What is the responsibility accounting system?

Let us make an in-depth study of the meaning, features and steps for achieving goals of responsibility accounting.

Meaning and Definition of Responsibility Accounting:

The systems of costing like standard costing and budgetary control are useful to management for controlling the costs. In those systems the emphasis is on the devices of control and not on those who use such devices. Responsibility Accounting is a system of control where responsibility is assigned for the control of costs. The persons are made responsible for the control of costs.

Proper authority is given to the persons so that they are able to keep up their performance. In case the performance is not according to the predetermined standards then the persons who are assigned this duty will be personally responsible for it. In responsibility accounting the emphasis is on men rather than on systems.

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For example, if Mr. A, the manager of a department, prepares the cost budget of his department, then he will be made responsible for keeping the budgets under control. A will be supplied with full information of costs incurred by his department. In case the costs are more than the budgeted costs, then A will try to find out reasons and take necessary corrective measures. A will be personally responsible for the performance of his department.

Charles, T. Horngreen:

“Responsibility accounting is a system of accounting that recognizes various responsibility centres throughout the organisation and reflects the plans and actions of each of these centres by assigning particular revenues and costs to the one having the pertinent responsibility. It is also called profitability accounting and activity accounting”. According to this definition, the organisation is divided into various responsibility centres and each centre is responsible for its costs. The performance of each responsibility centre is regularly measured.

Anthony and Reece:

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“Responsibility accounting is that type of management accounting that collects and reports both planned actual accounting information in terms of responsibility centres”. The emphasis in this definition is on setting the objectives of responsibility centres and then recording the actual performance so that the persons in-charge of various activities are able to assess their performance.

Institute of Cost and Works Accountants of India. Responsibility accounting is “a system of management accounting under which accountability is established according to the responsibility delegated to various levels of management and a management information and reporting system instituted to give adequate feedback in terms of the delegated responsibility. Under this system divisions or units of an organisation under a specified authority in a person are developed as responsibility centres and evaluated individually for their performance.”

According to this definition the organisation is divided into different cost centres. These cost centres are put under certain persons and adequate authority is delegated to them for completing the work assigned to them. A system of management reporting is used to assess the performance of cost centres.

Kohler E.L.:

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It is “the classification, management, maintenance, review and appraisal of accounts serving the purpose of providing information on the quality, quantity and standards of performance attained by persons to whom authority has been assigned.” Responsibility accounting, according, to Kohler, is the maintaining of accounts in such a way that the performance and level of achievement of various persons responsible for different works is studied”.

Louderback and Dominiak:

“Responsibility accounting is the name given to that aspect of the managerial process dealing with the reporting of information to facilitate control of operations and evaluation of performance.”

Charles T. Horngren:

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“Responsibility accounting is a system of accounting that recognises various decision centres throughout an organisation and traces costs to the individual managers who are primarily responsible for making decisions about the costs in question.”

Schaltke, R.W. & Jonson, H. G.:

Responsibility accounting “is a system of accounting in which costs and revenues are accumulated and reported to managers on the basis of the manager’s control over these costs and revenues. The managerial accounting system that ties budgeting and performance reporting to a decentralised organisation is called responsibility accounting.” This is a system of accounting in which cost data are reported to managers who are in-charge of various cost centres. In this system, budgets are prepared and actual performance is recorded and reported.

David Fanning:

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Responsibility account “is a system or mechanism for controlling the wider freedom of action that executives— decision centre manages in other words—are given by senior management and for holding those executives responsible for the consequences of their decisions.”

According to this definition, responsibility accounting is used as a controlling device by top management for controlling the performance of other executives. The executives’ decisions are judged on the basis of their performance and they are made responsible for the outcome of their actions.

Responsibility accounting focuses main attention on responsibility centres. The managers of different activity centres are responsible for controlling the costs of their centres. Information about costs incurred for different activities is supplied to the persons in-charge of various centres. The performance is constantly compared to the standards set and this process is very useful in exercising cost controls. Responsibility accounting is different from cost accounting in the sense that the future lays emphasis on cost control whereas the latter lays emphasis on cost ascertainment.

