9.1 The Need for Performance Measures: Responsibility Accounting, Controllability and Service Industries
Key Takeaways
Responsibility accounting links costs, revenues and assets to the managers who have authority over them, so each manager is evaluated on items they can control.
The controllability principle says managers should be held accountable only for costs and revenues they can significantly influence within the reporting period.
Cost, revenue, profit and investment centres differ by the decisions the manager controls, from costs only up to revenues, costs and capital investment.
Services are intangible, produced and consumed at the same time, perishable and variable in quality, which is why service organisations rely heavily on non-financial measures.
Service organisations often use composite cost units such as the patient-day, passenger-kilometre or tonne-kilometre to measure output.
Why this topic is examined
Syllabus area C3(a) asks you to explain the need for appropriate performance measures, naming two items of indicative content: the characteristics of service industries and responsibility accounting (authority, responsibility and controllability). The following section, 9.2, then calculates financial and non-financial measures. Questions here usually test definitions: which type of responsibility centre fits a description, whether a cost is controllable by a given manager, or which service characteristic a scenario illustrates.
Why organisations need performance measures
Performance measures turn plans into targets and then show whether the targets were achieved. They help organisations to:
- communicate objectives: what gets measured tells managers what matters;
- control operations: comparing actual results with targets highlights problems early;
- motivate and reward: fair measures linked to incentives encourage effort;
- evaluate managers and units: senior management can see which parts of the organisation perform well; and
- support goal congruence: well-chosen measures lead managers to act in the interests of the whole organisation.
Poorly chosen measures do the opposite. If a manager is judged on something they cannot influence, the measure demotivates; if a measure is easy to manipulate, it encourages short-term behaviour.
Responsibility accounting
Responsibility accounting is a system that divides an organisation into responsibility centres and reports costs, revenues and assets to the manager responsible for each one. It rests on three linked ideas:
| Concept | Meaning |
|---|---|
| Authority | The right to make decisions and use resources, for example to hire staff or buy materials |
| Responsibility | The obligation to account for the results of those decisions |
| Controllability | The extent to which a manager can actually influence a cost, revenue or asset |
Authority and responsibility should match. Holding a manager responsible for results without giving them the authority to act is unfair and demotivating.
The controllability principle
The controllability principle says a manager should be evaluated only on items they can significantly influence. Reports are therefore often split into controllable and uncontrollable items.
| Item | Controllable by the production supervisor? | Why |
|---|---|---|
| Material usage | Yes | Wastage and efficiency happen on the shop floor |
| Overtime worked in the department | Usually yes | The supervisor schedules the work |
| Factory rent apportioned to the department | No | Set by the lease; the supervisor cannot change it |
| Head office costs recharged to the department | No | Decided centrally |
| Material price | Usually no | Negotiated by the purchasing department |
Controllability is not always clear-cut:
- Time horizon: most costs are controllable by someone in the long run, but not by a supervisor within one month.
- Shared responsibility: material usage may depend on both the production team and the quality of material bought by purchasing.
- Level of management: a cost that is uncontrollable for a supervisor may be controllable by the factory manager or the board.
Types of responsibility centre
| Responsibility centre | Manager controls | Typical measures | Examples |
|---|---|---|---|
| Cost centre | Costs only | Actual cost against flexed budget or standard; cost variances; cost per unit | Production department, maintenance, IT support |
| Revenue centre | Revenues only (and perhaps selling costs) | Actual sales against budget; sales price and volume variances | Regional sales team |
| Profit centre | Revenues and costs | Controllable profit; contribution; profit margin | A retail branch, a product division |
| Investment centre | Revenues, costs and capital investment | Return on investment (ROI); residual income (RI) | A subsidiary or strategic business unit |
Each centre type builds on the previous one. The broader a manager's authority, the broader the measure used to judge them.
Important
Classify a responsibility centre by the decisions the manager controls, not by what the unit does. A branch that sets its own prices and controls its costs is a profit centre; if its manager can also approve capital investment, it is an investment centre.
Characteristics of service industries
Service organisations (banks, hospitals, airlines, hotels, schools, consultancies, public services) differ from manufacturers in ways that affect costing and performance measurement. Study texts summarise the differences as follows:
| Characteristic | Meaning | Consequence for performance measurement |
|---|---|---|
| Intangibility | There is no physical product to inspect or count | Output and quality are harder to measure; customer satisfaction measures become important |
| Simultaneity (inseparability) | The service is produced and consumed at the same time, often with the customer present | Quality problems cannot be caught by inspection before delivery; staff performance matters directly |
| Perishability | A service cannot be stored; unused capacity is lost | Capacity utilisation (occupancy, load factor) is a key measure |
| Variability (heterogeneity) | The service differs each time, depending on who delivers it and to whom | Consistency is hard to standardise; standard costing is harder to apply |
| No transfer of ownership | The customer buys access or an experience, not an asset | Revenue depends on repeat custom and reputation |
Measuring service output: composite cost units
Because there is no single physical unit, service organisations often combine two measures into a composite cost unit:
| Organisation | Composite cost unit |
|---|---|
| Hospital ward | Patient-day (or bed-night) |
| Airline or bus company | Passenger-kilometre |
| Haulage company | Tonne-kilometre |
| Hotel | Occupied room-night |
| College | Student-hour or full-time equivalent student |
Cost per composite unit is calculated as total cost ÷ total composite units. Section 10.4 works through a full example.
Not-for-profit and public sector organisations
Organisations such as charities and public services do not aim to maximise profit, so profit-based measures are not enough. They are often judged on value for money, using the three Es:
- Economy: acquiring resources at the lowest cost for the quality required;
- Efficiency: getting the most output from the resources used (for example, cost per patient treated); and
- Effectiveness: achieving the organisation's objectives (for example, patient recovery rates).
Pulling it together
| Situation | Measurement emphasis |
|---|---|
| Cost centre manager in a factory | Controllable cost variances, efficiency, quality of output |
| Hotel manager (profit centre) | Occupancy, revenue per available room, controllable profit, guest satisfaction |
| Hospital department (not-for-profit) | Cost per patient-day, waiting times, clinical outcomes, value for money |
| Subsidiary chief executive (investment centre) | ROI or RI alongside non-financial measures |
The common thread is fit: measures must match the manager's authority and the nature of the organisation.
A production supervisor's monthly performance report includes an apportionment of head office administration costs, which the supervisor cannot influence. Which principle does this breach?
The going concern principle
The prudence principle
The controllability principle
The matching principle
A hotel cannot sell tonight's empty rooms tomorrow, so any room left unoccupied is revenue permanently lost. Which characteristic of services does this illustrate?
Intangibility
Variability
Perishability
Simultaneity
The manager of a regional division sets selling prices, controls operating costs and can approve the purchase of new equipment. Which type of responsibility centre is the division?
Cost centre
Revenue centre
Profit centre
Investment centre
Sections you finish are checked off in the contents.