1. Chapter 12
Responsibility Accounting, Quality Control, and Environmental Cost Management
Chapter 12: Responsibility Accounting, Quality Control, and Environmental Cost Management
McGraw-Hill/Irwin
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Learning Objective 1
Learning Objective 1. Explain the role of responsibility accounting in fostering goal congruence.
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3. Responsibility Accounting
Responsibility accounting is used to measure the performance of people and departments to foster goal congruence.
Most organizations are divided into smaller units or departments, each of which is assigned particular responsibilities. Each department is made up of individuals who are responsible for particular tasks or managerial functions. Goal congruence results when the managers of subunits throughout an organization strive to achieve the goals set by top management. Responsibility accounting refers to the various concepts and tools used by managerial accountants to measure the performance of people and departments in order to foster goal congruence. (LO1)
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4. Learning Objective 2
Learning Objective 2. Define and give an example of a cost center, a revenue center, a profit center, and an investment center.
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5. Responsibility Centers
A subunit in an organization whose manager is held accountable for specified financial results.
A responsibility center is a subunit in an organization whose manager is held accountable for specified financial results of the subunit’s activities. There are four common types of responsibility centers. (LO2)
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6. Responsibility Centers
Cost Center
Segment has control over the incurrence of costs.
Revenue Center
Segment
is responsible
for the revenue of a unit.
A cost center is an organizational subunit, such as a department or division, whose manager is held accountable for the costs incurred in the subunit. The Painting Department in an automobile plant is an example of a cost center. The manager of a revenue center is held accountable for the revenue attributed to the subunit. For example, the Reservations Department of an airline and the Sales Department of a manufacturer are revenue centers. (LO2)
The Paint Department
in an automobile plant.
The Reservations
Department of an airline.
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7. Responsibility Centers
Profit Center
Segment has control over both costs and revenues.
Investment Center
Segment has control over profits and invested capital.
A division of a
large corporation.
A profit center is an organizational subunit whose manager is held accountable for profit. Since profit is equal to revenue minus expense, profit- center managers are held accountable for both the revenue and expenses attributed to their subunits. An example of a profit center is a company-owned restaurant in a fast-food chain. The manager of an investment center is held accountable for the subunit’s profit and the invested capital used by the subunit to generate its profit. A division of a large corporation is typically designated as an investment center. (LO2)
Company-owned restaurant in a fast-food chain.
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8. Learning Objective 3
Learning Objective 3. Prepare a performance report and explain the relationships between the performance reports for various responsibility centers.
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9. Performance Reports
Show the budgeted and actual amounts, and the variances between these amounts, of key financial results appropriate for the type of responsibility center.
A performance report shows the budgeted and actual amounts, and the variances between these amounts, of key financial results appropriate for the type of responsibility center involved. The data in a performance report help managers use management by exception to control an organization’s operations effectively. (LO3)
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10. Performance Reports
The performance report for Waikiki Sands Hotel shows the relationships between the February performance reports for several of its subunits. The numbers for the Grounds and Maintenance Department, the Housekeeping and Custodial Department, and the Kitchen are in parentheses. These subunits are cost centers, so the numbers shown are expenses. All of the other subunits shown are either profit centers or investment centers. The numbers for these subunits are profits, so they are not enclosed in parentheses. The kitchen is the lowest-level subunit shown. The total expense line from the kitchen performance report is included as one line in the performance report for the Food and Beverage Department. Also included are the total profit figures for the department’s other two subunits: Banquets and Catering, and Restaurants. The hierarchy of performance reports starts at the bottom and builds toward the top, just like the organization structure. Each manager in the organization receives the performance report for his or her own subunit in addition to the performance reports for the major subunits in the next lower level. (LO3)
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11. Learning Objective 4
Learning Objective 4. Use a cost allocation base to allocate costs.
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12. Cost Allocation
The process of assigning the costs in the cost pool to the cost objects is called cost allocation or cost distribution.
An organization will have costs that are a joint result of the activities of several subunits. A responsibility-accounting system will assign these joint costs to the subunits that cause them to be incurred. A collection of costs to be assigned is called a cost pool. The responsibility centers, products, or services to which costs are to be assigned are called cost objects. The process of assigning the costs in the cost pool to the cost objects is called cost allocation or cost distribution. (LO4)
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13. Cost Allocation Bases
An allocation base is a measure of activity, physical characteristic, or economic characteristic that is associated with the responsibility centers, which are the cost objects in the allocation process.
An allocation base is used to distribute (or allocate) costs to responsibility centers. An allocation base is a measure of activity, physical characteristic, or economic characteristic that is associated with the responsibility centers, which are the cost objects in the allocation process. The allocation base chosen for a cost pool should reflect some characteristic of the various responsibility centers that is related to the incurrence of costs. Each cost pool is distributed to each responsibility center in proportion to that center’s relative amount of the allocation base. (LO4)
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14. Activity-Based Responsibility Accounting
Traditional responsibility-accounting systems tend to focus on the financial performance measures of cost, revenue, and profit for subunits of the organization.
