The salary of the manager of a responsibility center is usually controllable by such manager

Departmental accounting reports often provide data used to evaluate a department’s performance, but are they useful in assessing how well a department manager performs? Neither departmental income nor its contribution to overhead may be useful because many expenses can be outside a manager’s control. Instead, we often evaluate a manager’s performance using responsibility accounting reports that describe a department’s activities in terms of controllable costsCosts that a manager has the power to control or at least strongly influence.. A cost is controllable if a manager has the power to determine or at least significantly affect the amount incurred. Uncontrollable costsCosts that a manager does not have the power to determine or strongly influence. are not within the manager’s control or influence.

C2

Explain controllable costs and responsibility accounting.

Controllable versus Direct Costs

Controllable costs are not always the same as direct costs. Direct costs are readily traced to a department, but the department manager might or might not control their amounts. For example, department managers often have little or no control over depreciation expense because they cannot affect the amount of equipment assigned to their departments. Also, department managers rarely control their own salaries. However, they can control or influence items such as the cost of supplies used in their department. When evaluating managers’ performances, we should use data reflecting their departments’ outputs along with their controllable costs and expenses.

   Distinguishing between controllable and uncontrollable costs depends on the particular manager and time period under analysis. For example, the cost of property insurance is usually not controllable at the department manager’s level but by the executive responsible for obtaining the company’s insurance coverage. Likewise, this executive might not control costs resulting from insurance policies already in force. However, when a policy expires, this executive can renegotiate a replacement policy and then controls these costs. Therefore, all costs are controllable at some management level if the time period is sufficiently long. We must use good judgment in identifying controllable costs.

Responsibility Accounting System

A responsibility accounting system uses the concept of controllable costs to assign managers the responsibility for costs and expenses under their control. Prior to each reporting period, a company prepares plans that identify costs and expenses under each manager’s control. These plans are called responsibility accounting budgetsReport of expected costs and expenses under a manager’s control.. To ensure the cooperation of managers and the reasonableness of budgets, managers should be involved in preparing their budgets.

   A responsibility accounting system also involves performance reports. A responsibility accounting performance reportResponsibility report that compares actual costs and expenses for a department with budgeted amounts. accumulates and reports costs and expenses that a manager is responsible for and their budgeted amounts. Management’s analysis of differences between budgeted amounts and actual costs and expenses often results in corrective or strategic managerial actions. Upper-level management uses performance reports to evaluate the effectiveness of lower-level managers in controlling costs and expenses and keeping them within budgeted amounts.

   A responsibility accounting system recognizes that control over costs and expenses belongs to several levels of management. We illustrate this by considering the organization chart in . The lines in this chart connecting the managerial positions reflect channels of authority. For example, the four department managers of this consulting firm (benchmarking, cost management, outsourcing, and service) are responsible for controllable costs and expenses incurred in their departments, but these same costs are subject to the overall control of the vice president (VP) for operational consulting. Similarly, this VP’s costs are subject to the control of the executive vice president (EVP) for operations, the president, and, ultimately, the board of directors.

EXHIBIT 21.27

Organizational Responsibility Chart

   At lower levels, managers have limited responsibility and relatively little control over costs and expenses. Performance reports for low-level management typically cover few controllable costs. Responsibility and control broaden for higher-level managers; therefore, their reports span a wider range of costs. However, reports to higher-level managers seldom contain the details reported to their subordinates but are summarized for two reasons: (1) lower-level managers are often responsible for these detailed costs and (2) detailed reports can obscure broader, more important issues facing a company.

Point: Responsibility accounting does not place blame. Instead, responsibility accounting is used to identify opportunities for improving performance.

    shows summarized performance reports for the three management levels identified in . shows that costs under the control of the benchmarking department manager are totaled and included among controllable costs of the VP for operational consulting. Also, costs under the control of the VP are totaled and included among controllable costs of the EVP for operations. In this way, a responsibility accounting system provides relevant information for each management level.

EXHIBIT 21.28

Responsibility Accounting Performance Reports

   Technological advances increase our ability to produce vast amounts of information that often exceed our ability to use it. Good managers select relevant data for planning and controlling the areas under their responsibility. A good responsibility accounting system makes every effort to provide relevant information to the right person (the one who controls the cost) at the right time (before a cost is out of control).

Summary of Cost Allocation

summarizes the cost allocation techniques shown in this chapter. These methods focus on different types of costs, as managers need different information for different decisions.

Point: Responsibility accounting usually divides a company into subunits, or responsibility centers. A center manager is evaluated on how well the center performs, as reported in responsibility accounting reports.

EXHIBIT 21.29

Cost Allocation Methods

10.

Are the reports of departmental net income and the departmental contribution to overhead useful in assessing a department manager’s performance? Explain.

11.

Performance reports to evaluate managers should (a) include data about controllable expenses, (b) compare actual results with budgeted levels, or (c) both (a) and (b).

L’Oreal is an international cosmetics company incorporated in France. With multiple brands and operations in over 100 countries, the company uses concepts of departmental accounting and controllable costs to evaluate performance. For example, a recent annual report shows the following for the major divisions in its Cosmetics branch:

For L’Oreal, nonallocated costs include costs that are not controllable by division managers, including fundamental research and development and costs of service operations like insurance and banking. Excluding noncontrollable costs enables L’Oreal to prepare more meaningful division performance evaluations.

We can further examine investment center (division) performance by splitting return on investment into profit marginRatio of a company’s net income to its net sales; the percent of income in each dollar of revenue; also called net profit margin. and investment turnoverThe efficiency with which a company generates sales from its available assets; computed as sales divided by average invested assets. as follows

A2

Analyze investment centers using profit margin and investment turnover.

profit marginRatio of a company’s net income to its net sales; the percent of income in each dollar of revenue; also called net profit margin. measures the income earned per dollar of sales. investment turnoverThe efficiency with which a company generates sales from its available assets; computed as sales divided by average invested assets. measures how efficiently an investment center generates sales from its invested assets. Higher profit margin and higher investment turnover indicate better performance. To illustrate, consider Best Buy which reports in results for two divisions (segments): Domestic and International.

EXHIBIT 21.30

Best Buy Division Sales, Income, and Assets

Profit margin and investment turnover for its Domestic and International divisions are computed and shown in :

EXHIBIT 21.31

Best Buy Division Profit Margin and Investment Turnover

Best Buy’s Domestic division generates 5.55 cents of profit per $1 of sales, while its International division generates only 1.32 cents of profit per dollar of sales. Its Domestic division also uses its assets more efficiently; its investment turnover of 3.83 is over twice that of its International division’s 1.69. Top management can use profit margin and investment turnover to evaluate the performance of division managers. The measures can also aid management when considering further investment in its divisions.

Division Manager   You manage a division in a highly competitive industry. You will receive a cash bonus if your division achieves an ROI above 12%. Your division’s profit margin is 7%, equal to the industry average, and your division’s investment turnover is 1.5. What actions can you take to increase your chance of receiving the bonus?

3 The terms cost and expense are often used interchangeably in managerial accounting, but they are not necessarily the same. Cost often refers to the monetary outlay to acquire some resource that can have present and future benefit. Expense usually refers to an expired cost. That is, as the benefit of a resource expires, a portion of its cost is written off as an expense.

Which of the following is an example of controllable cost?

Is a responsibility center in which a manager is responsible only for costs?

Is considered to be the best measure of the manager's performance in controlling revenues and costs?

Who has the overall responsibility for managing both revenues and cost elements of a production as well as the day to day operations of the productions business?