Responsibility accounting: Core concept, Techniques & Practices

Transcription

1 CHAPTER TWO Responsibility accounting: Core concept, Techniques & Practices 2.1. Definition & Salient features: Responsibility accounting is a system of collecting and presenting of accounting data that segregates and identifies revenue and /or cost and the resultant profitability with the areas of personal responsibility in order to evaluate the performance of persons to whom responsibility has been assigned to carry out the corporate plans and objectives. According to CIMA1, London Responsibility accounting is a system of management Accounting under which accountability is established according to the responsibility delegated to various levels of management and management information and reporting system instituted to give adequate feedback in terms of delegated responsibility. Under this system divisions or units of an organisation under specified authority in a person are developed as responsibility centers and evaluated individually for their performance. A good system of transfer pricing is essential to establish at the performance and result of each responsibility center. Responsibility accounting is thus used as control technique." Eric. L. Kohler2 defines Responsibility accounting as method of accounting in which costs are identified with persons assigned to their control rather than with product or function." According to Schaltke, R.W and Jonson H.G3 Responsibility accounting system is a system of accounting in which costs and revenue are accumulated and reported to managers on the basis of manager s control over these costs and revenues. The managerial accounting system that ties budgeting and performance reporting to a decentralized organization is called responsibility accounting. As observed by Landouceur A G4 Responsibility Accounting for most part is a change in emphasis from conventional product accounting to the cost control aspects of accounting and management control, wherein the statement flowing throughout the management hierarchy on a vertical basis or throughout the various components of the organization emphasize measurement of performance based on decision variable identified with the particular level of the 28

2 segment. In this respect RA has provided a tool which did not exist on a systematized basis prior to The definition as above gives a logical derivation of its features as under: Different from the product or functional accounting, it is a positional accounting system fitted into an environment of the delegated responsibility in favour of individual for execution of organisational plans and evaluation of actual performance for determining whether actual operations have gone according to what. was planned. And also, if the actual are in a deviating path, then the extent thereof, the causes for deviation and the contemplated remedial measures to bring in the future actions more in line with the plan. According to Horngren CT5 The corner stone of management control system in a decentralized structure is the concept of Responsibility Accounting ( RA). RA is a system which recognizes various responsibility or decision centers within the organization and traces costs, revenues and resources to individual managers who are primarily responsible for making decision about them." The significance is that, the accounting under this system is not directly related to product or function with a consequent difference that in the concept of accounting of product or function, only a passive cognizance in accounting term is taken for the person ill charge of that. The personal responsibility remains outside the ambit of being measured in terms of accounting. This gives rise to analysing the organisational structure in its aspects and extent of centralisation and decentralisation. The individual responsibility can be measured only when his authority to influence the cost and/ or revenue can be identified and assigned to with reasonable clarity, in a centralised organisation as one extreme, the product or function may have persons in charge with no reasonable decision making authority for the operation of respective product or function. In this case, the scope of responsibility accounting shall be too insignificant and the accounting will be more oriented towards product / function rather than the individual. One of the earliest writers to make a systematic presentation of Responsibility Accounting was Riggings. His main task 29

3 centered on developing an accounting system which aimed at controlling expenditure by relating the latter to the individuals in organization who are responsible for their control. Thus the system would result in the preparation of accounting statements for all level of management so that the operating personnel could effectively use them as a tool for controlling their operations. Higgin's postulation implied a sound budget system, realistic standards and participation of responsible managers in goal setting as pre-requisites for successful application of Responsibility Accounting.4 >» Focus on Controllable and Non-controllable cost differentiation: As may follow from above, the responsibility accounting system is associated with delegated authority at the discretion of the individual responsible for execution of a task. More the delegation, more the controllable cost at the discretion of the individual and more the scope of accounting the responsibility of the individuals. Authority is the power of autonomy and this can be the guiding factor for determining the assignment of responsibility for each activity and for each corresponding item of expenses, income, capital expenditure and assets investment. In establishing the responsibility accounting system, the corporate may decide on certain guidelines for assigning cost to individual for reporting. The American Accounting Association7 has recommended the following: a If the person has authority over both the acquisition and use of service, he should be charged with the cost of such services. The cost of resources deployed by a responsibility center head for his own operation is an example of such cost. If the person significantly influences the cost through his own action, he may be charged with such cost. Regional allocation for example may come under this category, where a Business Area manager has reasonable influence to direct regional sales personnel to do his job even though, they are not reporting to him. The additional cost so triggered by the BA manager should be charged to him. 3 0

