Reported by:

Casanova, Jan R. and

Villegas, Sionie Joy

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RESPONSIBILITY
ACCOUNTING
Definition
An accounting system that provides information

Relating to the To evaluate

responsibilities of managers on
individual managers controllable items

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Centralization
Decision-making authority is concentrated at the top, and
only a few people are responsible for making decisions and
creating the organization's policies.

Decentralization
Authority is delegated to all levels of management and
throughout the organization. An organization's degree of
centralization or decentralization depends on the extent of
decision-making power that is distributed throughout all
levels.

Employee Empowerment
Is giving employees a certain degree of autonomy and
responsibility for decision-making regarding their specific
organizational tasks.
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 Authority
Is the right or power assigned to an executive or a manager
in order to achieve certain organizational objectives.

Responsibility
Indicates the duty assigned to a position. The person holding
the position has to perform the duty assigned. It is his
responsibility.

Accountability
Every employee/manager is accountable for the job
assigned to him. He is supposed to complete the job as per
the expectations and inform his superior
accordingly. Accountability is the liability created for the use
of authority. It is the answerability for performance of the
assigned duties.
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Responsibility Centers
Is a segment of an organization for
which a particular executive is
responsible. Such a center is used to tie
specific responsibility for revenues
generated, expenses incurred, and/or
funds invested to individuals. This allows
the senior managers of a company to
trace all financial activities and results of
a business back to specific employees.

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 Types Of Responsibility Centers

Investment Center Profit Center Revenue Center Cost Center

The manager of an The manager of a This group is solely The manager of a
investment center profit center has responsible for cost center has
has control over control over both generating sales. A control over costs,
cost, revenue, and costs and revenue. typical revenue but not over revenue
investments in center is the sales or investment funds.
operating assets. department.

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“
Performance evaluation requires managers to have a
benchmark to use as a guide for future periods. This
benchmark is communicated to managers via a budget
for their responsibility center. At the end of the year,
managers are evaluated based on the actual figures
generated by the responsibility center.

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Basis of evaluating responsibility centers

Responsibility Center Manager Evaluation Techniques

Cost Center Management Cost Variance Analysis

Revenue Center Manager Revenue Variance Analysis

Profit Center Manager Segment Margin Analysis

Investment Center Manager Return on Investment (ROI)

Residual Income Model
Economic Value Added (EVA),etc.

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Cost Center Manager’s Performance

Cost Center: The majority of managers are responsible for cost centers.
A cost center is a segment where the manager is only responsible for
managing costs. Examples of cost centers include human resource
departments and production departments. These departments are not
concerned with revenue generation. Therefore, managers are evaluated
on their ability to manage costs. When attempting to determine if a
segment is a cost center, determine if revenue is a factor. If revenue is
not a responsibility of the manager of the department, the department is a
cost center.

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Revenue Center Manager’s Performance

￮ Revenue Center – While revenue is a major factor for most

businesses, revenue centers are actually the smallest portion of
responsibility centers. Typically, revenue centers are sales
territories and sales departments. These managers are evaluated
based off their ability to generate revenue. This segment is rare
because most managers that are generating revenue are also
responsible for managing the costs of generating that revenue.

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Profit Center Manager’s Performance

￮ Profit Center – These responsibility centers are also quite

common. A profit center manager is responsible for generating
revenue but also managing costs to increase profitability. These
managers include retail managers, like Target or Wal-Mart store
managers. These managers must maximize profitability in their
stores, but major decisions about asset management (like
renovations and improvements) are outside their scope of
responsibility.

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Profit Center Manager’s Performance

￮ The performance of a profit center is measured by its Segment Margin.

