RESPONSIBILITY ACCOUNTING

Responsibility Center Types  Underlying the accounting classifications of responsibility centers is the concept of controllability: the manager of a responsibility center should be held responsible only for the revenues, costs, or investment that responsibility center personnel control  Five types: Cost centers Discretionary Cost centres Revenue centers Profit centers Investment centers

5. Investment Center  A responsibility center in which the manager and other employees control revenues, costs, and the level of investment in the responsibility center

Performance Measurement in Investment Centers ROI = Income Invested capital ROI = × Sales revenue Invested capital Income Sales revenue or

Return on Investment: Calculation $150,000 ÷ $600,000 = 25% ROI

Criticisms of ROI In the absence of the balanced scorecard, management may not know how to increase ROI. Managers often inherit many committed costs over which they have no control. Managers evaluated on ROI may reject profitable investment opportunities.

Residual Income Residual income is defined as... The imputed interest rate should be the rate of return on investments of similar risk that are being forgone. Investment center’s profits – Investment center’s invested capital Imputed interest rate ×

Residual Income: Calculation

Comparing ROI and RI  Advantage: It uses percentages, which allow easy comparison with required returns.  Disadvantage: Value of invested capital is measured in dollars of different purchasing power.  Advantage: It facilitates goal congruence with its required rate of return  Disadvantage: It is biased in favor of larger companies because it shows dollar results. ROI Residual Income Solution: Use both in evaluating investments.

Economic Value Added (EVA) Investment center’s after- tax operating profit EVA= – Weighted- average cost of capital × Investment center’s total assets Investment center’s current liabilities – Investment center current liabilities are subtracted from its total assets.

Measuring Investment Capital Ê What assets should be included? Total assets. Total productive assets. Total assets less current liabilities. Only the assets controllable by the manager being evaluated. Ë Should we measure the investment at the beginning or end-of-period amount, or should we use an average of beginning and end-of- period amounts? Ì Should the assets be shown at historical or current cost? (Gross or NBV)