Traditional responsibility-accounting systems tend to focus on the financial performance measures of cost, revenue, and profit for the subunits of an organization. Contemporary cost management systems, however, are beginning to focus more and more on activities. Activity-based costing systems associate costs with the activities that drive those costs. In activity-based responsibility accounting attention is directed not only to costs incurred but also to the activity creating the cost. (LO4)
Activity-based costing systems associate costs with the activities that drive those costs. In activity-based responsibility accounting attention is directed not only to costs incurred but also to the activity creating the cost.
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15. Behavioral Effects of Responsibility Accounting
Controllability
Motivating Desired Behavior
Information versus Blame
Responsibility-accounting systems can influence behavior significantly. Whether the behavioral effects are positive or negative, however, depends on how responsibility accounting is implemented. When used properly, a responsibility accounting system does not emphasize blame. The proper focus of a responsibility-accounting system is information. Performance reports can be used to distinguish between controllable and uncontrollable costs or revenues. Managerial accountants often use the responsibility-accounting system to motivate actions considered desirable by upper-level management. Sometimes the responsibility accounting system can solve behavioral problems as well. (LO4)
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16. Learning Objective 5
Learning Objective 5. Prepare a segmented income statement.
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17. Segmented Reporting
A segment is any part or activity of an organization about which a manager seeks cost, revenue, or profit data.
Segmented reporting refers to the preparation of accounting reports by segment and for the organization as a whole.
A segment is any part or activity of an organization about which a manager seeks cost, revenue, or profit data. Segmented reporting refers to the preparation of accounting reports by segment and for the organization as a whole. Many organizations prepare segmented income statements, which show the income for major segments and for the entire enterprise. (LO5)
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18. Aloha Hotels and Resorts
Segmented Reporting
Divisions
Aloha Hotels and Resorts •
Maui Division
Oahu Division
Waimea Beach Resort
Diamond Head Lodge
Waikiki Sands Hotel
A segmented income statement for Aloha Hotels and Resorts’ Oahu division would show income for Aloha Resorts and Hotels as a whole, then for each division, then for each unit within the Oahu Division. (LO5) •
Units
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19. Segmented Reporting
Segmented income statements are prepared in the contribution format. Three items require special emphasis. First, the common fixed expenses is not allocated to the company’s two divisions. Included in this figure are such costs as the company president’s salary. These costs cannot be allocated to the divisions, except in some arbitrary manner. Second, there are fixed expenses controllable by the segment manager allocated to each unit within the Oahu division, but some of those costs are not allocated. These are costs that cannot be traced to the division’s three hotels, except on an arbitrary basis. For example, this expense includes the salary of the Oahu Division’s vice president. This procedure illustrates an important point. Costs that are traceable to segments at one level in an organization may become common costs at a lower level in the organization. Third, there are fixed expenses, traceable to the segment, but controllable by others. A large portion of those expenses cannot be allocated among the three hotels, except arbitrarily. Therefore, that portion is in the column marked Not Allocated. (LO5)
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20. Key Features of Segmented Reporting
Contribution format.
Controllable versus uncontrollable expenses.
Segmented income statement.
To summarize, there are three important characteristics of segmented reporting:
1. These income statements use the contribution format. The statements subtract variable expenses from sales revenue to obtain the contribution margin.
2. The income statements highlight the costs that can be controlled, or heavily influenced, by each segment manager. This approach is consistent with responsibility accounting.
3. Segmented reporting shows income statements for the company as a whole and for its major segments.
(LO5)
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21. Customer Profitability Analysis and Activity-Based Costing
We can handle
that - but we need
to quote a price that
reflects the value
of these services.
Let’s see, I need . . .
Special credit terms,
Small order lots,
Special packing,
Great field service,
and JIT delivery.
Customer profitability analysis uses the concept of activity-based costing to determine how serving particular customers causes activities to be performed and costs to be incurred. Suppose, for example, that customer A requests special credit terms, small order lots, special packaging, increased service and JIT delivery. These services can be provided, but at a cost. (LO5)
Company
Sales Rep
Customer
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22. Learning Objective 6
Learning Objective 6. Prepare a quality-cost report.
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23. Total Quality Management
Design
Grade
Conformance
Quality
What is meant by a high-quality product? A product’s grade refers to the extent of its capability in performing its intended purpose, in relation to other products with the same functional use. A product’s quality of design refers to how well it is conceived or designed for its intended use. The quality of conformance refers to the extent to which a product meets the specifications of its design. Both quality of design and quality of conformance are required in order to achieve a high-quality finished product. (LO6)
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24. Cost of Quality Quality costs include the follows: Prevention costs,
Appraisal costs,
Internal failure costs, and
External failure costs.
Many companies measure and report the costs of ensuring high quality. Four types of costs are monitored. First are prevention costs, the costs of preventing defects. Second are appraisal costs, the costs of determining whether defects exist. The third type of costs are internal failure costs, those costs of repairing defects found prior to product sale. The last type of costs are external failure costs, those costs incurred when defective products have been sold. (LO6)
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25. Cost of Quality
The opportunity cost of lost sales and decreased market share can represent a significant hidden cost.
