Responsibility Accounting and Total Quality Management

CHAPTER 12

Responsibility Accounting and Total Quality Management

ANSWERS to Review Questions

12-1A responsibility-accounting system fosters goal congruence by establishing the performance criteria by which each manager will be evaluated. Development of performance measures and standards for those measures can help to ensure that managers are striving toward goals that support the organization's overall objectives.

12-2Goal congruence results when the managers of subunits throughout an organization strive to achieve objectives that are consistent with the goals set by top management. In order for the organization to be successful, the managers and employees throughout the organization must be striving toward consistent goals.

12-3Several benefits of decentralization are as follows:

(a)The managers of an organization's subunits have specialized information and skills that enable them to manage their departments most effectively.

(b)Allowing managers autonomy in decision making provides managerial training for future higher-level managers.

(c)Managers with some decision-making authority usually exhibit greater motivation than those who merely execute the decisions of others.

(d)Delegating some decisions to lower-level managers provides time relief to upper-level managers.

(e)Delegating decision making to the lowest level possible enables an organization to give a timely response to opportunities and problems.

Several costs of decentralization are as follows:

(a)Managers in a decentralized organization may have a narrow focus on their own units' performance.

(b)Managers may tend to ignore the consequences of their actions on the organization's other subunits.

(c)In a decentralized organization, some tasks or services may be duplicated unnecessarily.

12-4(a)Cost center: A responsibility center, the manager of which is accountable for the subunit's costs. (An example is a production department in a manufacturing firm.)

(b)Revenue center: A responsibility center, the manager of which is accountable for the subunit's revenue. (An example is a sales district in a wholesaling firm.)

(c)Profit center: A responsibility center, the manager of which is accountable for the subunit's profit. (An example is a particular restaurant in a fast-food chain.)

(d)Investment center: A responsibility center, the manager of which is accountable for the subunit's profit and the capital invested to generate that profit. (An example is a commuter airline division of an airline company.)

12-5It would be appropriate to change a particular hotel from a profit center to an investment center if the manager of the hotel is given the authority to make significant investment decisions affecting the hotel's resources.

12-6Flexible budgeting allows a performance report to be constructed in a meaningful way. The performance report should compare actual expenses incurred with the expenses that should have been incurred, given the actual level of activity. The expenses that should have been incurred given the actual level of activity can be obtained from the flexible budget.

12-7Under activity-based responsibility accounting, management's attention is directed toward activities, rather than being focused primarily on cost, revenue, and profit measures of subunit performance. Activity-based responsibility accounting uses the database generated by an activity-based costing system coupled with nonfinancial measures of operational performance for key activities. Such an approach can help management eliminate non-value-added activities and improve the cost effectiveness of activities that do add value to the organization's product or service.

12-8Attention to the following two factors may yield positive behavioral effects from a responsibility-accounting system.

(a)When properly used, a responsibility-accounting system does not emphasize blame. The emphasis should be on providing the individual who is in the best position to explain a particular event or financial result with information to help in understanding reasons behind the event or financial result.

(b)Distinguishing between controllable and uncontrollable costs or revenues helps the individuals who are evaluated under a responsibility-accounting system to feel as though they are evaluated on the basis of events and results over which they have some control or influence.

12-9Rarely does a single individual completely control a result in an organization. Most results are caused by the joint efforts of several people and the joint impact of several events. Nevertheless, there is usually a person who is in the best position to explain a result or who is in the best position to influence the result. In this sense, performance reports based on controllability really are based on a manager's ability to influence results.

12-10(a)Cost pool: A collection of costs to be assigned to a set of cost objects. (An example of a cost pool is all costs related to material handling in a manufacturing firm.)

(b)Cost object: A responsibility center, product, or service to which a cost is assigned. (The various production departments in a manufacturing firm provide examples of cost objects. For example, the material-handling cost pool may be allocated across the various production departments that use material-handling services.)

12-11Cost allocation (or distribution): The process of assigning costs in a cost pool to the appropriate cost objects. (An example of cost allocation would be the assignment of the costs in the material-handling cost pool to the production departments that use material-handling services. For example, the material-handling costs might be allocated to production departments on the basis of the weight of the materials handled for each department.)

