Responsibility Centers

Instructor: Dr. Zhu ZinanEmail: [email protected]

Office: BIZ1 #7‐24

ACC3602

Managerial Planning and Control

Semester II, AY 2014/15

Lecture 2 Responsibility Centers

Relevant Chapters:• Merchant and Van der Stede, Management Control Systems:

Performance Measurement, Evaluation, and Incentives, Chapters 7

• Additional reading materials posted in IVLE (2 files)

Learning Objectives:1. Responsibility centers2. Allocation of service department costs: 3 methods3. Allocation of service department costs: dual cost allocation

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1. Financial responsibility centers

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• Results controls Financial results controls• Why are financial results control systems so widely used in practice? (Alternatively, we may ask why we focus on financial results?)– Financial objectives are paramount in for‐profit firms. Managers

of not‐for‐profit organizations, too, must monitor finances closely. (cash flow)

– Financial measures provide a summary measure of performance.

– Most financial measures are relatively precise and objective.– Core financial results control measurement elements are largely

in place.


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• Financial results control systems have three core elements:– Financial responsibility centers

• The apportioning of accountability for financial results within the organization

– Planning and budgeting • To define performance expectations and standards for evaluating performance

– Motivational contracts (incentive contracts)• To define the links between results and various organizational incentives/rewards


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• Responsibility center– An organization unit (entity) headed by a manager with responsibility for a particular set of inputs and/or outputs

• Financial responsibility center– A responsibility center in which the manager’s responsibilities are defined primarily in financial terms

– Four basic types: revenue centers, cost centers, profit centers, and investment centers.

• Managers of revenue centers are held accountable for generating revenues (a financial measure of outputs)– E.g., sales departments in commercial organizations, fundraising

managers in not‐for‐profit organizations• However, most revenue center managers are also held

accountable for some expenses (e.g., salespeople’s salaries and commissions)

• Advantages/disadvantages

1. Financial responsibility centers: Revenue centers

• Managers of cost (expense) centers are held accountable for expenses (a financial measure of the inputs consumed by the responsibility center)– Standard cost centers (engineered cost centers)

– E.g., manufacturing departments – Inputs and outputs can be measured in monetary terms– There is a ‘causal’ relationship between inputs and outputs

– Discretionary cost centers (managed cost centers)– E.g., R&D departments, human resources departments– Outputs produced are difficult to measure– Relationship between inputs and outputs is hard to establish

1. Financial responsibility centers: Cost centers

• Standard cost centers (engineered cost centers)– Standard cost vs. actual cost

– Analysis of the cost of inputs that should have been consumed in producing the output vs. the cost that was actually incurred

– Additional controls– Volume produced, quality, etc.

• Discretionary cost centers (managed cost centers)– Ensuring that managers adhere to the budgeted expenses while successfully accomplishing the tasks of their center

– Subjective, non‐financial controls– For example, quality of service provided

1. Financial responsibility centers: Cost centers

• Managers of profit centers are held accountable for generating profits (a financial measure of the difference between revenues and costs)

• In deciding whether an entity is a profit center, – Does the manager have significant influence over both revenues and costs?

– it is not important to consider– Whether the entity’s goal is to maximize profits– Whether any revenues are generated from outside the

organization

1. Financial responsibility centers: Profit centers

RevenueCost of goods sold

Gross marginAdvertising + promotion

Research + development

Profit before taxIncome tax

Profit after tax

Gross MarginCenter

IncompleteProfit

Center

Before-taxProfitCenter

CompleteProfit

Center

Note: signifies that the responsibility center manager is held accountable for that financial statement line item.

1. Financial responsibility centers: Profit centers

• Managers of investment centers are held accountable forthe accounting returns (profits) and the investments madeto generate those returns– E.g., top‐level managers in most organizations– Objective = return on capital– Involve a ratio of the profits earned to the investment capital

used, e.g., ROI– Absolute differences in profits are not meaningful if the various

organizational entities use different amounts of resources• In fact, managers have two performance objectives

– Generate maximum profits from the resources at their disposal– Invest in additional resources only when such an investment will

produce an adequate return

1. Financial responsibility centers: Investment centers


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• Controllability principle– Employees should be held accountable only for what they control.

• Financial responsibility centers (behavioral angle)– Hold employees accountable for the performance areas that management wants them to pay attention to.

• Examples:– Charging corporate administrative (overhead) costs to segments

– How are these costs allocated?

2. Allocation of service department costs

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Carry out the central purposes of the organization

Do not directly engage in Operating activities

Operating Departments

Service Departments

To encourage operating departments to wisely use service department

resources.

To provide operating departments with more complete cost data for making decisions.

To help measure the profitability of operating

departments.

To create an incentive for service

departments to operate efficiently.

Service department costs are charged to operating departments for a variety of reasons including:


DifficultyService departments may

provide services to each other (interdepartmental or reciprocal services)

MethodsDirect methodStep method

Reciprocal method


Servicedepartment(Cafeteria)

Service department(Janitorial))

Operatingdepartment(Machining)

Operatingdepartment(Assembly)

Cost of servicesbetween servicedepartments areignored and all

costs areallocated directly

to operatingdepartments.

