Our Lady of the Pillar College - San Manuel, Inc. DISTRICT 3, SAN MANUEL, ISABELA, PHILIPPINES E-mail: nuestrasenioradelpilar@gmail.com RESPONSIBILITY ACCOUNTING Responsibility Accounting Most organizations are divided into smaller units, each of which is assigned particular responsibilities. These units may be called ‘divisions’, ‘segments’, ‘business units’ or ‘departments’. Each of which is composed of individuals who are responsible for particular tasks or managerial functions. The main goal of any manager is to ensure that the people in each department strive toward the same overall goals. Decentralization – Refers to the separation or division of the organization into more manageable units wherein each unit is managed by an individual who is given decision authority and is held accountable for his or her decisions. Decision-making authority is spread throughout the organization, and lower-level managers are given the authority to decide how to manage their individual units. A decentralized organization would help top management to concentrate on strategic planning and for division managers to react promptly to problems involving operating decisions. Responsibility accounting – a system of accounting that is implemented to an organization so that performance, in terms of costs and/or revenues, are recorded, reported, and evaluated by levels of responsibility within an organization. It also refers to various concepts and tools used by managers to measure the performance of people and departments in order to foster goal congruence. • Goal congruence – the result when managers of subunits throughout an organization strive to achieve the goals set by top management. Responsibility of managers – managers is given responsibility for a particular part of the business and are then evaluated based on performance in that area. The area of business that managers are responsible for is referred to as responsibility center. Controllability principle – states that managers should be held responsible only for what they can control. In responsibility accounting, the most relevant classification of costs is whether such costs are controllable or non-controllable. Responsibility center – a segment of organization engaged in the performance of a single function or a group of closely related functions and is usually governed by a manger, who is accountable and responsible for the activities of the segment. Types of responsibility centers: • Cost center – the manager is responsible for controlling cost. The managers have the authority to incur costs to support their areas of responsibility. Cost centers are evaluated by comparing actual costs to budgeted costs. • Revenue center – the manager is responsible for generating revenue for their segment of the business. Companies often give revenue center managers sales targets or quotas and then evaluate and reward them based on whether they meet those targets. • Profit center – the managers are held responsible for both revenues and costs (profit) of the segment. Unlike cost center managers who are primarily responsible for cost, and revenue center managers who are primarily responsible for revenue, profit center managers are responsible for both. • Investment center – managers have the authority to make decisions about how and where to invest the company’s assets to drive long-term profitability. They have more responsibility than the previously discussed managers because they are also responsible for investing the company’s assets. Profit Centers Segmented income statement – The most common method of evaluating a profit center manager. This is an income statement that is broken down by product line, region, or other business segment. This is useful in evaluating because it separates those costs that are within the segment manager’s control from those costs that are outside it. Exercise 1. DMCI Co. is the largest holding company in the country engaged in real estate, manufacturing, mining, power, retailing and banking. Its power plant segment, Electro Corp has shown the following data for the year ended 31 December 2023. Revenues Variable expenses Fixed expenses controllable by Electro Corp.’s general manager Fixed expenses controllable by DMCI Co.’s general manager traceable to Electro Corp. DMCI Co.’s head office’s common expenses allocated to its business units (25% of these expenses were allocated to Electro Corp. P3,000,000 1,000,000 800,000 1,300,000 800,000 a. How much is Electro Corp’s contribution margin? b. How much is Electro Corp’s segment controllable margin? c. How much is Electro Corp’s segment margin? d. How much is Electro Corp’s operating income? e. What figure is relevant in deciding whether the manager of Electro Corp is doing a good job? f. What figure is relevant in deciding whether the division, Electro Corp is doing well? Problem 1. The Cloth division of JEANS, Inc. produces only one type of fabric. The 1mx1m sized fabric has a selling price of PhP20.00. Costs for each 1mx1m piece of fabric include: Direct material of PhP3.00; Direct labor of PhP4.00; Variable factory overhead of PhP1.00; Fixed factory overhead allocation of PhP4. Variable selling and Fixed administrative costs are PhP2.00 and PhP1.00 respectively. The division produced 100 000 1mx1m fabric squares this year and sold 95 000 of them. This is the first year of operations. Actual figures equal budgeted. JEANS’ head office allocated PhP700 000 common fixed costs to the division. a. How much is the Cloth division’s manufacturing margin? b. How much is the Cloth division’s contribution margin? c. If only 40% of the Cloth division’s fixed cost is controllable by the manager of the cloth division, how much is the segment controllable margin? d. If only 40% of the Cloth division’s fixed cost is controllable by the manager of the cloth division, how much is the segment margin? e. How much is the division’s operating income? f. What is the purpose of computing for (e.)