Professional Documents
Culture Documents
Responsibility Accounting and Segment Evaluation 1
Responsibility Accounting and Segment Evaluation 1
Responsibility Accounting and Segment Evaluation 1
Introduction
In a well- managed organization, responsibilities for specific functions among its employees are clearly
identified. A responsibility center is a specific unit of an organization assigned to a manager who is held
accountable for its operations and resources. Each manager’s performance is judged by how well he or
she manages those items under his or her control. In a budgeting program, each manager is assigned
responsibility for those items of revenues and costs in the budget that he or she is able to control. Each
manager is then held responsible for deviations between budgeted goals and actual results. This concept
known as Responsibility accounting is central to any effective profit planning and control system.
Centralized organization exists when decisions rest only to the top management. Decentralization
happens when the authority to make decisions is delegated to responsible officers in different
organizational units. Either decision model, centralization or decentralization, provides great results.
Managers have already realized they can produce more astounding results and accumulate more wealth by
doing things along with others. When top management rains, trusts, and delegates authority to capacitated
personnel operating decisions are made flexible, suitable, and faster leading to more satisfied and
delighted customers. These organizational attributes are needed to stay abreast and be relevant in a
competitive environment. This premise strengthens the practice of decentralization in managing large
organizations.
Figure 4.1 shown on the next page shows the basic difference among centralization, decentralization, and
empowerment in terms of the power to make organizational decisions.
Authority is the power to do or not to do, give orders, give command, give instructions, or make
decisions.
Accountability is the answerability on the consequences of what had been done, undone, or had not been
done.
Authority and responsibility must go together, one should not be present without the other. Authority
without responsibility is absolute power and absolute power corrupts absolutely. Responsibility without
authority is blind obedience, a plain servitude. Equationally, we could express that
Authority = Responsibility
As authority is shared to trusted men, responsibility must be performed in line with the principle of
accountability. The manner on how the authority is exercised and the effects of the acts performed to
fulfill a responsibility should be evaluated. This is the moving concept of accountability. Without it, there
would be no logical value of assessing how things are done and what have been done. Without
accountability, there would be no compelling reasons to evaluate performance fairly and objectively. In
an expanded equation, we could say:
Authority and responsibility would loose their intrinsic meanings without accountability. It is in this
context that the power of individuals is harnessed, extolled, and recognized. This principle gives birth to
the powerful idea of providing a reward system in organizations.
Responsibility Centers
A responsibility center is a unit within the organization which has control over costs, revenues and /or
investment funds.
An investment center manager decides on which strategic business opportunity should the company
undertake.
A profit center manager controls both the generation of income and incurrence of costs.
A cost center manager has a control or influence over the incurrence of costs.
The diagram on the next page shows the scope and relationships of these centers.
Figure 4.2 Responsibility Centers and Organizational Structure
In the hierarchical organizational design presented above, there are six levels starting from the corporate
headquarter chief to the division heads down to the workers. The perspective of the discussions that will
follow gears towards a holding company operating domestically or internationally. The corporate
headquarter is headed by the Chief Executive Officer. The holding company has divisional units that are
legally separate and independent from it. A division is managed by a President with his Vice-Presidents to
assist him in running the affairs of the business.
Organizational designs
Organizational strategy precedes structure. The overall corporate strategy defines the powers and duty to
be assigned to a division manager based on organizational priority or emphasis in a given period of
performance. A division is an investment center or a business segment having its separately defined
business and financing activities from that of the parent or controlling company. The first layer of
organizational emphasis, for example, may be on the functional areas, product lines, or geographical areas
as depicted in Figure 4.3.
The layer of emphasis normally speaks of the overall strategy adopted by the enterprise. Figures 4.4 to 4.6
is an illustration on how people would be assigned throughout the organizational structure.
This organizational design emphasizes the strategic importance of product lines such as consumer
products, industrial products, agro-tourism related products, health and health related services, and the
like. Further, the said product lines may be sub-categorized into a more detailed products groups such as
tree planting and land development, organic farming, herbal products, and wellness city for the agro
tourism products.
Men shall be grouped along these lines and all other subsequent or lower business units would
subordinate their decisions, actions, and reports to the product line managers. The lines of powers and
duties will be delegated along these product lines areas and performances shall be evaluated accordingly.
It should be highlighted that in the creation of organizational designs the chief executive officer stays at
the top and the personnel at the bottom. The middle layers may be defined or rearranged according to the
strategies adopted by the organization.
The span of authority given to a manager defines the area over which he has controls. Controllability
refers to the power of the manager to decide or influence the incurrence or non-incurrence of an item,
event or activity. This concept of controllability is extremely important in measuring a person’s
performance where it states that a manager should be evaluated only on matters that he controls.
