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KOMAL P PATEL

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K N V INSTITUTE OF BUSINESS MANAGEMENT MCS-2

INTRODUCTION

STRUCTURE

RESPONSIBILITY CENTERS-DEFINITION –TYPE-EXPECNCE & REVENUE CENTERE

ENGINEERED & DISCRETIONARY CENTER

PROFIT CENTERS

MEASURING PROFITABILITY

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2/1/2011K N V INSTITUTE OF BUSINESS

MANAGEMENT MCS-2

AN IMPORTANT COMPONENT OF MANAGEMENT CONTROLS –ASSIGNING RESPONSIBILITY FOR EXECUTING STRATEGY

Implementing strategies is not adequate if individualswho must execute them fall short.

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2/1/2011K N V INSTITUTE OF BUSINESS

MANAGEMENT MCS-2

The characteristics of organizations affectthe control process, focusing on the varioustypes of responsibility centers, thetechniques that are the important to control.

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THEREFORE, MANAGEMENT CONTROLS MUST INCLUDE

How responsibility is assigned and measured

How tasks are measured (not necessarily tasks done byhumans but also by machines; e.g. units produced)

Task controls such as when to order inventory, why theactual differ from budgeted (the causes)

And, not easy to measure or quantify items such as impacton behaviors, intangible assets, and so on.


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Responsibility centers constitute thestructure of a control system and theassignment of responsibility toorganizational subunit must reflect theorganization’s strategy.

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A responsibility center is an organizationunit that is headed by manager who isresponsible for its activities

• Company is collection of responsibility centers each represented by box in organization chart.

• They are in hierarchy

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Robert Anthony:

A responsibility centre is an organization unit that isheaded by manager who is responsible for itsactivities.

Concept of Responsibility Centers

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From the definition it is clear:

• First, delegation of responsibility for specific tosuccessive lower levels of organisation.

• Second, motivation of the level of management towhich a certain task has been delegated.

• Third, measurement of the achievement of specifiedobjectives.

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The key consideration in determining the responsibility centre is

ability to control cost or revenue

determining the question of controllability

evaluation of responsibility centre as per predetermined criteria

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• Exists to accomplish one or more purposes termed as objectives

• The product produced by responsibility centers furnish to another responsibility centers or outside marketplace

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Work

Inputs Outputs

Resources used,Measurement by cost

Goods or services

Capital

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• Relationship between inputs & outputs in responsibility centers can be direct or indirect, e.g. production dept. & Advertising Dept.

• Inputs are measured in monetary terms e.g. like per hr. cost labor which is referred as cost. Cost is a monetary measure of the amount of resources used by a responsibility center

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• Inputs are used by responsibility centers unlike students & patients.

• It is difficult to measure qualitative inputs of the organization

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Introduction of responsibility centres the following changes arerequired in present organisation structure:

1. The responsibility for all the revenues and expenses must beassigned to identified individuals in the organisation.

2. The accounting system should be modified so as to accumulateand report revenues and expenses on the lines of assignedresponsibilities within the organisartion.

3. A system of evaluation based on comparison of revenues andexpenses of different responsibility centres pre assigned targetshould be established.

Organisation Structure and Responsibility Centres

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• The concept of input, output & cost can be used to explain efficiency & effectiveness.

• Efficiency is the ratio of outputs to inputs or the amount of output per unit of input

• Efficiency can be measured by comparing actual Vs. standard

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• Effectiveness is determined by the relationship between a responsibility center’s output and its objectives

• Efficiency & effectiveness are not mutually exclusive; every responsibility center ought to be both efficient and effective.

• Profit measures both effectiveness and efficiency

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“A responsibility center is efficient if it does things right and it is effective if it does the right things”

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The responsibility centers may be classified as

(I) Revenue Centers

(II) Expense Centers

(III) Profit Centers

(IV) Investment Centers

Types of Responsibility Centres I.M.P.

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Investment Centre

President

Profit Centre

Vice – President

Revenue Centre

Marketing Manager

Expense Centre

Production Manager

Relationships between different RCs

Investment Centre

President

Profit Centre

Vice – President

Revenue Centre

Marketing Manager

Expense Centre

Production Manager

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EFFECTIVE Responsibility centre

• Clearly defined segment of an organisation.

• A designated individual is responsible for its performance.

• He has the necessary authority.

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1. Study & list all the different operations,activities, functions, tasks in the organization.

2. Define each activity in descriptive terms.

3. Evaluate the need for any reorganisation &develop an OS on the lines of desired RC.

4. Divide the organisation into various RC.

5. Ensure that the centres satisfy the 3characteristics.

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FACTORS TO BE CONSIDERED

• Objectives of the system

• Need for flexibility

• Ease in allocation

• Future need

• Comparison

• Segregation

• Volume of Information

• A System of Coding

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• In a revenue centre, output (I.e., revenue) is measured inmonetary terms, but no formal attempt is made to relateinput (I.e., expenses or cost) to output.

