RESPONSIBILITY CENTERS AND REPORTING TYPES OF RESPONSIBILITY CENTERS

SEGMENTS
• COST CENTER
CENTRALIZED ORGANIZATION - managers are responsible mainly for the
costs incurred by the unit
- Little freedom to make decisions
- KEY PERFORMANCE MEASURE: Variance
DECENTRALIZED ORGANIZATION Analysis – Actual Costs vs.
Budgeted/Standard Costs
- Spreads decision at different - Provide service to other parts of the
responsibility center levels organization
- Separation into manageable units - NOT responsible for generating revenue
- avoid SUB-OPTIMIZATION: happens
through sales to outside customers
when managers decide in favor of their
• REVENUE CENTER
own decentralized unit even at the
- managers are responsible mainly for the
expense of the entire organization
revenues generated by the unit
RESPONSILIBILITY CENTER - KEY PERFORMANCE MEASURE: Variance
Analysis: Actual Sales vs.
- a.k.a: Strategic Business Unit Budgeted/Target Sales
- any portion of a business that grants the - Sell their product or service to outside
center’s manager responsibility over customers
costs, profits, revenues or investments • PROFIT CENTER
- make decision at the local level - managers are responsible for both
RESPONSIBILITY ACCOUNTING revenues and costs of the unit
- KEY PERFORMANCE MEASURE: Variance
- method of defining segments or Analysis: Actual Profit vs.
subunits in an organization as types of Budgeted/Target Profit Segmented
responsibility centers based on Income Statement
o their level of autonomy - Sell their product or service to outside
(authority, accountability and customers
controllability) • INVESTMENT CENTERS
o the responsibilities of their - managers are responsible for revenues,
managers, and costs and investment of capital.
o performance evaluations on - Strategic investments would be
these factors evaluated for their fit with company
- classified by their primary effect on the strategy, while other investments would
company as a whole be judged on their ROI and preservation
- consistent with management by of capital
objectives – the management process in - KEY PERFORMANCE MEASURE: Variance
which managers and subordinates agree analysis: Actual Profit vs.
on goals as well as the methods to Budgeted/Target Profit Segmented
achieve them and subordinates are Income Statement ROI, Residual Income,
subsequently evaluated EVA
- aims goal congruence - Segmented Income Statement: a
detailed version of the contribution
format of income statement. This
 income statement presentation Methods of Allocating Common Costs
highlights controllability of costs by
• Stand-alone cost allocation
behavioral classification.
- Determines the relative proportion cost
Contribution Margin driver for each party that shares a
common cost and allocates the costs by
- Amount that contributes toward fixed
those percentages
expenses and profits
- Eliminates fized expenses Example:
- DISADVANTAGE: Not all fixed expenses
Company has a new and old plant but both
are uncontrollable so it can lead a
require workers.
manager to ignore possible cost
reductions Old New
- Shows how profits are affected by Common 28,000 42,000
changes in volume, because fixed costs Costs: (4/10 x (6/10 x
and operating capacity are kept constant 60,000+10,000 100,000) 100,000)
- Evaluating contribution margin report Cost driver:
often involves the use of cost-volume- Numbers of
40 60
profit ratios required
- A balanced scorecard is a more workers
comprehensive tool used in evaluating
performance • Incremental Method
- Allocates costs by ranking the parties by
a primary user and incremental users or
Direct/Controllable Profit or Performance those users who add an additional cost
Margin due to the fact that there is now more
- Managers using this measure may be than one user of the cost
content with a lower level of success - Allows manipulation
than if common costs were also - Not as balanced as the stand-alone
deducted from the measurement method
- Should be used for the SBU’s Example: Company hires a trainer because the
performance because corporate charges new plant is being opened. The trainer is based
are beyond SBU management control in the new plant’s city, thus new plant is the
COMMON COST ALLOCATION primary user of the trainer’s time. He works at
the new plant for three quarters of the time and
- Common costs are any cost that is old
shared by two or more segments or
entities New Old
- cannot be traced to a specific Common 45,000 15,000
Costs: 60,000 (3/4 x (1/4 x
department, shared costs
60,000) 60,000)
- often uncontrollable
Incremental
Costs: having
10,000
the trainer
relocate to
 serve old Example:
plant
Cost driver:
Numbers of
3/4 1/4
required
workers
plant for one quarter of the time.

