Performance Responsibility Accounting Decisions

A subtle issue that is completely overlooked by many accountants is the proper structuring of the reports that they issue to various company employees. In addition to the creation of a single, companywide set of financial statements, a considerable amount of attention should be paid to the creation of an underlying set of reports that target specific areas of responsibility, which may be at the levels of an entire division, a department, or perhaps a single machine cell. When creating such reports, the accountant may in uire about the nature of responsibility accounting, the types of responsibility centers for which reports are created, and what types of costs should be included or e!cluded from them. Ancillary issues involve whether a balanced scorecard or a benchmarking system should be used" in both cases, the information selected for inclusion in reports can have a significant impact on the resulting performance of a company. #he following table itemi$es the section number in which the answers to each uestion posed in this chapter can be found% &ection Decision '() What is responsibility accounting* '(+ What are the types of responsibility centers* '(, &hould allocated costs be included in responsibility reports* '(- What is balanced scorecard reporting* '(. /ow does benchmarking work* '() W/A# I& R0&P12&I3I4I#5 A66172#I28* A key task of the accountant is to create accounting systems that ensure that costs are incurred in accordance with e!pectations. #he best way to do so is through the concept of responsibility accounting, which is the assumption that every cost incurred must be the responsibility of one person somewhere in the company. 9or e!ample, the cost of rent can be assigned to the person who negotiates and signs the lease, while the cost of an employee:s salary is the responsibility of that person:s direct manager. #his concept also applies to the cost of products, for each component part has a standard cost ;as listed in the item master and bill of materials<, which it is the responsibility of the purchasing manager to obtain at the correct price. &imilarly, scrap costs incurred at a machine are the responsibility of the shift manager. 3y using this approach, cost reports can be tailored for each recipient. 9or e!ample, the manager of a work cell will receive a financial statement that itemi$es only the costs incurred by that specific cell, whereas the production manager will receive a different one that itemi$es the costs of the entire production department, and the president will receive one that summari$es the results of the entire organi$ation. As one moves upward through the organi$ational structure, it is common to find fewer responsibility reports being used. 9or e!ample, each person in a department may be placed in charge of a separate cost, and so each one receives a report that itemi$es his or her performance in controlling that cost. /owever, when the more comple! profit center approach is used, these costs are typically clumped together into the group of costs that can be directly associated with revenues from a specific product or product line, which therefore results in fewer profit centers than cost centers. #hen, at the highest level of responsibility center, that of the investment center, one must make investments that may cut across entire product lines, so that the investment center tends to be reported at a minimal level of an entire production facility. #hus, there is a natural consolidation in the number of responsibility reports generated by the accounting department as more comple! forms of responsibility reporting are used.

W/A# AR0 #/0 #5P0& 19 R0&P12&I3I4I#5 602#0R&* #he most elementary form of responsibility center is the cost center, which itemi$es all of the e!penses incurred to run a specified function, but ignores the cost of capital invested in it, as well as any associated revenues. #he primary form of control in a cost center is against a fi!ed or semivariable budget that is determined at the beginning of the year. It is not common to see a variable budget being used in a cost center, since purely variable costs tend to be most closely associated with production, for which there are associated sales" this relationship means that variable budget costs are more commonly found in profit centers than in cost centers. An e!ample of the cost center reporting format is shown in 0!hibit '.), where we see all the e!pense line items for the =anitorial department listed. #here is also a subtotal for those costs that are directly attributable to the department, followed by an overhead allocation for administrative costs ;which is not controllable by the =anitorial manager<. #his general format can be used for any cost center. #hough this is a good start for a company that wants to implement controls over its e!penditures, it suffers from one main flaw>those responsible for cost centers are concerned only with the tight control of costs, rather than other key company goals, such as customer service, creating new products, or ac uiring new customers. #his can lead to counterproductive behavior. 