￮ His managerial performance is evaluated based on Controllable Margin
while the center’s performance is evaluated based on segment (or direct)
margin. Once more, the controllable and segment margin computations are
presented below:

Contribution Margin Px
Less: Controllable direct fixed costs and expenses x
Controllable Margin x
Less: Noncontrollable direct fixed costs and expenses x
Segment Margin x

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Profit Center Manager’s Performance

￮ Segment profitability analysis requires that all costs be classified into one of
two categories: direct and indirect fixed costs

A DIRECT FIXED COST

￮ Is specifically traceable to a given cost object

￮ Vanish if the segment is eliminated.
￮ Relate Specifically to a responsibility center
￮ Incurred for a sole benefit of the center
￮ Most controllable by the profit center manager

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Profit Center Manager’s Performance

Controllable direct fixed costs or Noncontrollable direct fixed costs.

￮ Controllable costs are costs that can be influenced or regulated by the

manager or head responsible for it.

￮ If a department has authority and responsibility for certain costs, those

costs are called controllable costs.

￮ Example: the sales manager has control over the salary and commission of
sales personnel.

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Profit Center Manager’s Performance

￮ An uncontrollable cost is an expense over which a person has no direct

control.

￮ These cannot be influenced by decisions or actions of the manager.

￮ These costs are imposed by the top management or allocated to several

departments.

￮ Examples include depreciation, insurance, share in rent, share in

organization-wide security costs, etc.

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Profit Center Manager’s Performance

AN INDIRECT FIXED COST:

￮ Is not traceable to a given cost object but has been allocated to it.
￮ Pertain to a company’s overall operating activities
￮ Incurred for the benefit of more than one profit center
￮ Most not controllable by the profit center manager
￮ They would not be reduced or eliminated if any particular segment were
eliminated.

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Profit Center Manager’s Performance

￮ The contribution margin is the difference between sales revenue

and variable expenses. The segment margin is the amount
remaining after deducting traceable fixed expenses from the
contribution margin. The contribution margin is useful as a planning
tool for many decisions, including those in which fixed costs don’t
change. The segment margin is useful in assessing the overall
profitability of a segment.

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Profit Center Manager’s Performance

Sales - Variable costs = Contribution margin

Contribution margin - Direct fixed costs controllable by managers = Contribution

controllable by segment managers (also known as short-run segment margin)

Contribution controllable by segment managers - Direct fixed costs controllable

by others = Segment margin

For evaluation purposes in segment reporting, common costs are not allocated.
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Profit Center Manager’s Performance
￮ Villegas Company operates two divisions: Gordon and Ron in. A segmented income
statement for the company’s most recent year is as follows:

A.) If the Gordon Division increased its sales by $85,000 per year, how much would the company’s net
income change? Assume that all cost behavior patterns remained constant.

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Profit Center Manager’s Performance

￮ Answer:
Segmented Income Statement
*250,000+
Particulars Total Company G Division R Division
85,000
Sales $935,000 $335,000* $600,000
+335,00-
Variable Expenses 554,300 194,300 360,000 194,300

Contribution Margin 380,700 140,700+ 240,000 Therefore

Net Income
Less: Traceable 145,000 45,000 100,000
Fixed expenses
would
increase by
Segment Margin 235,700 95,700 140,000 35,700
Less: Common 130,000
Fixed Expenses
Net Income 105,700
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Profit Center Manager’s Performance

The data available for the current year are given below:

Whole Co. Division 1 Division 2

Cost of Goods Sold $ 400,000 $ 220,000 $ 80,000

Unallocated costs (e.g., president’s 100,000 - -

salary)
Fixed costs controllable by Div.
Managers (e.g., advertising, eng’g 90,000 50,000 40,000
supervision costs)
Sales 1,000,000 600,000 400,000

Variable selling and administrative costs 130,000 70,000 60,000

Fixed costs controllable by others (e.g.,

depreciation, insurance) 120,000 70,000 50,000

How much is the contribution margin, controllable margin and segment margin
of Division 1?
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Profit Center Manager’s Performance
Sales P600,000
Variable Costs (290,000)
Contribution Margin 310,000
Controllable Direct Fixed Costs (50,000)
Controllable Margin 260,000
Noncontrollable Direct Fixed Costs (70,000)
Segment Margin P190,000

