Management Responsibility And

Performance Measurement
Areas to be covered:

 RESPONSIBILITY ACCOUNTING

 RESPONSIBILITY CENTRES

 PERFORMANCE MEASURES
Responsibility Accounting:
An accounting system under which responsibilities; like revenue and cost, are

assigned to managers (responsible persons);

RESPONSIBILITY CENTRE: A function or department of an organization that is

headed by a manager and the manager has direct responsibility for its performance is

known as a responsibility centre. Responsibility centres are usually divided into different

categories. Here describes cost centre, revenue centre, profit centre and investment

centre.
Responsibility Accounting:

1. Cost Centre: A cost centre is a production or service location, function, activity or

item of equipment for which costs are accumulated or a unit of an organization to which

costs can be separately attributed.

If a manager is responsible for costs attributable to his area of business, it means that the

manager is responsible for a cost centre. But manager is not responsible for shared or

apportioned costs, as these are not controllable for him.

Each cost centre will have a cost code and so all items of expenditure will be recorded

according to the correct cost code.

Responsibility Accounting:

2. Revenue Centre: A centre, which raises revenue and has no responsibility for costs.
Manager of revenue centre is accountable only for revenues. For example department

which obtains grants and donations for a charity, sales department

3. Profit Centre: A profit centre is a part of a business accountable for both cost and
revenue. Manager (likely to be a senior person) is responsible for costs as well as income

attributable to his area of business, it means that the manager is responsible for a profit

centre. It covers large area of operations. It might be an entire division within the

organization or there may be a separate profit centre for each product, brand, service etc.

There are likely to be several cost centres within a profit centre.

Responsibility Accounting:

4. Investment Centre: It refers to a profit centre with an additional responsibility for

capital investment. Manager of investment centre has the responsibility for profit in

relation to capital invested in his area. Mostly used in public sector organizations where

the organization is required to make a particular level of profit in relation to their fixed

assets (return on capital employed).

PERFORMANCE MEASURES
a. Performance Measures of Cost Centre
Productivity
• Output in relation to input.
• Efficiently utilization of resources.
• For example quantity of product produced in relation to the
resources that were put in.
• It measures how efficiently/how well resources are being used.

Examples:
• units produced per hour.
• units produced per employee.
• units produced per tonne of material, etc.

Total cost
Cost per unit =
Number of units produced

Example 1, 2, 3 & 12: Solve

b. Performance Measures of Revenue Centre
Sales are also called turnover, actual sales are usually measured
against.
• Targeted volume
• Targeted revenue
• Targeted market share

Other measures may include the following ratios:

Customer rejects or returns
Customer rejects or returns ratio = x 100
Total sales

Checks efficiency of quality control procedures

Late deliveries
Late deliveries ratio = x 100
Total deliveries

May be applied to sales made to customers (so checks efficiency of

production scheduling) May also be applied to goods received from
suppliers

Customer satisfaction questionnaires: e.g. in restaurants.

Performance Measures for Profit centers:
$
Sales XXXX
Cost of sales:
Opening stock X
Production XX
Closing stock (X)
(XX)
Gross Profit X
Selling/ marketing (X)
Distribution (X)
Administration (X)
(X)
Operating Profit/ Profit before Interest & Tax (PBIT) X
Interest (X)
Tax (X)
(X)
Net Profit X
c. Performance Measures of Profit Centre
1. Gross profit margin (%): Gross profit included only the pure trading
activities of the business.
Gross Profit
• Gross Profit Margin (%) = x 100
Total Sales

• Gross Profit = (Sales – direct material – direct labour –

direct expenses - Production overheads)

• Direct material: directly involved in production so they form a part

of the end/final product

• Direct labour: labour involved directly in making the product

• Direct expenses: directly related to production. It is rare for

expenses to be directly traceable to the product

• Production overheads = indirect material + indirect labour +

indirect expenses.
• Total sales = Cash Sales + Credit Sales
2. Operating profit Margin (%): It includes all the activities of the
business trading as well as non-trading activities.