9or e!ample, the manager of the computer ?anagement Accounting 3est Practices services department, which is operated as a cost center, is determined to avoid any cost overruns. #he sales manager, who is trying to increase profits, asks that a customi$ed report be created that lists the margins for each e!isting customer, so that the sales team will know which customers are the best ones to sell to. /owever, the computer services manager refuses this re uest, for it will result in e!tra costs that will e!ceed her budget. #his problem occurs regularly when a company is structured into many cost centers, each of which looks out for its own self(interest. As the name implies, a revenue center is one where the employees located in a specific functional area are solely responsible for attaining preset revenue levels. #he sales department is sometimes considered to be a revenue center. In this capacity, employees are essentially encouraged to obtain newsales without regard to the cost of obtaining them. #his can be a dangerous way to run a function, unless strict guidelines are set up that control the overall spending limits allowed, the si$e and type of customer solicited, and the si$e and type of orders obtained. 1therwise, the sales staff will obtain orders from all kinds of customers, including those with poor credit records or histories of returning goods, not to mention orders that are so small that the cost of processing the order e!ceeds the profit gained from the sale. 1ther counterproductive activities associated with revenue centers are the inordinate use of travel funds to meet with customers, selling products at large discounts from the standard price, offering special promotional guarantees to customers, allowing credits on previously purchased products if the price subse uently declines, and offering to e!tend payment terms. 9or all of these reasons, revenue centers are not recommended without the addition of stringent controls to ensure that the sales staff obtains only revenues that will result in ade uate levels of profitability. #he profit center resolves many of the problems =ust noted for the cost and revenue center concepts by combining the two. #he manager of a profit center is primarily responsible for generating the highest possible profit ;or least possible loss<. #his results in a strong incentive to pursue only those sales that have a sufficient margin, while also incurring e!penses only if they will result in an incremental increase in revenue. An e!ample of a profit center report is shown in 0!hibit '.+. #his format is very similar to the one used for a cost center, e!cept that it now includes a revenue line at the top and a profit amount at the bottom. 0!hibit '.) &ample 6ost 6enter Report 0!pense #ype Actual 0!penses 3udgeted 0!penses @ariance Wages A.B,CCC ADC,CCC EA+,CCC Personnel benefits D,CCC .,.CC F.CC 0 uipment depreciation +,-CC +,CCC F-CC &upplies -,BCC ,,+CC F),DCC 0!pense subtotal AG),+CC AGC,GCC FA.CC

1verhead allocations D,)CC D,)CC C #otal e!penses AGG,,CC AGD,BCC FA.CC '(+ What Are the #ypes of Responsibility 6enters* +)' #he profit center concept is highly recommended, since it results in the strongest possible management attention to profitability. /owever, there are some cases where it is difficult to convert a cost center to a profit center, because there is no way for it to gain revenues by directly selling its services. 0!amples of such cost centers are the computer services, engineering, and production departments. #hese groups are all involved in the production or support of products, but it can be difficult to attribute sales directly to them. 1ne way around this problem is to have each department charge other departments for its services. A good e!ample is the computer services function, where many organi$ations create a programming cost per hour that is charged to all other departments that re uest changes to computer programs" it is also common to charge for the processing time used by each department:s programs, as well as the cost of report processing, generation, and distribution. #hese are valid charges to make, for departments now have the option of outsourcing some functions, such as computer services, so that suppliers provide the same services that have previously been performed internally. If a department can find a better deal outside of the company, then it should go ahead and purchase the outside services. 3y using this approach, a company can force many of its cost centers to pay a much greater level of attention to their costs incurred and services rendered to other departments>if they drop below the level of outside service providers, then there will be no call for their services, and the employees in those departments will lose their =obs. #his approach can be used for many functions besides computer services, such as engineering, production, and accounting. When determining revenues for profit centers, it may be necessary to allocate revenues based on the cost of services or materials added to a product as it moves through a department. If there are cases where it becomes difficult to =ustify a revenue allocation, or it is impossible to prove that any value is added to a product or service, then it may be better to leave the function as a cost center. 0!hibit '.