You are on page 1of 10

[1]

RESPONSIBILITY ACCOUNTING
Introduction :
Difficult for companies to manage all its operations, especially if there were many products
and services they provide, the more the magnitude of the company and the number of
branches and has expanded the scope of work, no company can take all the information to
make management decisions at the right time, and the reason for this is lack of time with the
senior management, as they are busy in matters of the company's future to make strategic
decisions in the medium and long term. So many companies have resorted to the method of
decentralization in strategic decision-making, and that the delegation of authority to branch
managers or departments as well as the heads of departments in their departments.
Thus, decentralized management have the freedom to take decision on the minimum level of
management (section), the more able administrators make decisions at a low level the more
the enterprise is managed in an efficient way.
It is relevant to measurement of performance of divisions of an organization. Thus Budgeting and
standard costing are part of the responsibility accounting process.

Meaning and Definition:-

Horngren has defined responsibility accounting as, a system of accounting that recognizes various
responsibility centers throughout the organization and reflects the plans and actions of each of
these centers by assigning particular revenues and costs to the one having the pertinent
responsibility.

Responsibility Accounting is a method of accumulating and reporting both budgeted and actual
costs, by divisional managers responsible for them. In this system, business activities are identified
with persons rather than products for that to make effective control to appoint a manager.

Assumptions for Responsibility Accounting:-

The development of a sound Responsibility Accounting system is based on the following
assumptions:
It should be a big company with a divisionalized organizational structure and where
responsibility are classified at different levels of the organization.
There are clearly set goals and targets for each responsibility centre.
Managers must try to attain the goals and objectives.
Goals and responsibilities set out by the management are attainable with efficient and
effective performance.
[2]

Employees of the organization give their best effort to achieve the goals and
responsibilities delegated upon them.
Employees are held responsible for the areas over which they exercise control.
Performance of the employees is evaluated by the higher management through Feedback
Reports at regular intervals.
Performance evaluation process of the employees is based on reward-providing nature.

Responsibility Centers:-
A responsibility centre is a sub-unit of an organization under the control of a manager who is held
responsible for the activities of that centre.
They are as follows:

1) Cost Centre or Expense Centre:-

An expense centre is a responsibility centre in which inputs, but not outputs, are measured
in monetary terms. Responsibility accounting is based on financial information relating to
inputs (costs) and outputs (revenues). In an expense centre of responsibility, the accounting
system records only the cost incurred by the centre but the revenues earned (outputs) are
excluded. An expense centre measures financial performance in terms of cost incurred by it.
In other words, the performance measured in an expense centre is efficiency of operation in
that centre in terms of the quantity of inputs used in producing some given output. The
modus operandi is to compare actual inputs to some predetermined level that represents
efficient utilization. The variance between the actual and budget standard would be
indicative of the efficiency of thedivision.

2) Profit Centre:

A centre in which both the inputs and outputs are measured in monetary terms is called a profit
centre. In other words both costs and revenues of the centre are accounted for. Since the
difference of revenues and costs is termed as profit, this centre is called profit centre. In a
centre, there are financial measures of the outputs as well as of the input, it is possible to
measure the effectiveness and efficiency of performance in financial terms. Profit analysis can
be used as a basis for evaluating the performance of divisional manager. A profit centre as well
as additionaldata regarding revenues. Therefore, management can determine whether the
division was effective in attaining its objectives. This objective is presumably to earn a
satisfactory profit. Profit directly traceable to the division and voidable if the division were
closed down. The concept of divisional profit is referred to as profit contribution as it is
amount of profit contribution directly by the division.The performance of the managers is
measured by profit. In other words managers can be expected to behave as if they were running
their own business. For this reason, the profit centre is good training for general management
responsibility.