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Investment Center Manager’s Performance

￮ Investment Center – While we spend a lot of time discussing profit,

asset management is just as important. If assets are not managed
efficiently to maximize the profit that can be made with those assets,
the company runs the risk of hurting cash flow and future profitability.
Managers in an investment center are responsible for asset
management and profit maximization. These managers have the ability
to approve the construction of new factories, stores, and the purchase
of major equipment. Investment center managers include CEO’s of
major companies and small business owner-managers. If asset
management is involved, the segment is an investment center.

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 Some of the important investment center performance
evaluation measures are:

The Return on DuPont Model The Residual Economic

Investment Return on equity is equal Income Model Value Added
(ROI) to the profit margin Residual income is Is an estimate of a
Is a performance multiplied by asset the net operating firm's economic
measure used to turnover multiplied by income that an profit, or the value
evaluate the financial leverage. By investment center created in excess
efficiency of splitting ROE (return on earns above the of the required
an investment or equity) into three parts, minimum required return of the
compare the companies can more return on its company's
efficiency of a easily understand assets. shareholders. EVA
number of different changes in their ROE is the net profit
investments. over time. less the equity cost
of the firm's
capital. 26
Return On Investment (ROI)

￮ A segment that has a large amount of assets usually earns more in an absolute
sense than a segment that has a small amount of assets. Therefore, a firm
cannot use absolute amounts of segmental income to compare the performance
of different segments. To measure the relative effectiveness of segments, a
company might use Return on investment (ROI), which calculates the return
(income) as a percentage of the assets employed (investment). The formula for
ROI is:

ROI = Segment Profit

Segment Investment

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Return On Investment (ROI)

￮ For example, a segment that earns $500,000 on an investment base

of $5,000,000 has an ROI of 10% ($500,000 /$5,000,000). Return on
investment is reported as a percentage. The return on investments means
how much income do we generate for every dollar of investment. In this
example, ROI was 10% which means the company earns 10 cents on every $1
of investment. To illustrate the difference between using absolute amounts
and using percentages in evaluating a segment’s performance, consider the
data in the table below for a company with three segments.
￮ Segment B Segment C Total
Segment A

(a) Income $250,000 $1,000,000 $500,000 $1,750,000

(b) Investment 2,500,000 5,000,000 2,000,000 9,500,000

Return on
10% 20% 25% 18.42%
investment (a) ÷ (b)
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Return On Investment (ROI)
￮ Expanded form of ROI computation

Income Sales

ROI = x

Sales Turnover

The first part of the formula, Income/Sales, is called margin or return on sales.
The margin refers to the percentage relationship of income or profits to sales. This
percentage shows the number of cents of profit generated by each dollar of sales.
The second part of the formula, Sales/Investment, is called
turnover. Turnover shows the number of dollars of sales generated by each dollar
of investment. Turnover measures how effectively each dollar of assets was used.

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Understanding ROI
Net operating income
ROI =
Average operating assets
Net operating income
Margin =
Sales
Sales
Turnover =
Average operating assets

ROI = Margin  Turnover

Return On Investment (ROI)

￮ Example:

Regal Company reports the following:

Net Operating Income P30,000
Average Operating Assets 200,000
Sales 500,000
Operating Expenses 470,000

What is Regal Company’s ROI?

