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JRMORENO
RESPONSIBILITY ACCOUNTING

B ASIC C ONCEPTS & R ESPONSIBILITY C ENTERS

T ERMINOLOGY

Responsibility accounting (or “Activity Accounting”) is a system of accounting which is tailored to an organization so that
performance, in terms of costs, or costs and revenues, are recorded and reported by levels of responsibility within the
organization.

Objectives of Responsibility Accounting

 To accumulate cost (or costs and revenue) according to areas of responsibility in order that deviations from standard
can be identified with the person or group responsible.
 To encourage managerial effort to attain organizational goals by motivating managers to make decisions consistent
with those goals.
 To provide a basis for determining managerial compensation.

Principles of Good Organization followed in a Responsibility Accounting Program

1. There should be the appropriate assignment of each function to a unit of the organization.
2. Specific assignment of responsibilities should be understood.
3. There should be no overlapping of responsibilities.
4. Many-to-one relationship exists between reporting employees and their only supervisor.
5. There should be a supervisory position over each logical grouping (either geographic or functional) of activities at each
management level.

A responsibility center (also called “strategic business units” or SBUs ) is an organizational unit engaged in the performance of
a single function or a group of closely related functions having a single head accountable for activities of the unit (NAA).

Types of Responsibility Centers

1. Cost or expense centers — in which performance is measured in terms of cost or expenses incurred.
Example: Maintenance department
Related Issues: Cost Shifting, Allocation of Service department costs to Cost Centers

2. Revenue Centers — in which performance is measured In terms of revenues earned

Example: Sales department

3. Profit centers — in which performance is measured In terms of both revenues earned and costs incurred.
Example: Store Outlets
Related Issues: Goal Congruence among production, marketing, and support centers

4. Investment centers — in which performance is measured in terms of the use of assets as well as the revenues earned
and costs incurred.
Example: Branch Office
Related Issues: Permits an evaluation of performance that can be compared with that of other responsibility centers or
other potential investments on a return on investment basis, i.e., on the basis of the effectiveness of asset usage.

5. Service centers — are usually operated as cost centers. Service centers exist primarily and sometimes solely to
provide specialized support to other organizational sub-units

Note: The business firm as a whole may also be considered a responsibility center.

M ANAGEMENT BY O BJECTIVES (MBO)

Management by objectives (MBO) is a behavioral, communications-oriented responsibility approach to employee self-direction.
Under MBO, a manager and his/her subordinates agree upon objectives and the means of attaining them. The plans that result
are reflected in responsibility accounting and in the budgeting process.

G OAL C ONGRUENCE
It is the coherence of the various independent objectives of each responsibility center to the organization goal at large.

S UB - OPTIMIZATION
This occurs when one segment of a firm takes action that is in its own best interests but is detrimental to the firm as a whole.

C ENTRALIZATION
Decisions are made at the top level of management.

D ECENTRALIZATION
CRC: MS Responsibility Accounting & Performance Evaluation 2
The decision making can be delegated to the lower levels of management without much intervention from the top management.

R ESPONSIBILITY AND ACCOUNTABILITY

Responsibility involves both: the obligation to secure results, and the obligation to report back to higher authority on the results
achieved.
Accountability denotes only the obligation to report results achieved to higher authority.

Therefore, Responsibility involves Accountability at all times, but Accountability does not involve the obligation to achieve results.

C OST C ONTROL VS . C OST R EDUCTION

Control -The process through which actual costs are made to conform to standard or expected costs.
Reduction - The use of management devices (i.e. searching for cheaper materials, improved methods of production. etc.) to
reduce costs.

While cost control maintains costs in accordance with established standards, cost reduction challenges the standards and
endeavors to reduce them continuously.

