Responsibility accounting is the system of gathering and reporting revenues and costs by areas of responsibility.
Advantages of Responsibility Accounting
1. Responsibility accounting delegates decision making. Line managers, department heads, and supervisors are entrusted with operational decisions. The top management (executives) could then focus on strategic or long-term organizational objectives.
2. It provides a guide to the evaluation of performance. It helps to establish standards which are used for comparison with actual results.
3. It promotes management by objectives and management by exception.
Management by Objectives and Management by Exception
Management by objective is an approach in which a manager agrees on a set of goals or objectives (hence the term management by objective). The performance of the manager and his or her subordinates are evaluated based on achievement of these goals.
Management by exception is another managerial approach in which management gives attention to matters that materially deviate from established standards. For example: when a department has very high costs compared to what was budgeted, the management will focus on finding out the reason behind it and fixing the concern perhaps by cutting costs, process re-engineering, establishing new standards, etc.
Requisites of Effective Responsibility Accounting
For effective implementation of responsibility accounting, the following must be met.
1. A well-defined organizational structure. Authority and responsibility must be clearly established and understood by all levels of management.
2. Performance evaluation measures and standards must be clearly established.
3. Only items that are under the influence of the manager of the responsibility center are included in performance evaluation reports. The manager should not be evaluated based on matters that are out of his or her control.
A responsibility center can be classified according to control over costs, revenues, and investments.
1. Cost center - A subunit of the organization that has control over cost only. It has no control over revenues and investments. Examples include: production department, maintenance department, accounting department, legal department, etc. Cost centers are evaluated using variance analysis of costs.
2. Revenue center - has control over revenue generation, but has no control over costs and investment, e.g. the sales and marketing department. Revenue centers are evaluated using variance analysis of revenues.
3. Profit center - has control over both revenues and costs. Examples include branches operating in different geographic locations. The performance of profit centers are evaluated by measuring segment income (based on controllable revenues and costs).
4. Investment center - A subunit that has control over revenues, costs, and investments (assets such as receivables, inventory, fixed assets, etc.). Since investment centers are given authority to decide over its investments, it operates like a separate entity. Examples include corporate headquarters and subsidiaries. Investment centers are evaluated using different profitability measures such as return on investment, residual income, economic value-added, and others.