Responsibility Accounting
Responsibility Accounting is a system of control that works by delegating and locating responsibility for costs. It is similar to other cost-control systems such as standard costing and budgetary control, but places greater emphasis on fixing responsibility on individuals entrusted with specific tasks.
In Responsibility Accounting, costs are identified with the person responsible for incurring them. This leads to better cost control because, in essence, cost control is ultimately the control of the people who incur the costs.
Responsibility Accounting is a method in which costs and revenues are assigned to individuals who have the authority to control them, rather than being linked to products or functions. It classifies costs and revenues according to responsibility centres units within an organization that are accountable for generating revenue or incurring costs.
Definition & Meaning
Eric L. Kohler defines Responsibility Accounting as “a method of accounting in which costs are identified with persons assigned to their control rather than with products or functions.”
It is a system that identifies various responsibility centres throughout the organization and reflects their plans and actions by assigning specific revenues and costs to those who hold the corresponding responsibilities.
According to the Institute of Cost and Works Accountants of India (ICWAI), 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 is instituted to provide adequate feedback in terms of the delegated responsibility.”
Basic Principles of Responsibility Accounting
Responsibility Accounting operates on several fundamental principles that ensure effective delegation, control, and performance evaluation within an organization.
General Principles
- The organizational structure must be clearly defined, and responsibility must be delegated so that every individual understands their role.
- The extent and limits of functional control should be clearly determined.
- Responsible individuals must receive regular performance reports.
- Every activity or cost item should be assigned to a specific individual within the organization.
Four Basic Principles of Responsibility Accounting
- Objectives The overall objectives of the business are divided and further sub-divided into the objectives of each of its constituent parts. These objectives may be expressed in terms of profit, contribution, or cost. This ensures that each responsibility centre works toward the organization’s broader goals.
- Controllable Costs Responsibility Accounting focuses only on those costs that are directly controllable by a particular manager. Non-controllable costs are excluded or shown separately. Example: In a machine shop, the amount of waste produced is controllable by the manager, but expenses like rent are not.
- Explanation of Results Not all results in a responsibility centre are directly controllable by the manager. External factors can influence both revenue and expenditure. Responsibility Accounting requires managers to explain the reasons for variances between actual results and the budget or forecast.
- Management by Exception In this system, feedback reports highlight only significant deviations from the budget. This “management by exception” principle ensures managers focus their attention on problem areas rather than on operations that are running smoothly.
Benefits of Responsibility Accounting
- It requires clear definition and communication of corporate objectives and individual goals.
- It encourages management to set realistic plans and budgets.
- Exception reporting enables managers to focus on key issues that need immediate attention.
- It provides a system of closer control over activities, costs, and performance.
Implementation Process of Responsibility Accounting
- Identify Responsibility Centres: The first step is to identify various responsibility centres within the organization.
- Define the Scope of Responsibility: For each responsibility centre, the extent and limits of responsibility must be clearly defined.
- Design an Appropriate Accounting System: An accounting system should be developed that can collect and classify information according to areas of responsibility.
- Prepare Performance Reports: Regular performance reports must be prepared to provide relevant information to managers who need it for decision-making and control.
- Classify Activities as Controllable or Non-Controllable: At each level of responsibility, activities should be analyzed and classified into controllable and non-controllable categories.
Responsibility Centre
A responsibility centre is a segment or unit of an organization for which an individual manager is held responsible for performance.
Example: In a company that operates a chain of hotels—Hotel 1, Hotel 2, Hotel 3, Hotel 4, and Hotel 5 each hotel can be treated as a responsibility centre. Similarly, various functional departments such as the Sales Department, Purchase Department, Finance & Accounts Department, and Human Resource Department can also be responsibility centres.
In Responsibility Accounting, the organization must be divided into appropriate responsibility centres so that the authority and responsibility of each manager are clearly defined. Each manager should know:
- What is expected of him, and
- What his performance has been.
Responsibility Accounting focuses more on cost control rather than cost ascertainment, and more on individual accountability rather than on cost elements alone.
Classification of Costs under Responsibility Accounting
Costs are classified in the following manner:
- By Responsibility Centres Costs are grouped according to the centre responsible for incurring them.
- Controllable vs. Non-Controllable Costs Within each responsibility centre, costs are separated into controllable and non-controllable categories.
- Further Classification of Controllable Costs Controllable costs are further classified by cost elements in sufficient detail to provide a useful basis for analysis and decision-making.
Responsibility Reporting
Responsibility Reporting is an accounting and management reporting system designed to control costs by assigning them to specific responsibility centres. It involves clearly defining and grouping responsibilities within the organizational structure, determining and assigning costs to the appropriate levels of activity, and placing strong emphasis on the concept of controllability.
