CIMA Paper P2

Advanced Management Accounting

Ian Kusano and Nathi Thela
 Chapter 5 Responsibility Centres

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 Learning Objectives
Lead B1: Discuss decision making in responsibility centres

Component B1a): Discuss the information needed for decision

making in different organisational structures
-Relevant cost information for cost centre managers: controllable and
uncontrollable costs and budget flexing.

-Relevant revenue and cost information for profit and investment

centre managers: cost variability, attributable costs, controllable
costs and identification of appropriate measures of profit centre
'contribution'.

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 Session Content

Cost Centres, Profit Centres

and Investment Centres

Organisation Residual Behavioural

ROI
Structure Income Issues

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 Decentralization/ Divisionalisation
Decentralisation seeks to overcome the problem of
managing a large organisation by creating a structure based
on several autonomous decision-making units.

Objective
1. Promote goal congruence
2. Increase motivation of management
3. Reduce head office bureaucracy
4. Provide better training for junior and middle management
Problems
Divisions make decisions in their own best interests, but which are not
good from the company point of view. The problem is overcome by
introducing a suitable system of performance evaluation.
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 Objectives of Performance Evaluation
1. Promote goal congruence
2. Encourage initiative and motivation
3. Provide feedback to management
4. Encourage long-term rather than short-term views

These objectives can only be achieved with the introduction of

responsibility centres.
- Cost Centres
- Profit Centres
- Investment Centres
In responsibility accounting, a specific manager is given the
responsibility for a particular aspect of the budget, and within the budgetary
control system, he or she is then made accountable for actual
performance.

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 Objectives of Performance Evaluation
In responsibility accounting, a specific manager is given the responsibility
for a particular aspect of the budget, and within the budgetary control
system, he or she is then made accountable for actual performance.

The area of operations for which a manager is responsible is called a

responsibility centre.

Each cost centre, profit centre and investment centre should have its own
budget, and its manager should receive regular budgetary control
information relating to the centre, for control and performance
measurement purposes.

If the principle of controllability is applied, a manager should be made

responsible and accountable only for the costs (and revenues) that he or she
is in a position to control.
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 Behavioural aspects of Budgeting
• Participation in the budget setting process will improve motivation,
which in turn will improve the quality of budget decisions and the efforts of
individuals to achieve their budget targets

• There are two ways in which a budget can be set:

Imposed Participative

• Top down • Bottom up

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 Behavioural aspects of Budgeting
Top-Down Approach to budgeting:
'a budget allowance which is set without permitting the ultimate budget
holder to have the opportunity to participate in the budgeting process'

Advantages
• Time efficient
• Managers may not have the skills or motivation to participate usefully in
the budgeting process.
• Senior managers have a better overall view of the company and its
resources and may be better-placed to create a budget which utilises
those scarce resources to best effect.
• Senior managers also are aware of the longer term strategic objectives of
the organisation and can prepare a budget which is in line with that
strategy.
• Avoid budgetary slack or biasness
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 Behavioural aspects of Budgeting
Advantages
• Managers cannot use budgets to play games which disadvantage other
budget holders.
• By having the budgets imposed by senior managers, i.e. someone outside
the department, a more objective, fresher perspective may be gained.

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 Behavioural aspects of Budgeting
Participative budgets

'a budgeting system in which all budget holders are given the opportunity
to participate in setting their own budgets‘
Advantages
• The morale of the management is improved. Managers feel like their
opinion is listened to, that their opinion is valuable.

• Managers are more likely to accept the plans contained within the budget
and strive to achieve the targets if they had some say in setting the budget,

• The lower level managers will have a more detailed knowledge of their
particular part of the business than senior managers and thus will be able
to produce more realistic budgets.
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 Behavioural aspects of Budgeting
Participative budgets

'a budgeting system in which all budget holders are given the opportunity
to participate in setting their own budgets‘
Advantages
• The morale of the management is improved. Managers feel like their
opinion is listened to, that their opinion is valuable.

• Managers are more likely to accept the plans contained within the budget
and strive to achieve the targets if they had some say in setting the budget,

• The lower level managers will have a more detailed knowledge of their
particular part of the business than senior managers and thus will be able
to produce more realistic budgets.
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 Behavioural aspects of Budgetary Control
Another very important aspect of budgetary control systems is its impact on
the human beings who will operate and be judged by those systems.

• Specific behavioural issues encountered in budgeting include the

following:

-Motivation and co-operation

-Failure of goal congruence

-The budget as a pot of cash

-Budget negotiation

-Influence on accounting policies

-Budget constrained management styles

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