A PROJECT ON

Responsibility Accounting
2011-13

INDEX
Acknowledgement ................................................................................................................................................... 3 Meaning of Responsibility accounting............................................................................................................. 4 Advantages .................................................................................................... Error! Bookmark not defined. Conditions for effective Responsibilty Accounting System ..................................................... 5 Advantages of Responsibility Accounting ............................................................................................... 6 Disadvantages of Resposbility Accounting ............................................................................................ 7 Case Study of Responsibility Accounting ............................................................................................ 8 Conclusion ............................................................................................................................................................. 11

ACKNOWLEDGEMENT
I am grateful to our Management Accounting Faculty at the MET League of Colleges, Prof. Chopde for his valuable guidance and giving me this wonderful opportunity to learn and know more responsibility accounting.

MEANING OF RESPONSIBILITY ACCOUNTING

Responsibility accounting is the system for collecting and reporting revenue and cost information by areas of responsibility. It operates on the premise that managers should be held responsible for their performance, the performance of their subordinates, and all activities within their responsibility center. Responsibility accounting is also called profitability accounting and activity accounting. Planning & control are essential for achieving good results in any business. Firstly, a budget is prepared and, secondly, actual results are compared with budgeted ones. Any difference is made responsibility of the key individuals who were involved in (i) setting standards, (ii) given necessary resources and (iii) powers to use them. In order to streamline the process, the entire organization is broken into various types of centers mainly cost centre, revenue centre, profit center and investment centre. The organizational budget is divided on these lines and passed on to the concerned managers. Actual results are collected and displayed in the same form for comparison. Difference, if any, are highlighted and brought to the notice of the management. This process is called Responsibility Accounting. DEFINITION OF RESPONSIBILITY ACCOUNTING Responsibility accounting involves the creation of responsibility centres. A responsibility centre may be defined as an organization unit for whose performance a manager is held accountable. Responsibility accounting enables accountability for financial results and outcomes to be allocated to individuals throughout the organization. The objective is to measure the result of each responsibility center. It involves accumulating costs and revenues for each responsibility centre so that deviation from performance target (typically the budget) can be attributed to the individual who is accountable for the responsibility centre.

CONDITIONS FOR EFFEC TIVE RESPONSIBILTY ACCOUNTING SYSTEM

For an effective responsibility accounting system, the following three basic conditions are necessary: (a) The organization structure must be well defined. Management responsibility and authority must go hand in hand at all levels and must be clearly established and understood. (b) Standards of performance in revenues, costs, and investments must be properly determined and well defined. (c) The responsibility accounting reports (or performance reports) should include only items that are controllable by the manager of the responsibility center. Also, they should highlight items calling for managerial attention. A well-designed responsibility accounting system establishes responsibility centers within the organization. A responsibility center is defined as a unit in the organization which has control over costs, revenues, and/or investment funds. Responsibility centers can be one of the following types: Cost center. A cost center is the unit within the organization which is responsible only for costs. Examples include production and maintenance departments of a manufacturing company. Variance analysis based on standard costs and flexible budgets would be a typical performance measure of a cost center. Profit center. A profit center is the unit which is held responsible for the revenues earned and costs incurred in that center. Examples might include a sales office of a publishing company, and appliance department in a retail store, and an auto repair center in a department store. The contribution approach to cost allocation is widely used to measure the performance of a profit center. This topic is covered in Chapter 9 (Control of Profit Centers). Investment center. An investment center is the unit within the organization which is held responsible for the costs, revenues, and related investments made in that center. The corporate headquarters or division in a large decentralized organization would be an example of an investment center.

ADVANTAGES OF RESPONSIBILITY AC COUNTING

1. Provides a way to manage a large diversified organization. Better decisions can be made at the local level.

2.

Provides incentives to department managers and individuals to optimize their individual performances. Provides managers with the freedom to make local decisions.

3.

4. Provides top management with more time to make policy decisions and

engage in strategic planning.

5. Allows management to avoid understanding the system by using top down

remote control based on accounting measurements. Supports point 4.

6. Supports management and individual specialization based on comparative

advantage. 7. Overall, it supports individualistic capitalism.