A responsibility center manager has to understand the breadth and depth of his authority. The authority to
the manager should commensurate with the responsibility assigned to him. Consequently, he is
accountable to his actions or inaction. This model stresses the need to evaluate managerial performance.
Figure 4.7. Responsibility Centers and Performance Evaluation
Performance Evaluation
A manager’s performance should be evaluated in line with the established objectives and standards of his
center. Different responsibility center managers should be evaluated differently inasmuch as their
authority, responsibility, and accountability vary from each other.
Reports submitted by a responsibility center manager should segregate the controllable from the non
controllable items. Managers’ performance should be measured for items they have control over with.
The techniques used in measuring managers’ performance are presented below:
A cost center manager has control or influence over the incurrence of non-incurrence of costs. The cost
center manager report should separate the controllable from the non-controllable costs and should
highlight the variances between the actual and budgeted costs.
Let us refer to the organizational chart shown in Fig. on page. Focus on department manager 2. He reports
to the Vice President for Product 2 and has 3 supervisors under him. An abbreviated example of a
department manager’s report is presented in Table 4.2 shown in the following page.
Variances are identified as either unfavorable (U) or favorable (F). Unfavorable variances indicate
excessive costs and should be avoided. Favorable variances mean savings, however, should also be
investigated.
The three (3) production supervisors have already submitted their respective reports to production
manager 2. The summary of these supervisors’ reports is captured in the departments manager’s report as
“cost center 1”, “cost center 2”, and “cost center 3” and included in the controllable items. The other
controllable costs are direct costs of operating department manager’s department. These items are
captured in the report of the Vice-President for Product 2 to be submitted to the Chief Operating Officer
as shown in Table 4.3 on page.
Controllable Costs Actual Budget Variance - U (F) Cost center 1 832,000 845,000.00 (13,000.00) F
Cost center 2 655,000 650,000.00 5,000.00 U Cost center 3 440,000 450,000.00 (10,000.00) F Direct
materials 590,000 580,000.00 10,000.00 U Direct labor 900,000 920,000.00 (20,000.00) F Indirect
materials 26,000 27,000.00 (1,000.00) F Fringe benefits 40,000 38,000.00 2,000.00 U Factory supplies
33,000 36,000.00 (3,000.00) F Electricity and water 20,000 25,000.00 (5,000.00) F
Telecommunications 18,000 12,000.00 6,000.00 U Gas and oil 9,000 10,000.00 (1,000.00) F Repairs
and maintenance 21,000 19,000.00 2,000.00 U Supervisors' salaries 92,000 90,000.00 2,000.00 U
Miscelleneous 44,000 47,000.00 (3,000.00) F Total controllable costs 3,720,000 3,749,000.00
(29,000.00) F
Noncontrollable Costs
Managers' salary 70,000.00 66,000.00 4,000.00 U Depreciation expense 90,000.00 95,000.00
(5,000.00) F Rent expense 22,000.00 26,000.00 (4,000.00) F Allocated costs 66,000.00
66,000.00 -
Total noncontrollable costs 248,000.00 253,000.00 (5,000.00) F Total Costs 3,968,000.00
4,002,000.00 (34,000.00)
When presented in the VP for Product 2’s report, the department manager’s 2 report becomes only a “line
item”. In the same way, the report of the VP for Product 2 to the Chief Executive Officer will also be
presented in a single line. At the end of the reporting line, the Chief Executive Officer has only a page of
report summarizing the vital information in the organization.
Table 4.3. Vice-President’s Performance Report
X Corporation
Vice-Presiden for Product 2 Performance Report September 9-15, 20CY
Controllable Costs Actual Budget Variance - U (F) Department Manager 1 3,336,000 3,350,000.00
(14,000.00) F Department Manager 2 3,720,000 3,749,000.00 (29,000.00) F Department Manager 3
2,290,000 2,300,000.00 (10,000.00) F Office Salaries 122,000 120,000.00 2,000.00 U Fringe benefits
20,000 24,000.00 (4,000.00) F Supplies 23,000 25,000.00 (2,000.00) F Electricity and water 33,000
38,000.00 (5,000.00) F Telecommunications 48,000 50,000.00 (2,000.00) F Gas and oil 19,000
17,000.00 2,000.00 U Miscelleneous 64,000 69,000.00 (5,000.00) F Total controllable costs 9,675,000
9,742,000.00 (67,000.00) F
Noncontrollable Costs
VP Production Salary 80,000.00 80,000.00 - Depreciation expense 300,000.00
300,000.00 - Allocated costs 466,000.00 466,000.00 - Total noncontrollable costs
846,000.00 846,000.00 -
A revenue center manager has control or influence in generating revenue but not of costs. His performance
report should show the variances between actual revenue and budgeted revenue. When the actual revenue
is greater than budgeted revenue, there is a favorable revenue variance, and vice-versa. A favorable
variance at a blush maybe given a commensurate reward and recognition however should be immediately
evaluated for learning and further improvements. While an unfavorable variance should be critically
studied to avoid its recurrence.
