Responsibility Accounting & Divisional Performance Measurement

The process of delegating decision authority and responsibility in an organization is known as

decentralization.

Large organizations are often decentralized or divisionalised, and different responsibility centers may
be created wherein individual managers have authority and control.

Types of responsibility centers:

A responsibility center may be defined as an area of responsibility which is controlled by an

individual.

Cost center: Managers are accountable for the costs incurred in that center. Performance evaluation
is done on the basis of cost variance being equal to the actual cost and the budgeted cost for a
period. In manufacturing organizations, production and service departments are cost centers.

Revenue center: Primarily responsible for generating sales revenue. The performance of a revenue
center is evaluated on the basis of actual revenue and budgeted revenue. The marketing manager of
a product line or the sales representatives are examples of revenue centers.

Profit center: Main purpose of this responsibility center is to earn profit. Both revenues and costs
are accumulated. Profit center managers aim at both production and sales of the product. Managers
are evaluated on the basis of budgeted profit and profit margin.

Investment center: Investment center is responsible for both profits and investments. The
investment center manager is therefore responsible for revenues, costs as well as investment in
operating assets. The manager is accountable for all items of assets including receivables, payables
as well as inventory.

Responsibility Accounting:

Also known as activity accounting, responsibility accounting refers to the process that reports how
well the managers have fulfilled their responsibility. It is an information system that personalizes
control reports by accumulating cost and revenue information according to defined responsibility
areas.

Managers are only charged with items and responsibility over which they can exercise direct control.
Goals defined for each area of responsibility should be attainable with efficient and effective
performance.

Measuring Divisional Performance:

1. Variance analysis
2. Profit: Divisional Revenues – Divisional Controllable Costs: G.P, N.P or CM ratio
3. Return on Investment (ROI) : Divisional Profit / Divisional Investment
ROI = Profit Margin x Asset Turnover = Operating Income / Sales x Sales / Capital Employed
4. Residual Income: Residual income is the net operating income of a division less the capital
charge on the investment in assets.
RI = Divisional NOI – (Investment in Divisional Assets x Minimum Required Rate of Return )
 Advantage of RI over ROI:
a. It helps in avoiding suboptimal decision making, as investments are not rejected just
because they lower the divisional ROI
b. It maximizes growth of the company and increases shareholders wealth by accepting
investment opportunities which earn a rate of return in excess of the cost of capital
Disadvantages of RI:
a. No satisfactory definition of ‘divisional profit’ and ‘divisional investment’.
b. Might be difficult to compute accurate cost of capital.

Illustration: ROI v. RI
I know headquarters wants us to add that new product line", said Dell Havasi, manager of
Billings Company's Office Products Division.
"But I want to see the numbers before I make any move. Our division's return on investment
(ROI) has led the company for three years and I don't want any let-down."
Billings Company is a decentralized wholesaler with five autonomous divisions.
The divisions are evaluated on the basis of ROI, with year-end bonuses given to the divisional
managers who have the highest ROIs.
Operating results for the company's Office Products Division for the most recent year are given
below:
Sales $ 10,000,000
Variable expenses 6,000,000
Contribution margin 4,000,000
Fixed expenses 3,200,000
Net operating income 800,000
Divisional operating assets 4,000,000

The company had an overall return on investment (ROI) of 15.00 % last year (considering all
divisions).
The Office Products Division has an opportunity to add a new product line that would require an
additional investment in operating assets of $ 1,000,000.
The cost and revenue characteristics of the new product line per year would be:

Sales $ 2,000,000
Variable expenses 60 % of sales
Fixed expenses $ 640,000
a. Compute the Office Products Division's ROI for the most recent year; also compute the
ROI as it would appear if the new product line is added. 
b. If you were in Dell Havasi’s position, would you accept or reject the new product line?
c. Why do you think headquarters is anxious for the Office Products Division to add the new
product line?
d. Supposing the company’s minimum required rate of return is 12%, and performance is
evaluated using Residual Income.
e. Compute the Office Products Division’s RI for the most recent year, and also the RI as it
would appear if the new product line is added.
f. Under the circumstances, if you were in Dell Havasi’s position, would you accept or reject
the new product line?