Responsibility Accounting G.

Ong
Responsibility accounting involves accumulating and reporting costs (and revenues, where relevant) on the
basis of the manager who has the authority to make the day-to-day decisions about the items. Under
responsibility accounting, a manager’s performance is evaluated on matters directly under that manager’s
control. Responsibility accounting can be used at every level of management in which the following
conditions exist.
A. Costs and revenues can be directly associated with the specific level of management responsibility.
B. The costs and revenues can be controlled by employees at the level of responsibility with which they are
associated.
C. Budget data can be developed for evaluating the manager’s effectiveness in controlling the costs and
revenues.

Responsibility accounting is especially valuable in a decentralized company. Decentralization means that

the control of operations is delegated to many managers throughout the organization. Decentralized
organizations need responsibility accounting systems that link lower-level managers’ decision-making
authority with accountability for the outcomes of those decisions.

The term segment is sometimes used to identified an area of responsibility in decentralized operations.
Under responsibility accounting, companies prepare segment reports periodically, such as monthly, quarterly,
and annually, to evaluate managers’ performance.

The term responsibility center is used for any part of an organization or a segment whose manager has control
over and is accountable for cost, profit, or investments.

Reasons for Decentralization

Firms decide to decentralize for several reasons, including the following:
 ease of gathering and using local information.
 focusing of central management.
 training and motivating of segment managers.
 enhanced competition, exposing segments to market forces.

Advantages and Disadvantages of Decentralization

The major advantages of decentralization include:
1. Top management freed to concentrate on strategy.
2. Lower-level managers gain experience in decision making.
3. Decision making authority leads to job satisfaction.
4. Lower-level decisions often based on better information.
5. Lower-level managers can respond quickly to customers.

The major disadvantages of decentralization include:

1. Lower-level managers may make decisions without fully understanding the company’s overall strategy.
2. If lower-level managers make their own decisions independently of each other, coordination may be
lacking.
3. Lower-level managers may have objectives that clash with the objectives of the entire organization.
4. Spreading innovative ideas may be difficult in a decentralized organization. Someone in one part of the
organization may have a terrific idea that would benefit other parts of the organization, but without strong
central direction the idea may not be shared with, and adopted by, other parts of the organization.

Responsibility Centers
A responsibility center is a functional entity within a business that has its own goals and objectives,
dedicated staff, policies and procedures, and financial reports. It is used to give managers specific
responsibility for revenues generated, expenses incurred, and/or funds invested. This allows the senior
managers of a company to trace all financial activities and results of a business back to specific employees.
Doing so preserves accountability, and may also be used to calculate bonus payments for employees.
Responsibility Accounting G. Ong
There may be many responsibility centers in a business, but never less than one such center. Thus, a
responsibility center is usually a subset of a business. These centers are usually stated on a firm’s
organization chart.

From an accounting perspective, a financial report should be issued to each responsibility center that
itemizes the revenues, expenses, profits, and/or return on investment for which the manager of each center
is solely responsible. This can result in quite a large number of customized reports being issued on an
ongoing basis.

The use of multiple responsibility centers requires a certain amount of corporate infrastructure to develop
each center, track its results, and manage expectations with the various managers.

Responsibility Centers

Investment Center Profitability Center Cost Center

The Center Manager

The Center Manager
shall be responsible for
the cost, profits, losses
and assets to be used
and for making the
center's decision.
Example: Subsidiary
companies
The Center Manager
shall be responsible for
the costs and revenues
incurred within the
center and for the
decision-making of the
center. Example:
Marketing department.
shall be responsible for
the cost incurred
within the center and
for the decision-
making of the center.
Example: accounting
department.
Production
department.

