MCS-Responsibility Centres & Profit Centres

8/22/2019 MCS-Responsibility Centres & Profit Centres

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Responsibility Centre

Prof. Nand Dhameja


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Responsibility Centre

A segment of organisation

Involving use of resources

Has a purpose or objective

A manager responsible for the centre

An organisation is a set of responsibilitycentres

Responsibility centres form a hierarchy: acentre may have sub-centres

Involves InputsPhysical quantity Value ofresources used

Involves Outputs Physical quantityvalue ofwork done


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Responsibility Centre- Accounting: Steps

Divide organisation into segments/centres-a

division or function unit

Each centre headed by an executive having authority

& responsibility

Accounting for each centre: costs & revenues;Controllable vs. non-controllable costs

Develop organisational control mechanism:

Standard of performance for each centre

Reward/punishment system

Develop transfer price mechanism


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Responsibility Centre- Efficiency &Effectiveness

Two criteria to judge the performance of a

responsibility centre

Comparative terms rather than a absolute one

Efficiency Output/Inputcomparison of actual cost with

standard

Effectiveness relationship between Output &objectives

difficult to quantify objective & output


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Responsibility Centre- Efficiency &Effectiveness contd.

Efficiency & effectiveness are not

mutually exclusive, every centre ought

to be both efficient & effective

In summary, a responsible centre isefficient if it does things right, & it is

effective if it does the right things

In commercial organisations, Profit is an

important measure of efficiency &

effectiveness


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Responsibility Centres - Types

Expense Centre

Revenue Centre

Profit Centre

Investment Centre


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Responsibility Centres Types Contd.

Revenue Centre- output in money terms

e.g. market/sales units: don't have to set selling

price & are not charged for costs

Expense Centre: inputs measured in monetary

terms

Engineered expense centre, or

Discretionary expense centre

Profit Centre- An absolute measure

Profit a useful performance measure-inputs &

outputs in monetary terms


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Responsibility Centres TypesContd.

Profit centre- Delegation of authority to

generate profit-two conditions:

a). Manager has access to relevant information to

make decisions

b). There is a way to measure effectiveness of

expense/revenue trade-offs

Investment centre Profit in relation toInvestment

Management decision whether a profit centre orinvestment centre


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Responsibility CenterResponsibility Center: Center In charge

Responsible for..

1.Expense Centre 1. Expenses2.Revenue centre 2. Revenues3.Profit Centre 3. Expenses,

Revenues & Profits

4. Investment Center 4 Expenses, RevenuesProfits & Investment


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Responsibility Centre-Profit Centre:Illustrations

For a bank: branch as profit centre;

programme or a product profitability ,customer

profitability, ATM Profitability ATM used as

credit to branch having customer account

Power cos.- generation, transmission &distribution as profit centres

Soya sauce manufacturer- each production

process as profit centre

Marketing Division given profit responsibility-marketing manager can trade-off between

cost/revenues


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Responsibility Centre-ProfitCentre: Illustrations contd

Manufacturing may be a profit centre to motivate , to guard against inferiorquality

Given selling price-ascertain profit Service & support units-maintenance,

transportation, consulting, customerservice units e.g. Singapore Airlines-

Singapore Airlines Engineering Co.;Singapore Airport Terminal Services;Catering or laundry service in hospitalsor trains


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Responsibility Centre-Profit Centre

Management Decision whether a ProfitCentre-amount of influence (not necessarilycontrol), a manager exercises on activitiesthat affect profit

Profit centre managers control over a) product decisions;

b) marketing decisions;

c) procurement or outsourcing decisions.

If these are split among two or moremanagers, separating contribution of eachmay be difficult


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Advantages:

+ Quality of decisions improves

+ Speed of operating decisions increases

+ HQ relieved of day-to-day decisions &concentrates on policy matters

+ Managers autonomy- free to useimagination & initiative

+ Improves competitiveness+ Profit consciousness motivates managers


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Disadvantages:

Decentralised decision-making-management relies on control reports

rather than on personal knowledge Quality of decision at unit level may get

reduced

Lack of appropriate transfer price

conflict of interests & demotivating Competition among responsibility centres

undesirable cost consequences

Emphasis on short-term profit rather

than long-term profits


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Profitability Measurement: two types

a). Management performance; how wellManageris doing?

b). Economic Performance: How well ProfitCentre is doing as an Entity?

MCS design be addressed to (a) above

Profit Centre economic performance

measured by PAT Profit centre manager performance

evaluated by Five different measures


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Responsibility Centre-Profitability MeasuresSales Rs.1000

Less Variable Expenses 780

CONTRIBUTION MARGIN 220 (1)

Less Fixed expenses in Profit Centre 90

DIRECT PROFIT 130 (2)

Less Controllable corporate charges 10

CONTROLLABLE PROFIT 120 (3)

Less othe corporate allocations 20

PBT 100 (4)

Less Taxes 40

PAT 60 (5)


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Profit Centre-Profitability Measures

1. Contribution Margin:reflects spreadbetween revenue & variable expenses

+ since fixed expenses are beyond his

control, manager should focus onmaximising contribution

-- wrong premise- fixed expenses are

partially controllable-- Is Manager responsible for controllingemployees efficiency & productivity?


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Profit Centre-Profitability MeasuresContd.

2) Direct Profit: reflects profit centres

contribution to general overhead and co.s

profit; traces expenses to the Centre

--does not recognise motivational benefit of

charging HQ costs

3). Controllable Profit: considers Controllable

expenses of HQ

Since non-controllable HQ expenses are excluded,

this cannot be directly compared with

published data


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Profit Centre-Profitability MeasuresContd

4) PBT: all corporate O/H are allocated;

++ awareness of corporate allocated

expenses

5) PAT: Profit after all expenses & imputedtax

--Since decisions which affect PAT aretaken at HQ tax allocation notappropriate

++ IT varies among profit centres, managerscant influence


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Responsibility Centre- Profit Centre Sales

Sales Rs 1000

Less Variable Expenses 780

CONTRIBUTION MARGIN 220 (I)Less Fixed expenses in Profit Centre 90

DIRECT PROFIT 130 (2)

Less Controllable corporate charges 10

CONTROLLABLE PROFIT 120 (3)

Less other corporate allocations 20PBT 100 (4)

Less Taxes 40

PAT 60 (5)


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Responsibility Centre: Investment Measure

a). Total assets Available All business assets

b). Total assets employed Exclude Idle assets

c). Capital Employed b) Less C. L

d). Net Worth

Capital + Reserves


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Responsibility Centre: Investment MeasureContd.

Current Assets: Extent to which Controllable byDivisional Manager

When not directly identifiable:

Allocate cash & Cash needs

Inventory Sales needs Receivables credit terms

Fixed Assets: Whether Book value- Gross, or Net,or Current values

Objectively measured; Not affected byaccounting practicesTreatment of:Off-B/S Items e.g. Lease;or : Intangibles


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Responsibility Centre- Performance Parameter

ROI vs. EVA +a comprehensive measure + a basis of comparison of divisions

+a basis of investment divisions + reported in Financial statement - Too simple a decision Rule - Computation not easy

- Lack Goal Congruence EVA is conceptually sound while ROI ismore widely used


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Control System: Characteristics

Goal Congruence

Motivation

Autonomy

MCS-Responsibility Centres & Profit Centres

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