Responsibility Accounting (#65)
/In this podcast episode, we discuss the nature of responsibility accounting, and how such a system can be operated. Key points made are noted below.
How Responsibility Accounting is Used
Under responsibility accounting, the basic point is that every cost incurred must be the responsibility of someone, somewhere in the company. That’s it. Doesn’t sound too complicated, but it means that the accountant should create a whole subset of reports below the company-wide financial statements, and distribute them to every responsible party.
These reports come in three flavors. The first is a profit center, where the recipient is usually in charge of an entire facility, and wants to see everything, including revenues, expenses, and profits. There’re usually not a whole lot of profit centers in a company.
The second flavor is a cost center. This is where there are no revenues directly associated with an activity. It could be an accounting department, or perhaps a production cell on the factory floor. This tends to have a pretty small number of expense line items, but they many involve hundreds of managers. So you could issue hundreds of cost center reports.
And there are also revenue centers. Kind of obviously, they only report on revenue results. This type of report goes to the sales staff and product managers, though product managers can also receive full profit center reports. These reports can itemize sales right down to individual stock keeping units, and so they can be fairly hefty.
Now if you’ve never issued responsibility reports, you may ask why you should start. Well, consider the distribution of the normal set of financial statements. It goes to the senior management team, perhaps some subsidiary managers, and that’s about it. No one else knows what’s going on, until they get called into a senior manager’s office near the end of the year, and get blasted for having cost overruns or profit shortfalls that they knew nothing about.
But if you have responsibility-level reports, practically every manager gets something. It may be a really short report, with one line item on it. But if that’s what they’re responsible for, then that’s a good report.
How Overhead is Allocated
So, what about allocated overhead? Lots of companies like to allocate overhead to individual subsidiaries, or to departments within those subsidiaries. It can be things like corporate overhead, or the cost of janitorial services. Allocating overhead is a really bad idea. The main point of responsibility accounting is that you only see in a financial report those items for which you are responsible. That’s it. Nothing else is included. Therefore, take out overhead allocations.
But this doesn’t mean that overhead is never reported anywhere. After all, this can be a really large number. What you do is only report it to the person who is – what a surprise – responsible for it. So, you should report corporate expenses to someone like the chief operating officer. Or, if you have janitorial expenses for an entire facility, you can report those expenses to the maintenance manager, and to the manager of that entire facility – but don’t report it to the department managers within that facility. They can’t do anything about it, so don’t bother them with it.
Contents of a Responsibility Report
So… what exactly goes into a responsibility report? You can certainly send out just the last month’s results. But that doesn’t give the reader anything to compare it to. To fix this, the most obvious option is a budget versus actual report, both for the current month and for the year-to-date. The trouble is, some of the most enjoyable science fiction I’ve ever read involves budgets. In a lot of cases, they don’t even bear a slight resemblance to reality. And strangely enough, the budgeted results are always better than the actuals.
A better alternative is to run a rolling 12-month report, which shows actual results for each of the last 12 months. This has nothing but actuals in it – no budget allowed. This gives readers a really good idea where everything is trending, which I find is much better information than a budget to actual comparison.
A variation on the rolling 12-month report is to do it as percentages, so that revenues appear as 100%, and the various expense line items are fractions of that 100%. I think it has some value, but most users prefer seeing the underlying numbers.
How to Roll Out Responsibility Reports
Now, any controller who wants to just close the books each month and get on with life is shaking his head and wondering where to find the time to issue this massive number of additional reports. Well, there are a couple of solutions. First, see if your accounting package automatically prints and e-mails reports. If it does, then set up all the responsibility reports in one massive batch, and run the batch right after the books are closed.
Second, you can push responsibility reporting down into the organization in stages. The traditional financials are for the top level of managers. Then go down one level, and you’ll probably find that you need about three times as many customized reports for this group. Then push down another level, and you’ll triple the number of reports again, and so on.
The number of new reports needed at each level is directly associated with the span of control at each level of management. If the span of control is five direct reports for each manager, then you can expect to create five times as many reports when you go down one additional level in the organization.
In essence, address one management level at a time, and stop issuing more reports when you can longer support the extra workload.
So far, we’ve talked about creating reports for all kinds of responsible parties. But – what if no one seems to be responsible for something? There are situations where an expense is incurred, but no one is authorizing the expense – it just happens. This is usually minor stuff, like office supplies, and it isn’t an overwhelming concern. But on the other hand, if you find a stray item, then bring it to the controller’s or CFO’s attention. They should park it under someone’s jurisdiction, and should make sure that the newly responsible person knows about all it.