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Meaning of Responsibility Center

A Responsibility Center is an organization unit that is

headed by a manager who is responsible for its activities. In a sense, a company is a collection of responsibility centers ,each of which is represented by a box on the organization chart. A Responsibility center should be separable and identifiable for operating purposes.

Nature of Responsibility Center


Created for one or more purposes ,termed its

objectives. Created to help implement various organizati-nal strategies. Represents sub unit of an organization.

Types of Responsibility Centers


Responsibility Centers

Engineered Expense Center

Discretionary Expense Center

Revenue Center

Profit Center

Investment Center

Criteria for the Judgement of Performance of Responsibility Center


Efficiency :- Efficiency is the ratio of

outputs to inputs or the amount of output per unit of input. Efficiency is a relative term. Effectiveness :- Effectiveness is determined by the relationship between a responsibility centers output and its objectives. i.e the more this output contributes to the objectives ,the more effective the unit.

Expense center
Expense centers are responsibility centers

whose inputs are measured in monetary terms ,but whose outputs are not. There are two general types of expense centers: (a) Engineered Expense Center (b) Discretionary Expense Center

Engineered Expense Center


It deals with engineered cost for which the right or

proper amount can be estimated with reasonable reliability- for e.g , a factory cost for direct labor, direct materials, components ,etc. Their input can be measured in monetary terms. Their output can be measured in physical terms. These centers are usually found in manufacturing operations The optimum dollar amount of input required to produce one unit of output can be determined.

Investment Center
This responsibility center goes a step further than a

profit center. The success of this center is not measured not only by its income but also by relating that income to its invested capital. The managers of this center are responsible for both sales revenues and costs and ,in addition ,have responsibility and authority to make capital investment decision.

Measurement of Performance
As a responsibility center , the performance of a

unit would be measured in relation to the revenues or profits and the assets employed in a division. Measurement of investment center performance can be viewed as the evaluation of an aggregation of past and present capital projects as opposed to the evaluation of each project individually.

Ways to relate Profits with Assets


Return on Investment (ROI)

Residual Income or Economic value added.

(EVA)

Return On Investment (ROI)


This is the most common measure for making

evaluation of an investment center. This measures takes into consideration two elements: 1. Net Income Before Taxes. 2. Invested Assets (Assets employed)

Advantages of ROI
1. 2.

3. 4.

5.

Generally accepted measure of overall performance. This is a ratio or percentage ,because of this serves as a better basis for comparing the performance of different division. This measures encourages goal congruence between the division and the firm. ROI also shows whether the companys borrowing policy was wise economically and whether the capital had been employed fruitfully. The business can survive only if ROI is more than coat of capital employed in the business.

Defects of ROI
1.

2.
3. 4. 5. 6. 7.

Manipulation possible. Different basis for computation of profit and investments. Emphasis on short term profits. Poor measure. Undue significance to capital resources. Limits initiative. Change factor.

Elements for computation of ROI


(A) Assets employed

(B) Net Income

(A) Assets employed


(1) Measuring & controlling assets employed

(2) Assigning the values to allocated assets

(1) Measuring and controlling assets employed


The following considerations are kept in mind ,for accurate measurement and control of the divisional investment : 1. Structure of analysis 2. Issues in measurement of assets employed (i) Treatment of controllable assets. (ii) Treatment of non-controllable assets. (iii) Treatment of idle assets. (iv) Treatment of leased assets. (v) Treatment of intangible assets.

(2) Assigning the values to allocated assets


These include : 1. Book value 2. Gross value 3. Replacement Cost basis.

(B) Net Income


Net income before interest and tax 2. Net income after interest but before taxes. 3. Net income after interest and tax.
1.

Residual Income or Economic values added


It is the residual income with the company after

charging for the cost of capital provided by the lenders and shareholders. RI (EVA) = Actual income desired income

Merits of EVA
Encourages capital investment.

EVA or RI is more flexible concept.


It helps in achieving the goal congruence.

DEMERITS OF EVA
It is an absolute measure.

It is difficult to select a fair and equitable cut off

rate(cost of capital)