4 Even if the person cannot significantly influence the cost through his direct action, he may be charged with those elements with which corporate management desires him to be concerned so that he will help to influence those who are responsible Control rather than mem accounting: Responsibility accounting is a concept that aims at helping achieve a fit between planning & control system and managerial responsibility. -Under the conventional system of cost accounting, overhead accumulated are allocated amongst different cost centers defined for this purpose. A cost center as we know is.the unit of an organisation in which the individual in charge administers his activities directly. Obviously, this definition of cost center seems necessary from the point of view of the cost control and to determine responsibility. But cost allocation at best is loaded with assumption and in many cases highly arbitrary methods of apportionment are employed in practice. Product is not an appropriate unit of cost control. Through this conventional system of cost accounting an individual in charge of cost center is burdened with a large number of overheads over which he may have little control. Hence, the system of responsibility accounting is recommended whereby, the person controlling or initiating a particular cost should be held responsible for it. It is therefore, very clear to note that the very purpose of introducing this concept is to work as a management control tool for the corporate office as well as for toe responsibility center head with a view to deciding about his operation Not an accounting by Itself: Responsibility accounting as a concept of cost control uses various accounting and cost control techniques like budgeting, standard costing, financial trend line analysis, operating leverage and pricing techniques with only difference that it has a bias towards fixation of responsibility of individual as against a product or function. It just makes use of different financial accounting and costing tools to assess the performance of the person who can best influence the cost and revenue of a business unit he is responsible for. 31

5 Pricing o f interdepartmental transactions: The value of services rendered by one division / department to others need to be quantified for evaluating the value addition done by one unit for other and for the organisation as a whole. Unless the inter-divisional transactions are identified and quantified, the managerial output cannot be measured in an objective way. Responsibility accounting system is also a tool for assessing individual performance in certain predetermined financial and non-financial terms, which has given rise to the need for identifying and quantifying the interdivisional transaction value.,2.2. Nature of responsibility center One of the principles of responsibility accounting is that the overall objectives of an organization are divided and subdivided into the objectives of its constituent part. A responsibility center as one of such constituent parts exists to accomplish one or more of such purposes and these purposes are its objectives. The company as a whole has goals and the top management has decided a set of strategies to accomplish these goals. The objectives of a responsibility center are to help implement these strategies. Because, the organization is the sum of its responsibility centers, if strategies are sound and if each responsibility center meets its objectives, the whole organization should achieve its goals. A responsibility center uses resource-inputs, which are physical quantities of material, hours of various types of labour, cost of using premises & facilities and a variety of other services. These inputs under the business process get converted into outputs that may be classified as goods, if they are tangible or services if they are intangible. Every responsibility center has output, that is, it does something. In a production plant, the outputs are Products and in a project execution function, the output is commissioning of Projects. For many responsibility centers, especially staff units, output are difficult to measure, nevertheless, they exist. Engineering department of many organizations for example provides services to the various operating BUs, which may be valued at certain hourly rate as may be agreed upon. The products (i.e. goods and services) produced by a responsibility center may be finished either to another responsibility center or to the final customer. In the first case, the products are inputs 3 2

6 to the other responsibility centers and in the latter case they are output of the whole organization. Revenues are the amounts earned from providing these outputs. 2.3 Relation between inputs and outputs Management is responsible for obtaining the optimum relationship between inputs and outputs. In some situations, the relationship is causal and direct. In a production department for example, the inputs of raw material resources become a physical part of finished goods outputs. Control focuses on producing the output at the time needed, in the desired quantities according to the contract specification and quality standards and with minimum input. In many situations, however, inputs are not directly related outputs. Advertising expenses are the input that is expected to increase sales revenue, but revenue is affected by many factors other than advertising. So the relationship between additional amount of advertising and resulting revenue rarely is known. Marketing decision on amount to spend for advertising is based on judgement. For research & development, the relationship between input and output is even more ambiguous in the short run; the value of today s R&D effort may not be known for several years and the optimum amount that a given company should spend for R&D may be indeterminable. Business input, output and the relation between them constitute the basis of parameters of performance evaluation. Responsibility accounting system percolates down this mechanism of performance evaluation at the ground level of an organization. This gives a clear idea of the degree of efficiency and effectiveness in operation earned out at different levels of an organization. In this context, apart from the power plant EPC contractors, reference can be taken from Indian Railway. The committee appointed for studying existing accounting system has come out with the following recommendation* The committee has accordingly come to the conclusion that the cost incurred on performing various activities at each of the three level's - functional, divisional and zonal- should be maintained in such way that they can be looked at as distinct and separate from each other. In other words, cost data and records should be compiled / documented / reported separately at / by each level in keeping with the principles of Responsibility Accounting. To elaborate, the level that 33