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Return On Investment (ROI)

ROI = Margin x Turnover

ROI= Net Operating Income x Sales

Sales Average Operating Assets

ROI = P30,000 x P500,000

P500,000 P200,000

ROI = 6% X 2.5 = 15%

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Return On Investment (ROI)

Suppose that Regal's manager invests in a $30,000 piece of equipment that

increases sales by $35,000, while increasing operating expenses by $15,000

Regal Company reports the following:

Net operating income $ 50,000

Average operating assets $ 230,000
Sales $ 535,000
Operating expenses $ 485,000

Calculate the new ROI

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 ROI = Margin  Turnover

Net operating income Sales

ROI = Sales × Average operating assets

$50,000 $535,000
ROI = $535,000 × $230,000

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ROI = 9.35%  2.33 = 21.8%

ROI INCREASED FROM 15% TO 21.8%

Return On Investment (ROI)

￮ Situation Definition of Income Definition of Investment

1. Evaluation of the earning power of the

company. Do not use for segments or
Net income of the company.* Total assets of the company.†
segment managers due to inclusion of
non controllable expenses.

2. Evaluation of rate of income

contribution of segment. Do not use for Assets directly used by and identified
Contribution to indirect expenses.
segment managers due to inclusion of with the segment.
non controllable expenses.

Controllable income. Begin with

contribution to indirect expenses and
3. Evaluation of income performance of Assets under the control of the segment
eliminate any revenues and direct
segment manager. manager.
expenses not under the control of the
segment manager.

* Often net operating income is used; this term is defined as income before interest and taxes.

† Operating assets are often used in the calculation. This definition excludes assets not used in normal operations.

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The DuPont Model

DuPont analysis examines the return on equity (ROE) analyzing profit margin,
total asset turnover, and financial leverage.

Formula:

ROE = Profit Margin x Total Asset Turnover x Leverage Factor

The formula breaks down further to:

ROE = (Net Income/Revenues) x (Revenues/Total Assets) x (Total Assets/

Shareholders' Equity)

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The DuPont Model
For example, let's consider the following information for Company XYZ:

￮ Using the formula above, we can calculate that Company XYZ's ROE is:
ROE = ($2,000/$10,000) x ($10,000/$25,000) x ($25,000/$5,000) = 0.20 x 0.40 x 5 = 0.40 or
40%
￮ The DuPont analysis analyzes the numbers shown in profit margin ($2,000/$10,000), total
asset turnover ($10,000/$25,000) and leverage factor ($25,000/$5,000) to find Company
XYZ's ROE.
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The Residual Income Model

Segment Income Px
Less: Minimum Income x (Investment x Cost of Capital Percentage)

Residual Income Px

Residual Income is defined as the amount of income a segment has in excess of

the segment’s investment base times its cost of capital percentage. Each company
based on debt costs establishes its cost of capital coverage and desired returns to
stockholders.

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The Residual Income Model

Example:

The Retail Division of Zopher, Inc. has average operating assets of P100,000 and is
required to earn a return of 20% on these assets.
In the current period the division earns P30,000

Calculate the Residual Income.

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The Residual Income Model

Operating Assets P100,000

Required Rate of Return 20%
Minimum Required Return P20,000

Actual Income P30,000

Minimum Required Return (20,000)
Residual Income P10,000

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The Residual Income Model

Example:

Marsh Company has two divisions, A and B. Division A has P1,000,000

and Division B has P3,000,000 in average operating assets. Each division is
required to earn a minimum return of 12% on its investment in operating assets.

Calculate the Residual Income.

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The Residual Income Model

Division A:
Operating Assets P1,000,000
Required Rate of Return 12%
Minimum Required Return P120,000

Actual Income P200,000

Minimum Required Return (120,000)
Residual Income P80,000

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The Residual Income Model

Division B:
Operating Assets P3,000,000
Required Rate of Return 12%
Minimum Required Return P360,000

Actual Income P450,000

Minimum Required Return (360,000)
Residual Income P90,000

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The Residual Income Model

Redmond Awnings, a division of Wrap-up Corp., has a net operating income of

$60,000 and average operating assets of $300,000. The required rate of return
for the company is 15%. What is the division’s residual income?

a. $240,000
b. $ 45,000
c. $ 15,000
d. $ 51,000

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The Residual Income Model

Redmond Awnings, a division of Wrap-up Corp., has a net operating income of

$60,000 and average operating assets of $300,000. The required rate of return
for the company is 15%. What is the division’s residual income?

