Large businesses divide operations into responsibility centers to improve management control. Responsibility accounting provides financial information on resource usage and output for each center. Managers are evaluated based on their centers' performance. Centers can be cost centers, which control costs, profit centers controlling both costs and revenues, or investment centers controlling costs, revenues and capital investment. Traceable costs are directly linked to a center, while common costs apply to the whole business. Transfer prices set the cost when one division supplies another and impact each division's reported profits. Non-financial metrics also measure center performance. Financial statements disclose segment revenue, profits/losses, assets and other data at a high level.

1. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Responsibility Accounting
and Transfer Pricing
Chapter
21

2. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Responsibility CentersResponsibility Centers
Large complex
businesses are
divided into
responsibility
centers enabling
managers to have a
smaller effective
span of control.

3. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
The accounting system provides information
about resources used and outputs
achieved.
The accounting system provides information
about resources used and outputs
achieved.
The Need for Information About
Responsibility Center Performance
The Need for Information About
Responsibility Center Performance
This information is used to:
Plan and allocate resources.
Control operations.
Evaluate the performance
of center managers.

4. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Cost
Cost Centers, Profit Centers, and
Investments Centers
Cost Centers, Profit Centers, and
Investments Centers
Cost Center
A business section
that has control
over the incurrence
of costs, but no
control over
revenues or
investment funds.

5. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Cost Centers, Profit Centers, and
Investments Centers
Cost Centers, Profit Centers, and
Investments Centers
Profit Center
A part of the
business that has
control over both
costs and revenues,
but no control over
investment funds.
Revenues
Sales
Interest
Other
Costs
Mfg. costs
Commissions
Salaries
Other

6. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Corporate HeadquartersCorporate Headquarters
Cost Centers, Profit Centers, and
Investments Centers
Cost Centers, Profit Centers, and
Investments Centers
Investment Center
A profit center
where management
also makes capital
investment
decisions.

7. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Cost
Center
Cost control
Quantity and quality
of services
Profit
Center
Investment
Center
Return on assets (ROA)
Residual income (RI)
Evaluation Measures
Profitability
Cost Centers, Profit Centers, and
Investments Centers
Cost Centers, Profit Centers, and
Investments Centers

8. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
An accounting system that
provides information . . .
Responsibility Accounting SystemsResponsibility Accounting Systems
Relating to the
responsibilities of
individual managers.
To evaluate
managers on
controllable items.

9. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
 Prepare budgets for
each responsibility center.
 Prepare timely performance reports
comparing actual amounts with budgeted amounts.
 Measure performance of
each responsibility center.
Responsibility Accounting SystemsResponsibility Accounting Systems

10. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Successful implementation of responsibility
accounting may use organization charts with
clear lines of authority and clearly defined
levels of responsibility.
Successful implementation of responsibility
accounting may use organization charts with
clear lines of authority and clearly defined
levels of responsibility.
V ic e P r e s id e n t
o f F in a n c e
D e p a r t m e n t M a n a g e r
S t o r e M a n a g e r
V ic e P r e s id e n t
o f O p e r a t io n s
V ic e P r e s id e n t
o f M a r k e t in g
P r e s id e n t
B o a r d o f D ir e c t o r s

11. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Amount of detail varies according
to level in organization.
A department manager
receives detailed reports.
A store manager receives
summarized information
from each department.
Responsibility Accounting SystemsResponsibility Accounting Systems

12. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
The vice president of operations
receives summarized information
from each store.
Management by exception:
Upper-level management
does not receive operating
detail unless problems arise.
Amount of detail varies according
to level in organization.
Responsibility Accounting SystemsResponsibility Accounting Systems

13. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Responsibility Accounting SystemsResponsibility Accounting Systems
To be of maximum benefit, responsibility
reports should . . .
Be timely.
Be issued regularly.
Be understandable.
Compare budgeted
and actual amounts.

14. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
$$$$$$
Service
Department
Assigning Revenue and Costs to
Business Centers
Assigning Revenue and Costs to
Business Centers
Revenue is easily and automatically
assigned to specific departments using
point of sale entries from cash registers.

15. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Assigning Revenue and Costs to
Business Centers
Assigning Revenue and Costs to
Business Centers
Two guidelines should be followed in allocating
costs to the various parts
of a business . . .
 According to cost behavior patterns:
Fixed or variable.
 According to whether the costs are
directly traceable to the centers
involved.

16. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Profit Center ReportingProfit Center Reporting
Webber, Inc. has two divisions.
C o m p u t e r D iv is io n T e le v is io n D iv is io n
W e b b e r , In c .
Let’s look more closely at the Television
Division’s income statement.

17. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Income Statement
Contribution Margin Format
Television Division
Sales 300,000$
Variable COGS 120,000$
Other variable costs 30,000
Total variable costs 150,000$
Contribution margin 150,000$
Traceable fixed costs 90,000
Responsibility margin 60,000$
Cost of goods
sold consists of
variable manu-
facturing costs.
Profit Center ReportingProfit Center Reporting

18. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Income Statement
Contribution Margin Format
Television Division
Sales 300,000$
Variable COGS 120,000$
Other variable costs 30,000
Total variable costs 150,000$
Contribution margin 150,000$
Traceable fixed costs 90,000
Responsibility margin 60,000$
Fixed and
variable costs
are listed in
separate
sections.
Profit Center ReportingProfit Center Reporting

19. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Income Statement
Contribution Margin Format
Television Division
Sales 300,000$
Variable COGS 120,000$
Other variable costs 30,000
Total variable costs 150,000$
Contribution margin 150,000$
Traceable fixed costs 90,000
Responsibility margin 60,000$
Responsibility margin
is the Television
Division’s contribution
to overall operations.
Profit Center ReportingProfit Center Reporting

20. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
No computerNo computer
division means . . .division means . . .
No computerNo computer
division manager.division manager.
Traceable Fixed CostsTraceable Fixed Costs
Traceable fixed costsTraceable fixed costs would disappear over
time if the center itself disappeared.

21. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Common fixed costsCommon fixed costs arise because ofarise because of
overall operation of the company and areoverall operation of the company and are
not due to the existence of a particularnot due to the existence of a particular
center.center.No computerNo computer
division but . . .division but . . .
We still have aWe still have a
company president.company president.
Common Fixed CostsCommon Fixed Costs

22. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Let’s see how the Television
Division fits into Webber, Inc.
Profit Center ReportingProfit Center Reporting

23. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Income Statement
Company Television Computer
Sales 500,000$ 300,000$ 200,000$
Variable costs (230,000) (150,000) (80,000)
CM 270,000$ 150,000$ 120,000$
Traceable FC (170,000) (90,000) (80,000)
Responsibility margin 100,000$ 60,000$ 40,000$
Common costs (25,000)
Net income 75,000$
Common costs arise because of overallCommon costs arise because of overall
operating activities and are not due to theoperating activities and are not due to the
existence of a particular division.existence of a particular division.
Profit Center ReportingProfit Center Reporting

24. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Let’s see how this works!Let’s see how this works!
Traceable Costs Can Become
Common Costs
Traceable Costs Can Become
Common Costs
Fixed costs that are traceable on one level
can become common if the business is
divided into smallersmaller parts.

25. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Income Statement
Television
Division Color
Black and
White
Sales 300,000$ 200,000$ 100,000$
Variable costs (150,000) (95,000) (55,000)
CM 150,000$ 105,000$ 45,000$
Traceable FC (80,000) (45,000) (35,000)
Responsibility margin 70,000$ 60,000$ 10,000$
Common costs 10,000
Net income 60,000$
Profit Center ReportingProfit Center Reporting

26. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Income Statement
Television
Division Color
Black and
White
Sales 300,000$ 200,000$ 100,000$
Variable costs (150,000) (95,000) (55,000)
CM 150,000$ 105,000$ 45,000$
Traceable FC (80,000) (45,000) (35,000)
Responsibility margin 70,000$ 60,000$ 10,000$
Common costs 10,000
Net income 60,000$
45,000$ To Color
35,000 To B & W
10,000 Common
90,000$ TV Division
$90,000 cost directly traced
to the Television Division.
Profit Center ReportingProfit Center Reporting

27. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
TimeTime
ProfitsProfits
Responsibility MarginResponsibility Margin
Responsibility margin is the best gaugebest gauge of the
long-run profitability of a business center.

28. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Home Appliance Company
Income Statement
Laundry
Division Washers Dryers
Sales 300,000$ 200,000$ 100,000$
Variable costs (150,000) (95,000) (55,000)
CM 150,000$ 105,000$ 45,000$
Traceable FC (95,000) (45,000) (50,000)
Responsibility margin 55,000$ 60,000$ (5,000)$
Common costs (10,000)
Net income 45,000$
The Dryer Division is unprofitable because
the responsibility margin is negative.
When is a Business
Center Unprofitable?
When is a Business
Center Unprofitable?

29. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
The key issue is controllability.
Evaluating Business
Center Managers
Evaluating Business
Center Managers
Managers should be evaluated on the portion
of responsibility margin they control.
Common fixed costs can not be traced to the
Dryer Division or the Washer Division, so they
are excluded from the responsibility margin.

30. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Arguments Against Allocating
Common Fixed Costs
Arguments Against Allocating
Common Fixed Costs
Common fixed costs would not change
even if a business center were eliminated.
Common fixed costs are not under the
direct control of the center’s managers.
Allocation of common fixed costs may
imply changes in profitability that are
unrelated to the center’s performance.

31. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Let’s change topics!
Transfer PricesTransfer Prices

32. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
The amount charged when one division sells
goods or services to another division.
The amount charged when one division sells
goods or services to another division.
Battery Division Auto Division
Batteries
Transfer PricesTransfer Prices

33. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
A higher transfer
price for batteries
means . . .
. . . greater
profits for the
Battery Division.
Auto DivisionBattery Division
Transfer PricesTransfer Prices
The transfer price affects the profit measure
for both buying and selling divisions.
The transfer price affects the profit measure
for both buying and selling divisions.

34. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
. . . lower
profits for the
Auto Division.
Auto DivisionBattery Division
A higher transfer
price for batteries
means . . .
Transfer PricesTransfer Prices
The transfer price affects the profit measure
for both buying and selling divisions.
The transfer price affects the profit measure
for both buying and selling divisions.

35. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Many companies use the external
market value of goods transferred
as the transfer price.
Transfer PricesTransfer Prices
Transfer prices have no direct effect upon
the company’s overall net income.

36. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Transfer prices have no direct effect upon
the company’s overall net income.
When the external
market value of goods
transferred is unavailable . . .
Transfer PricesTransfer Prices
Negotiated
transfer
price
Cost-plus
transfer
price

37. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Product Quality Personnel
Number of defective parts Number of sick days taken
Number of customer returns Employee turnover
Number of customer complaints Number of grievances filed
Marketing Efficiency and Capacity
Number of new customers Cycle time (manufacturing)
Number of sales calls initiated Occupancy rates (hotels)
Market share Passenger miles (airlines)
Number of product stockouts Patient days (hospitals)
Transactions processed (banks)
Nonfinancial Performance
Measures
Nonfinancial Performance
Measures

38. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
This information is
far less detailed than
the responsibility
center information
developed for
management.
This information is
far less detailed than
the responsibility
center information
developed for
management.
Segment Reporting in
Financial Statements
Segment Reporting in
Financial Statements
Companies engaged in different lines of
business are required to report certain
information about each segment.
 Revenue.
 Operating profits or losses.
 Identifiable segment assets.
 Depreciation and amortization.
 Capital expenditures.

39. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
End of Chapter 21End of Chapter 21