Responsibility Accounting: A Comprehensive Guide

Responsibility Accounting is a powerful management tool. It holds decision-makers accountable for financial outcomes. This article takes a further look in an easy to understand way. Let's dive into what responsibility accounting is and how to maximize its potential.

What is Responsibility Accounting?

Responsibility accounting is a management approach. It involves assigning financial responsibility to managers. This system empowers them to make decisions within their area of control. It fosters efficiency, effectiveness, and accountability.

Key Considerations for Effective Responsibility Accounting

Maximise the benefits of responsibility accounting with these crucial factors:

• Firstly, Clear Objectives: Set specific, measurable, achievable, relevant, and time-bound (SMART) goals. This ensures each manager understands their role and expected outcomes.
• Secondly, Defined Responsibility Centers: Establish clear responsibility centers. These include cost centres, revenue centres, profit centres, and investment centers. Clarity leads to better decision-making and accountability.
• Thirdly, Performance Measurement: Implement a robust performance measurement system. Compare actual results with budgeted targets. This helps identify areas for improvement and rewards top performers.
• Fourthly, Transparent Reporting: Create a culture of open communication. Share performance reports with all team members. This encourages collaboration and drives progress.
• Fifthly, Regular Feedback: Provide managers with constructive feedback. Help them learn from mistakes and celebrate successes. This fosters a growth mindset.
• Next, Employee Training: Invest in employee development. Equip managers with necessary skills and knowledge. This enhances their ability to make informed decisions.
• Finally, Flexibility: Encourage adaptability. Allow managers to adjust plans as needed. This enables them to respond to changing business environments.

Unlock the Full Potential 

Understanding Responsibility accounting is a necessary part of your management toolbox. It promotes efficiency, effectiveness, and accountability. By implementing these key considerations, you can unlock the system's full potential. Start reaping the benefits of responsibility accounting today!

Conclusion and good to know

Understanding Responsibility Accounting helps business clarity, decision making and improving performance.

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As our businesses grow and expand, it's less likely that we are going to be doing every single activity, carry out every single function. That's going to be next to impossible. So, we are going to have in-house accounting functions, HR departments are going to be growing, people are going to be taking on responsibility for marketing.

And in this week's I Hate Numbers podcast, I'm going to introduce the concept of responsibility accounting. I'm going to outline the main types of responsibility centre that we have. I'm going to look at some of the key issues involved, and as next week's episode, I'm going to be looking and focusing on the reporting

against those responsibility centers and the KPIs that we will develop to help us manage and improve the performance in our businesses.

You are listening to the I Hate Numbers Podcast with Mahmood Reza. The I Hate Numbers podcast mission is to help your business survive and thrive by you better understanding and connecting with your numbers. Number love and care is what it's about. Tune in every week. Now, here's your host, Mahmood Reza.

Hi folks. My name is Mahmood. I am the founder director of I Hate Numbers, and for the last 28 years I have been helping thousands of businesses grow their businesses, make more profit, improve the battle that goes on between their ears, have the lifestyles they want, save tax, and save time. What's not to love about that?

Let's crack on with the podcast. Now, a feature of most modern organisations, whether they're private, social enterprise, not-for-profit, is the business is divided into what are called semi-autonomous units or areas. What a lovely phrase that is. Now, in those semi-autonomous units or areas, individuals are then made responsible, and I will add, and accountable for those areas.

This is effectively known as responsibility accounting. Each area of responsibility is often referred to as a responsibility centre. Now, when we hear that term responsibility, I would strongly urge that we factor in the association of accountability as well, and that will become clearer as we talk more in this podcast. Managers are allocated in responsibilities centres, and then held responsible and accountable for the performance of those areas.

Responsibility accounting systems identify individual areas of responsibility in the business structure, and each of those areas is referred to as a responsibility centre. Now, in a few moments, I'm going to explain and outline, typically, the four main types of responsibility centre we are likely to encounter.

One of those is less popular, but nevertheless, there are four that exist. Now the four main types of responsibility centre is as follows, and I'll explain each one in turn. At one level we have what's called a cost centre. Now, a cost centre is where costs can be attributed, and costs are identified. Perversely,

this can either be a piece of machinery in a factory. A piece of machine can be a cost centre. It can be a location geographical, it could be an individual person, or it could be a department. If I take a little deep dive into how accounting systems are structured, this might make more sense. Let's assume that we are a manufacturing company and we receive an invoice for some agency staff.

Now, those agency’s staff that come in, and we've had to recruit half a dozen because we are short on people power, and we've had one person working on the shop floor, we've had one person who's been working the quality assessment department. And what we will do, we can identify the quality assessment department and the production area as two separate cost centres.

That invoice will be allocated, first of all, to the production area where it belongs, and also the other invoice will be allocated to the QA department. Those two are effectively cost centres, and you'll either have one manager responsible for both those departments, or depending on the size of the organisation, you have individual managers who are responsible for QA separately, and the production area separately as well.

