Responsibility Centers and Responsibility Accounting
The need for power or control is often a flawed trait in human nature. In a professional setting, one might call this person a control freak. In politics, the person might carry the label power hungry. In management, this uninspiring trait often goes by the moniker micro-management. Accounting systems can be a particularly strong breeding ground for control freaks and micro-managers. Responsibility accounting represents a financial reporting system that helps cede control from these strict individuals by placing more responsibility with department or segment managers.
Decentralized companies have many different management positions responsible for all aspects of a department or segment. This organizational system is quite common for budgetary purposes. However, companies should recognize that more accounting processes outside of budgets can be in each department or segment. Hence, responsibility accounting can place many different financial or managerial accounting activities underneath the manager who directly controls the related resources. An essential part of this process is placing only the controllable aspects of certain activities within each department or segment.
Companies can further create decentralization within their operations by setting up responsibility centers. Three types of responsibility centers are common in a business: cost, profit, and investment. Each responsibility center has the accounting resources necessary to record transactions, budget finances for related activities, and function on a daily basis. Some aspects of these responsibility centers – and responsibility accounting activities – overlap depending on each center’s structure.
Cost centers only incur costs and expenses in a company. Managers in these centers only have the authority to govern activities related to costs or expenses; no revenue generation activities exist here. Common cost center examples include a procurement or maintenance department. Each of these activities expends a company’s cash without creating revenue to offset the costs.
A profit center will often incur costs and expenses, with the additional responsibility of generating revenue from cash expenditures. An example here is a retail store. The store will spend cash hiring workers and ordering inventory. The store must then justify these centers by creating revenue that offsets the costs and results in profit retained by the organization. Profit centers will most likely need to meet certain income or profitability goals set by higher managers or executives.
Investment centers are the final responsibility center in a company. These centers will often have the most responsibility of the three centers discussed here. In addition to being responsible for the first three activities – costs, expenses, and profits – an investment center will also need to properly manage a company’s assets. Investment centers may have the responsibility to manage cash or other physical assets. The rate of return generated from investing assets into various projects is an additional goal for this responsibility center. Managers in this responsibility center will typically need the most experience or education in order to succeed with the investment center. Subsidiary companies under a large corporate umbrella are fine examples of an investment center.
The type of accounting practices in each responsibility center can vary among companies. The goal is to not necessarily micro-manage the activities in each one, but push the accounting activities from higher business levels to those levels on the front line. This may create some upheaval in a company that operates mostly by tradition. Fresh managers – often brought from outside the company – can usually help accomplish the decentralization of a company into responsibility accounting and responsibility centers.