7 incurs the cost should maintain records of cost incurred at that level and render prescribed report to the next higher level, which in turn should maintain records of cost incurred at that level, amalgamate its cost distinctly with the cost reported from the lower level before reporting to the next higher level and so on. Only then, each level will not only be aware of cost-in all its constituents-incurred by it report to the next higher level, in juxtaposition with its own historical or standard cost (wherever it is made available), and can be held responsible for deviations and variations and can by itself, or at the instance of the next higher level, identifies required control measures." 2.4. Areas of operation for control Depending upon the nature of activities as well as the organizational philosophy, the units of operation can be classified as under: Cost center: A cost center in the CIMA s9 official terminology is defined as a product, services, functions or items of equipment of which cost may be attributed to cost unit." Cost center denotes a location, function or items of equipment in respect of which cost may be ascertained and related to cost units for the purpose of control. It is the smallest of organizational sub-unit for which separate cost allocation is attempted. It may be a personal or impersonal cost center. Whether it is personal or impersonal, cost center represente organizational span for which separate cost determination is aimed at for deciding the needs of the management. Managers of functional department s like production: personnel and marketing are treated as heads of the respective cost center and made, responsible for their cost. If the responsibility is measured in financial terms, the performance statement should analyze the cost a) which are directly attributable / controllable by the concerned cost center and b) which may not be the result of significance influence by the cost center manager, but the management wants him to be concerned with such cost. Illustration: In order to control the execution of an on going power project, the EPC contractor decided that the TG Island would be designated as cost center. The cost pertaining to this cost 34

8 center is originated and controlled by the following department / divisions of the organization. The TG Island erection in charge was the cost center head. A ctivities 1. Supply of turbine, generator and ancillaries 2. Erection of TG Islands according to the design R esponsibility Head of Supply management group Turbine erection in charge, who belongs to the erection department, which is a business unit of the organization and is responsible for the erection & commissioning at a transfer price. 3. Commissioning of TG Islands Head of Engineering Department, a separate BU 4. Overhead at project site The project site manager 5. Erection department s overhead Head of erection department The management wanted the TG Island in charge, to co-ordinate the supplies at site although it was not directly his responsibility. He would also be loaded with a specified amount of the project site overhead as well as that of the parent BU (i.e. erection unit). The cost center performance report shall reflect the followings as the responsibility of the various group heads: ' Events 1 Delay in supplies due to problem with suppliers that resulted into additional cost to make up the overrun 2 Delay in mounting the Turbine due to civil front not being ready thus raising the godown charges and other related expenses. 3 Increase in sub-contracting cost not as a result of above 4 Increase in allocated BU overhead as compared with the budgeted estimate A ccountability Head of Supply management group A co-ordination problem, hence the TG Island in charge is accountable An increase in controllable cost under the responsibility of the TG Island in charge For the excess of allocated overhead, the head of erection group is accountable. Building up and reporting of cost under this guideline will not only depict the total cost of the cost center (TG Island in this case), and the variation from the budgeted ones but also the efficiency level of the different individuals. It also does bring into limelight the areas that require attention to take necessary corrective measures to initiate effectively the process of perfection. Since, the responsibility of controlling the operational cost is pulled down to the much lower level of organizational hierarchy, where the cost is really committed by the actions of the operational staff, 35

9 th e re is e v e ry possibility o f putting th e e ffe c tiv e -m o s t e n d e a v o r to h o n o r th e individual c o m m itm e n t. C o s t control c a n b e volu n tary a n d re m a in s less likely to s u ffe r th e h a lf-h e a rte d n e s s c a u s e d by im position from th e top le v e l. It a lso instills a s e n s e o f c o s t a w a re n e s s a n d fulfillm ent o f individual responsibility. R e v e n u e c e n t e r : It e m a n a te s fro m th e a ct o f divisionalisatio n o f e a rn in g. T h u s, a re v e n u e c e n te r m a y b e d e fin e d a s a n o p era tio n a l responsibility th a t is d e v o te d to raising re v e n u e w ith no d ire ct a ccountab ility fo r th e cost o f goods o r s e rv ic es sold by this o p e ra tio n. M a rk e tin g a n d s ales c e n te r c an th e re fo re be rightly c a te g o riz e d a s re v e n u e c e n te rs w ith th e e x p e c ta tio n th a t the c o n c e rn e d m a n a g e r s effort will p ro p o rtionately in c re a s e o r d e c re a s e th e re v e n u e. T h e c o m m itte e e m p lo y e d by th e Indian R a ilw a y fo r identification o f c o s t / profit c e n te rs a n d the re la te d fin an cial issu es, h a v e in tro d uced a n d d e s c rib e d th e c o n c e p t o f re v e n u e c e n te r. A ccord in g to th e c o m m itte e th e m ajo rity o f responsibility c e n te rs o f In d ia n R a ilw a y (IR ) i.e. th e functional units o f all s e rv ic e d e p a rtm e n ts P e rfo rm s activities th a t e v e n tu a lly contrib u te to th e production of tran s p o rt s e rv ic e s a n d re la te d activities. F o r e x a m p le a p e rm a n e n t w a y in s p e c to r (P W I) o f th e civil e n g in e e rin g d e p a rtm e n t is resp o n sib le fo r th e u p k e e p o f th e p e rm a n e n t w a y, sig nal inspecto r o f th e S & T d e p a rtm e n t m a in ta in s th e signaling e q u ip m e n t a n d s o o n. In th e a b s e n c e th e concep t o f tra n s fe r pricing, th e serv ic es p ro vided by th e functio nal units o f v a rio u s d e p a rtm e n t incurs only cost a n d no re v e n u e o f th e ir o w n. H e n c e, th e y h a v e b e e n te rm e d a s c o s t c e n te rs. S im ilarly, the functional units th a t a re re sp o n sib le fo r booking a n d h an d ling th e traffic fo r c a rria g e such as g o o d s s h e d s, p a s s e n g e r a n d p arc e l b o oking office etc. a re th e units th a t a re re sp o n sib le fo r the bookin g all traffic a n d collecting th e re v e n u e. T h e costs incurred b y th e s e units a re for those fun ctio ns a re v e ry s m all a s c o m p a re d to th e re v e n u e g e n e ra te d. In o th e r w o rd s, in th e c a s e o f s uch c e n te rs, re v e n u e p re d o m in a te s cost. T h e re v e n u e thus g e n e ra te d a t th o s e functional units a d d s u p to th e total re v e n u e o f th e IR o r a t le a s t th e bulk o f it. H e n c e, th e y h a v e b e e n te rm e d a s re v e n u e cen ters. T h e principal activity o f such c e n te r is b o oking o f traffic. T h e individual o p e ra tio n a l activities such a s booking o f goods, p a s s e n g e rs a n d p a rc e ls m a y b e te rm e d a s subactivities o f the con cern ed station (th e m ain activity c en ter) fo r the purp o se o f evalu atio n of 36

10 performance of those sub-activity centers. The revenue generated by each sub-activity center is accounted for through various returns prepared by it, cumulating into the balance sheet of the station. P rofit center: A profit center may be construed as the smallest possible functional unit for which both revenue and expenditure can be worked out in actual terms. This would enable determination of accountability right from the grass root level, especially when the organization is vast, multi-location and multi-product in nature. For a profit center organization to be established, it is necessary to have units of an organization to which both revenue and cost can be separately attributed. Managers of profit centers should be responsible both for the revenue as well as cost, which implies that there should be sufficient decentralization of authority within the organization to permit the profit center managers to make decisions about the selling prices and the output level at those prices. A profit center performance report measured in absolute terms would show profit as the bottom line. A profit center may have sub -profit centers within it. How a responsibility center may take the form of Profit Center has been explained by Anthony Robert N 10 when he says A given responsibility center is a profit center only if the top management decides to measure its output in monetary terms and believes it to be a good idea to do so. No accounting principle requires that revenue be measured for individual responsibility centers within the company. With some ingenuity, practically, any cost (or expenses) center could be turned into a profit centers can be found. The question is whether there are sufficient positive benefits in doing so. illustration: The erection and commissioning division of a power plant EPC contractor, which has been defined as profit center may have under it, different on going project sites operating as profit center by themselves. Although, in their cases the control over revenue by the respective project site managers would be restricted only to the additional revenue that they can generate by doing extra and out of the scope work. Whereas, the erection & commissioning operation as a whole, which is the parent profit center, the sources of revenue by way of direct marketing and inter divisional transfer order are both reasonably controllable by the said profit center head. The 37

11 project performance can be measured by the project profitability, as a part of the erection & commissioning profit center and the latter s performance by profit earned by various projects executed under different project -site mangers. The individual project manager gets the targeted profitability in consultation with the parent profit center, which he can influence either by reducing input cost or by raising additional revenue by way of proper claim management among others or both. The parent profit center is responsible for maintaining the profitability target fixed by the corporate management by allocating and employing resources to various functions like marketing and project management within well defined control system. In profit center both input and output are capable of measurement in financial terms and it provides more effective assessment of the managerial performance since, both costs and revenue are measured in monetary terms. The two major aspects of profit center accounting under responsibility center concept are transfer pricing and non-controllable cost. Corporate and segmental allocations are the example of noncontrollable items arising out of the vertical relation between the profit centers and the controlling bodies. This apart, there may be lateral movement of common cost allocation by other profit centers along the same hierarchy. The budgeted level of such cost may be loaded to the particular profit center as the receiver of services in exchange but of course not the variation therefrom, which may be due to the efficiency level of other bodies, laterally or / and vertically. Illustration: The profit target of a responsibility center X attached to a particular segment of a firm was fixed at 30 MINR, which included expenses allocated by segment 3 MINR, corporate charges 2 MINR and also I MINR as the share of location office. The annual account of X showed a profit of 28 MINR after charging segment allocation of 5 MINR, corporate charges 2 MINR and location allocation 1.5 MINR. The increase in segment cost has neither been influenced by, nor any additional services accruing to the profit center X". The rise in location allocation was on account of an increase in legal expenses relating to X and was incurred at the behest of the manager of that profit center. The business performance in terms of profit is in fact 30 MINR and therefore, has not been in variation from the compliance level affixed to the manager of X as the responsibility center head. The additional charge of 0.5 MINR from location 3 8

12 has been duly accommodated by corresponding reduction in other expenses of the profit center concerned. In vestm ent C enter: As noted by Manohar Bhatia," Another concept related to profit center concept is the Investment Center. An investment center is a unit or division of the company, which is responsible to the top a management for its profitability in relation to its investment base. As in profit centers, revenue and expenses are measured but in addition the assets employed in the division are also measured with a view to determining its investment base. Thus, an investment center is an extension of profit center idea. Profit is measured in both, but only in investment center is this profit related to the size of the investment involved." Thus, a factory or an erection function as BUs, can be considered as investment center to measure the return on investment. In fact, even Profit Centers, where there is no significant amount of tangible investment, still can be measured in terms of Investment center because, all the BUs need some value of investment as input resources and working capital requirement is one of them Profit center accounting under the concept of responsibility accounting Profit center accounting in essence is the collecting, analyzing and presenting of data relating to cost, revenue and profitability of an area of operation, which is so defined and designated by the corporate strategy of an organization. The profit center accounting measures and reports the performance of the concerned profit center as a whole without any primary attention towards the people behind its management. One profit center can have more than one person to influence the related objects of control and reporting; and as if in disregard of this the concept of profit center accounting will focus on the abstract of the area of operation concerned. It is thus oriented to the product or function. In a power plant business, the activities involving servicing of turbines and other machines of various plants in the country and abroad may be a functional profit center, whereas, the business of supplying turbine and other machines may be considered profit center dealing in products. 39

13 Responsibility center concept fixes its attention to the controlling body of a cost / profit / investment center. It tends to identify and focus on the prime mover of an operation, preferably a human element, which is supposed to exercise his control over the desired compliance level. In action, it churns out the controllable part of the activities of such areas of operation, attaches them to various persons concerned and holds them responsible for their part of compliance. The difference between these two concepts may be summarized as under: 1. Profit center accounting is more of reporting than control; and control being the primary objective of responsibility accounting. 2. Profit center accounting is aimed at describing a product s or function's performance level, whereas, the concept of responsibility center accounting goes in for describing the extent of compliance ensured by the individual concerned. 3. Profit center accounting is more in the nature of historic than the relatively more futuristic objectivity that governs the responsibility accounting system. 4. The identification, extraction, analyzing and deciding the individual accountability around them is.the key feature of the responsibility accounting, which has no relevance to the profit center accounting concept. 5. Profit center can be defined without reasonable degree of delegation. It is a function of divisionalisation such that control may be retained at corporate level. The responsibility accounting on the other hand, is a functional delegation of authority in favour of the person whom the management would like to hold responsible. 6. In fact, profit center is the pre-requisite of implementing the responsibility center, which on the other hand is valid for a profit center which is the offspring of both divisionalisation as decentralisation of authority. The following observation brings out the difference between the concept of responsibility center and profit center in reporting the degree of management efficiency in a BU s performance: Products and plants are two profit centers of business area x \ During the year 1999, it did a business of total 217 MINR with 77 MINR and 240 MiNR for product and plant respectively at a capacity level of 60 %. Total 36 number employees of this BA have been allocated to products 40

14 a n d p la n ts a s 1 5 a n d 21 re sp e ctiv ely. T h e B A o v e rh e a d s w e re a llo c a te d to th e s a id profit c e n te rs on th e b as is o f th e n u m b e r o f e m p lo y e e s. In addition to this, th e B A is lo a d e d w ith s e g m e n ta l allo catio n b a s e d on th e v o lu m e o f re v e n u e. T h e profitability s ta te m e n t o f th e B A x h a s b e e n furnish ed a s under. B u s i n e s s P e r f o r m a n c e K e v D a t a. B A,x P r o d u c t P l a n t T o t a l R e v e n u e M a te ria l c o s t C ontrib u tio n A s % o f re v e n u e 2 1 % 1 8 % 1 9 % P e rs o n n e l c ost in d ire c t o v e rh e a d s 8 11' 1 9 A m o rtizatio n o f T e c h n ic a l k n o w h o w fe e s 3 3 In te re s t & d e p re c ia tio n S e g m e n t a llo catio n T o ta l cost In c o m e b e fo re T a x T h is g iv es a p ic tu re o f th e profit c e n te r p erfo rm a n ce u n d e r th e B A x \ It s h o w s c le a rly, th a t a lth o u g h th e B A h a s e a rn e d a profit o f 2 M l N R, its product b u sin e ss is ru n n in g a t lo ss. T h e loss h a s b e e n o ffs e t b y th e p la n t b u sin ess o n th e o th e r h a n d. C o ntin u in g w ith this re v e la tio n, th e profit c e n te r a ccountin g w o u ld g o fu rth e r to a n a ly z e th e a re a s o f c o n c e rn s a s th e c a u s e o f th e loss. It a n a ly s e s th e d eviation fro m b u d g e t fo r th e p roduct busin ess a n d m a d e th e fo llo w in g n o te s. T h e a c tu a l contribution level h a s b e e n 21 % a s a g a in s t th e b u d g e t e x p e c ta tio n o f 2 0 %. 41

