Responsibility accounting

1
Responsibility accounting

• Benefits of managing decentralised organizations
• management concentrates on strategic decisions
  and coordination of activities of the whole
  organisation
• better information for decision-taking at a level
  where the problem exists
• improved management of managers' knowledge, they
  learn as the organisation grows and
  responsibilities change
• greater elasticity in decentralised organisations
  
• decentralisation allows for more effective
  assessment of managers
• Need to develop managerial control
• control is aimed at ensuring fulfillment of goals
  set by the management
• Accounting based on responsibility centers -
  provides information needed for managerial
  control

2
Responsibility centers (1)

• Responsibility center (pl. centrum
  odpowiedzialnosci)
• organisational unit, which is responsible for
  management of particular (selected) group of
  activities and which is headed by a manager with
  a delineated set of competences and
  responsibilities
• Conditions for effective managerial control
• organisational structure with specific units
• specified set of skills and responsibilities
  required for the unit managers
• precisely described relationships between
  employers and employees
• Types of responsibility centers
• for costs, for profit, for investment

3
Responsibility centers (2)
4
Cost center

• Cost center (pl. Centrum kosztów )
• lowest scope of responsibility
• managers are responsible for incurring costs
• managers have a right to take decisions that have
  an impact on the level of costs and need
  information required to control the process of
  the implementation of decisions and costs
• Identification of responsibility centers
• spatial
• organisational
• informational
• subjective
• decisional
• Assessment of cost centers
• minimalisation of total costs for the fixed level
  of activities

5
Cost center - problems

• Responsibility of cost centers
• taking decisions which ensure implementation of
  activities as well as conformity of controlled
  costs to a plan (budget, standards)
• explaining existing deviations, also due to
  reasons beyond cost center's control
• Limitations of cost control
• in a short-term there is a low possibility to
  change costs
• subjective assessment, which costs are controlled
  
• impact of external economic variables
• impact of unpredictable events
• problem of interdependencies between
  responsibility centers

6
Profit center

• Profit center (pl. Centrum zysków)
• greater need for management than for cost centers
  
• managers responsible for originating costs and
  generating income (profits)
• specifying profit centers is based on the same
  criteria as specifying cost centers
• profit centers may include one, few or tens of
  cost center(s)
• if a profit center provides services to other
  profit centers in a company in order to price the
  internal services transfer prices (internal
  prices) are used
• Assessment of profit centers
• based on income (profit)

7
Profit center - problems

• Set correct transfer prices inside the company
• Allocated common costs to responsibility centers
• Profit centers concentrating only on its profits
  often ignore activities which impact results of
  other responsibility centers

8
Investment center

• Investment center (pl. Centra inwestycyjne)
• possesses the largest scope of responsibility
• managers are responsible for profits, costs and
  assets
• investment centers may include one or more profit
  centers
• for investment decision-taking ex-ante
  information about costs and profits as well as
  information about inflows and outflows of various
  alternatives are necessary
• Assessment of investment centers
• Return on Investment (ROI)
• Residual Income (RI)
• Economic value added (EVA)

9
Investment centers - problems

• Choice of measure used for assessment
• necessity to include costs and profits common
  with other centers as well as services present
  among centers
• necessary to include effectiveness investment
  processes
• Difficulty in comparing cost centers of different
  sizes

10
Return of Investment - ROI

• Return on Investment ROI (pl. Stopa zwrotu z
  aktywów)

11
Calculation of ROI
12
How to calculate ROI?
13
Example How to calculate ROI

• Assets of the operational unit 100 000
• Income from operations
  18 000
• Sales
  200 000

Income from operations Assets of operational unit
18 000 100 000
ROI

18
Return on sales
18 000 200 000

9
Return on assets
200 000 100 000

2 times
ROI 9 x 2 18
14
Limitations of utilising ROI

• Using ROI to assess activities has its
  limitations
• ROI measure is not directly tied to the goal of
  maximising the value of the enterprise for its
  owners
• ROI used as an assessment measure of managers can
  lead to incorrect investment decisions
• ROI is a short-term assessment measure