C OST C LASSIFICATIONS IN R ESPONSIBILITY ACCOUNTING

Responsibility accounting requires that costs be classified:

Organization
(1) by responsibility centers
S Controllable (2) within each responsibility center, by whether
controllable or non-controllable, and
Responsibility (3) within the controllable classification, by cost types or
natural elements (i.e. indirect labor, supplies, power,
Center L etc.) in a way that provides a useful basis for analysis.
Non-
M

Controllable

Controllable and Non-Controllable Costs

Controllable costs are those which may be directly regulated at a given level of managerial authority.
Non-controllable costs are those which are not subject to regulation at a given level of managerial authority.

Two Determinants of Controllability

(a) Managerial Area of Responsibility (b) Time Period Reference

Note: “All costs are controllable, to some degree and by somebody over the long run.”
It is the top management which has control over all costs in the long run.

Guide in Deciding Whether the costs are appropriately charged to a person*

* Suggested by the AAA Committee on Cost Concepts and Standards
1. If the person has authority over both the acquisition and use of the services he should be charged with the cost of such
services.
2. If the person can significantly influence the amount of cost through his own action , he may be charged with such costs.
3. Even if the person cannot significantly influence the amount of cost through his own direct action, he may be charged with
those elements with which the management desires him to be concerned so that he will help to Influence those who are
responsible.

P ERFORMANCE E VALUATION OF R ESPONSIBILITY C ENTERS

C ONTRIBUTION APPROACH
Focus: Controllability
Rationale: Contribution Margin is a fairer basis for evaluation than Gross Margin, since fixed costs are uncontrollable
Bases of Measurement (see Exhibit 1.0, below):
1. Manufacturing Margin
2. Profit Margin Computation
3. Short-run performance margin (i.e. the contribution margin minus controllable (discretionary) fixed costs.)
Discretionary costs are characterized by uncertainty about the relationship between input (the costs) and the value of the
related output. Examples are advertising and research costs.
4. Segment margin (i.e. the short-run performance margin minus traceable (committed) fixed costs)
CRC: MS Responsibility Accounting & Performance Evaluation 3
5. Net Income for the Center (i.e. the segment margin minus allocated common costs)

Exhibit 1.0 Measurement applying Contribution Margin Approach

Sales
Controllable Variable Manufacturing Costs
Manufacturing Margin
Controllable Variable Operating Costs
Profit Margin
Controllable (or Discretionary) Fixed Costs
Short-run performance margin
Traceable (or Committed) Fixed Costs
Segment Margin
Allocated Common Costs
Net Income for the Center

Fundamental issue : Allocation of central administration costs

a. If allocation is based on actual sales or contribution margin, responsibility centers that increase their sales (or CM) will
be charged with increased overhead.
b. If central administrative or other fixed costs are not allocated, responsibility centers might reach their revenue (or CM)
goals without covering all fixed costs (which is necessary to operate in the long run).
c. Allocation of overhead, however, is motivationally negative; central administrative or other fixed costs may appear non-
controllable and be unproductive.

R ESIDUAL I NCOME (RI) AND R ETURN ON I NVESTMENT (ROI)

Major Advantage: The advantage of these measures is that they permit of entities with investment bases of different sizes.

1.0 Residual Income (RI)- the excess of the return on an investment over a targeted amount equal to an imputed interest
charge on invested capital. It is the difference between income and the minimum pesos required on a company’s operating
assets.

RI = Operating Income – (Minimum rate of Return x Operating Assets)

a. The rate is ordinarily the weighted-average cost of capital, but it may be an arbitrary yield rate.
b. Projects with a positive residual income should be accepted, and projects with a negative residual income should be
rejected.
c. Residual income is often seen as superior to ROI. It may be more consistent with maximizing profits.

Economic value added (EVA) is a more specific version of residual income. This calculates the excess of after-tax
operating profit over the total annual cost of capital.

EVA = After-tax operating income – ( After-tax weighted-average x (Total Assets – Current Liabilities)
)
cost of capital (or WACC *)
* The after-tax WACC is usually determined based on the fair values of debt and equity.

Benefits derived for using EVA:

(1) EVA represents the business unit's true economic profit.
(2) EVA measures the marginal benefit obtained by using resources in a particular way.
(3) It is useful for determining whether a segment of a business is increasing shareholder value.
(4) EVA is one of several straightforward methods for measuring managerial performance regarding creation of
shareholder value.

