Responsibility Accounting

Responsibility Accounting

An accounting system that

provides information . . .

Relating to the To evaluate

responsibilities of managers on
individual managers. controllable items.

9-2 Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

 Decentralization
Decentralization
often occurs as
Top organizations
M anagem ent
continue to grow.

M id d le M id d le
M anagem ent M anagem ent

S u p e r v is o r S u p e r v is o r S u p e r v is o r S u p e r v is o r

Decision Making is Pushed Down

9-3 Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

 Decentralization

Promotes better Improves

decision making. productivity.

Improves Develops
performance lower-level
evaluation. managers.

Advantages
Allows upper-level management to
concentrate on strategic decisions.

9-4 Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

 Responsibility Reports

Responsibility
Reports
Prepared for each
individual who st
has control over C o

revenue or
expense items

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 Responsibility Reports

 Prepare budgets for  Measure performance of

each responsibility center. each responsibility center.

 Prepare timely performance reports

comparing actual amounts with budgeted amounts.
9-6 Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
 The Controllability Concept
Successful
Successful implementation
implementation of of responsibility
responsibility
accounting
accounting depends
depends onon clear
clear lines
lines of
of authority
authority
and
and clearly
clearly defined
defined levels
levels of
of responsibility.
responsibility.

B o a r d o f D ir e c t o r s

P r e s id e n t

V ic e P r e s id e n t V ic e P r e s id e n t V ic e P r e s id e n t
o f F in a n c e o f O p e r a t io n s o f M a r k e t in g

S to re M a n a g e r

D e p a rtm e n t M a n a g e r
9-7 Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
 Management by Exception and the
Degree of Summarization
Amount of detail varies according
to level in organization.

Department Store manager receives

manager receives summarized information
detailed reports. from each department.
9-8 Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
 Management by Exception and the
Degree of Summarization
Amount of detail varies according
to level in organization.
Management by exception
Upper-level management
does not receive operating
detail unless problems arise.

The vice president of operations

receives summarized information
from each store.
9-9 Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
 Qualitative Reporting Features
To be of maximum benefit, responsibility
reports should . . .
 Be timely.
 Be issued regularly.
 Be understandable.
 Compare budgeted
and actual amounts.

9-10 Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

 Responsibility Centers
 A responsibility center is the point in an
organization where the control over
revenue or expense is located, e.g.
division,department or a single machine.
 A responsibility center may be divided
into three categories
 cost
 profit
 investment

9-11 Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

 Types of Responsibility Centers

Cost Center
A business
segment that
incurs expenses st
but does not C o

generate revenue.

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 Types of Responsibility Centers

Profit Center Revenues

A part of the Sales
business that has Interest
Other
control over both Expenses
revenues and Manufacturing
Commissions
expenses, but no
Salaries
control over Other
investment funds.

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 Types of Responsibility Centers

Investment Center
A profit center
where management
also makes capital
investment
decisions.

Corporate Headquarters

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 Measuring Managerial Performance
Evaluation Measures
Cost control
Cost
Quantity and quality
Center
of services

Profit
Profitability
Center

Investment Return on investment (ROI)

Center Residual income (RI)

9-15 Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

 Return on Investment
Return on investment is the ratio of
income to the investment used to
generate the income.

Net Income
ROI =
Investment

9-16 Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

 Return on Investment

Net Income
ROI =
Investment

ROI = Net Income Sales

×
Sales Investment

Margin
Margin Turnover
Turnover

9-17 Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

 Return on Investment

Cola Company reports the following:

Net Income $ 30,000

Sales $ 500,000
Investment $ 200,000

Let’s calculate ROI.

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 Return on Investment

ROI = Net Income Sales

×
Sales Investment

ROI = $30,000 $500,000

×
$500,000 $200,000

ROI = 6% × 2.5 = 15%

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 Improving R0I
 Reduce
Expenses
 Increase  Reduce
Sales Investment

Three ways to improve ROI

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 Improving R0I

 Cola Company’s manager was able to

increase sales to $600,000 which
increased net income to $42,000.
 There was no change in investment.

Let’s calculate the new ROI.

9-21 Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

 Improving R0I

ROI = Net Income Sales

×
Sales Investment

ROI = $42,000 $600,000

×
$600,000 $200,000

ROI = 7% × 3 = 21%
Cola Company increased ROI from 15% to 21%.