? Investment Centers The following may be used as basis for evaluating the performance of investment centers: • Return on Investment = Net operating income / Average invested assets = Net profit margin * Asset turnover • Residual income = net operating income – required income • Where required income = average invested assets * hurdle rate • It compares the net operating income and the minimum acceptable profit based on the required rate of return (aka hurdle rate). The hurdle rate will depend on a number of factors, including the risk of the investment, the cost of financing it, and the return that could be earned in other investments. • It is the amount of net operating income earned over and above the minimum amount needed to meet the required rate of return. • It encourages managers to maximize pesos of profit after a required ROI has been achieved. • It overcomes some of the problems associated with ROI. • It encourages managers to accept projects which provide returns in excess of the company’s required rate of return. Exercise 2. Return on Investment. ABC Corporation, a subsidiary of XYZ Holdings has shown the following information for 2021 and 2022: Income Assets 2022 P100,000 700,000 2021 P200,000 900,000 a. What is the return on investment for year 2022? Problem 2. DEF Company, a division of MARIO Inc. has shown the following income statement for the year ended 2022: Sales Revenues Cost of sales Gross Profit Selling and administrative expenses Operating income Interest Expenses Net income before tax Income tax (30%) Net income P900,000 100,000 800,000 200,000 600,000 100,000 500,000 150,000 350,000 Total assets as of 31 December of the year are as follows: Total Assets 2022 P2,000,000 2021 P2,800,000 a. What is the return on investment for the year 2022? Problem 3. GHI Inc., a subsidiary of SM Corp, has shown the following information for the year just ended: Asset TO 5x Profit margin 2% a. What is the return on investment for the year? Problem 4. ALC Company has 2 investment centers, ETHYL and METHYL. The following details for given for the two centers: ETHYL METHYL Net sales P200,000 P6,300,000 Cost of goods sold 50,000 700,000 Selling and admin expenses 30,000 1,400,000 Average assets 800,000 42,000,000 Desired rate of return for these types of investment 5% a. What is the sales margin for both centers? b. What is the turnover for both centers? c. What is the return on investment for both centers (Use the Du-pont equation)? Problem 5. You are a manager of ABC division, a segment of J&J Corporation with an average invested capital of around P2 000 000. You boast ABC division’s ROI of 20%, which is higher than J&J’s required rate of return of 12%. It is in the belief of the top executives in J&J Corporation that any investment that gives the company a return of 12% is desirable and thus should be engaged in. J&J evaluates its subordinate managers based on the ROI of their corresponding segments. A new project requiring an investment of P500 000 is available and can give ABC an ROI of 15%. In other words, it gives ABC an additional income of P75 000 (P500 000 x 15%). a. Assume that for the coming year, ABC is expected to yield the same ROI if it will not engage in other businesses. Should you, as the manager of ABC division, invest in that project? b. Describe the implications of this situation to J&J Corporation. Exercise 3. Residual Income. ABC Corporation, a subsidiary of XYZ Holdings has shown the following information for 2021 and 2022: Income Assets 2022 P120,000 700,000 2021 P200,000 800,000 a. What is the required income in 2022? Problem 6. You are a manager of ABC division, a segment of J&J Corporation with an average invested capital of around P2 000 000. You boast ABC division’s ROI of 20%, which is higher than J&J’s required rate of return of 12%. It is in the belief of the top executives in J&J Corporation that any investment that gives the company a return of 12% is desirable and thus should be engaged in. J&J evaluates its subordinate managers based on the ROI of their corresponding segments. A new project requiring an investment of P500 000 is available and can give ABC an ROI of 15%. In other words, it gives ABC an additional income of P75 000 (P500 000 x 15%). a. What is the ROI of ABC division if you will not invest in the project? What about if you will invest in the project? b. Assume this time that RI will be used instead of ROI in evaluating subordinate managers. Will this facilitate goal congruence? Problem 7. You are the manager of the Home Care Products Division of EQUITY Corporation. As a manager of an investment center, your performance is measured using the residual income method. For the coming year, you want to achieve a residual income target of P100 000 using an imputed interest charge of 20%, other forecasted figures for the coming year are as follows: Working capital Plant and equipment Cost and expenses P90,000 860,000 1,210,000 a. How much should revenues be next year to achieve the residual income target? b. By what percent would the division’s ROI next year exceed the desired rate of return? (answer in percentage points) Problem 8. ALC Company has 2 investment centers, ETHYL and METHYL. The following details for given for the two centers: Net sales Cost of goods sold Selling and admin expenses Average assets ETHYL P200,000 50,000 30,000 800,000 METHYL P6,300,000 700,000 1,400,000 42,000,000 Desired rate of return for these types of investment 5% a. What is the return on investment for both centers? b. What is the residual income for both centers? c. How does one arrive at the desired rate of return? Exercise 3. Consider the following for one of REGINE Company’s investment center: Investment center’s after-tax operating profit Investment center’s after total assets Investment center’s total current liabilities. WACC Minimum required ROI a. What is the economic value added? P50,000 2021 P200,000 800,000 80,000 800,000 6.50% 8.00% Problem 9. The following year-end data pertains to ROLLS Corporation: Earnings before interest and taxes Current assets Non-current assets Current liabilities Non-current liabilities P900,000 100,000 800,000 200,000 600,000 a. ROLLS Corporation pays an income tax rate of 30%. Its weighted average cost of capital is 10%. What is ROLLS Corporation’s economic value added?
