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Unit 4 of 4 · B.Com Sem 3

Unit 4: Responsibility accounting

Management Accounting notes · PTU syllabus (BCOM 301-18)

3 min read4 topics10 exam questions
On this page
  1. Unit summary
  2. Concept and significance of responsibility accounting
  3. Responsibility centres
  4. Divisional performance: financial measures
  5. Divisional performance: non-financial measures
  6. Key terms
  7. Quick revision
  8. Important questions

Unit summary

In large organisations, each manager should be answerable only for what they control. Responsibility accounting links costs, revenues and investments to the managers responsible. This unit covers the concept and significance of responsibility accounting, types of responsibility centres, and divisional performance measurement using financial and non-financial measures.

After this unit you can

  • Explain the concept, significance and principles of responsibility accounting
  • Distinguish cost, revenue, profit and investment centres
  • Measure divisional performance using ROI, residual income and EVA
  • Explain non-financial measures and the balanced scorecard

PTU syllabus topics

  • Concept and significance of responsibility accounting
  • different responsibility centres
  • divisional performance measurement — financial and non-financial measures
ClassificationResponsibility centres
Responsibility centres

  • Cost centre

    Manager controls costs

  • Revenue centre

    Manager controls sales

  • Profit centre

    Manager controls costs and revenues

  • Investment centre

    Manager also controls investment

1

Topic 1

Concept and significance of responsibility accounting

Responsibility accounting is a system of accounting that recognises various responsibility centres throughout the organisation and reflects the plans and actions of each centre by assigning particular revenues and costs to the person having the related responsibility (Charles Horngren).

ProcessSteps in responsibility accounting
  1. 1

    Divide the organisation into responsibility centres

  2. 2

    Assign a manager to each centre

  3. 3

    Set budgets/targets for controllable items

  4. 4

    Record actual performance by centre

  5. 5

    Compare actual with budget

    Variance reports

  6. 6

    Take corrective action and reward performance

Principles

  • Each centre headed by a manager with clear authority.
  • Only controllable costs used to evaluate the manager.
  • Targets set with the participation of the manager.
  • Timely reports flowing upward with increasing summarisation (pyramid reporting).

Significance

  • Fixes accountability; management by exception; cost consciousness; motivation through clear goals; better decentralised decision-making; improved planning and control.

Controllable and uncontrollable costs

  • Controllable cost: can be influenced by the manager of the centre within a period (materials used, overtime).
  • Uncontrollable cost: cannot be influenced (allocated head-office costs, rent fixed by HQ). Controllability depends on the level and the time horizon.
2

Topic 2

Responsibility centres

FrameworkTypes of responsibility centres

  • Cost centre

    Responsible for costs only — production department, maintenance

  • Revenue centre

    Responsible for revenues — sales department

  • Profit centre

    Responsible for revenues and costs — product division, branch

  • Investment centre

    Responsible for profit and capital invested — subsidiary, strategic business unit

CentreManager controlsPerformance measure
Cost (standard / discretionary)Inputs and costsVariance from budget or standard cost
RevenueSalesActual vs budgeted sales, market share
ProfitRevenues and costsControllable profit, contribution
InvestmentRevenue, cost and assetsROI, residual income, EVA
  • Transfer pricing: price charged when one division supplies another — market-based, cost-based or negotiated. It affects divisional profits; should promote goal congruence.
3

Topic 3

Divisional performance: financial measures

Key formulasDivisional performance measures

  • Return on investment (ROI)

    Divisional operating profit ÷ Divisional investment × 100

  • ROI (DuPont)

    Profit margin (Profit ÷ Sales) × Asset turnover (Sales ÷ Investment)

  • Residual income (RI)

    Divisional profit − (Divisional investment × Cost of capital)

  • Economic value added (EVA)

    NOPAT − (Capital employed × WACC)

Example

Division X: profit ₹3,00,000, investment ₹15,00,000; cost of capital 15%. ROI = 20%. RI = 3,00,000 − 2,25,000 = ₹75,000. A new project offering 18% would lower X's ROI (so the manager may reject it) but adds positive RI (18% > 15%) — so RI promotes goal congruence.

ComparisonROI vs residual income
ROI
Residual income

Form

Percentage

Absolute amount

Comparison across divisions

Easy

Difficult (size effect)

Goal congruence

May reject projects above cost of capital but below current ROI

Accepts all projects above cost of capital

Popularity

Widely used

Better for decisions

4

Topic 4

Divisional performance: non-financial measures

  • Financial measures are short-term and backward-looking; non-financial measures capture drivers of future performance.
AreaNon-financial measures
CustomerCustomer satisfaction index, complaints, market share, repeat orders, on-time delivery
Internal processDefect rate, cycle time, productivity, capacity utilisation
InnovationNew products launched, R&D pipeline, time to market
EmployeesTraining hours, attrition, absenteeism, employee satisfaction
Social and environmentalEmissions, safety incidents, CSR activities

Balanced scorecard (Kaplan and Norton, 1992)

FrameworkBalanced scorecard perspectives

  • Financial

    How do we look to shareholders? ROI, EVA, revenue growth

  • Customer

    How do customers see us? Satisfaction, retention, share

  • Internal business process

    What must we excel at? Quality, cycle time, cost

  • Learning and growth

    Can we continue to improve? Skills, systems, culture

Exam tip

Conclude any divisional performance answer by recommending a mix of financial (ROI, RI, EVA) and non-financial (balanced scorecard) measures.

Key terms

Responsibility accounting
Assigning costs and revenues to managers responsible for them
Responsibility centre
A unit headed by a manager accountable for its performance
Investment centre
A centre responsible for profit and the capital invested
Residual income
Profit minus a capital charge at the cost of capital
Balanced scorecard
Performance measures across financial, customer, process and learning perspectives

Quick revision

  • Responsibility accounting: centres, controllable costs, variance reports.
  • Centres: cost, revenue, profit, investment.
  • ROI = margin × turnover; RI = profit − capital charge; EVA = NOPAT − WACC × capital.
  • RI improves goal congruence over ROI.
  • Non-financial measures and balanced scorecard complement financial measures.

Important exam questions

Practice questions written to the PTU exam pattern for this unit's syllabus: short answers (Section A style) and long answers (Sections B and C style).

Short-answer questions

  1. Q1.Define responsibility accounting.
  2. Q2.What is a profit centre?
  3. Q3.Distinguish controllable and uncontrollable costs.
  4. Q4.What is residual income?
  5. Q5.What is EVA?
  6. Q6.Name the four perspectives of the balanced scorecard.

Long-answer questions

  1. Q1.Explain the concept, principles and significance of responsibility accounting.
  2. Q2.Explain the different types of responsibility centres with their performance measures.
  3. Q3.Compare ROI and residual income as measures of divisional performance.
  4. Q4.Discuss non-financial measures of divisional performance and the balanced scorecard.

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