The business system of responsibility accounting is divided into functional units known as responsibility centers and there are multiple types of responsibility centers. A manager is responsible for overseeing a reliable center’s operations, which includes, among other things, taking responsibility for Accounting Reports (RARS). These RARS are sent to the organization’s highest management to make decisions regarding different corrections.
The quality of the RARS assesses the performance of the director in charge of a responsibility center received from the center. The inputs to a responsibility center that is part of manufacturing firms are raw materials and labor overheads.
In contrast, the outputs of finished products are manufactured. These outputs can measure against the activities of the responsibility centers that are engaged in providing services. These categories are advertising, accounts, finance, human resources, etc. They are difficult to quantify.
Most Popular Category/Types of Responsibility Centers
These are specify broadly into three categories or types of responsibility centers, as shown below:
1) Investment Centers
The responsibilities of an investment center are the management of costs, as well as managing and revenue generation. Investments in other assets utilized for the center. The person in charge of an investment center is also responsible for the earnings and assets that the center manages. It is the main types of responsibility centers.
The chief of an investment center has an upper amount of authority. It is accountable for a more incredible amount of responsibility compared to the head of cost center or profit center. It is one of the types of responsibility centers. The measurement of an investment center is measured using the concept of return on investments (ROI), which is calculated with the aid of the following formula:
Return on Investment (%)= Profits from the investment center/assets employed for the Investment center X100
Managerial Implications of Investment Centers
Investment center can be utilized in a productive way to assess the level of performance or contribution of a division or the manager of a division. An assessment of the connection between profits and income measures the performance of an investment center. It shows the managerial implications of types of responsibility centers.
You can describe the relationship between assets and income in these methods:
1) Return on Investment (ROI)
The return on investment of an investment facility is the only factor in the performance of the facility. It is the amount of capital invested. The connection between these two elements is called the ROI, which is calculated using the formula below:
Return on Investment= Income of the Investment Center/Assets of the Investment Center
2) Residual Income (RI)
The extra income above the rate of return required for investments is known by the term Residual Income (RI). The idea behind the possibility cost lies at the fundamental basis for calculating the required return rates. The payment is considered higher than the capital investment’s value. The interest earned on this investment is considered part of the expense.
Major Advantages of Investment Centers
Investment centers play a significant contribution to the advantages of a company organization, as is evident from the following points:
- The investment centers can be used to measure the performance or evaluate the performance of a division or the manager who manages it.
- Their earnings, along with the value of the assets utilized to make the profit, are considered by investment centers.
- Analyzing ROI at an investment center is an incentive to make the most efficient utilization of the assets that belong to a business.
- Analyzing ROI at an investment center agrees with the idea that one of the main goals of investment is to attain an expected yield.
Extreme Disadvantages of Investment Centers
Investment centers suffer from the following drawbacks:
- To measure performance, measuring performance is the concept of an ROI analysis. But, there are certain limitations to its application because of the availability of various methods for calculating it.
- Because assigning values to investments in an investment center is a challenging task, and measuring the investment base is an intricate process. It is the disadvantages of types of responsibility centers.
- Certain assets that are part of multiple divisions will likely receive a different treatment.
2) Cost or Expense Centers
Cost assessment is the duty of the cost centers, units, or both. It is the second types of responsibility centers. A cost center analyzes costs to have a cost-control system. The cost center for an enterprise could be described as an equipment item, an individual, or even a site. It could be a mix of one as well.
Types of Cost Centers
Cost centers can be classified according to the following parameters:
1. Based on what is referred to as a definition for a cost center, they classified as:
(i) Cost center that are not personal include a place, equipment, or a collection.
(ii) Cost center that are impersonal
(iii) Personal expense center include one or more groups of people.
2. Manufacturing organizations could be broadly classified as
(i) Production cost center
(ii) Service cost center
Production cost center can subdivide into
(a) Cost centers for operations comprising machines and personnel who are involved in operations.
(b) Cost centers for processes that are considered to resemble operations.
3. A cost center could comprise a particular machine or a set of devices performing similar activities.
4. Cost centers can be classified per the area in which they are situated, e.g., a particular division, sales area tool room, stockyard, administrative office, etc. Costs for one employee within the organization (viz., sales manager and works manager. purchase manager, finance manager, personnel manager, storekeeper, foreman, etc.) are included.
Managerial Implications of Cost Center
To implement an effective cost control system, all costs incurred by the organization and created by the cost centers must be executed transparently.
- An accurate assessment of the functional division’s costs the division incurs as well as its contribution to the financial viability of the company.
- The transmission of essential information to management for making decisions. The main requirement for the above is assigning costs according to their source. This is quite a difficult task, particularly regarding overhead expenses. The assignment of costs to a cost center demonstrates an effort to charge the cost center all expenses directly related to it.
