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Responsibility ACCOUnting
ConCept of Cost, Revenue, Profit and Responsibility Centres
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, also called profitability accounting and activity
accounting
A responsibility accounting system produces responsibility reports that assist each
successively higher levelof management in evaluating the performances of subordinate
managers and their respective organizational units. The reports should be tailored to fit the
planning, controlling, and decision-making needs of subordinate managers and should include
both monetary and nonmonetary information.

Information for Responsibility Reports

1. Monetary

Monetary responsibility report are as follows

🖸 Budgeted and actual revenues

🖸 Budgeted and actual costs (computed on a comparable basis)

🖸 Variance computations for revenues and costs

🖸 Asset investment base
2. Non-monetary

🖸 Capacity measures (theoretical and that used to compute predetermined overhead rates)
🖸 Target rate of earnings on investment base

🖸 Desired and actual market share

🖸 Departmental or divisional throughput
🖸 Number of defects (by product, product line, and supplier)
Number of orders backlogged (by date, cost, and selling price)
Number of customer complaints (by type and product); method of complaint resolution Percentage

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of orders delivered on time

🖸 Manufacturing (or service) cycle efficiency

🖸 Percentage of reduction of non-value-added time from previous reporting period (broken down by
idle time, storage time, move time, and quality control time)

🖸 Number and percentage of employee suggestions considered significant and practical

🖸 Number and percentage of employee suggestions implemented
🖸 Number of unplanned production interruptions

🖸 Number of schedule changes

🖸 Number of engineering change orders; percentage change from previous period
🖸 Number of safety violations; percentage change from previous period
🖸 Number of days of employee absences; percentage change from previous period
The principal approaches to arranging company activities are by (1) function, (2) product, and (3) geographic location.
Manager’s responsibility report should reflect his or her degree of influence and should include only the revenues and/or
costs under that manager’s control. Normally, some of an organizational unit’s revenues or costs arenot controllable
(or are only partially or indirectly controllable) by the unit manager. In such instances, the responsibility accounting
report should separately classify all reported monetary information as controllable or non- controllable by the manager.
Alternatively, separate reports should be prepared for the organizational unit (showing all monetary amounts) and for
the unit manager (showing only those monetary amounts under his or her control).

A responsibility accounting system helps organizational unit managers to conduct

the five basic control functions:
1. Preparing a plan (e.g., using budgets and standards) and use it to communicate
output expectations and delegate authority.
2. Gathering actual data classified in accordance with the activities and categories
specified in the plan. The responsibility accounting system can be used to record and
summarize data for each organizational unit.
3. Monitoring the differences between planned and actual data at scheduled intervals.

Responsibility reports for subordinate managers and their immediate supervisors

normally include comparisons of actual results with flexible budget figures. In contrast,
responsibility reports can provide comparisons of actual performance to the master
budget.
4. Exerting managerial influence in response to significant differences. Because of day-
to-day contact with operations, unit managers should be aware of any significant
variances before they are reported, identify the variance causes, and attempt to
correct them. Top management, on the other hand, might not know about operational
variances until it receives responsibility reports. By the time top management receives
the reports, the problems causing the variances should have been corrected, or
subordinate managers should have explanations as to why the problems were not or could

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not be resolved.

5. Continuing comparing data and responding; then, at the appropriate time, the
process will begin again

Assumptions of Responsibility Accounting

The responsibility accounting system makes the following important assumptions:
1. The areas of responsibility are defined for which managers should be held responsible.
2. Managers are only charged with the items and responsibility over which they can exercise a
significant
degree of direct control.
3. Managers should actively participate in establishing the goals or budgets against which their performance
is measured.
4. Goals defined for each area of responsibility should be attainable with efficient and effective performance.
Control (performance) reports should contain significant information related to each area of responsibility.
5. Responsibility centre managers should try to accomplish the budgets and objectives established for
their respective areas of responsibility.

