I.
Responsibility Accounting
a. Types of Responsibility Centers
i. Cost Center: Are centers where cost is the only area of concern for the manager.
Examples: Human resources, accounting, legal, and other administrative items
don’t directly generate revenues; however they do create expenses for an
organization. Other items such as maintenance and engineering also fall into this
category.
ii. Revenue Center: Are centers where revenue is the only are of concern for the
manager.
Examples: Hotels’ revenue centers lie in their room and food departments. This is
because they are the areas that produce revenue through the sales of their services.
iii. Profit Center: Are centers where both cost and revenue are concerns for the manager
Examples: Restaurant chains may view each individual store as profit center,
where the manager must take into account both revenues and expenses. Stores
that generated more revenue would inevitably encounter more food costs that the
manager would have to deal with at each location.
iv. Investment Center: Are centers where revenues, costs, and investments are a concern
for the manager.
Examples: The corporate headquarters which is measured on terms such as ROI
and RI is an example of such a center. They have to make decisions such as
opening or closing stores, continuation of products, and etc.
References: http://www.principlesofaccounting.com/chapter%2022.htm
http://www.businessdictionary.com
http://www.allbusiness.com
b. The Role of Information and Accountability
i. The essence of the role of information is that each department is handled by a
manager that only focuses on that area. For instance, sales are the responsibility of
sales managers and departmental costs are the responsibility of the production
managers.
ii. Management accountants are effected in the sense that they are required to stay up to
date on various areas of the business from politics to marketing; anything that may
affect the firm.
iii. Accountability is an evaluation of the different department managers and the
management accountants against expected outcomes.
iv. Responsibility accounting is the mixture of responsibility, accountability, and
performance evaluation.
II.
Decentralization
a. Concept
i. Decentralization: When lower divisions/sub-units are in control of the decision
making processes.
Example: Lower level managers may be in charge of setting their own price or
implementing their own marketing campaigns.
References: http://www.allbusiness.com
b. How to Decentralize
i. Creating division or sub-units through segmentation is how decentralization is
normally achieved. The divisions or sub-units are usually created on the bases of the
goods or services they produced or types of customers served.
Examples: The table below depicts some of PepsiCo’s divisions and sub-divisions
PepsiCo
PepsiCo Americas Beverage
PepsiCo Americas Food
SoBe
Frito-Lay
Tropicana
Quaker Foods & Snacks
Gatorade
Sabritas
Aquafina Water
Gamesa and Latin America Foods
Pepsi Cola
ii. These divisions or sub-units are organized based on their respected responsibility
center (list mentioned above) allowing for them to be controlled through
responsibility management.
Reference: Cornerstones of Cost Accounting; pg. 475
c. Why Decentralize
There are 7 reasons as to why a firm would want to decentralize; they are as follows:
i. Better Access to Local Information: Due to their ability to understand and access
local information, lower level managers present the company with vital information
concerning local competition, the local labor force, and etc. that would be difficult to
obtain if upper level management controlled the decisions.
ii. Cognitive Limitations: Allows companies to reduce costs by letting the lower level
managers deal with specialized issues on their own. Companies’ would need
individuals to dissect the lower level managers’ information if it was transmitted to
the headquarters, therefore, why not cut this cost by having the managers handle the
information themselves. In doing so, lower level managers develop specific fields of
expertise in addition to their managerial talent.
iii. More Timely Response: By allowing lower level managers to implement and make
decisions, the chance of potential miscommunication and delays in transmitting
information is greatly reduced.
iv. Focusing of Central Management: Central management within the organization can
now focus on future long term strategic matters and not have to worry about day to
day items.
v. Training and Evaluation of Segment Managers: This prepares lower level managers
for possible promotions into upper management roles, by allowing them to make and
implement decisions on their own concerning day to day operations.
vi. Motivation of Segment Managers: Greater responsibility can produce more job
satisfaction and motivate local managers; which may in turn benefit the company as a
whole.
vii. Enhanced Competition: Competition is enhanced through central management’s
ability to view its organization as independent components; forcing each division to
produce its own financial figures that can measure its performance.
Reference: Cornerstones of Cost Accounting, pgs. 473 – 475
III.
Return on Investment (ROI)
a. ROI is a formula that calculates the efficiency of an investment in terms of profit earned
per dollar of investment; most commonly measures performance for an investment center
b. ROI has three advantages:
i. The relationship between sales, expenses, and investment becomes closely observed
by managers.
ii. It promotes cost efficiency.
iii. Enormous investments in operating assets are discouraged.
c. ROI has disadvantages when it is used as the sole bases for decision making, for instance:
i. It doesn’t say anything about the expected returns and costs that were predicted, and
if the predictions were accurate.
ii. Doesn’t say anything about the risk involved with the investment.
iii. Can be modified to suit to the desired situation.
d. ROI can be calculated in the following 3 ways:
i. ROI =
ii. ROI =
Operating income
Average operating assets
Operating income
Sales
*
Sales
Average operating assets
iii. ROI = Operating income margin × Operating asset turnover
e. The Average Operating Assets, the Operating Income Margin, and the Operating Asset
Turnover figures are broken down as such:
i. Average Operating Assets = (Beginning Assets + Ending Assets) / 2
ii. Operating Income Margin = Operating Income / Sales
iii. Operating Asset Turnover = Sales / Average Operating Assets
References: http://www.solutionmatrix.com/return-on-investment.html
http://www.investopedia.com
Cornerstones of Cost Accounting, pgs. 476 - 479
IV.
Residual Income (RI)
a. Residual Income (RI) is another performance measure. Ultimately, it’s the difference
between operating income and the minimum dollar return required on a company’s
operating assets
b. RI is advantageous because all a manager has to do is see if the figure is greater than the
minimum rate of return, and if so it will increase profitability for the entire organization.
c. RI has two disadvantages:
i. Difficult to compare divisions that are different sizes
1. Solution: Compute a residual return on investment, as follows.
2. Residual return on investment =
RI
Average operating assets
ii. Can cause managers to overemphasis short-run results at the expense of long-term
profitability.
d. Residual Income is calculated as follows:
i. Residual Income = Operating Income – (Minimum Rate of Return * Operating
Assets)
V.
Economic Value Added (EVA)
a. EVA is a performance measure that tries to illustrate the true economic profit of a
company through a calculation that takes into account residual wealth. Simply put,
positive EVAs indicate a creation of wealth and negative EVAs indicate a destruction of
wealth.