+ &ample Profit 6enter Report Account #ype Actual 0!penses 3udgeted 0!penses @ariance Revenue A'C,CCC A'+,CCC FA+,CCC 0!penses% Wages .B,CCC DC,CCC EA+,CCC Personnel benefits D,CCC .,.CC F.CC 0 uipment depreciation +,-CC +,CCC F-CC &upplies -,BCC ,,+CC F),DCC 0!pense subtotal AG),+CC AGC,GCC FA.CC 1verhead allocations D,)CC D,)CC C #otal 0!penses AGG,,CC AGD,BCC FA.CC Profit A)+,GCC A).,+CC FA+,.CC Profit percentage )-H )GH F,H ?anagement Accounting 3est Practices A step beyond the profit center in its level of sophistication is the investment center. #his is the same as a profit center, but nowthe responsible manager is also held accountable for any investments in the business. #his added responsibility means that one additional measure is added to the normal set of measures used for a profit center% return on investment. #his measures the ability of a manager not only to generate a profit, but to also create one at a sufficiently high level to offset the cost of capital on any newly invested funds. #he investment center is particularly appropriate for those cases where investment decisions must be made very rapidly in order to take advantage of changes in local business conditions. #his is a particularly important issue for those companies in rapidly e!panding markets, or where consumer needs change rapidly, where waiting for investment approval from a central authority may result in lost sales. #hough the investment center seems like

the most sophisticated of all the various types of responsibility accounting, given its incorporation of revenues, costs, and invested funds, it is a rarely used format. #he reason is that the manager of an investment center could obligate a corporation into a very large investment, and never generate a sufficient return to pay off the investment, thereby worsening the financial condition of the corporation as a whole. #his problem can be restricted by adding some form of investment oversight. 9or e!ample, an investment committee at the corporate head uarters or division level can be used to approve all investments over a certain amount. #his approach gives the managers of investment centers total leeway to invest smaller amounts of money, while still reducing the overall corporate risk of a bad investment by re uiring a more detailed analysis for large investments. Investment centers function less efficiently when there is a highly centrali$ed corporate management structure in place. In this instance, very few decisions are left for the local manager, and certainly not investment(related decisions, which are strictly controlled by a central capital investment review function. #he alternative corporate structure, that of decentrali$ation, nearly re uires the use of investment centers, since the corporate management staff goes out of its way not to become involved in operational issues at the local facility level. #hus, the overall management structure is a strong driver of the level of usage of investment centers. &/174D A4416A#0D 61&#& 30 I2647D0D I2 R0&P12&I3I4I#5 R0P1R#&* A common costing scenario is when responsibility reports include a variety of corporate or local overhead costs. #he person who is responsible for the operating results of each department or division has virtually no control over the incurrence of these overhead costs, and so can make a reasonable argument against being =udged on this number. #he simplest way to avoid this issue is to restructure the responsibility financial statements by subtotaling all other financial results prior to adding in allocated costs. #his approach keeps actual operating results from being obscured by allocated costs. &hould Allocated 6osts 3e Included in Responsibility Reports* #he decision to include or e!clude an allocated cost from a responsibility report can be made by sub=ecting the cost to two rules. 9irst, if a local manager has no direct ability to control a cost, then it should be e!cluded from that manager:s responsibility reports. &econd, if the cost would remain if the responsibility center were to be completely eliminated, then the cost should also be e!cluded from the same reports. 9or e!ample, corporate overhead generally should not be allocated to any responsibility centers, because the corporate overhead costs would still e!ist even if the responsibility centers were eliminated. W/A# I& 3A4A260D &61R06ARD R0P1R#I28* #oo often, a company focuses e!clusively on its financial results. 3y doing so, it may be forcing attention away from other key measures that ultimately have a strong impact on financial performance and that enhance that performance in the long run. #o counteract this problem, consider using the balanced scorecard. 7nder this approach, a company:s key performance measurements are split into four areas, which are the financial, customer, internal business processes, and learning and growth areas. #hese areas are designed to build on each other, so that a proper level of attention to the three nonfinancial measurement areas will result in an improved set of financial measurements as well. An e!ample of this measurement system is shown in 0!hibit '.,. In it, we see that the learning and growth measurements, shown in the lower left(hand corner, are designed to improve the performance of employees through training as well as reduced turnover ;on the