9-22 Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

 ROI - A Major Drawback
 As division manager at Cola Company,
your compensation package includes
a salary plus bonus based on your division’s
ROI -- the higher your ROI, the bigger your bonus.
 The company requires an ROI of 20% on all new
investments -- your division has been producing
an ROI of 30%.
 You have an opportunity to invest in a new project
that will produce an ROI of 25%.
As division manager would you
invest in this project?

9-23 Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

 ROI - A Major Drawback
Gee . . .
I thought we were
supposed to do what
was best for the
company!
As division manager,
I wouldn’t invest in
that project because
it would lower my pay!

9-24 Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

 Residual Income
Earned Income
– Investment charge
= Residual income

Investment
× Desired ROI
= Investment charge

Investment center’s
cost of acquiring
investment capital
9-25 Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
 Residual Income

 Cola Company has an opportunity to

invest $100,000 in a project that will
earn $25,000.
 Cola Company has a 20 percent desired
ROI and a 30 percent ROI on existing
business.

Let’s calculate residual income.

9-26 Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

 Residual Income

Investment = $100,000
× Desired ROI = 20%
= Investment charge = $ 20,000

Investment center’s
cost of acquiring
investment capital
9-27 Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
 Residual Income
Earned Income = $25,000
– Investment charge = 20,000
= Residual income = $ 5,000

Investment = $100,000
× Desired ROI = 20%
= Investment charge = $ 20,000

Investment center’s
cost of acquiring
investment capital
9-28 Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
 Residual Income

 As a manager at Cola
Company, would you
invest the $100,000 if
you were evaluated
using residual income?
 Would your decision be
different if you were
evaluated using ROI?

9-29 Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

 Residual Income
Residual income encourages managers to
make profitable investments that would
be rejected by managers using ROI.

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 Transfer Pricing

Let’s change topics!

9-31 Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
 Transfer Pricing

The
The amount
amount charged
charged when
when one
one division
division
sells
sells goods
goods or
or services
services to
to another
another division.
division.

Batteries

Battery Division Auto Division

9-32 Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

 Transfer Pricing

The
The transfer
transfer price
price affects
affects the
the profit
profit measure
measure for
for
both
both the
the selling
selling division
division and
and the
the buying
buying division.
division.

A higher transfer
price for batteries
means . . .

Battery Division Auto Division

greater profits for lower profits for
the battery division. the auto division.
9-33 Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
 Transfer Pricing

The
The ideal
ideal transfer
transfer price
price allows
allows
each
each division
division manager
manager to to make
make
decisions
decisions that
that maximize
maximize thethe
company’s
company’s profit,
profit, while
while
attempting
attempting toto maximize
maximize thethe
division’s
division’s profit.
profit.

9-34 Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

 Setting Transfer Prices
Market-based
Market-based transfer
transfer prices
prices are
are
preferred
preferred because
because they
they promote
promote
efficiency
efficiency and
and fairness.
fairness.

When market prices are not available,

companies may use . . .
 Cost-based prices
 Negotiated prices

9-35 Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

 Negotiated Transfer Price
A
A system
system where
where transfer
transfer prices
prices are
are arrived
arrived
at
at through
through negotiation
negotiation between
between managers
managers ofof
buying
buying and
and selling
selling divisions.
divisions.

Excessive
Excessive management
management
time
time may
may bebe used
used in
in the
the
negotiation
negotiation process.
process. May
May not
not be
be in
in the
the
best
best interest
interest ofof
the
the company.
company.

9-36 Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

 Cost-Based Transfer Prices
Cost-based
Cost-based transfer
transfer prices
prices are
are the
the
least
least desirable
desirable because
because thethe incentive
incentive
to
to control
control cost
cost is
is diminished.
diminished.

When
When used,
used, cost-based
cost-based transfer
transfer prices
prices .. .. ..
 Are either variable cost or full cost.
Are either variable cost or full cost.
 Should use standard rather than actual costs.
Should use standard rather than actual costs.

9-37 Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

 Setting Transfer Prices

Conflicts may arise between the company’s

interests and an individual manager’s interests
when transfer-price-based performance
measures are used.

9-38 Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

 End of Chapter 9
Let’s transfer some of
your capital to me so
that my rate of return
will be higher!

9-39 Copyright © 2003 McGraw-Hill Ryerson Limited, Canada