Responsibility AccountingA system of accounting that assigns responsibility/accountability to an individual for certain areas of cost control

It is usually the accountant and his/her accounting staff that are responsible for the financial accounting of the business.

The main outputs of financial accounting are the business’s financial statements (balance sheet, income statement, cash flow statement, etc.).

So, does that mean that the accounting team is the only one responsible for all the finances of the business?

Are they the only ones responsible for making sure that the budgets are followed?

Well, for a small business, that may be the case.

But for a larger business that employs tons of staff and has lots of departments/functions, that may not be feasible.

In some cases, it is the department heads themselves that are responsible for following the budget set by the business.

Anyway, the department heads typically have more control over the finances of their respective departments.

For example, it is typically the sales department that knows best the revenue projection of the business.

And the very same sales department typically knows best how to attain such a goal.

To keep track of the progress, the sales department will assign the monitoring of the business’s current sales to one of its staff (most often the department head).

This system of assigning responsibility/accountability to an individual is the essence of responsibility accounting.

But of course, a business should assign responsibility to just anyone. It should be assigned based on the individual’s knowledge and skills.

In this article, we will be talking about responsibility accounting. What is it?

How can responsibility accounting help a business?

What are the components of responsibility accounting?

What are the requisites of an effective responsibility accounting?

We will try to answer these questions and more as we go along with the article.

What is Responsibility Accounting?

Responsibility accounting is a system of accounting in which the business assigns responsibility/accounting to certain individuals for certain management functions such as executing the budget.

The main objective of responsibility accounting is to support the operations of the business, including planning and budgeting.

It makes use of responsibility centers in assigning accountability to these certain individuals. Effective responsibility accounting can greatly help in improving the management of operations.

Responsibility accounting typically involves the separate accounting/reporting of revenues and/or costs of the business’s responsibility centers.

For example, let’s say that the business assigns the cost of rent to the employee responsible for the negotiation and signing of leases.

Now, if the actual cost of rent exceeds the budget for it, the employee is accountable and answerable for the increase.

This encourages the employee to properly manage the cost of rent.

Another important aspect of responsibility accounting is cost control. It does this by making certain individuals accountable for the costs of their assigned responsibility center/s.

However, this cost control only applies to costs that the business can actually control. Uncontrollable costs such as inflation aren’t something that responsibility can greatly help with.

The thing with responsibility accounting is that it requires manpower. But not just any manpower.

It requires people that have the necessary skills and knowledge.

Assigning responsibility/accountability to an employee that is inexperienced can lead to disastrous results.

As such, it may not be feasible for a newly-formed business. However, for businesses that are large enough and can cover the cost, responsibility accounting will do wonders for the management of operations.

The Types of Responsibility Centers

Responsibility centers are an important element of responsibility accounting.

They facilitate the assignment of responsibility and accountability to certain individuals.

There are four types of responsibility centers, which are the following:

Cost Center

The cost center refers to a department or unit that is responsible for cost control.

A cost center may only be responsible for a certain cost or the entire costs of the business.

Some of its responsibilities include the supervision, management, and allocation of costs. It may also work to eliminate or limit unwanted and unnecessary expenditures (e.g. penalties).

A cost center can only be held accountable for costs that can actually be controlled.

An individual responsible for a cost center is accountable and answerable for any amount of excess actual cost (vs budgeted or targeted cost).

For example, let’s say that Jane is responsible for handling the cost of raw materials.

Jane approves the purchase of raw materials.

For the current, the budget for raw materials is $80,000.

However, the actual cost of raw materials amounted to $83,300.

This means that actual costs exceeded the budget by $3,300.

Jane explains there the excess was due to a price increase in a certain raw material.

There we no other suppliers that can provide the same quality, and as such, Jane had no other choice but to accept the price increase.

Revenue Center

A revenue center refers to a department or unit that is solely responsible for the generation of revenues.

This is typically a business’s sales department.

A business’s revenue center is responsible for attaining the projected revenue in the budget.

It is accountable for generating and monitoring the business’s revenue.

To measure the performance of a revenue center, its actual revenue is compared to the business’s projected revenue.

Ideally, the actual revenue should be greater than or equal to the projected revenue.

Profit Center

A profit center is a department or unit that is responsible for both revenue generation and cost control.

The employees assigned to profit centers are typically their managers or department heads.

A typical example of a profit center is a product line or an entire factory.

The factory is responsible for producing the business’s goods that it will eventually sell for revenue generation.

Additionally, the factory is also accountable for the costs of production such as raw materials and direct labor.

Investment Center

An investment center is responsible for both profits and returns on investments.

It utilizes the business’s assets to ensure that the business gets the best returns on its investments.

An investment center is also responsible for the expenses that relate to investments.

It can also have the authority to form a credit policy.

Components of Responsibility Accounting

A typical responsibility accounting system has the following components:

• Inputs and Outputs
• Identification of Responsibility Center
• Target and Actual Information
• Relationship Between the Responsibility Center and Organization Structure
• Assigning Cost and Revenue to the Proper Individual

Inputs and Outputs

Responsibility accounting is typically implemented on the basis of information relating to inputs and outputs.

Inputs typically refer to the business’s costs and utilization of resources, while outputs typically refer to the business’s revenue.

For example, inputs may refer to the cost of raw materials and direct labor, while outputs refer to revenue generated from the sale of finished goods.

Identification of Responsibility Center

Responsibility centers are a major element of responsibility accounting.

They facilitate the whole process of responsibility accounting. They represent the decision points of the business.

Depending on the size of the business, they may be one or more responsibility centers.

Target and Actual Information

Responsibility accounting also covers the performance evaluation of the people that are accountable for the business’s responsibility centers

To do such performance evaluation, responsibility accounting will need target/budget data and actual data.

For example, to evaluate the performance of a revenue center, we need the budget or target revenue and the actual revenue.

Relationship Between the Responsibility Center and Organization Structure

One of the requisites of effective responsibility accounting is a structure that clearly shows authority and commitment.

It should also be designed to work with the business’s organizational structure.

Assigning Cost and Revenue to the Proper Individual

After identifying the inputs, outputs, and responsibility centers, as well as the authority-responsibility relationship, it’s time to assign the responsibility/accountability to an appropriate individual.

This individual will be accountable and answerable for the performance of the responsibility center that s/he is assigned to.