Responsibility Accounting

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23 Chapter Responsibility Accounting

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Cont…. Concept of Responsibility Accounting Responsibility accounting is an underlying concept of accounting performance measurement systems. Responsibility accounting can be used at every level of management that fulfils the following conditions: Costs and revenues can be directly associated with the specific level of management responsibility. The costs and revenues are controllable at the level of responsibility with which they are associated. Budget data can be developed for evaluating the manager's effectiveness in controlling the costs and revenues. Responsibility accounting is an information reporting system that (1) classifies financial data according to area of responsibility in an organization, and (2) reports each area's activities by including only the revenue and cost categories that the assigned manager can control. Responsibility accounting focuses on the reporting and not the recording of the operating cost and revenue data.

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Cont…. Definitions According to CIMA, London, "Responsibility accounting is a system of Management Accounting under which accountability is established according to the responsibility delegated to various levels of management and management information and reporting system instituted to give adequate feedback in terms of the delegated responsibility. Under this system division of units of an organisation under specified authority in a person are developed as a responsibility centre and evaluated individually for their performance.” Schaltake and Jonson, state that Responsibility accounting is a system of accounting in which costs and revenues are accumulated and reported to managers on the basis of the manager's control over these costs and revenues. The managerial accounting system that ties budgeting and performance reporting to a decentralised organisation is called responsibility accounting."

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Cont…. Features of Responsibility Accounting Inputs and Outputs Information of both Planned and Actual Performance are used Identification of Responsibility Centres Relationship between Organization Structure and Responsibility Accounting System Assigning Costs to Individuals and limiting their Efforts to Controllable Costs Transfer Pricing Policy Performance Reporting Participative Management Management by Exception Human Aspect of Responsibility Accounting

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Cont…. Assumptions of Responsibility Accounting System A sound responsibility accounting system is based on number of assumptions. The same are explained in brief as under: Managers are held responsible only for those activities over which they exercise control. Managers strive to achieve the goals and objectives that have been established for them. This is mainly because of their involvement in the planning process. Managers participate in establishing the goals against which their performance will be measured. Goals are attainable with efficient and effective performance. Performance reports and feedback are made available timely. The role of responsibility accounting in the company's reward structure is clearly stated and followed.

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Cont…. Interdependence and Responsibility Accounting/Redefining Control Traditional responsibility accounting uses budgets and variances to hold individuals responsible for those costs that they control. Activity-based accounting redefines accountability from costs to activities. Activity-based Responsibility Accounting Traditional Responsibility Accounting Basic Assumption Interdependence Independence Focus Organization Individuals Objective Analysis Cost control Control Emphasis Activities Costs Control Point Process Outcomes Variance Usage Improve process Balance ledger/accountability Standards Historical/trended Engineered/static Goals Encouraged Continuous improvement Meet standards Control Characteristics Multi-dimensional Ambiguous Strategic Financial & operational One-dimensional One-to-one map Budget-based Financial

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Cont…. Basic Principles of Responsibility Accounting For success in any activity, it is desirable that it should be based upon certain principles. The following are the basic principles, which, if followed will lead to a fruitful responsibility accounting system in an organisation. Objectives Controllable Costs Explanation Management by Exception

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Structure of Responsibility Accounting The process consists of bifurcating costs into controllable and non-controllable groups, flexible budgeting and performance reporting. All these fundamentals of responsibility accounting are being discussed below: Establishing Responsibility Centres Limits to Controllable Costs Flexible Budgeting Performance Reporting

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Cont…. Centres of Control of Responsibility Accounting Responsibility centres can be classified by the scope of responsibility assigned and decision-making authority given to individual managers. A responsibility centre should fulfil the following two criteria: The organisation unit should be separable and identifiable for operating purpose; and It should also be possible to measure the performance of the said unit. Broadly speaking, the responsibility accounting has following centres: Cost Centres Revenue Centres Profit Centres Investment Centres Contribution Centre.

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Various Centres and their performance Evaluation Type of Centres Control Variables of the Centre Variable Predetermined by Top Management Objective Expense Centre Prices and quantities of inputs Prices and quantities of output/budget Minimise cost Revenue Centre Prices and quantities of outputs Quantities to be sold/budget Maximise sales revenues Profit Centre Prices and quantities of inputs and outputs Investment Maximise profits Investment Centre Prices and quantities of inputs and outputs and investment None Maximise return on investment Contribution Centre Revenue and Variable costs Contribution Maximise centre's contribution

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Implementation of Responsibility Accounting System In order to implement the system of responsibility accounting in an organisation the following steps are to be followed: Determination of responsibility centres, Identify apportioned and pro-rated costs, Fix accounts to individual responsibility, Sub-divide to show nature of expenses, Establish goals, targets, and objectives and keep up to date, Identify justifiable variance with the rate of output, Prepare standards, budgets and allowances, Segregate variances, Report to responsible individual, Offer incentive as inducement.

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Cont…. Organisational Aspects of Responsibility Accounting The task of fixing responsibility and of implementing control using responsibility accounting system needs to focus on the following organisational aspects involved: The organizational structure must be clearly defined, and responsibility delegated so that each person knows his role. The extent and limits of functional control must be determined in advance. The responsible individuals should be fully involved in preparing plans if they are to be held responsible for results. In absence of such involvement, the desired results may not be obtained. Responsible individuals must be serviced with regular performance reports. This will help in timely corrective action. Means must be established to enable plans to be revised in line with actual performance in such a way that responsible individuals are involved. Every item should be the responsibility of some individual within the organization.