Advantages of Responsibility Accounting:

1. It facilitates delegation of decision making.
It helps management promote the concept of management by objective. In management by
objective, managers agree on a set of goals. The manager’s performance is then evaluated based on
his or her attainment of these goals.
2. It provides a guide to the evaluation of performance and helps to establish standards of
performance which are then used for comparison purposes.
3. It permits effective use of the concept of management by exception, which means that the manager’
attention is concentrated on the important deviations from standards and budgets.
There should be a direct relationship between responsibility and authority. If an individual is
answerable for his or her actions (responsible), that individual must have the authority to carry
out actions and execute decisions. There is an undermining of a person’s performance and
incentive when authority is not given while the person is still held accountable

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Responsibility Centre
A responsibility centre may be defined as an area of responsibility which is controlled by an individual.
A responsibility centre is an activity such as department over which a manager exercises
responsibility. Responsibility areas may be departments (drilling or maintenance department), product
lines (chemicals or fertilizers), territories (North or South) or any other type of identifiable unit or
combination of units.

Four types of responsibility centers are commonly identified:

1. Cost or Expense Center,

2. Profit Center or Earnings Center, and

3. Revenue Center
4. Investment Center.

Cost or Expense Center

A cost center is an organizational unit whose manager has the authority only to incur costs and is
specifically evaluated on the basis of how well costs are controlled. Cost centers commonly include
service and administrative departments. For example, a company’s human resources and accounting
departments could be considered cost centers because these units do not generate revenues or
charge for services, but they do incur costs.

In the traditional manufacturing environment, the production department is the largest cost center.
Managers of cost centers often concentrate only on the unfavorable standard cost variances and ignore
the efficient performance indicated by favorable variances. However, significant favorable variances
should not be disregarded if the management-by-exception principle is applied properly. Using this
principle, top management should investigate all variances (both favorable and unfavorable) that fall
outside the range of acceptable deviations.

This is a segment of the organization that has been assigned control over only the incurrence of
expenses or costs. A cost or expense center has no control over sales or marketing activities.

For example, a department within a factory may be considered a cost or expense center if the
manager is responsible only for controlling costs and has no responsibility over revenues.
In some instances, a cost center can generate revenues, but the revenues are either not under the
manager’s control or not effectively measurable. The first situation exists in a community library that
is provided a specific proration of property tax but has no authority to levy or collect the related
taxes. The second situation exists in cost centers, such as research and development centers, in
which the outputs (revenues or benefits generated from the cost inputs) are not easily measured. In
these situations, the revenues should not be included in the manager’s responsibility accounting
report.

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Profit Center or Earnings Center

A profit center is an organizational unit whose manager is responsible for generating revenues and
managing expenses related to current activity. Thus, profit centers should be independent
organizational units whose managers have the ability to obtain resources at the most economical
prices.
🖸 Sell products at prices that will maximize revenue.

🖸 Have a goal of maximizing the center’s profit.

The profit center resolves many of the problems just noted for the cost and revenue center concepts
by combining the two. The manager of a profit center is primarily responsible for generating the highest
possible profit (or least possible loss). This results in a strong incentive to pursue only those sales that
have a sufficient margin, while also incurring expenses only if they will result in an incremental
increase in revenue.
Costs not under a profit center manager’s control are those related to long-term investments in plant assets; as
such, separate evaluations should be made for the subunit and its manager.
The profit center concept is highly recommended, since it results in the strongest possible management attentionto
profitability. However, there are some cases where it is difficult to convert a cost center to a profit center, because
there is no way for it to gain revenues by directly selling its services. Examples of such cost centers arethe computer
services, engineering, and production departments.
These groups are all involved in the production or support of products, but it can be difficult to attribute sales directly
to them. One way around this problem is to have each department charge other departments for its services. A good
example is the computer services function, where many organizations create a programming cost per hour that is
charged to all other departments that request changes to computer programs; it is also common to charge for the
processing time used by each department’s programs, as well as the cost of report processing, generation, and
distribution.
This segment of the organization is assigned control over both costs and revenues. Net income and contribution
margins can therefore be computed for a profit center. For example, an entity that makes wood furniture may cut
lumber in one department and assemble the furniture in another department. The first department can be considered a
profit center if the cut lumber is “sold” to the second department. The selling price of this internal sale is called the
transfer price and may be used as revenue for the first department.

