II Sem MBA Strategic Cost Management

Module 4: Decision Involving Alternative Choices

Introduction
In business, decision-making often involves choosing between different
alternatives. These decisions can impact pricing, costing, and profitability.
Effective decision-making requires evaluating each alternative based on factors
such as costs, benefits, and strategic alignment with business goals.

Decision-Making Involving Alternative Choices:

Process of decision making

1. Defining the problem: While taking a decision, it is necessary to identify

the problem first. If problem is well defined, then fifty per cent of solution
may be achieved. The problem should be clear and measurable so that
timely decision may be taken.
2. Identification of different alternatives: After defining the problem
relevant information is collected to identify the potential solutions to the
problem. There may be more than one alternative for the solution of a
problem which can be identified through market research, consultant
advices or various external sources. Management has to consider all
possible alternatives to take appropriate decisions.
3. Selection of the best alternative: The next step is to evaluate and selecting
the best alternative among different ones on the basis of risk return or cost
benefit analysis. Various quantitative and qualitative measures based upon
the facts and statistics should be considered to select the best alternative.

Cost Related With Decision Making

While taking decisions in the business, various costs are associated with
the decisions, some of which are as follow:

1. Relevant Cost: These are future costs which can be affected by change
in decision of management. The relevant cost is variable cost which
may be incremental or avoidable. While comparing different
alternatives, if cost changes, then that particular cost will be
relevant cost. For example, if a firm purchased machinery costing
Rs 10,000 and now its book value remains Rs 1,000. The machinery
became obsolete but, can be sold for Rs 2000 after modification which
will cost Rs 500. Here, Rs. 2000 and Rs. 500 both will be relevant cost.

2. Differential Cost: It can be defined as an increase or decrease

in total cost after the decision of management. It may be incremental
or decremental cost. It is an important term for decision making. If total
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cost increases, when decision is changed from one alternative to

another, it is termed as incremental differential cost. Conversely, if total
cost decreases, when decision is changed from one alternative to
another, it is termed as decremental differential cost.

3. Opportunity Cost: Opportunity cost may be termed as benefit

sacrificed while choosing one alternative over other. If while choosing
an alternative profits are forgone, such sacrificed profit is known
as opportunity cost. For example, a producer can produce either chair
or table. The value of one chair is Rs. 500 and value of table is Rs.
700. The producer decides to manufacture chair instead of table
as resources are limited. The sacrificed value of table Rs. 700 over chair
is known as opportunity cost.
4. Shut down Cost: It is fixed cost which is incurred during the closing
down of a division, department or business. Since if production is not
done, variable cost is not incurred. But, some fixed cost is related with
the business such as salary, depreciation etc. which are unavoidable, are
defined as shut down cost.

5. Imputed Cost: These are the costs which are not actually incurred in
cash. For example, interest on capital which is not actually paid, but
essential for the management decision.Out of Pocket Cost: The cost
which is paid in cash is known as out of pocket cost such as cost of
material, labour, expenses, etc. The expenses which are not paid in cash
as depreciation, is not included in out of pocket cost.

6. Sunk Cost: It is the cost which cannot be collected if expended.

These costs are irrelevant for management decisions since they
have been incurred. The decisions which are irreversible, cost
associated to them are known as sunk cost i.e. investment in fixed
assets.

7. Escapable Cost: The cost which may be avoided during production

process is known as escapable cost and which cannot be avoided is
termed as unavoidable cost.

Transfer Pricing:

Meaning:
Transfer pricing refers to the pricing of goods, services, or intangibles transferred
within different divisions of the same company, particularly in multinational
corporations.
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Importance:

Profit Allocation: It helps in the allocation of profits among different subsidiaries

or divisions, affecting the overall profitability of the company.
Tax Implications: Transfer pricing decisions have significant tax implications,
as prices set for internal transactions can affect the taxable income of different
divisions, especially in different tax jurisdictions.
Performance Measurement: It aids in evaluating the performance of individual
units within a company by setting internal prices that reflect market conditions.

Methods:

Market-Based Pricing: Setting transfer prices based on external market prices.

Cost-Based Pricing: Prices are based on the production cost of the goods or
services.
Negotiated Pricing: Prices are determined through negotiations between
divisions.

