Divisional Performance Measurement

6. According to Kaplan and Norton, what should be the main perspective of the balanced scorecard?
A. Financial.
B. Customer.
C. Internal business process.
D. Learning and growth.
7. According to Norton and Kaplan, the balanced scorecard should be used as
A. A control system.
B. A diagnostic system.
C. A strategic system.
D. A and B.
8. The various stakeholders include vendors, employees, distributors, customers, stockholders and society.
According to Norton and Kaplan, which of these should be represented on the balanced scorecard?
A. All stakeholders are important and should be included.
B. All except society which is too general to be included.
C. Only employees, customers and stockholders.
D. Only those are vital for achieving the company’s strategy.
9. Norton and Kaplan recommend that a separate balanced scorecard be developed for
A. Each department within the company.
B. Each product line within the company.
C. Each division or business unit with the company.
D. The whole company.
10. Norton and Kaplan argue that balanced scorecard measurements should
A. Clearly indicates the person responsible.
B. Be linked.
C. Be reinforcing.
D. Both B. and C.
11. Advocates of which of the following theories would be the most likely to criticize the balanced scorecard
concept?
A. Japanese management theory.
B. Deming’s theory of management.
C. JIT management theory.
D. Goldratt’s theory of constraints.

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12. In the Balanced Scorecard, Kaplan and Norton describe four perspectives that need to be balanced for
companies to become and remain competitive. Which perspective places more emphasis on investing in
employees?
A. Financial.
B. Customer.
C. Internal business processes.
D. Learning & growth.
13. According to Kaplan & Norton, which of the balanced scorecard perspectives is first in the chain of
cause and effect relationships?
A. Financial.
B. Customer.
C. Internal business processes.
D. Learning & growth.
14. According to Kaplan & Norton, which of the balanced scorecard perspectives serves as the focus of the
other perspectives?
A. Financial.
B. Customer.
C. Internal business processes.
D. Learning & growth.
15. Which of the following is not one of the main parts of the Kaplan-Norton balanced scorecard concept?
Balancing:
A. Financial and non-financial measurements.
B. Cash flows and non-cash flows.
C. Short term and long term measurements.
D. Leading and lagging indicators.
Answers:
1- A, 2-B, 3-D, 4-C, 5-C, 6- A, 7- C, 8- D, 9- C, 10- D, 11- D, 12- D, 13- D, 14- A, 15-B.

 State True or False

1. The target return makes no allowance for the different risk of each investment centre.
2. To overcome some of the dysfunctional consequences of ROI, the residual income approach can be
used.
3. RI = Divisional profit — (Percent capital charge × Divisional investment)
4. In a market-driven economy many Companies cannot create wealth.
5. EVA was developed by the US consulting firm Stern Stewart & Co
6. Economic value (or ‘shareholder value’) is defined as ‘the present value of the future cash flows of a
company, of a particular project or decision’.

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7. Positive EVA indicates that a company surpassed the expectations of its shareholders.
8. NOPAT is net operating profit after tax
9. Cost of debt after tax = Cost of debt before tax × (100 − marginal tax rate).
10. Responsibility accounting segregates costs and revenues into areas of responsibility, and a specific
manager is made responsible for each area.
Answers:
1- True, 2- True, 3- True, 4- False, 5- True, 6- True, 7- True, 8-True, 9- True, 10-True.

 Fill in the Blanks

1. When an organization has a ……………. structure, top management retains the majority of decision-
making authority.
2. A ……………. company sets up responsibility centers.
3. Most businesses are somewhere along the………………………
4. An……………. is a group of people with a common purpose.
5. ………………… means decisions are made at divisional and departmental levels.
6. The …………………. is an extended return on equity model, determined by multiplying the net profit
margin with the asset turnover and the equity multiplier.
7. …………. is the use of debt to acquire additional assets or fund projects.
8. ……………………ignores the cost of equity capital.
9. ……………………is a form of ROCE.
10. …………………. are appraised by discounted cash flow (DCF)
11 An ..................... has control over both profits and investment.
12 Decentralization is the delegation of .................... to individual divisions of an organization.
13 Operating income divided by sales is referred to as............................
14 “Turnover ...........................is divided by ..........................
15 Return on investment (ROI) can be expressed as a product of two factors ................... and ......................
This breakdown is often called the ..............................formula.
16. ....................... less a minimum rate of return on operating assets is referred to as residual income (RI).
17. .................... encourages investment in projects that would otherwise be rejected under ..........................
18. In choosing an appropriate transfer price, the three problems of .........................., and ......................
must be considered simultaneously.
Answers:
1- Centralized., 2- Decentralized, 3- Continuum, 4- Organization, 5- Decentralization, 6- DuPont analysis,
7- Financial leverage, 8- Profit, 9- Return on investment (ROI), 10- Investments, 11- Investment center, 12-
Decision making, 13- Margin, 14- Sales, Operating assets, 15- Margin, Turnover, Du Pont, 16 - Operating
income, 17- Return on investment, Residual income, 18- Goal congruence, Performance evaluation,
Autonomy.

