1 Responsibility Accounting Prepared by Douglas Cloud Pepperdine

1 Responsibility Accounting Prepared by Douglas Cloud Pepperdine University 9

2 Objectives § Define goal congruence and explain its After reading relationship to control and this performance evaluation. chapter, you should be able to: § 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. Continued

3 Objectives § 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.

4 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.

5 Responsibility Centers A responsibility center is an activity, such as a department, that a manager controls. Types of Responsibility Centers Cost centers Revenue centers Profit centers Investment centers

6 Responsibility Centers 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

7 Responsibility Centers 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

8 Responsibility Centers • 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.

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

10 Performance Evaluation 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.

11 The 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.

12 The Balanced Scorecard 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)

13 Responsibility Reports for Cost Centers Current Month Year to Date Budget Over (Under) Budget (Under) $ 3, 200 $(80 ) $ 12, 760 $ 110 Report to Supervisor of Work Station 106—Drill Press Materials Direct labor 14, 200 170 87, 300 880 Supervision 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

14 Responsibility Reports for Cost Centers Current Month Budget Year to Date Over (Under) Budget (Under) Report to Supervisor of Fabrication Department Station 106—Drill Press $19, 410 $ Station 107—Grinding Station 108—Cutting Total work stations 17, 832 122 98, 430 (213 ) 23, 456 876 112, 456 1, 227 $60, 698 $1, 062 $318, 506 $2, 018 Continued 64 $107, 620 $1, 004

15 Responsibility Reports for Cost Centers Current Month Budget Year to Date Over (Under) Budget (Under) Report to Supervisor of Fabrication Departmental costs (common to work stations): General supervision $12, 634 $ 0 $ 71, 234 $ 0 Cleaning 6, 125 324 32, 415 762 Other 1, 890 (67 ) 10, 029 (108 ) Total $81, 347 $1, 319 $432, 184 $2, 672 Report to Manager of Factory

16 Responsibility Reports for Cost Centers Current Month Budget Report to Manager of Factory Fabrication department Milling department Assembly department Casting department Total departments Year to Date Over (Under) Budget (Under) $ 81, 347 $1, 319 $ 432, 184 $2, 672 91, 234 (2, 034 ) 405, 190 (4, 231 ) 107, 478 854 441, 240 1, 346 78, 245 (433 ) 367, 110 689 $358, 304 $ (294 )$1, 645, 724 $ 476 Continued

17 Responsibility Reports for Cost Centers Current Month Budget General factory costs (common to departments): Engineering $ 14, 235 Heat and light 8, 435 Building depreciation 3, 400 General administration 23, 110 Total factory costs $407, 484 Over (Under) $261 178 0 340 $ 485 Year to Date Over Budget (Under) $ 81, 340 $842 46, 221 890 20, 400 0 126, 289 776 $1, 919, 974 $2, 984

18 Responsibility Reports for Profit Centers (000 s) Report to Product Manager— Appliances, European Region Sales Variable costs: Production Selling and administrative Total variable costs Contribution margin Direct fixed costs Product margin Current Month Year to Date Over Budget (Under) $122. 0 $ 1. 5 $387. 0 $ 3. 2 $ 47. 5 12. 2 $ 59. 7 $ 62. 3 36. 0 $ 26. 3 $ 2. 8 1. 8 $ 4. 6 $ (3. 1 ) $ (1. 2 ) $ (1. 9 ) $150. 7 $ 5. 9 38. 7 1. 9 $189. 4 $ 7. 8 $197. 6 $(4. 6 ) 98. 5 (3. 1 ) $ 99. 1 $ (1. 5 ) To report to manage—European Region

19 Responsibility Reports for Profit Centers (000 s) Report to Manager— European Region Profit margins: Appliances Industrial equipment Tools Total product margins Regional expenses (common all product lines) Regional margin Current Month Year to Date Over Budget (Under) $26. 3 37. 4 18. 3 $82. 0 $(1. 9 ) 3. 2 1. 1 $ 2. 4 $ 99. 1 134. 5 59. 1 $292. 7 18. 5 $63. 5 0. 8 $ 1. 6 61. 2 $231. 5 $(1. 5 ) 7. 3 (2. 0 ) $ 3. 8 to (1. 3 ) $ 5. 1 Report to Executive Vice President

20 Responsibility Reports for Profit Centers (000 s) Report to Executive Vice President Regional margins: European Asian North American Total regional margins Corporate expenses (common all regions) Corporate profit Current Month Year to Date Over Budget (Under) $ 63. 5 78. 1 211. 8 $353. 4 87. 1 $266. 3 $ 1. 6 $ 231. 5 $ 5. 1 (4. 3 ) 289. 4 (8. 2 ) (3. 2 ) 612. 4 (9. 6 ) $ (5. 9 ) $1, 133. 3 $(12. 7 ) to 1. 4 268. 5 3. 1 $ (7. 3 ) $ 864. 8 $(15. 8 )

21 Analyzing Contribution Margin 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.

22 Contribution Margin Variance 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 Difference Sales $400, 000 $399, 000 $(1, 000) Variable costs 240, 000 252, 000 (12, 000) Contribution margin $160, 000 $147, 000 $(13, 000)

23 Sales 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 $8, 000 = $8 x (21, 000 – 20, 000)

24 Sales 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 $21, 000 F = units sold x (actual price – budgeted price) = 21, 000 x ($19 - $20)

25 Cost Allocations on Responsibility 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.

26 Arguments Against Allocating Indirect Fixed Costs 1. Because indirect fixed costs are not controllable by the users, allocating them violates the principle of controllability. 2. Including allocated costs on performance reports could lead to poor decisions because managers will treat the costs as differential.

27 Allocation Methods and Effects: Allocating Actual Costs Based on Actual Use This 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.

28 Allocation Example Raleigh Company has one service department, Maintenance, and two operating departments, Fabrication and Assembly. Data for the departments follow: Operating Hours of Maintenance Service Used Department: Budgeted Actual Fabrication 20, 000 Assembly 20, 000 10, 000 Total 40, 000 30, 000 Maintenance Department Costs for Year: Budgeted Actual Variable (budgeted, $5. 00; actual, $5. 10) $200, 000 $153, 000 Fixed 75, 000 79, 500 Totals $275, 000 $232, 500

29 Allocation Example Actual per-hour cost of providing the service = $232, 500 30, 000 hours = $7. 75/hr. Allocations would be: Fabrication (20, 000 x $7. 75) $155, 000 Assembly (10, 000 x $7. 75) 77, 500 Total maintenance costs allocated $232, 500

30 Methods to Allocate Service Department Costs (Appendix) ü Direct method ü Step method ü Reciprocal method

31 Direct Method • Illustrated in the chapter material • Direct method ignores services that service depts. Provide to other service depts.

32 Step-Down Method • Also called: step-down allocation or step method • Recognizes that service depts. Provide services for other service depts. As well as operating depts. • Result: costs of all service depts. , except first to be allocated, will reflect their shares of the costs of some other service depts.

33 Reciprocal Method • Also called simultaneous method • Recognizes the services that each service dept. renders to other service depts. • 1 st – the percentages that each service dept. receives from the other are decided upon. • 2 nd – adjusted costs are calculated – to recognize that depts. Provide service to each other. • Finally – these adjusted costs are allocated to the operating depts. Using the percentages computed.

34 Chapter 9 The End

35