Proforma Responsibility report format
Responsibility Report
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Department:
____________ Month: ____________ Foreman: ___________________ |
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Production (in units): |
Budgeted |
Actual |
Variance (adverse / favourable) |
Remarks |
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Controllable
Costs: |
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Direct
material |
XXX |
XXX |
XX |
|
|
Direct labour |
XXX |
XXX |
XX |
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|
Indirect
material |
XXX |
XXX |
XX |
|
|
Maintenance |
XXX |
XXX |
XX |
|
|
Indirect
labour |
XXX |
XXX |
XX |
|
|
Total
controllable costs (a) |
XXX |
XXX |
XXX |
|
|
Noncontrollable
Costs: |
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Depreciation |
XXX |
XXX |
XX |
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|
Building
maintenance |
XXX |
XXX |
XX |
|
|
Other
allocated cost |
XXX |
XXX |
XX |
|
|
Total
noncontrollable costs (b) |
XXX |
XXX |
XXX |
|
|
Total cost
(a + b) |
XXX |
XXX |
XXX |
|
Centres of Control in Responsibility Accounting or (Types of Responsibility Centres)
Based on cost allocation, revenue generation, and profit measurement, managerial units in an organization are classified into the following types of responsibility centres:
- Cost Centre A segment where the manager is responsible only for controlling costs.
- Revenue Centre A unit where the manager is responsible solely for generating revenue.
- Profit Centre A centre where the manager is responsible for both revenues and costs, and therefore for the profit earned.
- Investment Centre A responsibility centre where the manager is responsible not only for profit but also for the effective utilization of assets and investment decisions.
Cost Centre or Expense Centre
A Cost Centre is a location, function, or item of equipment for which costs are accumulated and measured for control purposes. The CIMA defines a cost centre as “a production or service function, activity, or item of equipment whose costs may be attributed to cost units.”
From a functional point of view, cost centres may be classified as:
- Production Cost Centre – A centre where actual production is carried out. Example: Assembly department, machining department.
- Service Cost Centre – A centre that provides services to production departments. Example: Personnel, accounting, repair shop, boiler plant.
- Manufacturing Centre – Centres involved in producing supporting materials. Example: Units that produce packing materials.
In Responsibility Accounting, a cost centre is a responsibility centre where the manager is accountable for the costs under his control but not for revenues. Only controllable costs are charged to the cost centre. Example: The maintenance department of a hotel may be treated as a cost centre because the maintenance manager is responsible only for controlling costs.
In simple words, An Expense Centre is a responsibility centre in which inputs (costs) are measured in monetary terms, but outputs are not. Responsibility Accounting relies on financial information about both inputs (costs) and outputs (revenues), but in an expense centre only costs are recorded.
Performance in an expense centre is measured by the efficiency of operations how well inputs are used to produce a given level of output. Actual costs are compared with predetermined or budgeted costs to determine variances. These variances reflect the efficiency or inefficiency of the centre.
Revenue Centre
A Revenue Centre is a responsibility centre devoted solely to generating revenue, without any responsibility for production activities. A manager of a revenue centre controls the level of revenue or output (measured in monetary terms) but does not control the cost of the goods or services sold, nor the investment made in the centre.
In a revenue centre, the manager is held accountable only for revenue-related decisions. These may include:
- Setting or influencing selling prices
- Deciding the product mix
- Planning and executing promotional activities
- Implementing strategies to increase sales volume
Since the focus is on revenue generation alone, costs associated with production or operations belong to other responsibility centres.
Example: The Sales Department of a hotel is a revenue centre, as it is responsible only for generating revenue from room bookings, events, and related services, but not for controlling the costs of delivering those services.
Profit Centre
A Profit Centre is any subunit of an organization to which both revenues and costs are assigned so that the profitability of that subunit can be measured. For a unit to function as a profit centre, it must be possible to identify and attribute both its revenues and its costs separately.
Managers of profit centres are responsible for both generating revenue and controlling costs. This requires a sufficient level of decentralization, allowing managers to make decisions regarding selling prices, output levels, and other operational matters that influence profitability.
A responsibility centre becomes a profit centre when the manager is accountable for both sales’ revenue and costs. The difference between revenue and cost represents the profit for which the manager is responsible.
Examples:
- A unit of a company responsible for both production and sales can be treated as a profit centre.
- The manager of a hotel is considered a profit centre manager because they oversee both revenue (room sales, food & beverage, events) and costs.
- In chain operations—such as restaurants, hotels, motels, or retail stores each individual outlet is typically treated as a profit centre.
If head office overheads are allocated to profit centres, these non-controllable costs should be shown separately from directly attributable costs to ensure fair performance evaluation.
Advantages of Profit Centres
- Motivates managers to perform well in areas they can control.
- Encourages initiative and entrepreneurial thinking.