Revenue Center
A revenue center is strictly defined as an organizational unit that is responsible for the generation
of revenues and has no control over setting selling prices or budgeting costs. For instance, in many
retail stores, each sales department is considered an independent unit and managers are evaluated
based on their departments’ total revenues. Departmental managers, however, might have no
authority to adjust selling prices to affect volume, and often they do not participate in the budgeting
process. Additionally, the departmental managers might have no ability to affect costs.
A revenue center is one where the employees located in a specific functional area are solely responsible for attaining
preset revenue levels. The sales department is sometimes considered to be a revenue center. In this capacity, employees
are essentially encouraged to obtain new sales without regard to the cost of obtaining [Link] can be a dangerous
way to run a function, unless strict guidelines are set up that control the overall spendinglimits allowed, the size and
type of customer solicited, and the size and type of orders obtained. Otherwise, the sales staff will obtain orders from
all kinds of customers, including those with poor credit records or histories ofreturning goods, not to mention orders

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that are so small that the cost of processing the order exceeds the profit gained from the sale. Other counterproductive
activities associated with revenue centers are the inordinate use of travel funds to meet with customers, selling products
at large discounts from the standard price, offering special promotional guarantees to customers, allowing credits on
previously purchased products if the price subsequently declines, and offering to extend payment terms. For all of
these reasons, revenue centers are not recommended without the addition of stringent controls to ensure that the sales
staff obtains only revenues that will result in adequate levels of profitability.
In a revenue center, performance evaluations are limited because the manager has control over only one
item: revenues. Actual performance in revenue centers (as well as in any other area that has revenue control)
should be compared against budgeted performance to determine variances from expectations. Budgeted and
actual revenues may differ because of either volume of units sold or price of units sold. To compare budgeted
and actual revenues, the price and volume components of revenue must be distinguished from one another.
The salesprice variance is calculated by multiplying the actual number of units sold by the difference between
actual andbudgeted sales prices. This variance indicates the portion of the total revenue variance that is
related to a changein selling price. The sales volume variance is calculated by multiplying the budgeted sales
price by the differencebetween the actual and budgeted sales volumes.

Investment Center

An investment center is an organizational unit whose manager is responsible for managing revenues
and current expenses. This center differs from a profit center in that it has control not only over
revenues and costs but also over invested funds. If the manager of the lumber-cutting department
also had control over how much was invested in the department, this segment would then be
considered an investment center. In addition to net income and contribution margin, the return on
investment can be computed for investment centers.

The investment center is particularly appropriate for those cases where investment decisions must
be made very rapidly in order to take advantage of changes in local business conditions. This is a
particularly important issue for those companies in rapidly expanding markets, or where consumer
needs change rapidly, where waiting for investment approval from a central authority may result in
lost sales.

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Preparation of Responsibility Report

Usry and Hammer have mentioned the following as characteristics of responsibility reporting:

1. Reports should fit the organization chart, that is, the report should be addressed to the individual

responsible for the items covered by it, who, in turn, will be able to control those costs under his

jurisdiction. Managers must be educated to use the results of the reporting system.

2. Report should be prompt and timely. Prompt issuance of a report requires that cost records be

organized so

that information is available when it is needed.

3. Reports should be issued with regularity. Promptness and regularity are closely tied up with the

mechanical

aids used to assemble and issue reports.

4. Reports should be easy to understand. Often they contain accounting terminology that managers with

little or no accounting training find difficult to understand, and vital information may be incorrectly

communicated. Therefore, accounting terms should be explained or modified to fit the user. Top

management should have some knowledge of the kind of items chargeable to an account as well as the

methods used to compute overhead rates, make cost allocations and analyze variances.

5. Reports should convey sufficient but not excessive details. The amount and nature of the details

depend largely on the management level receiving the report. Reports to management should neither

be flooded with immaterial facts nor so condensed that management lacks vital information essential

to carrying out its responsibilities.

