Responsibility accounting and the creation of responsibility centres

Concept of responsibility accounting

Responsibility accounting is a system in which accounting information is collected and reported according to areas of responsibility within the organisation. Each area is a responsibility centre under a manager who has authority over its activities, and the manager is evaluated on the costs, revenues or investment he or she can control. Budgets are set for each centre, actual results are recorded under the same heads, and performance reports compare the two so that corrective action can be taken by the person responsible.

Types of responsibility centres

The centres are taken from the widest accountability to the narrowest.

1. Investment centre. The manager controls revenue, costs and the investment in assets, and is judged by return on investment, residual income or economic value added. Example: a strategic business unit or a subsidiary.

2. Profit centre. The manager controls both revenues and costs and is judged by profit. This suits divisions that make and sell their own products. Where divisions trade internally, transfer prices are needed. Example: a product division.

3. Revenue centre. The manager is accountable mainly for generating revenue. The centre may incur some selling costs, such as salespersons' commission, but it is not answerable for controlling costs. Performance is judged by sales revenue, volume, mix and market share against budget. Example: a regional sales office.

4. Cost (expense) centre. The manager controls costs but not revenue. Performance is judged by comparing actual costs with budgeted or standard costs for the output achieved. Standard cost centres (production departments with measurable output) and discretionary cost centres (research, administration, where the link between cost and output is weak) are distinguished. Example: an assembly shop. Creating the centres for effective implementation

5. Study the organisation structure and redraw it, where necessary, so that each activity has one clearly identified manager.

6. Define each centre and its type according to the decisions the manager actually takes; do not call a unit a profit centre if its manager cannot influence price or sales.

7. Delegate authority equal to responsibility.

8. Separate controllable from uncontrollable items for every centre, and judge managers on controllable items.

9. Set budgets and standards for every centre, preferably with the manager's participation.

10. Design the accounting codes and reports so that costs and revenues are captured by centre, and report at intervals short enough for action.

11. Fix fair transfer prices for goods and services passing between centres.

12. Use reports for improvement, not blame, and link rewards to performance.

Conclusion

Responsibility accounting succeeds only when the organisation is divided into well-defined cost, revenue, profit and investment centres, each with matching authority, budgets and reports.