RESPONSIBILITY ACCOUNTING & TRANSFER PRICING

RESPONSIBILITY ACCOUNTING a system of accounting that is implemented to an organization so that performance, in terms of costs and/or revenues, are recorded and reported by levels of responsibility within an organization. STEPS IN IMPLEMENTING RESPONSIBILITY ACCOUNTING 1) Responsibility accounting requires that costs and/or revenues be classified according to responsibility centers. RESPONSIBILITY CENTER is a segment of organization that is engaged in the performance of a single function or a group of closely related functions. This segment is usually governed by a manager, who is accountable and responsible for the activities of the segment. Types of Responsibility Centers: a. COST center managers are held responsible for the costs incurred by the segment b. REVENUE center managers are held responsible primarily for revenues of the segment c. PROFIT center managers are held responsible for both revenues and costs of the segment d. INVESTMENT center managers are held responsible for revenues, costs and investments. The central performance is measured in terms of the use of the assets as well as revenues earned and the costs incurred. The following may be used as basis of evaluating performance: Return on Investment (RoI) = Operating Income/Operating Assets = Margin x Turnover Residual Income = Operating Income Required Income Where: Required Income = Operating Assets x Minimum RoI Economic value added (EVA) more specific version of residual income that measures the investment centers real economic gains. It uses the weighted -average cost of capital (WACC) to compute the required income. EVA = Operating Income after Tax Required Income Where: Required Income = (Total Assets Current Liabilities) x WACC 2) Within each responsibility center, costs are classified either controllable or non-controllable. Generally, all costs are controllable. The key difference lies in the level of management who can control the costs. CONTROLLABLE COSTS are those items of cost that may be directly regulated at lower levels of management. NON-CONTROLLABLE COSTS are costs that cannot be regulated at a particular management level other than the top level. Costs may also be classified into DIRECT (attributable to a particular segment) or INDIRECT (common to a number of segments), the latter being subject to arbitrary allocation. 3) Within the controllable classification, costs are further classified according to the nature of expense. 4) A PERFORMANCE REPORT is furnished by each center and reported to the appropriate level of management. The performance report is the end product of the responsibility accounting process. It is a report that shows and compares actual results with the intended (budgets or standards) results of a responsibility center, thereby highlighting deviations that need corrective actions. The contribution format to computing results of operations (income) is emphasized in responsibility accounting. This income statement presentation highlights controllability of costs by behavioral classification. In addition to the usual variable costs and fixed costs, a more detailed classification of costs may be made. Consider the following illustrative example: Sales Variable manufacturing costs Manufacturing contribution margin Variable selling and administrative costs Contribution margin Controllable fixed costs: Manufacturing P500,000 (150,000) P350,000 (50,000) P300,000 P100,000

Selling and administrative Short-run performance margin Non-controllable fixed costs: Depreciation Rent and leases, insurance Segment margin Allocated common costs Income DECENTRALIZATION

75,000 P40,000 10,000

(175,000) P125,000 (50,000) P75,000 (30,000) P45,000

Decentralization refers to the separation or division of the organization into more manageable units wherein each unit is managed by an individual who is given decision authority and is held accountable for his or her decisions. DECENTRALIZATION-RELATED CONCEPTS GOAL CONGRUENCE All units of organization have incentives to perform for a common interest. The purpose of a responsibility system is to motivate management performance that adheres to company overall objectives. SUB-OPTIMIZATION This happens when one segment of a company takes action that is in its own best interests but is detrimental to the firm as a whole.

Note: Aside from its control function, responsibility accounting is designed to achieve goal congruence and discourage sub-optimization within an organization. ORGANIZATIONAL CHART a chart that shows the responsibility relationship among managers in an organization. It sets forth each principal management position and helps define authority, responsibility and accountability. A well-designed organizational chart helps a decentralized organization in carrying out duties with clear lines of responsibilities delegated to each of the segment of an organization.