3) Investment Centers:

A centre in which assets employed are also measured besides the measurement of inputs and
outputs is called an investment centre. Inputs are accounted for in terms of costs, outputs are
[3]

calculated on investment centre. Inputs are accounted for in terms of costs, outputs are
accountedfor 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 profits but also in
terms ofassets employed to generate profits.An investment centre differs from a profit centre in
that as investment centre is evaluated on thebasis of the rate of return earned on the assets
invested in the segment while a profit centre isevaluated on the basis of excess revenue over
expenses for the period.

4) Revenue Centre:-

A responsibility Centre is a Revenue Centre in which manager controls revenues but does not
control cost of production /service. Revenue centre may control on selling prices, product mix and
promotional activities.

Transfer Pricing:-

When profit centres are to be used, transfer prices becomenecessary in order to determine the
separate performancesof both the buying profit centres. Generally, the measurementof profit in a
profit centre becomes complicated by theproblem of transfer prices. The transfer price represents
the Value of goods / services furnished by a profit centre to other responsibility centres within an
organization. This most commonly happens in companies with high degree of vertical integration.
The transfer price is the price at which a product or service is internally transfer between two units
of the same company. For example : Goods From a Holding company may be transferred to its
subsidiary in a foreign country or goods from a production department may be sold to marketing
department I above situations, the prices are set within a company and the typical market
mechanism that fixed the product prices does not apply. Transfer pricing is very important it
directly affected with the revenues of the transferring unit and the costs of the receiving unit,
Normally, it affects the divisional profits.

Methods of Transfer Pricing:-

Generally, there are four methods of transfer pricing used, they are as follows:

(1) Variable Cost Method.
(2) Total Cost Method.
(3) Market Price Method.
(4) Negotiated Price Method

1. Variable Cost Method:-

Under this method, the transfer price is fixed at transferor units variable cost plus mark up, under
this situation the variable cost is its opportunity cost. So that naturally, the transfer price will be
comparatively low. Variable cost method may not be appropriate from the long point of view
because in the long run fixed costs are also relevant.

2. Total Cost Method:-

Here, under this method, the transfer price is set at full cost which includes variable cost. Its only
real advantage lies in its simplicity as it is easy to understand and implementation. However, it is
[4]

not considered a desirable method because its disadvantages are more serious. This method does
not provide any incentive to managers of the transferor divisions to keep costs down.



3. Market Price Method:-

Under this method, the transfer price is set at the current price of the product in the market. This
method is used only when there is a ready outside market for the concerned product. In this
method, needs to be adjusted for cost saving such as reduced, the selling and distribution expenses,
commission on sales etc. This method is very practical because this is some what based on the
decisions and situations.

4. Negotiated Method:-

Transfer price could be set by negotiation between the buying and selling divisions. This would be
appropriate if it could be assumed that such negotiations would result in decisions which were in
the interests of the firm as a whole and which
were acceptable to the parties concerned.



























[5]





INFLATION ACCOUNTING
Inflation :
Inflation means a change in the general prices of goods and services in the upward direction over
some defined time period.
Defination :
Inflation accounting is a term describing a range of accounting systems designed to correct
problems arising from historical cost accounting in the presence of inflation. Inflation accounting
is used in countries experiencing high inflation or hyperinflation.
Need for Inflation Accounting
Inflation, especially when it is prolonged and high, reduces considerably the meaningfulness and
use of the corporate accounts because the various amounts in current rupee values may not signify
proportionate real amounts, as the real worth of the rupee varies in different years. Moreover,
arithmetical operations involving different amounts in rupees having different real worth become
quite misleading. To make the accounts more meaningful, all items should be expressed in values
relating to a common year. This is attempted through inflation accounting, the following reasons
usually being advanced in its favour :
(a) It helps to correct the usually distorted picture of the financial operations and condition of a
company presented by the conventional system of accounts ;
(b) It facilitates inter-company comparisons since inflation hits different firms in different degrees;
(c) It also facilitates inter-period comparisons of the performance of a firm;
(d) Correct measurement of income is possible only with inflation accounting; and
(e) When some nominal value in the accounts forms the basis of government action, e.g., taxation
based on profits, MRTP Act measures based on a nominal value acting as a proxy for relevant
variables, determination of controlled price on the basis of nominal profits and so on, inflation may
cause unfair decisions by the government, unless the relevant nominal value is adjusted for
inflation.
NET PRESENT VALUE METHOD:
Definition of 'Net Present Value - NPV'
The difference between the present value of cash inflows and the present value of cash outflows.
NPV is used in capital budgeting to analyze the profitability of an investment or project.

