Page 64 - DMGT514_MANAGEMENT_CONTROL_SYSTEMS

Unit 4: Responsibility Centers

Notes

Notes A practice can be deemed “best” only in the context of a particular company’s
culture, its strategies, its use of technology, its product’s life cycles and its customers’
needs and wants.

Self Assessment

Multiple Choice Questions:
5. The profitability of a profit centre can be measured in terms of:
(a) Contribution margin
(b) Contribution margin and income before taxes
(c) Contribution margin, income before taxes and direct divisional profits and
(d) Contribution margin, income before taxes, direct divisional profits, and net income.

4.6 Profit Centres

A profit centre is a responsibility centre in which financial performance is measured in terms of
profit (i.e., the difference between the revenues and expenses) inputs are measured in terms of
expenses and outputs are measured in terms of revenues. Both the elements of accounting
information – cost (input) and revenues (output) are considered. Therefore, in a profit center, the
measures of performance is better and broader than in an expense centre since in case of expense
centre, the accounting system measures only one element (i.e., cost) whereas, in a profit centre
both the elements, cost as well as revenue is evaluated in monetary terms. The difference
between revenues and costs is profit. Each profit centre is a relatively independent operating
unit and its manager must have significant control over most operating decisions that affect
profit.

Example: Volume of production, methods of operation, and cost of goods sold pricing
and product mix.
In a financial organization, the profit centre as a responsibility center is at the CEO’s level since
at that level, he is held responsible for profits at that level, costs and revenues can be traceable.
In divisionalisation, the manager of each major unit is responsible for both the manufacture and
marketing and the term profit centre concept applies at that level.
Profit centre can be divided into (i) natural profit centre and (ii) constructive profit centre.
Natural profit centre e.g. a product division, uses inputs (costs) and produces outputs (revenues)
i.e., sales to outside customer. This profit centre is just like an independent firm. A constructive
profit centre as the name indicates has been constructed as a profit centre. As for example, the
computer centre, it uses input (cost) and produces output i.e., services to other departments. If
we want to calculate the monetary value, the computer centre becomes a profit centre, otherwise
it is logically an expense centre.
Since in a profit centre, there are financial measures of the output as well as of the input, it is
possible to measure the efficiency and effectiveness of performance in financial terms. Profit
analysis can be used for the performance evaluation of division and its divisional manager,
since in a profit center, you require all the data needed in an expense control as well as additional
data regarding revenues. Therefore, the management can determine whether the division was
efficient in the utilization of resources and whether the division was effective in attaining its

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