Challenges:

Regulatory Scrutiny: Transfer pricing is subject to stringent regulations to

prevent profit shifting and tax evasion.
Complexity: Determining the appropriate transfer price can be complex due to
varying market conditions and cost structures.

Target Costing:
Meaning:
Target costing is a pricing method in which a product's selling price is determined
first, and then efforts are made to ensure the product can be produced at a cost
that allows for the desired profit margin.

Importance:

• Market-Driven Pricing: Ensures that products are priced competitively while

still achieving desired profitability.
• Cost Control: Encourages cost reduction efforts from the outset of product
development, fostering innovation and efficiency.
• Alignment with Customer Needs: By focusing on the target price, businesses
align their product features and costs with what customers are willing to pay.

Process:

Set the Target Price: Determine the price customers are willing to pay.
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Determine Target Profit: Subtract the desired profit margin from the target price
to determine the allowable cost.
Cost Reduction: Adjust product design, materials, and processes to meet the
target cost.

Challenges:

Balancing Cost and Quality: It can be challenging to reduce costs without

compromising product quality.
Innovation Pressure: Continuous cost reduction may require constant
innovation, which can be resource-intensive.

Product Life Cycle Costing:

Meaning:
Product life cycle costing involves tracking and managing the costs associated
with a product over its entire life cycle, from development and introduction to
decline and discontinuation.

Importance:

• Comprehensive Cost Analysis: Provides a holistic view of the total cost of

ownership of a product, including development, production, marketing, and
disposal costs.
• Profitability Management: Helps in understanding how costs and revenues
are distributed across the different stages of the product life cycle, aiding in
strategic planning and pricing decisions.
• Cost Control: Enables companies to identify cost-saving opportunities at
various stages of the product life cycle.

Stages:
Introduction: High development and marketing costs; initial pricing strategies
are critical.
Growth: Focus on scaling production and optimizing costs as sales increase.
Maturity: Cost management becomes essential as market saturation occurs and
competition intensifies.
Decline: Efforts shift to managing decline-related costs and deciding when to
phase out the product.

Challenges:

Data Collection: Requires detailed and accurate cost data across all stages, which
can be difficult to obtain.
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Forecasting: Estimating future costs and revenues can be challenging, especially

for new or innovative products.

Module 5. Activity Based Costing

What is Activity-Based Costing?

The activity-based costing (ABC) system is a method of accounting you can use
to find the total cost of activities necessary to make a product.

The ABC system assigns costs to each activity that goes into production. It is a
costing method that identifies activities in an organization and assigns the cost of
each activity to all products and services according to the actual consumption by
each.

The Institute of Cost & Management Accountants of Bangladesh (ICMAB)

defines activity-based costing as an accounting method which identifies the
activities which a firm performs and then assigns indirect costs to cost objects.
ABC is used to improve the accuracy of cost analysis by improving the tracing of
costs to products or to individual customers. It is a system which focuses on
activities performed to produce product. In this system, first costs are traced to
activities and then to products, where as in traditional system, costs are first traced
not to activities but to an organisational unit, such
as department or plant and then to products.

In ABC system, activity means a unit of work; here cost driver is a factor, such
as the level of activity or volume that affects costs. Cost drivers signify factors,
forces or events that determine the costs of activities. This system brings accuracy
and reliability in product cost determination by emphasizing on cause and effect
relationship in the cost incurrence.

Objectives of Activity Based Costing

The major objectives of Activity Based Costing are as follows-

1. To identify value added activities in transactions.
2. To focus high-cost activities.
3. To distribute overheads on the basis of activities.
4. To identify the opportunities for improvements and reduction of costs.
5. To validate the success of the quality drive with ABC.
6. To ensure accurate product costing for decision making.
7. To use information to improve product mix and pricing decisions.

