Responsibility Centers

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What is a responsibility center?

In

simple words: an organizational unit for which a manager is made responsible. Examples: A specific store in a chain of grocery stores. A work-station in a production line manufacturing automobile batteries. The payroll data processing center within a firm.

Attributes of a responsibility center

It

is like a small business, and its manager is Asked to run that small business and preserve the interests of the larger organization. Goals for the center should be specific and measurable, and Should promote the long terms interests of the organization and should be compatible with other responsibility center activities.

Types of Responsibility Centers

Revenue

Centers Cost Centers or Expense Centers Profit Centers and Investment Centers

Revenue Centers
Responsibility

Centers whose members control

revenues but, Not the manufacturing or acquisition cost of the products or service they sell, or The level of investment in the responsibility center. In other words, you cannot link the input to the output.

Revenue Centers (continued)

Most

revenue centers may not set selling prices They definitely have no control over the costs of input acquired (service manager of an automobile workshop does not control gasoline costs) These centers are generally not allocated costs of the goods that they market (there are exceptions). Manager is responsible only for costs directly incurred by his/her unit. They are evaluated on the basis of actual sales or orders booked against budgets or quotas and Example: a unit of a chain store in a mall.

Expense/Cost Centers

Responsibility centers whose employees control costs, but Do not control their revenues or investment level. Examples: Production department in a manufacturing unit, a dry cleaning business Two types of costs:
Engineered: those costs that can be reasonably associated with a cost center direct labor, direct materials, telephone/electricity consumed, office supplies. Discretionary: where a direct relationship between a cost unit and expenses cannot be reasonably made; Management allocates them on a discretionary basis (e.g. depreciation expenses for machines utilized).

Engineered costs
Should

be measurable in monetary terms, outputs in physical quantities. Works well in units such as production, distribution, accounting receivables, payables where repetitive tasks are performed. Developing standard costs for such activities is more reliable than in other cases. Multiply standard cost per unit x no. of units produced or processed = this is the ideal cost. Compare it to actual costs and the difference is indicative of efficiency or lack thereof.

Engineered costs Important to remember

The

fundamental purpose of all responsibility centers is accountability; evaluating performance. And a engineered cost center, Does not merely compare costs but also Holds the managers accountable for obtaining/producing right quality of product Volume of production, speed of processing.

Discretionary costs

Mostly administrative and support service costs More difficult to measure in physical quantities or precisely on monetary terms (e.g. customer relations or even R & D). Discretionary means, management allocates them based on established polices (not arbitrarily). More caution is required while using discretion cost numbers. Difference between budgeted expenses and actual expenses does not indicate efficiency. Suppose if the actual cost is less than budget, does it mean good or bad? Suppose if the actual cost is higher than budget, does it mean good or bad?

Expense centers (continued) Comparing Budgeted and Actual Costs

Budgeted costs are target estimates. It points to a goal to be achieved. But, it is not written in concrete. Actual costs are that were incurred during a given period. The difference between the two could be either positive or negative variances. However, making conclusions on the basis of positive or negative variances must be done carefully. See the next set slides and the example.

Profit Centers
Managers

of profit centers control both the revenues and costs of the product or service they deliver. It is like an independent business except it is part of a larger organization (e.g. departmental stores of larger chains Wal Mart, restaurants, corporate hotels such as Hilton, Holiday Inn). The store manager would have responsibility for pricing, product selection, and promotion.

Profit Centers (continued)

Cost

for these units vary depending on ability to control labor, waste, and hours. Revenues also will vary depending on the units service level, location, etc. In other words, local discretion would affect revenues and costs. Investments and some costs (e.g. centralized purchasing). Therefore, profits represent a broader index of both corporate and local decisions.

Profit Centers (continued)

If

performance is poor, it may reflect poor conditions that no one in the organization could control as well as poor local conditions. For this reason, organizations should not evaluate performance only based on costs and profits, but Perform detailed evaluations that include quality, material use, labor use, and service measures that the local unit can control.

Investment Centers
Responsibility

centers whose managers and employees control revenues, costs, and the level of investment. It is also like an independent business (common when an organization acquires another organization e.g. Sears financial centers).

Administrative Centers (support centers)

One

of the most difficult to evaluate because neither the input nor the output is easy to measure (e.g. accounting services, marketing), and Linking units input and output to organizational objectives. But, with a little careful approach, the costs of such centers can be reasonably computed. Since most of these centers are treated somewhat like cost centers, an approach based on costs would be helpful.

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A simple summary of the responsibility centers

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Performance Measure
Business unit managers have two performance objectives

1. They should generate profit from the resources at their disposal.

2. They should invest in additional resources only when investment will produce an adequate return. The purpose of relating profit to investment is to motivate business unit managers to accomplish these objectives.

STRUCTURE OF THE ANALYSIS

Two ways of relating profit to assets employed 1. Return on Investment ( ROI ) ROI is a ratio. The numerator is income, as reported on the income statement. The denominator is assets employed. 2. Economic Value Added EVA is a amount, rather than a ratio. It is found by subtracting a capital charge from the net operating profit. This capital charge is found multiplying the amount of assets employed by a rate.