Responsibility accounting:

Most organizations are divided into smaller units, each of which is assigned responsibilities. These units may be
called “divisions”, “segments”, “business units” or “departments”. Each of which is composed of individuals who are
responsible for tasks or managerial functions. The main goal of any manager is to ensure that the people in each
department strive toward the same overall goals.

Type of Responsibility Centers:

Responsibility center – a segment of organization engaged in the usually governed by a manger, who is accountable
and responsible for the activities of the segment.
Types of responsibility centers:
1. cost center – the manager is responsible for controlling cost. The managers have the authority to incur costs to
support their areas of responsibility. Cost centers are evaluated by comparing actual costs to budgeted costs.
Compare the actual cost center to budgeted cost center, the check the performance whether doing good or not.
2. revenue center – the manager is responsible for generating revenue for their segment of the business. Companies
often give revenue center managers sales targets or quotas and then evaluate and reward them based on whether
they meet those targets. Actual revenue>budgeted revenue, the center is performing well, the manager is
performing well, if actual revenue<budgeted, the center does not performing well.
3. profit center – the managers are held responsible for both revenues and costs (profit) of the segment. Unlike cost
center managers who are primarily responsible for cost, and revenue center managers who are primarily responsible
for revenue, profit center managers are responsible for both.
Compare actual profit to budgeted profit – performing well.
4. investment center – managers have the authority to make decisions about how where to invest the company’s
assets to drive king-term profitability. They have more responsibility than the previously discussed managers
because they are also responsible for investing the company’s assets.
Manager is responsible not only for cost, revenue but also to assets entrusted to center. (ROI, Residual income and
EVA)

Why decentralize decision-making responsibility?

Decentralization enables units of an organization to respond more quickly and effectively to the uncertainties of
markets and economic change. Decentralization requires that senior level managers delegate decision-making
responsibilities to operating level managers who are closer to the action and who have access to more timely,
relevant information for making decisions.

In a centralized environment, control moves from task control to results control. In a task control environment, the
focus is on getting a particular task done. In a results control environment, the focus is on motivating people to use
their skill, knowledge, and creativity to improve operating results.

Controllability, a principle often used in control, asserts that people should only be held accountable for results that
they can control. The main application of this principle is that managers should not be held accountable for costs
outside their control. One major difficulty in applying this occurs when revenues and costs are jointly earned or
incurred. Separating these component revenues and costs can involve intricate, and often arbitrary, accounting
procedures.
A segment margin is the level of controllable profit reported by an organizational unit or product line. Each unit’s
segment margin is an estimate of its short-term effect on the organization’s profit. Interpreting segment margins
should be done carefully, as:
- Segment margins can represent highly aggregated summaries of each organizational unit’s performance.
Thus, other critical success factors should be used as well to assess performance.
- Some segment reports contain arbitrary numbers. Accountants call these soft numbers since they rest on
subjective assumptions over which there can be legitimate disagreement.
- The revenue figures often reflect assumptions and allocations that can be misleading. These assumptions
relate to how the revenues that the organization earned are divided among the responsibility centers.

Responsibility accounting – a system of accounting that is implemented to an organization so that performance, in

terms of costs and/or revenues, are recorded, reported and evaluated by levels of responsibility within an
organization. It also refers to various concepts and tools used by managers to measure the performance of people
and departments in order to foster goal congruence.
Goal congruence - the result when managers of subunits throughout an organization strive to achieve the goals set
by top management.
Controllable and Non-controllable Costs, Direct and Common Costs:
Controllable vs. Non-controllable costs – generally, all costs are controllable. The key difference lies in the level of
management who can control the costs. (Relate to direct vs. controllable costs)
- Controllable costs are those costs that may be directly regulated at lower levels of management.
- Non-controllable costs are costs that cannot be regulated at a particular management level other than the
top level.
Direct vs. indirect costs:
Direct costs – costs that can be easily and conveniently traced to a unit of product or other cost object.
Indirect costs – costs that cannot be easily and conveniently traced to a unit of product or other cost object.
Note: that classifying a cost as either direct or indirect depends upon the cost object to which the cost is being
related. A direct cost can be specifically associated with a single cost object in an economically feasible way. An
indirect cost cannot be specifically associated with a single cost object. Thus, the specific cost object influences
whether a cost is direct or indirect.
Common costs – a cost incurred for the benefit of more than one cost object. Common cost is synonymous to joint
cost. In this sense, common costs are incurred in the production of two or more inseparable products up to the point
at which the products become separable at the split-off point.

Return on Investment, Residual Income and Economic Value Added:

Investment center – managers have the authority to make decisions about how and where to invest the company’s
assets to drive long-term profitability. They have more responsibility than the previously discussed managers
because they are also responsible for investing the company’s assets. The following may be used as basis for
evaluating the performance of investment centers:
1. Return on Investment (ROI)
Net operating income/averaged invested assets or net profit margin*asset turnover
2. Residual Income (RI)
*RI = net operating income – required income
*where required income = average invested assets*hurdle rate
*it compares the net operating income and the minimum acceptable profit based on the required rate of return
(hurdle rate). The hurdle rate will depend on several factors, including the risk of the investment, the cost of
financing it, and the return that could be earned in other investments.
*it is the amount of net operating income earned over and above the minimum amount needed to meet the
required rate of return.
*it encourages managers to maximize pesos of profit after a required ROI has been achieved.
*it overcomes some of the problems associated with ROI.
*it encourages managers to accept projects which provide returns in excess of the company’s required rate of
return.

