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Responsibility Accounting. To be effective, organizations must ensure that allocation of decision rights and use of appropriate performance measures be designed to maximize firm profits given the specialized knowledge available to members of the organization.

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Responsibility Accounting

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responsibility accounting
Responsibility Accounting
  • To be effective, organizations must ensure that allocation of decision rights and use of appropriate performance measures be designed to maximize firm profits given the specialized knowledge available to members of the organization.
  • Responsibility accounting involves the choice of performance measures that can motivate firm members to take actions the firm desires.
  • Measures to evaluate managerial performance should reflect decision rights allocations within the firm.
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Responsibility Accounting
  • Three or four types of responsibility centers are used to hold managers accountable.
    • Cost center … cost per unit, capacity utilization ...
    • Profit center … return on assets
    • Investment center … Net Income, ROI, RI, EVA.
    • Discretionary cost center (e.g. R&D) … amount spent.
  • Controllability principal suggests that managers be held responsible for only those costs the manager controls … better viewpoint is to hold managers responsible for outcomes they can influence.
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Responsibility Accounting
  • Transfer pricing is intimately linked to responsibility centers and accounting. Transfers are sales by one division of a firm to another. Very often firms have special rules on prices of these transfers are to be chosen.
  • Note that the sale price (transfer price) affects both division’s profits: the buying division’s costs are the selling division’s revenues, so if both are profit centers, the buying division will push for lower prices while the selling division will push for more. This creates a conflict among divisions even though the company as a whole is equally well off no matter what the transfer price.
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Responsibility Accounting
  • The ideal transfer price is the opportunity cost of the goods or services transferred.
  • Opportunity cost may be the same as variable cost, but not always. If goods can be sold externally, opportunity cost may be the revenue forgone.
  • However external markets may not always exist as in the case of specialized or custom-built goods, or, proprietary costs of revealing information and/or production technological secrets, availability of a reliable outside source, quality concerns or synergies can make it hard to discover opportunity costs.
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Responsibility Accounting
  • Opportunity costs may be hard to verify. So firms often use the following types of transfer prices:
    • market-based prices where the division use prices charged on the open market as a guideline,
    • cost-based schemes (full or variable cost-based),
    • negotiated (with full autonomy to divisions to not trade if they cannot agree on a price) and
    • dual pricing schemes in which the price paid by the buying division is not the same as the price received by the selling division. The difference between the two prices is adjusted in the head-office books of accounts.
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Responsibility Accounting
  • Allowing managers to negotiate prices and the freedom to decide not to trade within the firm often appears to be the most unprofitable thing to do.
  • Yet, for decentralization, it is necessary to let the managers decide. If they turn down profitable business, division managers must be sure that the jobs they get are at least as profitable (else they would be better off taking the prices offered). So if they turn down some business from a sister division, they either will be worse off (and will learn) or they have other information based on which they rejected the offer. In either case the firm benefits.
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Responsibility Accounting
  • The magnitude of the market involved is another important criterion. Some times the amounts at stake are so large that divisions cannot be allowed the final word … top management has to review the deal.
  • Eventually, if the transfer pricing disputes are too large, too frequent and take up too much of top management’s time, then the solution may be to re-centralize and treat two profit centers as one, or to change some centers from profit centers to cost or discretionary cost centers or revenue centers.