An accounting system designed to measure the performance of each center within a business is referred to as a responsibility accounting system. Measuring performance along the lines of management responsibility is an important function. A responsibility accounting system holds individual managers accountable for the performance of the business centers under their control. In addition. such systems provide top management with information useful in identifying strengths and weaknesses among units throughout the organization.
The operation of a responsibility accounting system involves three basic steps. First. budgets are prepared for each responsibility center. Budgets serve as performance targets for each subunit in an organization. Second. the accounting system measures the performance of eaeh responsibility center. Third. timely performance reports are prepared that’ compare the actual performance of each center with the amounts. budgeted. Frequent performance reports help center managers keep their performance “on target.” -They also assist top management in evaluating the performance’ of each manager.
In this chapter. we emphasize the second step in the operation of a responsibility accounting system-measuring the performance of each responsibility center. (The use of budgets and of performance reports is discussed in more depth in following two chapters.)
Responsibility Accounting An Illustration
The key to a responsibility accounting system is the ability to measure separately the operating results of each responsibility center within the organization. These results can then be summarized in a series of responsibility income statements
A responsibility income statement shows not only the operating results of a particular part of a business but ‘also the revenue and expenses of each profit center within that part. Such income statements enable managers to review quickly the performance of the various profit centers under their control
As you read down the Nu Tech illustration. you are looking at smaller and sinaller parts of the company. The recording of revenue and costs must begin at the bottom of the illustration-that is. for the smalle siareas of management responsibility.If income statements are to be prepared for each profit center in’ the 42nd Street store. for’ example. Nu Tech’s chart of accounts must be ‘sufficiently detailed to measure separately the revenue and costs of these departments. The income statements for larger responsibility centers then may be prepared primarily by combining the amounts appearing in the income statements of the smaller subunits. Notice. for’ example. that the total sales of the 42nd Street store ($200.000) are equal to the sum of the sales reported by the two profit centers within the store ($180.000 and $20.(00).
Assigning Revenue and Costs to Responsibility Centers
In responsibility income statements. revenue is assigned .first to the profit center responsible for earning that revenue. Assigning revenue to the proper department is relalively easy. Electronic cash registers. for example, automatically classify .sales revenue by the department of origin ..
In assigning costs to parts of a business. two concepts generally are-applied:
1. Costs are classified into the categories of variable costs and fixed costs.So When costs are classified in this manner, a subtotal may be developed in the income statement showing the contribution margin of the business’ center. Arranging an income statement this manner is termed the contribution margin approach and is widely used in preparing reports for use by managers
In responsibility income statements, variable costs arc those costs that change in approximate proportion to changes in the center’s sales volume. For Nu’Icch, variable costs include the cost of goods sold. sales commissions paid to salespeople lor each system they sell, parts and labor costs incurred by each store’s Repairs Department. and numerous other operating expenses that vary with sales volume
Contribution margin (revenue minus variable costs) is an important tool for cost volume- profit analysis. For example, the effect of a change in sales income may be by either (I) multiplying the change in unit sales by the contribution margin per unit or (2) multiplying the dollar change in sales volume by the contribution margin ratio. (To assist in this type of analysis. responsibility income statements often include percentages as well as dollar amounts. A responsibility income statement with percentage columns is illustrated on page 90 I.)
Traceable Fixed Costs
In determining the extent to which a specific center adds to the profitability of the business, traceable fixed costs are typically subtracted from the contribution margin. In a responsibility income statement, the contribution margin less traceable fixed costs is termed the responsibility margin. For example, on page 900 we see that NuTech’s margins for its 42nd Street store and its Baker Street store are $42,000 and $78,000, respectively
Common Fixed Costs
Common fixed costs (or indirect fixed costs) jointly benefit several parts of the business. The level of these fixed costs usually would not change significantly even if one of the centers deriving benefits from these costs were discontinued
Common fixed costs cannot be assigned to specific subunits except by arbitrary means, such as in proportion 10 relative sales volume or square feet of space occupied. In an attemplto measure the “overall profitability” of each profit center. some businesses allocate common fixed costs’ 10 subunits along with traceable costs. A common approach, however.vis 10 charge each profit center only with those costs directly traceable to that part of the business. In this text, we follow this latter approach.
We have made the, point that certain store wide costs, such as the operation of the maintenance department and the store manager’s salary, are not traceable to the specific profit centers within the store. These costs are, however, easily traceable to the 42nd Street store. Therefore, whether these costs are classified as traceable or “common” depends on whether we define the centers as stores or as departments with in the stores .
As we move up a responsibility reporting system to broader and broader areas of responsibility, common costs at the lower levels of management responsibility become traceable costs as they fall under the control of the managers of larger responsibility centers