Responsibility Accounting
Chapter 9
Responsibility Accounting
An accounting system that
provides information . . .
Relating to the
responsibilities of
individual managers.
9-2
To evaluate
managers on
controllable items.
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Decentralization
Decentralization
often occurs as
organizations
continue to grow.
Top
Management
Middle
Management
Supervisor
Middle
Management
Supervisor
Supervisor
Supervisor
Decision Making is Pushed Down
9-3
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Decentralization
Promotes better
decision making.
Improves
productivity.
Improves
performance
evaluation.
Develops
lower-level
managers.
Advantages
Allows upper-level management to
concentrate on strategic decisions.
9-4
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Responsibility Reports
Responsibility
Reports
Prepared for each
individual who
has control over
revenue or
expense items
9-5
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Responsibility Reports
 Prepare budgets for
 Measure performance of
each responsibility center.
each responsibility center.
 Prepare timely performance reports
comparing actual amounts with budgeted amounts.
9-6
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
The Controllability Concept
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
Vice President
of Marketing
Store Manager
Department Manager
9-7
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Management by Exception and the
Degree of Summarization
Amount of detail varies according
to level in organization.
Department
manager receives
detailed reports.
9-8
Store manager receives
summarized information
from each department.
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Management by Exception and the
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.
9-9
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Qualitative Reporting Features
To be of maximum benefit, responsibility
reports should . . .
 Be timely.
 Be issued regularly.
 Be understandable.
 Compare budgeted
and actual amounts.
9-10
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Responsibility Centers


A responsibility center is the point in an
organization where the control over
revenue or expense is located, e.g.
division,department or a single machine.
A responsibility center may be divided
into three categories



9-11
cost
profit
investment
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Types of Responsibility Centers
Cost Center
A business
segment that
incurs expenses
but does not
generate revenue.
9-12
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Types of Responsibility Centers
Profit Center
A part of the
business that has
control over both
revenues and
expenses, but no
control over
investment funds.
9-13
Revenues
Sales
Interest
Other
Expenses
Manufacturing
Commissions
Salaries
Other
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Types of Responsibility Centers
Investment Center
A profit center
where
management also
makes capital
investment
decisions.
9-14
Corporate Headquarters
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Measuring Managerial Performance
Evaluation Measures
9-15
Cost
Center
Cost control
Quantity and quality
of services
Profit
Center
Profitability
Investment
Center
Return on investment (ROI)
Residual income (RI)
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Return on Investment
Return on investment is the ratio of
income to the investment used to
generate the income.
ROI =
9-16
Net Income
Investment
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Return on Investment
ROI =
Net Income
Investment
ROI =
Net Income
Sales
Margin
9-17
×
Sales
Investment
Turnover
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Return on Investment
Cola Company reports the following:
Net Income
Sales
Investment
$ 30,000
$ 500,000
$ 200,000
Let’s calculate ROI.
9-18
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Return on Investment
ROI =
Net Income
Sales
ROI =
$30,000
$500,000
×
Sales
Investment
×
$500,000
$200,000
ROI = 6% × 2.5 = 15%
9-19
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Improving R0I
 Reduce
Expenses
 Increase
Sales
 Reduce
Investment
Three ways to improve ROI
9-20
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Improving R0I
 Cola Company’s manager was able to
increase sales to $600,000 which
increased net income to $42,000.
 There was no change in investment.
Let’s calculate the new ROI.
9-21
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Improving R0I
ROI =
Net Income
Sales
ROI =
$42,000
$600,000
×
Sales
Investment
×
$600,000
$200,000
ROI = 7% × 3 = 21%
Cola Company increased ROI from 15% to 21%.
9-22
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
ROI - A Major Drawback



As division manager at Cola 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?
9-23
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
ROI - A Major Drawback
Gee . . .
I thought we were
supposed to do what
was best for the
company!
9-24
As division manager,
I wouldn’t invest in
that project because
it would lower my pay!
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Residual Income
Earned Income
– Investment charge
= Residual income
Investment
× Desired ROI
= Investment charge
Investment center’s
cost of acquiring
investment capital
9-25
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Residual Income
 Cola Company has an opportunity to
invest $100,000 in a project that will
earn $25,000.
 Cola Company has a 20 percent
desired ROI and a 30 percent ROI on
existing business.
Let’s calculate residual income.
9-26
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Residual Income
Investment
= $100,000
× Desired ROI
=
20%
= Investment charge = $ 20,000
Investment center’s
cost of acquiring
investment capital
9-27
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Residual Income
Earned 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
9-28
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Residual Income
 As a manager at Cola
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?
9-29
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Residual Income
Residual income encourages managers to
make profitable investments that would
be rejected by managers using ROI.
9-30
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Transfer Pricing
Let’s change topics!
9-31
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Transfer Pricing
The amount charged when one division
sells goods or services to another division.
Batteries
Battery Division
9-32
Auto Division
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Transfer Pricing
The transfer price affects the profit measure for
both the selling division and the buying division.
A higher transfer
price for batteries
means . . .
Battery Division
greater profits for
the battery division.
9-33
Auto Division
lower profits for
the auto division.
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Transfer Pricing
The ideal transfer price allows
each division manager to make
decisions that maximize the
company’s profit, while
attempting to maximize the
division’s profit.
9-34
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Setting Transfer Prices
Market-based transfer prices are
preferred because they promote
efficiency and fairness.
When market prices are not available,
companies may use . . .
 Cost-based prices
 Negotiated prices
9-35
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Negotiated Transfer Price
A system where transfer prices are arrived
at through negotiation between managers of
buying and selling divisions.
Excessive management
time may be used in the
negotiation process.
9-36
May not be in the
best interest of
the company.
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Cost-Based Transfer Prices
Cost-based transfer prices are the
least desirable because the incentive
to control cost is diminished.
When used, cost-based transfer prices . . .
 Are either variable cost or full cost.
 Should use standard rather than actual costs.
9-37
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Setting Transfer Prices
Conflicts may arise between the
company’s interests and an individual
manager’s interests when transfer-pricebased performance measures are used.
9-38
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
End of Chapter 9
Let’s transfer some of
your capital to me so
that my rate of return
will be higher!
9-39
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada