In order to make the organization working at its best and reaching its potential to achieve objectives, the actual results are compared with the targets. And if those targets are not achieved someone must be held responsible. Because without accountability we cannot control business operations and cannot ensure the effective and efficient achievement of business objectives.
This system of accountability that will be implemented at different locations inside an organization is called responsibility accounting.
Most of the time when the aspect of responsibility is discussed, many people think of holding somebody responsible for failures. But responsibility does not only mean identifying and relating only failures but it also includes identification of success and finding who made this achievement possible. So the system of accountability is not only used to penalize but also to reward the staff.
But before any entity decides about the punishment and rewards, it must decide how responsibility is determined and the extent of responsibility.
In order to implement responsibility accounting system effectively and to hold managers accountable for their actions two things must be decided:
- Role of the manager – i.e. what he is required to look after which will be determined by the type of responsibility center in which he is working and he will be held responsible just for that. This basically defines the authority of the manager i.e. his powers.
- Ability to exercise the authority – i.e. whether he had the reasonable time to act and the circumstances favourable for application of his powers.
These two aspects are collectively referred as Principle of controllability. This principle dictates that managers should be held only responsible against such costs, revenues, profits or other basis of performance measurement which were in their control. Managers should not be questioned for anything that was beyond their control. There are many reason why we should not be holding them responsible for uncontrollable aspects. Two of them are demotivation and dissatisfaction towards task and management respectively.
Therefore, we need a system through which roles and duties of managers are defined and also which has the capability to assess the second bit of controllability i.e. whether manager has the ability to exercise his powers which is really not easy.
Roles are defined by dividing the organization into different responsibility centers:
- Cost center where managers are responsible only for the costs incurred
- Revenue center where managers are responsible only the revenues generated
- Profit center where managers are responsible for both costs and revenues. We can understand that profit center manager will be responsible for both costs and revenues because he will have both cost and revenue centers under him and this managers at cost and revenue centers are subordinate to profit center manager.
- Investment center where managers are responsible for making decisions regarding investments. As decisions regarding investments are made on the basis of profits earned thus profit center manager works as a subordinate to investment center manager.
We can understand the scope of authority each responsibility center has over the other and the extent of decision making by understanding how they are connected with each other in the form of different layers of management. Remember each layer has its own degree of influence and as we move upwards, the capacity to influence increases as authority is increasing.
Cost and revenue centers basically resides in operational layer of management where as moving one step above we have profit center which is basically tactical layer of management and moving even further above we have strategic layer of management where managers are responsible to make important long term decisions that are crucial and important to the organization. Have a look at the following figure to easily understand how responsibility centers are connected with each other.