Evaluation of Cost Center:

– Based on manager’s ability to meet budgeted goals for controllable costs. Responsibility reports for cost
centers compare ACTUAL CONTROLLABLE COST with FLEXIBLE BUDGET DATA.
– Only controllable cost are included in the report, fixed and variable costs are not distinguished.
Favorable
Controllable Cost Budget Actual Unfavorable
Indirect materials 135,000 140,000 5,000 U
Indirect labor 180,000 170,000 10,000 F
Utilities 45,000 46,000 1,000 U
Supervision 40,000 40,000 0
400,000 396,000 4,000 F

Evaluation of Profit Center:

– In profit center, the operating revenue and variable expenses are controllable by the manager of the profit
center.
– To determine the controllability of fixed cost, it is necessary to determine between direct and indirect fixed
costs.
a. Direct fixed cost / Traceable cost – are costs that are specifically incurred by a responsibility center.
Most of direct fixed cost are controllable by the profit center manager.
b. Indirect fixed cost / Common costs – pertains to a company’s overall operating activities and are
incurred for the benefit of more than one profit center. Therefore, most of these costs are
uncontrollable by the profit center manager.
Responsibility Accounting G. Ong
Illustration 1: Midwest Division operates as a profit center. It reports the following for the year:
Budget Actual
Sales ₱ 1,500,000 ₱ 1,700,000
Variable costs 700,000 800,000
Controllable fixed costs 400,000 400,000
Noncontrollable fixed costs 200,000 200,000
Required: Prepare a responsibility report for the Midwest Division for December 31, 2023.

Solution:
Favorable
Budget Actual Unfavorable
Sales ₱ 1,500,000 ₱ 1,700,000 ₱ 200,000 F
Variable costs 700,000 800,000 100,000 U
Contribution margin ₱ 800,000 ₱ 900,000 ₱ 100,000 F
Controllable fixed cost 400,000 400,000 0
Controllable margin ₱ 400,000 ₱ 500,000 ₱ 100,000 F
**Noncontrollable fixed costs are not reported anymore.

Illustration 2: Ella Holding is a conglomerate engaged in real estate, manufacturing, power, retailing and
banking. Its power plant segment, Electro Corp has shown the following data for the current year ended,
December 31.
Revenue ₱ 3,000,000
Variable costs 1,000,000
Fixed costs controllable by Electro’s manager 800,000
Fixed costs controllable by Ella Co’s President traceable to Electro Corp. 1,100,000
Ella Holding’s head office’s common costs to be allocated to its business units
(25%) of these expenses were allocated to Electro Corp. 800,000
Required: Prepare a segmented income statement of Electro Corp.(which is for internal use only)

Revenue ₱ 3,000,000
Variable cost (1,000,000)
Contribution margin ₱ 2,000,000
Fixed Cost Controllable/Traceable (800,000)
Segment Controllable Margin ₱ 1,200,000
Fixed Cost Uncontrollable/Traceable (1,100,000)
Segment margin ₱ 100,000
Allocation of Common cost (800,000 x 25%) (200,000)
Operating Income / Loss ₱ (100,000)
Usage: To evaluate the person in-charge, the Electro’s manager, then we have to use Segment controllable
margin which is ₱1,200,00. Because it only include the variable cost, and the controllable cost of the
segment.
To determine the performance of the segment, then we have to use Segment margin as our basis of
Evaluation. Because it include all cost that are traceable or incurred by the segment. We cannot use
Operating income/loss, because it includes allocations that are determine by higher management
which is not controllable or traceable by the segment manager.

Evaluation of Investment Center:

– Unlike profit center we are concern whether revenue exceeded the cost, thus earning a profit. However,
aside from the profit, the manager of an investment center is also accountable for the effective utilization
of the assets.
– Methods of evaluating investment center include ROI (return on investment), residual income, and
economic value added (EVA).
Responsibility Accounting G. Ong
Return on investment (ROI) – pertains to income generated relative to the amount of resource invested. It’s
the amount of profit earned out of the investment made.

