Earlier chapters focused on techniques used for costing products and services, understanding cost behavior, budgeting, and so forth. These basic tools and techniques are essential to a well-managed organization. But, one must also be mindful that managers must be held accountable for the results of their decisions and related execution. Without performance-related feedback, the business will not perform at its best possible level, and opportunities for improvement may go unnoticed or unrealized. Given that managers must be held accountable for decisions, actions, and outcomes, it becomes very important to align a manager’s area of accountability with his or her area of responsibility. The “area” of responsibility can be a department, product, plant, territory, division, or some other type of unit or segment. Usually, the attribution of responsibility will mirror the organizational structure of the firm. This is especially true in organizations that have a decentralized approach to decision making. Centralize Vs. DecentralizeMany successes have occurred in highly decentralized organizations. Top management concentrates on strategy and leaves the day-to-day operation and decision-making tasks to lower-level personnel. This facilitates rapid “front-line” response to customer issues and provides for identifying and training emerging managers. It can also improve morale by providing each employee with a clear sense of importance that is often lacking in a highly centralized environment. Decentralization can prove to be a fertile ground for cultivating new and improved products and processes. Responsibility CentersA decentralized environment results in highly dispersed decision making. As a result, it is imperative to monitor and judge the effectiveness of each manager. This is easier said than done. Not all units are capable of being evaluated on the same basis. Some units do not generate any revenue; they only incur costs in support of some necessary function. Other units that deliver goods and services have the potential to be assessed on the basis of profit generation. As a generalization, the part of an organization under the control of a manager is termed a responsibility center. To aid performance evaluation it is first necessary to consider the specific character of each responsibility center. Some responsibility centers are cost centers and others are profit centers. On a broader scale, some are considered to be investment centers. The logical method of assessment will differ based on the core nature of the responsibility center. Cost CenterIt stands to reason that assessments of cost control are key in evaluating the performance of cost centers. This chapter will show how standard costs and variance analysis can be used to pinpoint areas where performance is above or below expectation. Cost control should not be confused with cost minimization. It is easy to reduce costs to the point of destroying enterprise effectiveness. The goal is to control costs while maintaining enterprise effectiveness. Nonfinancial metrics are also useful in monitoring cost centers: documents processed, error rates, satisfaction surveys, and other similar measures can be used. The concept of a balanced scorecard is discussed later in this chapter, and it can be very relevant to evaluating a cost center. Profit CenterA restaurant chain may evaluate each store as a separate profit center. The store manager is responsible for the store’s revenues and expenses. A store with more revenue would generate more food costs; an assessment of food cost alone would be foolhardy without giving consideration to the store’s revenues. For profit centers, the flexible budgets discussed in this chapter are useful evaluative tools. Other techniques include a unit-by-unit profitability analysis using traditional financial statement ratios. Investment CenterOne popular method was pioneered by E. I. du Pont de Nemours and Company. It is commonly known as the DuPont return on investment (ROI) model and is pictured at right. This model consists of a margin subcomponent (Operating Income ÷ Sales) and a turnover subcomponent (Sales ÷ Average Assets). These two subcomponents can be multiplied to arrive at the ROI. A bit of algebra reveals that ROI reduces to a simpler formula: Operating Income ÷ Average Assets. A prudent manager who is to be evaluated under the ROI model will quickly realize that the subcomponents are important. ROI can be improved by increasing sales, reducing expenses, and/or decreasing the deployed assets. The DuPont approach encourages managers to focus on increasing sales, while controlling costs and being mindful of the amount invested in productive assets. A disadvantage of the ROI approach is that some “profitable” opportunities may be passed by managers because they fear potential dilution of existing successful endeavors. Nexus of ControlCase StudyFollowing is an organization chart for Out To Lunch. The block colors in the organization chart indicate the character of performance/responsibility evaluation that is part of each position. The Chief Executive Officer reports to the owners, and the owners are primarily interested in their return on investment. Three vice presidents report to the CEO:
ReportingA company’s accounting system should support preparation of an accounting report for each responsibility center. This information is essential to monitor, control, and direct each business unit. Oftentimes, the reports will provide a comparison between budgeted and actual data, with the difference being reported as a variance. These reports should be consistent with the organizational structure of the firm. At higher levels, the reports tend to include less transaction-specific detail and more combinations of business units. For Out To Lunch, each store may have a customized performance report as shown: The next step up in the organizational chart is the Senior Manager of Store Operations. This person is concerned with making sure that each unit is profitable. Underperforming stores are identified, problems are studied, and corrective measures are taken. Very little time is spent on locations that are meeting or exceeding corporate profit goals. Although this manager has access to the detailed reports for each store, the performance report of interest is a compilation of summary data for each location that quickly highlights the areas of needed improvement. Review the following performance report, noting the carry forward of Location A’s data into the report. Obviously, some stores are performing much better than others. The senior manager will certainly want to focus on store E immediately! Also notice that there is $1,500,000 of fixed costs associated with store operations that is not traceable to any specific location; nevertheless, the senior manager of store operations must control this cost, and it is subtracted in calculating the overall margin. Thus, the total fixed cost for all store operations is $9,500,000 ($8,000,000 + $1,500,000). Continuing up the organizational chart, the VP of Operations will focus on summary data from store, catering, and procurement management. Notice that the “stores” column is derived from information found in the “combined” column (from the performance report for all stores). Again, note the presence of fixed costs that are not traceable to any specific operating segment ($1,300,000). Even though this cost is not assigned to a specific segment, it remains a cost for which the VP of Operations is responsible. The CEO would have access to all reports from within the organization, but would mostly focus on reports emanating from each vice president. Management will tend to focus on areas where corrective measures are necessary. This is generally referred to as management by exception. Traceable Vs. Common Fixed CostsThe preceding reports separated fixed expenses between those that were traceable to a specific business unit and common fixed costs. Traceable fixed costs would not exist if the unit under evaluation ceased to exist. Common fixed costs support the operations of more than one unit. Great care must be taken in distinguishing between the two. Effective performance evaluations require a clear alignment of responsibility and accountability. To the extent a unit manager is burdened with allocations of common costs, poor signaling of performance can result. Database Systems
Principlesofaccounting.com ™ Copyright © 2022. All rights reserved. Which of the following is a true statement a all costs are controllable at some level within a company?All costs are controllable at some level within a company. This is true.
Which types of responsibility centers generate both revenues and costs quizlet?A profit center is a business center that generates both revenue and costs. Some profit centers are also considered investment centers. An investment center is a profit center for which management is able to measure objectively the cost of assets used in the center's operations.
Which of the following is not an element of responsibility accounting?Accounting centre is not a part of responsibility accounting. Responsibility accounting basically refers to a system in which different divisions of the organisation are established as responsibility centres. Was this answer helpful?
Which center is a responsibility center that incurs costs but does not directly generate revenues?A cost center is a unit of a business that incurs costs but does not directly generate revenues.
|