12-12An example of a common resource in an organization is a computer department. The resource includes the computer itself, the software, and the computer specialists who run the computer system and assist its users. The opportunity costs associated with one person using the computer resource include the possibility that another user will be precluded from or delayed in using the computer resource. Allocating the cost of the computer services department to the users makes the users aware of the opportunity cost of using the computer.

12-13A computer system has a limited capacity at any one time. Allocating the cost of using the service to the user makes the user aware that his or her use of the system may preclude someone else from using it. Thus, the user is made aware of the potential opportunity cost associated with his or her use.

12-14A cost allocation base is a measure of activity, physical characteristic, or economic characteristic associated with the responsibility centers, which are the cost objects in the allocation process. One sensible allocation base for assigning advertising costs to the various components of a large theme park is the number of people patronizing the park's various components. Presumably, the number of people attending a certain part of the theme park is an indication of how popular that part of the park is. Notice that in most cases the sales revenue generated by the various components of the theme park is not a viable allocation base, since most theme parks have a single admission fee for the entire park.

12-15Marketing costs are distributed to the hotel's departments on the basis of budgeted sales dollars so that the behavior of one department does not affect the costs allocated to the other departments. If, on the other hand, the marketing costs had been budgeted on the basis of actual sales dollars, then the costs allocated to each department would have been affected when only one department's actual sales revenue changed.

12-16A segmented income statement shows the segment margin for each major segment of the enterprise.

12-17Many managerial accountants believe that it is misleading to allocate common costs to an organization's segments. Since these costs are not traceable to the activities of segments, they can be allocated to segments only on the basis of a highly arbitrary allocation base.

12-18It is important in responsibility accounting to distinguish between segments and segment managers, because some costs that are traceable to a segment may be completely beyond the influence of the segment manager. Proper evaluation of the segment as an investment of the company's resources requires that these costs be included with costs associated with the segment. However, in evaluations of the manager's performance, these costs should be excluded, since the manager has no control over them.

12-19Three key features of a segmented income statement are as follows: contribution format, identification of controllable versus uncontrollable expenses, and segmented reporting, which shows income statements for the company as a whole and for each of its major segments.

12-20A common cost for one segment can be a traceable cost for another segment. For example, the salary of the general manager of a hotel is traceable to that segment of the entire hotel company. However, the salary of the hotel's general manager is a common cost for each of the departments in that hotel, such as the food and beverage department and the hospitality department.

12-21Customer profitability analysis refers to using the concepts of activity-based costing to determine how serving particular customers causes activities to be performed and costs to be incurred. Examples of activities that can be differentially demanded by customers include order frequency, order size, special packaging or handling, customized parts or engineering, and special machine setups. Such activities can make some customers more profitable than others.

12-22Four types of quality costs are as follows:

(a)Prevention costs: the costs of preventing defects.

(b)Appraisal costs: the costs of determining whether defects exist.

(c)Internal failure costs: the costs of repairing defects found prior to product sale.

(d)External failure costs: the costs incurred when defective products have been sold.

12-23Observable quality costs can be measured and reported, often on the basis of information in the accounting records. For example, the cost of inspectors' salaries is an observable quality cost. Hidden quality costs cannot easily be measured, reported, or even estimated. For example, the opportunity cost associated with lost sales after a defective product is sold is a hidden quality cost to the company.

12-24A product's quality of design is how well it is conceived or designed for its intended use. The product's quality of conformance refers to the extent to which a product meets the specifications of its design.

12-25A product's grade is the extent of its capability in performing its intended purpose, viewed in relation to other products with the same functional use. An example in the service industry is airline travel. Airplane seats may be coach class or first class; the difference lies in seat size, comfort, and service. Either class will take you from Los Angeles to Chicago, but not with the same degree of comfort.

12-26"An ounce of prevention is worth a pound of cure" can be interpreted in terms of resources expended on various categories of quality costs. A dollar spent on prevention may save many dollars of appraisal, internal failure, or external failure costs.

12-27A cause and effect diagram shows by means of connected lines all the possible causes of a particular type of defect in a product or service.