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 Short Essay Type Questions

1. What is the meaning of performance measurement?
2. Explain traditional performance measurement techniques.
3. What are the shortcomings of traditional performance measures?
4. Describe the scope of the return on investment control.
5. Discuss the following perspectives of a balanced scorecard:
(a) Financial
(b) Customer
(c) Internal business process
(d) Learning and growth.
6. How is performance measures weighted?
7. In what way customer perspective is important in balanced scorecard?
8. Explain the prerequisites for adopting balanced scorecard in an organization.
9. Discuss the precautions to be taken in implementing balanced scorecards.
10. What is decentralization? What are the advantages of decentralization?

 Essay Type Questions

1. Define balanced scorecard. Explain characteristics of a good balanced scorecard.
2. List the components of ROI equation, tell how they are related and identify an action a manager can take
regarding each component to improve ROI.
3. Profit, Return on Investment and Residual Income have stood the test of time and are widely used for
measuring the performance of a division. Describe the strengths and weaknesses of these measures of
performance.
4. “The ROI measure may be based in favour of divisions with older plant and equipment.”
5. Explain the importance of learning and growth perspective.
6. Give some suggestions to be followed while using balanced scorecard.
7. Are financial measures alone sufficient to measure the performance of an organization during a period
and to use as a basis for compensating the senior executives of an organization? Why or why not?
8. What problems arise, if any, from monitoring and rewarding senior executives by a combination of
financial and non-financial measures?
9. What is strategic measurement model? Explain the important components of a strategic measurement
model.
10. Describe and compare the main performance measures that have been suggested to measure the divisional
performance.

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Practical Problems
 Multiple Choice Questions
1. At the end of 20X1, an investment centre has net assets of ₹1m and annual operating profits of ₹ 1,90,000.
However, the bookkeeper forgot to account for the following:
A machine with a net book value of ₹40,000 was sold at the start of the year for ₹50,000 and replaced
with a machine costing ₹ 2,50,000.
Both the purchase and sale are cash transactions. No depreciation is charged in the year of purchase or
disposal. The investment centre calculates return on investment (ROI) based on closing net assets.
Assuming no other changes to profit or net assets, what is the return on investment (ROI) for the year?
A 18·8%
B 19·8%
C 15·1%
D 15·9%
2. A division is considering investing in capital equipment costing ₹ 2.7m. The useful economic life of the
equipment is expected to be 50 years, with no resale value at the end of the period. The forecast return
on the initial investment is 15% per annum before depreciation. The division’s cost of capital is 7%.
What is the expected annual residual income of the initial investment?
A. ₹ 0
B. (₹ 2,70,000)
C. ₹ 1,62,000
D. ₹ 2,16,000
3. The following ratios have been calculated for a company:
Gross profit margin 42%
Operating profit margin 28%
Gearing (debt/equity) 40%
Asset turnover 65%
What is the return on capital employed for the company?
A. 27·3%
B. 18·2%
C. 11·2%
D. 16·8%
4. At the start of the year, a division has non-current assets of ₹ 4 million and makes no additions or
disposals during the year. Depreciation is charged at a rate of 10% per annum on all non-current assets
held at the end of the year. Working capital is ₹ 0.5 million at the start of the year although this is
expected to increase by 20% by the end of the year. The budgeted profit of the division after depreciation
is ₹1·2m.
What is the expected ROI of the division for the year, based on average capital employed?
A. 27·59%
B. 26·37%
C. 18·39%
D. 31·58%

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Answers:
1- B, 2-C, 3-B, 4-A.

 Comprehensive Numerical Questions

1. The cost accountant for Ray Lighting Manufacturing Company is planning production costs for a new
lamp. Production of the new lamp will be subject to a 60% learning curve since it involves only minimal
adjustments to established processes. The initial lot of 500 lamps is expected to require 1,000 hours of
labour. Costs are as follows:
Direct Labour ₹20/hour
Direct Materials ₹150/lot of 500
Variable OH Applied ₹25/Direct labour hour
What is the estimated cumulative average time per unit after 8 lots have been manufactured, if the
cumulative average-time learning model is used?
2. A company which has developed a new machine has observed that the time taken to manufacture the
first machine is 600 hours.
Required
Calculate the time which the company will take to manufacture the second machine if the actual learning
curve rate is (i) 80% and (ii) 90%. Explain which of the two learning rates will show faster learning.
3. The Chief Engineer of a manufacturing plant, manufacturing parts for aircraft observed that workers
performing manufacturing operations at the plant showed signs of a definite learning pattern.
He noted that most aircraft manufacturing tasks experienced what he called a 80 percent learning rate,
meaning that workers need 20 percent fewer hours to make a part each time their cumulative experience
making that part doubled. Thus, if the first part took 100 minutes, the second would require 80 minutes,
the fourth would require 64 minutes, and so on.
Required
Calculate the time required for parts 41 to 60.
[Note: learning coefficient is -0.322 for learning rate of 80%, log2=0.30103, log3=0.47712, log5=0.69897,
Antilog of 1.484 =30.48, Antilog of 1.4274 =26.75]
4. A Company makes gift items. A customer wants 4 identical pieces of gifts items. For this product, the
Company estimates the following costs for the 1st unit of the product:
Variable Costs (other than labour) ₹ 2,000
Direct Labour (20 hours @ ₹ 50 hour) ₹ 1,000
90 % learning curve ratio is applicable and one labourer works for one customer’s order.
(i) What is the price per piece to be quoted for this customer if the targeted contribution is ₹ 1,500 per
unit?

