Question Tag: Responsibility Accounting

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  • 3 Marks

MA – Dec 2023 – L2 – Q1c – Divisional performance

This question asks for a comparison between profit centers and investment centers in management accounting.

State ONE (1) similarity and TWO (2) differences between a Profit centre and an Investment centre.

Similarity:

  • Both centers are responsible for effective cost minimization and maximization of profit.

Differences:

  1. An Investment center has additional responsibility for capital investments, whereas a Profit center does not handle capital investments.
  2. The performance of an Investment center is measured by return on investment (ROI) or residual income (RI), while the performance of a Profit center is measured based on controllable profit.
  • 2 Marks

: MA – Dec 2023 – L2 – Q1b – Divisional Performance

This question defines the concept of responsibility accounting in management accounting systems.

Define the term responsibility accounting.

Responsibility accounting is a system of accounting that segregates revenue and costs into areas of personal responsibility to monitor and assess the performance of each part of an organisation.

  • 20 Marks

MA – July 2023 – L2 – Q1 – Performance analysis

This question involves explaining the controllability principle, calculating controllable profit, ROI, and RI, and analyzing the performance of two divisions.

Kenkah Ltd provides buffer storage for many companies throughout the country. The company has two divisions, namely Abura and Keta. Each division is autonomous and makes its own long-term investment decisions.

Kenkah Ltd measures the performance of its divisions using Return on Investment (ROI), calculated using controllable profit and average divisional net assets. The company has a cost of capital of 12% but a targeted ROI of 18%. The divisional managers’ annual bonus is determined by the extent to which the ROI earned by the division exceeds the target.

At the beginning of the year, the two divisions, Abura and Keta, bought assets worth GH¢12.5 million and GH¢18.2 million respectively. The assets have a five-year life span with no residual value. The company uses the straight-line depreciation method. The other assets are being controlled by the head office.

Over the years, Kenkah Ltd has used ROI in evaluating the performance of managers. However, to discourage dysfunctional behavior, Kenkah Ltd is considering introducing Residual Income (RI) as a performance measure. Like ROI, RI is calculated using controllable profit and average divisional assets.

The current year’s draft operating statement is shown below:

Abura (GH¢000) Keta (GH¢000)
Sales 15,350 17,020
Less controllable Variable Cost 7,505 8,950
Contribution 7,845 8,070
Less Fixed Cost [i) & ii)] 6,335 6,910
Profit 1,510 1,160

Additional Information:
i) Included in fixed costs are the current year depreciation charges of GH¢3,125,000 and GH¢4,550,000 for division Abura and Keta, respectively. Twenty percent (20%) of the depreciation cost in each division is from assets owned and controlled by the head office.
ii) Head office allocates some of its overhead costs to the two divisions using activity-based costing. These costs have been included in the fixed costs and amounted to GH¢210,000 and GH¢230,000 for Abura and Keta, respectively.
iii) The Management Accountant stated at a recent board meeting that “Responsibility accounting is based on the application of the controllability principle.” Hence, he would resist any attempt by management to deviate from this basic principle.

Required:
a) Explain the “controllability principle” and why its application is difficult in practice.
(4 marks)

b) Calculate the current year controllable profit for both divisions of Kenkah Ltd.
(4 marks)

c) Calculate the current year ROI for each of the two divisions of Kenkah Ltd.
(3 marks)

d) Calculate the current year RI for each of the two divisions of Kenkah Ltd.
(4 marks)

e) Discuss the performance of the two divisions for the year.

a) Controllability is defined as “the degree of influence that a specific manager has over costs, revenues, investments, or other items in question”.
The controllability principle is that managers should only be held responsible for costs, revenue, profit, or investment that they have direct control over. So, for example, a divisional manager would not be held responsible for the allocation of central costs or cost of depreciation to her department if she has no control over the incurrence or magnitude of these costs. Under this principle, it would be held that dysfunctional consequences would arise if managers were held accountable for costs over which they have no control.
Holding managers accountable/responsible for costs outside their control may encourage them to become more involved with such issues and, as a result, the total cost may be reduced, or the goods or services may be provided more efficiently.
However, there is difficulty in classification or drawing the line between cost which is controllable and cost which is uncontrollable. Furthermore, holding managers responsible for items outside their control may be demotivating.
(4 marks)

b) Current year controllable profit:

