Responsibility Accounting, Quality Control, and Environmental

Cost Management
Most organizations are divided into smaller units or departments, each of which is
assigned particular responsibilities. Each department is made up of individuals who are
responsible for particular tasks or managerial functions. Goal congruence results when the
managers of subunits throughout an organization strive to achieve the goals set by top
management. Responsibility accounting refers to the various concepts and tools used by
managerial accountants to measure the performance of people and departments in order to
foster goal congruence.

Responsibility Centers
A responsibility center is a subunit in an organization whose manager is held accountable
for specified financial results of the subunits activities. There are four common types of
responsibility centers.
A cost center is an organizational subunit, such as a department or division, whose
manager is held accountable for the costs incurred in the subunit. The Painting Department in an
automobile plant is an example of a cost center. The manager of a revenue center is held
accountable for the revenue attributed to the subunit. For example, the Reservations
Department of an airline and the Sales Department of a manufacturer are revenue centers.
A profit center is an organizational subunit whose manager is held accountable for profit.
Since profit is equal to revenue minus expense, profit- center managers are held accountable for
both the revenue and expenses attributed to their subunits. An example of a profit center is a
company-owned restaurant in a fast-food chain. The manager of an investment center is held
accountable for the subunits profit and the invested capital used by the subunit to generate its
profit. A division of a large corporation is typically designated as an investment center.

Performance Reports
A performance report shows the budgeted and actual amounts, and the variances
between these amounts, of key financial results appropriate for the type of responsibility center
involved. The data in a performance report help managers use management by exception to
control an organizations operations effectively.

Cost Allocation
An organization will have costs that are a joint result of the activities of several subunits.
A responsibility-accounting system will assign these joint costs to the subunits that cause them
to be incurred. A collection of costs to be assigned is called a cost pool. The responsibility centers,
products, or services to which costs are to be assigned are called cost objects. The process of
assigning the costs in the cost pool to the cost objects is called cost allocation or cost distribution.
An allocation base is used to distribute (or allocate) costs to responsibility centers. An
allocation base is a measure of activity, physical characteristic, or economic characteristic that is
associated with the responsibility centers, which are the cost objects in the allocation process.
The allocation base chosen for a cost pool should reflect some characteristic of the various
responsibility centers that is related to the incurrence of costs. Each cost pool is distributed to
each responsibility center in proportion to that centers relative amount of the allocation base.

Activity-Based Responsibility Accounting

Traditional responsibility-accounting systems tend to focus on the financial performance
measures of cost, revenue, and profit for the subunits of an organization. Contemporary cost
management systems, however, are beginning to focus more and more on activities. Activitybased costing systems associate costs with the activities that drive those costs. In activity-based
responsibility accounting attention is directed not only to costs incurred but also to the activity
creating the cost.

Behavioral Effects of Responsibility Accounting

Responsibility-accounting systems can influence behavior significantly. Whether the
behavioral effects are positive or negative, however, depends on how responsibility accounting
is implemented. When used properly, a responsibility accounting system does not emphasize
blame. The proper focus of a responsibility-accounting system is information. Performance
reports can be used to distinguish between controllable and uncontrollable costs or revenues.
Managerial accountants often use the responsibility-accounting system to motivate actions
considered desirable by upper-level management. Sometimes the responsibility accounting
system can solve behavioral problems as well.

Segmented Reporting
A segment is any part or activity of an organization about which a manager seeks cost,
revenue, or profit data. Segmented reporting refers to the preparation of accounting reports by
segment and for the organization as a whole. Many organizations prepare segmented income
statements, which show the income for major segments and for the entire enterprise.

To summarize, there are three important characteristics of segmented reporting:

1. These income statements use the contribution format. The statements subtract variable
expenses from sales revenue to obtain the contribution margin.
2. The income statements highlight the costs that can be controlled, or heavily influenced, by
each segment manager. This approach is consistent with responsibility accounting.
3. Segmented reporting shows income statements for the company as a whole and for its major
segments.

Customer Profitability Analysis

and Activity-Based Costing
Customer profitability analysis uses the concept of activity-based costing to determine
how serving particular customers causes activities to be performed and costs to be incurred.
Suppose, for example, that customer A requests special credit terms, small order lots, special
packaging, increased service and JIT delivery. These services can be provided, but at a cost.