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(ii) If 4 different labourers made the 4 products simultaneously to ensure faster delivery to the customer,
can the price at (i) above be quoted? Why?

5. A company has 10 direct workers, who work for 25 day a month of 8 hours per day. The estimated down
time is 25% of the total available time. The company received on order for new product. The first unit of
the new product required 40 direct labour hours to manufacture the product. The company expects 80%
(index is – 0.322) learning curve for this type of work.

The company uses standard absorption costing and the cost data on a under:

Direct Materials ₹60 per unit

Direct Labour ₹6 per direct labour hour

Variable Overheads ₹1 per direct labour hour

Fixed Overheads ₹7,500 per month

(i) Calculate the cost per unit of the first order of 30 units.

(ii) If the company receives a repeat order for 20 units, what price will be quoted to yield a profit of 25%
on selling price?

6. SBI considers acquiring new computer equipment. The computer will cost ₹1,60,000 and result in a cash
savings of ₹ 70,000 per year (excluding depreciation) for each of the five years of the asset’s life. It will
have no salvage value after five years. Assume straight-line depreciation (depreciation expensed evenly
over the life of the asset). The company’s tax rate is 15 per cent, and there are no current liabilities
associated with this investment.

(a) What is the ROI for each year of the asset’s life if the division uses beginning-of-year net book value
asset balances for the computation?

(b) What is the economic value added each year if the weighted-average cost of capital is 25 per cent?

7. The following information relates to the operating performance of two divisions of SAIL, for last year:

Bokaro Division (₹) Durgapur Division (₹)

Operating Profit 8,00,000 12,00,000

Total Assets (based acquisition cost) 40,00,000 75,00,000

Total Assets (based on current replacement costs) 60,00,000 80,00,000

(a) Compute the return on investment (ROI) of each division, using total assets stated at acquisition cost
as the investment base.

(b) Compute the ROI of each division, using total assets based on current replacement cost as the
investment base.

(c) Which of the two measures do you think gives the better indication of operating performance?

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8. Calculate EVA with the help of following data:

Financial Leverage: 1.4 times
Capital Structure: Equity Capital ₹170 Lakhs
Reserves and Surplus ₹130 Lakhs
10% Debentures ₹400 Lakhs
Cost of Equity: 17.5%
Income Tax Rate: 30%
9. The following data is available for a concern. Compute EVA.
Debt Capital 12%: ₹2,000 crores
Equity Capital: ₹500 crores
Reserves and Surplus: ₹7,500 crores
Capital Employed: ₹10,000 crores
Operating Profit after Tax: ₹2,100 crores
Risk Free Rate: 9% Beta Factor: 1.05 Market Rate of Return: 19% Market Risk premium: 10% Tax
Rate: 30%.
10. The following data is available for a concern. Compute EVA.
Long Term Debt: ₹400 Lakhs
Equity Capital: ₹2,000 lakhs
Reserves and Surplus: ₹4,000 lakhs
Risk Free Rate: 9%
Beta Factor: 1.05
Market Rate of Return: 16%
Tax Rate: 30%
Interest: ₹40 Lakhs
Profit before interest and Tax: ₹2,000 lakhs

� Unsolved Cases
1. Listed below are a number of scorecard measures:
(a) Number of new customers
(b) Percentage of customers’ complaints resolved with one contact

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(c) Unit product cost

(d) Cost per distribution channel
(e) Suggestions per employee
(f) Quality costs
(g) Product functionality ratings (from surveys)
(h) Cycle time for solving a customer problem
(i) Strategic job coverage ratio
(j) On-time delivery percentage
(k) Percentage of revenues from new products
(i) Lead time, product development
Classify each measure according to the following perspective: financial or nonfinancial, subjective
or objective, and external or internal. When the perspective is process, identify which type of process:
innovation, operations, or post-sales service.
2. Organizations in the public and non-profit sector, such as government agencies and social service entities,
have financial systems that budget expenses and monitor and control actual spending. Identify why these
organizations should consider developing a balanced scorecard of measurements to monitor and report on
their performance. What should be the various perspectives in such a balance scorecard of measurements?
3. Should top managers be responsible for delivering excellent financial performance to shareholders, leaving
the details of customer relations, engineering design, and manufacturing operations to the mid-level managers
of these various departments? Explain.
4. In the last Corporate Training Programme that you, have attended as a participant, you have heard about
certain terms like, EVA, ROI, RI, and DuPont Control etc. Your Divisional Head now wants to hear from you
about the related terms that you have learnt in the training. Compare and contrast the use of residual income
and return on investment in divisional performance measurement, stating the advantages and disadvantages
of each.

