Responsibility Centre

Prof. Nand Dhameja

Responsibility Centre

A segment of organisation Involving use of resources Has a purpose or objective A manager responsible for the centre An organisation is a set of responsibility centres Responsibility centres form a hierarchy: a centre may have sub-centres Involves InputsPhysical quantity Value of resources used Involves Outputs Physical quantityvalue of work done
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Responsibility Centre- Accounting: Steps

Divide organisation into segments/centres-a division or function unit

Each centre headed by an executive having authority & responsibility

Accounting for each centre: costs & revenues; Controllable vs. non-controllable costs Develop organisational control mechanism: Standard of performance for each centre Reward/punishment system

Develop transfer price mechanism

Responsibility Centre- Efficiency & Effectiveness

Two criteria to judge the performance of a responsibility centre Comparative terms rather than a absolute one Efficiency Output/Input

comparison of actual cost with

standard
Effectiveness relationship between Output & objectives
difficult to quantify objective & output

Responsibility Centre- Efficiency & Effectiveness contd.

Efficiency & effectiveness are not mutually exclusive, every centre ought to be both efficient & effective In summary, a responsible centre is efficient if it does things right, & it is effective if it does the right things In commercial organisations, Profit is an important measure of efficiency & effectiveness
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Responsibility Centres - Types

Expense Centre
Revenue Centre

Profit Centre
Investment Centre

Responsibility Centres Types

Contd.

Revenue Centre- output in money terms

e.g. market/sales units: don't have to set selling
price & are not charged for costs

Expense Centre: inputs measured in monetary terms

Engineered expense centre, or Discretionary expense centre

Profit Centre- An absolute measure

Profit a useful performance measure-inputs & outputs in monetary terms
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Responsibility Centres Types

Contd.
Profit centre- Delegation of authority to generate profit-two conditions:
a). Manager has access to relevant information to make decisions b). There is a way to measure effectiveness of expense/revenue trade-offs

Investment centre Profit in relation to Investment Management decision whether a profit centre or investment centre

Responsibility Center
Responsibility Center: 1.Expense Centre 2.Revenue centre 3.Profit Centre 4. Investment Center Center In charge Responsible for.. 1. Expenses 2. Revenues 3. Expenses, Revenues & Profits 4 Expenses, Revenues Profits & Investment

Responsibility Centre-Profit Centre:

Illustrations

For a bank: branch as profit centre; programme or a product profitability ,customer profitability, ATM Profitability ATM used as credit to branch having customer account Power cos.- generation, transmission & distribution as profit centres Soya sauce manufacturer- each production process as profit centre Marketing Division given profit responsibilitymarketing manager can trade-off between cost/revenues
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Responsibility Centre-Profit Centre: Illustrations contd

Manufacturing may be a profit centre to motivate , to guard against inferior quality Given selling price-ascertain profit Service & support units-maintenance, transportation, consulting, customer service units e.g. Singapore AirlinesSingapore Airlines Engineering Co.; Singapore Airport Terminal Services; Catering or laundry service in hospitals or trains

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Responsibility Centre-Profit Centre

Management Decision whether a Profit Centre-amount of influence (not necessarily control), a manager exercises on activities that affect profit Profit centre managers control over
a) product decisions; b) marketing decisions; c) procurement or outsourcing decisions.

If these are split among two or more managers, separating contribution of each may be difficult
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Responsibility Centre-Profit Centre

Advantages: + Quality of decisions improves + Speed of operating decisions increases + HQ relieved of day-to-day decisions & concentrates on policy matters + Managers autonomy- free to use imagination & initiative + Improves competitiveness + Profit consciousness motivates managers
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Responsibility Centre-Profit Centre

Disadvantages: Decentralised decision-makingmanagement relies on control reports rather than on personal knowledge Quality of decision at unit level may get reduced Lack of appropriate transfer price conflict of interests & demotivating Competition among responsibility centres undesirable cost consequences Emphasis on short-term profit rather 14 than long-term profits

Responsibility Centre-Profit Centre

Profitability Measurement: two types a). Management performance; how well Manager is doing? b). Economic Performance: How well Profit Centre is doing as an Entity? MCS design be addressed to (a) above Profit Centre economic performance measured by PAT Profit centre manager performance evaluated by Five different measures
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Responsibility Centre-Profit Centre

Responsibility Centre-Profitability Measures
Sales Rs.1000 Less Variable Expenses 780 CONTRIBUTION MARGIN 220 Less Fixed expenses in Profit Centre 90 DIRECT PROFIT 130 Less Controllable corporate charges 10 CONTROLLABLE PROFIT 120 Less othe corporate allocations 20 PBT 100 Less Taxes 40 PAT 60

(1)

(2)
(3) (4) (5)
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Profit Centre-Profitability Measures

1. Contribution Margin:reflects spread between revenue & variable expenses + since fixed expenses are beyond his control, manager should focus on maximising contribution -- wrong premise- fixed expenses are partially controllable -- Is Manager responsible for controlling employees efficiency & productivity?
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Profit Centre-Profitability Measures

Contd.
2) Direct Profit: reflects profit centres contribution to general overhead and co.s profit; traces expenses to the Centre --does not recognise motivational benefit of

charging HQ costs
3). Controllable Profit: considers Controllable expenses of HQ Since non-controllable HQ expenses are excluded, this cannot be directly compared with published data
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Profit Centre-Profitability Measures

Contd

4) PBT : all corporate O/H are allocated;

++ awareness of corporate allocated expenses 5) PAT: Profit after all expenses & imputed tax --Since decisions which affect PAT are taken at HQ tax allocation not appropriate ++ IT varies among profit centres, managers cant influence
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Responsibility Centre-Profit Centre

Responsibility CentreProfit Centre Sales Rs 1000 780 220 90 130 (2) 10 120 (3) 20 100 40 60 Sales Less Variable Expenses CONTRIBUTION MARGIN Less Fixed expenses in Profit Centre DIRECT PROFIT Less Controllable corporate charges

(I)

CONTROLLABLE PROFIT
Less other corporate allocations PBT Less Taxes PAT

(4)
(5)
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Responsibility Centre: Investment Measure

a). Total assets Available All business assets Exclude Idle assets

b). Total assets employed

c). Capital Employed

d). Net Worth

b) Less C. L
Capital + Reserves

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Responsibility Centre: Investment Measure Contd.

Current Assets: Extent to which Controllable by Divisional Manager When not directly identifiable: Allocate cash & Cash needs

Inventory Sales needs Receivables credit terms

Fixed Assets: Whether Book value- Gross, or Net, or Current values

Objectively measured; Not affected by accounting practices Treatment of :Off-B/S Items e.g. Lease; or : Intangibles
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Responsibility Centre- Performance Parameter

ROI vs. EVA +a comprehensive measure + a basis of comparison of divisions +a basis of investment divisions + reported in Financial statement - Too simple a decision Rule - Computation not easy - Lack Goal Congruence EVA is conceptually sound while ROI is more widely used
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Control System: Characteristics

Goal Congruence
Motivation Autonomy

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