ROI = Operating Income  Average Assets

Illustration: KNC Department of MBN Inc. has shown the following assets for the year ended, December 31,
2022 and 2023. Assets for 2023 is ₱2,000,000 and 2022 is ₱2,800,000.
Sales revenue ₱ 900,000
Cost of goods sold (100,000)
Gross profit ₱ 800,000
Operating expenses (200,000)
Operating income ₱ 600,000
Interest expense (100,000)
Profit before tax ₱ 500,000
Computation of ROI:
ROI = Operating Income  Average Assets ROI = ₱600,000  ₱2,400,000
Average assets = (₱2,000,000 + 2,800,000)/2 = 25.00%
= ₱2,400,000

Computation of ROI using Du Pont Equation:

ROI = Assets turnover (ATO) x Profit margin (PM)

ATO = Sales revenue PM = Income___

Investment Sales revenue

ROI = Sales revenue x Income__

Investment Sales revenue

ROI = ₱900,000 x ₱600,000

₱2,400,000 ₱900,000

= 37.5% x 66.67%
= 25.00%

Illustration: Geo, a manager of One product division, a segment of Happy Corp. with an average invested
capital of around ₱2,000,000. Geo boast One product division's ROI of 20%, which is higher than Happy's
required rate of return of only 12%. It is in the belief of the top executives in Happy Corporation that any
investment that gives the company a return of 12% is desirable and thus should be engaged in. Happy evaluates
its subordinate managers on the basis of ROI. A new project requiring an investment of ₱500,000 is available
and can give One product an additional ROI of 15%, i.e., it gives One an additional income of ₱75,000
(₱500,000 x 15%).
Required: Compute for the new ROI and compare with the current ROI of 20%, is there any sub-optimization
of resources, if Geo will decide to enter into the new project or not?

Current ROI = 20%, therefore, income would be ₱400,000 by multiplying 20% by ₱2,000,000 invested capital.

If taking the new project will give us a total profit of ₱400,000 + 75,000 = ₱475,000, with a new investment
of P2,000,000 + 500,000 = ₱2,500,000, therefore ₱475,000  ₱2,500,000 = 19%.

Conclusion: Even the new project will give overall 19%, but since One product division’s ROI is 20%, the
tendency is that you will not take the new project, which is incongruent with Happy Corp. ROI of 12%.
Therefore there is sub-optimization of project or opportunity.
Responsibility Accounting G. Ong
Residual Income – is the difference between operating income and the minimum peso return required on a
company’s operating assets:

Residual Income = Operating Income − (Minimum Rate of Return × Average Operating Assets)

Illustration: Using Happy Corp. information, :

A. Assuming that we are not going to take the new project that requires an investment of ₱500,000 is
available and can give One product an additional ROI of 15%

Residual Income = ₱400,000 – (12% x ₱2,000,000)

= ₱ 160,000

B. Assuming that we are going to take the new project that requires an investment of ₱500,000 is available
and can give One product an additional ROI of 15%

Residual Income = ₱475,000 – (12% x ₱2,500,000)

= ₱ 175,000

Summary
If the ROI of an investment is less than the expected ROI of the Division but greater than the minimum rate
of return. The investment will be considered desirable for TOP MANAGEMENT.

If the project will Division Manager will

Decrease the Division's ROI Reject the Investment
Increase the Division's RI Accept the Investment

Note: Goal Congruence (is a situation in which people in multiple levels of an organization share the same goal) is
attained if RI is used as the basis of evaluation!

Economic value added (EVA) – is after-tax operating income minus the peso cost of capital employed. The
peso cost of capital employed is the actual percentage cost of capital multiplied by the total capital employed,
expressed as follows:

EVA = Operating Income After-Tax – (Actual Percentage Cost of Capital × Total Capital Employed)

EVA = Operating Income After-Tax – (Assets – Operating Liabilities ) x Weighted Average Cost of Capital

Illustration: G Corporation has the following data:

Earnings before interest and taxes ₱ 8,000
Total Assets 40,000
Current Liabilities 4,000
Income tax rate 30%
Weighted Average Cost of Capital (minimum rate) 10%

EVA = OPAT – (Assets – Operating Liabilities ) x Weighted Average Cost of Capital

= ₱8,000 (1 – 30%) – [(40,000 – 4,000) x 10%]
= ₱5,600 – (36,000 x 10%)
= ₱5,600 – 3,600
= ₱ 2,000
Responsibility Accounting G. Ong

Note: ROI, Residual Interest and EVA are all financial aspect of evaluation. A summary on these 3 methods
are as follows:

Top Management Residual Income

Current Liabilities EVA -
Min. Rate of Return Assets Debt Bondholder /
Sub-Management Stockholder
Ordinary Shares

Residual Income – point of view of top management.