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Key Terms
Balance Scorecard: The balanced scorecard translates an organization mission and strategy into a set of
performance measures that provides the framework for implementing the strategy.
Beta factor: The beta (β) of an investment security (i.e., a stock) is a measurement of its volatility of returns
relative to the entire market.
Centralization: It refers to the extent to which authority and decision making lie at the top of a hierarchy
Decentralization: It is referred to as a form of an organizational structure where there is the delegation of
authority by the top management to the middle and lower levels of management in an organization

DuPont Analyses: It is a multi-step framework of financial equations that provide insight into business’s
fundamental performance.
Economic Value Added (EVA): EVA is a value based financial performance measure, an investment decision
tool and it is also a performance measure reflecting the absolute amount of shareholder value created.
Financial leverage: Financial leverage is the use of debt to buy more assets. Leverage is employed to increase
the return on equity.
Learning Curve: The learning curve theory proposes that a learner’s efficiency in a task improves over time
the more the learner performs the task.
Net Operating Profit after Tax (NOPAT): It represents a company’s theoretical after-tax operating income
if it had no debt in its capital structure.

Return on Investment (ROI): Return on investment (ROI), also called rate of return or yield, is a measure
of the performance and efficiency of an investment.
Return on Capital Employed (ROCE): The return on capital employed shows how much operating income
is generated for each dollar of capital invested.

Residual Income (RI): This measure expresses divisional profit as a percentage of the firm’s investment in
the division and is similar to the widely accepted ‘return on capital employed’ measure used in the external
analysis and interpretation of accounts.

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SECTION - G
RESPONSIBILITY ACCOUNTING

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512 The Institute of Cost Accountants of India

A Responsibility Accounting

Responsibility Accounting 9

This Module includes -

9.1 Concept of Cost, Revenue, Profit and Responsibility Centres

9.2 Preparation of Responsibility Report

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Responsibility Accounting

SLOB Mapped against the Module

To gather in-depth knowledge of techniques and tools for profit planning, variance
analyses, optimal utilization of resources and responsibility accounting. (CMLO 3b,
5a, 5b).

Module Learning Objectives:

After studying this module, this module will be able to
 Appreciate the nuances of responsibility accounting.
 Understand the various responsibility accounting centres within an entity.
 Cognize the contents of a responsibility report and the presentation of the report.

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Concept of Cost, Revenue, Profit and

9.1
Responsibility Centres
Responsibility Accounting- Concept
• It is used to measure performance of divisions of an organisation rather than organisation as a whole.
• Responsibility Accounting is a system of control where responsibility is assigned for the control of
costs. The persons are made responsible for the control of costs.
• Proper authority is given to the persons so that they are able to keep up their performance. In case the
performance is not according to the predetermined standards then the persons who are assigned this duty
will be personally responsible for it. In responsibility accounting the emphasis is on men rather than on
systems.
• Responsibility Accounting collects and reports planned and actual accounting information about the
inputs and outputs of responsibility centres”
• Responsibility Accounting must be designed to suit the existing structure of the organization.
• Responsibility should be coupled with authority. An organization structure with clear assignment of
authorities and responsibilities should exist for the successful functioning of the responsibility accounting
system. The performance of each manager is evaluated in terms of such factors.

Responsibility Accounting- Meaning & Definition

• Responsibility accounting is a system of management accounting under which accountability is
established according to the responsibility delegated to various levels of management and a management
information and reporting system instituted to give adequate feedback in terms of the delegated
responsibility.
• Under this system, divisions or units of an organisation under a specific authority in a person are
developed as responsibility centres & evaluated individually for their performance.
• Horngreen: defines “Responsibility accounting is a system of accounting that recognizes various
responsibility centres throughout the organisation and reflects the plans and actions of each of these
centres by assigning particular revenues and costs to the one having the pertinent responsibility. It is also
called profitability accounting and activity accounting”. According to this definition, the organisation is
divided into various responsibility centres and each centre is responsible for its costs. The performance
of each responsibility centre is regularly measured.
• Institute of Cost and Works Accountants of India defines Responsibility accounting as “a system
of management accounting under which accountability is established according to the responsibility

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delegated to various levels of management and a management information and reporting system
instituted to give adequate feedback in terms of the delegated responsibility. Under this system divisions
or units of an organisation under a specified authority in a person are developed as responsibility centres
and evaluated individually for their performance.”

Essential Features of Responsibility Accounting

1. Inputs and Outputs or Costs and Revenues:
• The implementation and maintenance of responsibility accounting system is based upon information
relating to inputs and outputs.
• The physical resources utilized in an organisation such as quantity of raw material used and labour hours
consumed, are termed as inputs. These inputs expressed in the monetary terms are known as costs.
• Similarly, outputs expressed in monetary terms are called revenues.
• Thus, responsibility accounting is based on cost and revenue information.

2. Planned and Actual Information or Use of Budgeting:

• Effective responsibility accounting requires both planned and actual financial information.
• It is not only the historical cost and revenue data but also the planned future data which is essential for
the implementation of responsibility accounting system.
• It is through budgets that responsibility for implementing the plans is communicated to each level of
management.
• The use of fixed budgets, flexible budgets and profit planning are all incorporated into one overall
system of responsibility accounting.

