Chapter Nine
Responsibility Accounting
McGraw-Hill/Irwin
©The McGraw-Hill Companies, Inc. 2006
Responsibility Accounting
An accounting system that
provides information . . .
Relating to the
responsibilities of
individual managers.
To evaluate
managers on
controllable items.
Decentralization
Decentralization
often occurs as
organizations
continue to grow.
Top
Management
Middle
Management
Supervisor
Supervisor
Middle
Management
Supervisor
Supervisor
Decision Making is Pushed Down
Decentralization
Improves quality
of decisions.
Improves
productivity.
Improves
performance
evaluation.
Develops
lower-level
managers.
Advantages
Encourages upper-level management to
concentrate on strategic decisions.
Organization Chart
Successful implementation of responsibility
accounting depends on clear lines of authority
and clearly defined levels of responsibility.
Board of Directors
President
Vice President
of Finance
Vice President
of Operations
Store Manager
Department Manager
Vice President
of Marketing
Responsibility Centers
Cost Center
A business
segment that
incurs expenses
but does not
generate revenue.
Responsibility Centers
Profit Center
A part of the
business that has
control over both
revenues and
expenses, but no
control over
investment funds.
Revenues
Sales
Interest
Other
Costs
Mfg. costs
Commissions
Salaries
Other
Responsibility Centers
Investment Center
A profit center
where management
also makes capital
investment
decisions.
Corporate Headquarters
Responsibility Reports
 Prepare budgets for
each responsibility center.
 Measure performance of
each responsibility center.
 Prepare timely performance reports
comparing actual amounts with budgeted amounts.
Management by Exception
and Degree of Summarization
Amount of detail varies according
to level in organization.
Department
manager receives
detailed reports.
Store manager receives
summarized information
from each department.
Management by Exception
and Degree of Summarization
Amount of detail varies according
to level in organization.
Management by exception
Upper-level management
does not receive operating
detail unless problems arise.
The vice president of operations
receives summarized information
from each store.
Controllability Concept
Managers should
only be evaluated on
revenues or costs
they control.
I’m in
control
Since the exercise of control may be clouded,
managers are usually held responsible for items
over which they have predominant rather
than absolute control.
Qualitative Reporting Features
To be of maximum benefit, responsibility
reports should . . .
 Be timely.
 Be issued regularly.
 Be understandable.
 Compare budgeted
and actual amounts
of controllable items.
Managerial Performance
Measurement
Evaluation Measures
Cost
Center
Cost control
Quantity and quality
of services
Profit
Center
Profitability
Investment
Center
Return on investment (ROI)
Residual income (RI)
Return on Investment
Return on investment is the ratio of
income to the investment used to
generate the income.
Operating Income
ROI =
Operating Assets
Return on Investment
A good example is interest you earn on
your saving account
Operating Income = $50 interest
Operating Assets = $5,000
ROI = $50 / $5,000 = 10%
Example
Green View is a lawn services company
whose operations are divided into two
districts. The District 1 manager controls
$12,600,000 of operating assets.
District 1 produced $1,512,000 of
operating income during the year. The
District 2 manager controls $14,200,000
of operating assets. The District 2
reported $1,988,000 of operating income
for the same period.
Example
What is the ROI for District 1?
$1,512,000 / $12,600,000 = 12%
What is the ROI for District 2?
$1,988,000 / $14,200,000 = 14%
Which District is performing better?
District 2
Another Example
Molly’s Pet Grooming has
operating assets of $150,000. She has
a ROI of 22%.
How much is her operating incoming?
More Examples
Greg’s Greenhouse
has an operating income
of $144,000. The ROI is 18%.
What is Greg’s investment?
Return on Investment
Operating Income
ROI =
Operating Assets
Sales
Operating Income
ROI =
×
Operating Assets
Sales
Margin
Turnover
Return on Investment
Rose Company reports the following:
Operating Income
Sales
Operating Assets
$ 40,000
$ 400,000
$ 200,000
Let’s calculate ROI.
Return on Investment
Sales
Operating Income
ROI =
×
Operating Assets
Sales
ROI =
$40,000
$400,000
×
ROI = 10% × 2 = 20%
$400,000
$200,000
Improving R0I
 Reduce
Expenses
 Increase
Sales
 Reduce
Operating
Assets
Three ways to improve ROI
Improving R0I
Rose Company was able to increase sales to
$500,000 which increased operating income to
$45,000.
 There was no change in operating assets.

Let’s calculate the new ROI.
Improving R0I
Sales
Operating Income
ROI =
×
Operating Assets
Sales
ROI =
$45,000
$500,000
×
$500,000
$200,000
ROI = 9% × 2.5 = 22.5%
Rose Company increased ROI from 20% to 22.5%.
ROI - A Major Drawback
As division manager at Rose Company,
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 20% 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%.

As division manager would you
invest in this project?
ROI - A Major Drawback
Gee . . .
I thought we were
supposed to do what
was best for the
company!
This condition is
known as
suboptimization.
As division manager,
I wouldn’t invest in
that project because
it would lower my pay!
How to Avoid Suboptimization
To avoid suboptimization, many
businesses base managerial evaluation
on residual income.
This approach measures a manager’s
ability to maximize earnings above
some targeted level.
The targeted level of earnings is based
on a minimum desired ROI.
Residual Income
Operating Income
– Investment charge
= Residual income
Investment
× Desired ROI
= Investment charge
Investment center’s
cost of acquiring
investment capital
Residual Income
Residual Income
= Operating Income – (Operating Assets
* Desired ROI)
Residual Income
Rose Company has an opportunity to invest
$100,000 in a project that will earn
$25,000.
 Rose Company has a 20 percent desired
ROI and a 30 percent ROI on existing
business.

Let’s calculate residual income.
Residual Income
Operating Income = $25,000
– Investment charge = 20,000
= Residual income = $ 5,000
Investment
= $100,000
× Desired ROI
=
20%
= Investment charge = $ 20,000
Investment center’s
cost of acquiring
investment capital
Residual Income

As a manager at Rose
Company, would you
invest the $100,000 if
you were evaluated
using residual income?

Would your decision be
different if you were
evaluated using ROI?
Residual Income
Residual income encourages managers to
make profitable investments that would
be rejected by managers using ROI.
Let’s apply what we’ve learned:
The Spokane Division of Cascade Inc. has
a current ROI of 20%. The company
target is 15%. The division has an
opportunity to invest $4,000,000 at
18% but is reluctant to do so because
its ROI will fall to 19.2%. The present
investment base for the division is
$6,000,000.
Should the company invest?
Responsibility Accounting and
the Balanced Scorecard
The balance scorecard is a holistic
approach to evaluating managers.
Balanced
Scorecard
Multiple
financial
measures
Multiple
nonfinancial
measures
End of Chapter Nine