RESPONSIBILITY

CENTERS


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Responsibility Centers
It is an organisation unit, headed by a manager, who is
responsible for its activities
Nature of Responsibility Centers:
They implement strategies, decided by senior management to
accomplish organisation goals
It receives inputs in the form of materials, labor and services
and produces output in form of goods or services
Products may be provided to outside market or to another
responsibility center
Responsibility Centers
Relation between inputs and outputs:
Management is responsible for ensuring optimum relationship
between inputs and outputs
In some cases, relationship is casual and direct, while in
situations, inputs are not directly related to outputs
Measuring inputs and outputs:
Cost is a monetary measure of amount of resources used by the
center
It is much easier to measure cost of inputs than to calculate the
value of outputs
Responsibility Centers

Efficiency and effectiveness:
In many centers, efficiency is measure by comparing actual
costs with standard costs.
Effectiveness is determined by relationship between a
responsibility centers output and its objectives, generally it tends
to be measured in subjective, non-analytical terms.

Role of profit:
profit measures both efficiency & effectiveness
how to compare profligate perfectionist with frugal manager

Types of Responsibility Centers
Revenue
Marketing R & D Administrative
Engineered Discretionary
Expense Profit
Investment
Types of Responsibility Centers
Revenue centers:
Output is measured in monetary terms
No formal attempt is made to relate input to output
They are marketing or sales units not having the authority to set
selling prices and are not charged for the cost of goods that they
market
Actual sales or orders booked are measured against budget or
quotas and manager is held accountable for expenses incurred
within unit.

Types of Responsibility Centers
Expense centers:
Their inputs are measured in monetary terms
There are two types of expense centers engineered and
discretionary
Engineered costs are those, where proper amount can be
estimated with reasonable reliability e.g. direct labour,
components etc.
Discretionary costs are those, where no engineered estimate is
feasible and costs incurred depend on management judgements

Engineered Expense Centers
Their input can be measured in monetary term and output can be
measured in physical terms
Optimum rupee amount of input for one unit of output can be
determined
Output multiplied by standard cost of each unit produced
measures cost of finished product
Their supervisors are responsible for quality of products and
volume of production with efficiency

Discretionary Expense Centers
It reflects managements decisions regarding certain policies,
whether to match or exceed marketing efforts of competitors, level
of service company should provide and appropriate amounts to
spend for R & D, financial planning etc.
One company may have a small headquarters staff, while other
company of similar size and in same industry may have a staff 10
times as large
Difference between budget & actual expense is not taken as
efficiency but simply difference between the budgeted input and
actual input.
General Control Expense Centers
Budget preparation:
management makes decisions for engineered centers based on
proposed operating budget representing unit cost of efficient
performance
For discretionary center, management determines magnitude of
the job to be done
Work done by discretionary center is either Special or
Continuing
For discretionary center, MBO is done, where budgetee
proposes to accomplish specific jobs and suggests performance
evaluation measures
General Control Expense Centers
Incremental Budgeting (Discretionary Center):
Current level of expenses are adjusted for inflation, anticipated
changes in workload of continuing job etc.
Centers current level of expenditure is accepted & not
reexamined during budget preparation process
Managers typically want to increase level of services and thus
request for additional resources which are usually provided
General Control Expense Centers
Zero-Base Review (Discretionary Center):
Resources actually required to carry out each activity are
estimated from scratch
New base is established at which annual budget review attempts
to keep costs in line with base until the next review after five years
Certain basic questions are often raised like:
Should review be performed ? Does it add value from
customers viewpoint ?
What should be quality level ?
General Control Expense Centers
Should function be performed in this way ?
How much does it cost ?
Information from other sources like similar units, trade
associations, is useful for comparison
Zero-based reviews are time-consuming and likely to be
traumatic for managers
Manages may try to show that such reviews are worthless,
justifying current level of expenses
In later 1980s and 1990s, companies conducted such reviews,
which were called downsizing
General Control Expense Centers
Cost Variability:
Costs in discretionary centers are insulated from short-run
volume changes unlike engineered
Once managers of discretionary centers hire additional
personnel or plan for attrition, it is uneconomical to adjust work-
force for short-term fluctuations
Type of Financial Control:
For engineered center, objective is to become cost competitive
by setting a standard
General Control Expense Centers
For discretionary center, costs are controlled by managers
participation in planning regarding tasks to be done and level of
effort required
Measurement of Performance:
In discretionary centers, unlike engineered, financial
performance report is not the measure of efficiency of the manager
For discretionary centers, control over spending is done by
requiring superiors approval before budget is overrun, however,
certain overrun ( 5%) is permitted
Administrative and Support Centers
Control Problems:
Difficulty in measuring output
some staff activities e.g. payroll accounting are so
routinised that their units are engineered centers
In other activities, principal output is advice and
service impossible to quantify and evaluate
Lack of goal congruence
Typically managers of administrative staff strive for
functional excellence, but, how to define excellence, is a big
question.