3. Identification of Responsibility Centres:

• The whole concept of responsibility accounting is focused around identification of responsibility centres.
• The responsibility centres represent the sphere of authority or decision points in an organisation.
In a small firm, one individual or a small group of individuals, who are usually the owners may possibly
manage or control the entire organisation.
• However, for effective control, a large firm is, usually, divided into meaningful segments, departments
or divisions. These sub- units or divisions of organisation are called responsibility centres.
• A responsibility centre is under the control of an individual who is responsible for the control of activities
of that sub-unit of the organisation.
• This responsibility centre may be a very small sub-unit of the organisation, as an individual could be
made responsible for one machine used in manufacturing operations, or it may be very big division of
the organisation, such as a divisional manager could be responsible for achieving a certain level of profit
from the division and investment under his control.
• However, the general guideline is that “the unit of the organisation should be separable and identifiable
for operating purposes and its performance measurement possible”.

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4. Relationship between Organisation Structure and Responsibility Accounting System:

• A sound organisation structures with clear-cut lines of authority—responsibility relationships are a
prerequisite for establishing a successful responsibility accounting system.
• Responsibility accounting system must be so designed as to suit the organisation structure of the
organisation.
• It must be founded upon the existing authority- responsibility relationships in the organisation.
• In fact, responsibility accounting system should parallel the organisation structure and provide financial
information to evaluate actual results of each individual responsible for a function.

5. Assigning Costs to Individuals and Limiting their Efforts to Controllable Costs:

• After identifying responsibility centres and establishing authority-responsibility relationships,
responsibility accounting system involves assigning of costs and revenues to individuals.
• Only those costs and revenues over which an individual has a definite control can be assigned to him for
evaluating his performance
• The following guidelines should be followed while assigning of costs
o If the person has authority over both the acquisition and use of the services, he should be charged
with the cost of these services.
o If the person can significantly influence the amount of cost through his own action, he may be
charged with such costs.
o Even if the person cannot significantly influence the amount of cost through his own direct action,
he may be charged with those elements with which the management desires him to be concerned, so
that he will help to influence those who are responsible.

6. Performance Reporting:
• A control system to be effective should be such that deviations from the plans must be reported at the
earliest so as to take corrective action for the future. The deviations can be known only when performance
is reported.
• Responsibility accounting system is focused on performance reports also known as ‘responsibility
reports’, prepared for each responsibility unit.
• Unlike authority which flows from top to bottom, reporting flows from bottom to top. These reports
should be addressed to appropriate persons in respective responsibility centres.
• The reports should contain information in comparative form as to show plans (budgets) and the actual
performance and should give details of variances which are related to that centre.
• The variances which are not controllable at a particular responsibility centre should also be mentioned
separately in the report.

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Pre-requisites of Responsibility Accounting

• It should be a big company with divisionalised organisation structure
• The organisation should have clearly set goals and targets
• Managers should actively participate in establishing budgets against which their performance is
measured
• Managers are held responsible only for those activities over which they exercise significant degree of
control
• Performance reporting should be timely and contain significant information relating to the responsibility
centres

CONCEPT OF RESPONSIBILITY CENTRE:

Responsibility centre
• The main focus of responsibility accounting lies on the responsibility centres.
• A responsibility centre is a sub unit of an organization under the control of a manager who is held
responsible for the activities of that centre.
• It is like a small business to achieve the objectives of a large organisation
1. Cost Centre
o A cost or expense centre is a segment of an organisation in which the managers are held responsible
for the cost incurred in that segment but not for revenues.
o According to CIMA, London a cost centre is “a location person or equipment , for which costs
maybe ascertained and used for purposes of cost control”
o Responsibility in a cost centre is restricted to cost.
o For planning purposes, the budget estimates are cost estimates; for control purposes, performance
evaluation is guided by a cost variance equal to the difference between the actual and budgeted costs
for a given period.
o Cost centre managers have control over some or all of the costs in their segment of business, but not
over revenues.
o In manufacturing organisations, the production and service departments are classified as cost centre.
Also, a marketing department, a sales region or a single sales representative can be defined as a cost
centre.
o Cost centre may vary in size from a small department with a few employees to an entire manufacturing
plant. In addition, cost centres may exist within other cost centres.
o E.g. accounting department, repairs & maintenance department

2. Revenue Centre
o It is a segment of the organisation which is primarily responsible for generating sales revenue.

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o A revenue centre manager does not possess control over cost, investment in assets, but usually has
control over some of the expense of the marketing department.
o The revenue centre manager will control the selling price, promotion mix and product mix
o The performance of a revenue centre is evaluated by comparing the actual revenue with budgeted
revenue, and actual marketing expenses with budgeted marketing expenses.
o E.g. sales department

3. Profit Centre
o Also called business centre
o It is a segment of an organisation whose manager is responsible for both revenues and costs.
o In a profit centre, the manager has the responsibility and the authority to make decisions that affect
both costs and revenues (and thus profits) for the department or division.
o The managers are encouraged to act as if they were running their own separate business.
o The main purpose of a profit centre is to maximise profit by making decisions relating to production
volume, product mix, selling price, marketing strategy.
o Profit centre managers aim at both the production and marketing of a product.