15 For the nature and volume of the product business carried out during 1999, there was a budget allocation of 10 numbers of employees at a total cost of 3 MINR, which actually turned to be15 numbers with a cost of 5 MINR as reported by the said Profit center. Indirect Overheads based on the same number of employees was budgeted at 5 MINR against at actual of 8 MINR. Interest & Depreciation increased by 0.10 MINR over a budget of 1.10 MINR and Segment allocation had been.80 MINR as against a budget of 1.30 MINR. The difference in actual profit level attained vis-a-vis budget as the corporate expectation had been reconciled as below: Budgeted profit for product business Increase in personnel cost Increase in overhead Increase in interest & Depreciation Decrease in segment allocation Decrease in material cost Reported profitability 2.00 MINR MINR MINR MINR 0.50 MINR 0.60 MINR MINR This is one of the best what profit center accounting can do i.e. identifying and allocations of revenue and cost to different profit centers; analyzing and reconciling the deviations and assigning reasons to that for remedial actions. It treats that profit center as an historical object of the business house and does not focus on the element of controlling as the guiding force behind the activities and this has become the entry point for the application of the concept of responsibility accounting. In fact, it is a supplementary to the profit center accounting concept. It can be noted below, in continuance of the derivatives given in the study, how the responsibility center accounting concept provides the finishing touch thus spelling out the role of individual who can be held responsible for the compliance level of the organization's plan as relating to a profit center. It is thus a feature that is involved in describing a process the management control process, while the profit center accounting is inclined to give the final result of the performance of 42

16 product / function as the control process aided by the responsibility accounting system. In the light of this, the responsibility center accounting report will describe the performance of the profit center as under. Business Area performance Report Figures in MINR R e s p o n s ib ility D is trib u tio n Budget Actual Product Manager BA Head Segment Chief Revenue Material cost (F) Contribution Amortization of TKH Personnel cost (A ) Indirect overhead (A) Interest expenses (A ) Segment charges (F ) Profit before Tax (F) 5.00 (A) 0.50 (F) Conclusion: Although the product business has suffered loss, from operational point of view, it has ended up with a bit of profit by the effort of the concerned Manager. There, has been improvement in material utilization part, which was entirely on the responsibility of the Product Manager, even though the gain therefrom had been partly offset by the sub-optimum utilization of the assets allocated. The rise in interest cost reflects it. The major problem affecting this business line being a non-controllable item for the product manager of the BA x is under absorption caused by the inadequate volume. As much as 5 MINR of unabsorbed cost had been loaded to this line of business, on which the product manager had no control. The responsibility of raising the volume of business was given on the BA manager. The interesting point to note is that although these two different lines of businesses i.e. product and plant are treated as profit centers for arriving at the profitability, the line managers did not have the responsibility to explore business. Hence, their profitability targets could be triggered by only the possible cost reduction, 4 3

17 which the product manager had reasonably carried out. The overall BA s not so satisfactory performance can be solely attributed to the BA Manager. In spite of the loss reported by the profit center accounting the product-in- charge can surely not be held responsible Allocation for services Corporate allocation: Every responsibility center has to share the part of corporate expenses according to the corporate strategic resources consumed by the respective responsibility centers. The share of corporate expenses is consisting of the services extended to the SBUs by way o f: 1. Corporate personnel services 2. Corporate finance & treasury function 3. Regional marketing services 4. Other corporate services like IT, secretarial and taxation matters. in fact, corporate and segment allocations are the charges for common services rendered to the SBUs. Since, a business area / unit cannot function without the overall corporate intervention, the resulting expenses are to be recovered against the revenue earned by individual business unit. In determining the BAs contribution to the organization the routine and specific value- of the corporate and segment function needs to be accounted for. Depending upon the nature of organization, a segment office may come in between the corporate and cluster of SBUs attached to a particular segment. In that case the nature of segment allocation represents the following: 1. Segment personnel cost 2. Engineering expenses including design and drawing relating to one or more of the attached SBUs. 3. Administrative and other expenses Corporate and segment allocation becomes the uncontrollable part of the expenses on the part of ' a business area / unit manager, and are taken care in Budgeting and reporting. The typical responsibility accounting will report these allocations as under 4 4