Solutions to exercises

Exercise 12-28 (10 minutes)

The type of responsibility center most appropriate for each of the following organizational subunits is indicated below.
(1) / Movie theater: Cost center or profit center.
(2) / Radio station: Profit center.
(3) / Claims department: Cost center.
(4) / Ticket sales division of an airline: Revenue center.
(5) / Bottling plant: Cost center.
(6) / Orange juice factory: Profit center.
(7) / College of engineering at a university: Profit center.
(By designating the college of engineering as a profit center, this subunit is encouraged to generate research grants and manage its operations most effectively. The term "profit center" is used in a slightly different way here. No subunit in a university really makes a profit. However, treating the college of engineering like a profit center means that this subunit's management will have considerable authority in managing the subunit's revenues and expenses.)
(8) / European division of a multinational manufacturing company: Investment center.
(9) / Outpatient clinic in a profit-oriented hospital: Profit center.
(10) / Mayor's office of a city: Cost center.

Exercise 12-29 (10 minutes)

The appropriate responsibility-accounting treatment for each of the scenarios is the following:
(1) / Since the cost of idle time incurred in Department B was due to the breakdown of improperly maintained machinery in Department A, the costs of the idle time should be charged to Department A.
(2) / If the machinery had been properly maintained, it would be more appropriate not to charge the cost due to idle time in Department B back to Department A. This cost should be considered a normal cost of operating in a sequential production environment. The managers of Department B should anticipate such normal machine breakdowns and plan their production scheduling to accommodate such events.

Exercise 12-30 (10 minutes)

The Maintenance Department should not be charged for the excess wages of the skilled employees who are temporarily assigned to the Maintenance Department. Modifications should be made in the responsibility-accounting system as follows: (1) the Maintenance Department should be charged with only the normal wages for maintenance employees, $12 per hour. (2) The additional $10 per hour ($22 – $12) should be charged to a top management level account, since the decision to keep these employees on the payroll was made by top management.

Exercise 12-31 (10 minutes)

By designating this department as a profit center, the corporation has given the managers of the department an opportunity to manage their operation just like a full-fledged business. These managers have specialized knowledge and skills that make them experts in the area of logistics and distribution. They are in the best position to read the needs of other units to whom they provide logistics services, and are also in the best position to make cost-benefit trade-offs that arise in the provision of logistical services. By treating this service department as a profit center, the organization has given its managers an incentive to control costs and also provide a quality service that meets the needs of its customers.
A profit center such as this might not be free to sell its services outside the company. Moreover, the creation of this profit center suggests the need for an internal pricing structure for services supplied to other subunits.

McGraw-Hill/Irwin  2002 The McGraw-Hill Companies, Inc.

Managerial Accounting, 5/e 12-1

Exercise 12-32 (50 minutes)

Performance Reports for March: Selected Subunits of
Aloha Hotels and Resorts
(in thousands)
Flexible Budget* /
Actual Results* /
Variance†
March / Year to Date** /
March / Year to Date** /
March / Year to Date**
Food and Beverage Department
Banquets & Catering.. / $ 650 / $ 1,910 / $ 658 / $ 1,923 / $ 8 F / $ 13F
Restaurants...... / 1,800 / 5,550 / 1,794 / 5,534 / 6 U / 16 U
/ Kitchen...... / (1,065) / (3,233) / (1,069) / (3,242) / 4 U / 9 U
/ Total profit...... / $ 1,385 / $ 4,227 / $ 1,383 / $ 4,215 / $2 U / $12 U
/ Kitchen
Kitchen staff wages... / $(85) / $ (253) / $ (86) / $ (255) / $1 U / $ 2 U
Food...... / (690) / (2,110) / (690) / (2,111) / — / 1 U
Paper products...... / (125) / (375) / (122) / (370) / 3 F / 5 F
Variable overhead.... / (75) / (225) / (78) / (232) / 3 U / 7 U
/ Fixed overhead...... / (90) / (270) / (93) / (274) / 3 U / 4 U
/ Total expense...... / $(1,065) / $ (3,233) / $(1,069) / $ (3,242) / $4 U / $ 9 U
*Numbers without parentheses denote profit; numbers with parentheses denote expenses.
†F denotes favorable variance; U denotes unfavorable variance.
**Year-to-date column equals year-to-date column for February in Exhibit 12-4 in the text plus March amount. For example, $1,910 equals $1,260 plus $650.

