In every organization, it is the prime objective of high authorities to manage and control the costs. Businesses have many expenses, the incoming and outgoing of money is part of daily activities. To manage the cost of business the term “Responsibility Accounting” is used where specific people are made responsible for controlling expenditures and accounting of certain departments. So let’s start with the basic definition of responsibility accounting.
Table of contents
- What is Responsibility Acounting?
- Types of Responsibility Center in Responsibility Accounting
- Centralization Vs Decentralization in Divisional Performance
- The Principle of Controllability
- How Performance is Measured in Responsibility Accounting?
- Advantages and Disadvantages of Responsibility Accounting
What is Responsibility Acounting?
Responsibility Accounting is referred to an accounting system that includes the identification of responsibility centers, their goals, developing performance measurement programs, preparation & analysis of responsibility center performance reports. The responsibility center is a subunit of an organization where the manager has some degree of responsibility for all the tasks and activities designed for that unit.
The management, internal accounting, planning, budgeting, and responsibility center of a corporation are major objectives of responsibility accounting. This accounting procedure usually involves the monthly and annual budget preparation for a responsibility center. It also records the cost and profits of a firm on a monthly & yearly basis where the report is submitted to the concerned manager for taking feedback. In case of any mismanagement of money, the responsible manager is held accountable.
Types of Responsibility Center in Responsibility Accounting
A responsibility center is divided into 4 types;
Cost Center: A cost center is also known as expense center is refers to the department of an organization in which employees of a cost center is only accountable for the cost incurred in that department but not for the profits. In multinational companies, the prime objective of using cost center is to examine the cost of the company and to minimize the undesired expenditures.
Revenue center: As the name suggests a revenue center is a department that is accountable for monitoring, initiating, and generating sales revenues. The revenue center management does not have any authority over the capital investment or cost but can access a few of the charges in the marketing department. It is calculated by examining the budget revenues with actual revenues. & actual expenses of marketing with budgeted marketing costs.
Profit center: The profit center is a division of an organization in which management is responsible for both cost and revenues. The prime goal of the profit center is to follow all the strategies that increase company sales and profits. The managers are responsible for all the tasks connected with the sales of production. The profit center managers decide the goods selling rate, production policies, and several marketing programs.
Investment center: In the investment center the higher authorities are accountable for both investments and profits. The expenses, revenues, and invested amount on assets are controlled by the managers’ team. The manager also constructs the debit policy which has a direct impact on the collection of debt and policy of inventory.
Centralization Vs Decentralization in Divisional Performance
As the business activities begin it’s convenient for owners to keep track of different things but as the business grows such enhances sales, more employees, additional branches, and products, it becomes complex to estimate the company performance. To manage better business operations, centralized and decentralized management is used for efficient decision making. Once the corporation sets up its management levels, the owner decides whether he will prefer a centralized or decentralized system.
Centralization is a company structure in which one person makes major decisions e.g. company strategic direction, resource allocation, and product sale policies, etc. Mostly centralized system is preferred by businesses where the owner or top hierarchy makes all important decisions. Brands like Pizza Hut, Apple, Burger King, and McDonald’s are the example of a centralized structure.
In a decentralization structure, the decision is made at several levels of the company. Generally, a decentralized system is divided into smaller groups to efficiently measure the overall performance of the organization. To maintain competitive advantages and grow further in the market, decentralization is preferred by many businesses.
The Principle of Controllability
A controllability principle requires that the assessment of the manager must be on the factors that are under control.
• Controllable vs Non-Controllable Cost
The cost on which a firm has full authority and responsibility is known as controllable cost e.g. factory overheads, direct material, labor costs, or marketing expresses. The head or managers have the authority to regulate or influence the costs.
The costs that a firm cannot change are known as non-controllable costs e.g. advertising costs, insurance, and rent. These costs are allocated by higher authorities and specific managers cannot influence or control these expenses.
• Controllable vs Non-Controllable Profit
The profit or gain that is made by the department after subtracting only those expenditures that are controlled by a divisional manager and do not take notice of expenditures that cannot be controlled by the department manager. On the other hand, non-controllable profit is the ones that can’t be influenced by someone.
How Performance is Measured in Responsibility Accounting?
The information regarding the used resources and output achieved is provided to managers. The manager uses this accounting information to plan strategy, allocate resources, and control operations. The control, revenues, profit, and investment centers perform their respective responsibilities to achieve the objective of the company to control operating costs. The responsibility accounting system manages the cost and managers’ performances that are accountable for the department expresses. The common key performance indicators (KPIs) that are widely used to measure the performance of divisions are residual income (RI) and return on investment (ROI). In this performance measure, we take the controllable profits before deducting any head office costs or reallocation costs which are not in the control of divisional manager.
Example of Responsibility Accounting
Let’s consider a scenario in which the company’s responsibility accounting system XYZ command the authority heads to assign the expenses and manage the costs. The top management would track manager performance and report accounting performance.
Advantages and Disadvantages of Responsibility Accounting
The benefits of responsibility accounting are as follows;
- It is a well-structured method to control organization costs.
- Provide a way to make a better decision at a large diversified company.
- Give an efficient mechanism to managers and individuals to evaluate performance.
- It helps in comparing actual achievement by encouraging budgeting.
The limitations of responsibility accounting are as follows;
- There is a possibility that conflicts may arise between an organization and individual interests.
- It is complex to design an organization chart and a lot of report making is required.
- Passive resistance may occur when personal reactions are neglected by the company due to which company objectives slowdown.
Responsibility accounting measures the financial performance of the company. The right implementation of all steps helps in smoothly achieve the company goal.