4. Investment Centre
o It is responsible for both profits and investments.
o The investment centre manager has control over revenues, expenses and the amounts invested in the
centre’s assets.
o He also formulates the credit policy which has a direct influence on debt collection, and the inventory
policy which determines the investment in inventory.
o The manager of an investment centre has more authority and responsibility than the manager of
either a cost centre or a profit centre.
o Besides controlling costs and revenues, he has investment responsibility too. ‘Investment on asset’
responsibility means the authority to buy, sell and use divisional assets.
o E.g. a new hotel being developed

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Preparation of Responsibility Report 9.2

Responsibility performance reporting implies the reporting phase of responsibility accounting.
Responsibility reporting has two purposes:
(i) To determine the degree of performance in the area of responsibility for which the responsibility manager is
directly responsible.
(ii) To formulate measures to improve the performance of the responsibility centre manager.
The responsibility reporting should be suitable and relevant with respect to content, frequency of reporting and
level of details required. In order to provide relevant contents in the report, only those items that are controlled
by the particular responsibility centre manager should be reported. Frequency of reporting and the quantum
of details in the report can be decided in terms of requirements. Generally, in a production department of a
manufacturing enterprise, detailed data on production, direct costs, and indirect costs needs to be gathered and
reported to foreman quite frequently. However, the same data is reported to senior management in a summarized
form and at less frequent intervals. The difference in the frequency of reporting in this situation is due to the
fact that the foreman has direct responsibility whereas senior managers have overall responsibility for long-term
and strategic decisions. Usry and Hammer have mentioned the following as characteristics of responsibility
reporting:
1. Reports should fit the organization chart, that is, the report should be addressed to the individual responsible
for the items covered by it, who, in turn, will be able to control those costs under his jurisdiction. Managers
must be educated to use the results of the reporting system.
2. Report should be prompt and timely. Prompt issuance of a report requires that cost records be organized so
that information is available when it is needed.
3. Reports should be issued with regularity. Promptness and regularity are closely tied up with the mechanical
aids used to assemble and issue reports.
4. Reports should be easy to understand. Often they contain accounting terminology that managers with little or
no accounting training find difficult to understand, and vital information may be incorrectly communicated.
Therefore, accounting terms should be explained or modified to fit the user. Top management should have
some knowledge of the kind of items chargeable to an account as well as the methods used to compute
overhead rates, make cost allocations and analyze variances.
5. Reports should convey sufficient but not excessive details. The amount and nature of the details depend
largely on the management level receiving the report. Reports to management should neither be flooded
with immaterial facts nor so condensed that management lacks vital information essential to carrying out its
responsibilities.
6. Reports should give comparative figures, i.e., a comparison of actual with budgeted figures or of
predetermined standards with actual results and the isolation of variances.

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7. Reports should be analytical. Analysis of underlying papers, such as time tickets, scraps tickets, work orders,
and materials requisitions, provide reasons for poor performance which might have been due to power
failure, machine breakdown, an inefficient operator, poor quality of materials, or many other similar factors.
8. Reports for operating management should, if possible, be stated in physical units as well as in terms of
money since monetary information may give a foreman not trained in the language of the accountant a
certain amount of difficulty.
9. Reports may tend to highlight departmental efficiencies and inefficiencies, results achieved future goals or
targets.
Responsibility reports help each successively higher level of management in evaluating the performances of
subordinate managers and their respective organizational units. The reports should be tailored to fit the planning,
controlling and decision making needs of subordinate managers and should include both monetary and non-
monetary information.
Responsibility Report for Cost Centres
(₹)
General Manager Actual Cost Budgeted Cost Variance
Sales Department 3,65,000 3,75,000 (+)10,000
Production Department 3,75,000 3,75,000 -
Office and Administration 1,10,000 1,15,000 (+) 5,000
Interest on loans 20,000 15,000 (-) 5,000
Total 8,70,000 8,80,000 (+)10,000
(₹)
Production Manager Actual Cost Budgeted Cost Variance
Mfg. section 94,000 96,000 (+) 2,000
Testing section 1,20,000 1,21,000 (+) 1,000
Assembly section 1,61,000 1,58,000 (-) 3,000
Total 3,75,000 3,75,000 -
(₹)
Foreman (Manufacturing Division) Actual Cost Budgeted Cost Variance
Direct materials 50,000 48,400 (–) 1,600
Direct labour 31,000 34,000 (+) 3,000
Indirect labour 12,000 12,000 -
Supplies 1,000 1,600 (+) 600
Total 94,000 96,000 (+) 2,000
Analysis:
It is observed from the above that, each responsibility report contains items and information which are required
by the concerned responsibility centre manager and which are within his responsibility area.
Similarly, Responsibility Reports can also be prepared for other centres.

