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Responsibility accounting Responsibility accounting Responsibility accounting Responsibility accounting

Benefits of managing decentralised organizations:– management concentrates on strategic decisions and coordination of activities

of the whole organisation – better information for decision-taking at a level where the problem exists– improved management of managers' knowledge, they learn as the

organisation grows and responsibilities change– greater elasticity in decentralised organisations – decentralisation allows for more effective assessment of managers

Need to develop managerial control – control is aimed at ensuring fulfillment of goals set by the management

Accounting based on responsibility centers - provides information needed for managerial control

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Responsibility centersResponsibility centers (1) (1)Responsibility centersResponsibility centers (1) (1)

Responsibility center (pl. centrum odpowiedzialności)– organisational unit, which is responsible for management of

particular (selected) group of activities and which is headed by a manager with a delineated set of competences and responsibilities

Conditions for effective managerial control:– organisational structure with specific units – specified set of skills and responsibilities required for the unit

managers – precisely described relationships between employers and

employees

Types of responsibility centers: – for costs, for profit, for investment

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Responsibility centersResponsibility centers (2) (2)Responsibility centersResponsibility centers (2) (2)

Cost centerCost center Profit centerProfit center Investment center

Investment center

ResponsibilityResponsibility

centerscenters

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Cost centerCost centerCost centerCost center Cost center (pl. Centrum kosztów )

– lowest scope of responsibility– managers are responsible for incurring costs– managers have a right to take decisions that have an impact

on the level of costs and need information required to control the process of the implementation of decisions and costs

Identification of responsibility centers:– spatial – organisational– informational – subjective – decisional

Assessment of cost centers: – minimalisation of total costs for the fixed level of activities

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Cost centerCost center - problem - problems s Cost centerCost center - problem - problems s

Responsibility of cost centers:– taking decisions which ensure implementation of activities

as well as conformity of controlled costs to a plan (budget, standards)

– explaining existing deviations, also due to reasons beyond cost center's control

Limitations of cost control:– in a short-term there is a low possibility to change costs– subjective assessment, which costs are controlled – impact of external economic variables – impact of unpredictable events – problem of interdependencies between responsibility centers

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Profit centerProfit centerProfit centerProfit center

Profit center (pl. Centrum zysków)– greater need for management than for cost centers – managers responsible for originating costs and generating

income (profits)– specifying profit centers is based on the same criteria as

specifying cost centers – profit centers may include one, few or tens of cost center(s)– if a profit center provides services to other profit centers in a

company in order to price the internal services transfer prices (internal prices) are used

Assessment of profit centers:– based on income (profit)

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Profit centerProfit center - problem - problemssProfit centerProfit center - problem - problemss

Set correct transfer prices inside the company

Allocated common costs to responsibility centers

Profit centers concentrating only on its profits often ignore activities which impact results of other responsibility centers

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Investment center Investment center Investment center Investment center

Investment center (pl. Centra inwestycyjne)– possesses the largest scope of responsibility – managers are responsible for profits, costs and assets – investment centers may include one or more profit centers– for investment decision-taking ex-ante information about costs

and profits as well as information about inflows and outflows of various alternatives are necessary

Assessment of investment centers:– Return on Investment (ROI)– Residual Income (RI)– Economic value added (EVA®)

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Investment centersInvestment centers - problem - problemssInvestment centersInvestment centers - problem - problemss

Choice of measure used for assessment – necessity to include costs and profits common with other

centers as well as services present among centers– necessary to include effectiveness investment processes

Difficulty in comparing cost centers of different sizes

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Return of InvestmentReturn of Investment - ROI - ROIReturn of InvestmentReturn of Investment - ROI - ROI

Return on Investment – ROI (pl. Stopa zwrotu z aktywów)

ROIROI == Income from operationsIncome from operations

Average assets of operational unitAverage assets of operational unit

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Calculation of ROICalculation of ROICalculation of ROICalculation of ROICost of products sold and services rendered Cost of products sold and services rendered

Sales, administrative and managerial costs Sales, administrative and managerial costs

Other operational revenues – other operational costs

Other operational revenues – other operational costs

Operational costsOperational costs

Sales Sales

Income from

operations

Income from

operations

ROIROIROIROISales Sales

Return

on sales

Return

on sales

Return

on assets

Return

on assets

Operational assets

Operational assets

Cash and cash equivalentCash and cash equivalent

Liabilities Liabilities

Inventory and other short-term assetsInventory and other short-term assets

Long-term assets Long-term assets

Legal assets Legal assets

Other long-term assets Other long-term assets

Short-term assets

Short-term assets

Long-term assets Long-term assets

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How to calculate ROIHow to calculate ROI??How to calculate ROIHow to calculate ROI??