ECONOMIC VALUE ADDED (EVA) - it measures the economic wealth that is created when a company’s aftertax
operating income exceeds its cost of capital. It is similar to the residual income computation; however, EVA makes a
number of important adjustments:
*measures profitability based on after-tax net operating income rather than pre-tax net operating income.(note: this
amount is earnings after taxes but before interest expense)
*uses the cost of capital as the hurdle rate. Conceptually, the cost of capital represents the after-tax cost of financing
the company’s operations through some combination of debt and equity.
*uses total capital employed as the measure of investment rather than average invested assets.
*thus, the equation is:
EVA = Operating income after tax - {(total assets - current liabilities)* WACC}

Illustration:
Problem 1. For each of the following independent cases, the minimum desired return on investment is 20%.
Division A Division b Division c
sales P100,000 175,000 P168,000
Operating income 14,000 10,080
Operating assets P70,000 24,000
Profit margin 12% 8% 6%
Asset turnover 2.5 7x
Residual income 0 5,280
Return on investment 15% 20% 42%
Required: Compute for each division’s missing items

Problem 2. Consider the following data for the two divisions of ABC Company:
QC Division Manila Division
Average invested assets P4,800,000 P3,600,000
Sales revenue P11,520,000 P5,760,000
Operating expenses 11,174,400 5,184,000
Net operating income 345,600 576,000
Required:
1. Compute the investment turnover, profit margin, return on investment, and residual income for each division.
Assume a 9% hurdle rate.
2. The manager of the Manila division has the opportunity to invest an additional P1,600,000 in a project expected to
generate additional operating income of P204,000 per year. Calculate the new ROI and residual income if the
manager accepts the project.
3. Based on your answer in (2), should the manager invest in the project, assuming he is evaluated based on:
A. Return on Investment
B. Residual Income

Problem 3. ABAM Corporation has the following year-end data:

Earnings before interest and taxes P250,000
Current assets 280,000
Non-current assets 1,000,000
Current liabilities 130,000
Non-current liabilities 800,000
Required: ABAM Corporation is subject to an income tax rate of 30%. Its weighetd average cost of capital is 12%?
what is ABAM Corporation’s economic value added (EVA)

PROBLEM 4
Amber Products Inc. has two product lines: A-100 and A-200. Revenue and cost information for each of the product
lines for the year are as follows:
A-100 A-200
Selling price per unit P60 P45
Variable costs per unit 25 15
Traceable fixed expenses P40,000 P30,000

During the year Amber had common fixed expenses of P50,000, and the company produced and sold 4,000 units of
A-100 and 6,000 units of A-200.

Requirement: Prepare a segmented income statement with a column for each product line and the total company.
A-100 A-200
Selling price 60 45
Variable cost 25 15
CM per unit 35 30
X unit sold 4,000 6,000
140,000 180,000
Direct fixed costs 40,000 30,000
100,000 150,000
Total segment margin 250,000
Less: common fixed costs (50,000)
Net income 200,000

PROBLEM 5
El Campo is a division of a major corporation. The following data are for the latest year of operations:

Sales P10,890,000
Net operating income P609,840
Average operating assets P3,000,000
 The companys minimum required rate of return 16%

Requirements:
1. what is the division’s margin? Income/sales
609,840/10,890,000 = 5.6%
2. what is the division’s turnover? Sales/assets
10,890,000/3,000,0000 = 3.63:1 meaning for every peso of asset kaya mo mag produce nang 3.63 pesos, the higher
turnover the better.
3. what is the division’s turnover on investment (ROI)? income/assets
609,840/3,000,000 = 20.33% or income times assets (5.6% x 3.63)
4. what is the division’s residual income?
609,840 - (3,000,000 x 16%)
= 129,840

PROBLEM 6.
REB Service Co. is a computer service center. For the month of May 2022, REB had the following statistics:
Sales P450,000
Operating income 25,000
Net profit after taxes 8,000
Total assets 500,000
Shareholders’ equity 200,000
Cost of capital 6%

Requirements:
1. Compute ROI? 25,000/500,000
2. Compute Residual income? 25,000 - (500,000 x 6%)

PROBLEM 7
The following data refer to the AIM division of Master Company.
Average selling price P100
Average variable cost 40
Total fixed costs P2,000,000
Average investment P5,000,000 x 18% = 900,000

Requirements:
1. How many units must AIM to sell to earn an 18% ROI? 900,000+2,000,000/(100-40) = 48,334 units
2. If the division sells 60,000 units, what will ROI be? 60,000 x 60 = 3,600,000 - 2,000,0000 = 1,600,000
1,600,000/5,000,000 = 32%
3. The minimum desired ROI is 14%. At the sales volume of 55,000 units, what is RI? 55,000 x 60 = 3,300,000 -
2,000,0000 = 1,300,000
RI = 1,300,000 - (5,000,000 X 14%) = 600,000
4. The manager desires a 22% ROI and wishes to sell 50,000 units. What selling price must the division charge?
1,100,000 + 2,000,000/50,000 = 62 + 40 = 102
5. Using the original information, if the minimum ROI is 20% and RI is P300,000, what are sales in units?
Residual income = income - (assets x minimum roi)
300,000 = x - (5,000,000*20%)
300,000 = x - 1,000,000
X = 1,300,0000

1,300,000 + 2,000,000/60
= 55,000 units