Management by exception and responsibility accounting

What is Management by Exception and Responsibility Accounting?

Management by exception and responsibility accounting are two related concepts that can help managers improve the performance and efficiency of their organizations. In this blog post, we will explain what these concepts mean, how they work, and what are their advantages and disadvantages.

Management by Exception

Management by exception is the practice of examining the financial and operational results of a business, and only bringing issues to the attention of management if results represent substantial differences from the budgeted or expected amount². For example, the company controller may be required to notify management of those expenses that are greater than $10,000 or 20% higher than expected.

The purpose of management by exception is to only bother management with the most important variances from the planned direction or results of the business. Managers will presumably spend more time attending to and correcting these larger variances. The concept can be fine-tuned, so that smaller variances are brought to the attention of lower-level managers, while a massive variance is reported straight to senior management.

Responsibility Accounting

Responsibility accounting is the process of assigning responsibility for revenues, costs, assets, and liabilities to specific managers or units within an organization¹. The “area” of responsibility can be a department, product, plant, territory, division, or some other type of unit or segment. Usually, the attribution of responsibility will mirror the organizational structure of the firm. This is especially true in organizations that have a decentralized approach to decision-making.

Responsibility accounting provides reports to different levels of management. The amount of detail varies depending on the manager’s level in the organization. For example, a product manager may receive a report showing the revenues and costs of their product line, while a division manager may receive a report showing the income and assets of their division. These reports are called responsibility reports.

Responsibility reports help managers to monitor and evaluate the performance of their subordinates and units. They also help managers make decisions that are consistent with the goals and objectives of the organization. Responsibility reports should only include those items that are controllable by the manager or unit being evaluated. For example, a plant manager should not be held accountable for changes in market demand or interest rates that are beyond their control.

Advantages and Disadvantages

Management by exception and responsibility accounting has several advantages and disadvantages. Some of them are:

Advantages:

  – They reduce the amount of financial and operational results that management must review, which is a more efficient use of their time.

  – They allow employees to follow their own approaches to achieving the results mandated in the company’s budget. Management will only step in if exception conditions exist.

  – They motivate managers and employees to perform better by holding them accountable for their results and rewarding them accordingly.

  – They facilitate coordination and communication among different levels and units of the organization.

Disadvantages:

  – They require the existence of a well-formulated budget against which actual results are compared. If the budget is unrealistic or inaccurate, there may be a large number of irrelevant or misleading variances.

  – They require the use of financial analysts who prepare variance summaries and present this information to management. This adds an extra layer of corporate overhead and may introduce errors or biases.

  – They are based on the command-and-control system, where conditions are monitored and decisions are made by a central group of senior managers. This may stifle lower-level managerial talent, innovation, and morale.

  – They assume that only managers can correct variances. This may ignore the potential contributions of front-line employees who can deal with most variances as soon as they arise.

Conclusion

Management by exception and responsibility accounting are useful tools for managing and improving organizational performance. However, they also have some limitations and challenges that need to be considered. Managers should use these concepts with caution and flexibility, and adapt them to suit their specific situations and needs.

Works Cited:

(1) Management by exception definition — AccountingTools. https://www.accountingtools.com/articles/what-is-management-by-exception.html

(2) Responsibility Accounting And Management By Exception. https://www.principlesofaccounting.com/chapter-22/responsibility/

(3) 9.3 Responsibility Reports | Managerial Accounting – Lumen Learning. https://courses.lumenlearning.com/suny-managacct/chapter/responsibility-reports/

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