Cost, revenue and profit centres in responsibility accounting

Responsibility accounting and responsibility centres

Responsibility accounting collects and reports costs, revenues and investments by areas of responsibility. Each area is a responsibility centre headed by a manager, who is held accountable for the items he or she can control. Centres are classified by what the manager controls.

(i) Cost centre

A cost centre is a segment whose manager is responsible for controlling costs but not for earning revenue.

• Measurement: actual costs are compared with budgeted or standard costs for the actual output; variances are analysed and reported.
• Types: standard (engineered) cost centres, where the relation between inputs and output is measurable, such as a machining shop; and discretionary cost centres, where it is not, such as research, personnel or administration.
• Example: the painting department of a car factory is judged on whether its paint, labour and power costs per car are within standard.

(ii) Revenue centre

A revenue centre is a segment whose manager is responsible mainly for generating sales revenue. It may incur some selling costs, such as commission to salespersons, but it is not held responsible for controlling costs.

• Measurement: actual sales revenue, volume, mix and market share are compared with the sales budget.
• Example: a regional sales office judged on its sales against target.

(iii) Profit centre

A profit centre is a segment whose manager controls both revenues and costs and is therefore responsible for profit.

• Measurement: actual profit (often contribution or controllable profit) is compared with budgeted profit.
• Requirements: the manager must be able to influence prices, sales and costs; where the centre supplies other divisions, transfer prices are needed to measure its revenue.
• Advantages: encourages managers to think like owners, speeds decisions and gives a clear measure of performance.
• Example: a product division of a consumer-goods company, or a branch of a retail chain.

The controllability principle

A manager should be judged only on the items he or she can control. Costs allocated from other departments, or fixed costs decided at a higher level, are reported separately so that the centre's performance is not distorted.

Benefits of responsibility centres

1. They make each manager answerable for a defined area, so that good and poor performance can be traced to a person.
2. They let top management practise management by exception, looking only at centres with significant variances.
3. They improve planning, because each manager takes part in setting the budget for his or her own centre.
4. They motivate managers, especially when rewards are linked to the centre's results.

A further type, the investment centre, is a profit centre whose manager also controls the investment in assets, and is judged by return on investment or residual income.