• The main focus of management’s efforts will be onrevenue generated by it.

• The sales department is an example for a revenue centre.

• The effectiveness of the centre is not judged by howmuch sales revenue exceeds the cost of the centre.

• Sales budget are prepared for revenue centre andbudgeted figures are compared with actual sales.

• Generally the costs are not related to output.2/1/2011


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Work

InputsOutputs

Revenue Centres

Input not related to outputs

Examples

Marketing functionRupeesonly forcosts directlyincurred

Rupees revenue

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Expenses Centre

It is the lowest level of responsibility centre in anorganization.

Its manager is basically responsible for production of aproduct or service; his decision authority relates tohow human resource, machinery and materials shouldbe used to produce the product or service.

Expense centre manager has no control over revenues,profits or investment.

He has no control over marketing decisions orinvestment decisions.

Total performance of an expense centre managerdepends on how effectively and efficiently an expensecentre is operated.

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Effectiveness of an expense centre manager will dependon a host of non-financial parameters such asmaintaining quality level of output, compliance withproduction schedules and targets, maintaining moraleof the workers and so on.

Normally, separate reporting systems are used to reporteffectiveness.

Efficiency is judged in terms of financial performance.

It is measured and reported by the responsibilityaccounting system.

Evaluation of of the financial performance of an expensecentre manager is by comparing the actual expenses ofthe centre against the budgeted expenses.

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• Activities or operations of every expense should behomogeneous so as to ensure uniform basis of chargingexpenses within the centre.

• The activities or operations of each expense centremust be well defined and clearly identifiable.

• Inputs are measured in monetary terms.

• Outputs are not measured in monetary terms.

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Types of Expenses Center

engineered expenses center discretionary expenses center

expenses center

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Engineered Expenses Center

These are the centers for which cost can beestimated

inputs can be measured in monetary terms

outputs can be measured in physical terms

optimal input-output combination can bedetermined

It is usually found in manufacturing operations.

Warehousing, distribution, trucking and similarunits within the the marketing organizationmay also be engineered expenses centres.

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Work

InputsOutputs

Engineered Expense Centres

Optimum relationshipcan be established

Examples

ManufacturingfunctionRupees

physical

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Discretionary Expenses Center

The output of these centers cannot be measured in monetary terms.

They are basically support activities.

Types of discretionary expenses centers:-

-Administrative and support activities

-R&D centers

-Marketing centers

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Work

InputsOutputs

Discretionary Expense Centres

Optimum relationshipcannot be established

Examples

Research & developmentfunction

Rupeesphysical

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• Budget Preparation

• Incremental Budgeting

• Zero Base Review

• Cost Variability

• Types of Financial Control

• Measurement of Performance

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Administrative and Support Centers

• It includes senior corporate management, business unitmanagement, along with the managers of supportingunits.

• Supporting centres are units that provide services toother responsibility centres.

• Control problems :-

- Difficulty to measure output

- lack of goal congruence

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Research and Development Centers

• Control problems :-

- Results are difficult to measure quantitatively

- lack of goal congruence

- Time period is too long

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Marketing Centers

• Marketing activities are divided into two

- Logistics activities:

It involved in moving goods from the companyto its customers and collecting the amountsdue from customers in return.

It include transportation to distributioncentres, warehousing, shipping and delivery,billing and related credit function and thecollection of accounts receivables.

Responsibility centres to this activities issimilar to expense centres.

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This centres can be control through imposingstandard costs and budgeting.

- Marketing activities

It is undertaken to obtain orders for companyproducts.

It include test marketing, the establishment, trainingand supervision of the sales force, advertising and salespromotion.

To measure its output is possible but evaluating theeffectiveness of the marketing effort is much more

difficult. Because of responsible factor of it is not undercontrol of organization.

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PROFIT CENTER

• A profit centre is an organisational unit responsible forboth revenues and costs.

• Profit centre manager has no control over theinvestment in the centre’s assets.

• Managers are concerned with both the production andmarketing of the products.

• Activities of the manager is much more broader thanthat of a revenue centre manager because of theresponsibility to produce the product most efficiently.

• Profit centre’s performance measured in terms ofprofit.

• It enhances profit consciousness

• Example:division of a company that produces andmarkets different products.2/1/2011


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Work

InputsOutputs

Profit Centres

Input are related to outputs

Examples

Business unitRupeescosts Rupees

profit

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ADVANTAGES

• Increase in speed of operating decisions

• Quality of decisions increases.

• Head quarter management relieved of day to daydecisions and can therefore concentrate onbroader issues.