DISADVANTAGES OF RESPOSBILITY ACCOUNTING

1. The point at left has some credibility at the division level, but the system

must be managed as a system not a group of subsystems. A RA stovepipe organization creates conflicts between segments, e.g., transfer pricing problems, purchasing department buying on the basis of price, production departments pushing defective products downstream to maximize labor efficiency and production volume measurements.
2. This causes competition between segments and individuals rather than

cooperation and teamwork. Prevents goal congruence. Creates slack and excess, e.g., inventory buffers, excess capacity, people, and vendors. Promotes ranking people which ignores statistical variation. According to Deming, this destroys moral, intrinsic motivation and teamwork.
3. According to Deming, a system cannot manage itself. 4. The top down approach also ignores the concept of continuous improvement

and Demings concept of leadership, i.e., managers need to understand the system so that they can help facilitate improvement, not judge and blame people for variations in financial accounting results.
5. Specialist can not understand the system and the system cannot manage

itself.
6. Overall, it conflicts with communitarian capitalism and a Companys

attempt to change to the team oriented model.

CASE STUDY OF RESPON SIBILITY ACCOUNTING

An integrated textile unit showed a net profit after tax of Rs.272 million. Its ROI (Return on Investment), was 17.5% which is much above the supposed cost of capital of 12.5%. The company was operating three divisions: (i) Spinning Unit, (ii) Weaving Unit and (iii) a Finishing Unit. As of now, it is not apparent who earned what. So managers of the three departments would be asking for bonuses or rewards. Now suppose, the company asks its accountants to prepare Division-wise P&L account and present the same to the management for performance appraisal of the three managers. DIVISION WISE ACCOUNTS

After considering division-wise performance, who do you think deserve the bonus? Only the manager, Spinning Division, deserves the bonus. Manager Weaving has just broken even by earning profit equal to cost of capital. Manager Finishing was really a drag on the companys resources and its losses were only hidden in consolidated statements because of substantial contribution made by Spinning Unit. However, this is over-simplified example but it brings glaring facts to the notice of the management and other users of the accounts.

PACKAGES LTD - ORGANIZATIONAL CHART

RESPONSIBILITY CENTRES Packages Ltd had two autonomous units, Lahore Plant and Karachi Plant. In our responsibility accounting terminology, these would be called Investment Centres. General Manager, Lahore Plant, can decide how much to invest on what. (Of course, he would be guided by a multifunctional teams which includes industrial engineers, economists, researchers and financial analysts.) The GM, Lahore Plant would be evaluated on the basis of ROI or RI or EVA. And so the GM, Karachi Plant. The yardsticks would remain the same in the case of both the Managers. In the second Layer there are Managers of Paper Mills, Packaging Plant and Printing Plant. All of them have been given necessary Production Facilities and working Capital. Their performance would be based on Gross Margin or Contribution Margin. The latter is a better measure since it does not take into account fixed cost (Depreciation, Salaries of Permanent staff

and markup) over which the Manger has no control. (Decisions for capital investments are made in the Investment Centers). In the last layer there are three sections. The first two are classified as Cost Centers and their managers should try to remain within their allocated budgets. The third one, Marketing Cell, is a Revenue Centre and its manager must exert as much as possible to bring the business as per target level or budget level.

CONCLUSION There are no set rules or Generally Accepted Accounting Principles (GAAP) in management accounting which serves the management and not outsiders. So performance reports may be prepared in any form and styles as long as these give useful information to the Chief Executive and the top-managers. One such format is given above. The modern business concerns adopt a variety of way to achieve their goals. Since a Chief Executive cannot over-see all affairs of a company in different fields, in different locations and in different time-frames, he or she introduces a systematic control through budgets and responsibility accounting techniques. The organization is broken into various responsibility centres. The Accountant maintains records for each of the centre and periodically prepare and submit reports on their performance which ultimately reflect on the capability of its managers. To use such techniques effectively, the emphasis must be on the useful information rather than a blame game or passing on the buck. The managers should be provided feedback as to how near or away they are from their targets. These reports should be well in time to allow them to adjust their approach. The ultimate aim would be welfare of the organization and its gradual rise in the industrial sector. In the process, good managers must be rewarded and bad one eliminated to stay afloat in a most competitive and dynamic environments.