Question

Can someone provide me with a detailed answer for the question below.

Indicate and justify the type of responsibility centre that is most appropriate for each department in the company.

Answer 1

Any organizational or functional unit headed by a manager who is responsible for the activities of that unit is called a responsible center. The manager is responsible or accountable for the accomplishments of the tasks set in his unit.

The total organizational task is divided into sub-tasks, which are performed by different departments. In this sense, all departments in an organization are responsibility centers.

The decision usually will depend on the activity performed by the organizational unit and on the manner in which inputs and outputs are measured by organizational control system.

All responsibility centers use resources [inputs or costs] to produce something [output or revenues]. Typically responsibility is assigned to a revenue, expense, profit and/or investment center.

• Revenue center. This group is solely responsible for generating sales. A typical revenue center is the sales department.
• Cost center. This group is solely responsible for the incurrence of certain costs. A typical cost center is the janitorial department.
• Profit center. This group is responsible for both revenues and expenses, which result in profits and losses. A typical profit center is a product line, for which a product manager is responsible.
• Investment center. This group is responsible not only for profits, but also for the return on funds invested in the group's operations. A typical investment center is a subsidiary entity, for which the subsidiary's president is responsible.

Types of Responsibility Centers in more detail:

(a) Revenue Centers:

Revenue centers are those organizational units or segments in which outputs are measured in monetary terms but are not directly compared to input costs. The main focus of management’s efforts will be on revenue generated by it. A sales department is an example for a revenue center.

The effectiveness of the center is not judged by how much sales revenue exceeds the cost of the center. Rather budgets [in the form of sales quotas] are prepared for the revenue center and the budgeted figures are compared with the actual sales.

(b) Expense Centers:

In expense centers, inputs [cost and expenses] are measured in monetary terms but outputs are not. The main focus of the management will be on the control of the expenses or costs incurred by the responsibility center.

So budgets will be devised only for the input portion of these centers’ operations. Organizational units commonly considered expense centers include administration service, and research departments.

There are two types of expense centers namely engineered expense/costs center and discretionary expenses/costs center. Engineered costs are those for which costs can be estimated with high reliability based on the engineering or technical relationship that exists between costs and output; for example the cost of direct materials or direct labour.

Discretionary costs are those for which costs cannot be reliably estimated before hand and must depend to a large extent on the manager’s discretion. In other words, it is not possible to determine the optimum relationship between costs and outputs and the choice of relationship is quite often highly subjective and is left to the discretion of the manager.

(c) Profit Center:

A profit center generally refers to a segment of an organization that generates revenue. It is a responsibility center, the manager of which is responsible for the amount of profits earned. In a profit center, performance is measured by the numerical difference between revenues [outputs] and expenditures [inputs].

The managers in the profit center are therefore, responsible for both revenues and costs. Such a measure is useful to determine the economic efficiency of the center and individual efficiency of the manager in charge of the center.

Each division’s performance can be evaluated in terms of profits. Since divisional managers take all decisions relating to technology, product mixes strategies, and personnel, they may influence both revenues and expenses. The expenditure of a department’s sub-units are added and then deducted from the revenues derived from that division’s all products and services.

(d) Investment Center:

An investment center is a responsibility center whose manager is responsible for earning a rate of return on the assets used in his responsibility center. In an investment center, the control system again measures the monetary value of inputs and outputs, but it also assesses how those outputs compare with the assets employed in producing them.

For example, divisions in an automobile manufacturing company, individual departments in a departmental store and individual branches of a multiple shop are investment centers.

It is important to realize that any profit center can also be considered an investment center, because its activities require some form of capital investment. In other words, an investment center can be considered as a special type of profit center, in which focus is also on assets employed.