GOUTHAM G SHETTY

GIRISH DEYANNAVAR

JOEL ROSHAN

RAGHU GOWDA

RANJINI

Responsibility Centers: Revenue and Expense Centers

Definition:A responsibility center is an organization

unit that is headed by a manager who is responsible for its activities

Responsibility centers for a hierarchyLowest level :Sections, work shifts

other organisational unitsDepartments or Business units

comprises smaller units Senior management and Board of

Directors

Nature of Responsibility CentersAccomplish one or more purpose or goalSenior management decides on set of

strategies or goalResponsibility centers should implement

these strategiesResponsibility centers receive inputs in form

of material, labor and serviceRevenues are amounts earned from

providing these outputs

Measuring Inputs and OutputsInputs are measured in hours of labor,

quarts of oil, reams of paper, and kilowatts hours of electricity

Monetary value is calculated by multiplying a physical quantity by a price per unit (Cost)

Cost is monetary measure of amount of resources used by a responsibility center

Performance MeasurementEfficiency is the ratio of outputs to inputs,

or the amount of output per unit of inputA responsibility center is more efficient if it

uses fewer resources than responsibility Center

Else if it uses the same amount of resources but produces a greater output

Efficiency is measured by comparing actual cost with standard cost

Effectiveness is measured by relationship between a responsibility center’s output and its objectives

A organisation is efficient if it does things right and it is effective if it does the right things

Role of ProfitProfit can be used to measure both

Effectiveness and EfficiencyBut there may be conflict between the two

Types of Responsibility CentersRevenue Centers : Output are measured in

monetary termsExpense Centers: Inputs are measured in

monetary termsProfit centers: both inputs and outputs are

measured in monetary termsInvestment centers: Relationship between

investment and profit is measured

Types of Expense centersEngineered Expense centersDiscretionary Expense centers

Engineered Expense centersCharacteristics: Input can be measured in monetary termsOutput can be measured in physical termsUsually found in manufacturing operationsEg. Distribution, trucking, warehousing and

similar units

Discretionary Expense CentersIncludes administrative and support unitsEg. (Accounting, legal, industrial relations,

public relations, human resources)These expenses are mostly based on the

managements expensesIn discretionary expense the difference

between budget and actual input and does not incorporate the value of the output

General Control CharacteristicsBudget PreparationIncremental BudgetingZero Base BudgetingCost VariabilityType of Financial ControlMeasurement of Performance

Budget Preparation

Discretionary expense centers categories: continuing and special.

Continuing work is done consistently from year to year

Special work is a “one shot” project

A technique often used in preparing a discretionary expense center's budget is management by objectives, a formal process in which a budgetee proposes to accomplish specific jobs and suggests the measurement to be used in performance evaluation.

Incremental Budgeting In this model, the discretionary expense center's current

level of expenses is taken as a starting point. This amount is adjusted for inflation, anticipated changes in the workload of continuing job, special job, and—if the data are readily available—the cost of comparable jobs in similar units.

Limitations :1. Discretionary expense center's current level of expenditure

is accepted and not reexamined during the budget preparation process.

2. Managers of these centers typically want to increase the level of services, and thus tend to request additional resources, as a result overheads cost increases

Zero Base ReviewAn alternative budgeting approach is to make a

thorough analysis of each discretionary expense center on a rolling schedule, so that all are reviewed at least once every five years or so. Such analysis is often called a zero-base review.

Advantages: It can help for comparative analysis with the

benchmark

Limitation:Zero-base reviews are time-consumingTraumatic for the managers whose operations are

being reviewed (this is one reason for scheduling such reviews so infrequently).

Cost variability

Cost in engineered expense centers, which are strongly affected by short-run volume changes, costs in discretionary expense centers are comparatively insulated from such short-term fluctuations.

This difference stems from the fact that in preparing the budgets for discretionary expense centers, management tends to approve changes that correspond to anticipated changes in sales volume

for example, allowing for additional personnel when volume is ex pected to increase, and for layoffs or attrition when volume is expected to decrease. Personnel and personnel-related costs are by far the largest expense items in most discretionary expense centers; thus, the annual budgets for these centers therefore tend to be a constant percentage of budgeted sales volume.

Limitations:Managers cannot adjust the work force for short-run

fluctuations; hiring and training personnel for short-run needs is expensive, and temporary layoffs hurt morale.

