Responsibility Centers: Revenue and

Expense Centers

GOUTHAM G SHETTY
GIRISH DEYANNAVAR
JOEL ROSHAN
RAGHU GOWDA
RANJINI
Definition:
A responsibility center is an organization unit that
is headed by a manager who is responsible for its
activities
Responsibility centers for a hierarchy
Lowest level :Sections, work shifts other
organisational units
Departments or Business units comprises
smaller units
Senior management and Board of Directors
Nature of Responsibility Centers
Accomplish one or more purpose or goal
Senior management decides on set of strategies or goal
Responsibility centers should implement these
strategies
Responsibility centers receive inputs in form of material,
labor and service
Revenues are amounts earned from providing these
outputs
Measuring Inputs and Outputs
Inputs are measured in hours of labor, quarts of oil,
reams of paper, and kilowatts hours of electricity
Monetary value is calculated by multiplying a physical
quantity by a price per unit (Cost)
Cost is monetary measure of amount of resources used
by a responsibility center
Performance Measurement
Efficiency is the ratio of outputs to inputs, or the
amount of output per unit of input
A responsibility center is more efficient if it uses fewer
resources than responsibility Center
Else if it uses the same amount of resources but
produces a greater output
Efficiency is measured by comparing actual cost with
standard cost
Effectiveness is measured by relationship between a
responsibility center’s output and its objectives
A organisation is efficient if it does things right and it
is effective if it does the right things
Role of Profit
Profit can be used to measure both Effectiveness and
Efficiency
But there may be conflict between the two
Types of Responsibility Centers
Revenue Centers : Output are measured in monetary
terms
Expense Centers: Inputs are measured in monetary
terms
Profit centers: both inputs and outputs are measured in
monetary terms
Investment centers: Relationship between investment
and profit is measured
Types of Expense centers
Engineered Expense centers
Discretionary Expense centers
Engineered Expense centers
Characteristics:
Input can be measured in monetary terms
Output can be measured in physical terms
Usually found in manufacturing operations
Eg. Distribution, trucking, warehousing and similar units
Discretionary Expense Centers
Includes administrative and support units
Eg. (Accounting, legal, industrial relations, public
relations, human resources)
These expenses are mostly based on the managements
expenses
In discretionary expense the difference between budget
and actual input and does not incorporate the value of
the output
General Control Characteristics
Budget Preparation
Incremental Budgeting
Zero Base Budgeting
Cost Variability
Type of Financial Control
Measurement of Performance
 Discretionary expense centers categories: continuing and special.

 Continuing work is done consistently from year to year

 Special work is a “one shot” project

 A technique often used in preparing a discretionary expense

center's budget is management by objectives, a formal process in
which a budgetee proposes to accomplish specific jobs and
suggests the measurement to be used in performance evaluation.
 Incremental Budgeting
 In this model, the discretionary expense center's current level of
expenses is taken as a starting point. This amount is adjusted for
inflation, anticipated changes in the workload of continuing job,
special job, and—if the data are readily available—the cost of
comparable jobs in similar units.

 Limitations :
1. Discretionary expense center's current level of expenditure is
accepted and not reexamined during the budget preparation process.

2. Managers of these centers typically want to increase the level of

services, and thus tend to request additional resources, as a result
overheads cost increases
Zero Base Review
 An alternative budgeting approach is to make a thorough
analysis of each discretionary expense center on a rolling
schedule, so that all are reviewed at least once every five years or
so. Such analysis is often called a zero-base review.
Advantages:
 It can help for comparative analysis with the benchmark

Limitation:
 Zero-base reviews are time-consuming
 Traumatic for the managers whose operations are being
reviewed (this is one reason for scheduling such reviews so
infrequently).
 Cost variability
 Cost in engineered expense centers, which are strongly affected by
short-run volume changes, costs in discretionary expense centers
are comparatively insulated from such short-term fluctuations.

 This difference stems from the fact that in preparing the budgets for
discretionary expense centers, management tends to approve
changes that correspond to anticipated changes in sales volume
 for example, allowing for additional personnel when volume is
ex­pected to increase, and for layoffs or attrition when volume is
expected to decrease. Personnel and personnel-related costs are
by far the largest expense items in most discretionary expense
centers; thus, the annual budgets for these centers therefore
tend to be a constant percentage of budgeted sales volume.

