What is Responsibility Accounting?
Responsibility accounting is a system of accounting where specific persons are made responsible for the accounting of particular areas and cost control. If that cost increases, then the person will be held accountable and answerable. In this type of accounting system, responsibility is assigned based on a person’s knowledge and skills, and the proper authority is given to that person so that he can make a decision and show his performance.
Steps of Responsibility Accounting
Below are the steps or formulas of Responsibility Accounting.
- Define responsibility or cost centerCost CenterCost center refers to the company's departments that don't contribute directly to the corporate revenue; however, the firm has to incur expenses for keeping such units operative. It comprises research and development, accounting and human resource departments..
- Target should be fixed for each responsibility center.
- Track the actual performance of each responsibility centerResponsibility CenterThe term "Responsibility Center" refers to a specific segment or unit of an organization for which a specific manager, employee, or department is held accountable and responsible for its business goals and objectives..
- Compare actual performance with a Target performance.
- The variance between actual performance and target performance is analyzed.
- After variance analysis, responsibility of each center should be fixed.
- The management takes corrective action, and the same should be communicated to the individual Persons of responsibility center.
Types of Responsibility Center
Below are the types of responsibility centers.
Type #1 – Cost Center
These are the center in which individual persons are responsible only for cost controlCost ControlCost control is a tool used by an organization in regulating and controlling the functioning of a manufacturing concern by limiting the costs within a planned level. It begins with preparing a budget, evaluating the actual performance, and implementing the necessary actions required to rectify any discrepancies.. They are not responsible for any other functions. In this center, it is essential to differentiate the controllable costs and uncontrollable costs. A person responsible for a particular cost center will be held accountable only for controllable costsControllable CostsThe controllable costs are the costs that can be managed and changed in the short-term horizon based on business requirements and needs. Examples of such cost include advertisement cost, direct material cost, donations, compensation.. The performance of each center is evaluated by comparing the actual cost vs. targeted cost.
Type #2 – Revenue Center
The revenue center takes care of revenue with no other responsibility. Mainly sales teams of the company are responsible for these centers.
Type #3 – Profit Center
These are the center whose performance is measured in terms of cost and revenue. Generally, the Factory of the company is treated as a profit centerA Profit CenterProfit Center is the segment or division of a business responsible for generating revenue & contributing towards its overall profit. Here, the objective is to increase sales & reducing the cost incurred. where consumption of raw material is a cost and finished product sell to its other department is revenue.
Type #4 – Investment Center
A manager responsible for these centers is responsible for utilizing the assets of the company in the best manner so that the company can earn a good return on capital employedReturn On Capital EmployedReturn on Capital Employed (ROCE) is a metric that analyses how effectively a company uses its capital and, as a result, indicates long-term profitability. ROCE=EBIT/Capital Employed..
Examples of Responsibility Accounting
Below are examples of Responsibility Accounting.
Example #1 – Cost Center
Below is the responsibility report on the cost of production.
ABC Pharma Inc is engaged in the manufacturing of medicine company has decided to produce 10000 medicine in the year 2018 for which the company has defined the budget of $ 90000 at the beginning of the year. Still, at the end of the year, it has noticed the actual cost incurredCost IncurredIncurred Cost refers to an expense that a Company needs to pay in exchange for the usage of a service, product, or asset. This might include direct, indirect, production, operating, & distribution charges incurred for business operations. for the production is $95000. There is an excess expenditure of $5000 over-budgeted expenditure, which the responsibility manager has to explain why this has increased.
It may be possible that Govt. has increased the rate of electricity charges and water charges because of which overhead has increased.
Manger has used the superior quality of the material. Therefore, the cost of material has increased, but at the same time, it takes less no. of manpower hour due to which labor costLabor CostCost of labor is the remuneration paid in the form of wages and salaries to the employees. The allowances are sub-divided broadly into two categories- direct labor involved in the manufacturing process and indirect labor pertaining to all other processes. has decreased.
Example #2 – Revenue Center
Below is the responsibility report of the revenue center of Samsung Inc.
Samsung Inc had targeted revenue of $ 95000 from their electronic segment for the year ended 2018. But at the end of the year, they achieved revenue of $ 93000. There is a decrease of $2000 in their revenue.
In the below report it has been seen that company has achieved its target in Television and washing machine division. In contrast, they have outperformed in Microwave and Mobile division. But their Refrigerator and Air conditioner division have not achieved the targeted revenue due to which their electronic division target falls short by $2000 for which Manager of a Revenue center will be responsible, and he has to explain about the underperformance of these two divisions.
Components of Responsibility Accounting
Below are the Components of Responsibility Accounting:
- Inputs and Outputs – The implementation of responsibility accounting based upon information relating to inputs and outputs. The resource utilized in an organization like qty of raw material consumed, Labor hours consumed are termed as Inputs, and finished product generated is termed as outputs.
- Identification of Responsibility Center – The whole concept of responsibility accounting depends upon identification of responsibility center. The responsibility center defines the decision point in the organization. In small organizations generally, one person who is probably owners of the firm can manage the entire organization.
- Target and Actual Information – Responsibility accounting requires target or budget data and Actual data for performance evaluation of the responsible manager of each responsibility center.
- Responsibility between Organization Structure and Responsibility Center – An organization structure with clear authority and responsibility is required for a successful responsibility accounting system. Similarly, the responsibility accounting system must be designed as per the organization structure.
- Assigning Cost and Revenue to an Individual – After defining the authority – responsibility relationship, cost, and revenue which are controllable should be assigned to individuals for evaluating their performance.
Advantages of Responsibility Accounting
Following are some benefits of Responsibility Accounting
- It establishes a system of control.
- It is designed according to the organization structure.
- It encouraged to budget for comparison of actual achievements with the budgeted data.
- It encourages the interest and awareness of in-office staff as they have to explain about the deviation of their assigned responsibility center.
- It simplifies the performance report because it excludes those items which are beyond the control of individuals.
- It is helpful for top management to make an effective decision.
Disadvantages/Limitations of Responsibility Accounting
- Generally, a prerequisite for establishing a successful responsibility accounting system like proper identification of responsibility center, an adequate delegation of work, proper reporting is missing that makes it difficult for establishing a responsibility accounting system.
- It requires skilled manpower in each department, which increases the cost of the company.
- The responsibility accounting system applies only to controllable costs.
- If the responsibility and objective are not properly explained to the person, then the responsibility accounting system will not give proper results.
The responsibility accounting system is a mechanism by which cost and revenue accumulated and reported to the top management to make an effective decision. It gives freedom to individuals to show their skills for reducing the cost and increasing the revenue of the organizations.
In a responsibility accounting system, organizations divide their department in different – different responsibility center, which helps an organization to focus on only those departments whose performance is not as per target.
At the same time, this accounting systemAccounting SystemAccounting systems are used by organizations to record financial information such as income, expenses, and other accounting activities. They serve as a key tool for monitoring and tracking the company's performance and ensuring the smooth operation of the firm. is useful only for the big organization because it requires skill and more manpower for each responsibility center, For an effective responsibility accounting system, it is necessary that all the managers are aligned with the company objective, and they know their responsibility.
This has been a guide to what is Responsibility Accounting. Here we discuss the critical components of responsibility centers along with examples and responsibility center types. We also discuss the advantages and disadvantages. You can learn more about accounting from the following articles –