RESPONSIBILITY ACCOUNTING is the system that recognizes various decision centers throughout an organization and traces costs (and

revenues,
assets and liabilities where pertinent) by areas of responsibility. It operates on the premise that managers should be held responsible for their
performance, the activities of their subordinates and all activities within their responsibility center. It is used to measure the performance of people and
departments to foster goal congruence.

What are its benefits? Aside from the fact that it is a way to delegate decision making, responsibility accounting also helps the management to
determine centers or units on which they could focus more (management by exception). Further, responsibility accounting aids the management in
establishing standards in a more specific perspective and eventually helps the management in the evaluation of the performance of different units in
an organization, and eventually, the organization on its entirety.

What are needed to initiate & maintain an effective responsibility accounting system?

1. A well-defined organization structure. Since responsibility accounting deals with a decentralized organization, the managers of the different units
must have a clear-cut definition & understanding on the jurisdiction of their decision making function.
2. Well-defined and established standards of performance in revenues, cost & investments. A well-defined and realistic plan must be made &
followed in terms of managing activities which may affect the financial performance of the company. This required an integrated plan on how
operations should be controlled, limitations and guidelines in costing, budgeting expenses, forecasting sales, programs for investments and all
other ways and means to carry on plans for the any business undertaking.
3. A system of accounting that identifies any revenues, expenses & assets to specific units in the organization.
4. A system that provides for the preparation of regular performance reports. This involves segment reports showing variances, if any, from actual to
the planned results. Report should only include controllable items and must highlight issues needed to be addressed.
RESPONSIBILITY CENTER. It is a subunit in an organization whose manager is held accountable for specified financial results. It can either be a cost
center, profit center, investment center & revenue center.

How is the performance of a responsibility center measured?

1. COST CENTER – i.e. maintenance department. The manager’s job is to see whether the actual cost incurred is within the budget. Should there be
any variance, such must be assessed whether material or not, or if material, whether favorable or favorable, and must eventually be reported &
justified including consideration on the nature of costs whether controllable or not. The performance of the cost center is evaluated using
performance reports or variance analysis. Performance of the manager will then be evaluated on the basis of the results of the analysis. Segment
has control over the incurrence of cost.

2. PROFIT CENTER – i.e a branch. The performance of the profit center is evaluated by preparing income statements using contribution approach,
presenting actual results & budgeted figures. Revenues, direct and indirect costs will then be compared and analyzed. The operating performance
will then be favorable if the unit will be able to cover its share in the indirect cost (or even exceed) thru profit generation. Segment has control over
both costs and revenues.

3. INVESTMENT CENTER - i.e. a division of a large corporation. The manager’s job is to see whether assets (all assets, not only PPE) on which the
company invest is giving value to the company. Segment has control over profits and invested capital. The evaluation is done thru the assessment
of the income generated and cost incurred of a particular asset or investment. The assessment may be done thru the following measures.

● Return of Investment (ROI). Operating Income vs. Average Operating Assets Income before interest
(Computed ROI will then be compared to the targeted ROI) and taxes (EBIT)

Net operating income

ROI =
Average operating assets Cash, accounts receivable,
inventory, plant & equipment,
and other productive assets

The DuPont equation the use of ROI and recognized the importance of looking at the components of ROI, namely margin and turnover.
Margin = Net Operating Income / Sales
Turnover = Sales / Average Operating Asset
ROI = Margin x Turnover
***Any increase in ROI must involve at least one of the following – increased sales, reduced operating expenses, or reduced operating
assets.
IMPORTANT NOTE: Just telling managers to increase ROI may not be enough. Managers may not know how to increase ROI in a manner
that is consistent with the company’s strategy. A manager who is evaluated based on ROI may reject investment opportunities that are
profitable for the whole company but that would have a negative impact on the manager’s performance evaluation.
 ● Residual Income. Operating income less minimum desired ROI. (if positive, segment performance is favorable. Minimum desired
ROI is usually Investment x desired rate of return)

Net Average Minimum

Residual
= operating - operating  required rate of
income
income assets return

Notice that this computation differs from ROI. ROI measures net operating income
earned relative to the investment in average operating assets. Residual income
measures net operating income earned less the minimum required return on average
operating assets. NOTE: The residual income approach encourages managers to
make investments that are profitable for the entire company but that would be
rejected by managers who are evaluated using the ROI formula.

● Economic Value Added (EVA). A more specific& conservative version of residual income. It uses income net of tax rather than gross
of tax. Further, it considers the cost of capital (borrowing cost and cost of selling shares). The formula is Earnings after Income Tax
less desired income (desired income is the after-tax weighted average cost of capital multiplied to the difference between total assets
and current liabilities)

4. REVENUE CENTER– i.e. the reservation department of an airline – Managers of revenue centers use variance in sales price and sales mix to
monitor or control their operations. Managers of revenue centers are primarily responsible for achieving budgeted levels of contribution margin by
controlling the number of units sold, product mix, and selling prices. Secondarily, expense control which includes control in travelling,
entertainment, and other marketing expenses may also be considered by the manager. Segment is responsible for the revenue of a unit. ollowing
are 3 types of variance useful for managers in a revenue center.

