Responsibility centres

Question 1

How to achieve goal congruence?

Answer 1

1. Group activities into units
2. Decentralise decision-making to lower level managers
3. Assign financial responsibilities

Question 2

Centralisation vs decentralisation

Answer 2

Centralisation

• Most of the decision-making authority is reserved for top management
• Control is exercised through central planning and monitoring of deviations from these plans

Decentralisation

• Delegation of decision-making authority to lower levels
• Provision of sufficient material and formal resources to execute that authority
• Assignment of accountability and responsibility for the quality of decision-making

Question 3

Decentralisation: Advantages

Answer 3

• Greater responsiveness to local needs
• Quicker decision-making
• Increased motivation
• Aids management development and learning

Question 4

Decentralisation: Why need of control systems?

Answer 4

Decentralised managers do not automatically:

• Understand the goals and strategies developed by top management and how they can contribute
• Agree with the goals and strategies developed
• Have the right resources to act in line with goals and strategies
• > Responsibility centres

Question 5

Responsibility centres

Answer 5

• The assignment of financial responsibility to decentralised units
• The basic structure (skeleton) of the management control system
• Four main types

Question 6

Assigning financial responsibility

Answer 6

Dependent on:

1. The core operations of the unit based organisational structure
   - Functional vs business unit
2. The measurement possibilities of input and output
   - You cant manage want you cant measure
3. The controllability principle
   - Managers should be responsible only for the things they can control/influence
4. Strategic concerns

Question 7

Organisational structure

Answer 7

• The strategy influences how activities are organised into decentralised units - organisational structure
• Organisational structure -> responsibility for operating activities -> financial responsibility
• Three general structures

Question 8

Measurement (1)

Answer 8

• You cant manage what you cant measure

Issues:

1. Input
   - Resources used by RC
   - Can we measure it? (monetary or physical terms)
2. Output
   - The result of activities performed in RC
   - Can we measure it?
3. Causality: The relation between input and output

Question 9

Measurement (2)

Answer 9

Efficiency: The relation between input and output

• Output/Input
• Doing things right

Effectiveness: The relation between output and objectives

• The more output contributes to objectives, the more effective is the unit
• Doing the right things
• Each RC should be both efficient and effective

Question 10

The controllability principle

Answer 10

• Managers should only be responsible for the revenue/expenses/investments they can control or influence
• If not: lack of motivation (at best) or dysfunctional and/or fraudulent behaviour

Question 11

Investment centre

Answer 11

• Monetary measures of both input, output and capital used
• Trade-offs between expenses, revenues and capital used
• Appropriate when managers can influence profit and the assets employed in earning it
• The main responsibility is ROI and managers are accountable for investments, revenues and expenses

Question 12

Profit centre

Answer 12

• Monetary measures of both input and output
• Trade-offs between expenses and revenues (price, volume, quality and costs)
• Appropriate when managers can influence expenses and revenues but not the investment base
• The main responsibility is profit and managers are accountable for revenues and expenses

Question 13

Profit centre: Pros

Answer 13

• Higher information relevance
• Greater responsiveness to competitive challenges
• Frees up senior management through delegation
• Training ground
• Profit consciousness

Question 14

Profit centre: Cons

Answer 14

• Lower quality of decision-making at unit level - lack of competent staff
• Risk of intra-firm competition
• Transfer pricing can result in rivalrous behaviour
• Short-term profitability overemphasized
• Sub-optimisation (goal incongruence)

Question 15

Measuring performance in profit centre: influence?

Answer 15

Revenue
Cost of sales
Variable expenses
-> Contribution margin
Fixed expenses
-> Direct profit
Controllable corporate charges
-> Controllable profit
Corporate allocations (other)
-> EBIT
Taxes
-> Net income

Question 16

Revenue centre (1)

Answer 16

• Lack of influence over inputs and influence over direct expenses
• Appropriate when managers can influence output and output can be measured in monetary terms but can not influence cost
• The main responsibility is revenues (if setting price) or volume and mix of sales
• No attempt to relate input to output (efficiency?)

Question 17

Revenue centre (2)

Answer 17

Goal incongruence?

• Promote low-profit products since they do not know the cost of goods sold?
• Extending credit to customers for higher price (increase revenue, reduce ROI)?

Could be managed by:

• Complementary measures of effectiveness (costumer satisfaction)
• Rules of conduct
• Transforming unit to profit centre

Question 18

Engineered expense centre (standard cost centre)

Answer 18

Characteristics:

• Input can be measured in monetary terms
• Output can be measured in physical terms
• Optimal relationship/causality can be established
• The optimum amount of input required to produce one unit of output can be determined (standard cost)
• Main responsibility is cost efficiency (productivity): standard cost vs actual cost

Question 19

Problems with engineered expense centre?

Answer 19

Risk of goal incongruence:

• Is employee training and development reduced to reduce cost?
• Minimizing manufacturing costs at the expense of quality?

Question 20

Main difference between engineered and discretionary?

Answer 20

Engineered expenses can be estimated with reasonable reliability, whereas for discretionary/managed expenses no such engineered estimate is feasible. Instead expenses depends on management’s judgement of what is appropriate.

Question 21

Discretionary expense centre

Answer 21

• Appropriate when output cant be readily measured and no standard cost can be derived
• No optimal relationship between input and output can be established (R&D, time lag)
• Focus on desired level and quality of output
• Set a discretionary budget for acceptable levels on input (incremental vs zero-based)

Question 22

Problems with discretionary expense centre?

Answer 22

Risk of goal incongruence:

• Functional excellence vs “good enough”
• > Use non-financial measures

Question 23

Summary: generic types of RCs

Answer 23

Engineered

• Input in monetary terms
• Output in physical terms
• Optimal relationship between input and output

Discretionary

• Input in monetary terms
• Difficult to measure output in physical terms
• No optimal relationship between input and output

Revenue centre

• Output in monetary terms
• Input not related to output

Profit centre

• Input in monetary terms
• Output in monetary terms
• Inputs related to output

Investment centre

• Input in monetary terms
• Output in monetary terms
• Profit related to capital