- Utilizes divisional managers’ specialized market knowledge.
- Gives local managers the responsibility for making trade-offs between revenue and cost.
- Helps in training future managers for higher responsibilities.
Disadvantages of Profit Centres
- May confuse divisional results with the manager’s actual performance.
- Can lead to overemphasis on short-term results at the expense of long-term strategy.
- Involves the risk of poor decisions by divisional managers, which top management might have avoided.
- Achieving goal congruence (alignment with overall company goals) can be difficult.
- Performance evaluation can be complicated due to transfer pricing issues.
Investment Centre
An Investment Centre is a responsibility centre where the manager is responsible not only for revenues and costs but also for decisions related to investment, such as working capital management, asset utilization, and capital expenditure. Because the manager controls investment decisions, assessing performance based solely on profit is inadequate.
In an investment centre, the manager’s performance is measured by relating profit to the amount of capital invested. This aligns managerial decisions with the goal of maximizing returns on the division’s assets.
Such divisions are often evaluated using:
- Return on Capital Employed (ROCE)
- Return on Investment (ROI)
- Residual Income (RI) and other subsidiary ratios
Formula for ROI
ROI can be expressed in multiple equivalent ways:
An investment centre operates almost like an independent business unit, where even investment decisions are made by the divisional manager.
Example:
A new hotel project developed by a company would be treated as an investment centre if the manager is responsible for the investment decisions, as well as for the centre’s costs and revenues.
Difference Between Investment Centre and Profit Centre
- A Profit Centre manager is responsible for revenues and costs (i.e., profit).
- An Investment Centre manager has all the responsibilities of a profit centre plus additional responsibility for investment decisions and asset management.
Features of Responsibility Accounting or (Methods or Steps of Control)
Responsibility Accounting operates through a structured process designed to control performance at various responsibility centres. Its key features or steps are:
- Creation of Responsibility Centres The organization is divided into suitable responsibility centres such as cost centres, revenue centres, profit centres, and investment centres.
- Preparation of Plans or Budgets Budgets, targets, or standard performance levels are prepared for each responsibility centre. These plans serve as benchmarks for evaluating performance.
- Performance Evaluation The actual performance of each responsibility centre is measured and compared with the budgeted or targeted results in regular (usually monthly) performance reports.
- Reporting of Variances Any significant deviations (variances) between actual and budgeted performance are reported to higher management, along with the name of the manager responsible for the respective responsibility centre.
- Corrective and Preventive Action Management takes corrective and preventive actions based on the variances identified and informs the responsible managers to ensure continuous improvement.
- Identification of Responsibility Centres Clearly identifying various centres within the organization ensures proper allocation of tasks and authority.
- Delegation of Authority and Responsibility (Decentralization) Authority is delegated and responsibility is assigned so that each manager has control over the activities and costs under their domain.
- Use of Controllable Performance Evaluation Criteria Evaluation focuses on factors and costs that are controllable by the manager of each responsibility centre.
- Selection of Cost Allocation Bases Appropriate and fair cost allocation bases are selected to ensure accurate assignment of shared or indirect costs to different responsibility centres.
Main Roles or Contributions of Responsibility Accounting
- Decentralization Responsibility Accounting supports decentralization by dividing the organization into manageable units. This makes the overall structure easier to control and improves managerial effectiveness.
- Performance Evaluation It provides periodic performance reports that measure the results of each responsibility centre. This helps management assess efficiency, identify variances, and take corrective action.
- Motivation When individuals are given clear responsibilities and authority, their jobs become more challenging and engaging. This motivates employees to utilize their full potential and improves overall productivity.
- Transfer Pricing Responsibility Accounting facilitates internal transfer of goods or services between departments or divisions. Proper transfer pricing helps measure the performance of different units more accurately.
- Drop or Continue Decisions It assists in decision-making regarding the continuation or discontinuation of a responsibility centre. If the savings in costs exceed the revenues lost, a centre may be discontinued.
Advantages of Responsibility Accounting
- Clear Identification of Responsibility The system clearly identifies who is responsible for any adverse or unfavorable performance, making accountability transparent.
- Improved Managerial Morale Managers feel motivated and valued because they participate in decision-making processes related to their respective responsibility centres.
- Higher Job Satisfaction and Motivation Responsibility Accounting encourages managers to take ownership of their areas. This increases job satisfaction and motivates them to put in their best efforts to achieve organizational goals.
Disadvantages of Responsibility Accounting
Difficulty in Establishing Controllability
It is often challenging to determine which costs are truly controllable by a specific manager. Very few costs are entirely under the influence of just one person.
Example: Material Cost = Material Price × Material Quantity
- Material price is controlled by the purchase manager.
- Material quantity is influenced by the production manager.
Because more than one manager influences the total cost, assigning sole responsibility becomes complicated.
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