Lesson 7

Responsibility Accounting

Learning Objectives:
1. To be able to comprehend the fundamental principles and concepts underlying responsibility accounting.
2. To learn how to design performance measurement systems that effectively evaluate the performance of
responsibility centers and individual managers.
3. To learn how to utilize performance reports generated through responsibility accounting for decision-
making purposes.

Discussion:

Responsibility Accounting is the system that recognizes various decision centers throughout an organization and
traces costs (and revenues, assets and liabilities where pertinent) by areas of responsibility. This system is also
known as activity accounting and pro itability accounting. It operates on the premise that managers should be
held responsible for their performance, the activities of their subordinates and all activities within their
responsibility center.

Bene its of Responsibility Accounting

a. If facilitates delegation of decision-making.
b. It helps management promote the concept of management by objective wherein managers agree on a
common set of goals and their performance evaluated on the bais of their attainment of goals.
c. It aids in establishing standards of performance which are used in evaluating the ef iciency and
effectiveness of the different units in the organization.
d. It permits effective use of management by exception which provides that the manager will maximize his
ef iciency by concentrating on those operational factors which are deviations from plans.

Cost centers – is any responsibility center that has control over the incurrence of cost.
Pro it center – has control over both cost and revenue.
Investment center – any responsibility center that has control over cost and revenue, and also has control over
investment funds.

Proforma Responsbility Cost Report

Cost Items Actual Budget Variance* Remarks

Unfavorable
(Favorable)
Direct Costs
Controllable Costs
_________________________ Pxx Pxx Pxx
_________________________ xx xx xx
_________________________ xx xx xx
_________________________ xx xx xx
Total xx xx xx

Noncontrollable Costs
_________________________ xx xx xx
_________________________ xx xx -
_________________________ xx xx -
Total xx xx xx

Indirect Costs
_________________________ xx xx xx
_________________________ xx xx (xx)
_________________________ xx xx xx
Total indirect Costs xx xx xx
Total Costs Pxx Pxx Pxx
*Material variances, favorable or unfavorable, are analyzed to determine their causes and whether they are
controllable or not. Ef iciency of the managers is evaluated on the basis of the results of the analysis.

Evaluation of pro it Center

Revenue Pxx
Less: Direct variable costs xx
Contribution margin xx
Less: direct ixed costs xx
Contribution to indirect cost
Or segment margin Pxx**
** if positive, performance is generally considered satisfactory.

Evaluation of investment center

 Return on Investment (ROI)**** = Operating income / Average Operating Assets
 Residual income****
Operating income Pxx
Less: minimum desired return on investment xx
Residual income Pxx

*** compared with the minimum desired ROI.

**** if positive, performance of the segment is generally considered satisfactory.

Margin – refers to the ratio of net operating income to total sales. Turnover refers to the number of times that the
assets are “sold” each period, i.e., the number of times they are represented in total sales pesos.

ROI formula is more exacting measure of performance than the ratio of net income to sale, because the ratio of
net income to sales measures only the margin earned during a period. ROI is more exacting in that it measures
the turnover of assets, as well as the margin earned on sales.

Three approaches to improving the overall pro itability when using the ROI formula:
 By increasing sales;
 By reducing expenses; and
 By reducing assets

Illustration 1:
X company has high ixed expenses and is currently operating somewhat above the break-even point. Form this
point on, will percentage increases in net income tend to be greater than, about equal to, or less than percentage
increases in total sales? Why? (Ignore income taxes).

Ans.
Percentage increases in net income will tend to be greater than percentage increase in total sales. Once the
breakeven point has been reached, the full contribution margin on each unit sold goes into net income. Therefore,
net income will increase very rapidly relative to increases in total sales.

What is meant by residual income?

Residual income is the net operating income which an investment center is able to earn above some minimum
rate of return on operating assets.

ROI may lead to dysfunctional decisions in that divisional managers may reject otherwise pro itable investment
opportunities simply because they would reduce the division’s overall ROI igure. The residual income approach
overcomes this problem by establishing a minimum rate of return which the company wants to earn on its
operating assets, thereby motivating the manger to accept all investment opportunities promising a return in
excess of this minimum igure.

Illustration 2:
Division A has operating assets of P100,000, and Division B has operating assets of P1,000,000. Can residual
income be sued to compare performance in the two divisions? Explain.
Ans.
No. residual income can’t be sued to compare the performance of divisions of different sizes. Larger divisions of
different sizes. Larger division will almost always look better, not necessarily because of better management but
because of the larger peso igures involved. That is, given equally competent management, one would expect the
peso residual income igure for a division with P1 million in operating assets to be greater than the peso residual
income igure for a division with only P100,000 in operating assets.

Bene its and costs of decentralization

Several bene its of decentralization are as follows:
o The managers of an organization’s subunits have specialized information and skills that enable them to
manage their department’s most effectively.
o Allowing managers autonomy in decision making provides managerial training for future higher-level
managers.
o Managers with some decision-making authority usually exhibit greater motivation than those who merely
execute the decisions of others.
o Delegating some decisions to lower-level mangers provides time relief to upper-level managers.
o Delegating decision making to the lowest level possible enables an organization to give a timely response
to opportunities and problems.

Several costs of decentralization are as follows:

o Managers in a decentralized organization may have a narrow focus on their own units’ performance.
o Managers may tend to ignore the consequences of their actions on the organization’s other subunits.
o In a decentralized organization, some tasks or services may be duplicated unnecessarily.

References:
1. Abaquita, M. (2023). Strategic Cost Management Module. Southern Leyte State University San Juan Campus.
2. De Leon, N., De Leon, E., and De Leon, G. (2022). Cost Accounting and Control 2022 Edition. Sampaloc Manila,
Philippines: GIC Enterprises.
3. De Jesus, P.A. (2023). Cost Accountin. Manila, Philippines: Omri and Sons Corporation.
4. Apepe, A. (2022). Management Advisory Services Reviewer. Cainta Rizal, Philippines: BCV Accounting
Bookshop.
5. Cabrera, M.E., Cabrera, G.A., and Cabrera, B.A. (2022). Manageriral Accounting An Integrated Approach.
Sampaloc Manila, Philippines: GIC Enterprises.
6. Hock, B., and Roden, L (2014). CMA Preparatory Program 6th Edition. Oxford, Ohio: Hock International, LLC
7. Zain, M. (2019). Certi ied Management Accountant (CMA), US – Part 1. Karachi, Pakistan: Zain Academy
8. Bobadilla, A. (2020). Comprehensive Reviewer in Management Advisory Services. Manila, Philippines: Lares
Bookstore and Copy Center.
Exercise 1:
The following information is for four questions:

The Zena Division recorded operating data as follows for the past year:
Sales P2,000,000
Net operating income 25,000
Average operating assets 100,000
Gross pro it 75,000
Stockholder’s equity 80,000
Residual income 13,000

1. For the past year, the return on investment was

2. For the past year, the margin was
3. For the past year, the turnover was
4. For the past year, the minimum required rate of return was