Steps or stages in ABC System

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For allocating/absorbing overheads to products/services under Activity-Based

Costing, the
following steps are to be taken:

1. Identifying Activities: The first stage is to identify the functional areas or

major activities involved in the production. Examples of activities include
machine related activities, divert labour related activities and various support
activities like ordering, receiving, material handling, packing, despatching etc.
Various activities are identified by carrying out activity analysis. The activities
may be basically fall into four categories as suggested by Cooper and
Kaplan.

a) Unit Level Activities or Primary Activities: The cost of primary activities

(like use of indirect materials and consumables, testing of every item
produced) may be correlated to number of units produced (i.e. on volume-
basis).
b) Batch Level Activities: These are manufacturing support activities (like
material ordering, machine set-up costs, inspection of products etc). The cost
of such activities is driven by number of batches of units produced.
c) Product Level Activities: Activities like designing of the product, keeping
technical drawings of product, activities up to date, advertising of a specific
product are called product level. The cost of these activities is driven by the
creation of a new product line and its maintenance.
d) Facility Level Activities: Certain activities cannot be related to a particular
product, instead may be related to certain facilities like maintaining the
building, security of plant, salaries of production manager, advertisement to
promote organisation etc. It may be noted that unit level activities and facility
level activities are the same as those in traditional absorption costing which
will be allocated on physical volume basis, ABC will be more useful if there
is significant size of batch level and product level activities.

2. Assigning Costs to Activity Cost Centres: The second stage requires that a
cost centre (also called a cost pool) be created for each activity. After the
activities have been identified the cost of resources consumed over a specified
period must be assigned to each activity. These costs will have to be
apportioned on some suitable basis. For example, the total costs of all set ups
might constitute one cost centre for all setup related costs.

3. Selecting Appropriate Cost Drivers: The third stage of designing ABC

system is to identify the factors that influence the cost of a particular activity.
The term cost-driver is used to describe the significant determinant of the cost
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of the activity. The most suitable cost driver in each activity under functional
areas should be identified. A cost driver is any factor that influences costs.

4. Assigning the Cost of the Activities to Products: The final stage is to trace
the cost of the activities to products according to each product’s demand for
these activities using cost drivers as a measure of demand. A product’s demand
for the activities is measured by the number of transactions it generates for the
cost driver. The cost driver should be measurable in a way that enables it to be
identified with individual products.

Cost Driver

Activity based information may be non-financial but concerns activities across

the entire chain of value adding process and focuses the attention of managers on
activities that cause rather than the costs themselves.

These activities are known as cost drivers. Cost drivers are used to describe the
events or forces that are the significant determination of the cost activities, e.g.,
production scheduling cost is generated by the number of productions runs that
each product generates. Thus, cost drivers are factors that drive consumption of
resources. Therefore, management of cost drivers is essential to manage costs.

Meaning of cost pool

A company producing T shirt has cost of materials such as buttons, threads, labour
cost for stitching the T shirt and other costs are accumulated into meaning ful
groups. These groups are called cost pool.

What benefits does ABC provide?

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Activity-based costing provides a more accurate method of product/service

costing, leading to more accurate pricing decisions. It increases understanding of
overheads and cost drivers; and makes costly and non-value adding activities
more visible, allowing managers to reduce or eliminate them. ABC enables
effective challenge of operating costs to find better ways of allocating and
eliminating overheads. It also enables improved product and customer
profitability analysis. It supports performance management techniques such as
continuous improvement and scorecards.

ABC has been accepted as very useful for product costing where production
overheads are high in relation to direct cost, where there is diversity in the product
range, where products consume different amount of overhead and where
consumption of overhead is not basically driven by their volume. In brief
following are main benefits of using ABC technique

1. ABC helps to reduce costs by providing meaningful information for cost-

management. It helps in making the right decision.
2. ABC technique provides due importance to non-manufacturing cost which
constitute a substantial portion of total cost. Traditionally non-manufacturing
costs have been allocated under volume basis and thus, high volume products
have been overvalued.
3. ABC technique provides accurate and reliable cost information. This cost
information is essential for recent approaches in productivity improvement like
Total Quality Management (TQM) and Business Process Reengineering.
4. ABC enables the management in formulating an effective pricing policy while
fixing prices.
5. Cost of each activity is determined with the help of ABC. There is accuracy in
indirect cost-allocation to products. This technique is helpful in make or buys
decisions and transfer pricing.

