A

PROJECT REPORT

ON

“Responsibility Accounting in Marketing Organization”

Submitted by-

Amit Kashikar

Dinesh Dhera

Roshan Rathi

Nitesh Naralkar

Swati Nikalje

Under the guidance of

MR. SUHAS CHAVHAN (Faculty- Marketing Finance)

Bharati Vidyapeeth’s Institute of Management Studies & Research

Sector 8, CBD-Belapur, Navi Mumbai –400614

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ACKNOWLEDGEMENT

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Index

Sr. no. Topic Pg. no

1 Introduction 4

2 Significance of Responsibility accounting 8

3 Principle and Objective 9

4 Centralization Vs Decentralization 10

5 Responsibility Centers 11

6 Affixing Responsibility 13

7 Responsible Center Report 15

8 Transfer Pricing 24

9 Problems in Responsibility Accounting 25

10 Conclusion 27

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INTRODUCTION TO RESPONSIBILITY BUDGETING

The gist of 20th century thinking management control is expressed by the mantra: let the
managers manage; make the managers manage. Responsibility budgeting is the stock answer
given by students of management accounting and control to the question of how to empower
managers to manage and, at the same time, motivate them to use their collective intelligence to
create value through exchange in product and financial markets and by establishing and
sustaining mutually beneficial relationships with customers, suppliers, and especially other
members of their organizations.

We cannot simply explain how responsibility budgeting is used and how it works. Responsibility
budgeting makes sense only as a part of a framework of structural, procedural, and
monitoring/reporting relationships. Therefore, it is essential to explain the framework that gives
it utility and power. At the same time, responsibilities budgeting and accounting, or their
functional equivalents, make an essential contribution to the efficacy of this broader framework
of relationships. One cannot arbitrarily mix and match administrative relationships and expect
that the outcome will be productive. The efficacy of administrative relationships depends upon
their congruity with each other as well as with the purposes and products of the entity in question
and the productive and information processing technologies available to it.

Responsibility budgeting is now the most common remote control system used by large-scale
organizations in the private sector. Within the accounting literature, agency theorists tend to
interpret responsibility budgeting as a practice for structuring the contractual relationship
between providers of economic resources (principals) and those who apply those resources in
economic activity (agents). The broad outline of this relationship is one where substantial
decisional authority is decentralized to agents, within the context of well-specified rules
determining how agents will be rewarded for their efforts. Rewards are to be based on economic
quantities of interest to principals, such as returns on capital employed. According to this
perspective, the management process mainly involves acquiring and deploying assets and, to
influence this process, principals must establish a consistent set of delegated decisions (grants of
authority to acquire assets), performance measures (resulting from the use of assets by agents),
and rewards (incentives for the agent to acquire and utilize assets in the principal's interests).
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While private businesses were quick to learn bureaucratic control from government,
governmental organizations have been slow to adopt remote control systems. The biggest
difference between government budgets and responsibility budgets is that government budgets
tend to be highly detailed spending or resource acquisition plans, which must be scrupulously
executed just as they were approved . In contrast, operating budgets in the private sector are
usually sparing of detail, often consisting of no more than a handful of financial targets. As we
noted earlier, Sloan of General Motors, one of the fathers of responsibility budgeting, believed it
was inappropriate for corporate managers know the details of responsibility center operations.
The notion that responsibility centers should be managed at arm's length, by the numbers, from a
small corporate headquarters, reflects the effort to delegate authority and responsibility down
into the organization. As the OECD report, Budgeting for Results: Perspectives on Public
Expenditure Management (1995), explains, delegation of authority means giving agency
managers the maximum feasible authority needed to make their units productive -- or, in the
alternative, subjecting them to a minimum of constraints. Hence, delegation of authority requires
operating budgets to be stripped to the minimum needed to motivate and inspire subordinates.
Under responsibility budgeting the ideal operating budget would contain a single number or
performance target (e.g., a production quota, a unit cost standard, or a profit or return on
investment target) for each administrative unit/responsibility center.

In responsibility budget formulation, an organization's policies, the results of all past policy
decisions, are converted into financial targets that correspond to the domains of administrative
units and their managers. In responsibility budget execution, operating performance is monitored
and subordinate managers are evaluated and rewarded. Operating performance targets must be
expressed in financial terms. This makes it possible to make comparisons across unlike
responsibility centers, thereby permitting the relative performance of managers to be evaluated
and increasing the motivational efficacy of internal competition. In traditional responsibility
budgets this also has the effect of keeping higher levels of administration ignorant of operating
details, thereby discouraging them from meddling in the affairs of their responsibility center
managers.