Quality costs that can be measured are observable. But what about hidden quality costs? When products of inferior quality make it to market, customers are dissatisfied. Their dissatisfaction can result in decreased sales and a tarnished reputation for the company. Not only does the company experience lost sales for the inferior products but it will also likely experience lost sales in its other product lines. The opportunity cost of these lost sales and decreased market share can represent a significant hidden cost. Such hidden costs are difficult to estimate or report. (LO6)
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26. Learning Objective 7
Learning Objective 7. Discuss the traditional and contemporary views of the optimal level of product quality.
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27. Changing Views of Optimal Product Quality
Costs
Traditional View
Total quality costs
Failure costs
One way to express product quality is in the percentage of products that fail to conform to their specifications, that is, the percentage of defects. The traditional viewpoint holds that finding the optimal level of product quality is a balancing act between incurring costs of prevention and appraisal on one hand and incurring costs of failure on the other. As the percentage of defective products decreases, the costs of prevention and appraisal increase. However, the costs of internal and external failure decrease. Adding the costs of prevention, appraisal, and internal and external failure yields total quality costs. The optimal product quality level is the point that minimizes total quality costs. (LO7)
Prevention and appraisal costs
Percentage of defective products 0%
100%
Minimum
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28. Changing Views of Optimal Product Quality
Costs
Contemporary View
Total quality costs
Failure costs
The contemporary view is that if both observable and hidden costs of quality are considered, any deviation from a product’s target specifications results in the incurrence of increasing quality costs. Under the contemporary viewpoint, the optimal level of product quality occurs at the zero defect level. The observable and hidden costs of internal and external failure increase as the percentage of defective products increases. The observable and hidden costs of prevention and appraisal increase slightly and then decrease as the percentage of defects increases. The most important point, though, is that the total costs of quality are minimized at the zero defect level. (LO7)
Prevention and appraisal costs
Percentage of defective products 0%
100%
Minimum
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29. Identifying Quality Control Problems
Poor reception/ static on line
Pareto Diagram
Too easily moves out of transmission range
A helpful tool in quality improvement programs is the Pareto diagram. The Pareto diagram shows graphically the frequency with which various quality control problems are observed for a particular model of cordless telephone. The Pareto diagram helps the TQM team visualize and communicate to others what the most serious types of defects are. Steps can be taken then to attack the most serious and most frequent problems first. (LO7)
Power declines too rapidly
Faulty casing (easily broken)
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30. ISO 9000 Standards
The International Standards Organization (ISO), require that a manufacturer have a well-defined quality control system in place, and that the target level of product quality be maintained.
Sustain quality of product.
Effective quality control system in place.
Provide purchaser confidence in the product.
A key factor in determining the quality of a company’s products is its quality control system. In 1987, the International Standards Organization (ISO), issued a set of quality control standards for companies selling products in Europe. The ISO 9000 standards focus on a manufacturer’s quality control system. The ISO 9000 standards basically require that a manufacturer have a well-defined quality control system in place, and that the target level of product quality be maintained consistently. The first standard, ISO 9000, lists three objectives:
• The company should sustain the quality of its product or service at a level that continually meets the purchaser’s stated or implied needs.
• The quality control system should be sufficient to give the supplier’s own
management confidence that the intended quality is being maintained.
• The supplying company should give the purchaser confidence that the intended quality is consistently achieved in the delivered product or service.
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31. Learning Objective 8
Learning Objective 8. Understand the different types of environmental costs and discuss environmental cost management.
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32. Environmental Cost Management
Private environmental costs are assumed by a company.
The costs of dealing with environmental issues in one way or another are enormous. One important distinction is between private costs and social (or public) costs. Private environmental costs are those borne by a company or individual. Examples would be costs incurred by a company to comply with EPA regulations or to clean up a polluted lake. Social environmental costs are those borne by the public at large. Examples of these include costs borne by the taxpayers to staff the EPA; costs borne by the taxpayers to clean up a polluted lake or river; or costs borne by individuals, insurance companies, and Medicare due to health problems caused by pollutants. (LO8)
Social environmental costs are assumed by the public.
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33. Environmental Cost Management
Visible private environmental costs are measurable and clearly identified environmental issues.
Hidden private environmental costs are caused by environmental issues but have not been so identified by the accounting system.
Visible private environmental costs are those that are measurable and have been clearly identified as tied to environmental issues. Hidden private environmental costs are those that are caused by environmental issues but have not been so identified by the accounting system. Visible and hidden costs can be further classified as Monitoring costs, abatement costs, on-site remediation costs and off-site remediation. (LO8)
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34. Environmental Cost Strategies
End-of-pipe
Process improvement
Prevention
Three strategies for managing environmental costs are:
End-of-pipe strategy. Companies produce the waste or pollutant, and then clean it up before it is discharged into the environment.
Process improvement strategy. Under this approach, companies modify products and production processes to produce little or no pollutants, or find ways to recycle wastes internally.
Prevention strategy. Under this strategy, the company strives to produce no pollutants at all. (LO8)
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35. End of Chapter 12
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