Responsibility accounting


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Responsibility accounting

  1. 1. Assignment ON “Responsibility Accounting” (Cost Accounting) Submitted to: Department of Management Studies AMRAPALI INSTITUTE, SHIKSHA NAGAR LAMACHAUR, HALDWANI UTTRAKHAND TECHNICAL UNIVERSITYSubmitted to: Submitted by:MS. ARTI SHARMA SAURBH BHANDARILecturer, MBA 4th SemAIMCA Deptt.
  2. 2. RESPONSIBILITY ACCOUNTINGDEFINITION: Responsibility accounting is a reporting system that compiles revenue, cost,and profit information at the level of those individual managers most directly responsible forthem. The intent is to provide this information to those people most able to act upon it, as well asto judge their performance with it.Responsibility accounting is an internal system used to better control costs and performance. Itsmain focus is making individual managers responsible for those elements of a companysperformance which they can control. In most cases, responsibility accounting does not affect acompanys public accounts.WHAT IS RESPONSIBILITY ACCOUNTING?Responsibility accounting refers to a company’s internal accounting and budgeting. Theobjective is to assist in the planning and control of a company’s responsibility centers—such asdecentralized departments and divisions.Responsibility accounting usually involves the preparation of annual and monthly budgets foreach responsibility center. Then the company’s actual transactions are classified by responsibilitycenter and a monthly report is prepared. The reports will present the actual amounts for eachbudget line item and the variance between the budget and actual amounts.Responsibility accounting allows the company and each manager of a responsibility center toreceive monthly feedback on the manager’s performance.In responsibility accounting, each department will have stated goals. The relevant manager willthen be judged on how well he or she meets these goals. This is similar to most target systems,but will usually work by measuring on a financial basis. The important distinction is that thisfinancial assessment will not necessarily be a pure profitability measure.In most responsibility accounting systems, each department is classified into one of fourcategories. A cost center will be judged purely on how low it keeps spending; the traveldepartment in the example above would fall into this category. A revenue department such as thesales team will be judged purely on the revenue it generates. A profit center will be judged on astandard profit or loss basis. This could apply to individual stores in a chain.The final category is an investment center. This may literally involve financial investments, butcould also cover departments involved in long-term projects. Departments in such a category areusually judged using a longer-term view that takes account of issues such as capital spendingwhere the resulting revenue will not all be gathered in the first year.Generally, responsibility accounting is a purely internal measure. It is possible that details fromits operation and results could be included in a company report, for example as information todetail changes a company has made. These details would only be used as a way of sharing
  3. 3. information with investors and potential investors. The details do not usually form a part of themandatory financial information that a company must include in its public accounts.Responsibilities of an Accounting DepartmentMost people don’t realize the importance of the accounting department in keeping a businessoperating without hitches and delays. That’s probably because accountants oversee many of theback-office functions in a business — as opposed to sales, for example, which is front-lineactivity, out in the open and in the line of fire.Folks may not think much about these back-office activities, but they would sure notice if thoseactivities didn’t get done. On payday, a business had better not tell its employees, “Sorry, but theaccounting department is running a little late this month; you’ll get your checks later.” Typically, the accounting department is responsible for the following: Payroll: The total wages and salaries earned by every employee every pay period, which are called gross wages or gross earnings, have to be calculated. Based on detailed private information in personnel files and earnings-to-date information, the correct amounts of income tax, social security tax, and other deductions from gross wages have to be determined. Stubs, which report various information to employees each pay period, have to be attached to payroll checks. The total amounts of withheld income tax and social security taxes, plus the employment taxes imposed on the employer, have to be paid to federal and state government agencies on time. Retirement, vacation, sick pay, and other benefits earned by the employees have to be updated every pay period. In short, payroll is a complex and critical function that the accounting department performs. Many businesses outsource payroll functions to companies that specialize in this area. Cash collections: All cash received from sales and from all other sources has to be carefully identified and recorded, not only in the cash account but also in the appropriate account for the source of the cash received. The accounting department makes sure that the cash is deposited in the appropriate checking accounts of the business and that an adequate amount of coin and currency is kept on hand for making change for customers. Accountants balance the checkbook of the business and control who has access to incoming cash receipts. (In larger organizations, the treasurer may be responsible for some of these cashflow and cash-handling functions.) Cash payments (disbursements): In addition to payroll checks, a business writes many other checks during the course of a year — to pay for a wide variety of purchases, to pay property taxes, to pay on loans, and to distribute some of its profit to the owners of the business.
  4. 4. The accounting department prepares all these checks for the signatures of the business officers who are authorized to sign checks. The accounting department keeps all the supporting business documents and files to know when the checks should be paid, makes sure that the amount to be paid is correct, and forwards the checks for signature. Procurement and inventory: Accounting departments usually are responsible for keeping track of all purchase orders that have been placed for inventory (products to be sold by the business) and all other assets and services that the business buys — from postage to forklifts. A typical business makes many purchases during the course of a year, many of them on credit, which means that the items bought are received today but paid for later. So this area of responsibility includes keeping files on all liabilities that arise from purchases on credit so that cash payments can be processed on time. The accounting department also keeps detailed records on all products held for sale by the business and, when the products are sold, records the cost of the goods sold. Property accounting: A typical business owns many substantial long-term assets called property, plant, and equipment — including office furniture and equipment, retail display cabinets, computers, machinery and tools, vehicles (autos and trucks), buildings, and land. Except for small-cost items, such as screwdrivers and pencil sharpeners, a business maintains detailed records of its property, both for controlling the use of the assets and for determining personal property and real estate taxes. The accounting department keeps these records.The accounting department may be assigned other functions as well, but this list gives you a prettyclear idea of the back-office functions that the accounting department performs. Quite literally, abusiness could not operate if the accounting department did not do these functions efficiently and ontime. To do these back-office functions well, the accounting department must design a goodbookkeeping system and make sure that it is accurate, complete, and timely. Advantages and Disadvantages Responsibility accounting has been an accepted part of traditional accounting control systems for many years because it provides an organization with a number of advantages. Perhaps the most compelling argument for the responsibility accounting approach is that it provides a way to manage an organization that would otherwise be unmanageable. In addition, assigning responsibility to lower level managers allows higher level managers to pursue other activities such as long term planning and policy making. It also provides a way to motivate lower level managers and workers. Managers and workers in an individualistic system tend to be motivated by measurements that emphasize their individual performances. However, this emphasis on the
  5. 5. performance of individuals and individual segments creates what some critics refer to as the"stovepipe organization." Others have used the term "functional silos" to describe the same idea.Consider 9-6 Exhibit below. Information flows vertically, rather than horizontally. Individuals inthe various segments and functional areas are separated and tend to ignore the interdependencieswithin the organization. Segment managers and individual workers within segments tend tocompete to optimize their own performance measurements rather than working together tooptimize the performance of the system.
