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403MSBARespAcc.ppt 1

Responsibility Accounting To be effective, organizations must ensure that allocation

of decision rights and use of appropriate performance

measures be designed to maximize firm profits given thespecialized knowledge available to members of the

organization.

Responsibility accounting involves the choice of

performance measures that can motivate firm members to

take actions the firm desires.

Measures to evaluate managerial performance should

reflect decision rights allocations within the firm.

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403MSBARespAcc.ppt 2

Responsibility Accounting Three or four types of responsibility centers are used to

hold managers accountable.

Cost center cost per unit, capacity utilization ... Profit center return on assets

Investment center Net Income, ROI, RI, EVA.

Discretionary cost center (e.g. R&D) amount spent.

Controllability principal suggests that managers be heldresponsible for only those costs the manager controls

better viewpoint is to hold managers responsible for

outcomes they can influence.

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403MSBARespAcc.ppt 3

Responsibility Accounting Transfer pricing is intimately linked to responsibility

centers and accounting. Transfers are sales by one division

of a firm to another. Very often firms have special ruleson prices of these transfers are to be chosen.

Note that the sale price (transfer price) affects both

divisions profits: the buying divisions costs are the

selling divisions revenues, so if both are profit centers,

the buying division will push for lower prices while theselling division will push for more. This creates a conflict

among divisions even though the company as a whole is

equally well off no matter what the transfer price.

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403MSBARespAcc.ppt 4

Responsibility Accounting The ideal transfer price is the opportunity cost of the goods

or services transferred.

Opportunity cost may be the same as variable cost, but not

always. If goods can be sold externally, opportunity costmay be the revenue forgone.

However external markets may not always exist as in the

case of specialized or custom-built goods, or, proprietary

costs of revealing information and/or productiontechnological secrets, availability of a reliable outside

source, quality concerns or synergies can make it hard to

discover opportunity costs.

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403MSBARespAcc.ppt 5

Responsibility Accounting Opportunity costs may be hard to verify. So firms often

use the following types of transfer prices:

market-based prices where the division use prices charged on theopen market as a guideline,

cost-based schemes (full or variable cost-based),

negotiated (with full autonomy to divisions to not trade if they

cannot agree on a price) and

dual pricing schemes in which the price paid by the buyingdivision is not the same as the price received by the selling

division. The difference between the two prices is adjusted in the

head-office books of accounts.

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403MSBARespAcc.ppt 6

Responsibility Accounting Allowing managers to negotiate prices and the freedom to

decide not to trade within the firm often appears to be the

most unprofitable thing to do. Yet, for decentralization, it is necessary to let the managers

decide. If they turn down profitable business, division

managers must be sure that the jobs they get are at least as

profitable (else they would be better off taking the prices

offered). So if they turn down some business from a sisterdivision, they either will be worse off (and will learn) or

they have other information based on which they rejected

the offer. In either case the firm benefits.

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403MSBARespAcc.ppt 7

Responsibility Accounting The magnitude of the market involved is another important

criterion. Some times the amounts at stake are so large

that divisions cannot be allowed the final word topmanagement has to review the deal.

Eventually, if the transfer pricing disputes are too large,

too frequent and take up too much of top managements

time, then the solution may be to re-centralize and treat

two profit centers as one, or to change some centers fromprofit centers to cost or discretionary cost centers or

revenue centers.