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There are two types of accounting and these are Managerial Accounting and Financial Accounting. Distinguishing these quickly, managerial accounting deals with activities within the company while as Financial accounting deals much with external information of an organization. Managerial accounting is what this assay will be discussing and mainly to do with management control systems. In management control systems, the main focus will be discussing what responsibility centers are, then later on we will be looking into the types of responsibility centers along with examples of those responsibility centers and how these responsibility centers operate in an organization. There are four types of Responsibility Centers (ABE, 2011). Namely, (1) Cost Center, (2) Revenue Center, (3) Profit Center, (4) investment centers, (Drury, 2001).
Traditionally, the owners of the organizations, companies or an entity, were divided into functional divisions/segments. A segment is defined as a fairly autonomous unit of company defined according to function or product line. As segments or rather put it simply, departments are organized along functional lines to perform specific function such as marketing, production, finance, purchasing, and shipping. Therefore responsibility center, is a department or segment or division of an organization for which a particular executive is responsible (Rutgers Accounting, 2020). In addition to this definition, Drury, define it also as the unit of a firm where an individual manager is held accountable for the performance of the unit under his or her control, (Drury, 2001).
Accountability of a manager is limited to only costs under their control (Rutgers Accounting, 2020). Cost Centers are divided into two areas and these are (a) Standard costs and (b) Discretionally Costs. With Standard Costs is where the outputs can be measured and input required to produce each unit of output can be specified. In order to control this, it is expressed through making a comparison of the cost of inputs intended to be used in the process of production against the actual cost incurred, (Drury, 2001). The variance becomes the difference that is observed between the standard cost and actual cost. Later, is discretionally cost where outputs cannot be measured in monetary forms. There is no clear and observable relationship between inputs and outputs consumed and achieved. Managers control using cost centers come function in the following forms; actual expenditure has to be tarrying with the budgeted expenditure and this has to be for each expense category. Secondly, ensure that tasks allocated to each center have been achieved and successfully. Examples where cost centers are used are as follows; cost centers are used in (a) advertising and publicity, (b) research and development departments. Care should be taken into consideration here especially in research and development. Managers need not to underspend with intention of cutting cost. According to Drury, (2001, p.326-329) explained that “underspending in research and development could mean bad results since that may bring about undesirable outcome. Therefore the problem with discretionally is measuring of effectiveness. On expenditures, advertising using less expenses in marketing does not mean that advert expenses have been effective, (Drury, 2001). It could be due to poor timing, also may be directed to the wrong audience, wrong message and this tends to be a biggest challenge in cost centers under discretionally management control.
Mangers are made accountable for only financial outputs. Their full contribution is eyed at generation of sales revenues. Examples of revenue centers could be as follows, regional managers accountable for sales only within their regions. Selling and distribution of finished goods in case of manufacturing companies. Performance evaluation is based completely on sales target. The main challenge here is that since their concentration is only on sales, they do not have concern on profitability since they consider that not being their responsibility (Rutgers Accounting, 2020). This occurs when sales are not equally profitable and managers can achieve higher sales revenue by promoting low profit production. They are held accountable for selling expenses such as sales person salaries, and order getting costs.
According to Association of Business Executives (ABE, 2011 p.13-29) profit center, is defined as areas of organization for which sales and costs are identifiable and attributable. Both revenues are received and expenditures are controlled in this responsibility center. There is limited decision making authority. Defining profit center, Drury, (2001, p.326-329, are units or segments within an organization whose managers are accountable for revenues and costs. When mangers are given authority both in production and sales, there is a significant increase in managerial autonomy (Rutgers Accounting, 2020). Doing so, gives the managers freedom to set selling prices, choosing which market to sell in, make product mix and output decisions as well as selecting suppliers.
Managers are responsible for both sales and revenues and costs. They have responsibility and authority make working capital and capital investment decisions. Good examples on this are ROI (Return on Investment), and Economic Value added (Drury, 2001). These measures are influenced by revenues, costs and assets employed and therefore reflect the responsibility that managers have for both generating profits and managing the investment base. There is highest level of management autonomy. They include company as a whole, operating subsidiaries, operating groups and divisions, (Drury, 2001). Here inputs are measured in terms of expenses and outputs measured in terms of revenues and in which assets employed also measured the excess of revenue over expenditure then being related to assets employed, (ABE, 2011).
Responsibility centers are established in order to ensure that every department or segment should be controlled using this centers. This helps the organization to device the course of action should there seem to be some disparities from the established goals. Therefore, the following are served as main reasons for establishing management controlling measures according to Drury, (2001); “express and aggregate the results of the wide range of dissimilar activities using a common measure, profitability and liquidity are essential to the success of all organizations and financial measures related to these and other areas are closely monitored by stakeholders and hence the managers will wish to monitor performance in monitoring terms, course of action benefits an organization only if it results in an improvement in its financial performance, managers need full autonomy for them to perform their duties properly as long as their acts are ethically proven.” Responsibility centers as control measures, are very important looking at the reasons for their existence. Monitoring performance in the form of conducting audit becomes easy since they deal with one segment from the other thereby pinpointing exact weak managers.
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