DIFFICULTIES IN PERFORMANCE EVALUATION OF DISCRETIONARY EXPENSE CENTRES

Meaning of Discretionary Cost Discretionary cost can be explained with the help of following two important features. They arise from periodic (usually yearly) decisions regarding the maximum outlay to be incurred. They are not tied to a clear cause and affect relationship between inputs and outputs Based on the nature of the financial input and/or output that are measured for control purposes, four basic types of responsibility centres, Revenue, Cost, Profit and Investment, are generally distinguished (Anthony and Govindarajan, 2004) Meaning of Discretionary Cost Centre A discretionary cost centre (corporate overhead department) are subunits that arises from yearly appropriation decisions and have no well specified function relating to outputs or inputs. Such examples include but are not limited to; R&D, legal, public relations, advertising, executive training, health care, and internal consulting. (Zimmerman, 205) Types of tasks Repetitive (e.g. Accounting, Budgeting) Special (e.g. Projects appraisals) Performance evaluation Cost control Choose the tasks to be executed and level of effort Economic performance: Budget control Operational performance: Quality and level of service (opinions) DIFFICULTIES IN PERFORMANCE EVALUATION OF DISCRETIONARY EXPENSE CENTRES Difficult for budgeting Difficult to guarantee congruence between department and company objectives. Discretionary Cost Centres have limited to zero measurement on the actual output. Investing time into training an employee, Example - Yields increased knowledge, perhaps more efficiency, but by accounting standards is hard to quantify. Similarly, it becomes just as difficult to measure the actual quality of the output. In this example, how much did

the employee retain for use in his everyday job and how much will he forget without repetition? Discretionary cost centres also have limited decision rights. Discretionary cost centre managers wont know the optimal input mix and have no way of controlling it. Application in action of Discretionary Cost Centre in Business A mid-sized steel company manager Max Jarvis that is converting two of its cost centres into discretionary cost centres Benefits: A more focused approach on market research and environmental protection. In the market research department they should see better product/service launches, and they should have a deeper understanding of the competition and current customers, including any prospects. With a shift in focus for the environmental protection department, Jarvis should see his company become more compliant with government laws and subsequently portray a healthier public image for doing so. Another consideration is that by shifting the cost centres to discretionary cost centres, Jarvis may be inclined to institute tighter financials controls to manage them. Ultimately, this decision to move current cost centres to discretionary cost centres will lead to more profits for Jarviss company. Today, these functions do not produce a good/service to transfer to another department. It is believed that the classification of a discretionary cost centre is appropriate for budgeting minimization (if necessary) and the potential for maximizing intangibles (outputs).

References Management Accounting For Business By Colin Drury An Analysis Of Discretionary Cost Centres By Ryan Kiscaden