revenue. these centers are devoted to increasing the net revenue and assume no responsibility for production. In these centers the outlet manager is responsible for the level of revenue or output is measured in monetary terms, but is not responsible for the costs of the goods sold through the outlet. E.g. Sales outlet of Tanishq

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Profit center

Profit centers are those responsibility centers which are responsible for profits. The manager of profit center has control over both the inputs (Cost of resources) as well as output ( revenue earned) Profit center managers does not have control over the level of investment , which are controlled by the top management or which might have been decided. The objective of profit center is to achieve profit target: the manager of profit center has to focus on both the cost reduction and revenue maximization. The profit center manager cannot afford to reduce the quality of the goods. There may be a situation that the manager of profit center is not utilizing its capital employed efficiently. e.g. in order to increase the sales for the current period the profit center manager may allow the sale on extended credit terms. This means that even though higher revenue is generated it not realized immediately. Capital which may have been utilized for a more useful purpose is blocked in the form of receivable to be realized at a later point in time.

Characteristic of profit Center:1. Operational independence:- each profit center manager must have the authority to make most if not all of the key operating decision that affect his profits, subject to broad policy directions from the top. The areas where independence cannot exist should properly be considered to be service centers. Access to sources and markets:- the profit center manager must have control over all sources and market decisions and be free to buy and sell in alternative markets. This freedom to trade dissolves and helps establish responsibility. Quantifiable cost and revenues:- a profit center must be able to identify its true costs and establish a reasonable price for its product. Otherwise measurement by profits is questionable.

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Investment center

Investment centers are held responsible for the overall economic performance in terms of cost incurred, the revenue generated as well as the associated investment. The performance of investment centers is measured with respect to Return of Investment or Return on Capital Employed, and Economic Value Added. In investment centers, the managers have control over the inputs, outputs and investments. This allows and motivates them to make the best possible utilization of resources under their control. Drawback of Investment Centers: is that since the value of capital employed is taken from the balance sheet, the value of ROI or ROCE may depend on accounting technique adopted by organization. The manager of an investment center may postpone new investments like purchasing new equipment or expanding capacity, as the ROCE will decrease in the short run, though the organization may benefit from these investments in long run.

Points of differences Inputs Output Type of Activities

Expense Center Expressed in monetary term Expressed in term of units Core Activities Strategically and operationally necessary Highly creative, non repetitive task

Cost Center Expressed in monetary term Expressed in term of units Non core activities Operational activities

Revenue Center Expressed in monetary term Expressed in monetary term Core activities Market & customer driven activities Sales and distribution activities

Profit Center Expressed in monetary term Expressed in monetary term Core activities Market & customer driven activities

Investment Center Expressed in monetary term Expressed in monetary term Core activities Capital market /customer driven market Mostly performed for shareholders Return on Investment on R&D Determine minimum required return on investment

Example

Facility management activities, IT system maintenance activities

Distribution activities Speculative activities of treasury department

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