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Cont…. Advantages/Benefits of Responsibility Accounting The following are the advantages of responsibility accounting: Performance Evaluation Delegating Authority Management by Objectives Corrective Action Growth and Prosperity of the Business High Morale and Efficiency Motivation

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Difficulties in Implementing Responsibility Accounting The clear-cut distinction between controllable and uncontrollable items. Such distinction is a basic requisite for efficient responsibility accounting system. This is practically a difficult process. The responsibility centre may act in the best interest of its own, but not in the corporate interest. This situation demands the effort on the part of management to bring harmonization and coordination between different segments of the enterprise. The preparation of responsibility accounting reports is not an easy job. Measures should be taken to avoid irrelevant information. It is difficult to prepare an organisation chart, which clearly delineates lines of responsibility and grants authority requisite to responsibility assigned. Individual interest may conflict with organisational interest and serious problems of implementation may occur. The system faces passive resistance, if not active and it will lose its purpose, till it is judiciously applied. At times, it ignores the personal reactions of the people, who are involved with its implementation.

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Cont…. Management Reporting System Performance evaluation is the centre of responsibility accounting. Performance evaluation is a management function that compares actual results with budget goals. It is based on internal reports prepared by the managerial accountant. Performance evaluation involves both behavioural and reporting principles. We shall first discuss the reporting principles. Reporting Principles Performance evaluation under responsibility accounting also involves reporting principles. These principles pertain primarily to the internal reports that provide the basis for evaluating performance. Performance reports should: Contain only data that are controllable by the manager of the responsibility centre. Provide accurate and reliable budget data to measure performance. Highlight significant differences between actual results and budget goals. Be tailor-made for the intended evaluation. Be prepared at reasonable intervals.

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Behavioural Principles The human factor is critical in evaluating performance. Behavioural principles include the following: Managers of responsibility centres should have direct input into the process of establishing budget goals of their area of responsibility. The evaluation of performance should be based entirely on matters that are controllable by the manager being evaluated. Criticism of a manager on matters outside his or her control reduces the effectiveness of the evaluation process. The top management should support the evaluation process. The evaluation process must allow managers to respond to their evaluations. Evaluation is not a one-way street. Managers should have the opportunity to defend their performance. Evaluation without feedback is both impersonal and ineffective. The evaluation should identify both good and poor performance.

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Cont…. Social Reporting Social reporting is reporting on those activities of an organisation that have an impact on society at large and are not necessarily represented by its traditional financial report. The concept of social reporting is gaining popularity on account of the following factors: Increasing awareness of society regarding the contributions the corporate units are making. Providing meaningful means of identifying and rewarding business for social contribution. Identifying adverse effects on the environment of the business houses. Social reporting improves credibility and reputation of business. Transferring cost of social activities to other segments of society. The concept of social responsibility extends beyond the provisions embodied in current law. Essentially, it represents an emerging debate having its roots in political and social theory.

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Cont…. Objectives of Social Reporting To identity, measure and report the net social contribution of an individual firm towards society, which includes not only the costs and benefits of a firm internally but also those arising from external factors affecting the different segments of the society. To determine whether the individual firm's strategies and practices are consistent with widely shared social principles of the society. For example, discrimination on the basis of caste, creed or sex will not be considered a good practice by the society. To make available relevant information about the firm's goals, policies, programmes, performances, use of and contribution to scarce resources etc. Relevant information is that which provides for public accountability and also facilitates public decision-making regarding capital choices and social resources allocation. For example, Indian companies have to disclose their use and earnings of foreign exchange.

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Cont…. Major Areas Covered in Social Reporting Community Development Human Resources Environmental Contribution Product or Service Contribution Limitations of Social Reporting Lack of Clear-cut Definition of Social Reporting Not Mandatory No Standard Format Auditing Social Cost and Benefit is an Intricate Function No Cadre of Social Auditors Social Reporting vs Value Added Statements

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Cont…. Suggestions for Better Social Reporting With the changing social and economic realities there is a need for reorienting the accounting system to serve the public interest in the widest context and meaning. In order to witness better social reporting by the business houses the following suggestions are offered: Reorienting the Accounting System Statutory Provision in the Companies Act, 1956 Proper Format for Social Reporting Social Reporting Disclosures be developed Social Audit Proper Publication

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Cost Centres vs. Responsibility Centres A cost centre is "a location, person or item of equipment (or group of these) for which costs may be ascertained and used for purposes of cost control". Thus, cost centre is used as a means of assembling items of cost, so that they can be assigned to goods and services. In the case of cost centre, emphasis is more on products, jobs or processes whose costs are to be ascertained. Thus, here the emphasis is not on the persons who may be managing a level or product or process. Responsibility centres, on the other hand, are established on the basis of responsibility delegated to responsible personnel of the organization with a view to identify costs that can be controlled by each one of them. However, cost centres sometimes may be used as responsibility centres too. In that case, cost reports are prepared both cost-wise and responsibility centre-wise.

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Cont…. Transfer Pricing Large business units are usually organised into different divisions for better control. In such a situation, if one division supplies its finished output as input to other division, there arises a very important issue. The issue being at which price should be transferring unit transfer its product or service. Such price is known as transfer price. Transfer prices are the amounts charged by one segment of an organization for a product or service that it supplies to another segment of the same organization. Purpose of Transfer Pricing To communicate data that will lead to goal-congruent decisions. To evaluate segment performance and thus motivate managers toward goal- congruent decisions. Multinational companies use transfer pricing to minimize their worldwide taxes, duties, and tariffs. Transfer pricing is a critical issue in the organisation. This is because the transfer price decides: The revenue of the supplying division thus influences divisional profit; and The cost of the receiving division thus influences divisional profit.

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Objectives of Transfer Pricing Evaluating Divisional Performance Improving the Quality of Decisions Promoting Autonomy Allocation of Profit Transfer Pricing Methods Market Based Transfer Prices Cost-based Transfer Prices Negotiated Transfer Prices Variable-Cost Pricing

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