meaning of responsibility center (2)
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Meaning of Responsibility Center
A Responsibility Center is an organization unit that isheaded by a manager who is responsible for its
activities.
In a sense, a company is a collection of responsibility
centers ,each of which is represented by a box on the
organization chart.
A Responsibility center should be separable and
identifiable for operating purposes.
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Nature of Responsibility
Center
Created for one or more purposes ,termed itsobjectives.
Created to help implement various organizati-
-nal strategies. Represents sub unit of an organization.
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Types of Responsibility
Centers
ResponsibilityCenters
Engineered
Expense
Center
Discretionary
Expense
Center
Revenue
Center
Profit
Center
InvestmentCenter
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Criteria for the Judgement of
Performance of Responsibility Center
Efficiency :- Efficiency is the ratio of
outputs to inputs or the amount of output
per unit of input. Efficiency is a relative
term.Effectiveness :- Effectiveness is determined
by the relationship between a responsibility
centers output and its objectives. i.e themore this output contributes to the
objectives ,the more effective the unit.
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Expense center
Expense centers are responsibility centers
whose inputs are measured in monetary terms
,but whose outputs are not.
There are two general types of expensecenters:
(a) Engineered Expense Center
(b) Discretionary Expense Center
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Engineered Expense Center
It deals with engineered cost for which the right orproper amount can be estimated with reasonable
reliability- for e.g , a factory cost for direct labor,
direct materials, components ,etc.
Their input can be measured in monetary terms.
Their output can be measured in physical terms.
These centers are usually found in manufacturing
operations The optimum dollar amount of input required to
produce one unit of output can be determined.
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Investment Center
This responsibility center goes a step further than aprofit center.
The success of this center is not measured not only by
its income but also by relating that income to its
invested capital.
The managers of this center are responsible for both
sales revenues and costs and ,in addition ,have
responsibility and authority to make capital investment
decision.
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Measurement of Performance
As a responsibility center , the performance of aunit would be measured in relation to the revenues
or profits and the assets employed in a division.
Measurement of investment center performancecan be viewed as the evaluation of an aggregation
of past and present capital projects as opposed to
the evaluation of each project individually.
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Return On Investment (ROI)
This is the most common measure for makingevaluation of an investment center.
This measures takes into consideration two elements:
1. Net Income Before Taxes.
2. Invested Assets (Assets employed)
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Advantages of ROI
1. Generally accepted measure of overall performance.2. This is a ratio or percentage ,because of this serves as
a better basis for comparing the performance ofdifferent division.
3. This measures encourages goal congruence betweenthe division and the firm.
4. ROI also shows whether the companys borrowingpolicy was wise economically and whether the
capital had been employed fruitfully.5. The business can survive only if ROI is more than
coat of capital employed in the business.
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Defects of ROI
1. Manipulation possible.
2. Different basis for computation of profit and
investments.
3. Emphasis on short term profits.
4. Poor measure.
5. Undue significance to capital resources.
6. Limits initiative.
7. Change factor.
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Elements for computation of ROI
(A) Assets employed
(B) Net Income
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(A) Assets employed
(1) Measuring & controlling assets employed
(2) Assigning the values to allocated assets
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(1) Measuring and controlling assets
employed
The following considerations are kept in mind ,foraccurate measurement and control of the
divisional investment :
1. Structure of analysis
2. Issues in measurement of assets employed
(i) Treatment of controllable assets.
(ii) Treatment of non-controllable assets.
(iii) Treatment of idle assets.(iv) Treatment of leased assets.
(v) Treatment of intangible assets.
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(2) Assigning the values to allocated
assets
These include :
1. Book value
2. Gross value
3. Replacement Cost basis.
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(B) Net Income
1. Net income before interest and tax
2. Net income after interest but before taxes.
3. Net income after interest and tax.
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Residual Income or Economic values
added
It is the residual income with the company aftercharging for the cost of capital provided by the lenders
and shareholders.
RI (EVA) = Actual incomedesired income
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Merits of EVA
Encourages capital investment.
EVA or RI is more flexible concept.
It helps in achieving the goal congruence.
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DEMERITS OF EVA
It is an absolute measure.
It is difficult to select a fair and equitable cut off
rate(cost of capital)