Equity Spread = Beginning Equity Capital x (ROE –Percentage Cost of Equity)

Shareholder Return = (Change in the Stock Price + Dividends per share)

Initial Stock Price

Market Value Added = Market Value of Equity – Equity supplied by Shareholders

= (Shares outstanding x Market price) – Equity supplied by
Shareholders
2.0 Return on Investment (ROI)– Ratio of operating income to average operating assets

ROI = Operating income / Average Operating Assets

CRC: MS Responsibility Accounting & Performance Evaluation 4
= (Operating Income / Sales) x (Sales / Average Operating Assets)
= Operating income Margin x Operating Asset turnover

Wherein the OPERATING INCOME = Earnings BEFORE interest and Taxes

Different Attributes of Investment Base

The following may be used to measure the elements of the investment base:
a. Cost
b. Market value

Invested capital may be defined in various ways, for example, as

1) Total assets available
2) Total assets employed, which excludes assets that are idle, such as vacant land
3) Working capital plus other assets. This investment base assumes that the manager controls short-term credit.
4) Shareholders' equity. A portion of long-term liabilities must be allocated to the investment center to determine the
manager's resource base. One problem with this definition of the resource base is that, although it has the
advantage of emphasizing return to owners, it reflects decisions at different levels of the entity: short-term
liabilities incurred by the responsibility center and long-term liabilities controlled at the corporate level.

Alternative Income Measurements

1) Net income
2) Net income adjusted for price level changes

Fundamental Issues on the use of ROI :

The comparability of ROI measures may be affected by:
1. Differences in the accounting policies used by different business unit (e.g. depreciation methods, capitalize
policies, inventory flow assumptions, and revenue recognition).
2. Differences in the tax systems in the jurisdictions where business units operate
3. Changes in foreign currency exchange rates and inflation rates affecting the numerator and denominator of the
ROI calculation
4. The presence of extraordinary items of profit or loss
5. The allocation of common costs
6. The imposition of tariffs and import-export duties
7. Price controls, and
8. Varying availability of resources.

Benefits from the use of ROI

(a) There is the emphasis on the relationship among sales, expenses and investment
(b) Cost efficiency is highlighted
(c) Excessive investment in operating assets is prevented.

Drawbacks with the use of ROI

(a) Investments that will decrease segment’s ROI is avoided even when the overall ROI will not suffer.
(b) Short-term benefits are held more important than long-term advantages.

Review of the Dupont Method

The well-known Dupont method of financial planning and control decomposes ROI into total assets turnover and profit margin.

Sales x Net income = Net income

Total assets Sales Total assets

A variant of the Dupont formula is return on equity, which equals total assets turnover times the profit margin times the equity
multiplier.
Sales x Net income x Total assets = Net income
Total assets Sales Equity Equity

Note to Candidate:
Now that you have familiarized yourself with the concepts, try answering the following review questions.

REVIEW QUESTIONS - THEORY

1
. What term identifies an accounting system in which the operations of the business are broken down into cost centers and the
control function of a foreperson, sales manager, or supervisor is emphasized?
(a) responsibility accounting (c) control accounting
(b) operations research accounting (d) budgetary accounting.
2
. The format for internal reports in a responsibility accounting system is prescribed by:
(a) Generally accepted accounting principles.
CRC: MS Responsibility Accounting & Performance Evaluation 5
(b) The Accounting Standards Council.
(c) The Philippine Institute of Certified Public Accountants
(d) Management.

3
. Goal congruence is
(a) The desire and the commitment to achieve a specific goal.
(b) The sharing of goals by supervisors and subordinates.
(c) The extent to which individuals have the authority to make decisions.
(d) The extent of the attempt to accomplish a specific goal.
4
.Motivation is
(a) The desire and the commitment to achieve a specific goal.
(b) The sharing of goals by supervisors and subordinates.
(c) The extent to which individuals have the authority to make decisions.
(d) The extent of the attempt to accomplish a specific goal.