NPV analysis is sensitive to the reliability of future cash inflows that an investment or project will
yield.
[6]


In addition to the formula, net present value can often be calculated using tables, and spreadsheets
such as Microsoft Excel.
'Net Present Value - NPV'

NPV compares the value of a dollar today to the value of that same dollar in the future, taking
inflation and returns into account. If the NPV of a prospective project is positive, it should be
accepted. However, if NPV is negative, the project should probably be rejected because cash flows
will also be negative.

For example, if a retail clothing business wants to purchase an existing store, it would first estimate
the future cash flows that store would generate, and then discount those cash flows into one lump-
sum present value amount, say $565,000. If the owner of the store was willing to sell his business
for less than $565,000, the purchasing company would likely accept the offer as it presents a
positive NPV investment. Conversely, if the owner would not sell for less than $565,000, the
purchaser would not buy the store, as the investment would present a negative NPV at that time
and would, therefore, reduce the overall value of the clothing company.

Negotiated price method of transfer prices:
The transfer price is reached by negotiation between the relevant division managers. The
advantage of this method is that it preserves the divisions' autonomy. Its problem is the sensitivity
of the outcome to the managers' negotiation skills.
Here, the firm does not specify rules for the determination of transfer
prices.Divisionalmanagersareencouragedtonegotiateamutuallyagreeable transfer price. Negotiated
transfer pricing is typically combined with free sourcing. In some companies, though, headquarters
reserves the right to mediate the negotiation process and impose an arbitrated solution.


Methods of Inflation Accounting

[7]

Inflation accounting essentially involves identifying any value in the accounts which is expressed in
terms of past rupees and updating them in line with the rest. This is conceptually simple, as all one
has to do is to convert the values in past rupees to values in current rupees using a suitable index.
One would suggest the use of a general price index like the GNP deflator or the consumer price
index irrespective of the item in the accounts to which it is being applied. The other would require a
large number of specific price indices to be applied, one for each item needing adjustment. The first
is called current purchasing power (CPP)method and the other is called current cost accounting
(CCA)method.

Some of the generally accepted methods of Inflationaccounting are as follows
(a) Current Purchasing Power Method (CPP Method)
(b) Current Cost Accounting Method (CCA Method)

Current Purchasing Power Method (CPP Method):

Under CPP method, all items in the financial statements are restated in terms of units of equal
purchasing power.
The CPP method basically attempts to remove the distortions in financial statements, which arise
due to change in the value of rupee.
CPP method distinguishes between monetary and non-monetary items.

Value of asset as per CPP = Historical Cost of Asset x Conversion Factor
Conversion Factor =



Illustration:
A company purchased a plant on 1/1/2005 for a sum of Rs. 45,000. The consumer price index on
that date was125 and it was 250 at the end of the year. Restate thevalue of the plant as per CPP
method as on 31stDecember 2005.

Solution:
Conversion Factor =




=

= 2
Value of the plant on 31/12/05 =Historical Cost x Conversion Factor
Rs 45,000 x 2 = Rs 90,000

Monetary Vs Non Monetary Items:

Monetary Items (both assets and liabilities) are those items whose amounts are fixed by
contracts or otherwise they remain constant in terms of monetary units. Example debtors,
creditors, debentures, Preference share capital etc.
During the period of inflation the holder of monetary assets lose general purchasing power
since their claims against the firm remain fixed irrespective of any changes in the general
price levels. Conversely, the holder of monetary liabilities gains since he is to pay the same
amount due in rupees of lower purchasing power.
Non monetary items are those items that cannot be stated in fixed monetary amounts. They
include tangible assets such as building, plant &machinery, stock etc.
[8]

Under CPP method all such items are to be restated to represent the current purchasing
power. For example a machinery costing Rs25,000 in 1996 may sell for Rs 35,000 today
though it has been used. This may be due to change in the general price level.
Note : Equity capital is a non monetary item since the equity shareholders have a residual
claim on the companys net assets.


