MCS - RBS

Chapter 4
Responsibility Centers:
Revenue & Expense Centers
By,
Sanjay Borad
MBA-Finance, CWA & B’Com
 Responsibility Centers
• 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 organization chart.
• Responsibility Center
– An organization unit for which a manager is
made responsible.
– CIMA, UK says – a segment of the organization
where an individual manager is held responsible
for the segment’s performance.
 RESPONSIBILITY CENTERS
RESPONSIBILITY CENTERS

Revenue Center Expense Center

Engineered EC Discretionary EC
 Nature of Responsibility centers
• A responsibility center exists to accomplish
one or more purposes, termed its objectives.
The company as a whole has goals, and
senior management decides on a set of
strategies to accomplish these goals.
• The objectives of the company’s various
responsibility centers are to help implement
these strategies.
• Since, every organization is the sum of its
responsibility centers, if each RC meets its
objectives the goals of the organization will
have been achieved.
 Relation between Inputs and Outputs
Management is responsible for establishing optimum
relationship between inputs and outputs.
Relationship

Direct and Causal Indirect

Relationship Relationship

R&D,
Production Advertisements

Control Focus: Control Focus:

Using Minimum Based on
Input to produce Judgment rather
required output. than data
 Measuring Inputs and Outputs
• Cost is the common expression of inputs of
responsibility centers. Cost is the monetary measure
of the amount of resources used by a responsibility
center.
• Inputs are resources used by the responsibility
center. Eg. Students in a school are not inputs.
Rather, inputs are the resources that the school uses
to accomplish the objective of educating the
students.
• It is much easier to measure the cost of inputs than
to calculate the value of output generated by
using those inputs.
 Efficiency and Effectiveness
• Efficiency is the ratio of outputs to inputs, or the
amount of output per unit of input.
• Efficiency is measure in comparison to others.
• RC-A is more efficient than RC-B if
– It uses fewer resources – same output
– It uses same resources – greater output
• Comparing with set standards have following flaws:
– Recorded costs are not precise measures of the resources
actually consumed
– The standard is merely an approximation of what ideally
should happen under certain situations.
 Efficiency and Effectiveness
• If a credit department handles the
paperwork connected with delinquent
accounts at a low cost per unit; it is efficient;
but it, at the same time, it is unsuccessful in
making collections, it is ineffective.
• Summary: a RC is efficient if it does things
right and its effective if does the right things.
 Responsibility Centers and the Role of Profit.

The Role of Profit:

• Major objective: Profit
• Its an important measure of effectiveness.
• Since, it’s the difference between
revenue (a measure of output) and
expense (a measure of input), it is also a
measure of efficiency.
• Manager of Responsibility Center would
– Establish goals
– Promote long-term interests
– Promote coordination of each responsibility center’s
activities
 Responsibility Centers
• Each RC consumes certain amount of resources
“INPUTS” and produces certain results “OUTPUT”
• Performance can be judged using Efficiency and
Effectiveness.
– Efficiency is ratio of output to input.
– Effectiveness is decided on the basis of its output and its
goals.
• According to the nature of inputs and outputs,
responsibility centers are classified into four types –
– Revenue Centers
– Cost Centers
– Profit Centers
– Investment Centers
 Revenue Center
• Prime concern of the REVENUE CENTER – “TOPLINE”
• Example of Revenue Center – Marketing Center.
• RC has no authority to decide price.
• RC is charged with cost of Marketing and not with
cost of goods produced, the net revenue is
considered for performance purpose.
• No formal relationship possible between I & O
• Performance Measure for the RC can be Revenue
Budgets.
 Revenue Center
Inputs Output
(Money directly RC’s (Sales Generated
spent on achieving TASK in money terms)
sales i.e. Mktg. Exp.)
Generate Sales

