Responsibility accounting focuses attention on responsibility centers. A responsibility center is a sub-unit of an organization under the supervision of a manager who has the responsibility for the activities of that responsibility center. Each sub-unit has certain activities to perform and its manager is assigned the responsibility and / or authority to carry out those activities. responsibility center is the segment of business with reference to which information will be communicated to pin point responsibilities.
In the words of Anthony and Races, “A responsibility center is like an engine in that it has inputs, which are physical quantities of material, hours of various types of labor, and a variety of services; it works with these resources usually; working capital and fixed assets are also required. As a result of this work, it produces output, which are classified either as goods, it they are tangible or as services, if they are intangible. These goods or services go either to other responsibility centers within the company or to
customers in the outside would.”
Responsibility centers, for planning and control purposes, is classified into the following cases:
- Expense Center: An expense center is a responsibility center in which inputs, but not outputs, are measured in monetary terms. Expense or cost center is a segment of an organization in which the managers are held responsible for the costs incurred in that segment. Responsibility accounting is based on financial information relating to input (costs) and outputs (Revenues). In an expense center of responsibility, the accounting system records only the cost incurred in/by the center or unit but revenues earned (output) are excluded. In case of certain responsibility centers, it is neither possible nor necessary to measure the output in terms of monetary units. Most of the service departments come in this category.
- Revenue Center: A revenue center is a segment of the organization which is primarily responsible for generating sales revenue. A revenue center manager does not possess control over cost, investment in assets, but usually has control over some of the expenses of the marketing department. The performance of a revenue center is evaluated by comparing the actual revenue with budgeted revenue. The marketing manager of a product line, or an individual sales representative are example of revenue centers.
- Profit Center: A responsibility center is called a profit center when the manager is held responsible for both costs (inputs) and revenues (outputs) and thus for profit. A profit center is a big segment of activity for which both revenues and costs are accumulated. A center whose performance is measured in terms of both – the expense it incurs and revenue it earns, is termed as a profit center. The output of a responsibility center may either be meant for internal consumption or for outside customers. In the latter case the revenue is realized when the sales are made. That is, when the output is meant for outsiders, then the revenue will be measured from the price charged from customers. If the output is meant for other responsibility center, then management takes a decision whether to treat the center as profit center or not. In fact, any responsibility center can be turned into a profit center by determining a selling price for its outputs. For instance, in case of a process industry, the output of one process may be transferred to another process at a profit by taking into account the market price. Such transfers will give some profit to that responsibility center. Although such transfers do not increase the Company’s assets, they help in management control process.
- Investment Center: It is defined as a responsibility center in which inputs are measured in terms of cost/expenses and outputs are measured in terms of revenues and in which assets employed are also measured. A responsibility center is called an investment center, when its manager is responsible for costs and revenues as well as for the investment in assets used by his center. He is responsible for maintaining a satisfactory return on investment i.e. revenues, expenses and the amounts invested in the center’s assets. The manager of an investment center is required to earn a satisfactory return. Thus, return on investment (ROI) is used as the performance evaluation criterion in an investment center.
Cost centers vs. Responsibility centers
A cost center is “a location, person or item of equipment (or group of these) for which costs may be ascertained and used for purposes of cost control”. Thus, cost center is used as a means of assembling items of cost, so that they can be assigned to goods and services. In the case of cost center, emphasis is not on the persons who may be managing a level or product or process. Responsibility centers, on the other hand, are established on the basis of responsibility delegated to responsible personnel of the organization with a view to identify costs which can be controlled by each one of them. However, cost centers sometimes may be used as responsibility centers too. In that case cost reports are prepared both cost center-wise and responsibility-center-wise.