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KOMAL P PATEL

K N V INSTITUTE OF BUSINESS
2/1/2011
MANAGEMENT MCS-2
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 INTRODUCTION
 STRUCTURE
 RESPONSIBILITY CENTERS-DEFINITION –
TYPE-EXPECNCE & REVENUE CENTERE
 ENGINEERED & DISCRETIONARY CENTER
 PROFIT CENTERS
 MEASURING PROFITABILITY

K N V INSTITUTE OF BUSINESS
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 AN IMPORTANT COMPONENT OF MANAGEMENT CONTROLS –
ASSIGNING RESPONSIBILITY FOR EXECUTING STRATEGY

Implementing strategies is not adequate if individuals

who must execute them fall short.

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 The characteristics of organizations affect

the control process, focusing on the various
types of responsibility centers, the
techniques that are the important to control.

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 THEREFORE, MANAGEMENT CONTROLS MUST INCLUDE

 How responsibility is assigned and measured

 How tasks are measured (not necessarily tasks done by
humans but also by machines; e.g. units produced)
 Task controls such as when to order inventory, why the
actual differ from budgeted (the causes)
 And, not easy to measure or quantify items such as impact
on behaviors, intangible assets, and so on.

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 Responsibility centers constitute the

structure of a control system and the
assignment of responsibility to
organizational subunit must reflect the
organization’s strategy.

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 A responsibility center is an organization

unit that is headed by manager who is
responsible for its activities
• Company is collection of responsibility
centers each represented by box in
organization chart.

• They are in hierarchy

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 Concept of Responsibility Centers
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Robert Anthony:
A responsibility centre is an organization unit that is
headed by manager who is responsible for its
activities.

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From the definition it is clear:

• First, delegation of responsibility for specific to
successive lower levels of organisation.
• Second, motivation of the level of management to
which a certain task has been delegated.
• Third, measurement of the achievement of specified
objectives.

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The key consideration in determining the responsibility
12 centre is

 ability to control cost or revenue

 determining the question of controllability
 evaluation of responsibility centre as per
predetermined criteria

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• Exists to accomplish one or more purposes

termed as objectives

• The product produced by responsibility

centers furnish to another responsibility
centers or outside marketplace

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Inputs Outputs
Work
Resources used,
Goods or services
Measurement by cost

Capital

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• Relationship between inputs & outputs in

responsibility centers can be direct or indirect, e.g.
production dept. & Advertising Dept.

• Inputs are measured in monetary terms e.g. like

per hr. cost labor which is referred as cost. Cost is a
monetary measure of the amount of resources used
by a responsibility center

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• Inputs are used by responsibility centers

unlike students & patients.

• It is difficult to measure qualitative inputs

of the organization

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 Organisation Structure and Responsibility Centres
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Introduction of responsibility centres the following changes are

required in present organisation structure:
1. The responsibility for all the revenues and expenses must be
assigned to identified individuals in the organisation.
2. The accounting system should be modified so as to accumulate
and report revenues and expenses on the lines of assigned
responsibilities within the organisartion.
3. A system of evaluation based on comparison of revenues and
expenses of different responsibility centres pre assigned target
should be established.

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• The concept of input, output & cost can

be used to explain efficiency &
effectiveness.
• Efficiency is the ratio of outputs to inputs
or the amount of output per unit of input
• Efficiency can be measured by comparing
actual Vs. standard

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• Effectiveness is determined by the relationship

between a responsibility center’s output and its
objectives
• Efficiency & effectiveness are not mutually
exclusive; every responsibility center ought to be
both efficient and effective.
• Profit measures both effectiveness and efficiency

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“A responsibility center is efficient if it does

things right and it is effective if it does the
right things”

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 Types of Responsibility Centres I.M.P.

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The responsibility centers may be classified as

(I) Revenue Centers
(II) Expense Centers
(III) Profit Centers
(IV) Investment Centers

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 Relationships between different RCs

Investment Centre
President

Profit Centre
Vice – President

Expense Centre Revenue Centre

Production Manager Marketing Manager
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 EFFECTIVE Responsibility centre

• Clearly defined segment of an organisation.

• A designated individual is responsible for its
performance.
• He has the necessary authority.

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 PROCESS
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1. Study & list all the different operations,

activities, functions, tasks in the organization.
2. Define each activity in descriptive terms.
3. Evaluate the need for any reorganisation &
develop an OS on the lines of desired RC.
4. Divide the organisation into various RC.
5. Ensure that the centres satisfy the 3
characteristics.

