40. Business Units & Performance Evaluation

Question 1

What two important behavioral considerations must be made when assigning responsibilities to managers in a responsibility accounting system?

Answer 1

• The responsible manager should be involved in developing the plan for the unit over which the manager has control.
• The manager should be held accountable only for the costs, revenues, or assets for which the manager has “substantial control.”

Question 2

Briefly describe the four general types of responsibility centers.

Answer 2

• Cost center: Organizational unit in which the manager of the unit has control only over the costs incurred.
• Revenue center: A business unit set up to focus exclusively on generating sales and revenue.
• Profit center: Usually found at higher levels of an organization than cost centers. The manager is responsible for costs and revenues.
• Investment center: Found at the highest levels in the organization. Responsible for managing costs, revenues, and assets.

Question 3

Briefly describe how to distinguish between controllable costs, direct costs, and indirect costs

Answer 3

• Controllable costs: Costs that managers can significantly influence or directly control. These costs should be used when assessing the performance of the manager or management team.
• Direct costs: Include controllable costs and any other costs that are directly connected to the operations of the unit.
• Indirect costs: Costs that are allocated to the business unit that represent general administrative costs for the organization. Not controllable by the business unit being allocated the costs

Question 4

What are the main reasons that indirect costs should not be used for internal evaluation decisions?

Answer 4

• Allocating indirect (common) costs can interfere with effective performance evaluations that are internal to the organization.
• Analyzing decisions regarding keeping or dropping a business unit from the organization or decisions of where to invest resources with allocated indirect costs can lead to management decisions with death-spiral results.
• There is no direct relationship between indirect costs and the business unit they are assigned to.