Responsibility centers that are responsible in developing and maintaining sources of supply such as
sources of materials and labor may also be classified as revenue centers.
A profit center manager has control over revenues and costs. his managerial performance is evaluated
based on controllable margin while the center’s performance is evaluated based on segment (or direct)
margin. The controllable margin and segment margin computations are presented below:
Deduct the allocated (or indirect or unavoidable) fixed costs and expenses from the segment margin and
you will get the operating profit. The difference between controllable margin and segement margin is
fixed cost and expenses controllable not by the concerned manager but by others.
The actual controllable margin and segment margin should be compared with the budgeted amounts to get
the variances and evaluate performances.
Bajada Corporation has been experiencing negative operating results in the last six quarters. Its most
recent income statement is as follows:
Sales P 6,300,000
Less: Variable costs 3,474,000
Contribution margin 2,826,000
Less: Fixed costs 2,906,000
Profit P (80,000)
The company operates three product lines which has the following related data:
Product 1 Product 2 Product 3 Total
Required: Compute the segment margin for each of the product lines and of the corporation. Evaluate the
data.
Solutions/ Discussions:
∙ The segment margins of the three product lines are determined as follows:
A B C Total
Sales 1,200,000 2,100,000 3,000,000 6,300,000 - Variable costs 672,000 882,000 1,920,000 3,474,000
Contribution margin 528,000 1,218,000 1,080,000 2,826,000 - Controllable direct fixed costs 220,000
880,000 800,000 1,900,000 Controllable margin 308,000 338,000 280,000 926,000 - Noncontrollable
direct fixed costs 220,000 100,000 800,000 1,120,000 Segment margin 88,000 238,000 (520,000)
(194,000) - Allocated fixed costs 102,000 102,000 102,000 306,000 Profit (loss) (14,000) 136,000
(622,000) (500,000)
∙ Product line B registers the best performance in terms of peso amount amounting to a segment
margin of P 238,000 and margin return on sales of 11% (i.e., P 238,000/ P 2,100,000). Product
line C produces a negative segment margin of P 520,000. This product line does not contribute to
the overall profitability of the company but rather reduces the overall amount of the company’s
profit by the amount of its negative segment margin. Product line C, based on the computations
above, should be disposed.
∙ In terms of individual segment manager’s performance, the manager of product line B still registers
the best performance posting a controllable margin of 16% (i.e., P 338,000/ P 2,100,000)
compared to that of product line C’s manager of 9% (i.e., P 280,000 / P 3,000,000) and that of
product line A’s manager of 3% (i.e., P 308,000/ P 1,200,000)
The investment center manager has authority to decide over which investment opportunity should be
considered and pour in the funds for investments. As such, their performance is evaluated based on the
results of investments. The cost-benefit criterion plays a vital role in the investment selection decision
process. The benefit refers to the returns derived from investments while the cost refers to the amount
used in undertaking the opportunity.
There are several models in evaluating investment center performance. Some of these are the return on
equity, return on investment (DuPont Model), residual income, economic value added, equity spread, total
shareholders return, and the market value added.
The ROI is sometimes referred to as return on assets (ROA), or accounting rate of return (ARR). It is
computed as follows:
Take a second look, you will notice that the ROI is a measure of benefit over cost analysis. Benefit is
represented by the segment profit while the cost is the amount of the segment investment which is
preferred to be the assets employed in the division.
The higher the ROI, the better it will be for the business. The issue, therefore, is how to increase ROI.
Quantitatively speaking, ROI is increased by increasing profit and reducing investment, as follows:
This model encourages investment center managers to wisely take investment only for those which are of
relevance to their operations. This will result to efficiency in allocating investment funds. Only those
investment of which the investment center manager has control and use in operations shall be included in
the ROI determination.
Frances Beau Corporation’s balance sheet indicates that the company has P 5,000,000 investment in
operating assets. In 20CY, Frances Beau earned P 1,100,000 of profit on P 11,000,000 of sales.
Solutions/ Discussions:
The use of ROI has several limitations. Significant differences in the amount of investment from one
project to another and the difference in the life of the asset used in investment opportunities may render
the use of ROI difficult to apply. To highlight these limitations, consider the following:
Company A Company B
Return on investment 20% 40%
Amount of investment P 1 billion P 1 million
Life of assets in years 15 years 2 years
Using the ROI, company B manager with 40% ROI would be better off than that of company A manager
with 20% ROI. However, considering the amount of investment supervised by each manager respectively,
we could easily say that managing a million worth of business (e.g., Company B) is a lot much easier than
managing a billion worth of business resources (e.g., Company A).