Computation of Monetary gain or loss:

The changes in purchasing power affects both monetary and non monetary items of the
financial statements. In case of monetary assets and monetary liabilities, the firm receives
or pays the amounts fixed as per the terms of the contract,but it gains or losses in terms of
real purchasing power.
Such monetary gain or loss should be computed separately and shown as a separate item in
the restated income statement in order to find out theoverall profit or loss under CPP
method.

Adjustment for cost of sales and Inventories:

The restatement of the Cost of Sales and inventories under the CPP method, depends upon
the method used for accounting for inventories (FIFO or LIFO).
Under FIFO method, the cost of sales normally includes the entire opening stock and current
purchases less closing stock. Closing stock comprises latest purchases.
Under LIFO method, the cost of sales normally includes the latest purchases and the closing
comprises the earliest purchases.

Current Cost Accounting Method (CCA Method):
Under the CCA method money remains to be the unit of measurement.
The items of the financial statements are restated in terms of current value of that item
and in terms of general purchasing power of the money.
Assets and liabilities are stated at their current value to the business. Similarly, the
profits are computed on the basis of current values of the various items to the business.

This requires carrying out the following adjustments
a) Revaluation adjustment
b) Depreciation adjustment
c) Cost of Sales adjustment
d) Monetary Working Capital adjustment


A. Revaluation adjustment :
Fixed Assets Are shown in the balance Sheet at their values to the business. To the business
of an asset refers to the opportunity loss to the business of were deprived of such assets.
The replacement cost could be taken as gross or et.
Gross replacement cost of an asset is the cost to be incurred at the time of valuation to
obtain a similar asset for replacement. Net replacement cost of an asset is the gross
replacement costless depreciation.

[9]

Illustration:
An asset purchased on 1/1/2005 for Rs50,000 now costs Rs 80,000 on 31/12/2005 , then
the gross replacement cost of the asset is Rs 80,000.
Assuming that the useful life the asset is 5years,
then the net replacement cost = 80,000 80000 x 3 / 5 = 32,000.

B. Depreciation adjustment:

The profit and loss account should be charged for depreciation with an amount equal to
the value of fixed assets consumed during the period.
Depreciation charge may be computed either on the basis of total replacement cost of the
asset or on average net current cost of assets. i.e.





C. Cost of Sales adjustment :

COSA represents the difference between value to the business and the historical cost of stock
consumed in the period.
COSA Adjustment = CS OS Ia ( CS/Ic OS/Io)
Where: CS means Closing Stock
OS means Opening Stock
Ia means Average Index for the year
Ic means Closing Index for the year Io means Opening Index for the year

D. Monetary Working Capital adjustment :

MWCA refers to the excess of accounts receivable and unexpired expenses over accounts
payable and accruals.
CCA ensures that the impact of changing prices on working capital is taken care of through
MWCA. This adjustment is required only for price level changes and not for any increase in
volume of the business.
MWCA = C O Ia ( C/Ic O/Io)
Where :C means Closing Monetary
WCO means Opening Monetary
WCIa means Average Index for the year
Ic means Closing Index for the year
Io means Opening Index for the year

Illustration:
From the following information carry out MWC Aunder the CCA method

Opening balance Closing Balance
Accounts receivable
Accounts payable
Price Index
18000
10000
175
21000
12000
205
Avg. price index


190

[10]


MWCA =C O Ia ( C/Ic O/Io)
Opening MWC = 18000 10000 = 8000
Closing MWC = 21000 12000 = 9000
MWCA =(9000 - 8000) 190(9000/205 8000/175)= 1000 190 ( 43.90 45.70)= 1342

You might also like