Chapter21

RESPONSIBILITYACCOUNTING
Horngren hasdefinedresponsibilityaccountingasasystemofaccountingthatrecognizes variousresponsibilitycentres throughouttheorganizationandreflectstheplansandactions ofeachofthesecentres byassigningparticularrevenuesandcoststotheonehavingthe p p y pertinentresponsibility. PrerequisitesforResponsibilityAccounting
1. 2. 3 3. 4. 5 5. 6. 7. 8. Itshouldbeabigcompanywithadivisionalized organizationalstructureandwhereareasof responsibility p yarewelldefinedatdifferentlevelsoftheorganization. g Thereareclearlysetgoalsandtargetsforeachresponsibilitycentre. Managersactivelyparticipateinestablishingthebudgetsagainstwhichtheirperformanceis measured measured. Accountingsystemgeneratesdependableinformationforeachresponsibilitycentre. Themanagersareheldresponsibleonlyforthoseactivitiesoverwhichtheyexercisesignificant degreeofcontrol. control Managersmusttrytoattainthegoalsandobjectives. Goalsforeachareaofresponsibilityshouldbeattainablewithefficientperformance. Performancereportingshouldbetimelyandshouldcontainsignificantinformationrelatingtothe responsibilitycentre.

RESPONSIBILITYCENTRE
Aresponsibilitycentreisadivisionoftheorganizationforwhichamanagerisheld responsible.CIMA,Londonhasdefinedresponsibilitycentreasasegmentofthe organization, sperformance. organization whereanindividualmanagerisheldresponsibleforitssegment segments performance

TypesofResponsibilityCentre
Costcentre Itisdefinedby CIMA,Londonas aproductionor a servicelocation, function,activity oritemof q p whose equipment costsmaybe attributedtocost units. RevenueCentre Aresponsibility centreisa revenuecentrein whichmanager controlsrevenues butdoesnot controleitherthe costsof products/services orthelevelof investmentmade i the in th responsibility centre. Profitcentre Accordingto CIMA,London,a profitcentreisa a partofabusiness accountablefor costsand y revenues.Itmay becalleda businesscentre, businessunit,or strategicbusiness unit. it Investmentcentre Itisdefinedby CIMA,Londonas aprofitcentre a whose performanceis measuredbyits p returnoncapital employed.

FEATURESOFRESPONSIBILITY ACCOUNTING
Responsibilitycentres are created created. Aplanispreparedinthe formofbudgetsorstandards foreachresponsibility centre.

Theperformanceofthe responsibilitycentreis evaluatedbycomparing actualresultswiththose budgetedintheregular monthlyreports. reports

Variancesbetweenactual andbudgetedperformance areanalysed soastofix responsibility.

Correctiveandpreventive action ti is i taken, t k wherever h possible.

MEASUREMENTOFDIVISIONAL PERFORMANCE

TECHNIQUESOFMEASUREMENTOF DIVISIONALPERFORMANCE
Variance Analysis: In this technique, actual performance is compared with standard or budgeted performance and any variance between the two is the analysis to know the causes so that responsibility can be established and corrective action taken. 2. Profit: The absolute amount of profit revealed by a profit centre can also be used as a measure to judge its performance. 3 Return on Investment(ROI): Instead of considering the absolute size of a division 3. divisions s profit, most organizations prefer return on investment of a division as a measure of its performance. ROI expresses divisional profit as a percentage of firms investment in the division. This is calculated as follows: 1.

4. Residual Income(RI): It may be defined as the profit of a division less cost of capital charge on the investments used by the division. division It is also known as Economic Value Added (EVA) method where EVA is profit minus the cost of invested capital in the division. The rate of interest at which cost of capital is calculated may be notional and not actual and such a rate is specified by the top management. Thus residual income may thus be calculated as follows:

TRANSFERPRICING
InthewordsofHansenandMowen thetransferpricesarethepriceschargedforthegoods producedbyonedivisionandtransferredtoanother. another.Thus,thetransferpriceisthepriceat whichaproductorserviceisinternallytransferredbetweentwounitsofthesamecompany.

TransferPricingMethods

Variable cost t method

Totalcost method

Market price method h d

Negotiated price method h d

TRANSFERPRICINGMETHODS
VariableCost Method: Underthismethod, thetransferpriceis fixedattransferor unitsvariablecost plusmarkup. markup Sucha transferpriceshould beusedwhenthe transferordivisionis notutilizingitsfull productioncapacity andhassomeidle capacity. TotalCostMethod: Herethetransferprice issetatfullcostwhich includesvariablecost, allocatedfixedcost andmarkup.Itsonly realadvantageliesin itssimplicityasitis easytounderstand andimplement becausetotalcost informationisreadily availableinthe accountingrecords. MarketPrice Method: Underthemarket pricemethod,the transferpriceissetat thecurrentpriceofthe productinthemarket. Thismethodcanbe usedonlywhenthere isareadyoutside marketforthe concernedproductor the h intermediate d productsbeing transferred. Negotiated g Price Method: Thesellerandthe buyerdivisions negotiatefortheprice atwhichgoodsareto betransferredasany otherpurchasersand sellersbargaintosettle theprice.Thisisdue tolackofcompetition inthemarket.