18 RESPONSIBILITY DISTRIBUTION P ro fit c e n te r B u s in e s s A re a S e g m e n t C o rp o ra te Less: R e v e n u e O w n cost P rofit 1 Less: B A allocation Profit 2 Less: S e g m e n t allo catio n profit 3 L e s s : C o rp o ra te a llo catio n R esponsibility Level P roject Profit Profit 1 re p re s e n t s th e re su lt o f th e g a m e plan o f th e profit c e n te r h e a d, w h ich is re d u c e d by the cost o f s e rv ic e s re n d e re d from th e level o f th e B A m a n a g e m e n t, including th e c o s t o f u n d erre co v ery, if a n y. T h e profit 2 s o arrived a t is sub jected to th e s e g m e n t a llo c a tio n, w h ic h is m e a n t for re co v e rin g s e g m e n t cqst. In th e s a m e w a y th e p ro d u ct s / pro ject's profitability is finally d e te rm in e d by re d u c in g th e s h a re o f corp o ra te cost attrib u ta b le to th e s a id profit c e n te r In te rfa c e a n d in te rd e p e n d e n c e a m o n g s t re s p o n s ib ility cente rs : R esponsib ility c e n te rs a re highly s p e c ia lize d in th e ir re sp e ctiv e field a n d th e re fo r in th e total b u sin ess p ro cess c an n o t b e in d e p e n d e n t o f o n e a n o th er. T h e s e q u e n c e o f th e w o rk flo w a n d the position o f d iffe re n t S B U s in th a t flo w brings about th e configuration o f th e s aid in te rd e p e n d e n c e. 4 5

19 Illustration: There are five profit centers of business segment. One is responsible for the marketing and project management of small sized (<50 MW) power plant and is named as CP, there are two other SBUs namely, US and GP engaged in power projects of different size and nature which are not relevant in this context. Second related one being the erection & commissioning group (EC), which is common for all the power projects of different size & nature executed by this segment. The third SBU concerned is manufacturing & supply management (ES), which is responsible for the manufacturing and procurement of material for different power projects. The SBU CP got an order form an industry house and as usually awarded the erection & commissioning part to the SBU EC at an agreed price for an agreed scope. Now according to the work schedule, this group can start work when civil fronts are ready, drawings are clear and the materials reach the site. Supplying materials at site has been the responsibility of the supply management group i.e. ES whereas making the civil front ready by a separate contractor has been kept within the project management group (CP) itself. The interfaces of these three groups are as under: ES v / Interfaces amongst SBUs in a common process flow The erection function is dependent on PC for civil front, which is direct and vertical interface. On the other hand, the dependence of EC on ES for material delivery at site is lateral and indirect. Because, ES is not responsible to EC for on time delivery. These interfaces have the bearing on the nature of re-defining controllable and non-controllable cost around a responsibility center in a matching manner. 46

20 Let us assume that, CP has booked the order at a price of 200 crones. It passed on the engineering and supply part to ES at RS 150 Crones and erection & commissioning part to EC at RS 20 crones. These prices are based on the offer submitted by the concerned SBUs. The transfer prices of RS 150 crones and RS 20 crones contain a permitted 7,5% margin for the SBUs. While executing the project following points were noted. The SBU, Es could not from time to time stick to the delivery schedule at the project site. The idle hour of the erection SBU (EC) on account of project staff & labour was computed at RS 40 lacs, of which unit s own overhead accounts for Rs.10 lacs. And after the material reached, in order to reduce the time over run, crash programmes were taken up by employing further more number of contract labour by overtime deployment. This resulted into extra cost of another RS. 40 lacs. On the other hand due to delay in completion of civil fronts, there has been unplanned expense of another RS. 25 lacs. The delay on the part of the supply management BU was partly because of alteration in design & drawing specifications and has been quantified at Rs. 20 lacs. At the end of the project ( duration of one year), the profitability of this project in the books of three different SBUs looked as under. Summarised Profit & Loss statemnet in crores CP EC ES Revenue ( Direct) 200 Revenue ( IDTO) Purchases & subcontracting ( Direct) Purchases & subcontracting ( IDTO) 170 Engineering & others 5 Overhead Profit before Tax The project shows dismal performance in the books of all the SBUs in varying degree. However, it does not reflect the true performance by three different SBU management, because, the influence of one SBU on other has not been reported. The profit & loss statement can be recast as under according the responsibility accounting concept. 47

21 SUMMARISED PROFIT & LOSS STATEMNT In crore CP EC ES Revenue Controllable cost: Purchase & subcontracting Overhead & others Total controllable cost Controllable profit Uncontrollable cost Subcontracting : Idle hour : Overtime 0.40 Overhead : Idle hour 0.10 Total uncontrollable cost Total cost Profit of other SBUs Total profit before Tax as per Profit & Loss a/c The difference may be noted. The controllable profit is what really can be attributable to the performance of individual SBU managers. The profit of other BUs appearing against the BUs as above, represents the profit lost by the said other BUs. Out of 45 Lacs shown under CP, 25 lacs belongs to the EC and similarly, the entire 80 lacs appearing under ES actually belongs to EC. The effect does not get reported in the normal Profit &Loss account. The alternative solution to this problem is claim management and claim accounting. The cost of extended duration for example, can be presented before the SBU CP as claim by SBU EC" and the same can be accounted for in normal course. An example of claim proposal for extended duration is given under:. - Mr. X is site manager of a project of 24 months-scheduled duration. The project price is 200 MINR with a variable cost of 55 % of revenue and fixed cost of 24 MINR p.a. The project went on smoothly till the 25 % of its actual work was over. Soon after, there occurred an inordinate delay in material supply. The project work stopped for four months without much variation in the fixed cost. Finally, the problem was over and stringent action plan was made to expedite the activities. Overtime increased and so did the variable cost that rose to a level of 65%. Ultimately the project was completed with two months delay. There is good case of lodging claim on the customer 48