2. Allocation of service department costs: Direct method

Direct Method Example

Service department Allocation base

Cafeteria Number of employeesJanitorial Square feet occupied

Service Departments Operating Departments

Cafeteria Janitorial Machining AssemblyDepartmental costs before allocation 250,000$ 160,000$ 100,000$ 60,000$ Number of employees - 20 60 20 Square feet occupied 1,000 - 4,500 4,500



Cafeteria Janitorial Machining AssemblyDepartmental costs before allocation 250,000$ 160,000$ 100,000$ 60,000$

Cafeteria allocation (250,000) 0 187,500 62,500

Janitorial allocation ? ? ? ?

Total after allocation ? ? ? ?

$250,000 ×20

60 + 20 = $62,500

Allocation base: number of employees




Cafeteria allocation (250,000) 0 187,500 62,500

Janitorial allocation 0 (160,000) 80,000 80,000

Total after allocation 0 0 367,500$ 202,500$

$160,000 ×4,500

4,500 + 4,500 = $80,000

Allocation base: square feet occupied

Service departmentcosts are allocated

to other service departments and

to operatingdepartments, usually

starting with theservice departmentthat provides the

greatest amount ofservice to otherdepartments.

Service department(Cafeteria)

Service department(Janitorial)



2. Allocation of service department costs: Step-Down method

Step Method





Once a servicedepartment’s costs

are allocated, other service

department costsare not allocated

back to it.

Step Method

Janitorial willhave a new

total to allocateto operating

departments: itsown costs plus

those costsallocated from

the cafeteria dept.





Step Method Example



Cafeteria allocation (250,000) 50,000 150,000 50,000

Janitorial allocation 0 ? ? ?

Total after allocation 0 ? ? ?

$250,000 ×20

20 + 60 + 20 = $50,000

Allocation base: number of employees

Step Method Example




Janitorial allocation 0 (210,000) ? ?

Total after allocation 0 ? ? ?

New total in Janitorial = $160,000 (original Janitorial cost)plus $50,000 (allocated from Cafeteria).

Step Method Example




Janitorial allocation 0 (210,000) 105,000 105,000

Total after allocation 0 0 355,000$ 215,000$

$210,000 ×4,500

4,500 + 4,500 = $105,000

Allocation base: square feet occupied

Recognizes all interactions of

service departments.

The usage of one service departmentby another is used to determine thetotal cost of each

service department.

Servicedepartment(Cafeteria)




2. Allocation of service department costs: Reciprocal method

Reciprocal Method Example

Cafeteria Janitorial Machining AssemblyDepartmental costs before allocation 250,000$ 160,000$ 100,000$ 60,000$ Number of employees - 20 60 20 Square feet occupied 1,000 - 4,500 4,500

Cafeteria Janitorial Machining AssemblyAllocation ratios:

Cafeteria --- 0.2 0.6 0.2Janitorial 0.1 --- 0.45 0.45

Proportion of Output Used by

Reciprocal Method ExampleSpecify a set of equations that express the relationships between the departments.

Cafeteria (CA) = dept. costs + Share of Janitorial’s cost= $250,000 + 0.1 JA (1)

Janitorial (JA) = dept. costs + Share of Cafeteria’s cost= $160,000 + 0.2 CA (2)

Solve for CA and JA,CA (Cafeteria) = $271,429JA (Janitorial) = $214,286

Reciprocal Method ExampleAllocated to

Machining Assembly

Cafeteria 162,857 54,285

Janitorial 96,429 96,429

Total 259,286$ 150,714$

Total Cost

271,429$

214,286

$271,429 × 0.6

$214,286 × 0.45

$271,429 × 0.2

$214,286 × 0.45

Comparison of Methods

Direct Method Step Method Reciprocal Method

Machining Assembly Machining Assembly Machining AssemblyDepartmental cost before allocation 100,000$ 60,000$ 100,000$ 60,000$ 100,000$ 60,000$

Cafeteria allocation 187,500 62,500 150,000 50,000 162,857 54,285

Janitorial allocation 80,000 80,000 105,000 105,000 96,429 96,429 Total after allocation 367,500$ 202,500$ 355,000$ 215,000$ 359,286$ 210,714$

Comparison of Methods

Cost Allocation Accuracy

The Direct method does not consider interactions among service departments.

The Reciprocal method is more thorough in considering interactions among service

departments.

The Step method considers some interactionsamong service departments.

VariableCosts

Charge to userdepartments at a

budgeted rate timesthe actual usage ofthe allocation base.

FixedCosts

Allocatebudgeted amountsto user departmentsin proportion to the

capacity demanded bythe user department.

3. Allocation of service department costs: Dual cost allocation

Dual Cost Allocation

Maintenance Dept

Budgeted Costs FY10

Variable $120,000Fixed 360,000Total $480,000

Machine Hours Usage

Normal Budgeted FY10 Actual FY10

Machining 6,000 8,000 7,000 Assembly 4,000 4,000 5,000

Total 10,000 12,000 12,000

Dual Rate: VC: $120,000/12,000 = $10 per MHFC: Machining = $360,000 x 0.6 = $216,000

Assembly= $360,000 x 0.4 = $144,000

Dual Cost AllocationDual Rate

Machining AssemblyDept Dept

VC allocation: $10×7,000 MH 70,000$ $10×5,000 MH 50,000$ FC allocation 60%x$360,000 216,000 40%x$360,000 144,000 Total cost 286,000$ 194,000$

End of Lecture 2

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Responsibility Centers

Documents

Transcript of Responsibility Centers