  6. 6. TYPES OF RESPONSIBILITY CENTERS1.Cost Center / Discretionary Cost Center2. Revenue Center3. Profit Center4. Investment CenterCost center managers are responsible for the incurring and controlling costs in theirorganizational subunit.Discretionary cost center managers are typically responsible for adhering to a budget.Revenue center managers are responsible for revenues generated by their organizationalsubunit.Profit center managers are responsible for revenues and expenses generated and incurred bytheir organizational subunit.Investment center managers are profit as well as the capital investments required to generate theprofit.
  7. 7. RESPONSIBILITY CENTRE AND THEIR EVALUATIONRESPONSIBILITY CENTRES EVALUATION METHODSRevenue Centre Sale Price Variance Sale Quantity Variance Sale Mix VarianceCost Centre Raw Material Variances: Labor Variances Overhead VariancesProfit Centre Gross Profit Contribution MarginInvestment Centre ROI Residual Income Economic Value Added ADVANTAGES DISADVANTAGESHelps manage a large and diversified May create conflicts between various divisionsorganizationMotivate Manager to optimize their Undue competition may become dysfunctionalperformance Narrows down vision as overall companyProvide manager freedom to make local prospective are not considered by individualdecisions managers.Top management get more time for policy May prove costly due to duplicationmaking and strategic planningSupports management and individualspecialisation based on comparative Problem in coordination across divisionsAdvantagesRESPONSIBILITY ACCOUNTING- PROFIT PLANNING & CONTROLPlanning & control are essential for achieving good results in any business. Firstly, a budget isprepared and, secondly, actual results are compared with budgeted ones. Any difference is maderesponsibility of the key individuals who were involved in (i) setting standards, (ii) givennecessary resources and (iii) powers to use them.In order to streamline the process, the entire organization is broken into various types of centersmainly cost centre, revenue centre, profit center and investment centre. The organizationalbudget is divided on these lines and passed on to the concerned managers. Actual results are
  8. 8. collected and displayed in the same form for comparison. Difference, if any, are highlighted andbrought to the notice of the management. This process is called Responsibility Accounting.CONTROLLABILITY CONCEPTAn underlying concept of responsibility accounting is referred to as controllability.Conceptually, a manager should only be held responsible for those aspects of performance thathe or she can control. In my view, this concept is rarely, if ever, applied successfully in practicebecause of the system variation present in all systems. Attempts to apply the controllabilityconcept produce responsibility reports where each layer of management is held responsible forall subordinate management layers as illustrated below.MANAGERIAL PERFORMANCE AND ECONOMIC PERFORMANCEAll businesses operate in a complex environment. The traditional approach of centralized controlis not possible. There is a shift towards decentralization. At the same time, the managementwants to retain some sort of control over activities of its managers.
  9. 9. When authority is decentralized and passed on to managers, there is a problem of goal-congruence. This means that the management will constantly review all operations and activitiesof individual divisions to insure that none of them is working against the overall objectives of thecompany. Such a behavior is called dysfunctional and is damaging to the company.While evaluating, performance of an individual manager, two factors have to be considered: Should the manager’s job be separated and a manager is rewarded or penalized only for those activities over which the manager has control. Should the manager’s decision be seen in a wider prospective and final judgment be given only after reviewing full impact of such decisions.It is obvious that a managers decisions should be evaluated after seeing their impact on thebottom line i.e. profitablity of the comany. But such policy would not be motivational for theindividual manager and the good results may be nullified by the factors not under the control ofthe particular manager. Hence, the company follows first appraoch i.e. managerial performance.
  10. 10. CONSOLIDATED P&L ACCOUNTSAn example to explain Responsibility AccountingAn integrated textile unit showed a net profit after tax of Rs.272 million. Its ROI (Return onInvestment), was 17.5% which is much above the supposed cost of capital of 12.5%.The company was operating three divisions: (i) Spinning Unit, (ii) Weaving Unit and (iii) aFinishing Unit. As of now, it is not apparent who earned what. So managers of the threedepartments would be asking for bonuses or rewards.Now suppose, the company asks its accountants to prepare Division-wise P&L account andpresent the same to the management for performance appraisal of the three managers.DIVISION WISE ACCOUNTSAfter considering division-wise performance, who do you think deserve the bonus?Only the manager, Spinning Division, deserves the bonus. Manager Weaving has just brokeneven by earning profit equal to cost of capital. Manager Finishing was really a drag on the
  11. 11. company’s resources and its losses were only hidden in consolidated statements because ofsubstantial contribution made by Spinning Unit.However, this is over-simplified example but it brings glaring facts to the notice of themanagement and other users of the accounts.