Responsibility Centers

 Responsibility Center
 An organization unit for which a manager is
made responsible
 Manager of Responsibility Center
 Establish goals
 Promote long-term interests
 Promote coordination of each responsibility
center’s activities
Responsibility Centers & Financial
Control

 Coordinating Responsibility Centers

 Financial Results
 Aggregate measures
 Nonfinancial Results
 Identify causes/drivers of financial results
 Financial Control
 A summary measure
Responsibility Center Types – I
 Cost Centers
 Control: costs
 Candidate: processing group
 Evaluation
 actual costs vs. target/standard costs
 current costs vs. previous costs
 Other measurements
Responsibility Center Types – II
 Revenue Centers
 Control: revenues
 Candidate: sales office of a corporation
 Evaluation
 based solely on revenues
 net revenue
 Undesirable consequences
Responsibility Center Types – III
 Profit Centers
 Control: revenues and costs
 Candidate: individual units of chain operation
 Evaluation: not rely only on the unit’s profit
 no one in organization can control performance
 poor corporate decisions
 poor local decisions
 Quality, material use, labor use, service
Responsibility Center Types – IV
 Investment Centers
 Control: revenues, costs, and
investment
 Candidate: independent business
 Evaluation: ROI relative to target
Evaluating Responsibility
Centers
 Controllability Principle
 the manager of a responsibility center should be
held responsible only for the revenues, costs, or
investment that responsibility center personnel
control
Exclude: Revenues, costs, or investments
that people outside the responsibility
center’s control
Problems with the
Controllability Principle
 many revenues and costs are jointly
earned or incurred

 the activities that create the final product

are sequential and interdependent

 requires the firm to consider many facets

of performance
Problems with the
Controllability Principle
(cont.)
 The organization could prepare accounting
summaries of the performance to support some
system of financial control.
 What are the harvesting revenues?
 What costs of production does marketing control?
 How much influence does harvesting and processing
have on sales?
Using Performance Measures
to Influence (instead of
evaluate)

 When more costs or revenues are

included in performance measures,
managers are more motivated to
find actions that can influence
incurred costs or generated
revenues
Margin Reports

 Organization units as profit centers.

 Decide how to assign the responsibility

for jointly earned revenues and jointly
incurred costs

 How to handle the interactions among

the various profit center units?
Example
Earl’s Motors
 New car sales
 Used car sales
 Body shop
 Service department
 Leasing
Good or Bad Numbers?
1. Past Performance
• Is the performance this period reasonable,
given past periods?
1. Comparable Organizations
• How does performance compare with similar
organizations?

• Evaluate by using absolute and relative

amounts.
!!! CAUTION !!!
 Segment margins reflect many
assumptions that disguise underlying
issues.
 Must also consider
 Quality and service that will affect future profits
 Subjective revenue and cost allocation
assumptions
 Transfer pricing issue (most important)
Transfer Pricing
Transfer Pricing is the set of rules
an organization uses to allocate
jointly earned revenue among
responsibility centers.
The primary purpose of producing
management accounting numbers
is to motivate desirable behavior
regarding managers’ decision
making.
Sale of a new car with a trade-in
will affect profits of both the
dealership’s new car dept. and
used care dept.
Approaches to Transfer
Pricing
 Market-based transfer prices

 Cost-based transfer prices

 Negotiated transfer prices

 Administered transfer prices

Market-Based Transfer
Prices
 Indication
 If external markets exist for the transferred product,
market prices are the most appropriate basis for pricing
the transferred product between responsibility centers.
 Example
 Car Trade-ins, there is an external market for used cars
with well-defined yet subjective values.
 Problem
 Well-defined competitive markets seldom exist
Cost-Based Transfer Price
 Indication
 When the transferred good does not have a
well-defined market price.
 Example
 Some common transfer prices are flexible cost,
flexible cost + markup, full cost.
 Problem
 May lead centers’ managers to choose a lower
than optimal level of transactions, causing loss
to the organization.
Negotiated Transfer Price
 Indication
 In the absence of market prices, organizations allow
supplying and receiving responsibility centers to
negotiate transfer prices among themselves.
 Example
 Best transfer price results when the purchasing unit
offers to pay the net realizable value or the
selling price of the product less costs of preparation
for final sale.
 Problem
 During negotiation the supply division want a higher
price than optimal and the receiving division want a
lower price than optimal.
Administered Transfer
Price
 Indication
 When all else fails, an arbitrator sets the
transfer price.
 Example
 Manager may choose market price less 10%,
provides an arbitrary distribution of revenues
and costs between the divisions.
 Problem
 Subsidies will occur and obscure the economic
interpretation of the responsibility centers and
may provide a negative emotional effect.