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Responsibility Responsibility AccountingAccounting

Prepared by Douglas Cloud

Pepperdine University

99

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Define goal congruence and explain its relationship to control and performance evaluation.

Identify the types of responsibility centers and explain the differences among them.

Determine the positive and negative aspects of specific criteria used for evaluating the performance of responsibility centers.

ObjectivesObjectives

After reading this After reading this chapter, you should chapter, you should

be able to:be able to:

ContinuedContinued

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Calculate contribution margin variances and explain their significance. Describe the pros and cons of including cost allocation in performance reports. Describe some approaches to allocating costs to responsibility centers. Explain how cost allocations can create ethical problems.

ObjectivesObjectives

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A major objective of management control is

to encourage goal congruence, which

means that as people work to achieve their own goals, they also

work to accomplish the company’s goals.

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Responsibility CentersResponsibility CentersA responsibility center is an activity, such as a department, that a manager controls.

Types of Responsibility Centers

Cost centersRevenue centersProfit centersInvestment centers

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A cost center is a segment whose manager is responsible for costs, but not revenues. A cost center can be relatively small.

Examples: A manufacturing cell The office of the chief executive

The legal department

Responsibility CentersResponsibility Centers

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A revenue center is a segment whose manager is responsible for earning revenues, but not for the costs of generating revenues.

Examples: Hospitals Marketing departments

Responsibility CentersResponsibility Centers

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• A profit center is a segment whose manager is responsible for revenues as well as costs.

• An investment center is a segment whose manager is responsible not only for revenues and costs, but also for the investment required to generate profits.

Responsibility CentersResponsibility Centers

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Transfer PriceTransfer Price

A transfer price is the price that one center charges another center within the company.

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PerformancePerformance Evaluation CriteriaEvaluation Criteria

Selecting criteria to measure and evaluate performance is important because the criteria influence managers’ actions. The most common deficiencies in performance measures are:

– using a single measure that emphasizes only one objective of the organization; and

– using measures that either misrepresent or fail to reflect the organization’s objectives or the employee’s responsibilities.

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The Balanced ScorecardThe Balanced Scorecard

An approach known as the balanced scorecard has become popular

recently. This approach extends performance evaluation from

merely looking at financial results to formally incorporating measures that look at customer satisfaction,

internal business processes, and the learning and growth potential of the

organization.

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The balanced scorecard asks four basic questions:1. How do customers see us? (the customer

perspective)2. What must we excel at? (the internal business

process perspective)3. Can we continue to improve and create value?

(the learning and growth perspective)4. How do we look to stockholders? (the financial

perspective)

The Balanced ScorecardThe Balanced Scorecard

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Responsibility Reports for Cost CentersResponsibility Reports for Cost Centers

Current Month Year to Date Over Over Budget (Under) Budget (Under)

Report to Supervisor of Work Station 106—Drill Press

Materials $ 3,200 $(80 ) $ 12,760 $ 110Direct labor 14,200 170 87,300 880Supervision 1,100 (50 ) 4,140 (78 )Power, supplies, miscellaneous 910 24 3,420 92 Totals $19,410 $ 64 $107,620 $1,004

Report to Supervisor of Fabrication Department

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Responsibility Reports for Cost CentersResponsibility Reports for Cost Centers

Current Month Year to Date Over Over Budget (Under) Budget (Under)

Report to Supervisor of Fabrication Department

Station 106—Drill Press $19,410 $ 64 $107,620 $1,004Station 107—Grinding 17,832 122 98,430 (213 )Station 108—Cutting 23,456 876 112,456 1,227 Total work stations $60,698 $1,062 $318,506 $2,018

ContinuedContinued

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Responsibility Reports for Cost CentersResponsibility Reports for Cost Centers

Current Month Year to Date Over Over Budget (Under) Budget (Under)

Report to Supervisor of Fabrication Department

Departmental costs (commonto work stations):General supervision $12,634 $ 0 $ 71,234 $ 0Cleaning 6,125 324 32,415 762Other 1,890 (67 ) 10,029 (108 )

Total $81,347 $1,319 $432,184 $2,672Report to Manager of

Factory

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Responsibility Reports for Cost CentersResponsibility Reports for Cost Centers

Current Month Year to Date Over Over Budget (Under) Budget (Under)

Report to Manager of FactoryFabrication department $ 81,347 $1,319 $ 432,184 $2,672Milling department 91,234 (2,034 ) 405,190 (4,231 )Assembly department 107,478 854 441,240 1,346Casting department 78,245 (433 ) 367,110 689Total departments $358,304 $ (294 )$1,645,724 $ 476

ContinuedContinued

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Responsibility Reports for Cost CentersResponsibility Reports for Cost Centers

Current Month Year to Date Over Over Budget (Under) Budget (Under)

General factory costs (common to departments):Engineering $ 14,235 $261 $ 81,340 $842Heat and light 8,435 178 48,221 890Building depreciation 3,400 0 20,400 0General administration 23,110 340 126,289 776

Total factory costs $407,848 $ 485 $1,919,974 $2,984

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Responsibility Reports for Profit Centers (000s)Responsibility Reports for Profit Centers (000s)Current Month Year to Date

