If the performance of the responsibility centre is measured in terms of both revenue it earns and the expenses it incurs it is called

as profit centre. Revenue is monetary measure of output while expenses is a monetary measure of input. The generally accepted accounting principle is to recognize revenue only when sales are made i.e. revenue is realized but for profit centre monetary measure of output in a given period is sales whether the firm actually realizes it or not.

Profit centre managers should be evaluated only against expenses which they are in a position to influence. Thus responsibility should be for expenses incurred directly in profit centre. The degree of influence that the manager of a responsibility centre can exercise over items vary from centre to centre. However there are certain items over which manager may have certain amount of influence but no control. When managers have influence over tax they pay, they should be evaluated on the basis of after tax profits. Items such as currency fluctuation, cost of goods can not be influenced by managers, hence the effect of such items should not be considered.

In order to gain maximum advantages from profit centre, the head of such unit should have complete autonomy as CEO of an independent organization. This may not practically be possible because the organization may be losing the advantages of size and synergy. It would also lead to the abdication of top managements responsibility. As a result organizational designers are forced to make trade offs and the manner in which these trade offs are made to determine the effectiveness of business unit.

There are number of services which are centralized at the corporate level for reasons of providing economy in services like internal auditing, legal, training, data processing and public relations etc. Quality is one of the constraints. In order to maintain corporate image units are forced to maintain quality of products as per companys policy. Financial decisions are retained at corporate level. Hence profit centres have to compete with each other for corporate funds to finance new project and expansion. There are certain restrictions to bring uniformity such as remuneration and personnel policies, vendor selection policy, data processing, design of documentation and stationery etc. Profit centres are required to provide number of management reports to the corporate management which should confirm to the requirements of corporate management control system.

Production Function as Profit Centre: In this case manufacturing dept. is credited with the sales proceeds of the products. The estimated marketing expenses are debited. However there are other factors which have their influence on the mix and volume of sales which are beyond production managers control. Production centre as profit centre can produce better results if they are designed properly.

When the marketing head is best judge regarding the principal cost and revenue trade offs, the marketing dept. is treated as profit centre. In this case sales promotion expenses, marketing expenses and advertisement expenses are charged with the cost of product sold. The transfer price serves as the cost of product sold. The transfer price should be based on standard cost because this would separate production cost performance of profit centre heads.

Service and support departments such as maintenance dept., customer service, after sales service etc. provide administration and support to the entire organization. So these can be treated as profit centres. In this case these departments are credited with the charges for services rendered to other departments in the organization. The departments using these services can be given option of availing of such services from other firms provided they offer the same quality and lower price. In this case responsibility centres availing such services are motivated to make cost benefit analysis and service centre providing the services is forced to control the costs.

The top management is relieved of the day to day decision making. It can concentrate on other important issues. The quality of decisions may improve because they are being made by managers closest to the point of decision making. The speed of operating decisions can be increased since they do not have to be referred to the corporate headquarters. Profit consciousness is enhanced among the managers because the managers are responsible for profits. They will constantly seek ways and means to increase profits. Profit centres are like independent companies and hence managers can gain experience in managing all functions. Profit centres are responsive to pressure to improve their competitive performance because their output is readily measured. The contribution of each manager to the goal of the entire organization is easier to measure. The top management can easily delegate the authority to the profit centre managers as they know the operating performance of the centre.

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Criterion for profit centres:The criteria to use profit centre as responsibility centre requires the following considerations:Extra record keeping to measure input-output in monetary terms. It will be of little use as a control device unless the divisional managers responsibility centres have reasonable authority to decide on the quality and quantity. Measurement of Expenses:There is a scope for difference of opinion relating to the tratement of those expenses which relate to the organization as a whole. Tranfer Prices:The measurement of profit in a profit centre is complicated in case of transfer price. When internal exchange of goods and services take place between the different divisions of the firm, they have to be expressed in monetary terms. The determination of an appropriate transfer price is one of the major problems of profit centres. Divisionalization may impose additional costs due to additional staff, records and managers. Organizational units that once cooperated as functional units may be incompetition with one another. An increase in profit of one manager may mean decrease for another.

Profit Centre evaluation requires an income statement approach. The criteria of variability, controllability and attributability are applicable. The controllable concept implies that the performance attributes should be controllable by the division or responsibility centre. The attributability concept refers to the outcomes that are directly associated with or directly traceable to the existence and operations of a segment. According to the variability attributes costs that are neither directly controllable by a particular segment nor attributable to it are excluded from the measurement of divisional performance.

Multibusiness companies are generally divided into business units each of which is treated as an independent profit centre. The sub units within these business units may be functionally organized. It may be sometimes desirable to constitute one or more of the functional units as profit centres. There is no guiding principle declaring that certain types of units are inherently profit centres. Managements decision is important as to whether a given unit should be a profit centre. The decision is based on the amount of influence the unit manager exercises over the activities that affect the bottom line.