6. Reports should give comparative figures, i.e., a comparison of actual with budgeted figures or

of predetermined standards with actual results and the isolation of variances.

7. Reports should be analytical. Analysis of underlying papers, such as time tickets, scraps tickets, work

orders, and materials requisitions, provide reasons for poor performance which might have been due

to power failure, machine breakdown, an inefficient operator, poor quality of materials, or many other

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similar factors.

8. Reports for operating management should, if possible, be stated in physical units as well as in terms

of money since monetary information may give a foreman not trained in the language of the accountant

a certain amount of difficulty.

9. Reports may tend to highlight departmental efficiencies and inefficiencies, results achieved future

goals or targets.

Responsibility reports help each successively higher level of management in evaluating the

performances of subordinate managers and their respective organizational units. The reports should

be tailored to fit the planning, controlling and decision making needs of subordinate managers and

should include both monetary and non- monetary information.

Responsibility Report for Cost Centres

(₹)
General Manager Actual Cost Budgeted Cost Variance
Sales Department 3,65,000 3,75,000 (+)10,000
Production Department 3,75,000 3,75,000 -
Office and Administration 1,10,000 1,15,000 (+) 5,000
Interest on loans 20,000 15,000 (-) 5,000
Total 8,70,000 8,80,000 (+)10,000
(₹)
Production Manager Actual Cost Budgeted Cost Variance
Mfg. section 94,000 96,000 (+) 2,000
Testing section 1,20,000 1,21,000 (+) 1,000
Assembly section 1,61,000 1,58,000 (-) 3,000
Total 3,75,000 3,75,000 -
(₹)
Foreman (Manufacturing Division) Actual Cost Budgeted Cost Variance
Direct materials 50,000 48,400 (–) 1,600
Direct labour 31,000 34,000 (+) 3,000
Indirect labour 12,000 12,000 -
Supplies 1,000 1,600 (+) 600
Total 94,000 96,000 (+) 2,000
Analysis:
It is observed from the above that, each responsibility report contains items and information which are required
by the concerned responsibility centre manager and which are within his responsibility area.
Similarly, Responsibility Reports can also be prepared for other centres.

Solved Illustrations & Cases

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Illustration 1
The processing department of a large company informs the marketing department that the price of processing 2,00,000
items will be ₹50,00,000. The marketing department submits the material for the item two weeks laterthan originally
planned and tells the processing department that the scheduled date of completion has been advanced two weeks. In
order to achieve the new schedule, the processing department incurs an additional production cost of ₹16,00,000.
(i) In an organization using responsibility accounting, where would the additional costs be assigned? Would these costs
be considered controllable costs? What effect might this have on future printing orders from themarketing department?
(ii) In an organization that does not use responsibility accounting, where would the various costs be assigned? What effect
might this have on future printing orders from the marketing department?
Solution:
(i) In an organization using responsibility accounting, the originally quoted price of ₹ 50,00,000 plus the additional cost
of ₹16,00,000 would be assigned to the marketing department. This would be considereda controllable cost. The
long-range effect might be that the marketing department will become more cost- conscious and will plan activities
better.
(ii) In an organization that does not employ responsibility accounting; the additional production costs most probably
would be assigned to the processing department. There would be no motivation by the marketing department to adhere
to scheduled dates or to plan processing needs in a better fashion.
Illustration 2
The receipt of raw materials used in the manufacture of products and the shipping of finished goods
to customers are under the control of the warehouse supervisor. Approximately 60% of the warehouse supervisor’s
time is spent on receiving activities and 40% on shipping activities. Separate employees handlethe receiving and
shipping operations. The labour-related costs for the warehousing function are as follows:
Warehouse supervisor’s salary ₹40,000
Receiving clerks’ wages ₹75,000
Shipping clerks’ wages ₹55,000
Employee benefit costs (30% of wage and salary costs) ₹51,000
₹2,21,000
The company employs a responsibility accounting system for performance reporting purposes. The costs are classified
on the report as period or product costs. You are required to state the total labour-related costs to list onthe responsibility
accounting performance report as product costs under the control of the warehouse supervisor for the warehousing
function.
Solution:
This question focuses on product costs that are under the control of the warehouse supervisor. The supervisor controls
both receiving and shipping, but shipping is a selling cost. Thus shipping is a period cost that is expensedin the period in
which it is incurred, so shipping costs are not product costs. Therefore, the costs for the shippingdepartment are not
part of the answer, even though they are controllable by the warehouse supervisor. The supervisor’s salary is not
controlled by the supervisor, so that is not a part of the answer, either. The labour-relatedproduct costs that the supervisor
can control include only the wages and benefits of the receiving department. The receiving clerks’ wages are ₹75,000
and their benefits are 30% of this amount (₹22,500). Therefore, the supervisor controls ₹ 97,500 of costs (₹75,000 +
₹ 22,500).