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In Budgetary Control, it is crucial that responsibility centre and accounting should be
initiated otherwise the managers will not be able to properly understand the company’s goals
or objectives

Responsibility Accounting is a system where:

• Managers are held responsible for the difference between the actual performance and
those budgeted;
• The managers are closely involved in the planning and controlling of the resources and
• Has a Responsibility centre which is a division or department in the organization for
them to be responsible for their performance.

Responsibility accounting is an underlying concept of accounting performance measurement

systems. The basic idea is that large diversified organizations are difficult, if not impossible
to manage as a single segment, thus they must be decentralized or separated into manageable
parts. These parts, or segments are referred to as responsibility centers that include:

1) Revenue centers :- Here, the manager is responsible for generating sales. A typical
example is the Sales Department
2) Cost Centers :- Here, the manager is responsible for costs. Example like for purchasing
department and Maintenance department.
3) Profit Centers :- The manager is responsible for both revenue and cost. The reason been
Revenue minus cost is the profit.The manager is therefore overall responsible or
accountable for making profit for the company. For example a company has many
restaurants which are all profit center. A manager is assigned to each restaurant to make
sure it is a profit center.
4) Investment centers An example of an investment centre is a Corporate division
responsible for project investments.Here, the manager is responsible for the investments
which includes all the revenue, costs and investments (invested capital or assets)

This approach allows responsibility to be assigned to the segment managers that have the
greatest amount of influence over the key elements to be managed. These elements include
revenue for a revenue center (a segment that mainly generates revenue with relatively little
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 costs), costs for a cost center (a segment that generates costs, but no revenue), a measure of
profitability for a profit center (a segment that generates both revenue and costs) and return
on investment (ROI) for an investment center (a segment such as a division of a company
where the manager controls the acquisition and utilization of assets, as well as revenue and
costs).

SIGNIFICANCE OF RESPONSIBILITY ACCOUNTING

The significance of responsibility accounting for management can be explained in the following
way:
• Easy Identification: It enables the identification of individual managers responsible for
satisfactory or unsatisfactory performance.

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 • Motivational Benefits: If a system of responsibility accounting is implemented,
consider-Accounting able motivational benefits are assured.

• Data Availability: A mechanism for presenting performance data is provided. A

framework of managerial performance appraisal system can be established on that basis,
besides motivating managers to act in the best interests of the enterprise.

• Ready-hand Information: Relevant and up to the minutes information is made available

which can be used to estimate future costs and or revenues and to fix up standards for
departmental budgets.

• Planning and Decision Making: Responsibility accounting helps not only in control but
in planning and decision making too.

• Delegation and Control: The twin objectives of management are delegating

responsibility while retaining controls are achieved by adoption of responsibility
accounting system.

PRINCIPLE & OBJECTIVE OF RESPONSIBILITY ACCOUNTING

The main features of responsibility accounting are that it collects and reports planned and actual
accounting information about the inputs and outputs of responsibility accounting.

Inputs and outputs:

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Responsibility accounting is based on information relating to inputs and outputs. The resources
used are called inputs. The resources used by an organization are essentially physical in nature
such as quantity of materials consumed, hours of labour, and so on. For managerial control, these
heterogeneous physical resources are expressed in monetary terms they are called cost. Thus,
inputs are expressed as cost. Similarly, outputs are measured in monetary terms as “revenues”. In
other words, responsibility accounting is based on cost and revenue data or financial
information.

Objectives of Responsibility Accounting:

Responsibility accounting is a method of dividing the organizational structure into various

responsibility centers to measure their performance. In other words responsibility accounting is a
device to measure divisional performance measurement may be stated as under:

1. To determine the contribution that a division as a sub-unit makes to the total

organization.

2. To provide a basis for evaluating the quality of the divisional managers performance.
Responsibility accounting is used to measure the performance of managers and it
therefore, influence the way the managers behave.

3. To motivate the divisional manager to operate his division in a manner consistent with
the basic goals of the organization as a whole.

CENTRALIZATION Vs DECENTRALIZATION DECISION

Sometimes by plan, and sometimes simply as a result of top managements' leadership style,
organizations will tend to gravitate to either a centralized or a decentralized style of
management. With a centralized style, the top leaders make and direct most important
decisions. Lower-level personnel execute these directives but are generally powerless to

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independently make policy decisions. A centralized organization is benefited by strong
coordination of purpose and methods, but it has some glaring deficiencies. Among these are the
stifling of lower-level managerial talent, suppression of innovation, and reduced employee
morale.