• Profit consciousness may be enhanced.

• Due to greater autonomy managers are free to usetheir imagination and initiative

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DIFFICULTIES WITH PROFIT CENTERS

• Since decisions are decentralised, top managementmay lose some control.

• Organisational units may now compete with eachother disadvantageously.

• An increase in one manager’s profit may decreasethose of another.

• Complexity in the concept of profit. Book profit, realprofit etc.

• There may be arguments over transfer prices.

• Too much emphasis on short run profitability at theexpense of long run profitability.

• Problems of analysis of profit centre results. Singleproduct division – multi product division.

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PROFIT CENTER AS A MOTIVATIONAL TOOL

• A profit center manager is perceived to have a higherstatus in the organisation so it provides a psychologicalbenefit to division manager.

• It enhance the profit consciousness of the managers andsubordinates within the division and hence they allstrive for maximising the profits of the division.

• Brings in a sense of pride and belongingness.

• The freedom and authority given to managers imbibe asense of independence and responsibility.

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INVESTMENT CENTER

• What is an investment center.

• How to measure an investment center performance.

• ROI=(profit before interest&tax)/net operating investment*100

• Residual income

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• An investment centre is responsible for theproduction, marketing and investment in the assetsemployed in the segment.

• An investment centre manager decides on aspectssuch as the credit policies, inventory policies, andwithin broad framework.

• Investment centre manager responsible for profit inrelation to amounts invested in the division.

• Financial performance of the manager of the divisionis measured by comparing the actual with projectedrate of return on investments of the centres.

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Capital Employed

InputsOutputs

Investment Centres

Profits are related to capital employed

Examples

Business unitRupeescosts Rupees

profit

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• Most of the problems faced in the context ofinvestment centre relate to performance evaluationof the division.

• Two of the most important profit related measuresused in the investment centre context are the ReturnOn Investment (ROI) and Residual Income (RI)measures.

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• ROI is the relationship between return (profit) andinvestment expressed as a percentage.

• In this method basic difficulty is in deciding whatshould be taken as profit and what should be theinvestment base for relating same.

Profit Before Interest and Taxes

ROI =

Net Operating Investment

* 100

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ROI Computation Using Net Book Value Of Assets

Year

1 2 3 4 5Net Book Value At

the Beginning of

the year (Rs,’000)

100 80 60 40 20

Cash return

(Rs,’000) 50 50 50 50 50

Less : Depn.20 20 20 20 20

Profit Before Tax30 30 30 30 30

Return on

Investment % 30 37.5 50 75 150

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• To eliminate the problems associated with using aratio as performance measure, many companies usethe RI approach.

• RI is the difference between actual income earned bythe division on an investment and the desiredincome on the investment as specified by minimumdesired rate of return. It is calculated as follows:

• RI = Actual Income – Desired Income (Maximumdesired rate of return * Invested capital)

• Desired Income is also known as Capital Charges.

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RI Computation Using Net Book Value Of Assets

Year

1 2 3 4 5Net Book Value At

the Beginning of

the year (Rs,’000)

100 80 60 40 20

Profit before tax

(Rs,’000) 30 30 30 30 30

Less : Capital

Charge 25 % of

Investment Base

25 20 15 10 5

RI5 10 15 20 25

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Management Control Structure of Ibis Apparels

Production Manager

Apparels

Marketing Managers

Apparels

Vice President

Apparel Division

Vice Presidents

Other Divisions

President

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As presented in chart the management control structure of Ibis Apparels is structured into responsibility centres as follows:

Designation Responsibility Centres

President Investment Centre: Responsible for all investment

decisions & hence to be evaluated on the basis of

performance of ROI

Vice President Profit Centre: Responsible for all the revenues &

Apparels Division expenses of divisions & hence responsible for

the profits of the division

Production Manager Expense Centre: Responsible for production

Apparels and hence responsible for all the expenses to be incurred for production

Marketing Manager Revenue Centre: Responsible for all

Apparels revenues of the division

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Various Centres & their Performance Evaluation

Types of

Centres

Control

variables of the

centre

Variable

predetermined by

top management

Objectives

ExpenseCentre

Prices &quantities of

inputs

Prices & quantitiesof output/budget

Minimise cost

RevenueCentre

Prices &quantities of

inputs

Quantities to besold/budget

Maximise salesrevenue

Profit

Centre

Prices &

quantities ofinputs & outputs

Investment Maximise

profit

Investme

nt centre

Prices &

quantities ofinputs & outputs

& investment

None Maximise

return oninvestment

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UNIT-2_

Documents

responsibility centers

assignment of responsibility

delegation of responsibility

includehow responsibility

revenue centers

investment centers

expense centers

inputs outputs