Responsibility Accounting describes the decentralisation of authority with performance of the decentralised units measured in terms of accounting results.
Responsibility Accounting recognises various decision centres throughout an organisation and trace costs, revenues, assets and liabilities to the individual managers who are responsible for making decisions about the costs in question.
It is a ‘ system of accounting that segregates revenues and costs into areas of personal responsibility in order to assess the performance attained by persons to whom authority has been assigned’.
Accounting reports are provided so that every manager is aware of all the items which are within his/her area of authority so that he is in a position to explain them.
There are three responsibility centres or units. A responsibility centre is’ a unit or function of an organisation headed by a manager having direct responsibility for its performance’.
| Type of unit | Manager has control over | Performance Measurement |
| Cost centre | Controllable costs | Variance Analysis, |
| | | Efficiency measures |
| | | |
| Profit centre | Controllable costs | Profit |
| | Sales volume/prices | |
| | | |
| Investment centre | Controllable costs | Return on Investment |
| | Sales | Residual Income |
| | Investment in fixed/ WC assets | Other financial ratios |
Cost centre: ‘a location function or item of equipment in respect of which costs may be ascertained and related to cost units for control purposes’.
Profit centre; ‘a segment of the business entity by which both revenues are received and expenditures are caused or controlled, such revenues and expenditure being used to evaluate segmental performance'’
The manager of a profit centre is made accountable and responsible for the profits achieved. The manager should be able to make decisions which may improve profitability. In organisations where power is centralised the individual manager may not have autonomy to make these decisions.
Investment centre: ‘ a profit centre in which inputs are measured interms of expenses and outputs are measured in terms of revenues and in which assets employed are measured – the excess of revenue over expenditure then being related to assets employed’.
The investment centre or divisional manager is allowed discretion about the amount of investment undertaken by the division so profit measurement alone is not sufficient to measure performance. Profit should be related to the capital employed in the division.
Divisional Management Performance
There are two main performance measures for divisions – Return on Capital Employed or Risidual Income.
ROCE or ROI is a relative statistic it looks at the relationship between profitability and capital employed.
Net Profit/ Net Investment in Assets
ROI can be used in two ways.
(1) As a control technique to compare divisional performance within a company.
(2) As a planning decision technique to decide to accept or reject projects
ROI can be looked at in two ways:
ROI = Net profit / Net investment in assets
OR
ROI = Net profit x Sales
---------------- ------------
Sales Net assets
ROI is not only a function of profitability but is also a result of asset utilisation
It is essential that when the ratio is used for comparison purposes that the same accounting rules and procedures are used to arrive at profit and capital employed.
| Management action | Effect on ROI |
| Reduce level of costs | Improvement in |
| Increase profit mark up on sales | Profit element |
| | |
| Reduce net assets employed | Improvement in |
| Increase level of sales | Asset use element |
Advantages
(1) It is regarded as one of the prime performance measures
(2) It deals with profit and net assets which are concepts well understood in business.
(3) Useful for comparison of one business unit with another provided the same accounting rules are used.
Limitations
(1) Can lead to sub-optimal decision-making. A manager will be unwilling to accept projects and investment opportunities which do not produce a ROCE equal or better to the current ROCE being earned by that division. (See overhead)
(2) Care has to be exercised in terms of how the ROCE is calculated.
Net profit/ Capital employed
Net profit, Controllable contribution, Contribution.
Capital employed – net total assets, intangible assets?, leased or hired assets
(4) There can be manipulation of the ratio. It can lead to an emphasis on short-termism in respect to the profit figure. The total asset figure can be manipulated- a reluctance to invest in new assets, lease rather than buy assets.
(5)
Limitations of ROI
The main drawback with ROI is it can lead to sub-optimal decision-making. If a divisional manager’s performance is to appraised by ROI he/she will be unwilling to accept projects which do not realise a return at least equal to the current ROI being earned by that division.
EG. A divisional manager has investment in assets standing at £4 million with a current return of £800,000 profit. A new investment opportunity presents itself. The investment would involve £1.6 million with an estimated £240,000. The manager’s performance is determined by ROI.
Would the manager accept the project?
| | Current position | New project | New position |
| | £’000 | £’000 | £’000 |
| Investment level | 4,000 | 1.600 | 5,600 |
| Income from investment | 800 | 240 | 1,040 |
| ROI | 20% | 15% | 18.6% |
The manager would be inclined to reject the project since it would dilute the ROI. Let’s suppose the company’s overall cost of capital is 10%. Any project which delivers a return in excess of 10% increases the wealth of the company. This is sub-optimal planning and decision-making.
Net Residual Income
Whereas ROI is a relative measure RI is an absolute income measurement. The decision rule is if a new investment project generates a positive return in excess of the company’s cost of capital should be accepted by divisions within the organisation.
The RI works by charging divisions with an imputed interest charge equal to the organisation’s cost of capital. Any new projects giving a surplus of income after being charged interest or rent should be accepted.
Using the same information as before:
| | Current position | New project | New position |
| | £’000 | £’000 | £’000 |
| Investment level | 4.000 | 1,600 | 5,600 |
| Income from investment | 800 | 240 | 1,040 |
| Less interest charge @ 10% | (400) | (160) | (560) |
| | --------- | --------- | -------- |
| NRI | 400 | 80 | 480 |
| | ====== | ===== | ===== |
The manager would accept the project since his divisional and the company’s residual income is increased after a notional rent or interest is charged for the use of assets.
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