Reasons for adopting Activity Based Costing System

The fundamental advantage of using an ABC system is to more precisely

determine how overhead is used. Once you have an ABC system, you can obtain
better information about the following issues:
1. Activity costs. ABC is designed to track the cost of activities, so you can use
it to see if activity costs are in line with industry standards. ABC is an excellent
feedback tool for measuring the ongoing cost of specific services as
management focuses on cost reduction.
2. Customer profitability. Though most of the costs incurred for individual
customers are simply product costs, there is also an overhead component, such
as unusually high customer service levels, product return handling, and
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cooperative marketing agreements. An ABC system can sort through these

additional overhead costs and help you determine which customers are
actually earning you a reasonable profit. This analysis may result in some
unprofitable customers being turned away, or more emphasis being placed on
those customers who are earning the company its largest profits.
3. Distribution cost. The typical company uses a variety of distribution channels
to sell its products, such as retail, Internet, distributors, and mail order
catalogues. Most of the structural cost of maintaining a distribution channel is
overhead, so if you can make a reasonable determination of which distribution
channels are using overhead, you can make decisions to alter how distribution
channels are used, or even to drop unprofitable channels.
4. Make or buy. ABC provides a comprehensive view of every cost associated
with the in-house manufacture of a product, so that you can see precisely
which costs will be eliminated if an item is outsourced, versus which costs
will remain.
5. Margins. With proper overhead allocation from an ABC system, you can
determine the margins of various products, product lines, and entire
subsidiaries. This can be quite useful for determining where to position
company resources to earn the largest margins.
6. Minimum price. Product pricing is really based on the price that the market
will bear, but the marketing manager should know what the cost of the product
is, in order to avoid selling a product that will lose a company money on every
sale. ABC is very good for determining which overhead costs should be
included in this minimum cost, depending upon the circumstances under
which products are being sold.
7. Production facility cost. It is usually quite easy to segregate overhead costs
at the plant-wide level, so you can compare the costs of production between
different facilities.

Disadvantages of ABC System

Despite of various advantages, following are the weaknesses of adopting

ABC system1.
1. It is based on historical costs; while for planning decisions future costs are
more relevant.
2. For many short-term decisions, identification of variable costs is very
important. But ABC system does not partition variable and fixed elements
of overhead costs.
3. The accuracy of ABC system fully depends upon the quality of cost
drivers. The allocation and absorption of costs may become an arbitrary
allocation process, if the cost drivers are not associated with the factors
causing costs.
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4. ABC system tends to be more costly than the traditional methods of

applying costs to products.

Practical Problems:

1. The budget overheads and cost driver volumes of S Ltd. Are as follows

2. Amrit Company produces 3 products A, B and C. The company follows

Activity Based Costing system. Information related to various costs of
these products for the last year:
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The price of Raw materials remained constant throughout the year at

Rs.1.2 per kg and the labour cost was Rs.14.8 per hour. The annual
Overhead costs are as follows:

3. MNC Ltd has collected the following data for its two activities. It
calculates Activity cost rates on cost driver capacity.
Activity Cost driver Capacity Cost
Power Kilowatt hours 50,000 Kilowatt Rs. 2,00,000
Quality No. of hours Rs. 3,00,000
inspection inspections 10,000
inspections

The company makes three products M,S and T. for the year ended
31/3/2013, the following consumption of cost drivers were reported
Product Kilowatt hours Quality inspection
M 10,000 3,500
S 20,000 2,500
T 15,000 3,000

You are required

1. To compute the costs allocated to each product for each activity.
2. Calculate the cost of unused capacity for each activity.
3. Discuss the factors the management considers in choosing a capacity level to
compute the fixed budget overhead cost rate.

4. ABC Ltd. produces three components X, Y and Z. The profit and Loss
budget, for the year ending 31.03.10 are as follows:
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Overheads are absorbed on the basis of labour hours. The following are the further
data regarding cost volume and the cost drivers

5. A manufacturing company produces two products ie X and Y. The particulars

relating to two products are given below.
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Product X Product Y
Direct material cost per unit 10 12
Direct wages per unit 10 8
Units produced 200 200
Direct labour per unit 12 12
Materials move per product line 10 14

Budget material handling cost Rs 24,000 Determine the cost per unit of the
products using the volume-based allocation method (Direct labour hour rate)
Determine the cost per unit of the products using the ABC method.

6. S co. Has furnished the following particulars in respect of two products A &
B. A is a newly introduced product with some technical problems requiring
substantial engineering changes. On the other hand, Product B is a mature
and established product and thus does not require much attention regarding
engineering changes.

