“Responsibility Accounting collects and reports planned and actual accounting information about the inputs and outputs of responsibility centers”.It is based on information pertaining to inputs and outputs. The resources utilized in an organization are physical in nature like quantities of materials consumed, hours of labour, etc., are called inputs. They are converted into a common denominator and expressed in monetary terms called “costs”, for the purpose of managerial control. In a similar way, outputs are based on cost and revenue data.
Responsibility Accounting must be designed to suit the existing structure of the organization. Responsibility should be coupled with authority. An organization structure with clear assignment of authorities and responsibilities should exist for the successful functioning of the responsibility accounting system. The performance of each manager is evaluated in terms of such factors.
The main focus of responsibility accounting lies on the responsibility centres. A responsibility centre is a sub unit of an organization under the control of a manager who is held responsible for the activities of that centre. The responsibility centres are classified as follows:
1) Cost Centres,
2) Profit Centres and
3) Investment centres.
1) Cost Centres
When the manager is held accountable only for costs incurred in a responsibility centre, it is called a cost centre. It is the inputs and not outputs that are measured in terms of money. In a cost centre records only costs incurred by the centre/unit/division, but the revenues earned (output) are excluded form its purview. It means that a cost centre is a segment whose financial performance is measured in terms of cost without taking into consideration its attainments in terms of “output”. The costs are the planning and control data in cost canters. The performance of the managers is evaluated by comparing the costs incurred with the budgeted costs. The management focuses on the cost variances for ensuring proper control. A cost centre does not serve the purpose of measuring the performance of the responsibility centre, since it ignores the output (revenues) measured in terms of money. For example, common feature of production department is that there are usually multiple product units. There must be some common basis to aggregate the dissimilar products to arrive at the overall output of the responsibility centre. If this is not done, the efficiency and effectiveness of the responsibility centre cannot be measure.
2) Profit Centres
When the manager is held responsible for both Costs (inputs) and Revenues (output) it is called a profit centre. In a profit centre, both inputs and outputs are measured in terms of money. The difference between revenues and costs represents profit. The term “revenue” is used in a different sense altogether. According to generally accepted principles of accounting, revenues are recognized only when sales are made to external customers. For evaluating the performance of a profit centre, the revenue represents a monetary measure of output arising from a profit centre during a given period, irrespective of whether the revenue is realized or not.
The relevant profit to facilitate the evaluation of performance of a profit centre is the pre–tax profit. The profit of all the departments so calculated will not necessarily be equivalent to the profit of the entire organization. The variance will arise because costs which are not attributable to any single department are excluded from the computation of the department’s profits and the same are adjusted while determining the profits of the whole organization. Profit provides more effective appraisal of the manager’s performance. The manager of the profit centre is highly motivated in his decision-making relating to inputs and outputs so that profits can be maximized. The profit centre approach cannot be uniformly applied to all responsibility centres. The following are the criteria to be considered for making a responsibility centre into a profit centre. A profit centre must maintain additional record keeping to measure inputs and outputs in monetary terms. When a responsibility centre renders only services to other departments, e.g., internal audit, it cannot be made a profit centre. A profit centre will gain more meaning and significance only when the divisional managers of responsibility centres have empowered adequately in their decision making relating to quality and quantity of outputs and also their relation to costs. If the output of a division is fairly homogeneous (e.g., cement), a profit centre will not prove to be more beneficial than a cost centre. Due to intense competition prevailing among different profit centres, there will be continuous friction among the centres arresting the growth and expansion of the whole organization. A profit centre will generate too much of interest in the short-run profit to the detriment of long-term results.