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 FACTORS TO BE CONSIDERED

• Objectives of the system

• Need for flexibility
• Ease in allocation
• Future need
• Comparison
• Segregation
• Volume of Information
• A System of Coding
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• In a revenue centre, output (I.e., revenue) is measured in
monetary terms, but no formal attempt is made to relate
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input (I.e., expenses or cost) to output.
• The main focus of management’s efforts will be on
revenue generated by it.
• The sales department is an example for a revenue centre.
• The effectiveness of the centre is not judged by how
much sales revenue exceeds the cost of the centre.
• Sales budget are prepared for revenue centre and
budgeted figures are compared with actual sales.
• Generally the costs are not related to output.
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 Revenue Centres

Input not related Examples

to outputs

Inputs
Outputs
Work Marketing function
Rupees
only for Rupees
costs directly revenue
incurred

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 Expenses Centre
 It is the lowest level of responsibility centre in an
organization.
 Its manager is basically responsible for production of a
product or service; his decision authority relates to
how human resource, machinery and materials should
be used to produce the product or service.
 Expense centre manager has no control over revenues,
profits or investment.
 He has no control over marketing decisions or
investment decisions.
 Total performance of an expense centre manager
depends on how effectively and efficiently an expense
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centre is operated.
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 Effectiveness of an expense centre manager will depend
31 on a host of non-financial parameters such as
maintaining quality level of output, compliance with
production schedules and targets, maintaining morale
of the workers and so on.
 Normally, separate reporting systems are used to report
effectiveness.
 Efficiency is judged in terms of financial performance.
 It is measured and reported by the responsibility
accounting system.
 Evaluation of of the financial performance of an expense
centre manager is by comparing the actual expenses of
the centre against the budgeted expenses. K N V INSTITUTE OF BUSINESS
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• Activities or operations of every expense should be

homogeneous so as to ensure uniform basis of charging
expenses within the centre.
• The activities or operations of each expense centre
must be well defined and clearly identifiable.
• Inputs are measured in monetary terms.
• Outputs are not measured in monetary terms.

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 Types of Expenses Center

expenses center

engineered expenses center discretionary expenses center

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 Engineered Expenses Center
 These are the centers for which cost can be
estimated
 inputs can be measured in monetary terms
 outputs can be measured in physical terms
 optimal input-output combination can be
determined
 It is usually found in manufacturing operations.
 Warehousing, distribution, trucking and similar
units within the the marketing organization
may also be engineered expenses centres.

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 Engineered Expense Centres

Optimum relationship Examples

can be established

Inputs
Outputs
Work Manufacturing
Rupees function
physical

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 Discretionary Expenses Center
 The output of these centers cannot be
measured in monetary terms.
 They are basically support activities.
 Types of discretionary expenses centers:-
-Administrative and support activities
-R&D centers
-Marketing centers

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 Discretionary Expense Centres

Optimum relationship Examples

cannot be established

Inputs
Outputs
Work Research &
Rupees development
physical function

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• Budget Preparation
• Incremental Budgeting
• Zero Base Review
• Cost Variability
• Types of Financial Control
• Measurement of Performance

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 Administrative and Support Centers
• It includes senior corporate management, business unit
management, along with the managers of supporting
units.
• Supporting centres are units that provide services to
other responsibility centres.

• Control problems :-
- Difficulty to measure output
- lack of goal congruence

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 Research and Development Centers
• Control problems :-
- Results are difficult to measure quantitatively
- lack of goal congruence
- Time period is too long

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 Marketing Centers
• Marketing activities are divided into two
- Logistics activities:
It involved in moving goods from the company
to its customers and collecting the amounts
due from customers in return.
It include transportation to distribution
centres, warehousing, shipping and delivery,
billing and related credit function and the
collection of accounts receivables.
Responsibility centres to this activities is
41similar to expense centres.
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 This centres can be control through imposing
standard costs and budgeting.
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- Marketing activities
It is undertaken to obtain orders for company
products.
It include test marketing, the establishment, training
and supervision of the sales force, advertising and sales
promotion.
To measure its output is possible but evaluating the
effectiveness of the marketing effort is much more
difficult. Because of responsible factor of it is not under
control of organization.
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 PROFIT CENTER
• A profit centre is an organisational unit responsible for
both revenues and costs.
• Profit centre manager has no control over the
investment in the centre’s assets.
• Managers are concerned with both the production and
marketing of the products.
• Activities of the manager is much more broader than
that of a revenue centre manager because of the
responsibility to produce the product most efficiently.
• Profit centre’s performance measured in terms of
profit.
• It enhances profit consciousness
•43 Example:division of a company that produces and
markets different products.
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 Profit Centres