A B
Output units 2000 2000
Engineering changes noticed per product line 30 18
Unit cost per engineering change notice 1250 1250
Machine hours required per unit. 4 8

You are required to:

1. Ascertain overhead cost per unit of each product by using the traditional
machine hour rate method
2. Ascertain overhead cost per unit of each product using ABC
3. Comment on the results.

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Module 6: Responsibility Accounting

Responsibility Accounting- Introduction

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 them 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
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
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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:

Responsibility accounting centers on identifying responsibility centers within an organization, each
managed by an individual accountable for its performance. In small firms, owners may manage the
entire organization, but in larger firms, it's divided into meaningful segments, departments, or divisions
to ensure effective control. A responsibility center can be as small as a single machine or as large as an
entire division. The key is that each unit must be separable and identifiable for operating purposes, with
its performance measurable. This system ensures clear accountability and aligns individual
responsibilities with the organization's overall goals.

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. If the person has
authority over both the acquisition and use of the services, he should be charged with the cost of these
services. If the person can significantly influence the amount of cost through his own action, he may be
charged with such costs. 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. To be effective, the
reports should be clear and simple. Use of diagrams, charts, illustrations, graphs and tables may be
made to make them attractive and easily understandable.

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

Responsibility centre
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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
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.

According to CIMA, London a cost centre is “a location person or equipment, for which costs may be
ascertained and used for purposes of cost control”

Responsibility in a cost centre is restricted to cost. 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. Cost centre managers have control
over some or all of the costs in their segment of business, but not over revenues. 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. 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. E.g. accounting department, repairs &
maintenance department

2. Revenue Centre
It is a segment of the organisation which is primarily responsible for generating sales revenue. 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. The revenue centre manager will control the selling
price, promotion mix and product mix. The performance of a revenue centre is evaluated by comparing
the actual revenue with budgeted revenue, and actual marketing expenses with budgeted marketing
expenses. E.g. sales department\

3. Profit Centre
Also called business centre. It is a segment of an organisation whose manager is responsible for both
revenues and costs. 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. The
managers are encouraged to act as if they were running their own separate business. The main purpose
of a profit centre is to maximise profit by making decisions relating to production volume, product mix,
selling price, marketing strategy. Profit centre managers aim at both the production and marketing of a
product.

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

Steps for Achieving Goals of Responsibility Accounting:

1. The organisation is divided into various responsibility centres each responsibility centre is put under
the charge of a responsibility manager. The managers are responsible for the performance of their
departments.
2. The targets of each responsibility centre are set in. The targets or goals are set in consultation with
the manager of the responsibility centre so that he may be able to give full information about his
department. The goals of the responsibility centres are properly communicated to them.
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3. The actual performance of each responsibility centre is recorded and communicated to the executive
concerned and the actual performance is compared with goals set and it helps in assessing the work of
these centres.
4. If the actual performance of a department is less than the standard set, then the variances are conveyed
to the top management. The names of those persons who were responsible for that performance are also
conveyed so that responsibility may be fixed.
5. Timely action is taken to take necessary corrective measures so that the work does not suffer in future.
The directions of the top-level management are communicated to the concerned responsibility centre
so that corrective measures are initiated at the earliest. The purpose of all these steps is to assign
responsibility to different individuals so that the performance is improved. In case the performance is
not up to their targets set, then responsibility may be fixed for it. Responsibility accounting will certainly
act as control device and it will help in improving the overall performance of the business.

Advantages of Responsibility Accounting

1. • Individual Accountability: Each employee is assigned specific responsibilities,

ensuring they are directly accountable for their actions and performance, fostering a
sense of ownership and diligence.
2. Fixed Responsibility: Responsibilities are clearly delineated for each individual,
preventing the transfer of accountability, which promotes clear lines of authority and
responsibility within the organization.
3. Cost and Revenue Control: This system enhances monitoring of costs and revenues
by holding individuals accountable, leading to more disciplined financial management
and improved overall organizational efficiency.
4. Improved Planning and Decision-Making: Responsibility accounting facilitates
strategic planning and informed decision-making, as managers have clearer insights
into their areas of responsibility and performance metrics.
5. Enhanced Managerial Importance: Clearly defined responsibilities empower
managers, making them feel essential to the organization’s success, thereby increasing
their commitment and engagement with organizational goals.
6. Increased Motivation: By encouraging initiative and ownership, responsibility
accounting enhances employee motivation, leading to higher productivity and a more
proactive workforce.
7. Information Presentation: The system provides a structured way to present relevant
data, allowing managers to make informed decisions and understand performance
drivers within their departments.
8. Framework for Performance Appraisal: Responsibility accounting establishes clear
metrics for assessing managerial performance, enabling fair evaluations and
encouraging managers to align their actions with organizational goals.
9. Up-to-Date Information: Timely access to relevant data allows for accurate forecasts
of future costs and revenues, helping managers set realistic departmental budgets and
performance standards.