Many contemporary business successes have occurred in highly decentralized organizations.

Top management concentrates on strategy, and leaves the day-to-day operation and decision-
making tasks to lower-level personnel. This facilitates rapid "front-line" response to customer
issues and provides for identifying and training emerging managers. It can also improve morale
by providing each employee with a clear sense of importance that is often lacking in a highly
centralized environment. Decentralization can prove a fertile ground for cultivating new and
improved products and business processes.

RESPONSIBILITY CENTERS:

A decentralized environment results in highly dispersed decision making. As a result, it is

imperative to monitor and judge the effectiveness of each manager. This is easier said than
done. Not all units are capable of being evaluated on the same basis. Some units do not

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generate any revenue; they only incur costs in support of some necessary function. Other units
that deliver goods and services have the potential to be assessed on the basis of profit generation.

As a generalization, the part of an organization under the control of a manager is termed a

"responsibility center." To aid performance evaluation it is first necessary to consider the
specific character of each responsibility center. Some responsibility centers are cost centers and
others are profit centers. On a broader scale, some are considered to be investment centers. The
logical method of assessment will differ based on the core nature of the responsibility center.

1) Cost Centers :

Cost center managers are responsible for producing a stated quantity and/or quality of output at
the lowest feasible cost. Someone else within the organization determines the output of a cost
center ; usually including various quality attributes, especially delivery schedules. Cost center
managers are free to acquire short-term assets (those that are wholly consumed within a
performance measurement cycle), to hire temporary or contract personnel, and to manage
inventories.

• In a standard cost center, output levels are determined by requests from other
responsibility centers and the manager's budget for each performance measurement cycle
is determined by multiplying actual output by standard cost per unit. Performance is
measured against this figure; the difference between actual costs and the standard.
• In a quasi-profit center, performance is measured by the difference between the
notational revenue earned by the center and its costs. For example, let's say an air
logistics center rebuilt 500 F-16 jet engines and 200 F-15 engines for the Air Combat
Command. The notational revenue earned was $2.5 million per F-16 (500) = $1.25
billion and $5 million per F-15 (200) = $1 billion, or $2.25 billion total. If the logistics
center's operating costs (including non cash expenses such as depreciation of plant and
equipment and imputed rents) were $1.8 billion, it would earn a quasi-profit of $425
million ($2.25 billion - $1.8 billion). These notational revenues (or transfer prices)
usually reflect historical costs or market prices.

2) Profit Center:
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Profit center managers are responsible for both revenues and costs. Profit is the difference
between revenue and cost. Thus, profit center managers are evaluated in terms of both the
revenues their centers earn and the costs they incur. In addition to the authority to acquire short
term assets, to hire temporary or contract personnel, and to manage inventories, profit center
managers are usually given the authority to make long term hires, set salary and promotion
schedules (subject to organization wide standards), organize their units, and acquire long lived
assets costing less than some specified amount. Note, however, real revenue can be earned only
on sales outside the organization -- AFMC's sales of services to foreign governments and private
firms earns revenue, for example; services performed for other elements of the Air Force would
merely earn notational revenues or transfer prices3)

3) Investment Center:

Investment center managers are responsible for both profit and the assets used in generating
profit. Thus, an investment center adds more to a manager's scope of responsibility than does a
profit center, just as a profit center involves more than a cost center. Investment center managers
are typically evaluated in terms of return on assets (ROA), which is the ratio of profit to assets
employed, where the former is expressed as a percentage of the latter. In recent years many have
turned to economic value added (EVA), net operating "profit" less an appropriate capital charge,
which is a dollar amount rather than a ratio. If, for example, the logistics center described earlier
had assets of $7.5 billion ($5 billion in fixed assets and $2.5 in current assets, primarily work-in-
progress and parts inventories) and the federal government's cost of capital were 5 percent, its
quasi-EVA would have been $50 million ($425 million - $375 million); its ROA would have
been 5.7 percent.

AFFIXING RESPONSIBILITY:

Lower-level managers may only be responsible/accountable for a small subset of business

activities. As one moves up the organizational chart, mid and upper-level managers assume ever
greater degrees of responsibility. The reporting system should mimic the expanded scope, and
develop information which reveals the performance for all units within the control of a particular
manager. At successively higher steps, individual performance reports are combined to reveal

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the success or failure of all activities beneath a particular manager. This can result in one
manager being held accountable for a combination of cost, profit, and investment centers. A
keen manager must be familiar with the specific techniques for managing and gauging the
success of each!