Limitations:
 Managers cannot adjust the work force for short-run
fluctuations; hiring and training personnel for short-run needs is
expensive, and temporary layoffs hurt morale.
Type of Financial control
 Financial control in discretionary expense centre is primarily exercised
at the planning stage before the cost are incurred where as in engineered
expense centre is different

Measurement of performance
 The primary job of a discretionary expense center's manager is to obtain the
desired output
 The financial report is not means to evaluate the performance of the
manager

 If these two types of responsibility centers are not carefully

distinguished, management may erroneously treat a discretionary
expense center's performance report as an indication of the unit's
efficiency, thus motivating those making spending decisions to expend
less than the budgeted amount, which in turn will lower output For this
reason, it is unwise to reward ex­ecutives who spend less than the
budgeted amount

 Control over spending can be exercised by requiring the superior's

approval before the bud­get is overrun. Sometimes, a certain percentage
of overrun (say, 5 percent) is permitted
Administrative and Support Centers
Control Problems
Difficulty in measuring output
Lack of goal congruence

• Budget Preparation
Research & Development Centers
Control Problems
Difficulty in relating results to inputs
Lack of goal congruence

• The R&D continuum

• Annual Budgets
• Measurements of Performance
Marketing Centers
Logistics Activities
Marketing Activities
Vershire Company Case study
In 1996 Vershire Company Was a diversified
packaging company with several major divisions,
including the Aluminum Can division.
This Aluminum Can division was one of the largest
aluminum beverage cans manufacturers in united
states.
 The division had plants scattered throughout the
United States. Each plant served customers in its
own geographic region, often producing several
different sizes of cans for a range of customers that
included both large and small breweries and soft
drink bottlers.
Most of these customers had between two and four
suppliers and spread purchases among them.
 All Aluminum can producers employed essentially
the same technology, and the division's product
quality was equal to that of its competitors.
Containers were made from one of several
materials: aluminum, steel, glass, fiber-foil (paper
and metal composite), or plastic.
The metal container industry consisted of the
hundred-plus firms that produced aluminum and
tin-plated steel cans.
Aluminum cans were used for packaging beverages
(beer and soft drinks).
 While tin-plated steel cans were used primarily for
food packaging, paint and aerosols .
In 1970 steel cans accounted for 88% of the metal can
production.
In 1996 aluminum cans accounted for over 75% of
metal can production.
Than soft drinks bottlers were purchased by small
independent franchises of coco-cola and pepsi cola .
Five beverage container manufactures accounted for
88% of the market.
Minimum efficient scale for a container plant was 5
lines and it cost $ 20 million in equipment per line
Raw Materials :64%
Other cost (includes labour) : 15%
Marketing and General administration 9%
Transportation 8%
Depreciation 2%
R & D 2%
In beverage processes container accounting for
approximately 40% of total manufacturing cost
In early 1970’s can were produced by rolling a steel
soldering and cutting it to size.
In 1970 the industry was revolutionized when aluminum
producers perfected a 2 piece process in which a flat
sheet of metal was pushed into a deep cup and top was
attached .

By 1996 manufacturing had become even more efficient,

by producing over 2,000 cans per minute
Advantages of aluminum over steel
It was easier to shape
It reduced the problem of flavouring
It permitted more attractive packaging
Reduced transportation cost
More attractive recycling material
Scrap value
Questions
 1- Outline the strengths and weaknesses of Vershire
Company planning and control
 2. Trace the profit budgeting process at Vershire, starting in
May and ending with the Board of Directors' meeting in
December. Be prepared to describe the activities that took
place at each step of the process and present the rationale
for each.
 3. Should the plant managers be held responsible for
profits? Why? Why not?
 4. How do you assess the performance evaluation system
contained in Exhibits 2 and 3?
 5. On balance, would you redesign the management control
structure at Vershire Company? If yes, how and why?
 Sales Budget
Corporate Management
(Central Market Research Staff)
Preliminary
Report for 2 General
years Report
May

Divisional General Manager Vice President Marketing

Sales Sales
Forecast Sales
Forecast
Forecast

District District District

Sales Sales Sales
Manager Manager Manager
Sales budget was broken down according to plants
from which finished goods were shipped.
Estimate sales
Profit=sales-variable overhead- fixed overhead
Visit by controller staff from head office
Marketing Budget
Board of Directors

By December

C.E.O

Divisional Divisional
General Head
Manger Office

September 1st

Plant Plant Plant

Managers Managers Managers
MANAGEMENT INCENTIVES

Based on profit
Only capable managers were promoted
Plant manager’s compensation packages were tied to
achieving profit
Chart showing manufacturing efficiency was displayed
Items Actual $ Variance $Year-to-Date Variances
Total Sales
Variances doe to
5 axes mix Sales price
Sates volume
Total Variable Cost of Sales
Variances due to
Material
Labor
Variable overhead
Total Fixed Manufacturing Cost
Variances in fixed cost
Net Profit
Capital Employed
Return on Capital Employed
Thank you