Introduction

Definition: A responsibility center is an organization unit that is headed by a manager who is responsible for its activities and results

Nature of Responsibility Centers

Organization is the sum of its responsibility centers To help implement different strategies

Objectives of Responsibility Accounting:

Responsibility accounting is a method of dividing the organizational structure into various responsibility centers to measure their performance. In other words responsibility accounting is a device to measure divisional performance measurement may be stated as under: To determine the contribution that a division as a sub-unit makes to the total organization. To provide a basis for evaluating the quality of the divisional managers performance. Responsibility accounting is used to measure the performance of managers and it therefore, influence the way the managers behave.

To motivate the divisional manager to operate his division in a manner consistent with the basic goals of the organization as a whole.

Example of responsibility centers and inter-company transaction

Investment Centre Expenses Centre
Contract R&D activities
License

Owner/Parent company

Cost Centre Contract manufacturing

Manufacturing services

Profit centre
Entrepreneur

Sale of Products /services

Revenue Centre
Sales & distribution subsidiaries

Types of responsibility centers

There are four types of responsibility centers, according to the nature of the control over the inputs and outputs:

1. Cost Center 2. Revenue Center 3. Profit Center 4. Investment Center

1.Cost Center
A cost center is an organizational sub-unit such as department or division, whose manager is held accountable for the costs incurred in that division. For example, a Power and Airco Department can be defined as a cost center within the Operation and Maintenance Department in United Telecommunication Company. Manager of a cost center is responsible for controllable costs incurred in the department, but is not responsible for revenue, profit or investment in that center. A cost center is a responsibility center in which inputs, but not outputs are measured in monetary value.

2. Revenue Center
A manager of a revenue center is held accountable for the revenue attributed to the sub-unit. Revenue centers are responsibility centers where managers are accountable only for financial outputs in the form of generating sales revenue. A revenue center's manger may also be held accountable for selling expenses such as sales persons' salaries, commissions, and order receiving costs.

3. Profit Center
Profits are the excess of revenue over the total expenses. Therefore, the manager of a profit center is held accountable for the revenues, costs, and profits of the centre. A profit center is a responsibility center in which inputs are measured in terms of expenses and outputs are measured in terms of revenues.

Advantages of profit centers:

These help in increasing the speed of making operating decisions as they do not have to be referred to corporate headquarters. As the decision-making authority lies with the managers they can make better decisions related to the task they are performing, because they can understand the nature of the work better. Since profit centers make their day-to-day decisions themselves headquarters can concentrate on broader issues of the organization.

Managers are motivated to perform more effectively, as they are responsible for increasing the profit of their unit.
Managers use their imagination, take initiatives to perform effectively, to increase the profit of their unit. more

Types of profit centers

Marketing: A marketing activity can be given the responsibility of making profit when the marketing manager has the authority to make principal cost/revenue trade off in terms of marketing a product, spending on sales promotion, the appropriate time for this expenditure and on which media to spend. Manufacturing: This is an expense center and the management of activities here is based on performance against standard costs and overhead budgets. At times, there may arise the need to accommodate an order inbetween production schedules, and the manufacturing managers may be reluctant to interrupt these schedules. In manufacturing units, when performance is measured against standards, there may be no incentives for manufacturing products that are difficult to produce.

Cont
Measuring profitability: Profitability measurements in a profit center can be of two typesmanagement performance and economic performance. Management performance focuses on the managers performance while economic performance relates to how well a profit center is performing as an economic entity. Management performance is a measure used for planning, controlling and coordinating the day-to-day activities of the profit center. The performance measures of profit centers can be different and hence, the necessary purpose for the information should not be obtained from a single set of data. For example, the management performance report can show excellent performance of a profit center manager. But the economic and competitive forces for that particular report can show poor economic performance. As a result, the center may run into losses and may even have to close shop.

Types of profitability measures:

Contribution margin:
This performance measure is used on the premise that, since fixed expenses are not controllable by the manager, the focus should rest on maximizing the difference between revenues and variable expenses. The problems of using contribution margin is that since many of the centers expenses may vary according to the discretion of the profit center manager, focus on the contribution margin tends to direct the attention of the profit center manager away from the goals of the center.

Direct profit:
This measure helps in understanding the contribution of the profit center to the general overhead profit of the corporation. It encompasses all the expenses directly incurred by profit centers or related to profit centers, irrespective of whether the expenses are controllable by the profit center manager. However, it does not include corporate expenses.

Controllable profit:
The headquarters expenses in an organization can be divided into two categories-controllable and uncontrollable. Controllable expenses include expenses that are controlled by the business unit manager. The advantage of including such costs in the measurement system is that the profit will be calculated after the deduction of expenses that can be influenced by the profit center manager. Hence, these are controllable profits. As uncontrollable headquarters expenses are taken into consideration while calculating controllable profits, controllable profits cannot be compared directly with published data or with trade association data, which report the profits of other companies in the industry.

Income before taxes:

In this method, all corporate overhead profit is allocated to the profit center. The amount of expense incurred by each profit center forms the basis of allocation of profit. Such allotment has its own drawbacks. Firstly, the costs in departments like finance, and HR are not controllable by the profit center and hence, profit centers should not be held accountable for such costs. Also, it is difficult to quantify the amount that has been spent on human resources in each profit center. However there are certain advantages in allocating costs.

Net income:
The performance is measured by taking into consideration the net income after the payment of taxes. The disadvantage of using this method is that many decisions that have an impact on the income taxes are made at headquarters, and profit center managers should not be judged by these decisions. If the income after tax payment is constant percentage of the income before tax payment, then there would be no need to measure performance based on this method. This method would be useful if profit centers influence decisions like installing credit policies or disposing of equipment. This method is also useful to motivate the manager to minimize taxes in case the taxable income differs from income, as measured by using generally accepted accounting principles. The performance of profit centers can be measured by comparing actual results with one or more of the measures discussed above with budgeted amounts. In addition, data on competitors and industry provide a good crosscheck on the appropriateness of the budget.

4. Investment Center
The manger of investment centre is held accountable for the division's profit and the invested capital used by the centre to generate its profits. Investment centers consider not only costs and revenues but also the assets used in the division. Performance of an investment centre are measured in terms of assets turnover and return on the capital employed.

Expense centers:
Expenses center are responsibility centers for which input or expenses are measured in monetary terms, but for which outputs are not measured in monetary terms. There are two general types : engineered expense center and discretionary expense center. They correspond to two types of costs :
Engineered costs are elements of cost for which the right or proper amount of costs that should be incurred can be estimated with a reasonable degree of reliability. Costs incurred in factory for direct labor direct material component supplies and utilities are examples.