grounds that fewer employee departures results in fewer new employees, hence a more e!perienced staff<. ?easurements for the last month are compared with those from previous periods, so that employees can see trends in the measurements. &uccess in the learning and growth area should result in an improvement in the company:s internal business processes, which are itemi$ed in the lowerright corner of the e!ample. In this area, increased employee training has led to improved processing time for customer orders as well as the near(completion of a =ustin( time manufacturing system. #hese process changes should result in improved customer(related measurements, which are noted in the upper( right corner. With improved product uality, on(time shipments, and customer satisfaction, we assume that financial performancewill improve, which will be reflected in the final bo! in the upper(left corner. In this area, the financial measures are closely tied to the corporate goal, which is listed at the top of the page>that of spinning off enough cash from operations to fund new facilities and ac uire competitors. #hus, the balanced scorecard reporting system results in a coherent set of interlocking measurements that are directly tied to a company:s goals. #he balanced scorecard must be individuali$ed for each company that uses it, since each one operates within a uni ue set of constraints. #he measurements used in the e!ample are designed for a manufacturing facility, and so would be inappropriate for use by a service company. #o obtain the correct set of measurements for a balanced. ?anagement Accounting 3est Practices scorecard, a company:s senior management group should compile a short list of the most appropriate measures, possibly with the assistance of a trained facilitator who can keep the discussion on track. 1nce everyone has agreed on the most appropriate measures, there must be further agreement on how each one shall be calculated, as well as when the measures shall be sent back to the management team for periodic review. #hese up(front decisions will ensure that the correct measures are calculated and that they will be used by managers to improve the business. XYZ Company Balanced Scorecard 8oal% #o spin off enough cash flow to build new facilities and ac uire competitors. Financial: Actual 8oal Customer: Actual 8oal Net Profits 6% Customer Satisfaction 95% #his ?onth -..H #his ?onth .'..H #his Iuarter ,.-H #his Iuarter .-.CH 4ast 5ear +.DH 4ast 5ear .C.CH Inventory Turns 20.0 On-time Shipments 9 % #his ?onth )D.C #his ?onth G).CH #his Iuarter )+.. #his Iuarter DB.CH 4ast 5ear )+.C 4ast 5ear -+.CH Receivable Turns 9.0 Quality Percentage 99.5% #his ?onth B.+ #his ?onth '-..H #his Iuarter G.D #his Iuarter ').,H 4ast 5ear B.) 4ast 5ear B'.+H !earnin" # $ro%t&: 'nternal Business (rocesses: Actual 8oal Actual 8oal Employee Turnover )0% ust-in-Time System #his ?onth )'.CH Percentage Complete )00% #his Iuarter +).CH #his ?onth !"# 4ast 5ear ,B.CH #his Iuarter $"# 4ast 5ear %&# Training 'ours per Employee( )nnuali*e+ *0 )verage Time to #his ?onth +' Process Or+ers 2 +ays #his Iuarter +. #his ?onth +.' Days

4ast 5ear +) #his Iuarter ,.+ Days 4ast 5ear ,.. Days What Is 3alanced &corecard Reporting* #he balanced scorecard should not supplant all previous measurement systems that a company uses to track its performance. #here may be do$ens or even hundreds of measures already in place that are e!tremely useful for the conduct of daily operations and that should be continued. #he balanced scorecard is more for the use of the management group, which can use it to see how well they are directing the company:s performance in reaching its ma=or goals. #o this end, it should be treated as a high(level set of measurements, under which lie a great many other measures that must be still be used to transact daily company business. /1W D10& 3026/?ARJI28 W1RJ* 3enchmarking is the process of obtaining and productively using information about how to improve one:s processes, products, and strategies. It is a systematic process, rather than one that is only occasionally engaged in" this re uires the ongoing use of pro=ect teams that are continually renewed with well(trained employees from all parts of an organi$ation, and who are ade uately supported at the uppermost levels of the company. #here are three types of benchmarking that one can perform, each of which is targeted at a different part of a company:s operations. #he first is benchmarking for internal processes. 6omparisons can be made with companies frommarkedly different industries, since processes are readily adaptable across many industries. When one hears about how a company has conducted a benchmarking review with another company that is far outside of its normal field of competitors, it is most likely that the study addressed process changes. When processes are the sub=ect of benchmarking, the usual =ustification is that there will be immediate financial results, typically through the elimination of employee positions. It can also achieve shorter processing intervals, which is readily measured. 9or these reasons, process benchmarking is very popular. Another type of benchmarking is based on products or services. It uses comparisons between a company:s own products or services and those of other organi$ations. #he focus of such a study tends to be on the uality, reliability, and features of comparable products. #his does not mean that benchmarking comparisons are confined to products created by companies in the same industry, since products may be broken down into their component parts, which may individually be more readily comparable with products from other industries. Product benchmarking can be performed without the approval of any other company, since one can simply buy their products and directly review them, either through reverse engineering or feature comparisons. 