Planning & control are essential for achieving good results in any business. Firstly, a budget is prepared and, secondly, actual results are compared with budgeted ones. Any difference is made responsibility of the key individuals who were involved in (i) setting standards, (ii) given necessary resources and (iii) powers to use them.
In order to streamline the process, the entire organization is broken into various types of centers mainly cost centre, revenue centre, profit center and investment centre. The organizational budget is divided on these lines and passed on to the concerned managers. Actual results are collected and displayed in the same form for comparison. Difference, if any, are highlighted and brought to the notice of the management. This process is called Responsibility Accounting.
A FORMAL DEFINITION OF RESPONSIBILITY ACCOUNTING
Responsibility accounting involves the creation of responsibility centres. A responsibility centre may be defined as an organization unit for whose performance a manager is held accountable. Responsibility accounting enables accountability for financial results and outcomes to be allocated to individuals throughout the organization. The objective is to measure the result of each responsibility center. It involves accumulating costs and revenues for each responsibility centre so that deviation from performance target (typically the budget) can be attributed to the individual who is accountable for the responsibility centre.
(Colin Drury, Management and Cost Accounting, sixth edition)
MANAGERIAL PERFORMANCE AND ECONOMIC PERFORMANCE
All businesses operate in a complex environment. The traditional approach of centralized control is not possible. There is a shift towards decentralization. At the same time, the management wants to retain some sort of control over activities of its managers.
When authority is decentralized and passed on to managers, there is a problem of goal-congruence. This means that the management will constantly review all operations and activities of individual divisions to insure that none of them is working against the overall objectives of the company. Such a behavior is called dysfunctional and is damaging to the company.
While evaluating, performance of an individual manager, two factors have to be considered:
Should the manager ’s job be separated and a manager is rewarded or penalized only for those activities over which the manager has control.
Should the manager ’s decision be seen in a wider prospective and final judgment be given only after reviewing full impact of such decisions.
It is obvious that a manager’s decisions should be evaluated after seeing their impact on the bottom line i.e. profitablity of the comany. But such policy would not be motivational for the individual manager and the good results may be nullified by the factors not under the control of the particular manager. Hence, the company follows first appraoch i.e. managerial performance.
An example to explain Responsibility Accounting
An integrated textile unit showed a net profit after tax of Rs.272 million. Its ROI (Return on Investment), was 17.5% which is much above the supposed cost of capital of 12.5%.
The company was operating three divisions: (i) Spinning Unit, (ii) Weaving Unit and (iii) a Finishing Unit. As of now, it is not apparent who earned what. So managers of the three departments would be asking for bonuses or rewards.
Now suppose, the company asks its accountants to prepare Division-wise P&L account and present the same to the management for performance appraisal of the three managers.
After considering division-wise performance, who do you think deserve the bonus?
Only the manager, Spinning Division, deserves the bonus. Manager Weaving has just broken even by earning profit equal to cost of capital. Manager Finishing was really a drag on the company ’s resources and its losses were only hidden in consolidated statements because of substantial contribution made by Spinning Unit.
However, this is over-simplified example but it brings glaring facts to the notice of the management and other users of the accounts.
RESPONSIBILITY CENTRES
Packages Ltd had two autonomous units, Lahore Plant and Karachi Plant. In our responsibility accounting terminology, these would be called Investment Centres. General Manager, Lahore Plant, can decide how much to invest on what. (Of course, he would be guided by a multi-functional teams which includes industrial engineers, economists, researchers and financial analysts.) The GM, Lahore Plant would be evaluated on the basis of ROI or RI or EVA. And so the GM, Karachi Plant. The yardsticks would remain the same in the case of both the Managers.
In the second Layer there are Managers of Paper Mills, Packaging Plant and Printing Plant. All of them have been given necessary Production Facilities and working Capital. Their performance would be based on Gross Margin or Contribution Margin. The latter is a better measure since it does not take into account fixed cost (Depreciation, Salaries of Permanent staff and markup) over which the Manger has no control. (Decisions for capital investments are made in the Investment Centers).
In the last layer there are three sections. The first two are classified as Cost Centers and their managers should try to remain within their allocated budgets. The third one, Marketing Cell, is a Revenue Centre and its manager must exert as much as possible to bring the business as per target level or budget level.
CONCLUSION
There are no set rules or Generally Accepted Accounting Principles (GAAP) in management accounting which serves the management and not outsiders. So performance reports may be prepared in any form and styles as long as these give useful information to the Chief Executive and the top-managers. One such format is given above.
The modern business concerns adopt a variety of way to achieve their goals. Since a Chief Executive cannot over-see all affairs of a company in different fields, in different locations and in different time-frames, he or she introduces a systematic control through budgets and responsibility accounting techniques. The organization is broken into various responsibility centres. The Accountant maintains records for each of the centre and periodically prepare and submit reports on their performance which ultimately reflect on the capability of its managers.
To use such techniques effectively, the emphasis must be on the useful information rather than a blame game or passing on the buck. The managers should be provided feedback as to how near or away they are from their targets. These reports should be well in time to allow them to adjust their approach. The ultimate aim would be welfare of the organization and its gradual rise in the industrial sector. In the process, good managers must be rewarded and bad one eliminated to stay afloat in a most competitive and dynamic environments.
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