Also, considering the life span of the assets used, company B’s performance is an utter dismay because
only 80% of the investment would be recovered in 2 years, which is the life of the investment, given a
40% ROI per annum. This performance falls short of recovering the entire amount of investment over its
operational life. Whereas company A has a total return of 300% (e.g., 20% x 15 years) which means
investment in company A is recoverable three times and is indeed better than the 80% recovery rate of
company B.
ROI model may not also be the most suitable method in evaluating the performance of an excellent
manager who is assigned to make a business turnaround performance, say to deliver a profitable
performance of a previously unprofitable operations.
The limitations encountered in applying the ROI is improved by the residual income model that uses
amount as a basis of evaluating the acceptance of a prospective investment or the performance of an
investment project. The residual income is computed as follows:
Segment income P x
Less: Minimum income x (Investment x Implied Interest rate) Residual income P
x
The segment income is income expressed before tax. Segment income also refers to earnings before
interest and tax (e.g., EBIT) or the operating profit. Minimum income is sometimes labeled as imputed
income, implied income, implicit income or desired income.
The investment base used in computing the minimum income is to the amount agreed upon by the
corporate headquarter and the investment center manager. The imputed interest rate is to be determined
by the corporate headquarter management. Normally, the imputed interest rate is based on the prevailing
market rate form which the business generates profit without accepting a high business risk. The imputed
rate is ordinarily the pre-tax cost of capital, and in principle, should reflect the degree of risk of the
reporting responsibility center. If the residual income is positive, the performance is above standard and
is, therefore, favorable.
Residual income is considered superior than the ROI because it considers two levels of assessments, the
compliance to minimum return and the size of the excess return over the same minimum return.
Solutions/ Discussions:
∙ The average industry rate of return, though may be considered in setting the minimum desired rate
of return, is different from the minimum rate of return.
∙ The desired minimum income is normally expressed in amount before tax, hence, it is compared
with operating income or segment profit.
∙ Since the residual income of a division is positive, the division has met the expectations or standards
set by top management in terms of profitability and is therefore considered acceptable.
The economic value added (EVA) is a more specific after-tax version of residual income. It represents the
business unit’s true economic profit because a change in the cost of equity capital is implicit in the cost of
capital. the cost of equity is an opportunity cost, that is, the return that could have been obtained with the
best alternative investment having similar risk. The EVA is computed as follows
Operating Profit After Tax (EBIT x after tax rate) P x Less: Minimum income
(Investment x Weighted Average Cost of Capital) x Economic value added P x
The operating profit after tax (OPAT) is computed by multiplying the earnings before interest and taxes
(EBIT) by the after-tax rate (i.e., 1-Tax rate). The weighted average cost of capital is computed after tax.
EVA measures the marginal benefit obtained by using resources in relation to the business of increasing
shareholders’ value. Some adjustments in EBIT are needed such as research and development (R&D)
costs which are capitalized and amortized over 5 years. The true economic depreciation rather than the
accounting depreciation used for tax purposes is to be used in computing the EVA.
Global Holdings operates Star Corporation, a division in electronics industry, and provided you the
following data with regard to the division’s 20CY performance:
Divisional income before interest and taxes P 200 million
Interest expense P 60 million
Tax rate 40%
Weighted average cost of capital 12%
Average total assets
Carrying amount P 90 million
Current value P 120 million
Average current liabilities P 40 million
Required: Economic value added (EVA) assuming the investment base is:
1. Market value of long-term financing.
2. Carrying amount of long term financing.
3. Market value of total assets.
4. Carrying amount of total assets
Solutions / Discussions:
1. Investment base is the market value of long-term financing.
The economic value added is a measure of the management effectiveness in increasing investor’s value.
The best investment base to use is the market value of the long-term financing. The market value is used
to reflect the true amount of investment and the exercise prudence in the process. also, long-term
financing is used to isolate the interest of the true investors from the short-term ones. Maximizing the
interest of long-term investors, both creditors and owners, are the real intentions of enterprise
management.
Other divisional evaluation models are equity spread, total shareholders’ return and market value added.
The equity spread, like the EVA, is also a straightforward method for measuring managerial
performance regarding creation of shareholder value. It is computed as follows:
References used:
Agamata, Franklin T. Management Services 2019 Edition. GIC Enterprises & Co., Inc, 2019
Cabrera, Ma. Elenita B. Management Accounting Concepts and Applications. GIC Enterprises
& Co., Inc, 2014