Administrative and Support Centers
Severity of these two problems, is directly related to size and
prosperity of the company
In small & medium-sized businesses, senior management is in
close personal contact with staff units and can determine what they
are doing
In businesses with low earnings, regardless of size, discretionary
expenses are kept under tight control
Support centers often charge other responsibility centers for their
services e.g. MIS department charging others for computer services
Administrative and Support Centers
Budget Preparation:
Proposed budget contains section covering basic costs of the
center including costs of being in business plus costs of all
necessary activities for which no decisions are required
A section covers discretionary activities of center, including
objectives and estimated cost
A section explaining all proposed increases in the budget other
than inflation is also there
Amount of detail depends on importance of expenses and
desires of management
Research & Development Centers
Control Problems:
Difficulty in relating results to inputs:
Output is semi-tangible like patents, new product
Completed product may take several years
For evaluation, technical nature of function may
defeat managements attempts to find efficiency
Lack of goal congruence:
Research manager typically wants to build best
research organisation money can buy
Research people lack sufficient knowledge to
determine optimum direction of research efforts
Research & Development Centers
R & D Continuum:
Basic research and product testing are at the two extremes of
the continuum
Basic research is unplanned and often introduction of a new
successful product takes a long time
In some companies, basic research is included as a lump sum in
budget, while, in others, there is no specific allowance but an
understanding that scientists and engineers can devote part of their
time in exploring interesting direction
Research & Development Centers

For product testing, it is possible to estimate time and financial
requirements with sufficient accuracy to permit comparison with
actuals
As project moves along continuum, amount spent per year tends
to increase and decision has to be taken to either continue or
terminate the project
Research & Development Centers
R & D Program:
There is no scientific way of determining size of budget
Many companies take it as % of revenues
Program consists of list of programs plus a blanket
allowance for unplanned work; usually reviewed annually
by senior management
Such reviews are conducted by a research committee
having CEO, research director and production & marketing
managers, who will make broad decisions as to projects to
expand, to cut back and to discontinue

Research & Development Centers
Annual Budgets:
If company has decided on a long-range R & D program,
then preparing the budget is simple
Calendarisation of the expected expenses for the period is
done
If budget is in line with strategic plan, approval is routine
helps in cash & personnel planning

Research & Development Centers
Measurement of Performance:
In many companies, management receives 2 types of
financial reports
One type compares latest forecast of total cost with
approved amount for each active project
Second type of report consists of comparison between
budgeted and actual expenses for each responsibility center
Neither report gives information regarding effectiveness
of research effort, such information is available in progress
reports
At regular intervals, usually monthly or quarterly, most
companies compare actual with budgeted expenses and
summary is available for managers at higher levels to assist
in planning future expenses and keeping at approved levels

Marketing Centers
In many companies, two different activities are grouped under
marketing order filling or logistics and order getting or
marketing
Logistics Activities:
Responsibility centers here are engineered expense centers that
can be controlled through imposing standard costs and adjusting
budgets to reflect these costs at different volumes
In most companies, paperwork involved in filling orders and
collecting receivables is done quickly and at low cost by using
Internet
Marketing Centers
Marketing Activities:
It is much more difficult to evaluate marketing efforts
effectiveness than measuring its output
In any case, meeting budgetary commitment for marketing
expenses is not a major criterion in evaluation process as
impact of sales volume on profits tends to overshadow cost
performance
Control techniques applicable to logistics are not generally
applicable to marketing activities
Most companies budget marketing expenses as % of
budgeted sales due to hopes of higher sales

Marketing Centers
In short, there are three activity measures
Order-filling or logistics has engineered expenses as costs
Generation of revenue is usually evaluated by comparing actual
revenue and physical quantities sold with budgeted revenue and
budgeted units respectively
Order-getting costs are discretionary as no one knows what
should be the optimum amount, hence measurement of
efficiency & effectiveness for these costs is highly subjective in
nature