Total Quality Management

What is meant by a high-quality product? A products grade refers to the extent of its
capability in performing its intended purpose, in relation to other products with the same
functional use. A products quality of design refers to how well it is conceived or designed for its
intended use. The quality of conformance refers to the extent to which a product meets the
specifications of its design. Both quality of design and quality of conformance are required in
order to achieve a high-quality finished product.

Cost of Quality
Many companies measure and report the costs of ensuring high quality. Four types of
costs are monitored. First are prevention costs, the costs of preventing defects. Second are
appraisal costs, the costs of determining whether defects exist. The third type of costs are
internal failure costs, those costs of repairing defects found prior to product sale. The last type
of costs are external failure costs, those costs incurred when defective products have been sold.

Quality costs that can be measured are observable. But what about hidden quality costs?
When products of inferior quality make it to market, customers are dissatisfied. Their
dissatisfaction can result in decreased sales and a tarnished reputation for the company. Not only
does the company experience lost sales for the inferior products but it will also likely experience
lost sales in its other product lines. The opportunity cost of these lost sales and decreased market
share can represent a significant hidden cost. Such hidden costs are difficult to estimate or report.

Changing Views of Optimal Product Quality

One way to express product quality is in the percentage of products that fail to conform to their
specifications, that is, the percentage of defects. The traditional viewpoint holds that finding the
optimal level of product quality is a balancing act between incurring costs of prevention and
appraisal on one hand and incurring costs of failure on the other. As the percentage of defective
products decreases, the costs of prevention and appraisal increase. However, the costs of
internal and external failure decrease. Adding the costs of prevention, appraisal, and internal and
external failure yields total quality costs. The optimal product quality level is the point that
minimizes total quality costs.

The contemporary view is that if both observable and hidden costs of quality are
considered, any deviation from a products target specifications results in the incurrence of
increasing quality costs. Under the contemporary viewpoint, the optimal level of product quality
occurs at the zero defect level. The observable and hidden costs of internal and external failure
increase as the percentage of defective products increases. The observable and hidden costs of
prevention and appraisal increase slightly and then decrease as the percentage of defects
increases. The most important point, though, is that the total costs of quality are minimized at
the zero defect level.

Identifying Quality Control Problems

A helpful tool in quality improvement programs is the Pareto diagram. The Pareto
diagram shows graphically the frequency with which various quality control problems are
observed for a particular model of cordless telephone. The Pareto diagram helps the TQM team
visualize and communicate to others what the most serious types of defects are. Steps can be
taken then to attack the most serious and most frequent problems first.

ISO 9000 Standards

A key factor in determining the quality of a companys products is its quality control
system. In 1987, the International Standards Organization (ISO), issued a set of quality control

standards for companies selling products in Europe. The ISO 9000 standards focus on a
manufacturers quality control system. The ISO 9000 standards basically require that a
manufacturer have a well-defined quality control system in place, and that the target level of
product quality be maintained consistently. The first standard, ISO 9000, lists three objectives:
The company should sustain the quality of its product or service at a level that
continually meets the purchasers stated or implied needs.
The quality control system should be sufficient to give the suppliers own
management confidence that the intended quality is being maintained.
The supplying company should give the purchaser confidence that the intended
quality is consistently achieved in the delivered product or service.

Environmental Cost Management

The costs of dealing with environmental issues in one way or another are enormous. One
important distinction is between private costs and social (or public) costs. Private environmental
costs are those borne by a company or individual. Examples would be costs incurred by a
company to comply with EPA regulations or to clean up a polluted lake. Social environmental
costs are those borne by the public at large. Examples of these include costs borne by the
taxpayers to staff the EPA; costs borne by the taxpayers to clean up a polluted lake or river; or
costs borne by individuals, insurance companies, and Medicare due to health problems caused
by pollutants.
Visible private environmental costs are those that are measurable and have been clearly
identified as tied to environmental issues. Hidden private environmental costs are those that are
caused by environmental issues but have not been so identified by the accounting system.
Visible and hidden costs can be further classified as Monitoring costs, abatement costs, on-site
remediation costs and off-site remediation.
Three strategies for managing environmental costs are:
1. End-of-pipe strategy. Companies produce the waste or pollutant, and then clean it up
before it is discharged into the environment.
2. Process improvement strategy. Under this approach, companies modify products and
production processes to produce little or no pollutants, or find ways to recycle wastes
internally.
3. Prevention strategy. Under this strategy, the company strives to produce no pollutants
at all.