Expense Centres

An expense centre may be defined as a responsibility centre in which the manager has no control over revenue but is able to control expenditure. It will be recalled that we drew a distinction between the accumulation of costs for product costing purposes and for control purposes. In product costing, we noted that costs are first allocated and apportioned to service departments and production departments; next, that service department costs are apportioned to the production departments; finally, overhead recovery rates are computed to enable overhead costs to be absorbed into product costs. Since the production departments are the focal points on which the process of cost accumulation converges, these departments are known as 'cost centres'.

From the foregoing, we may distinguish an expense centre from a cost centre. An expense centre is a department which incurs expenditure. A cost centre is a production department in which product costs are accumulated.

As we stated earlier, a prerequisite for an effective responsibility accounting system is the establishment of an organizational framework which will define the formal relationships which link the different executive roles in the organization. Levels of responsibility may be delineated for foremen, departmental managers, works managers and upwards to director level. An organizational chart can be applied to a centralized organization and shows that the three foremen are responsible to the manager of department B, who in turn reports to the works manager. The works manager is responsible to the Board.

An important facet of a comprehensive planning and control programme is a system of performance reports incorporating comparisons of actual performance against planned performance for individual responsibility centres throughout the enterprise. These reports provide a means of instituting responsibility accounting, which is a method of cost control in which the cost of responsibility centres are identified with individual managers who are given authority over such costs and responsibility for them.

Responsibility budgets deal only with the costs for which each manager is to be held responsible, and their performance as managers is evaluated by reference to the success with which they have managed their own area of responsibility. It is important, therefore, to make a distinction between those costs which are under the control of a particular manager and those for which other managers are responsible. For example, the foreman of the assembly department may be responsible for the amount of direct labour used, but he will certainly not be responsible for the wage rate which is paid to these workers. This is determined by collective bargaining and is outside his sphere of influence. In assessing managerial performance under systems of responsibility accounting, a manager should not be held responsible for costs which are outside his control. An inference which may be drawn from our diagram is that the higher one ascends the pyramid of control, the greater is the proportion of total costs which is defined as controllable costs: at board of directors level all costs are by definition controllable as the board is ultimately responsible for all costs.

There are conflicting views as to whether non-controllable costs should be included in performance reports. One view is that, if they are included, managers will be informed of all the costs affecting their departments. Their inclusion also enables department managers to appreciate the size and the costs of the organizational support upon which his department depends. If non-controllable costs are included in performance reports, they should be distinguished from the costs which fall within the manager's responsibility, that is, those costs which are defined as controllable.

The manager in charge of an expense centre has the responsibility for seeing that the expenditure incurred by his department should not exceed the limits contained in his budgeted expenditure. Clearly, his ability to control expenditure will be an important consideration in the evaluation of his effectiveness as a manager. If follows, therefore, that the use of budgets for evaluating the performance of managers has implications for the manner in which budgets are organized.

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Control depends on the existence of an organizational framework which will define the responsibility for securing the performance of individual tasks. This is achieved by establishing responsibility centres throughout the organization, and defining the responsibilities of managers accordingly.

A responsibility centre may be defined as a segment of the organization where an individual manager is held responsible for the segment's performance.

The nature of the organizational framework and the kinds of responsibility centres established will depend partly on the size of the organization... see: Responsibility Accounting