Out To Lunch Hamburgers Case study

Below is an organization chart for Out To Lunch Hamburgers. Out to Lunch is a rapidly
growing fast-food restaurant chain. Their business model revolves around a uniquely flavored
hamburger, and a very simple menu consisting of a hamburger, fries, and drinks. They provide
simple "round number" pricing, few products, and rapid service. Out to Lunch also has a
catering service for sporting events, corporate outings, and similar occasions.

The block colors in the organization chart indicate the character of performance/responsibility
evaluation that is germane to each position. The Chief Executive Officer reports to the owners,
and the owners are primarily interested in their return on investment. Three vice presidents
report to the CEO:

1. The VP of operations is responsible for the overall investment in operations, which is

driven heavily by the combined profits of each store. The VP of Operations oversees
procurement, store management, and catering management.

o The Procurement Manager oversees purchasing of food and dishware.

 The Procurement activities are evaluated as cost centers, relying on
budgets and standard costs to control activities.
o The Store and Catering managers oversee supervisors from each location.
 The Store and Catering Managers are responsible for producing profits,
and are evaluated accordingly.
2. The VP of Finance is viewed and evaluated as a cost center.
3. The VP of Real Estate is responsible for site acquisition and construction. Although the
activities are largely viewed in the context of a cost center, there is an expected rate of

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 return for each new real estate investment. Therefore, the VP of Real Estate is evaluated
for cost control and return on investments.

RESPONSIBILITY CENTER REPORTS:

A company's accounting system should support preparation of an accounting report for each
responsibility center. This information is essential to monitor, control, and direct each business
unit. The exact form and detail of a performance report depends on the particular organization
and the nature of the responsibility center. Oftentimes, the reports will provide a comparison
between budgeted and actual data, with the difference being reported as a variance from budget.
These performance reports should be consistent with the organizational structure of the firm. At

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successively higher levels within an organization, the reports tend to include less transaction
specific detail and more combinations of business units.

Cost Center Reports

Cost Centers
Budget Performance Report
Supervisor, Department 1 - Plant A

Over Under
Budget Actaul Buget Budget
Factory wages 58100 58000 100
Materials 32500 34225 1725
Supervisory Salary 6400 6400
Power and light 5750 5690 60
Depriciation 4000 4000
Manintainance 2000 1990 10
Insurance, taxes 975 975
10972 11128
5 0 1725 170
These total are shown on the Manager, Plant A's budget
performance report

Cost Centers
Budget Performance Report
Manager, Plant A
For the Month Ended October 31, 2010
Over Under
Budget Actual Budget Budget
Administration 17500 17350 150
Department 1 109725 111280 1555
Department 2 190500 192600 2100
Department 3 149750 149100 650
467475 470330 3655 800

From Supervisory- Department 1

Plant A budget performance report
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Cost Centers

Cost Center
Budget Performance Report
Vice President, Production
For the Month Ended October 31, 2010
Over Under
Budget Actual Budget Budget
Administration 19500 19700
Plant A 467475 470330 200
Plant B 395225 394300 2855 925
882200 884330 3055 925
Note “Over budget” is the net figure

Cost Centers
Budget Performance Report
Vice President, Production
For the Month Ended October 31, 2010
Over Under
Budget Actual Budget Budget
Administration 19500 19700
Plant A 467475 470330 200
Plant B 395225 394300 2855 925
882200 884330 3055 925

Each of the line above are supported

by a cost center report

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Profit Center Reports

Profit Center

Charging Service Department

Costs to Production Divisions

Purchase Department: $400,000

(Activity base : number of purchase requisition)

Theme Park Division 25,000 purchase requisitions

Movie Production Division 15000 purchase requisitions

Total 40,000

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$ 400,000 = $10 per requition

40,000 purchase requisitions

Profit Center

Charging Service Department

Costs to Production Divisions

Legal Department : $250,000

(Activity base : number of payroll checks)

Theme Park Division 100 billed hours

Movie Production Division 900 billed hours

Total 1,000

$ 250,000 = $250 per hour

1,000 hours

Profit Center

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Nova Entertainment Group
Service Department Charges to NEG Divisions
For the Year Ended December 31, 2010