5
. Costs are accumulated by a responsibility center for control purposes when using:
Job Order Costing Process Costing
(a)Yes Yes
(b)Yes No
(c)No No
(d)No Yes

6
. In a responsibility accounting system, the process in which a supervisor and a subordinate jointly determine the subordinate's
goals and plans for achieving these goals is:
(a) Top-down budgeting. (c) Imposed budgeting.
(b) Bottom-up budgeting. (d) Management by objectives.
7
. Internal reports prepared under the responsibility accounting approach should be limited to which of the following costs?
(a) Only variable costs of production.
(b) Only conversion costs.
(c) Only controllable costs.
(d) Only costs properly allocable to the cost center under generally accepted accounting principles.
8
. The budgeting process that uses management by objectives and input from the individual manager is an example of the
application of
(a) Flexible budgeting. (c) Responsibility accounting
(b) Human resource management. (d) Capital budgeting.
9
. The most desirable measure, of departmental performance for evaluating the performance of the department manager is
departmental
(a) Net income
(b) Contribution to indirect expenses
(c) Revenue less departmental variable expenses
(d) Revenue less controllable departmental expenses
10
. When using a contribution margin format for internal reporting purposes, the major distinction between segment manager
performance and segment performance is
a. Unallocated fixed cost.
b. Direct variable costs of producing the product.
c. Direct fixed cost controllable by the segment manager.
d. Direct fixed cost controllable by others.
11
. Periodic internal performance reports based upon a responsibility accounting system should not:
(a) Distinguish between controllable and uncontrollable costs.
(b) Be related to the organization chart.
(c) Include allocated fixed overhead in determining, performance evaluation.
(d) Include variances between actual and budgeted controllable costs.
12
. A major problem in comparing profitability measures among companies is the:
(a) Lack of general agreement over which profitability measure is best.
(b) Differences in the size of the companies.
(c) Differences in the accounting methods used by the companies.
(d) Differences in the dividend policies of the companies.
(e) Effect of interest rates on net income.
CRC: MS Responsibility Accounting & Performance Evaluation 6
13
. The report to a territorial sales manager which shows the contribution to profit by each salesperson in the territory is called:
(a) A profit report. (d) A distribution report.
(b) An absorption profit report. (e) A responsibility report.
(c) A gross profit report.
14
. A company built a plant to produce a new product. Which of the decisions below is now probably the most important that
management will have to make?
(a) What profit to make. (d) What price to charge.
(b) What costs to incur. (e) What return on capital to receive.
(c) What customers to accept.
15
. The return on investment (ROI) ratio measures:
(a) Only asset turnover.
(b) Only earnings as a percent of sales.
(c) Both asset turnover and earnings as a percent of sales.
(d) Asset turnover and earnings as a percent of sales, correcting for the effects of differing depreciation methods.
16
. Return on Investment (ROI) is a term often used to express income earned on capital invested in a business unit. A company's
ROI would be increased if.
(a) Sales increased by the same peso amount as expenses and total assets increased.
(b) Sales remained the same and expenses were reduced by the same peso amount that total assets increased.
(c) Sales decreased by the same peso amount that expenses increased.
(d) Sales and expenses increased by the same percentage that total assets increased.
(e) Net profit margin on sales increased by the same percentage that total assets increased.
17
. ROI, residual income, and present value techniques are sophisticated budgeting and accounting methods, yet relatively few
organizations adopt these concepts in their entirety for internal purposes. What is a possible reason for this reluctance?
(a) Behavioral implications of changing the system.
(b) External influences from the larger environment.
(c) The cost of developing the systems exceeds the perceived benefits.
(d) Misunderstanding the importance of budgeting in responsibility accounting.
(e) All of the above.
18
. Which of the following is most liable to be a disadvantage of decentralization?
(a) Lower-level employees will develop less rapidly than in a centralized organization.
(b) Lower-level employees will complain of not having enough to do.
(a) Top management will have less time available to devote to unique problems.
(c) Lower-level managers may make conflicting decisions.
19
. Which of the following is not a cost of decentralization?
(a) Dysfunctional decision making owing to disagreements of managers regarding overall goals and sub goals of the
individual decision makers.
(b) A decreased understanding of the overall goals of the organization.
(c) Increased costs for developing the information system.
(d) Decreased costs of corporate-level staff services and management talent.