Abura (GH¢000) Keta (GH¢000)
Sales 15,350 17,020
Less: Variable cost 7,505 8,950
Contribution 7,845 8,070
Less: Division Depreciation** (2,500) (3,640)
Less: Other Overheads** (3,000) (2,130)
Controllable Profit 2,345 2,300

Notes:

  • Depreciation: 80% of GH¢3,125,000 for Abura and 80% of GH¢4,550,000 for Keta.
  • Other Overhead: GH¢6,335,000 – (GH¢3,125,000 + GH¢210,000) for Abura and GH¢6,910,000 – (GH¢4,550,000 + GH¢230,000) for Keta.
    (4 marks)

Alternative Solution:

Abura (GH¢000) Keta (GH¢000)
Net profit 1,510 1,160
Add back HQ depreciation 625 910
Add back HO Overhead cost 210 230
Controllable profit 2,345 2,300

Workings:

  1. Depreciation: 20% of GH¢3,125,000 = GH¢625,000 for Abura and 20% of GH¢4,550,000 = GH¢910,000 for Keta.
    (4 marks)

c) ROI Calculation:

Abura (GH¢000) Keta (GH¢000)
Controllable profit 2,345 2,300
Average Net Assets (12,500+10,000)/2 (18,200 + 14,560)/2
ROI (%) 20.84% 14.04%
(3 marks)

d) Residual Income (RI) Calculation:

Abura (GH¢000) Keta (GH¢000)
Controllable profit 2,345 2,300
Less: Imputed interest 1,350 1,965.60
RI (GH¢000) 995 334.40
(4 marks)

e) Comments on Performance:
If a decision about whether to proceed with the investments is made based on ROI, it is possible that the manager of Division Keta will reject the proposal whereas the manager of Division Abura will accept the proposal. This is because while division Abura has a ROI of 20.84%, higher than the target of 18%, which entitles the manager to a bonus, Division Keta would reject the investment because its ROI is 14.04%, lower than the target of 18%, hence not entitled to a bonus.
If they used residual income (RI) in order to aid the decision-making process, both proposals would be accepted by the divisions since both have a positive RI.
(5 marks)

  • 5 Marks

MA – Nov 2016 – L2 – Q3c – Budgetary control, Performance analysis

Explain the controllability principle and budgetary slack in the context of responsibility accounting.

Explain the following concepts and describe their application in responsibility accounting:

i) The controllability principle (2.5 marks)

ii) Budgetary slacks (2.5 marks)

i) The Controllability Principle:

The controllability principle requires that managers of responsibility centers are evaluated based on only those items (revenues and costs) that they have control over. This principle is essential to ensure fair and accurate performance assessment.

Application in Responsibility Accounting:

  1. Elimination of Uncontrollable Items: Uncontrollable items should be excluded from the performance evaluation of managers to ensure they are not held accountable for factors beyond their control.
  2. Distinction in Reports: Performance reports should clearly distinguish between controllable and uncontrollable items, allowing for a fair evaluation of managerial performance.

(Total: 2.5 marks)

ii) Budgetary Slack:

Budgetary slack refers to the process by which managers seek to obtain budget targets that can easily be achieved by understating revenues and/or overstating costs. This can lead to inefficiencies and a lack of alignment with organizational goals.

Application in Responsibility Accounting:

  1. Risk Avoidance: Managers may avoid risky but potentially profitable projects to ensure they meet their easier budget targets.
  2. Negotiation of Lower Targets: Managers might negotiate for lower budget targets, making it easier to achieve their goals but potentially harming the organization’s overall performance.
  3. Disputed Performance Assessments: Budgetary slack can lead to disputes in performance assessments, as the targets set may not accurately reflect the organization’s potential.