Profit before Interest & TAX

• Operating profit = x 100
Total sales

• Operating profit = Sales – direct material – direct labour – direct

expenses – production overheads – non-manufacturing overheads
(excluding Interest & TAX)

3. Net profit margin (%):

Net Profit
• Net Profit = x 100
Total Sales
• Net profit = Sales – direct material – direct labour – direct expenses
– production overheads – non-manufacturing overheads (including
Interest & TAX)

If profit margin unsatisfactory means excessive cost or low selling

price.
4. Cost of sales ratio:
• When profit targets are not meet, cost to sales ratios are calculated
to determine in which area of cost does the problem lies

• Some examples of cost to sales ratios that may be calculated are:

Production Cost
• Production cost to sales ratio = x 100
Total Sales

• Production costs may further be analyzed through the following

subsidiary ratios:

• Material costs to sales ratio = (Material Cost/Total Sales) x 100

• Labour costs to sales ratio = (labour cost/Total sales) x 100

Production overheads
• Production overheads to sales ratio = x 100
Total sales
5. Non-manufacturing overheads to sales ratio:

• Distribution cost to sales ratio = (Distribution cost/Total Sales) x 100

• Admin costs to sales ratio = (Admin Costs/Total Sales) x 100

Example 5: A business has credit sales of $200,000 and cash sales of

$75,000. The production costs are $160,000 with selling costs of
$40,000 and admin costs of $20,000.

Required:
a) Find the gross profit margin
b) Find the operating profit margin

Solution:
Example 4, 10 & 11: Solve
Performance Measurement
It is not possible to measure output in terms of units produced for a

department making several different products. This problem can be overcome

by ascertaining the standard hours produced, for example the amount of

time, working under efficient conditions, it should take to make each product.

Standard hours for actual output = Standard hours per unit x Actual output.

Standards/Budgeted hours per Unit = Budgeted hours ÷ Budgeted units

produced
Performance Measurement
Activity ratio / Production volume ratio/Volume ratio:

This ratio measures how the overall production compares to planned levels. It

compares the number of standard hours equivalent to the actual work

produced and budgeted hours. It is calculated as,

Activity Ratio = Standard Hours For Actual Output x 100

Budgeted Hours
Performance Measurement
Capacity Ratio:

This ratio measures the extent of worker's capacity by their working

hour has been achieved in a period with the planned labour hours

utilization. It is calculated as,

Actual Hours worked x 100

Budgeted Hours
Performance Measurement
Efficiency Ratio:

This ratio measures the efficiency of the labour force by comparing

equivalent standard hours for product produced and actual hours

worked. The benchmark of efficiency is 100%. It is calculated as,

Standard Hours for Actual Output x 100

Actual Hours worked
Performance Measurement

Relationship between the three ratios:

Activity ratio = Efficiency ratio x capacity ratio

Performance Measurement
Example 6: Budgeted output for a month is 3,000 units. Budgeted time

for the production is 300 hours. The actual output in the month is 3,300

units in 320 hours. Calculate labour performance ratios?

Solution:
Example 7: Solve
d. Performance Measures for Investment Centre
1. Return on investment (ROI) also called return on capital employed
(ROCE). ROCE compares profit to capital that has been used to earn
that profit. It is calculated as follows:
Net profit before interest and tax OR Net Profit
ROCE = x 100
Capital employed

Where;
Capital employed = Net Assets = Fixed Assets + Current Assets –
Current liabilities

Average Capital employed should be used. This is because if the

company has purchased assets near the year end, they will be
included in the capital employed figure increasing the value of the
capital employed figure BUT the profits will only show one or two
months of the assets contribution in generating profits.

ROCE = Net Profit Margin x Asset Turnover

Example 8: Solve
2. RESIDUAL INCOME (RI): It is the measure of the centre’s profits after
deducting a notional interest cost. The formula is as follows:

Residual income = Profit before interest and tax + Profit from any
other investments – (Total Capital Employed x Notional interest rate)

Important: the amount of total capital employed is calculated by

including the non-operational investments as well.

Example 9: A division with capital employed of $400,000 currently

earns a ROI of 22%. It can make an additional investment of $50,000
for a 5 year life with nil residual value. The average net profit from
this investment would be $12,000 after depreciation of $2,000. A
notional interest charge amounting to 14% of the amount invested is
to be charged to the division each year. The residual income of the
division after the investment, will be?

Solution:
Example 13 & 14: Solve
c. Asset Turnover:
Asset turnover measures how efficiently the assets of the business are being used.
It is a measure of how well the assets of a business are being used to generate sales.
Asset turnover = sales
Capital employed
 The link between ROCE, Net Profit Margin and Asset Turnover

ROCE

Equals

Net Profit Margin x Asset turnover

Example 15: Solve
Practice Question: Home Assignment