Responsibility Centers 529-534
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Responsibility Centers
Responsibility Center
An organization unit for which a manager is made responsible
Manager of Responsibility Center
Establish goals Promote long-term interests Promote coordination of each responsibility center’s activities
Responsibility Centers & Financial Control
Coordinating Responsibility Centers Financial Results
Nonfinancial Results
Aggregate measures Identify causes/drivers of financial results
Financial Control
A summary measure
Responsibility Center Types – I
Cost Centers
Control: costs Candidate: processing group Evaluation
actual costs vs. target/standard costs current costs vs. previous costs
Other measurements
Responsibility Center Types – II
Revenue Centers
Control: revenues Candidate: sales office of a corporation Evaluation
based solely on revenues net revenue
Undesirable consequences
Responsibility Center Types – III
Profit Centers
Control: revenues and costs Candidate: individual units of chain operation Evaluation: not rely only on the unit’s profit
no one in organization can control performance poor corporate decisions poor local decisions
Quality, material use, labor use, service
Responsibility Center Types – IV
Investment Centers
Control: revenues, costs, and investment Candidate: independent business Evaluation: ROI relative to target
Evaluating Responsibility Centers
Controllability Principle
the manager of a responsibility center should be held responsible only for the revenues, costs, or investment that responsibility center personnel control
Exclude: Revenues, costs, or investments that people outside the responsibility center’s control
Problems with the Controllability Principle
many revenues and costs are jointly earned or incurred the activities that create the final product are sequential and interdependent requires the firm to consider many facets of performance
Problems with the Controllability Principle (cont.)
The organization could prepare accounting summaries of the performance to support some system of financial control.
What are the harvesting revenues? What costs of production does marketing control? How much influence does harvesting and processing have on sales?
Using Performance Measures to Influence (instead of evaluate)
When more costs or revenues are included in performance measures, managers are more motivated to find actions that can influence incurred costs or generated revenues
Margin Reports
Organization units as profit centers.
Decide how to assign the responsibility for jointly earned revenues and jointly incurred costs
How to handle the interactions among the various profit center units?
Example Earl’s Motors
New car sales Used car sales Body shop Service department Leasing
Good or Bad Numbers? Past Performance
1. •
Is the performance this period reasonable, given past periods?
Comparable Organizations
1. •
•
How does performance compare with similar organizations? Evaluate by using absolute and relative amounts.
!!! CAUTION !!!
Segment margins reflect many assumptions that disguise underlying issues. Must also consider
Quality and service that will affect future profits Subjective revenue and cost allocation assumptions Transfer pricing issue (most important)
Transfer Pricing Transfer Pricing is the set of rules an organization uses to allocate jointly earned revenue among responsibility centers. The primary purpose of producing management accounting numbers is to motivate desirable behavior regarding managers’ decision making. Sale of a new car with a trade-in will affect profits of both the dealership’s new car dept. and used care dept.
Approaches to Transfer Pricing
Market-based transfer prices
Cost-based transfer prices
Negotiated transfer prices
Administered transfer prices
Market-Based Transfer Prices
Indication
Example
If external markets exist for the transferred product, market prices are the most appropriate basis for pricing the transferred product between responsibility centers. Car Trade-ins, there is an external market for used cars with well-defined yet subjective values.
Problem
Well-defined competitive markets seldom exist
Cost-Based Transfer Price
Indication
Example
When the transferred good does not have a well-defined market price. Some common transfer prices are flexible cost, flexible cost + markup, full cost.
Problem
May lead centers’ managers to choose a lower than optimal level of transactions, causing loss to the organization.
Negotiated Transfer Price
Indication
Example
In the absence of market prices, organizations allow supplying and receiving responsibility centers to negotiate transfer prices among themselves. Best transfer price results when the purchasing unit offers to pay the net realizable value or the selling price of the product less costs of preparation for final sale.
Problem
During negotiation the supply division want a higher price than optimal and the receiving division want a lower price than optimal.
Administered Transfer Price
Indication
Example
When all else fails, an arbitrator sets the transfer price. Manager may choose market price less 10%, provides an arbitrary distribution of revenues and costs between the divisions.
Problem
Subsidies will occur and obscure the economic interpretation of the responsibility centers and may provide a negative emotional effect.