Essential Features of Responsibility Accounting:

An analysis of the definitions given above reveals the following important features or fundamental aspects of responsibility accounting:

1. Inputs and Outputs or Costs and Revenues:

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The implementation and maintenance of responsibility accounting system is based upon information relating to inputs and outputs. The physical resources utilized in an organisation; such as quantity of raw material used and labour hours consumed, are termed as inputs. These inputs expressed in the monetary terms are known as costs. Similarly outputs expressed in monetary terms are called revenues. Thus, responsibility accounting is based on cost and revenue information.

2. Planned and Actual Information or Use of Budgeting:

Effective responsibility accounting requires both planned and actual financial information. It is not only the historical cost and revenue data but also the planned future data which is essential for the implementation of responsibility accounting system. It is through budgets that responsibility for implementing the plans is communicated to each level of management. The use of fixed budgets, flexible budgets and profit planning are all incorporated into one overall system of responsibility accounting.

3. Identification of Responsibility Centres:

The whole concept of responsibility accounting is focused around identification of responsibility centres. The responsibility centres represent the sphere of authority or decision points in an organisation. In a small firm, one individual or a small group of individuals, who are usually the owners may possibly manage or control the entire organisation.

However, for effective control, a large firm is, usually, divided into meaningful segments, departments or divisions. These sub- units or divisions of organisation are called responsibility centres. A responsibility centre is under the control of an individual who is responsible for the control of activities of that sub-unit of the organisation.

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This responsibility centre may be a very small sub-unit of the organisation, as an individual could be made responsible for one machine used in manufacturing operations, or it may be very big division of the organisation, such as a divisional manager could be responsible for achieving a certain level of profit from the division and investment under his control. However, the general guideline is that “the unit of the organisation should be separable and identifiable for operating purposes and its performance measurement possible”.

For effective planning and control purposes, responsibility centres are, usually, classified under three categories:

(i) cost centres;

(ii) profit centres; and

(iii) investment centres.

These have been discussed in detail later in this chapter.

4. Relationship between Organisation Structure and Responsibility Accounting System:

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A sound organisation structures with clear-cut lines of authority—responsibility relationships are a prerequisite for establishing a successful responsibility accounting system. Further, responsibility accounting system must be so designed as to suit the organisation structure of the organisation. It must be founded upon the existing authority- responsibility relationships in the organisation. In fact, responsibility accounting system should parallel the organisation structure and provide financial information to evaluate actual results of each individual responsible for a function.

The following chart shows relationship between organisation structure and responsibility centres:

5. Assigning Costs to Individuals and Limiting their Efforts to Controllable Costs:

After identifying responsibility centres and establishing authority-responsibility relationships, responsibility accounting system involves assigning of costs and revenues to individuals. Only those costs and revenues over which an individual has a definite control can be assigned to him for evaluating his performance.

Responsibility accounting has an appeal because it distinguishes between controllable and uncontrollable costs. Unlike traditional accounting where costs are classified and accumulated according to function such as manufacturing cost or selling and distribution cost, etc. or according to products, responsibility accounting classifies accumulated costs according to controllability.

‘Controllable costs’ are those costs which can be controlled or influenced by a specified person or a level of management of an undertaking. Costs which cannot be so controlled or influenced by the action of a specified individual of an undertaking are known as ‘uncontrollable costs’. The difference in controllable and uncontrollable costs may only be in relation to a particular person or level of management.

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The following guidelines recommended by the Committee of the American Accounting Association in regard to assigning of costs may be followed:

(a) If the person has authority over both the acquisition and use of the services, he should be charged with the cost of these services.

(b) If the person can significantly influence the amount of cost through his own action, he may be charged with such costs.

(c) Even if the person cannot significantly influence the amount of cost through his own direct action, he may be charged with those elements with which the management desires him to be concerned, so that he will help to influence those who are responsible.