So, a cost centre is anything where cost could be attributed and identified. On a departmental level, that could be the accounts department, it could be HR, it could be research and development. So, any area that we can divide something into where costs areidentified and attributed, we can make somebody responsible for.

Now, what that means essentially is they're responsible and accountable for controlling costs within that area that they've been allocated. The next centre I want to look at, the next responsibility centre is what's called a revenue centre. Now, this is less common, but it does exist and in this area, a manager is responsible and accountable for the revenue generation.

Typically, that might be a sales department where they are tasked with generating levels of revenue, and therefore, that is what they're accountable for as well. So, we dealt with two responsibility centres so far. That's the cost centre and the revenue centre. Now, the next one up, and you could argue these go up in areas of senior management responsibility,

is what's called a profit centre. Now, within a profit centre, first of all, a manager who's in charge of a profit centre, or managers who might be in charge of profit centres, are accountable and responsible for cost control, for generating revenue, and ultimately accountable for generating profit in their particular area.

Now, typically this would be somebody who, in a firm, in a business, that would have quite high levels of responsibility. Typically, that could be somebody that operates at a divisional level. It could be somebody who's in charge of a particular department. It could be somebody who's in charge of a particular division, and that profit centre, their responsibility, their accountability is for profit generation, cost control, and by nature, revenue generation as well.

Now, we have the last responsibility centre to deal with, and this one, I would argue, is typically something that's going to be seen at divisional level. So, if a company is broken down, and it divides its operations, it divides its performance accountability into divisions, to different areas, you can have what's called an investment centre.

Now, the investment centre is nothing to do with stocks and shares. Investment here refers to investment in capital equipment, what we might call CapEx items, i.e. equipment, machinery, plants, a whole bunch of fixed assets. Now, if a manager has the authority, has the ability to make those decisions about making investments in fixed assets, purchasing equipment, then they are going to be delegated and designated as an investment centre.

So, in this situation, the manager is responsible and accountable for revenue generation, cost control, profitability, and also CapEx, or capital investment decisions. So, we've got our four main types of responsibilities centre. What are some of the issues that we need to consider when we operate a responsibility accounting system?

The first thing to consider is the nature of the cost that we're looking at. Now, costs can either be controllable or uncontrollable. Now, by a controllable cost, that means a manager, by making a decision, pursuing a course of action, they have an influence and can impact on that cost in the short term.

There's a general philosophy in any area of performance management that you should only be judging people on what they can influence. So, costs that they, revenues they cannot control should not be what they're made accountable and responsible for. So, if a manager is allocated responsibility for what are called uncontrollable costs, then that could be a very demotivating factor.

So, for example, if a manager was made accountable for a foreign exchange rate, you would argue that there's nothing they can actually do to actually influence what those exchanges are. If they don't make those hedging decisions, they don't make those decisions as such, that will be extremely unfair. Costs, such as rent, perhaps on the premises,

if that's in the manager's budget line, and they cannot influence the level of rent, and very few people can influence the level of rent in the short term, then that again is an uncontrollable cost, and it might be considered unfair to make that manager responsible for controlling that level of cost. Other issues are when it comes to what's called dual responsibility.

Now, within your business, there could be areas of shared responsibility. So, for example, the hiring of workers, the hiring of labor may be the responsibility of the production manager. However, the training of that member or staff may be a decision that is taken on by the HR department. Now, those training courses that are attended may have an impact on the wage bill, on the overtime payment for attendance.

Then, in these instances, a responsibility system should ideally seek to assign a report on the cost, the primary cost to the person who has the major responsibility. So, it may be that training cost, including overtime, should be allocated to the HR department. The last thing I want to look at is what are called arbitrary costs.

Now, costs such as insurance, heating, and rent are what are called apportioned to cost centres on some sort of arbitrary basis. So, if you've got insurance for the whole business, you may decide to apportion that insurance cost across different responsibility centres. Now, if they're done in a completely arbitrary manner

with no logic behind them, a manager will have a cost on their budget line, which they could argue is they have no influence over, and it's unfair to make them accountable for that level of cost. Now, in next week's podcast, folks, just to give you a bit of a spoiler alert. I'm going to be looking more closely at the reporting dimensions in responsibility accounting.

We're also going to be looking at suitable KPIs that we can have for each of these four errors of responsibility. Now, folks, I hope you found this podcast useful. I'd love it if you can share some feedback. I'd even love it if you could actually share with those who you feel could benefit. Feedback is always appreciated.

It helps me shape the direction and the content that I share with my wonderful listeners. Check out the show notes, by the way, for some useful links here. And if you feel that you need some support about coming up with a responsibility accounting system in your business, then let me know. Until next week, folks, I'll see you on the other side.

We hope you enjoyed this episode and appreciate you taking the time to listen to the show. We hope you got some value if you did. Then we'd love it if you shared the episode. We look forward to you joining us next week for another I Hate Numbers episode.