15
Residual income

• Residual income RI (pl. Zysk rezydualny)
• so the surplus of an income from operations
  result of operational activities, which an
  investment center can generate over a specific
  rate of return using available operational assets
• RI as an assessment measure
• aim of the investment center maximising the
  residual income

16
How to calculate RI?

• Revenues from sales 12 000 000
• Average value of operational assets 8 000 000
• Income from operations 1 200 000
• ROI (1 200 000/8 000 000) x 100 15
• Minimum result from operations (12 x 8 000 000)
  960 000
• RI (1 200 000 960 000) 240 000

17
ROI and RI in decision-taking (1)

• Assumption ALFA Co. can invest 300 000 zl in
  activating new product line, which will lead to
  increase of sales by 636 000 zl per annum, cost
  of goods sold by 500 000 zl, sales costs by 56
  000 zl and administrative costs by 40 000 zl.

P/L Statement for ALFA Co. Before the project Incremental result from the project After the project
Sales revenue 1 200 0000 636 000 12 636 000
Cost of goods sold (COGS) 9 000 000 500 000 9 500 000
Gross income from sales 3 000 000 136 000 3 136 000
Sales costs 1 000 000 56 000 1 056 000
Administrative costs 400 000 40 000 440 000
Income from sales 1 600 000 40 000 1640 000
Other operational income 400 000 - 400 000
Other operational costs 800 000 - 800 000
Income from operations 1 200 000 40 000 1 240 000
18
ROI and RI in decision-taking (2)
Before the project Incremental result from the project After the project
Average operating assets 8 000 000 300 000 8 300 000
Income from operations 1 200 000 40 000 1 240 000
ROI 15 13 14,94

• Investment in the project decreases the ROI
  measure, which is why the ALFA manager, assessed
  based on ROI, will reject the project

19
ROI and RI in decision-taking (3)
Before the project Incremental result from the project After the project
Sales 12 000 000 600 000 12 600 000
Average operating assets 8 000 000 300 000 8 300 000
Income from operations 1 200 000 40 000 1 240 000
ROI 15 13 14,94
Minimal required result from operating activities 960 000 36 000 996 000
RI 240 000 4 000 244 000

• Investment in the project increases the RI
  measure, which means that the manager assessed
  based on RI will undertake the project
• Limited use of RI should not be used to assess
  investment centers of various sizes, bigger
  investment centers can show larger RI

20
Economic value added - EVA

• EVA (ang. economic value added)
• measure that shows the value that the activities
  of a given investment center "add" to the value
  of an enterprise
• shows the aim of activities of an enterprise
  maximialisation of its value

EVA Wynik operacyjny koszt kapitalu x
zainwestowane srodki

• Limitations of applying the EVA
• short-term measure based on annual data
• its used can lead to faulty investment decisions
  taken by managers interested in short-term
  benefits
• Modifications of EVA
• e.g. bonus bank managers lose motivation to
  conduct long-term non-income generating projects

21
EVA in decision-taking (1)
P/L Statement of Gamma Co. 2001 2002
Sales revenue 12 200 000 20 000 000
Cost of goods sold (COGS) 7 400 000 15 000 000
Gross income from sales 4 800 000 5 000 000
Sales costs 1 200 000 1 000 000
Administrative costs 2 000 000 1 500 000
Income from sales 1 600 000 2 500 000
Other operational income 400 000 400 000
Other operational costs 500 000 400 000
Income from operations 1 500 000 2 500 000

• Assets in 2001 - 10 000 000 zl, in 2002 20 000
  000 zl
• Liabilities in 2001 - 3 000 000 zl, in 2002 4
  000 000 zl
• Cost of capital set at 10

22
EVA in decision-taking (2)
2001 2002
Return on sales 12,29 12,5
Return on assets 1,22 1
ROI 15 12,5
EVA 800 000 900 000
Calculation 1,5 mln-7mln100,8 mln 2,5mln-16mln100,9 mln

• Decrease in ROI worsening of the investment
  center's effectiveness?
• Increase in EVA improvement of the investment
  center's effectiveness?