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Solved Illustrations & Cases

Illustration 1
The processing department of a large company informs the marketing department that the price of processing
2,00,000 items will be ₹50,00,000. The marketing department submits the material for the item two weeks later
than originally planned and tells the processing department that the scheduled date of completion has been
advanced two weeks. In order to achieve the new schedule, the processing department incurs an additional
production cost of ₹16,00,000.
(i) In an organization using responsibility accounting, where would the additional costs be assigned? Would
these costs be considered controllable costs? What effect might this have on future printing orders from the
marketing department?
(ii) In an organization that does not use responsibility accounting, where would the various costs be assigned?
What effect might this have on future printing orders from the marketing department?
Solution:
(i) In an organization using responsibility accounting, the originally quoted price of ₹ 50,00,000 plus the
additional cost of ₹16,00,000 would be assigned to the marketing department. This would be considered
a controllable cost. The long-range effect might be that the marketing department will become more cost-
conscious and will plan activities better.
(ii) In an organization that does not employ responsibility accounting; the additional production costs most
probably would be assigned to the processing department. There would be no motivation by the marketing
department to adhere to scheduled dates or to plan processing needs in a better fashion.
Illustration 2
The receipt of raw materials used in the manufacture of products and the shipping of finished goods
to customers are under the control of the warehouse supervisor. Approximately 60% of the warehouse
supervisor’s time is spent on receiving activities and 40% on shipping activities. Separate employees handle
the receiving and shipping operations. The labour-related costs for the warehousing function are as follows:
Warehouse supervisor’s salary ₹40,000
Receiving clerks’ wages ₹75,000
Shipping clerks’ wages ₹55,000
Employee benefit costs (30% of wage and salary costs) ₹51,000
₹2,21,000
The company employs a responsibility accounting system for performance reporting purposes. The costs are
classified on the report as period or product costs. You are required to state the total labour-related costs to list on
the responsibility accounting performance report as product costs under the control of the warehouse supervisor
for the warehousing function.
Solution:
This question focuses on product costs that are under the control of the warehouse supervisor. The supervisor
controls both receiving and shipping, but shipping is a selling cost. Thus shipping is a period cost that is expensed
in the period in which it is incurred, so shipping costs are not product costs. Therefore, the costs for the shipping

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department are not part of the answer, even though they are controllable by the warehouse supervisor. The
supervisor’s salary is not controlled by the supervisor, so that is not a part of the answer, either. The labour-related
product costs that the supervisor can control include only the wages and benefits of the receiving department.
The receiving clerks’ wages are ₹75,000 and their benefits are 30% of this amount (₹22,500). Therefore, the
supervisor controls ₹ 97,500 of costs (₹75,000 + ₹ 22,500).
Illustration 3
The following information for R & Co. for the prior year:
 The company produced 1,000 units and sold 900, both as budgeted.
 There were no beginning or ending work-in-process and no beginning finished goods inventory.
 Budgeted and actual fixed costs were equal, all variable manufacturing costs were affected by production
volume only, and all selling variable costs were affected by sales volume only.
 Budgeted per unit revenues and costs were as follows:
Sales price ₹100
Direct materials ₹30
Direct labour ₹20
Other variable manufacturing costs ₹10
Fixed manufacturing costs ₹5
Variable selling costs ₹12
Fixed selling costs (₹3,600 total) ₹4
Fixed administrative costs (₹1,800 total) ₹2
Calculate the contribution margin earned by R & Co. for the prior year
Solution:
Contribution margin is calculated as sales revenue minus the variable costs for the units sold. The sales price is
₹100 per unit and the variable costs total ₹72 per unit: Direct Material - ₹30; Direct Labour - ₹20; other variable
manufacturing costs - ₹10; Variable selling costs - ₹12. Thus, contribution is ₹28 per unit (₹100 − ₹72). 900 units
were sold, giving a contribution margin of ₹ 25,200.
Illustration 4
The Hind Company allocates national magazine advertising cost to territories on the basis of circulation, which
is determined by an index that measures relative buying power in the territories. Top management wants to know
if this method of allocation gives appropriate cost and benefit figures to make the following decisions:
(a) For deciding whether or not to close an unprofitable territory
(b) For deciding whether or not a territorial manager has obtained sufficient sales volume
(c) For determining how efficiently the territorial manager has operated the territory
(d) For determining whether or not advertising costs are satisfactorily controlled

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Solution:
The answers are as follows.
(a) It is not appropriate for deciding to close the territory. Closing the territory will not change the amount of
national advertising expenses. For deciding what action to take with respect to the territory, the segment
margin (sales less variable expenses less direct territorial fixed expenses) should be compared with the
amount of cost that can be saved by closing that territory. This will show whether or not the territory is
making a contribution to costs that will continue regardless of the decision.
(b) It may be appropriate for concluding that a territorial manager has obtained sufficient sales volume.
National advertising is one of the general distribution costs to be allocated to territories if there is evidence
of cause-and-effect relationships.
(c) The method is not appropriate. A territorial manager should be judged on the basis of expenses that he or she
has to control. By its nature, national advertising must be centrally controlled.
(d) It is not appropriate to allocate national advertising costs to territories from a control standpoint. Control can
be exercised only over the total expenditure for national advertising and at the source; control is not aided by
allocating this total to territories.
The following concepts are highlighted in the contribution approach to cost allocation:
 Contribution margin -Sales less variable costs.
 Contribution controllable by segment managers - Contribution margin less direct fixed costs controllable by
segment managers. Direct fixed costs include discretionary fixed costs such as certain advertising, research
and development, sales promotion, and engineering.
 Segment margin - Contribution controllable by segment managers less fixed costs controllable by others.
Fixed costs controllable by others include such traceable and committed fixed costs as depreciation, property
taxes, insurance, and the segment managers’ salaries.
 Net income - Segment margin less unallocated common fixed costs.
Illustration 5
You have a client who operates a large retail self-service grocery store that has a full range of departments.
Management has encountered difficulty in using accounting data as a basis for making decisions concerning
possible changes in departments operated, products, marketing methods, and so forth. List several overhead
costs, or costs not applicable to a particular department, and explain how the existence of such costs (sometimes
called common costs or joint costs) complicates and limits the use of accounting data in making decisions in
such a store.
Solution:
There are many examples of “common” costs to the sales department of a self-service grocery store. Some are
rent, supervision, trucking, and advertising.
Common costs are usually apportioned on various arbitrary bases to the sales departments, but for numerous
managerial decisions such apportionments produce misleading results. Decisions as to discounting a department,
adding a department, enlarging a department, or decreasing a department cannot be made based on the data
produced from the apportionments. For example, if a department is discontinued because it appears to be
unprofitable, it may be determined that the costs of other departments will increase as a result of having to absorb
more of the shared common costs. Thus, the overall operating results will be less favorable if the “unprofitable”
department is discontinued.

