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Responsibility Centre
Prof. Nand Dhameja
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Responsibility Centre
A segment of organisation
Involving use of resources
Has a purpose or objective
A manager responsible for the centre
An organisation is a set of responsibilitycentres
Responsibility centres form a hierarchy: acentre may have sub-centres
Involves InputsPhysical quantity Value ofresources used
Involves Outputs Physical quantityvalue ofwork done
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Responsibility Centre- Accounting: Steps
Divide organisation into segments/centres-a
division or function unit
Each centre headed by an executive having authority
& responsibility
Accounting for each centre: costs & revenues;Controllable vs. non-controllable costs
Develop organisational control mechanism:
Standard of performance for each centre
Reward/punishment system
Develop transfer price mechanism
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Responsibility Centre- Efficiency &Effectiveness
Two criteria to judge the performance of a
responsibility centre
Comparative terms rather than a absolute one
Efficiency Output/Inputcomparison of actual cost with
standard
Effectiveness relationship between Output &objectives
difficult to quantify objective & output
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Responsibility Centre- Efficiency &Effectiveness contd.
Efficiency & effectiveness are not
mutually exclusive, every centre ought
to be both efficient & effective
In summary, a responsible centre isefficient if it does things right, & it is
effective if it does the right things
In commercial organisations, Profit is an
important measure of efficiency &
effectiveness
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Responsibility Centres - Types
Expense Centre
Revenue Centre
Profit Centre
Investment Centre
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Responsibility Centres Types Contd.
Revenue Centre- output in money terms
e.g. market/sales units: don't have to set selling
price & are not charged for costs
Expense Centre: inputs measured in monetary
terms
Engineered expense centre, or
Discretionary expense centre
Profit Centre- An absolute measure
Profit a useful performance measure-inputs &
outputs in monetary terms
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Responsibility Centres TypesContd.
Profit centre- Delegation of authority to
generate profit-two conditions:
a). Manager has access to relevant information to
make decisions
b). There is a way to measure effectiveness of
expense/revenue trade-offs
Investment centre Profit in relation toInvestment
Management decision whether a profit centre orinvestment centre
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Responsibility CenterResponsibility Center: Center In charge
Responsible for..
1.Expense Centre 1. Expenses2.Revenue centre 2. Revenues3.Profit Centre 3. Expenses,
Revenues & Profits
4. Investment Center 4 Expenses, RevenuesProfits & Investment
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Responsibility Centre-Profit Centre:Illustrations
For a bank: branch as profit centre;
programme or a product profitability ,customer
profitability, ATM Profitability ATM used as
credit to branch having customer account
Power cos.- generation, transmission &distribution as profit centres
Soya sauce manufacturer- each production
process as profit centre
Marketing Division given profit responsibility-marketing manager can trade-off between
cost/revenues
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Responsibility Centre-ProfitCentre: Illustrations contd
Manufacturing may be a profit centre to motivate , to guard against inferiorquality
Given selling price-ascertain profit Service & support units-maintenance,
transportation, consulting, customerservice units e.g. Singapore Airlines-
Singapore Airlines Engineering Co.;Singapore Airport Terminal Services;Catering or laundry service in hospitalsor trains
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Responsibility Centre-Profit Centre
Management Decision whether a ProfitCentre-amount of influence (not necessarilycontrol), a manager exercises on activitiesthat affect profit
Profit centre managers control over a) product decisions;
b) marketing decisions;
c) procurement or outsourcing decisions.
If these are split among two or moremanagers, separating contribution of eachmay be difficult
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Responsibility Centre-Profit Centre
Advantages:
+ Quality of decisions improves
+ Speed of operating decisions increases
+ HQ relieved of day-to-day decisions &concentrates on policy matters
+ Managers autonomy- free to useimagination & initiative
+ Improves competitiveness+ Profit consciousness motivates managers
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Responsibility Centre-Profit Centre
Disadvantages:
Decentralised decision-making-management relies on control reports
rather than on personal knowledge Quality of decision at unit level may get
reduced
Lack of appropriate transfer price
conflict of interests & demotivating Competition among responsibility centres
undesirable cost consequences
Emphasis on short-term profit rather
than long-term profits
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Responsibility Centre-Profit Centre
Profitability Measurement: two types
a). Management performance; how wellManageris doing?
b). Economic Performance: How well ProfitCentre is doing as an Entity?
MCS design be addressed to (a) above
Profit Centre economic performance
measured by PAT Profit centre manager performance
evaluated by Five different measures
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Responsibility Centre-Profit Centre
Responsibility Centre-Profitability MeasuresSales Rs.1000
Less Variable Expenses 780
CONTRIBUTION MARGIN 220 (1)
Less Fixed expenses in Profit Centre 90
DIRECT PROFIT 130 (2)
Less Controllable corporate charges 10
CONTROLLABLE PROFIT 120 (3)
Less othe corporate allocations 20
PBT 100 (4)
Less Taxes 40
PAT 60 (5)
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Profit Centre-Profitability Measures
1. Contribution Margin:reflects spreadbetween revenue & variable expenses
+ since fixed expenses are beyond his
control, manager should focus onmaximising contribution
-- wrong premise- fixed expenses are
partially controllable-- Is Manager responsible for controllingemployees efficiency & productivity?
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Profit Centre-Profitability MeasuresContd.
2) Direct Profit: reflects profit centres
contribution to general overhead and co.s
profit; traces expenses to the Centre
--does not recognise motivational benefit of
charging HQ costs
3). Controllable Profit: considers Controllable
expenses of HQ
Since non-controllable HQ expenses are excluded,
this cannot be directly compared with
published data
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Profit Centre-Profitability MeasuresContd
4) PBT: all corporate O/H are allocated;
++ awareness of corporate allocated
expenses
5) PAT: Profit after all expenses & imputedtax
--Since decisions which affect PAT aretaken at HQ tax allocation notappropriate
++ IT varies among profit centres, managerscant influence
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Responsibility Centre-Profit Centre
Responsibility Centre- Profit Centre Sales
Sales Rs 1000
Less Variable Expenses 780
CONTRIBUTION MARGIN 220 (I)Less Fixed expenses in Profit Centre 90
DIRECT PROFIT 130 (2)
Less Controllable corporate charges 10
CONTROLLABLE PROFIT 120 (3)
Less other corporate allocations 20PBT 100 (4)
Less Taxes 40
PAT 60 (5)
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Responsibility Centre: Investment Measure
a). Total assets Available All business assets
b). Total assets employed Exclude Idle assets
c). Capital Employed b) Less C. L
d). Net Worth
Capital + Reserves
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Responsibility Centre: Investment MeasureContd.
Current Assets: Extent to which Controllable byDivisional Manager
When not directly identifiable:
Allocate cash & Cash needs
Inventory Sales needs Receivables credit terms
Fixed Assets: Whether Book value- Gross, or Net,or Current values
Objectively measured; Not affected byaccounting practicesTreatment of:Off-B/S Items e.g. Lease;or : Intangibles
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Responsibility Centre- Performance Parameter
ROI vs. EVA +a comprehensive measure + a basis of comparison of divisions
+a basis of investment divisions + reported in Financial statement - Too simple a decision Rule - Computation not easy
- Lack Goal Congruence EVA is conceptually sound while ROI ismore widely used
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Control System: Characteristics
Goal Congruence
Motivation
Autonomy