ROI = Income from operationsIncome from operationsAssets of operational unitAssets of operational unit

Income from operationsIncome from operationsSalesSales

SalesSalesAssets of operational unitAssets of operational unit

= x

= Return on Return on salessales

x Return onReturn onassetsassets

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Example: How to calculate ROIExample: How to calculate ROIExample: How to calculate ROIExample: How to calculate ROI

Assets of the operational unit $ 100 000

Income from operations $ 18 000

Sales $ 200 000

ROI = Income from operationsIncome from operationsAssets of operational unitAssets of operational unit

= Return onReturn on

salessales

Return Return on assetson assets

= 18 00018 000100 000100 000

= 18%

18 00018 000200 000200 000

= 9%

= 200 000200 000100 000100 000

= 2 times

ROI = 9% x 2 = 18%

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Limitations of utilisingLimitations of utilising ROI ROILimitations of utilisingLimitations of utilising ROI ROI

Using ROI to assess activities has its limitations:

– ROI measure is not directly tied to the goal of maximising the value of the enterprise for its owners

– ROI used as an assessment measure of managers can lead to incorrect investment decisions

– ROI is a short-term assessment measure

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Residual incomeResidual incomeResidual incomeResidual income

Residual income – RI (pl. Zysk rezydualny)– so the surplus of an income from operations – result of

operational activities, which an investment center can generate over a specific rate of return using available operational assets

RI as an assessment measure:– aim of the investment center: maximising the residual

income

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How to calculateHow to calculate RI? RI?How to calculateHow to calculate RI? RI?

Revenues from sales 12 000 000

Average value of operational assets 8 000 000

Income from operations 1 200 000

ROI (1 200 000/8 000 000) x 100% 15%

Minimum result from operations (12% x 8 000 000) 960 000

RI (1 200 000 – 960 000) 240 000

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ROI ROI andand RI RI in decision-taking in decision-taking (1) (1)ROI ROI andand RI RI in decision-taking in decision-taking (1) (1)

Assumption: ALFA Co. can invest 300 000 zł in activating new product line, which will lead to increase of: sales by 636 000 zł per annum, cost of goods sold by 500 000 zł, sales costs by 56 000 zł and administrative costs by 40 000 zł.

P/L Statement for ALFA Co. Before the

project

Incremental result

from the project

After the project

Sales revenue 1 200 0000 636 000 12 636 000

Cost of goods sold (COGS) 9 000 000 500 000 9 500 000

Gross income from sales 3 000 000 136 000 3 136 000

Sales costs 1 000 000 56 000 1 056 000

Administrative costs 400 000 40 000 440 000

Income from sales 1 600 000 40 000 1640 000

Other operational income 400 000 - 400 000

Other operational costs 800 000 - 800 000

Income from operations 1 200 000 40 000 1 240 000

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ROI ROI andand RI RI in decision-taking in decision-taking (2)(2)ROI ROI andand RI RI in decision-taking in decision-taking (2)(2)

Investment in the project decreases the ROI measure, which is why the ALFA manager, assessed based on ROI, will reject the project

Before the

project

Incremental result

from the project

After the project

Average operating assets 8 000 000 300 000 8 300 000

Income from operations 1 200 000 40 000 1 240 000

ROI 15% 13% 14,94%

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ROI ROI andand RI RI in decision-taking in decision-taking (3)(3)ROI ROI andand RI RI in decision-taking in decision-taking (3)(3)

Investment in the project increases the RI measure, which means that the manager assessed based on RI will undertake the project

Limited use of RI: should not be used to assess investment centers of various sizes, bigger investment centers can show larger RI

Before the

project

Incremental result

from the project

After the project

Sales 12 000 000 600 000 12 600 000

Average operating assets 8 000 000 300 000 8 300 000

Income from operations 1 200 000 40 000 1 240 000

ROI 15% 13% 14,94%

Minimal required result from operating activities 960 000 36 000 996 000

RI 240 000 4 000 244 000

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EVA® = Wynik operacyjny – koszt kapitału x zainwestowane środki

Economic value addedEconomic value added - EVA - EVA®® Economic value addedEconomic value added - EVA - EVA®®

EVA® (ang. economic value added)– measure that shows the value that the activities of a given investment center "add" to the value of an enterprise– shows the aim of activities of an enterprise – maximialisation of its value

Limitations of applying the EVA®:

– short-term measure based on annual data – its used can lead to faulty investment decisions taken by managers interested

in short-term benefits

Modifications of EVA®:

– e.g. bonus bank – managers lose motivation to conduct long-term non-income generating projects

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EVAEVA®® in decision-takingin decision-taking (1) (1)EVAEVA®® in decision-takingin decision-taking (1) (1)

Assets in 2001 - 10 000 000 zł, in 2002 – 20 000 000 zł Liabilities in 2001 - 3 000 000 zł, in 2002 – 4 000 000 zł Cost of capital set at 10%

P/L Statement of Gamma Co. 2001 2002

Sales revenue 12 200 000 20 000 000

Cost of goods sold (COGS) 7 400 000 15 000 000

Gross income from sales 4 800 000 5 000 000

Sales costs 1 200 000 1 000 000

Administrative costs 2 000 000 1 500 000

Income from sales 1 600 000 2 500 000

Other operational income 400 000 400 000

Other operational costs 500 000 400 000

Income from operations 1 500 000 2 500 000

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EVAEVA®® in decision-takingin decision-taking (2) (2)EVAEVA®® in decision-takingin decision-taking (2) (2)

Decrease in ROI: worsening of the investment center's effectiveness?

Increase in EVA®: improvement of the investment center's effectiveness?

2001 2002

Return on sales 12,29% 12,5%

Return on assets 1,22 1

ROI 15% 12,5%

EVA ®800 000 900 000

Calculation 1,5 mln-7mln*10%=0,8 mln 2,5mln-16mln*10%=0,9 mln