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Illustration 6
The monthly service charge a bank makes on a customer’s checking account is based on the cost of handling
each account. A customer disagrees with this policy because she cannot see how it is possible to determine the
exact cost of handling her account. Do you agree with the customer? Discuss fully the problems involved in
determining cost for such a service, including the limitations of the cost figures obtained.
Solution:
This is a problem involving fixed and common costs. Within considerable limits, the cost of operating a bank
would not change because of the addition of new accounts or the loss of old ones. The depreciation and other
costs associated with the bank building, fixtures and equipment, salaries of officers, and other such items are
fixed costs of operation within very wide limits. There would have to be a considerable change in the number
of accounts before there would be any noticeable impact on those fixed costs. There is also a question of joint
use of facilities among the various phases of bank operations. For example, the vault houses not only the files
of commercial accounts, but also the savings account records, collateral on loans, coins and bills, and many
other types of property and records. Unless the bank is large and the work highly specialized, a teller will handle
a good many types of operations during a working day. A given official may make loans, open new accounts,
advice customers as to investments, and so on. It would be extremely difficult to assign many of such operating
expenses to any particular type of operation, let alone any account.
The problem of determining a reasonable and useful cost for handling an account involves obtaining data related
to costs of functions and number of transactions handled, so that the direct or semi direct costs may be determined.
The average labour cost per transaction for tellers and for transit, clearings, and bookkeeping functions can be
obtained with considerable accuracy. Then it becomes necessary to allocate costs of all other necessary functions
to these and other principal banking operations. Like all allocations of fixed or indirect overhead, the allocations
will be arbitrary, but they can be made in a reasonable and logical manner by using appropriate bases.
While the costs obtained from such an accounting procedure may be useful for setting service charges, it must
be recognized that they do have one important limitation. They are average costs and not “differential costs.”
Therefore, they have limited usefulness for certain types of management decisions relating to expansion or
contraction of services or changes in operations.
Illustration 7
Consider each of the following scenarios:
(i) Mr. P K. Dhawan, plant manager for the laser printer factory of Bharat Co. brushed his hair back and
sighed. December had been a bad month; two machines had broken down, and some direct labourers (all on
salary) were idled for part of the month. Materials prices increased, and insurance premiums on the factory
increased. No way out of it —costs were going up. He hoped that the marketing VP would be able to push
through some price increases, but that really wasn’t his department.
(ii) Ms. Sonam Kapoor was delighted to see that her ROI figures had increased for the third straight year. She
was sure that her campaign to lower costs and use machinery more efficiently (enabling her factories to sell
several older machines) was the reason why she planned to take full credit for the improvements at her semi-
annual performance review.
For each of the above independent scenarios, indicate the type of responsibility center involved (cost,
revenue, profit, or investment).
Solution:
(i) Cost center — Total cost
(ii) Profit center — Operating Income
Hint: For explanation of the same, please read the relevant portion of the Study Module.

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EXERCISE
Theoretical Question
 Multiple Choice Questions
1. Which of the following would be the most appropriate measure to monitor the performance of the
manager of a profit centre?
A. Gross profit margin
B. Revenue minus all costs
C. Revenue minus controllable costs
D. Return on capital employed
2. In a responsibility accounting system, managers are accountable for:
A. Incremental costs.
B. Product costs but not for period costs.
C. Costs over which they have control.
D. Variable costs but not for fixed costs.
3. In designing a responsibility accounting system, one should keep in mind a certain characteristic
of each cost. This characteristic is:
A. The degree of cost controllability by the manager;
B. How the cost behaves with respect to volume;
C. The accuracy of cost allocation;
D. All of the above.
4. Which of the following statements are true about responsibility accounting?
A. Responsibility accounting results in inter-departmental conflicts
B. In responsibility center more focus is paid on products, processes or jobs
C. No focus is paid on controlling costs
D. None of the above
5. Which concept (or concepts) listed below is (are) consistent with traditional responsibility
accounting?
A. Vertical structure.
B. Cross functional measurements.
C. Bottom up control.
D. A and B.
6. In profit center revenue represents a monetary measure of output emanating from a profit center in
a given period irrespective whether
A. The revenue is realized or not
B. The output is sold or not
C. Both A and B
D. None of the above

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