SERVICE DEPARTMENT ALLOCATION

• Direct Method
- Transfers the service costs to productive
departments directly
- No allocations among service
departments

Example:

SERVICE PRODUCTIVE
1 2 A B
Costs 600k 900k 3.7M 2.5M • Reciprocal Method
1 (600k) 5/20 x 15/20 x - Recognizes all services provided by any
600k 600k service department, including services
provided to other service departments.
150k 450k - It accounts for cost flows among service
2 (900k) ¾ x 900k ¼ x 900k departments providing services to each
other.
675k 225k - It requires a simultaneous equation
TOTAL 4,525,000 3,175,000 solution.
Basis 5 15
30 10 Y Z A B
Costs 7,260 4K 12K 16K
Y 20% 40% 40%
• Step-Down Method (Sequential Z 30% 20% 50%
Method)
- Allocates some service costs to other
service departments Y = Ycost + Z%
- Once allocation is made from a service Z = Zcost + Y%
department, no further allocations are
made back to that service department
- Allocate in order of proportion of
services provided to other service
departments
TRANSFER PRICING - Not viewed favorably by tax authorities
because it lowers the profits
- Sets prices for internally exchanged
goods and services Full Cost (Absorption Model)
- Intermediate product is a good or
- Seller’s variable cost and then allocates
service that is transferred between two
fixed costs to the price
segments of a company
- Company strategy is affected by choice Dual Pricing
of transfer prices
- Charged by SELLING DIVISION - is an attempt to eliminate the internal
conflicts associated with transfer prices
Market Price Model by giving both the buying and selling
divisions the price that works best for
- True arm’s length model or ideal transfer
them:
price
o Selling division: uses market
- Sets the price for a good or service at
price as its transfer-out price to
going market prices
prevent decrease in divisional
- Used when product has a market and
income
when divisions are independent of each
o Buying division: uses variable
other
cost as its transfer-in price to
- keeps units autonomous
minimize divisional costs and
Negotiated Price Model avoid ‘profit sharing’ with selling
division by agreeing to a transfer
- Sets through negotiation between the
price above cost
buyer and seller
- Used when market prices are subject to Choose Transfer Price Models
rapid fluctuation or when there s no
1. Market Price (market price exists)
intermediate market price that exists
2. Negotiated Price (no market price
- Make both buying and selling less
3. Cost-based methods (but not
autonomous
recommendable as they lead to
- Within:
motivation problems)
o Maximum: Market Price (BD
POV) Make-or-buy Decision
o Minimum: (SD POV)
▪ SD @ capacity With outside suppliers
VC + CM USE MARKET PRICE MODEL
▪ SD with excess capacity
VC Compare Selling Divisions’ VC to the
Market price for the external substitute
Variable Cost Model
MULTINATIONAL COMPANY PERFORMANCE
- Unit’s variable cost MEASUREMENT
- Lower selling unit’s profits
- Increase buying unit’s profits due to the Multinational companies must account for
low price additional concerns, such as how tariffs,
exchange rates, taxes, currency restrictions,
expropriation risk, and the availability and
relative cost of materials and skills could affect ✓ Direct costs are separable costs that are
performance evaluations attributable or traceable to the segment or
business unit.
PERFORMANCE EVALUATION

Profitability Analyses measure the relative ✓ CONTROLLABILITY is based on degree of

success or failure of a company over a period influence a manager can exercise over an
amount with reference to assigned
- Shows which products are most responsibilities.
profitable, which need to have their
prices and costs reevaluated, and which ✓ Most controllable costs are discretionary costs
should get the greatest amount of by nature.
marketing and support attention
✓ Non-controllable costs are either committed
- Basis for compensation or bonuses
costs or costs that are controllable by others or
STEPS: by a higher authority.