22 (internal or external) for the loss suffered by the extended duration of the project. The claim paper would look like as under: Project duration as per schedule Actual duration Fixed cost for extended duration Additional variable cost (150 MINR *10%) Total minimum claim : 24 Months : 26 Months : 4 MINR : 15 MINR : 19 MINR On settlement of the claim, the amount would be offset against the additional cost in the books and the corresponding increase in the profitability would be reported in normal course. In the matter of such claim with the other SBUs, the major objection to this practice is the uncalled for accounting exercise, out of which the company as a whole does not gain anything Decentralization and responsibility accounting As Elwood & Miller11 have observed, As with many concepts, decentralization has several meanings. Activities, operations, physical facilities and management structures are often reflected to as decentralized. The first three references pose few barriers to understanding. Since they represent tangible things that are separated and often dispersed widely. Management structures and or organizations however, do pose problems since an intangible authority is the frame of reference. Therefore, responsibility can best be discharged when it goes with the corresponding degree of authority. Reasonable decentralization in decision-making authority therefore happens to be a pre-requisite for discharging and measuring one's responsibility in executing a task in an effective way. To understand how decentralization affects the responsibility accounting system, the two situations mentioned hereunder deserve consideration. S itu atio n 1: KPA Ltd. is engaged in power plant supply, commissioning and transmission business. Its operation is controlled by the Managing Director (MD). It has three line functional 4 9

23 units namely manufacturing, service and erection. Other functions like marketing, engineering, supplies, HR and finance cater to the said operational groups. There are eight functional heads all reporting to the MD. The HO is situated at Delhi and the manufacturing unit is at Mathura. The marketing function procures business from the field of public utility and independent power producers (IPP) both including gas and steam turbine for different use. The Finance & accounts function headed by Director finance is responsible for corporate finance, project finance and maintenance of complete accounting. Company s total turnover in 1999 was 500 Crores including all the businesses. All the operating departments cost like production, services and erection are monitored by detailed budget & variance analysis both in financial and non-financial parameters. The departments collect their operational data on their own which are presented upto the level of trial balance. Assets and customers accounts are maintained at HO. Within erection department, power projects worth more than Rs.100 lacs make their own Trial Balance, which is sent to HO for analysis and consolidation. At the HO, all of the projects expenses -direct and indirect - are collected and apportioned against each project to ascertain the project's profitability. In case of manufacturing activities also, the expenses of all the other related functions are allocated at HO level to find out the cost of individual product. The local finance & accounting Department at Mathura and various project sites are to report direct to the central finance at HO with of course remaining administratively responsible to the location head and individual project site manager. Operational performance in terms of Budget and deviation analysis are periodically furnished to the central finance as a part of report from the location finance and/or project site finance department. Suppliers bill worth more than Rs 10,000/- is to be sent to HO for scrutiny and approval. Similarly, all the POs more than Rs. 10,000 /- are to be vetted by HO. Assets worth Rs 10, 000 and more are to be procured from HO. Apart from these, product pricing, recruitment and promotion are decided at HO. Costing is product and / or project oriented and monitored by budget and variance analysis. Situation 2 : The company acquired another organization in similar business. The new management opted for large-scale decentralisation. It restructured the organization in terms of 50

24 four strategic business units ( SBUs) namely, manufacturing, erection & commissioning, servicing and transmission, headed by experts in the respective field of specialization. Every SBU got its own marketing, operational and finance set up as well as individual sets of books of accounts. Each SBU becomes the balance sheet point of activities. Every business area manager is given responsibility equipped with matching power to attain their preset goals as means of achieving the corporate objectives. The ambit and application of responsibility accounting for these two different set up is distinct enough. The first one is an orientation towards centralization, while the second one portrays an environment of decentralisation. While in situation 2 the accounting function is placed under respective functional heads, it is independent of their actions and decisions in the case of situation 1. With the decentralisation, the accounting function too becomes decentralized with each part attached to individual SBU. In this process of transition of significant part of decisionmaking authority from corporate to operational level, two important consequences involving finance & accounting functions take place. Firstly, each SBU manager gets the finance function under his disposal and secondly, the accounts department of each SBU tends to lose its thread link with the corporate finance the skeleton remains of the erstwhile massive accounting function under the direct supervision of the apex body of an organization. Since, the accounting function is a process of procurement, disbursement and analyzing the various kinds of organizational resources and since the SBU managers are given flexibility of taking prompt decision; the accounting function as the custodian of organization's resource is quite understandably placed at the reasonably sole discretion of the SBU Chiefs. Consequently, the communication link of the operational accounting functionaries with the corporate accounts as a result of this corporate philosophy tends to become insignificant enough. The performance of a SBU as well as its Supremo both are measured in terms of certain predetermined sets of parametric financial and non-financial terms. 51