For any kind of an organisation, the main aim is to maximize profits. For organisations which are global and multinational nature of business has led to complexity of operations. Responsibility accounting is a method where the managers are responsible for the difference between the budgeted and the real performance. "Responsibility accounting is the collection and reporting of the planned and actual accounting information about the inputs and the outputs of the responsibility centre". (www.scribd.com) the role of managers is how to organize both the physical resources and the human resource power. Therefore the organisation tries to divide the businesses into separate divisions and give responsibility to the divisional managers.
Part of the roles of the managers includes controlling, coordinating, planning and motivating. By controlling this is ways in which the manager compares its current performance to the planned in order for the manager to understand where the organisation stands, and what strategies to be used in order to reach them.
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Co- ordination is important since it involves teamwork, between different departments, which helps the work to flow like in a hierarchy.
Planning helps the managers to organize things like an action plan which it may assign different responsibilities to different departments. By this method it helps the managers to achieve the organisations objective.
Motivation of the staff is the most important factor, encouraging them to work more effectively in the given task given to them. This can be done by giving fringe benefits, flexibility timings, overtime, and bonuses.
"Non-revenue-producing element of an organisation is where costs are separately figured and allocated, and for which someone has formal responsibility. The personnel function is a cost centre in that it does not directly produce revenue". (http://www.answers.com)
It can also be defined as, a kind of an activity or location or different functions of an organisation where the cost can be identified separately.
Or it can be defined as a manager who is responsible for certain incurring expenses in the organisation. For instance in a mobile shop, there are technicians, customer care, sales representatives, it may be decided that each of the departments is a cost centre, another way of doing costing is to know the cost of unit of production. Like in the manufacturing of soaps, each piece of soap is counted as a cost unit. The purpose of doing the costing is to know the cost of the cost unit. This includes materials such as packaging, labour, sales and marketing cost, and additional costs such as insurance on fixed assets. For example, if a company is manufacturing pencils overhead costs is KSH 1,000,000 if 250,000 cost units have passed through, i.e. production overhead costs such as electricity, labour, packaging etc. The unit cost will be KSH 4. This will help the managers to account for those expenses, helps in decision making, and improves in controlling systems as well as staff motivation.
But the disadvantage of using this method is it can create unnecessary work for some people i.e. unproductive use for people resource, as well as there must be some external factors which may increase the costs and causing poor performance in the cost centre such as staff rates of pay.
In summary, cost centre will help in motivating individual responsibility. It also "calculates costs attributed to a specific area of the business". (http://webcache.googleusercontent.com).
It also "may add to pressures and stress on staff". (http://webcache.googleusercontent.com).
"A profit centre is measured on results. In theory, future profit is the measure. In theory, future profit is the measure. In theory, the manager is free to follow his own judgment except within explicit, specific constraints. In theory, current performance is factored by the long term benefits and the effect of corporate constraints. In fact, none of these conditions are ever wholly true". (http://books.google.co.ke)
This is similar to the cost centre but the difference is in cost centre where identifiable part of an organisation where the costs are calculated while profit centre is identifiable part of an organisation where both the costs and revenues are calculated. This is where the manager is responsible for both inputs like costs and outputs like revenues, whereby he has to reduce costs and increase sales by generating revenues, by having responsibilities such as production and sales performance and further look into matters such as pricing, marketing of products, volume of output.
Always on Time
Marked to Standard
If the profits are high, the manager will be given appraisal on his performance, hence motivating him on making decision making relating to inputs and outputs; hence he will look into ways of maximizing the profits to the maximum.
The profit centre can be used evenly to the entire responsibilities centre. Some of the factors must be kept under consideration for a responsibility centre into profit centre. Some of the factors to be considered can be, maintaining inputs and outputs in fiscal terms, the strong completion among different profit centre, there will be frequent abrasions among the centre arresting the expansion and growth of the entire organisations.
In brief summary it "calculates costs and revenues attributed to a specific area of business" (http://webcache.googleusercontent.com). It "helps control money, motivates staff but can be difficult to do, may increase pressure". (http://webcache.googleusercontent.com)
This is where the manager of an investment centre is held responsible for investment in assets of a responsible centre (investment centre), costs and revenues. Not only the profit is measure but is relation to the investments effected, since the manager is always concerned about maximum returns. ROI defined as return on investment helps the managers to evaluate the performance of an investment.
