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Management Control Systems

Notes objective i.e., to earn satisfactory profit. The criteria for satisfactory profit may be budgeted/
past profit in the division/profits of other similar divisions/some combination of them.
Profit as a performance is based on revenues and expenses directly traceable to the division and
can be avoided if the division is closed down. The concept of divisional profit is referred to as
“profits contribution” or “incremental profit.” The divisional profits are before taxes since taxes
are paid on the basis of profit of the entire company, therefore, excluded from the calculation of
divisional profit.

Did u know? The sum total profits of all the divisions will not necessarily be equal to the
profit of the entire firm. The reasons for difference may be costs not attributable to any
single division are excluded while computing divisional profits.

4.6.1 Advantages of Profit Centres

1. The quality of decisions may improve because they are being made by managers closer to
the point of decision.
2. It provides a powerful tool for measuring how well the profit centre has performed.
3. The speed of operating decisions may be increased since they do not have to be referred to
corporate headquarters.
4. The profit centre resembles a business in miniature form and like a separate firm, its
profits are calculated. The managers are motivated to take decisions about inputs and
outputs in such a way, that profit of a profit centre is maximized. The profit centre acts as
a good training ground for general management responsibility. Further, managers subject
to fewer corporate restraints are freer to use their imagination and initiative.
5. The profit centre makes decentralized organization possible. Top management can safely
delegate the authority to the divisional managers because the profit centre reports provide
adequate information about how well the operating managers are doing their jobs. It
gives a better and broader measurement of performance than the expense centers. If the
managers are responsible for both revenue and expense aspects of performance (profit
centre), the contribution of each manager to the goal of the entire organization is easier to
measure than when no single manager is responsible for both revenues and expenses
(expense centers). Further, profit consciousness is increased since managers who are
responsible for profits will constantly seek ways to increase them.

4.6.2 Limitations and Problems of Profit Centre

The profit centre has the following limitations:
1. Decentralized decision-making will force top management to rely more on management
control reports than on personal knowledge of an operation, entailing loss of control.
2. It cannot be used for all responsibility centres, the following points are to be considered:

(i) Extra record-keeping is necessary to compute input and output in monetary terms,
(ii) Unless the divisional managers of responsibility centres have reasonable authority
to decide on the quality/quantity of outputs or on the relation of output to costs, a
profit centre will be of a little use as a control device,
(iii) When a responsibility centre is required by management to provide service to other
responsibility centres, the service department cannot be considered as a profit centre
e.g. internal audits,

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