Contribution Margin:- It reflects the spread between revenue and variable expenses. As fixed expenses are beyond the control of managers they should focus on maximising contribution. Direct Profit:-This reflects a profit centres contribution to the general overhead and profit of the corporation. It incorporates all expenses either incurred by or directly traceable to the profit centre, regardless of whether or not these items are within the profit centre managers control. Expenses incurred at the head quarters are not included in this calculation. Controllable Profit:-The expenses incurred by the head office can be divided into controllable and uncontrollable. In this measure controllable expenses incurred by head office are deducted while arriving at profit. Income Before Taxes:-In this measure all corporate overhead is allocated to profit centres based on the relative amount of expenses each profit centre incurs. In this case corporate overheads should be allocated on the basis of budgeted rather than the actual costs. Net Income:-In this measure, the performance of the profit centre is based on the amount of net income after tax. Generally profit centres have no control over income tax. Hence income before tax is considered. However where profit centre can influence income taxes through their installment credit policies, decisions on acquiring or disposing of equipments and use of other generally accepted accounting principles to distinguish gross income from taxable income, net income after tax is considered as performance measure.

MBO is a system wherein the superior and the subordinate manager of an organization jointly define its common goals , define each individuals major areas of responsibility in terms of the results expected from him and use these measures as guides for operating the unit and assessing the contribution of each of its members.

Setting organizationss common goals and measures of performance. Superior sets goals and measures for subordinate. Subordinates proposes goals in key result areas along with measures of performance. A joint agreement on subordinates goals and measures is reached wherein an agreement session ensures alignment between subordinates and superiors objectives/goals and a joint plan of action of what needs to be done, by whom and when. Feedback on interim results is provided and compared with the agreed goals and measures. Quarterly reviews of progress are done and if necessary new inputs are added or inappropriate goals removed. Annual review is forward looking exercise. If targets are achieved, ways how to do it better are discussed and if targets are not achieved ways of correction of shortfall are discussed.

Benefits: There is better understanding between manager and boss about what the organization is trying to achieve. It is systematic planning as views of subordinates are considered. It provides systematic identification of training needs of managers. It provides better control and management control system. Weaknesses: There is difficulty on goal setting as superior and subordinates may not arrive at the common terms of agreement. There is overemphasis on appraisal. Loan term goals may get ignored. It is not possible to work continuously with subordinates and help measure their performance. Managers fail to teach the self control and self direct philosophy of MBO.

From the following details determine the net income of Z Ltd for the year ended 31st Dec 2009.
Rupees Sales Cost of Sales Variable Expenses 10,00,000 6,00,000 1,80,000

Fixed Expenses
Controllable Expenses Other allocations Tax @ 32%

90,000
10,000 20,000

H Ltd employs a budgetary control system and measures performance on segmented basis of its products A and B. The budgeted and actual sales for month of Nov 2009 are as follows.
Product
A B

Units Budgeted
10,000 20,000

Units Actual
12,000 20,000

Revenue Budgeted
1,00,000 1,00,000

Revenue Actual
1,20,000 1,20,000

The standard unit controllable variable costs are Rs 4 for product A and Rs 2 for product B. The company's budgeted controllable fixed costs for the month are 10,000 each for prod. A and B. However the actual fixed costs are 11,000 and 13,000 respectively. The attributable segments costs are :
Product A B Revenue Budgeted 20,000 30,000 Revenue Actual 22,000 32,000

These costs represent manufacturing costs and no opening and closing inventories. Actual variable manufacturing costs during the months were 42,000 and 48,000 for division A and B respectively. The common firm wide costs are assumed to be Rs. 24,000 to be apportioned on the basis of segment sales revenue. From the above data prepare a performance evaluation report, if H Ltd employs profit centre basis of divisional performance measurement.

ABC Ltd has following total operating results for year ended March 2010.
Rupees Sales Revenue Variable Costs Contribution Fixed costs Net Income 28,00,000 18,60,000 9,40,000 5,00,000 4,40,000

The following additional information covering the performance of each of the firms three operating departments has been provided.
Particulars Sales Revenue Variable costs Fixed costs Department X (Rs) 12,00,000 8,40,000 1,60,000 Dept Y (Rs) 10,00,000 6,00,000 1,40,000 Dept Z (Rs) 6,00,000 4,20,000 1,00,000

Rank the three departments on the basis of their performance measure of relative profitability

The sales manager of Arjun Ltd is judged by total sales. Exceeding the sales budget is considered good performance. The sales budget and the cost data for the year 2012 are shown below.
Particulars Sales Budget Variable cost Contribution Actual Sales Sarees Prod. 4,50,000 2,25,000 2,25,000 15,00,000 Long cloth 9,00,000 4,05,000 4,95,000 12,00,000 Bed Sheets 16,50,000 4,95,000 11,55,000 6,00,000 Total Rs. 30,00,000 11,25,000 18,75,000 33,00,000

Actual prices were equal to budgeted price and variable cost incurred were as budgeted per unit (a) Does the sales manager perform well? Support your answer with calculations. (b) Suggest better performance measurements criterion to be used by the company.

The operating results of three divisions of X Ltd are given below.

Divisions ( In Rupees) A B 4,00,000 2,00,000 2,00,000 8,00,000 C 20,00,000 18,00,000 2,00,000 40,00,000

Particulars

Sales Revenue Less: Expenses Segment Profit Contribution Segment Assets

4,00,000 3,60,000 40,000 2,00,000

Determine the rate of return for these three divisions and rank these divisions assuming that company follows investment centre basis of performance evaluation.

A factory is currently working at 50% capacity and produces 10,000 units. At 60% capacity utilization raw material cost increase by 2% and selling price falls by 2%. At 80% capacity product costs Rs 180 and is sold at Rs.200 per unit. The unit cost of Rs.180 is made up as follows: Material cost Rs.100, labour Rs.30, Factory overheads Rs.30 (40% fixed), administrative overheads Rs.20 ( 50% fixed) Estimate profits at all three levels of capacity utilization.