Meaning of Responsibility Center (2)

7/28/2019 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)

Documents

Meaning of Responsibility Center (2)