B.A. (SOL)



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Responsibility Accounting

Responsibility Centres are of four types, namely,
(1) Expense Centre,
(2) Revenue Centre
(3) Profit Centre.
(4) Investment Centre.

All the four have been explained below :
1. Expense Centre. An expense centre is a centre in which only inputs arc measured in monetary items, i.e., only costs arc accounted for. Production departments and science departments e.g., accounting department, repairs and maintenance department etc. arc examples of expense centres. The managers are held responsible for excessive incurrence of costs, if any.
An expense centre is taken as a synonym of cost centre, but it is not actually so. A cost centre is one which is meant for collection of costs to be subsequently charged to products, whereas a n expense centre is one which is meant for measuring the performance of the head of the centre. A centre may be a cost centre and an expense centre as well. For example, a production department may be both a cost centre and an expense centre. However, it is not necessary' to be so. If the production department has 10 machines, each machine will be a cost ccnlrc. but not an expense ccnlrc. The expense centre will be (he production department.
According to the Chartered Institute of Management Accountants, London, 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." Cost centres may be personal (consisting of a person or group of these) or impersonal (consisting of a location or item of equipment or group of these). Thus, it is a unit for the purpose of collection of costs, where all costs-direct and indirect-are included along with apportioned costs. On the oilier hand, an expense centre is a responsibility centre for the purpose of placing responsibility on managers for control of costs. where only controllable costs arc included and all apportioned costs and policy costs are excluded.

2. Revenue Centre : A revenue centre is a centre which is devoted to raising revenue and that has no responsibility for production. The Manager responsible for the centre has got no responsibility of investments in assets or for the cost of manufacture of the product. A sales centre can be termed as an example of revenue centre. II is a part of organisation where the primary responsibility of manager is to maximise sales revenue. The Manager of revenue centre is concerned about the control of some of the expenses related with marketing of the product.

3. Profit Centre. A centre in which both the inputs and outputs arc measured in monetary terms is called a profit centre. In other words both costs and revenues of the centre arc accounted for. Since the difference of revenues and costs is termed as profit, profit is automatically computed in respect of the centre-that is why it is treated as a profit centre. The managers of such centres are encouraged to act as if they were running their own separate business. The revenue of a centre is accounted for not only when sales arc effected on the basis of recognition of revenue from the point of view of business, but also when output of one centre is transferred to some other centre on the basis of the concept of notional charge or transfer pricing.

For example, a production department may be treated as a profit centre on the basis that it "sells" goods to the sales department. The accounting system can be so designed as to record revenues and profit on a notional basis immediately when the completed products are sent to the godown or sales department. Similarly, service departments may be profit centres, if the notional charge for the services rendered to the production or sales department is made from them and accounted for as sales value in the books. Of course, these will be simply book-keeping entries for fixing the responsibilities and evaluating the performance of such centres. There is no question of actual cash inflow since the transactions are simply in the nature of internal transfers. Sometimes, profit can be treated as a combined measure of efficiency and effectiveness both and if so, expense centres may be turned into profit centres, whenever it is feasible to measure the output of a centre in monetary terms, i. e, in terms of revenue by assigning a reasonable selling price to it. It is a very powerful force to measure the performance of the individual responsible for miming and managing the centre, though it may not be a perfect measure. It may consist of certain pitfalls, e.g., fixation of the notional transfer price may be arbitrary-it may show unreasonable profit made by one centre and a loss by the other and thus may lead to wrong allegation of lack of responsibility by the second centre.
In case of non-profit making organisations, instead of profit centres, there may be revenue centres, since profit is not the ultimate motive of such organisations. A centre is termed as revenue centre if the manager is held accountable for the outputs of his unit. Without bothering for the costs, the concentration point is simply on maximisation of outputs, may be, revenues.
Whether an expense centre is to be taken as a profit centre or not depends on the decision of the management. However, some of the expense centres cannot be taken as profit centres normally, e.g., accounts department, since it is almost impossible to place a value to the services of accounts department.