ROI (Return on investment)
"ROI= NET PROFIT/ TOTAL INVESTMENT * 100 = Return on investment"
This is an important and popular tool in assisting the managers to know the performance of an investment centre of responsibility accounting. ROI simply means the returns of an investment.
Example: - if your net profit is $15,000 and the total investment is $50,000, the return on investment is 15000/50000=0.3*100= 30%
Advantages of using ROI, it's a divisional performance measurement, as in its conventionality with the organisations rate of returns analysis, since ROI is accepted as a measure of an overall performance. Secondly ROI provides the basis for optimal usage of the assets of an organisation hence helping the managers to get or retain those assets yielding maximum returns and discard the ones which are not yielding. Finally ROI analysis is a comparative measure since it comprises a percentage or ratio, this helps a common denominator and helps in comparing between departments. The disadvantage of ROI, Is the determination of the investment base, hence leading to the problem of measurement of investments in relation to the investment centre analysis.
Among all the three responsibility centres, I presume an investment centre is an expansion of the profit centre, is therefore considered to yield better profits.
For any organisations to know the cost of its products or services in order for them to make decisions, the manager of the organisation has to make sure he has all the information to make the correct decision, and valid reasons of why he chose that particular decision. The manager has to make 'qualitative judgments' such as which sales person should be promoted, as well as he has to make 'quantitative' decision like what kind of strategy should I use in order to increase production.
Costing is the total value of money used in producing a certain product or services. Some of the short term decisions can be like accepting of a special order, make or buy decision, shutdown problems, choosing a product, adding or dropping a product etc. Some of the relevant costs for a decision can be:-
Future; Past costs are not considered relevant, and it cannot by affected by the current decisions, due to some other alternatives which can be chosen. Cash flow; loss of value such as depreciation is not cash flow and is not relevant, but the book value of existing assets is irrelevant, but the disposal value is relevant. Incremental; when making decisions, expenditure will be incurred or avoided. Whether the expenditure is incurred or not but is said to be incremental in a decision. Common costs; this can be costs which can be identical for all alternatives which are irrelevant, such as rent or rates on a factory. Sunken costs; It's another name for past costs, which is always irrelevant i.e. costs which are already incurred such as spending on advertising. Committed costs; this can be a long term investment of a business such as plant and machinery.
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"These are normally; direct labour, direct expenses, direct material and the variable overheads, as its variable costs". (http://wiki.answers.com).Marginal cost is a cost at every level of production that includes any additional costs in producing an extra unit. The decisions which are involved in marginal costing are normally short term decisions, which make sure it utilizes the best use of its existing facilities.
MC (MARGINAL COST) =CHANGE IN TC (TOTAL COST)/ CHANGE IN Q (QUANTITY)
(Source: - http://en.wikipedia.org)
"This is a method of presenting cost data, wherein variable costs and fixed costs are shown different ways for helping the managers to make a decision. By not charging the fixed overhead to cost of production, so the cause of varying charges are avoided". (http://wiki.answers.com). "This is a simple method of costing of analyzing the cost information, as it will assist the manager to understand the effect on profits due to the changes in the volume of the output". (http://wiki.answers.com).
MARGINAL COST= VARIABLE COST DIRECT LABOUR+DIRECT MATERIALS+DIRECT EXPENSE+VARIABLE OVERHEADS
CONTRIBUTION= SALES- MARGINAL SALES
(Source for formula:-http://aboutfinancialmatters.blogspot.com)
(As explained in fig 1.1)
Absorption costing can also be called full costing or full absorption costing. Absorption costing is a method of product costing, where all the manufacturing costs are absorbed by the cost of a finished product. This assigns overhead costs, materials and labour to the units of product manufactured.