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Illustration 3
The following information for R & Co. for the prior year:
🖸 The company produced 1,000 units and sold 900, both as budgeted.
🖸 There were no beginning or ending work-in-process and no beginning finished goods inventory.
🖸 Budgeted and actual fixed costs were equal, all variable manufacturing costs were affected by production volume
only, and all selling variable costs were affected by sales volume only.
🖸 Budgeted per unit revenues and costs were as follows:
Sales price ₹100
Direct materials ₹30
Direct labour ₹20
Other variable manufacturing costs ₹10
Fixed manufacturing costs ₹5
Variable selling costs ₹12
Fixed selling costs (₹3,600 total) ₹4
Fixed administrative costs (₹1,800 total) ₹2
Calculate the contribution margin earned by R & Co. for the prior year
Solution:
Contribution margin is calculated as sales revenue minus the variable costs for the units sold. The sales price is
₹100 per unit and the variable costs total ₹72 per unit: Direct Material - ₹30; Direct Labour - ₹20; other variable
manufacturing costs - ₹10; Variable selling costs - ₹12. Thus, contribution is ₹28 per unit (₹100 − ₹72). 900 unitswere
sold, giving a contribution margin of ₹ 25,200.

Illustration 4
The Hind Company allocates national magazine advertising cost to territories on the basis of circulation, which is
determined by an index that measures relative buying power in the territories. Top management wants to knowif this
method of allocation gives appropriate cost and benefit figures to make the following decisions:
(a) For deciding whether or not to close an unprofitable territory
(b) For deciding whether or not a territorial manager has obtained sufficient sales volume
(c) For determining how efficiently the territorial manager has operated the territory

For determining whether or not advertising costs are satisfactorily controlled Solution:
The answers are as follows.
(a) It is not appropriate for deciding to close the territory. Closing the territory will not change the amount of national
advertising expenses. For deciding what action to take with respect to the territory, the segment margin (sales less
variable expenses less direct territorial fixed expenses) should be compared with the amount of cost that can be saved
by closing that territory. This will show whether or not the territory is making a contribution to costs that will continue
regardless of the decision.
(b) It may be appropriate for concluding that a territorial manager has obtained sufficient sales volume.
National advertising is one of the general distribution costs to be allocated to territories if there is evidence
of cause-and-effect relationships.
(c) The method is not appropriate. A territorial manager should be judged on the basis of expenses that he or she

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has to control. By its nature, national advertising must be centrally controlled.

(d) It is not appropriate to allocate national advertising costs to territories from a control standpoint. Control can be
exercised only over the total expenditure for national advertising and at the source; control is not aided byallocating this
total to territories.
The following concepts are highlighted in the contribution approach to cost allocation:
🖸 Contribution margin -Sales less variable costs.
🖸 Contribution controllable by segment managers - Contribution margin less direct fixed costs controllable by segment
managers. Direct fixed costs include discretionary fixed costs such as certain advertising, research and development,
sales promotion, and engineering.
🖸 Segment margin - Contribution controllable by segment managers less fixed costs controllable by others. Fixed costs
controllable by others include such traceable and committed fixed costs as depreciation, propertytaxes, insurance, and
the segment managers’ salaries.
🖸 Net income - Segment margin less unallocated common fixed costs.