McGraw-Hill/Irwin  2002 The McGraw-Hill Companies, Inc.

Managerial Accounting, 5/e 12-1

Exercise 12-33 (30 minutes)

1. / Allocation of costs:
Division
Department
and
Allocation Base /
Liberal Arts /
Sciences /
Business Administration / Total
Cost
Allocated
Admissions (enrollment) / $36,000 (1,000/2,500) / $28,800 (800/2,500) / $25,200 (700/2,500) / $90,000
Registrar
(credit hours) / $56,250 (30,000/80,000) / $52,500 (28,000/80,000) / $41,250 (22,000/80,000) / $150,000
Computer Services
(courses requiring
computer) / $64,000
(12/60) / $128,000 (24/60) / $128,000
(24/60) / $320,000
The Admissions Department costs are allocated on the basis of enrollment. The more students enrolled in a division, the more admissions there are to process.
The Registrar's costs are allocated on the basis of credit hours. The greater the number of credit hours, the more course registrations there are to process.
The Computer Services Department's costs are allocated on the basis of the number of courses requiring computer work. The greater the number of computer-intensive courses, the greater will be the demands placed on the Computer Services Department.
2. / The number of courses would probably be a better allocation base for the Registrar's costs. Costs in this department are driven by processing course registrations, not credit hours. A four-credit course does not require any more registration effort than a three-credit course.
The estimated amount of computer time required would probably be a better allocation base for the Computer Services Department. Two different courses requiring computer work could place vastly different demands on the Computer Services Department.

Exercise 12-34 (40 minutes)

Segmented Income Statements: Countywide Cable Services, Inc.
Countywide / Segments of Company
Cable
Services / Metro / Suburban / Outlying
Service revenue...... / $2,200,000 / $1,000,000 / $ 800,000 / $ 400,000
Variable expenses.... / 450,000 / 200,000 / 150,000 / 100,000
Segment contribution margin / $1,750,000 / $ 800,000 / $ 650,000 / $ 300,000
Less: Fixed expenses
controllable by segment
manager...... /
870,000 /
400,000 /
320,000 /
150,000
Profit margin controllable by
segment manager.... /
$880,000 /
$ 400,000 /
$330,000 /
$ 150,000
Less: Fixed expenses,
traceable to segment, but
controllable by others. /
520,000 /
230,000 /
200,000 /
90,000
Profit margin traceable to
segment...... /
$360,000 /
$ 170,000 /
$130,000 /
$ 60,000
Less: Common fixed expenses / 95,000
Income before taxes... / $265,000
Less: Income tax expense / 145,000
Net income...... / $ 120,000

Exercise 12-35 (5 minutes)

1. / appraisal cost
2. / external failure cost
3. / internal failure cost
4. / prevention cost

Exercise 12-36 (20 minutes)

San Mateo Circuitry
Quality Cost Report
Current Month's Costs / Percentage of
Total
Prevention costs:
Training of quality-control inspectors...... / $21,000 / 22.2
Total...... / $21,000
Appraisal costs:
Inspection of purchased electrical components. / $12,000 / 12.7
Tests of instruments...... / 30,000 / 31.7
Total...... / $42,000
Internal failure costs:
Costs of rework...... / $ 9,000 / 9.5
Costs of defective parts that cannot be salvaged / 6,100 / 6.5
Total...... / $15,100
External failure costs:
Replacement of instruments already sold...... / $16,500 / 17.4
Total...... / $16,500 / _____
Total quality costs...... / $94,600 / 100.00

Exercise 12-37 (10 minutes)

Observable quality costs in the airline industry:

• Cost of repairing damaged luggage.

• Cost of providing lodging for passengers stranded when a flight is cancelled due to equipment malfunction.

• Cost of cleaning a passenger's clothing when a flight attendant spills food or beverages on the passenger.

Exercise 12-37 (continued)