1. Remove all fixed costs that are traceable ✓ CONTROLLABLE or PERFORMANCE MARGIN is
to the affected unit usually used to evaluate the performance of the
2. Remove all variable costs for the unit manager.
3. The analysis sums up the opportunity
✓ SEGMENT MARGIN is usually used to evaluate
cost of all sales that would be lost if the
product line were discontinued. the performance of the segment or business
unit.
Example:
✓ Common costs allocated to a segment are
If company had a profitable tennis ball line and usually not controllable by the manager of the
an unprofitable racquet ball line, the racquet ball same segment.
line could be analyzed to determine what effect
removing it would have on company profits. Income Before Taxes

- Deduct all costs for a business unit other

than taxes
- Makes the business unit manager seem
accountable for costs that are not under
• CONTRIBUTION AND SEGMENT
his control
REPORTING
- ADVANTAGE: managers will have
Sales realistic views of the level of profitability
Less: VARIABLE Manufacturing Costs needed to make the business unit a
Manufacturing Contribution Margin success part of the company and thereby
Less: VARIABLE Non-Manufacturing Costs would affect its pricing and productivity
Contribution Margin decisions
Less: Controllable Direct FIXED Costs
- Can be compared with competitors
Controllable or Performance Margin
Less: Non-Controllable Direct FIXED Costs Net Income
Segment Margin
Less: Allocated Common Costs - Income after taxes
Profit - Same benefits and drawbacks as
operating income
 - When tax rates differ, it is usually a result ✓ The term ‘invested capital’ is sometimes used
of corporate manipulation for tax as the denominator for the ROI formula. While
purposes, a factor beyond the manager’s the term means operating assets for most
control (taxes are corporate level investment centers, invested capital may also
decisions) mean total assets, owners’ equity or total assets
less current liabilities, depending on the situation
and application.
Customer Profitability Analysis

- Evaluates costs and benefits of providing

• RESIDUAL INCOME
goods or services to a particular
customer/segment Income or Controllable Profit or Operating
- OBJECTIVES Income
1. Measuring customer profitability Less: Required Income
2. Identifying effective and ineffective Residual Income
customer-related activities and
services
Or

Income or Controllable Profit or Operating

• RETURN ON INVESTMENT (ROI) Income
Less: Investment x COC% or Desired Rate of
Return
Residual Income

✓ Minimum ROI may also be known as desired

Note: Capital Employed = Fixed Assets + (Current rate of return or minimum required rate of
Assets – Current Liabilities) – LONG TERM return.

✓ ROI broken down into ‘margin’ and ‘turnover’ ✓ The ‘Minimum ROI’ under RI is usually based
is based on the Du Pont Technique. on the imputed interest rate, which is imposed
and set by a higher authority like a head office
✓ ROI is also known as return on assets. (for branches) or a holding company (for
subsidiaries).
✓ MARGIN - net profit margin, return on sales.
ROI vs RI
✓ TURNOVER - assets turnover, investment
turnover, capital turnover. ROI RI
division managers division managers
✓ ‘Operating income’ for most investment tend to accept only would accept an
centers is based on earnings before interests & the investments investment if it earns
taxes (EBIT). whose returns exceed an amount more than
the division’s ROI the minimum
✓ ‘Operating assets’ are preferably based on the required return.
average balance for the reporting period and Disincentive to invest advantage of having a
composed of productive assets used to earn the better measure of
operating income (i.e., idle assets are excluded). performance than
 ROI because it Cost of debt = Interest rate of the liability
encourages x (1 – Tax Rate)
investment in
projects that would WACC of Debt = Debt/Total Debt and
otherwise be rejected Equity x Cost of Debt
under RO
WACC of Equity = Equity/Total Debt and
Enables comparison major disadvantage
Equity x Cost of Equity
to be made with of RI is that it cannot
divisions or be used to compare Example:
companies of divisions of different
different size sizes or asset base -- Tax Rate = 20%
RI tends to favor
Notes Payable 6M at 5% interest
larger divisions
because of larger Bonds 8M at 6% interest
peso amount Stock 14M at 12%
involved
Forces to make good Encourages managers
WACC of Debt
use of existing capital to act in the best
resources and interest of the Notes Payable
focuses attention on company
them Debt/Total Debt and Equity x Cost of Debt
Lack of goal Achieve goal 6M/28M x (5% x (1-20%))
congruence congruence 0.2143 x 0.04
0.008572