4. Investment Centre. A centre in which assets employed arc also measured besides the measurement of inputs and outputs is called an investment centre. Inputs arc accounted for in terms of costs, outputs arc accounted for in terms of revenues and assets employed in terms of values. It is the broadest measurement, in the sense that the performance is measured not only in terms of profiles but also in terms of assets employed to generate profits. As a matter of fact, profit in absolute terms is not the proper index of effectiveness and efficiency both, i.e., failure of the management of enterprise; rather it is the relative profit or the profitability which is the measuring rod of the managerial performance-effectiveness and efficiency. And. in turn, the yardstick of overall profitability is the return on investment, i.e., capital employed or assets employed .It is, thus, the manager's task to see whether the centre for which lie is responsible has achieved the desired rate of return on capital employed or not.

To gauge his performance, assets employed in his centre will be taken into account and the inputs and outputs of his centre will be measured in monetary terms. In other words, the manager is held responsible for the return earned by the assets under his control. Practical difficulties arise in deciding as to which assets arc under the control of a manager. To what extant a manager has choice to employ the assets is a question, a suitable answer to which shall lead us to the identification of assets to his department. The use of the concept of investment centre, therefore, is restricted to 'stand alone' divisions or departments like a production unit for a particular class of goods or services, or a branch or a subsidiary co. etc.

Q.1. Compute return on investment in respect of Division "A" of a company on the basis of the following information :
Fixed Assets 15,000
Current Assets 70,000
Current Liabilities 20,000
Equity Share Capital 1,50,000

(ii) Residual Income Method.
If out of the operating profit, the imputed (notional) interest on the assets used by the division is deducted, it can be called as "Residual Income". The residual income shall be used to assess the performance of the division concerned. The reason why the notional interest is not considered is that, it is, in a way. a cost. Such criterion should be used only where divisional heads enjoy more or less complete autonomy meaning thereby thet arc free to take decisions regarding their respective divisions.
In other words, residual income is the difference of net earnings over cost of capital invested. The following illustration will make the point clear: Illustration 7.3.
Sales 5,00,000
Variable Costs 3,00,000
Fixed Costs (Controllable by Divisional Head) 1,00,000
Imputed Interest on Investment 50,000
Compute residual income. 

(ii) Sales volume Method. If the cost structure of different divisions is on the same pattern and same people are involved in dealing with incurrence of wages and material cost etc., volume of sales generated by a division may be taken to measure divisional performance.
(iv) Contribution Method : Contribution is the difference of sales and variable cost. The variable costs of the division are considered relevant for decision making and fixed costs are considered irrelevant for a particular division, as these are incurred as a whole for the entire organization. Therefore, the contribution given by various divisions may be used to evaluate there respective performances.
The last three measures arc absolute measures of divisional performance while the first is a relative measure. Sometimes, from the contribution, allocable fixed costs can be deducted, so as to arrive at controllable profit, which can also be taken as a measure of performance evaluation. In any case, uncontrollable investment should not be taken into account for making a division accountable for under-performance.
For evaluation of performance, either standard may be set for different divisions or inter divisional performance may be compared so as to rank the performances of different divisions of the enterprise. Performance of similar divisions in other companies can also be compared, to asess the relative contribution of the company's own divisions.

Non-financial Measures. Sometimes, financial measures may give misleading results regarding the performance of a division. Occasionally, certain other considerations are more important, even though financially, the performance of a division is not up to the mark. Such measures can, for example, be enumerated as under:
(i) Development of Human Resources;
(ii) Leadership Qualities;
(iii) Marketability of Divisional Product;
(iv) Attitudes of the Employees and Colleagues:
(v) Social Profitability (where social benefits exceed social costs or social cost-benefit ratio is positive or comparative to other divisions of the same company or same divisions of the other company).
(vi) Productivity.

Responsibility Reporting is used as a primary management control tool and a companion to the delegation of authority by management. 

Responsibility reporting compasses the reporting phase of responsibility accounting. Sometimes both these terms arc considered synonymous. Accountability means obligation of manager to report to higher authority. However, main objective of responsibility reporting is the control of costs at the different managerial levels. In reporting only such costs as arc influenced by the manager of the responsibility centre are reported.
Control of costs has been explained in detail previously, under the heading controllability'.

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