Responsibility Centres

Question 1

What is decentralization?

Answer 1

Structure based on several autonomous decision making units

Objectives:
Ensure goal congruence
Increase motivation of management
Reduce head office bureaucracy
Provide better training for junior and middle management

Potential problem:
Dysfunctional decision making

Question 2

What are the objectives of performance evaluation?

Answer 2

Objectives:
Promote goal congruence
Encourage initiative and motivation
Provide feedback to management
Encourage long-term rather than short-term views

Objectives can only be achieved with the introduction of responsibility centres

Question 3

What are the responsibility centres?(4)

Answer 3

Cost centre
A unit of an organisation where the manager responsible for the centre is made accountable for the costs of the centre

Revenue centre
A unit of an organisation where the manager responsible for the centre is made accountable for the sales revenue earned by the centre

Profit centre
A unit of an organisation where the manager responsible for the centre is made accountable for the profitability of the centre’s operations

Investment centre
A unit of an organisation where the manager responsible for the centre is made accountable for the profit of the centre and also its profitability in relation to the capital invested in the centre

Each centre should have its own budget and its manager should receive budgetary control information relating to the centre for control and performance measurement purposes

Question 4

What is the controllibility of costs?

Answer 4

In responsibility centres managers should only be responsible and accountable for those costs that can be controlled
Controllable costs usually assumed to be variable costs and directly attributable fixed costs
Sometimes managers made responsible for a share of general overhead costs

Question 5

What are the key metrics of responsibility centres?

Answer 5

Targets for achievement
Metric is a key concept in performance measurement
Essentially financial ratios – learn them for this modules too!
Key areas of financial performance:
Profitability, liquidity, asset turnover

Question 6

Ways of determining profitability?

Answer 6

ROCE : Profit/Capital Employed
Profit Margin: Profit/Turnover
Asset Turnover: Turnover/Capital Employed

Contribution/sales ratio: Contribution/turnover

Question 7

Ways of determining liquidity?

Answer 7

Current ratio:
Current assets/current liabilities
Acid test ratio:
(current assets – stock)/current liabilities

Question 8

Ways of determining working capital?

Answer 8

Inventory days:
(stock/purchases) x 365
Receivable days:
(receivables/sales) x 365
Payable days:
(payables/purchases) x 365

Question 9

Advantages of ROCE/ROI

Answer 9

Widely used and accepted
Enables comparisons between divisions and companies of different sizes
Can be broken down into secondary ratios for more detailed analysis

Question 10

Disadvantages of ROCE/ROI

Answer 10

Dysfunctional behaviour when projects with lower ROCE are turned away
Different accounting policies can confuse comparisons
ROCE increases artificially with age of assets, thus discouraging investment

Question 11

Advantages of residual income

Answer 11

Reduces ROI’s problem of rejecting projects with an ROCE in excess of the company’s target but lower that the division’s current ROCE
The cost of financing a division is brought home to divisional managers
Can be broken down into secondary ratios for more detailed analysis

Question 12

Disadvantages of residual income

Answer 12

Does not facilitate comparisons between divisions
Does not relate the size of a division’s profit to the assets employed in order to obtain that profit