Fixed overhead costs are normally are given to products by means of a certain cost rate, which divides planned overhead costs by planned output. With absorption costing, fixed overhead costs are included in the finished goods stock and in the value of work in progress. It's widely used normally for cost control purposes. As it helps to understand the importance of fixed costs in production, as well as it's going to assist in preparing the financial accounts and the tax authorities will accept this method where they will not undervalue the stocks. Furthermore it helps in making pricing decisions, "most companies add a mark-up to cost of unit to get the selling price per unit. if the absorption costing was ignored it will lead to understanding the unit cost leading to loss when the unit is sold secondly if the absorption was located to one department it could make the unit for that department expensive hence in market for those units". (http://www.elearning.strathmore.edu)
(As explained in fig 1.2)
ABC (ACTIVITY BASED COSTING)
This is an accounting method of product costing, where it tries to break down and divides both fixed and variable costs, where the costing tends to look at the total cost to the business of making the product. Cost drivers are all related to all costs, which mean the factors which influence the costing of a product. ABC helps in strategic decisions i.e. outsourcing, pricing etc. These costs are assigned for allowing organisations to gather information of the operating costs, as these are specific activities such as engineering, manufacturing etc. This helps the managers to make a good budget and helps them to understand the overall company's expenses, for the institution to run smoothly. "ABC is more effective when used over a longer period of time", (http://findarticle.com). ABC requires proper planning and commitment from the upper management may be by "experimenting on a department whose profit making performance is not living up to expectations", (http://findarticle.com). This kind of a scenario will help getting a greater chance of success, and will show the organisations in ways for saving money, and will also show the team of ABC on ways of saving money. The way to go about this is, organisation should have a team consisting different people from different areas such as finance, technology, and IT, if probably include an outside consultant. Therefore the team is assembled and data is gathered such as materials and utilities, as the team will sit together and discuss every detail and look at every detail as its very important since there may be hidden costs associated to it.
(As explained in fig 1.3)
Managerial decisions on different approaches
Marginal costing: -
The decisions which involve marginal costing principles are usually short run planned decisions which makes sure, it uses the best of its existing facilities, these may include make or buy decisions, or accepting of a special order.
In the make or buy decision the manufacturer of a product, it will consider things like manufacturing of a component or purchase it. This decision is normally based on the analysis of the cost implications. (As explained in fig 1.4)
Accepting or rejection of an order which uses its spare capacity, but which is only available if a lower than normal price is quoted. (As explained in fig 1.5)
Absorption costing: -
Absorption costing is a technique where all normal costs whether its variable or fixed costs are all charged to the cost units produced unlike marginal costing which takes fixed cost as period cost. The managerial decisions in this case are:-
It's going to assist in the preparation of financial statements, which can be used by either internal or external parties. Such as the government, taxes, internal and external auditors.
It will also help things like inventory, where the method is accepted by the tax authorities, as the stocks are not undervalued.
ABC costing: -
"This is a costing model that identifies activities in organisation and assigns costs to all activity resources to both products and services". (http://www.answers.com). It's going to assist managers in;
Is able to make a better budget and help them to understand all the expenses required by the company for it to run smoothly.
Also helps in making strategic decision such as pricing, outsourcing and in the measurement of process improvement initiatives.
I choose the ABC costing most appropriate than the other two, because it gives the management a good understanding of the cost structures of making and selling a wide range of products, as it provides accurate and dependable cost information, as it establishes a long run product cost as well as it provides information which can be used to assess different ways of delivering business.
The above diagram clearly indicates the clear percentage sales for different items. It also helps to show, how many products can be used in order to increase sales, as shown by the curve. As well as to prioritize the products, i.e. which product should be produced first?
EXAMPLE OF MAKE OR BUY DECISIONS
Prince systems, purchases equipment for Ksh 250,000 for in-house use, and produces the needed product at Ksh 10. Alternatively another supplier produces and delivers it at Ksh 15.
= 250,000+10p= 15p
It is cost effective for prince systems to purchase the product if the demand is under 50,000 units. If prince systems had idle capacity to produce the product, the cost of Ksh 250,000 would not be incurred (meaning not an incremental cost). Making the prospect of making the product too cost efficient to ignore.
EXAMPLE OF ACCEPTING OF A SPECIAL ORDER
Red bull manufactures and markets an energy drink, which has the capacity to produce 100,000 cans of red bull.
Red bull sells the energy drink to its regular customers at £ 20. However Nakumatt Supermarket has approached the company to purchase the excess capacity at £ 18 each.
If the special order is accepted the incremental revue will be:-
Incremental revenue 20%*100,000*£18= £ 360,000
Less incremental cost
Direct material £2*20,000= £40,000
Direct labour £5*2000= £100,000
Variable production overheads £3*20,000=£60,000
Total incremental costs (£40,000+£100,000+£60,000=£200,000)
Incremental profits (£360,000-£200,000 = £160,000)
Note the above only takes the relevant costs ignoring the fixed production overheads as it's still less than 100% production capacity.
Atrill Mclaney, Management Accounting for decision making, 6th Edition
Colin drury , Management Accounting for Business ,3rd ED 2003 Thomson
Nanture Wickramasighe, Chandana Alawattage, Management Accounting Change Approaches and perspectives 2007.