Problems in Responsibility Accounting

• Classification Difficulties: Distinguishing between controllable and non-controllable costs

is challenging due to the complex nature and variety of costs within an organization.
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• Inter-Departmental Rivalry: Focus on departmental performance can create competition

among departments, potentially undermining collaboration and negatively impacting the
organization’s overall goals and interests.

• Self-Interest of Managers: Managers might prioritize their department’s goals over the
enterprise’s objectives, leading to decisions that benefit their area but harm the organization
as a whole.

• Limited Management Control: Responsibility accounting cannot be solely relied upon

for comprehensive management control; it serves primarily to highlight performance areas
needing further analysis.

• Organizational Chart Complexity: Creating a clear organizational chart that defines lines
of responsibility and authority is a complex task, often requiring significant time and effort.

• Information Overload: Responsibility accounting reports may contain excessive

information, making it difficult for managers to focus on critical data and actionable insights
for decision-making.

Divisional Performance- Concept

The whole organisation is divided into separate divisions and each divisional manager has great deal of
independence. The manager of each division is accountable for performance of its operations as also
the nature of operations undertaken. It leads to creation of a decentralised organisation structure and
each division is treated as a separate responsibility centre. The performance of each responsibility centre
will be separately measured and compared with other responsibility centres for managerial decisions.
However, authority can’t be exclusive one, implying that full autonomy can’t be fully granted to the
divisional head as no unit can be independent of other units within one organisation. The performance
of each division has to be separately and independently evaluated only to place responsibility for
effective management so that those who are doing the jobs don’t shrink from their duties and the
operations which they are bound to perform.

Merits of Divisional Performance

Promotes quick decision making and avoids red tape and delays. Motivates divisional managers to
perform better. It also helps to improve their job satisfaction and self-fulfilment. Makes top management
free from detailed involvement in the day-to-day operations and enables them to devote themselves to
important policy matters.

Demerits of Divisional Performance

Various divisions may compete with each other and in that divisional mangers may try to increase their
own profits at the expenses of other divisions. There may be lack of coordination and cooperation
between divisions. This results in lack of harmony in achieving overall goals of the business

Measurement of Divisional Performance

1. Variance Analysis
• Actual performance is compared with standard or budgeted performance and any variance between
the two is analysed to know the causes so that responsibility can be established and corrective actions
taken.
• Should be undertaken at each cost centre & revenue centre.
II Sem MBA Strategic Cost Management

2. Profit
• The absolute amount of profit earned by a profit centre

3. Return on Investment
• ROI addressed divisional profit as a percentage of the assets employed in the division. Assets
employed can be defined as total divisional assets, assets controllable by the divisional manager, or net
assets.

ROI= (Divisional Profit/ Divisional investment) * 100

= (EBIT/ capital employed) * 100
= (Profit/ sales) * (Sales/ capital invested) * 100

• An organisation can improve the ROI either by improving the net profit margin or by increasing the
turnover with the same amount of investment. It implies that the performance of a firm/ segment can be
improved either by increasing the profit margin per rupee of sales or by generating more sales volume
per rupee of investment

Advantages
1. Is easy to understand & interpret
2. It Is a measure of relative performance and therefore can be used to compare the firms od
different sizes.
3. Helps in ensuring good congruence between the different divisions and the firm
4. Is widely accepted measure of performance because it relates net income to investments made
in the division
5. Motivate divisional managers to improve their performance by optimum utilisation of the
capital invested in the divisions.

Limitations
1. Satisfactory definition of profit & investment on which ROI is based are difficult to find
2. There are different methods of valuation of assets such as book value, original cost, current
replacement cost etc which of these valuations is to be taken for calculating ROI remains a
difficult

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