Over Over Budget (Under) Budget (Under)Report to Product Manager—

Appliances, European RegionSales $122.0 $ 1.5 $387.0 $ 3.2Variable costs:

Production $ 47.5 $ 2.8 $150.7 $ 5.9Selling and administrative 12.2 1.8 38.7 1.9

Total variable costs $ 59.7 $ 4.6 $189.4 $ 7.8Contribution margin $ 62.3 $ (3.1 ) $197.6 $(4.6 )Direct fixed costs 36.0 $ (1.2 ) 98.5 (3.1 )Product margin $ 26.3 $ (1.9 ) $ 99.1 $ (1.5 )

To report to manage—European Region

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Responsibility Reports for Profit Centers (000s)Responsibility Reports for Profit Centers (000s)Current Month Year to Date

Over Over Budget (Under) Budget (Under)Report to Manager—

European Region

Profit margins:Appliances $26.3 $(1.9 ) $ 99.1 $(1.5 )Industrial equipment 37.4 3.2 134.5 7.3Tools 18.3 1.1 59.1 (2.0 )

Total product margins $82.0 $ 2.4 $292.7 $ 3.8Regional expenses (common

to all product lines) 18.5 0.8 61.2 (1.3 )Regional margin $63.5 $ 1.6 $231.5 $ 5.1

Report to Executive Vice President

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Responsibility Reports for Profit Centers (000s)Responsibility Reports for Profit Centers (000s)Current Month Year to Date

Over Over Budget (Under) Budget (Under)Report to Executive Vice

President

Regional margins:European $ 63.5 $ 1.6 $ 231.5 $ 5.1Asian 78.1 (4.3 ) 289.4 (8.2 )North American 211.8 (3.2 ) 612.4 (9.6 )

Total regional margins $353.4 $ (5.9 ) $1,133.3 $(12.7 )Corporate expenses (common

to all regions) 87.1 1.4 268.5 3.1Regional margin $266.3 $ (7.3 ) $ 864.8 $(15.8 )

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Analyzing Contribution Analyzing Contribution Margin VarianceMargin Variance

Profit depends on several factors, including selling prices, sales volumes, and costs. Budgeted and actual profits rarely coincide because prices, volume, and costs can (and do) vary from expectations. To plan and to evaluate previous decisions, managers need to know the sources of variances.

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Contribution Margin Contribution Margin Variance ExampleVariance Example

Horton Company expected to sell 20,000 units at $20 with unit variable costs of $12. Horton actually sold 21,000 units at $19. Budgeted Actual DifferenceSales $400,000 $399,000 $(1,000)Variable costs 240,000 25,000 (12,000)Contribution margin $160,000 $147,000 $(13,000)

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Sales Volume VarianceSales Volume Variance

The sales volume variance is the difference between (1) the contribution margin the company would have earned selling the budgeted number of units at the budgeted unit contribution margin and (2) the contribution margin it would have earned selling the actual number of units at the budgeted unit contribution margin. Sales = budgeted contribution x (actual unit – budgeted unit)volume variance margin per unit sales sales $8,000 = $8 x (21,000 – 20,000)

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Sales Price VarianceSales Price Variance

The sales price variance is the difference between (1) actual total contribution margin and (2) total contribution margin that would have been earned at the actual volume and budgeted unit contribution margin.Sale price variance = units sold x (actual price – budgeted

price) = 21,000 x ($19 - $20) = $21,000 F

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Cost Allocations onCost Allocations onResponsibility ReportsResponsibility Reports

Operating departments in manufacturers work directly on products. Operating departments in a retail company serve customers directly.Service departments (service centers) provide services to operating departments and to one another. Examples: human resources, accounting, and building security.

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Arguments Against Allocating Arguments Against Allocating Indirect Fixed CostsIndirect Fixed Costs

1. Because indirect fixed costs are not controllable by the users, allocating them violates the principles of controllability.

2. Including allocated costs on performance reports could lead to poor decisions because managers will treat the costs as differential.

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Allocation Methods and Effects: Allocation Methods and Effects: Allocating Actual Costs BasedAllocating Actual Costs Based

on Actual Useon Actual UseThis method is flawed in two respects.

– It allocates actual costs rather than budgeted costs. Allocating actual costs passes the inefficiencies (or efficiencies) of one department to the next.

– It allocates fixed costs based on use.

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Raleigh Company has one service department, Maintenance, and two operating departments, Fabrication and Assembly. Data for the departments follow:Operating Hours of Maintenance Service UsedDepartment: Budgeted Actual Fabrication 20,000 20,000 Assembly 20,000 10,000Total 40,000 30,000Maintenance Department Costs for Year:

Budgeted ActualVariable (budgeted, $5.00; actual, $5.10) $200,000 $153,000Fixed 75,000 79,500 Totals $275,000 $232,500

Allocation Example

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Actual per-hour cost of providing the service = = $7.75/hr.

Allocation Example

$232,50030,000 hours

Allocations would be:Fabrication (20,000 x $7.75)

$155,000Assembly (10,000 x $7.75)

77,500Total maintenance costs allocated

$232,500

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Methods to Allocate ServiceMethods to Allocate ServiceDepartment Costs (Appendix)Department Costs (Appendix)

Direct method Step method Reciprocal method

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The End

Chapter 9Chapter 9

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