Type of Financial control Financial control in discretionary expense centre is primarily

exercised at the planning stage before the cost are incurred where as in engineered expense centre is different

Measurement of performance The primary job of a discretionary expense center's manager is

to obtain the desired output The financial report is not means to evaluate the performance

of the manager

If these two types of responsibility centers are not carefully distinguished, management may erroneously treat a discretionary expense center's performance report as an indication of the unit's efficiency, thus motivating those making spending decisions to expend less than the budgeted amount, which in turn will lower output For this reason, it is unwise to reward ex ecutives who spend less than the budgeted amount

Control over spending can be exercised by requiring the superior's approval before the bud get is overrun. Sometimes, a certain percentage of overrun (say, 5 percent) is permitted

Administrative and Support CentersControl Problems

Difficulty in measuring outputLack of goal congruence

• Budget Preparation

Research & Development CentersControl Problems

Difficulty in relating results to inputsLack of goal congruence

• The R&D continuum• Annual Budgets• Measurements of Performance

Marketing CentersLogistics ActivitiesMarketing Activities

Vershire Company Case studyIn 1996 Vershire Company Was a

diversified packaging company with several major divisions, including the Aluminum Can division.

This Aluminum Can division was one of the largest aluminum beverage cans manufacturers in united states.

The division had plants scattered

throughout the United States. Each plant served customers in its own geographic region, often producing several different sizes of cans for a range of customers that included both large and small breweries and soft drink bottlers.

Most of these customers had between two and four suppliers and spread purchases among them.

All Aluminum can producers employed essentially the same technology, and the division's product quality was equal to that of its competitors.

Containers were made from one of several materials: aluminum, steel, glass, fiber-foil (paper and metal composite), or plastic.

The metal container industry consisted of the hundred-plus firms that produced aluminum and tin-plated steel cans.

Aluminum cans were used for packaging beverages (beer and soft drinks).

While tin-plated steel cans were used primarily for food packaging, paint and aerosols .

In 1970 steel cans accounted for 88% of the metal can production.

In 1996 aluminum cans accounted for over 75% of metal can production.

Than soft drinks bottlers were purchased by small independent franchises of coco-cola and pepsi cola .

Five beverage container manufactures accounted for 88% of the market.

Minimum efficient scale for a container plant was 5 lines and it cost $ 20 million in equipment per line

Raw Materials :64%Other cost (includes labour) : 15%Marketing and General administration 9%Transportation 8%Depreciation 2%R & D 2%

In beverage processes container accounting for approximately 40% of total manufacturing cost

In early 1970’s can were produced by rolling a steel soldering and cutting it to size.

In 1970 the industry was revolutionized when aluminum producers perfected a 2 piece process in which a flat sheet of metal was pushed into a deep cup and top was attached .

By 1996 manufacturing had become even more efficient, by producing over 2,000 cans per minute

Advantages of aluminum over steelIt was easier to shapeIt reduced the problem of flavouringIt permitted more attractive packagingReduced transportation costMore attractive recycling materialScrap value

Questions1- Outline the strengths and weaknesses of Vershire

Company planning and control 2. Trace the profit budgeting process at Vershire, starting in

May and ending with the Board of Directors' meeting in December. Be prepared to describe the activities that took place at each step of the process and present the rationale for each.

3. Should the plant managers be held responsible for profits? Why? Why not?

4. How do you assess the performance evaluation system contained in Exhibits 2 and 3?

5. On balance, would you redesign the management control structure at Vershire Company? If yes, how and why?

Sales BudgetCorporate Management

(Central Market Research Staff)

District Sales Manager

District Sales Manager

District Sales Manager

Divisional General Manager Vice President Marketing

Sales Forecast

Sales Forecast Sales

Forecast

May

Preliminary Report for 2 years

General Report

Sales budget was broken down according to plants from which finished goods were shipped.

Estimate salesProfit=sales-variable overhead- fixed

overheadVisit by controller staff from head office

Marketing BudgetBoard of Directors

C.E.O

Divisional General Manger

Divisional Head Office

Plant Managers

Plant Managers

Plant Managers

September 1st

By December

MANAGEMENT INCENTIVES

Based on profit Only capable managers were promotedPlant manager’s compensation packages

were tied to achieving profitChart showing manufacturing efficiency

was displayed

Items Actual $ Variance $Year-to-Date VariancesTotal Sales Variances doe to 5 axes mix Sales price Sates volumeTotal Variable Cost of Sales Variances due to Material Labor Variable overheadTotal Fixed Manufacturing Cost Variances in fixed costNet ProfitCapital EmployedReturn on Capital Employed

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