Page 204 - DMGT403_ACCOUNTING_FOR_MANAGERS

Unit 9: Budgetary Control

approach allows responsibility to be assigned to the segment managers that have the greatest Notes
amount of influence over the key elements to be managed. These elements include revenue for
a revenue center (a segment that mainly generates revenue with relatively little costs), costs for
a cost center (a segment that generates costs, but no revenue), a measure of profitability for a
profit center (a segment that generates both revenue and costs) and Return on Investment (ROI)
for an investment center (a segment such as a division of a company where the manager controls
the acquisition and utilization of assets, as well as revenue and costs).

Cost Center

A cost center is the smallest segment of activity or area of responsibility for which costs are
accumulated. Obviously most business units incur costs, so this alone does not define a cost
center. A cost center is perhaps better defined by what is lacking; the absence of revenue, or at
least the absence of control over revenue generation.
Human resources, accounting, legal, and other administrative departments are expensive to
support and do not directly contribute to revenue generation. Cost centers are also present on
the factory floor. Maintenance and engineering fall into this category. Many businesses also
consider the actual manufacturing process to be a cost center even though a saleable product is
produced (the sales “responsibility” is shouldered by other units).

It stands to reason that assessments of cost control are key in evaluating the performance of cost
centers. This chapter will show how standard costs and variance analysis can be used to pinpoint
areas where performance is above or below expectation. Cost control should not be confused
with cost minimization. It is easy to reduce costs to the point of destroying enterprise effectiveness.
The goal is to control costs while maintaining enterprise effectiveness.
Non-financial metrics are also useful in monitoring cost centers: documents processed, error
rates, customer satisfaction surveys, and other similar measures can be used.

Example: 1. The manager for purchasing department.
2. The manager for maintenance department.

Revenue Center

Revenue center can be defined as a distinctly identifiable department, division, or unit of a firm
that generates revenue through sale of goods and/or services.

Example: Rooms department and food-and-beverages department of a hotel.

Profit Center

Some business units have control over both costs and revenues and are therefore evaluated on
their profit outcomes. For such profit centers, “cost overruns” are expected if they are coupled
with commensurate gains in revenue and profitability.

Example: A restaurant chain may evaluate each store as a separate profit center. The
store manager is responsible for the store’s revenues and expenses. A store with more revenue
would obviously generate more food costs; an assessment of food cost alone would be foolhardy
without giving consideration to the store’s revenues.

LOVELY PROFESSIONAL UNIVERSITY 199