REVIEW QUESTIONS – PROBLEM SOLVING

E. Carolina, president of the Deed Corporation, requires a minimum return on investment of 8% for any project to be undertaken
by her company. The company is decentralized, and leaves investment decisions up to the discretion of the division managers as
long as the 8% return is expected to be realized. M. Sander, manager of the Cosmetics Division, has had a return on investment
of 14% for his division for the past 3 years and expects the division to have the same return in the coming year. Sander has the
opportunity to invest in a new line of cosmetics which is expected to have a return on investment of 12%.

20
If the Deed Corporation evaluates managerial performance using residual income based on the
.
corporate minimum required rate of return, what will be the preference for taking on the
proposed cosmetics line by E. Carolina and M. Sander?
Carolina Sander Carolina Sander
a. Accept Reject c. Accept Accept
b. Reject Accept d. Reject Reject

. If the Deed Corporation evaluates managerial performance using return on investment, what
21

will be the preference for taking on the proposed cosmetics line by E. Carolina and M. Sander.
Carolina Sander Carolina Sander
a. Accept Reject c. Accept Accept
b. Reject Accept d. Reject Reject
CRC: MS Responsibility Accounting & Performance Evaluation 7
Question 20 and 21 are based on the following selected data, which pertain to the Dairy Division of Joey Corp.
Sales P300,000
Average invested capital 100,000
Operating income 20,000
Capital turnover 3.0
Imputed interest rate 12%

22
. The return on investment was
a. 6.67% b. 8.00% c. 20.00% d. 33.33%
23
. The residual income was
a. P2,400 b. P5;600 c. P6,667 d. P8,000

Questions 24 through 36 are based on the following information.

Segment A Segment B Segment C Segment D

Net Income P 5,000 P 90,000

Sales P 60,000 P750,000 P135,000 P1,800,000
Investment P 24,000 P500,000 P 45,000 -
Net income as % of sales - - - -
Turnover of investment - - - -
ROI - - 20% 7.5%
Minimum ROI -pesos - - - P 120,000
Minimum ROI - % 20% 6% - -
Residual Income - -0- P 2,250 -

24
. For segment B, net income as a percentage of sales is
a. 8% b. 6.67% c. 4% d. 10%
25
. For Segment C, net income as a percentage of sales is
a. 5% b. 6.67% c. 4% d. 20%
26
. For Segment C, the turnover of investment is
a. 3 b. 1.5 c. 2.5 d. 4
27
. For Segment D, the turnover of investment is
a. 3 b. 1.5 c. 2.5 d. 4
28
. For Segment A, ROI is
a. 6% b. 25% c. 20.8% d. 33%
29
. For Segment B, ROI is
a. 6% b. 25% c. 20% d. 7.5%
30
. For Segment A, the minimum peso ROI is
a. P30,000 b. P6,750 c. P4,800 d. P120,000
31
. For Segment B, the minimum peso ROI is
a. P30,000 b. P6,750 c. P4,800 d. P120,000
32
. For Segment C, the minimum peso ROI is
a. P30,000 b. P6,750 c. P4,800 d. P120,000
33
. In Segment C, the minimum percentage of ROI is
a. 20% b. 6% c. 15% d. 10%
34
. In Segment D, the minimum percentage of ROI is
a. 20% b. 6% c. 15% d. 10%.
35
. In Segment A, the residual income is
a. P200 b. 12,000 c. P(30,000) d. P(60,000)
36
. In Segment D, the residual income is
a. P1,200 b. P12,000 c. P(30,000) d. P(60,000)
CRC: MS Responsibility Accounting & Performance Evaluation 8

 JRM