Illustration 5
You have a client who operates a large retail self-service grocery store that has a full range of departments.
Management has encountered difficulty in using accounting data as a basis for making decisions concerning possible
changes in departments operated, products, marketing methods, and so forth. List several overhead costs, or costs not
applicable to a particular department, and explain how the existence of such costs (sometimescalled common costs or
joint costs) complicates and limits the use of accounting data in making decisions in such a store.
Solution:
There are many examples of “common” costs to the sales department of a self-service grocery store. Some are
rent, supervision, trucking, and advertising.
Common costs are usually apportioned on various arbitrary bases to the sales departments, but for numerous
managerial decisions such apportionments produce misleading results. Decisions as to discounting a
department,adding a department, enlarging a department, or decreasing a department cannot be made based
on the data produced from the apportionments. For example, if a department is discontinued because it appears
to be unprofitable, it may be determined that the costs of other departments will increase as a result of having to
absorb more of the shared common costs. Thus, the overall operating results will be less favorable if the
“unprofitable”department is discontinued.

Illustration 6
The monthly service charge a bank makes on a customer’s checking account is based on the cost of handling each
account. A customer disagrees with this policy because she cannot see how it is possible to determine the exact cost
of handling her account. Do you agree with the customer? Discuss fully the problems involved in determining cost
for such a service, including the limitations of the cost figures obtained.
Solution:
This is a problem involving fixed and common costs. Within considerable limits, the cost of operating a bank would
not change because of the addition of new accounts or the loss of old ones. The depreciation and other costs associated
with the bank building, fixtures and equipment, salaries of officers, and other such items are fixed costs of operation
within very wide limits. There would have to be a considerable change in the number of accounts before there would
be any noticeable impact on those fixed costs. There is also a question of joint use of facilities among the various
phases of bank operations. For example, the vault houses not only the files of commercial accounts, but also the
savings account records, collateral on loans, coins and bills, and many other types of property and records. Unless the
bank is large and the work highly specialized, a teller will handlea good many types of operations during a working
day. A given official may make loans, open new accounts, advice customers as to investments, and so on. It would be
extremely difficult to assign many of such operatingexpenses to any particular type of operation, let alone any account.
The problem of determining a reasonable and useful cost for handling an account involves obtaining data relatedto costs
of functions and number of transactions handled, so that the direct or semi direct costs may be [Link] average

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labour cost per transaction for tellers and for transit, clearings, and bookkeeping functions can be obtained with
considerable accuracy. Then it becomes necessary to allocate costs of all other necessary functionsto these and other
principal banking operations. Like all allocations of fixed or indirect overhead, the allocationswill be arbitrary, but they
can be made in a reasonable and logical manner by using appropriate bases.
While the costs obtained from such an accounting procedure may be useful for setting service charges, it must be
recognized that they do have one important limitation. They are average costs and not “differential costs.” Therefore,
they have limited usefulness for certain types of management decisions relating to expansion or contraction of services
or changes in operations.

Illustration 7
Consider each of the following scenarios:
(i) Mr. P K. Dhawan, plant manager for the laser printer factory of Bharat Co. brushed his hair back and sighed. December
had been a bad month; two machines had broken down, and some direct labourers (all on salary) were idled for part of
the month. Materials prices increased, and insurance premiums on the factoryincreased. No way out of it —costs were
going up. He hoped that the marketing VP would be able to push through some price increases, but that really wasn’t
his department.
(ii) Ms. Sonam Kapoor was delighted to see that her ROI figures had increased for the third straight year. She was sure
that her campaign to lower costs and use machinery more efficiently (enabling her factories to sell several older
machines) was the reason why she planned to take full credit for the improvements at her semi-annual performance
review.
For each of the above independent scenarios, indicate the type of responsibility center involved (cost,
revenue, profit, or investment).
Solution:
(i) Cost center — Total cost
(ii) Profit center — Operating Income
Hint: For explanation of the same, please read the relevant portion of the Study Module.

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