● Sales Price Variance. This shows how much of the difference between actual and budgeted contribution margin is caused by the
difference between actual and budgeted sales price.

= (Actual Sales Price – Master Budget Sales Price) x Actual Unit Sales

● Sales Volume Variance. It measures the difference between actual unit sales and budgeted unit sales.

= (Actual Unit Sales – Master Budget Unit Sales) x Master Budget

Average Contribution per Unit*

*Master budget average contribution margin per unit = Master Budget Contribution Margin / Master Budget Sales

● Sales Mix Variance. It measures the change in contribution margin caused by selling products in proportion (mix) different from
those that were budgeted.
 = (Flexible Budget Average Contribution Margin per Unit** – Master
Budget Sales Average Contribution per Unit) x Actual Unit Sales

**Flexible Budget Average Contribution Margin per Unit = Flexible Budget Total Contribution Margin / Actual Unit Sales

DECENTRALIZATION AND SEGMENT REPORTING. One of the purposes of a responsibility-accounting system is to help an organization balance
the costs and benefits of decentralization.
Benefits: (1) The manager’s special skills in a particular unit will enable them to manage most effectively.
(2) Managerial autonomy means managerial training.
(3) Decision-making function will exhibit greater motivation.
(4) Decision-making delegation provides more time for upper-level managers.
(5) Decision-making delegation will aid timely response to opportunities & problems.
Costs: (1) Managers in a unit will only have narrow focus.
(2) Managers might ignore the effect of their actions to other units.
(3) Some task may be duplicated unnecessarily.

Segmented Reporting - Segmented reporting refers to the

preparation of accounting reports by segment and for the
organization as a whole.
A segment is any part or activity of an organization about which a
manager seeks cost, revenue, or profit data.

CONTROLLABLE AND NON-CONTROLLABLE COSTS, DIRECT AND COMMON COSTS

✓ Controllable Costs – Cost that can be changed according to the discretion of the manager.
✓ Uncontrollable Costs – Cost that cannot be changed and that are fixed regardless of efforts of the manager.
✓ Direct Costs/Traceable Costs - fixed cost that is incurred because of the existence of the segment. If the segment were eliminated, the fixed
cost would disappear. Examples of traceable fixed costs include the following:
▪ The salary of the Fritos product manager at PepsiCo is a traceable fixed cost of the Fritos business segment of PepsiCo.
▪ The maintenance cost for the building in which Boeing 747s are assembled is a traceable fixed cost of the 747 business segment of
Boeing.

✓ Common Costs - fixed cost that supports the operations of more than one segment, but is not traceable in whole or in part to any one
segment. Examples of common fixed costs include the following:
▪ The salary of the CEO of General Motors is a common fixed cost of the various divisions of General Motors.
▪ The cost of heating a Safeway or Kroger grocery store is a common fixed cost of the various departments – groceries, produce, and
bakery.

SEGMENT MARGIN - The segment margin, which is computed by subtracting the traceable fixed costs of a segment from its contribution margin, is
the best gauge of the long-run profitability of a segment.
RULE: Do not allocate common fixed costs to a segment. Allocating common costs to segments reduces the value of the segment margin as a guide
to long-run segment profitability.

Exercises:
A. ROI - A Major Drawback
• As division manager at Winston, Inc., your compensation package includes a salary plus bonus based on your division’s ROI -- the higher
your ROI, the bigger your bonus.
• The company requires an ROI of 15% on all new investments -- your division has been producing an ROI of 30%.
• You have an opportunity to invest in a new project that will produce an ROI of 25%.
Q: As division manager would you invest in this project?

B. X Division recorded operating date as follows for the past year:

Sales Php 200,000.00
Net Operating Income 25,000.00
Average Operating Assets 100,000.00
Gross Profit 75,000.00
Stockholder’s Equity 80,000.00
Residual Income 13,000.00

Q1: For the past year, what is the ROI?

Q2: For the past year, what is the margin?
Q3: For the past year, the turnover was?
Q4: For the past year, the minimum required rate of return was?

C. The following results for the year pertain to Fox Division of X Corporation.
Sales Php 640,000
Variable Expenses 160,000
Fixed Expenses 300,000
The weighted average cost of capital is 12 percent. The firm’s minimum required rate of return is 14 percent. Taxes for the firm are 40
percent. If the average assets are Php 1,000,000, return of investment for Fox Division is?