Bonds

Debt/Total Debt and Equity x Cost of Debt

8M/28 X (6% x (1-20%)
• ECONOMIC-VALUE ADDED (EVA)
0.2857 x 0.048
NOPAT 0.013714
Less: Required Income
EVA
WACC of Equity
Or
Equity/Total Debt and Equity x Cost of Equity
Operating Profit x (1 – Tax Rate)
14M/28M x 12%
Less: WACC X Capital Invested
0.5 x .12
EVA
0.06

✓ WACC may also be called hurdle rate, cutoff

WACC = 0.008572 + 0.013714 + 0.06
rate, target rate, standard rate or minimum
8.16%
acceptable rate of return.

✓ WACC is the proportion of equity and debt and ✓ EVA is a specific form of RI that measures a
the cost of each of its capital segment’s economic profit based on residual
wealth after accounting for the costs of capital;
EVA is often used for incentive compensation & Implementation
investor relations.
1. Translate the strategy into operational
✓ Unlike RI, EVA uses the Weighted Average terms
Costs of Capital (WACC) as the minimum - Use strategy maps
required rate of return to determine the amount 2. Align the organization to the firm’s
of required income. strategy
- Using corporate scorecards as well as
✓ WACC is computed based on the long-term business unit and support unit
sources of financing -- debt and equity -- hence, synergies
the computation: (total assets – current 3. Make the strategy everybody’s everyday
liabilities) being equal to (long-term liabilities job
and equity). [WACC is covered in MS-11 (Cost of - Using personal scorecards, strategic
Capital, Leverage & Capital Structure)] awareness, and balanced paychecks
4. Make strategy a continual process
✓ Under EVA, ‘operating income after tax’ is
- By linking strategy to budgeting, using
based on the formula: EBIT (100% - tax rate)
analytical automation, holding strategy
meetings and implementing strategic
learning
BALANCED SCORECARD
5. Mobilize change through executive
- Goal congruence tool that strikes a leadership
balance between financial and operating - Using mobilization, governance
performance measures processes, and a strategic management
- Translates organization’s missions and system
strategy into operational objectives and
NON-FINANCIAL PERFORMANCE MEASURES
performances measures
• Delivery Cycle Time or Customer
Key Performance Indicators
Response Time
Firm needs to analyze its strengths and
Wait time from receipt of order to Delivery to
weaknesses, and opportunities and threats
Customers
(SWOT Analysis).
• Throughput or Manufacturing Cycle
- KPIs are specific, measurable goals that
Time
must be met in order to achieve a firm’s
strategy Start of Production (Process Time, Inspection
Time, Move Time and Queue Time) to Delivery to
(Figure 1C-19)
customers
Cause-and-Effect Relationships
• Manufacturing Cycle Efficiency
- KPIs should fit within an overall cause-
Process Time
and-effect relationship
Throughput or MCT
- Should progress through each of the four
areas where possible, and the net result
of all of the chains should explicitly
describe company’s strategy
 • Delivery Cycle Efficiency

Process Time
DCT
• Cycle Time
- time required to produce a unit of
output
- Time/Units produced
• Velocity
- Number of units produced in a given
period of time
- Units produced/Time
• Productivity
- Relationship between outputs and
inputs
- Output/Input
o Partial Productivity
Quantity of output produced
Quantity of Input Used
o Total Factor Productivity
Quantity of output produced
Cost of all Inputs Used