Responsibility Center
An organization unit for which a manager is made responsible
Manager of Responsibility Center
Establish goals Promote long-term interests Promote coordination of each responsibility center’s activities
Responsibility Centers & Financial Control
Coordinating Responsibility Centers Financial Results
Nonfinancial Results
Aggregate measures Identify causes/drivers of financial results
Financial Control
A summary measure
Responsibility Center Types – I
Cost Centers
Control: costs Candidate: processing group Evaluation
actual costs vs. target/standard costs current costs vs. previous costs
Other measurements
Responsibility Center Types – II
Revenue Centers
Control: revenues Candidate: sales office of a corporation Evaluation
based solely on revenues net revenue
Undesirable consequences
Responsibility Center Types – III
Profit Centers
Control: revenues and costs Candidate: individual units of chain operation Evaluation: not rely only on the unit’s profit
no one in organization can control performance poor corporate decisions poor local decisions
Quality, material use, labor use, service
Responsibility Center Types – IV
Investment Centers
Control: revenues, costs, and investment Candidate: independent business Evaluation: ROI relative to target
Evaluating Responsibility Centers
Controllability Principle
the manager of a responsibility center should be held responsible only for the revenues, costs, or investment that responsibility center personnel control
Exclude: Revenues, costs, or investments that people outside the responsibility center’s control
Problems with the Controllability Principle
many revenues and costs are jointly earned or incurred the activities that create the final product are sequential and interdependent requires the firm to consider many facets of performance
Problems with the Controllability Principle (cont.)
The organization could prepare accounting summaries of the performance to support some system of financial control.
What are the harvesting revenues? What costs of production does marketing control? How much influence does harvesting and processing have on sales?
Using Performance Measures to Influence (instead of evaluate)
When more costs or revenues are included in performance measures, managers are more motivated to find actions that can influence incurred costs or generated revenues
Margin Reports
Organization units as profit centers.
Decide how to assign the responsibility for jointly earned revenues and jointly incurred costs
How to handle the interactions among the various profit center units?
Example Earl’s Motors
New car sales Used car sales Body shop Service department Leasing
Good or Bad Numbers? Past Performance
1. •
Is the performance this period reasonable, given past periods?
Comparable Organizations
1. •
•
How does performance compare with similar organizations? Evaluate by using absolute and relative amounts.
!!! CAUTION !!!
Segment margins reflect many assumptions that disguise underlying issues. Must also consider
Quality and service that will affect future profits Subjective revenue and cost allocation assumptions Transfer pricing issue (most important)
Transfer Pricing Transfer Pricing is the set of rules an organization uses to allocate jointly earned revenue among responsibility centers. The primary purpose of producing management accounting numbers is to motivate desirable behavior regarding managers’ decision making. Sale of a new car with a trade-in will affect profits of both the dealership’s new car dept. and used care dept.
Approaches to Transfer Pricing
Market-based transfer prices
Cost-based transfer prices
Negotiated transfer prices
Administered transfer prices
Market-Based Transfer Prices
Indication
Example
If external markets exist for the transferred product, market prices are the most appropriate basis for pricing the transferred product between responsibility centers. Car Trade-ins, there is an external market for used cars with well-defined yet subjective values.
Problem
Well-defined competitive markets seldom exist
Cost-Based Transfer Price
Indication
Example
When the transferred good does not have a well-defined market price. Some common transfer prices are flexible cost, flexible cost + markup, full cost.
Problem
May lead centers’ managers to choose a lower than optimal level of transactions, causing loss to the organization.
Negotiated Transfer Price
Indication
Example
In the absence of market prices, organizations allow supplying and receiving responsibility centers to negotiate transfer prices among themselves. Best transfer price results when the purchasing unit offers to pay the net realizable value or the selling price of the product less costs of preparation for final sale.
Problem
During negotiation the supply division want a higher price than optimal and the receiving division want a lower price than optimal.
Administered Transfer Price
Indication
Example
When all else fails, an arbitrator sets the transfer price. Manager may choose market price less 10%, provides an arbitrary distribution of revenues and costs between the divisions.
Problem
Subsidies will occur and obscure the economic interpretation of the responsibility centers and may provide a negative emotional effect.
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