2onetheless, it is most useful to obtain the cooperation of the maker of each product, since the review team could glean much additional information regarding the manner in which each product was manufactured, information that is not readily apparent from a direct review of the product itself. #he final form of benchmarking is strategic" the review team wishes to discern whether there are other ways to position the company within its industry that it has not considered, but which other organi$ations are implementing with success. #his ?anagement Accounting 3est Practices usually re uires a close look at other industries, since the industry within which a company competes may be chock(full of organi$ations that all have the same strategic mindset, and which therefore are not good sources of information. #his type of review tends not to yield much in the way of short(term improvements, since strategic changes typically re uire several years of effort to implement. #hus, only the most forward( looking management teams tend to engage in this type of benchmarking, however useful it may prove to be in the long run. /ow does one conduct a benchmarking study* #he initial step is to decide e!actly what to benchmark. #hough there should already be some general idea of what is to be done, the

topic initially presented may have been a broad one, within which several more specific pro=ects could be fitted. 9or e!ample, the initial proposal may have been to shorten the cycle time of the disbursements business process. /owever, there are a number of steps within this process, such as ordering and receiving goods, forwarding the paperwork to accounting, matching accounts payable documentation, and issuing payment. #he pro=ect team may select only one of these subprocesses for a more detailed review. 1nce the specific subprocess has been selected, the pro=ect team can collect information about the performance level of whatever is targeted. #his information is needed in order to compare it with the results gained from a review of outside entities or other departments or divisions of the same company. 9or e!ample, a review of a process might re uire a workflow diagram that details e!actly how information flows through it, as well as the various control points and time re uirements at each step in the process. Alternatively, a reviewof an e!isting product would re uire an analysis of its cost, as well as a complete description of its various features and level of uality. #he ne!t step is to determine what companies to benchmark. #here are a variety of ways to make a list of benchmarking targets. 1ne is to review professional publications to see which ones are improving themselves in specific areas" another is to review general or industry(specific publications for the same information. Another source is speeches at industry symposiums. 5et another source may be networking connections between companies. If there are many company divisions, then yet another source is to call one:s counterparts in those divisions. 1nce a set of benchmarking targets have been selected, the pro=ect team must create a set of uestions to ask the representatives of the companies with whom they will meet. #his is a very important step, since the target companies are setting aside valuable time to meet with the team, and should not have their time wasted. #o this end, the team should first create the largest possible list of uestions, and then whittle it down to the most critical uestions that can be definitely handled during the assigned meeting time with the target company. #here should also be a secondary list of followup uestions that can be used if there is still time available after the primary uestions have been answered. #he completed review should give rise to a number of action items that can be used to either modify or ;more rarely< replace the internal process, product, or strategy. /owever, before implementing any changes, this is a good time to interact with the personnel who will be impacted by them. #he reason for doing so is that the person who will use the modification may be aware of internal problems that the pro=ect team is not aware of, and which will make the change inoperable. With these preparations completed, the team should create a thorough implementation plan that describes the precise changes, when they will take place, what they will impact, and who will be responsible for them, not to mention any re uired training, capital purchases, or personnel changes. #his plan should be carefully reviewed to ensure that nothing is missing, and that the timelines are reasonable. A final step is to schedule a reviewof all changes after some time has passed during which the changes have had a chance to settle in and either succeed or fail. If they have failed, then the team must review the situation and recommend changes to the management team in regard to what further steps must now be taken. If the changes have been a success, then the benefits should be uantified and forwarded to the financial analyst who is reviewing the pro=ect, so that the management team can be informed of the return on investment of its benchmarking initiative.