Input are related Examples

to outputs

Inputs
Outputs
Work Business unit
Rupees
costs Rupees
profit

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 ADVANTAGES

• Increase in speed of operating decisions

• Quality of decisions increases.
• Head quarter management relieved of day to day
decisions and can therefore concentrate on
broader issues.
• Profit consciousness may be enhanced.
• Due to greater autonomy managers are free to use
their imagination and initiative

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 DIFFICULTIES WITH PROFIT CENTERS
• Since decisions are decentralised, top management
may lose some control.
• Organisational units may now compete with each
other disadvantageously.
• An increase in one manager’s profit may decrease
those of another.
• Complexity in the concept of profit. Book profit, real
profit etc.
• There may be arguments over transfer prices.
• Too much emphasis on short run profitability at the
expense of long run profitability.
• Problems of analysis of profit centre results. Single
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 PROFIT CENTER AS A MOTIVATIONAL
TOOL
• A profit center manager is perceived to have a higher
status in the organisation so it provides a psychological
benefit to division manager.
• It enhance the profit consciousness of the managers and
subordinates within the division and hence they all
strive for maximising the profits of the division.
• Brings in a sense of pride and belongingness.
• The freedom and authority given to managers imbibe a
sense of independence and responsibility.

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 INVESTMENT CENTER

• What is an investment center.

• How to measure an investment center
performance.
• ROI=(profit before interest&tax)/net operating
investment*100
• Residual income

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 • An investment centre is responsible for the
production, marketing and investment in the assets
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employed in the segment.
• An investment centre manager decides on aspects
such as the credit policies, inventory policies, and
within broad framework.
• Investment centre manager responsible for profit in
relation to amounts invested in the division.
• Financial performance of the manager of the division
is measured by comparing the actual with projected
rate of return on investments of the centres.

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 Investment Centres

Profits are related Examples

to capital employed

Inputs
Outputs
Capital Employed Business unit
Rupees
costs Rupees
profit

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 • Most of the problems faced in the context of
51 investment centre relate to performance evaluation
of the division.
• Two of the most important profit related measures
used in the investment centre context are the Return
On Investment (ROI) and Residual Income (RI)
measures.

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• ROI is the relationship between return (profit) and
52investment expressed as a percentage.

• In this method basic difficulty is in deciding what

should be taken as profit and what should be the
investment base for relating same.
Profit Before Interest and Taxes
ROI = * 100

Net Operating Investment

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 ROI Computation Using Net Book Value Of Assets
Year
1 2 3 4 5
Net Book Value At
the Beginning of 100 80 60 40 20
the year (Rs,’000)
Cash return
(Rs,’000) 50 50 50 50 50
Less : Depn.
20 20 20 20 20
Profit Before Tax
30 30 30 30 30
Return on
Investment % 30 37.5 50 75 150

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• To eliminate the problems associated with using a
ratio as performance measure, many companies use
the RI approach.
• RI is the difference between actual income earned by
the division on an investment and the desired
income on the investment as specified by minimum
desired rate of return. It is calculated as follows:
• RI = Actual Income – Desired Income (Maximum
desired rate of return * Invested capital)
• Desired Income is also known as Capital Charges.
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 RI Computation Using Net Book Value Of Assets
Year
1 2 3 4 5
Net Book Value At
the Beginning of 100 80 60 40 20
the year (Rs,’000)
Profit before tax
(Rs,’000) 30 30 30 30 30
Less : Capital
Charge 25 % of 25 20 15 10 5
Investment Base
RI
5 10 15 20 25

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 Management Control Structure of Ibis Apparels

President

Vice President Vice Presidents

Apparel Division Other Divisions

Production Manager Marketing Managers

Apparels Apparels
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MANAGEMENT MCS-2
As presented in chart the management control structure of Ibis Apparels is structured into
responsibility centres as follows:
Designation Responsibility Centres
President Investment Centre: Responsible for all investment
decisions & hence to be evaluated on the basis of
performance of ROI
Vice President Profit Centre: Responsible for all the revenues &
Apparels Division expenses of divisions & hence responsible for
the profits of the division
Production Manager Expense Centre: Responsible for production
Apparels and hence responsible for all the expenses to be
incurred for production
Marketing Manager Revenue Centre: Responsible for all
Apparels revenues of the division

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 Various Centres & their Performance Evaluation
Types of Control Variable Objectives
Centres variables of the predetermined by
centre top management

Expense Prices & Prices & quantities Minimise cost

Centre quantities of of output/budget
inputs
Revenue Prices & Quantities to be Maximise sales
Centre quantities of sold/budget revenue
inputs
Profit Prices & Investment Maximise
Centre quantities of profit
inputs & outputs
Investme Prices & None Maximise
nt centre quantities of return on
inputs & outputs investment
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MANAGEMENT MCS-2
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