Minimum rate of return – point of view of, usually, sub-management.

EVA – point of view of capital provider, bondholders and stockholders.

Balance Scorecard
– integrated set of performance measures that are derived from and support the organization’s strategy.
– is a strategic management system that defines a strategic-based responsibility accounting system.
– it translates an organization’s mission and strategy into operational objectives and performance.
– Non-financial performance evaluation.
– Lead indicator of performance , says something about what is yet to happen.

The four perspectives measured by Balanced Scorecard:

1. The financial perspective is the most traditional view of the company. It employs financial measures of
performance used by most firms. Lag indicator, say something about what has happened.
2. The customer perspective evaluates the company from the viewpoint of those people who buy its products
or services. This view compares the company to competitors in terms of price, quality, product innovation,
customer service, and other dimensions.
3. The internal business perspective evaluates the internal operating processes critical to success. All critical
aspects of the value chain—including product development, production, delivery, and after-sale service—
are evaluated to ensure that the company is operating effectively and efficiently
4. The learning and growth (infrastructure) perspective defines the capabilities that an organization needs
to create long-term growth and improvement. This perspective evaluates how well the company develops
and retains its employees. This would include evaluation of such things as employee skills, employee
satisfaction, training programs, and information dissemination.

Cycle Time and Velocity (Internal Business Process measurement)

Cycle time can be applied to any activity or process that produces an output, and it measures how long it takes
to produce an output from start to finish. In a manufacturing process, cycle time is the length of time that it
takes to produce a unit of output from the time raw materials are received (starting point of the cycle) until
the good is delivered to finished goods inventory (finishing point of the cycle). Thus, cycle time is the time
required to produce one unit of a product (Time/Units produced).

Velocity is the number of units of output that can be produced in a given period of time (Units
produced/Time).

Productivity ratio is the ratio of output to input in manufacturing an item. How much output completed out
of the input used.
Responsibility Accounting G. Ong

Illustration: Assume that Frost Company takes 10,000 hours to produce 20,000 units of a product.

Required: What is the velocity in hours? Cycle time in hours? Cycle time in minutes?

Velocity = 20,000 units 10,000 hours = 2 units per hour

Cycle Time (hours) = 10,000 hours  20,000 units = 1/2 hour
Cycle Time (minutes) = 30 minutes

Cycle Time
Order made
Delivery Cycle Time

Prod. Starts Prod. Ends

Manufacturing Cycle
Time
Wait Process Move Inspect Queue
Time Time Time Time Time

 Wait time – Waiting time from orders being placed to start of production
 Queue time – Waiting time from start of production to completion, in line for the next process.
 Process time – the time spent on actual processing.
 Move time – transfer from one step to the next step.
 Inspection time – checking the quality of the product.

Illustration: Tree Co's finance manager has decided to use delivery performance measures for performance
evaluation. She requested the production manager to submit data that will be used for the evaluation. The
production manager submitted the following data, typical of the time involved to complete orders:
Waiting time from orders being placed to start of production 6 days
Waiting time from start of production to completion 2 days
Process time 7 days
Move time 4 days
Inspection time 1 days
Required: Compute the delivery cycle time and manufacturing cycle time.

Waiting time from orders being placed to start of production 6 days

Process time 7 days
Move time 4 days
Inspection time 1 days
Waiting time from start of production to completion 2 days
Delivery Cycle Time 20 days
Process time 7 days
Move time 4 days
Inspection time 1 days
Waiting time from start of production to completion 2 days
Manufacturing Cycle Time 14 days