(Total: 2.5 marks)

  • 20 Marks

IMAC – DEC 2022 – L1 – Q3 – Scope of Management Accounting | Standard Costing and Variance Analysis

Explanation of responsibility accounting classifications, reasons for full costing, and calculation of material, labour, and overhead variances.

a) Responsibility Accounting is a system of accounting in which costs are identified with persons who are primarily responsible for making decisions about the costs in question. Responsibility Accounting classifies cost under two main headings.

Required:
Explain the TWO (2) classifications of cost under Responsibility Accounting. (2 marks)

b) Full costing is an accounting method used to determine the complete end-to-end cost of producing products or services. Accountants use the term full cost to mean more than a product’s manufacturing or production costs (including fixed manufacturing overhead).

Required:
Explain FOUR (4) reasons full cost of a product or service may be calculated. (8 marks)

c) Afram Ltd has just introduced a standard marginal costing system to assist in the planning and control of the production activities for its single product, Amino. The system became operational on 1 January 2022. The Functional Director responsible for cost and management accounting had a discussion with the Production Manager, and both have agreed on the following standard cost information to manufacture one unit of product, Amino.

Budgeted cost:

  • Direct materials: 4kg @ GH¢1.75 per kg
  • Direct labour: 2 hours @ GH¢10 per hour
  • Variable overhead: 2 hours @ GH¢8.25 per hour.

Actual Results:
The actual results for January 2022 are as follows:

  • Sales: 22,000 units yielding a total revenue of GH¢1,276,000
  • Production: 23,000 units
  • Direct Materials: 90,000 kgs at a cost of GH¢162,000
  • Direct labour: 48,000 hours at a cost of GH¢576,000
  • Variable overhead: GH¢350,000

The budgeted level of production and sales activity has been agreed with both production managers and sales staff at 24,000 units per month.

Required:
Calculate the following variances:
i) Direct Material Price
ii) Direct Material Usage
iii) Direct Labour Rate
iv) Direct Labour Efficiency
v) Variable Overhead Efficiency (10 marks)

a) Cost classification under Responsibility Accounting:

  • Controllable cost: Cost that the responsibility head can influence the size of.
  • Uncontrollable cost: Cost that the responsibility head cannot influence the size of.
    (2 marks)

b) Reasons for full cost:

  • Overheads are expenses that are incurred in the production of goods, and excluding them will understate the cost of production.
  • Full cost will be needed in inventory valuation for external reporting purposes.
  • It provides details of cost for effective pricing.
  • Calculating over and under absorbed overheads will help in cost control.
  • By comparing the full cost with the selling price, management will be in a position to know which products are sold at a loss.
    (Any 4 points @ 2 marks each = 8 marks)

c) Calculation of variances:

i) Material price variance:
AQ x (SP – AP)
90,000 x (GH¢1.75 – GH¢1.80) = GH¢4,500A

ii) Material usage variance:
SP x (SQ – AQ)
GH¢1.75 x (92,000 kg – 90,000 kg) = GH¢3,500F
SQ = 4kg x 23,000 units = 92,000 kg

iii) Labour rate variance:
AH x (SR – AR)
48,000 hrs x (GH¢10 – GH¢12) = GH¢96,000A

iv) Labour efficiency variance:
SR x (SH – AH)
GH¢10 x (46,000 hrs – 48,000 hrs) = GH¢20,000A
AR = GH¢576,000 / 48,000 hrs = GH¢12

v) Variable overhead efficiency variance:
SR x (SH – AH)
GH¢8.25 x (46,000 hrs – 48,000 hrs) = GH¢16,500A
SH = 2 hours x 23,000 units = 46,000 hrs
(2 marks for each variance = 10 marks)

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