Most Significant Advantages of Cost Centers
A cost center is an asset for any company since the following benefits are derived from it:
1) Helpful to Center with conceptually identifiable output
Numerous cost centers produce outcomes that can be identified conceptually, e.g., the legal or public relations departments. It isn’t easy to quantify these results in terms of money.
2) Measurement of Cost per Unit
The price per unit figured by a cost center reflects efficiency and effectiveness.
3) Measurement at the Lowest Feasible Cost
With the aid of a financial budget, it’s possible to evaluate the performance in both financial and non-financial ways, which reveals the effectiveness and efficiency at the lowest cost.
Some Disadvantages of Cost Centers
The advantages of a cost center, however, there are negatives as well, which will be explained in the following sections:
- It doesn’t consider the measure of output in terms of financials.
- To determine the production of a cost center, an everyday basis is required to integrate all the products that are not identical in the production department. This kind of joint base is absent.
- The determination of the appropriate degree of connection between inputs and outputs can take time and effort.
3) Profit Centers
A profit center covers vast areas of operation and is accountable for controlling costs and generating revenue that will ultimately result in increased profit. The efficiency of the people who manage these profit centers assesses their capacity to generate revenue. By ensuring the effective monitoring of inputs and outputs, profit centers are expected to generate significant profits from the assets they utilize. It is also very important types of responsibility centers.
Quick Managerial Implications of Profit Center
The following are the managerial implications of a profit center:
1) Evaluation and Ranking of Profit Centers
The performance of a profit center is assessed, and a rating is attributable to it based on its accomplishment of profits targets which include. It is also essential to examine the aspects of achieving the goals of specific segments. It is the managerial implications of the types of responsibility centers. They are controllable contribution margin, controllable segment margin, segment profit contribution, contribution margin ratio, segment profit contribution rate, etc.
2) Decisions to Modify Operations of Profit Centers
The assessment of a profit center serves as a basis regarding the necessary adjustments in the operation of that profit center. The modifications can take the form of a decision regarding an expansion, contraction, or closing of the center.
These changes, if implemented, can result in an improvement in the efficiency of the company. Expanding or contracting the profit center’s process in the short term can impact the contribution margin. It can control if all attributable segment costs remain the same. In the long term, you can consider the changes in direct fixed cost and attributable segment expenses. In the case of adding or closing the whole segment, it all will depend on the effect it could have on the company’s overall profits.
Top Advantages of Profit Center
Profit center can benefit an organization in the following ways:
- It is a reliable and efficient method to evaluate and analyze the efficiency of a profit-making center.
- Profit centers are granted autonomy in their operations. The profits they earn are like independently-owned businesses. The managers are encouraged, with financial incentives, to make significant decisions regarding inputs and outputs, to maximize profit. Profit centers are considered to be appropriate training facilities in the field of general management. It is the advantages of the types of responsibility centers.
- It is an example of the decentralization phenomenon of a business organization. Because of an efficient and robust accounting information system, with a system that allows for close monitoring, top management is confident in confiding sufficient authority to directors of profit centers.
- Measurement of the performance of a manager at a profit center can be done more efficiently when compared with the manager of the expense center. The authority and accountability of a manager for a profit center are clearly defined, and he is accountable for both the revenue and cost aspects. It makes assessing the role played by the profit center (and the manager) to reach the organization’s overall goal simple and straightforward.
Check Disadvantages of Profit Centers
Profit center models suffer from a few disadvantages, a few of which are:
1) Cannot Uses for All Responsibility Centers
Based on the following aspects, Profit center approaches cannot be applied in the case of all responsibility centers:
- The calculation of inputs (costs) in addition to outgoings (revenue) in terms of money will require additional records:
- A proper amount of authority has to be given to divisional managers in a responsibility center to make important decisions about the quality and amount of outputs, the relationship of costs for production, etc. Without this, the effectiveness of the profit center as a means of monitoring and controlling will be restricted.
- If a responsibility center is requested by management to expand its services to a different responsibility center. It cannot be considered a profit center, e.g., internal audits.
- A profit center with greater or lesser uniform output (e.g., cement) is of no value.
- A few profit-making centers are enticed by the opportunity to provide short-term outcomes at the cost of losing a long-term vision. It could result in unhealthy competition (or friction) between profit centers.
2) Measurement of Expenses
It affects the cost of expenses by the business in general, between different profit centers, which affects their performance evaluation. It is a challenging job and can lead to a variety of perspectives.
3) Transfer Prices
Calculating the value of products and services transferred from one profit center to another within the same organization (transfer cost mechanism) is a complicated procedure. It also presents a significant problem due to the range of approaches available.
The significance lies in its profound impact on the profit center for selling and buying. In the first case, it’s an income source; however, in the second, it’s an element in the costs. This mechanism can influence the financial performance of the selling and buying profit centers, either positively or negatively.