Theme Movie
Park Production
Service Department Division Division
Purchase 2,50,000 1,50,000
Payroll Accounting 2,04,000 51,000
Legal 25,000 2,25,000
Total service department charge 4,79,000 4,26,000

Nova Entertainment Group

Service Department Charges to NEG Divisions
For the Year Ended December 31, 2010

Movie Production
Service Department Theme Park Division Division
Revenue 60,00,000 25,00,000
Operating Expense 24,95,000 4,05,000
Income from operation 35,05,000 20,95,000

Income from operations before service

department charge

Nova Entertainment Group

Service Department Charges to NEG Divisions
For the Year Ended December 31, 2010
Movie Production
Theme Park Division Division
Revenue 6000000 2500000
Operating expenses 2495000 405000
Income from operations 3505000 2095000

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Less service dept. charges
Purchasing 250000 150000
Payroll accounting 204000 51000
Legal 25000 225000
Total service department charges 479000 426000
Income from operations 3026000 1669000

Investment Centers

How to compute and interpret the rate of return on investment

Inv

Divis
For the Yea

Revenues
Operating expenses
Income from operations 20 | P a g e

before service dept. charges

 Rate of Return

ProfitROI
Margin
= Income fro
Income from operations S
Revenues (Sales)
Profit margin
Income from Operations -Minimum Acceptable Rate of Return on Assets

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Investment Turnover Pr
 =Residual Income

Divi
For the Ye

Income fromoperations
Minimumacceptable income
fromoperations as a percen
of invested assets:
$350,000 x 10%
TRANSFER PRICING $700,000 x 10%
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$500,000 x 10%
Under responsibility budgeting, support centers provide services or intermediate goods to other
responsibility centers in return for a notational transfer price, organizations are structured to take
advantage of specialized knowledge and local conditions, center managers make decisions and
are held responsible for the overall financial performance of their centers. Sound transfer pricing
is, therefore, the key to aligning the incentives of responsibility center managers with
organizational interests.

Transfer pricing is also important to transparency within organizations. It helps to determine the
costs of services provided by one unit to another, which is central to measuring performance
relative to a financial target, and therefore plays a major role in establishing, as well as
manipulating, the incentives facing responsibility center managers. Transfer pricing also reveals
the internal costs of service decentralization where costs are incurred in transferring decision
rights to others within an organization. When one sub-unit transfers tangible assets, knowledge,
skills, etc., to another, both units calculate the cost as a means of revealing their liquid and
tangible asset use internally and in external provision of service.

There are two common approaches to transfer pricing:

• Laissez-faire transfer pricing: buying and selling responsibility centers are completely
free to negotiate prices, to deal, or not to deal; and
• Marginal or incremental cost pricing: the responsibility center selling the service is
required to charge the buying responsibility center whichever is less of market or
incremental cost.

Benefits of Transfer Pricing

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1. Divisions can be evaluated as profit or investment centers.

2. Divisions are forced to control costs and operate competitively.

3. If divisions are permitted to buy component parts wherever they can find the best price
(either internally or externally), transfer pricing will allow a company to maximize its profits.

PROBLEMS IN RESPONSIBILITY ACCOUNTING

While implementing the system of responsibility accounting, the following difficulties are likely
to be faced by the management:

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 1. Classification of costs:
For responsibility accounting system to be effective a proper classification between
controllable and non controllable costs is a prime
requisite. But practical difficulties arise while doing so on account of the complex nature
and variety of costs.

1. Inter-departmental Conflicts:
Separate departmental persuits may lead to inter-departmental rivalry and it may be
prejudicial to the interest of the enterprise as a whole. Managers may act in the best
interests of their own, but not in the best interests of the enterprise.

2. Delay in Reporting:
Responsibility reports may be delayed. Each responsibility centre can take its own time
in preparing reports.

3. Overloading of Information:
Responsibility accounting reports may be overloading with all available information.
This danger is inherent in the system but with clear instructions by management as to the
functioning of the system and preparation of reports, etc., only relevant information flow
in.

4. Complete Reliance will be deceptive:

Responsibility accounting can’t be relied upon completely as a tool of management
control. It is a system just to direct the attention of management to those areas of
performance which required further investigation.

CONCLUSION :

Responsibility accounting is a management control system for measurement of division

performance of an organization. Responsibility accounting focuses on responsibility centers such
as cost centre, profit centre and investment centre.
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 For effective implementation of responsible accounting certain principles must be followed.
Responsibility accounting helps not only in control but in planning and decision making too.

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