• Decision Rights –
– Promotion Mix
• Performance Measures –
– Maximize total sales for a given promotion budget
– Actual sales in comparison with budgeted sales
• Typically used when –
– RC manager has thorough knowledge about market
– Promotion plays significant role in generating sales
– RC manager can establish optimal promotion mix
– He can set optimal quantity and appropriate rewards
 Cost Center
• Cost Centers are held responsible for the
costs incurred but not for generating
revenue.
• A cost center can operate in two ways –
– At given cost budget, maximize the output.
• Ex – public relation dept.
– At given output level, minimize the cost.
• Ex – maintenance dept.
• Problem
– Quality of the output, safety issues, and ethical
and environmental factors may suffer. Since
there is no incentive to achieve them.
 Cost Center
Inputs RC’s Output
(Money spent on (Physical units
TASK
production) Produced)

• Decision Rights –
• Input Mix – Labor, Material, Supplies
• Performance Measures –
• Minimize total cost for a fixed output
• Maximize output for a given “cost budget”
• Typically used when –
• RC manager can measure output & quality of output
• Knows cost functions, optimal input mix
• Can set optimal quantity and appropriate rewards
 Cost Center
• Two types of Cost Centers
• Standard Cost Center or Engineered Expense
Center
– The objective of the manager here is to prevent or reduce
unfavorable variance between the actual and budgeted
costs, while maintaining the quality and quantity of outputs
at the desired levels.
• Ex – Manufacturing Concern.
• Discretionary Cost Center
– The objective of the manager here is to maximize the
services offered while keeping within the budgeted limits.
• Ex – Accounting, HR, R&D etc.
 Cost Center
Engineered Costs
o e.g. Manufacturing a product
o Can be established scientifically
o Cost varies with even small
fluctuations in volume
o Control is easier. Control starts with
planning & ends with finished task.
o Financial Performance measure
suffice the purpose of evaluation.
Discretionary Costs
o e.g. R&D Project
o Can not be established scientifically
o Costs varies with bigger volume
changes
o Review of task is the only control
measure for cost control. Control is
exercised during planning stage
itself, by way of establishment of
budget
o Financial as well as non financial
Performance measure need to be
considered
 General Control Characteristics – Discretionary Centers

• Budget Preparation
• Continuing work is done consistently from year to year –
preparation of financial statements.
• Special work is a one-shot project – developing and
installing a profit-budgeting system in a newly acquired
division.
• Technique used for preparing budget for discretionary
expense center is MBO – Management by Objective.
– Budgetee suggests the specific jobs and their
performance evaluation
– Incremental budgeting
• Their Drawbacks
– No reexamination of current levels of expenses
– Over focus
 General Control Characteristics – Discretionary Centers

• Zero Based Review

– Make a thorough analysis of each discretionary expense center.
– Certain important questions asked under this review
• Should the function under review be performed at all? Does it add
value to customers
• Quality levels ?????? Are we doing too much
• Should the function be performed this way
• How much should it cost?
• Cost Variability
• Type of Financial Control
– Manager should involve in planning about task selection, level of
efforts.
– Financial control is exercised at planning stage before incurring
costs.
• Measurement of Performance
– Mainly non financial in nature
– Cannot reward on the basis of spending less because that would
mean planned work is done.
 Administrative and Support Centers
• Administrative centers include senior
corporate management and business unit
management, along with the managers of
supporting staff units. Support centers are
units that provide services to other
responsibility centers.
• Control Problems
– Difficulty in Measuring output
– Lack of congruence
• between the goals of departmental staff and company
as a whole
 Research and Development Centers
• Control problems
– Difficulty in relating results to inputs
– Lack of goal congruence
• R&D Continuum
– One side: Basic Research
• Unplanned
• Big time lapse between research and successful new product
– Other side: Product Testing
• Possible to estimate the time and financial requirements
• As project moves on, the expenses increases. So, if
failure is smelt, then the project should instantly be
stopped.
 Research and Development Centers
• R&D Program
– No scientific way of determining the optimum
size of an R&D budget
– Some percentage is applied
• Compared to competitors
• Compared to own spending history
• Measurement of Performance
– No scientific performance measurement possible
 Marketing Centers
• Two different types of activities are grouped
under the heading of marketing
– Order getting – Marketing Activities
– Filling of order – Logistics Activities
• Logistics Activities
– Moves goods from company to customers, does
collection
– Similar to expense center
• Marketing activities
– Output (sales) is measureable but marketing
effort is not measureable.
Thank You