Responsibility accounting: definition, explanation and pre-requisites

Definition of responsibility accounting

Responsibility accounting is a system of management accounting under which the organisation is divided into responsibility centres, each headed by a manager, and costs, revenues and investments are accumulated and reported by those centres, so that each manager is held accountable only for the items he or she can control.

Explanation

1. Responsibility centres. The organisation is broken into units, departments, divisions, plants, each placed under a manager. Centres are classified as cost centres, revenue centres, profit centres and investment centres, according to what the manager controls.
2. Assignment of controllable items. Every cost and revenue is traced to the centre and manager who can influence it. A cost that a manager cannot control (for example, an apportioned share of head-office rent) is reported separately or left out of his or her evaluation.
3. Budgets and standards for each centre. Targets are set for each centre in the budget.
4. Recording actual performance by centre. The accounting system collects actual results under the same heads.
5. Performance reports. Periodic reports compare actual with budget for each centre, show variances, and go up the hierarchy, becoming more summarised at each level.
6. Action. Managers investigate significant variances and correct them; good performance is recognised.

Example: in a factory, the machining department head is responsible for material usage, labour hours and power in the department; the sales manager for sales revenue and selling expenses; the divisional manager for the division's profit and return on investment.

Pre-requisites for introducing responsibility accounting in a company

1. A clear organisation structure with well-defined lines of authority and responsibility.
2. Identification of responsibility centres and their classification as cost, revenue, profit or investment centres.
3. Delegation of authority matching each manager's responsibility; managers cannot be held accountable for what they cannot influence.
4. Classification of costs into controllable and uncontrollable at each level.
5. A budgeting and standard-costing system, so that targets exist for each centre.
6. An accounting and information system that records actual costs and revenues by centre and reports them promptly.
7. A sound transfer-pricing policy where centres supply each other, so that profit centres are evaluated fairly.
8. Participation and acceptance: managers should help set their targets and accept the system.
9. Top-management support and a reward system linked to performance.

Conclusion

Responsibility accounting makes control personal by linking accounting information to the managers who can act on it. It works only when authority, budgets and reporting are organised around clearly defined responsibility centres.