a. $240,000
b. $ 45,000 Net operting income $ 60,000
c. $ 15,000
d. $ 51,000 Required return (15% × $300,000) (45,000)
Residual income $ 15,000

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The Economic Value Added

Operating Profit After Tax (PBIT x After-Tax Rate) Px

Less: Minimum Income (Investment x weighted average cost of capital) x
Economic Value Added x

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The Economic Value Added

Example:

Consider the following:

Investment center’s after-tax operating profit P50,000
Investment center’s total assets 800,000
Investment center’s current liabilities 80,000
Weighted-average cost of capital 6.5%

What is the economic value added (EVA)?

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The Economic Value Added

Example:

Consider the following:

Investment center’s after-tax operating profit P50,000
Investment center’s total assets 800,000
Investment center’s current liabilities 80,000
Weighted-average cost of capital 6.5%

What is the economic value added (EVA)?

P3,200 48
The Economic Value Added

￮ EVA = Investment center's after-tax operating income - (Investment center's

total assets - Investment center's current liabilities) x Weighted-average cost of
capital].

Net operating profit P50,000

Cost of investment (P800,000 – P80,000) x 0.075 46,800
Economic Value Added P 3,200

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2
TRANSFER
PRICING
 Definition
A Transfer Price is the price charged when one segment of a
company provides goods or services to another segment of the
company.

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There Are Five Types Of Transfer Prices
Cost-Based
Market Price
When external markets do not exist or are not available to
Refers to a price in the company or when information about external market
an intermediate prices is not readily available, companies may decide to
market between use some forms of cost-based transfer pricing system.
independent buyers
and sellers. Cost-based transfer prices may be in different forms such
as variable cost, actual full cost, full cost plus profit margin,
standard full cost.

Negotiated Arbitrary Dual

Are generally Its strength is anchored on Under dual prices of transfer

preferred as a middle the premise that the entire pricing, selling division sells
solution between corporate organization has to the transferred goods at a (i)
market prices and promote its overall goals market or negotiated market
price or (ii) cost plus some 52
cost- based prices. over and above that of the
division’s goals. profit margin.
Sample Problem
Great Flowers Holdings, Inc., has two independent divisions. Asian Enterprises and
Malayan Corporation, that conduct business in the same country. Asian Enterprises
produces product “Cute” of which Malayan Corporation buys from an external supplier
at P80 per piece. The relevant production data of Asian Enterprises is as follows:

Variable production costs P66

Allocated factory overhead 15

Required: Determine the profit for Asian Enterprises, Malayan Corporation, and Great
Flowers, Inc., if an inter-divisional transfer of goods occurred under each of the
following transfer prices:
1. Market Price of P80.
2. Variable Production Costs of P66.
3. Negotiated Price of P73.
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4. Dual Pricing
Solution Asian Enterprise Malayan Corporation Great Flowers
(Seller) (Buyer) Holdings, Inc.
1.Transfer price is market price at P80.
Transfer Price P80 Market Price P80 Market Price P80
-Var. prod. Cost 66 -Transfer price 80 -Var. prod Costs 66
Profit P14 Profit - Profit P14

2. Transfer price is variable production costs of P66.

Transfer price P66 Market Price P80 Market Price P80
-var. prod. Cost 66 -Transfer price 66 -Var. prod Costs 66
Profit - Profit 14 Profit P14

3. Transfer price is negotiated price of P73.

Transfer price P73 Market Price P80 Market Price P80
-var. prod. Cost 66 -Transfer price 73 -Var. prod Costs 66
Profit 7 Profit 7 Profit P14

4. Transfer price is dual prices.

Transfer price P80 Market Price P80 Market Price P80
-var. prod. Cost 66 -Transfer price 66 -Var. prod Costs 66
Profit 14 Profit 14 Profit P14
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Thanks!

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