6. Transfer Pricing Policy:

In a large scale enterprise having decentralized divisions, there is a common practice of transferring goods and services from one segment of the organisation to another. In such situations, there is a need to determine the price at which the transfer should take place so that costs and revenues could be properly assigned.

The significance of the transfer price can well be judged from the fact that for the transferring division it will be a source of revenue, whereas for the division to which transfer is made it will be an element of cost. Thus, there is a need of having a proper transfer policy for the successful implementation of responsibility accounting system. There are various transfer pricing methods in use, such as cost price, cost plus normal profit, incremental cost basis, negotiated price, standard price, etc. These methods of intra-company transfers have been discussed in detail later in this chapter.

7. Performance Reporting:

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As stated earlier, responsibility account is a control device. A control system to be effective should be such that deviations from the plans must be reported at the earliest so as to take corrective action for the future. The deviations can be known only when performance is reported.

Thus, responsibility accounting system is focused on performance reports also known as ‘responsibility reports’, prepared for each responsibility unit. Unlike authority which flows from top to bottom, reporting flows from bottom to top. These reports should be addressed to appropriate persons in respective responsibility centres.

The reports should contain information in comparative form as to show plans (budgets) and the actual performance and should give details of variances which are related to that centre. The variances which are not controllable at a particular responsibility centre should also be mentioned separately in the report. To be effective, the reports should be clear and simple. Use of diagrams, charts, illustrations, graphs and tables may be made to make them attractive and easily understandable.

A specimen of a performance report is given below:

8. Participative Management:

The function of responsibility accounting system becomes more effective if participative or democratic style of management is followed, wherein, the plans are laid or budgets/ standards are fixed according to the mutual consent and the decisions reached after consulting the subordinates. It provides motivation to the workers by ensuring their participation and self imposed goals.

9. Management by Exception:

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It is a well accepted fact that at successive higher levels of management in the organisational chain less and less time is devoted to control and more and more to planning. Thus, an effective responsibility accounting system must provide for management by exception, i.e., it should focus attention of the management on significant deviations and not burden them with all kinds of routine matters, rather condensed reports requiring their attention must be sent to them particularly at higher levels of management.

The following diagram explains the flow and reporting details at different levels of management:

10. Human Aspect of Responsibility Accounting:

‘The aim of responsibility accounting is not to place blame. Instead it is to evaluate the performance and provide feedback so that future operations can be improved’. Goals and objectives are achieved through people and, hence, responsibility accounting system should motivate people. It should be used in positive sense. It should not be taken as a device to punish subordinates.

It should rather help in improving their performance. Subordinates sometimes dislike control because they take them as restraints. The best responsibility accounting system enlightens employees about the positive side of control. To ensure the success of responsibility accounting system, it must look into the human aspect also by considering needs of subordinates, developing mutual interests, providing information about control measures and adjusting according to requirements.

Steps for Achieving Goals of Responsibility Accounting:

1. The organisation is divided into various responsibility centres each responsibility centre is put under the charge of a responsibility manager. The managers are responsible for the performance of their departments.

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2. The targets of each responsibility centre are set in. The targets or goals are set in consultation with the manager of the responsibility centre so that he may be able to give full information about his department. The goals of the responsibility centres are properly communicated to them.

3. The actual performance of each responsibility centre is recorded and communicated to the executive concerned and the actual performance is compared with goals set and it helps in assessing the work of these centres.

4. If the actual performance of a department is less than the standard set, then the variances are conveyed to the top management. The names of those persons who were responsible for that performance are also conveyed so that responsibility may be fixed.

5. Timely action is taken to take necessary corrective measures so that the work does not suffer in future. The directions of the top level management are communicated to the concerned responsibility centre so that corrective measures are initiated at the earliest.

The purpose of all these steps is to assign responsibility to different individuals so that the performance is improved. In case the performance is not up to their targets set, then responsibility may be fixed for it. Responsibility accounting will certainly act as control device and it will help in improving the overall performance of the business.

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