5.3 Responsibility centres
Decentralisation results in the creation of separate responsibility centres – aspects/areas of the organisation’s operations for which a particular manager is responsible. The main types of responsibility centre in common use are as follows.
Cost centre. The manager is assumed to be able to influence significantly the level of cost incurred and will be judged according to how well costs are controlled. There may or may not be revenues associated with the particular aspect of operations concerned, but if there are, the manager is assumed to have no control over these. Managers of cost centres will need regular information to be provided by the accounting system, concerning how individual cost items compare with budget – that is, budget variance and, of course, budgetary planning information, for example, cost targets to be achieved.
Revenue centre. The manager is assumed to be able to influence significantly the level of revenue earned and will be judged on the basis of this. Revenue centres are principally intended to be applied to sales operations, where the manager’s responsibilities relate to the generation of income, whether or not there are attributable costs. Managers will need information concerning targets for individual revenue generating units (e.g., products), and also regular feedback information on actual versus budgeted revenues.
Profit centre. The manager is assumed to be able to influence significantly both costs and revenues and is judged on the basis of the level of profit generated by the particular aspect of operations concerned. The term profit centre is usually limited to the situation where the manager does not have responsibility for the level of investment in the centre (this decision being made by more senior management). Managers need information concerning both revenues and costs, for example, which products/services are profitable.
Investment centre. This is a type of profit centre, but one for which the manager also has significant influence over investment decisions. In such cases, it would be expected that, in addition to the normal profit centre measures (e.g., Return on Sales), profit would be related to the capital invested (e.g., Return on Investment). Managers need the same information as for profit centres and in addition, detailed appraisals of potential investments and control information concerning the level of investment (e.g., working capital levels, namely, inventory, receivables and payables) at any particular point in time.
What do you think would be the appropriate type of responsibility centre for each of the following functions/departments?
- A marketing department
- A research and development department
- A machinery service and repair department of a factory
- The German manufacturing and distribution division of a large multinational company
- A regional sales office of a US company
How would you measure the performance of the manager/s of each centre?
In some organisations, which are departmentalised on the basis of product groups, each product group department will have its own marketing activities. Where, however, an organisation is departmentalised on a functional basis and has a separate marketing department serving all its product groups, this department will incur expenditure on behalf of the whole organisation, but will not have its own revenues. It is likely then to be a cost centre.
The same is true of a research and development and a service and repairs department. Research and development is difficult to measure, but this is attempted in many firms by use of such measures as number of patents registered, percentage of sales from recently introduced products and so on.
The German manufacturing division of a large multinational company is likely to earn revenues (the level of which it can presumably influence) and incur costs (the level of which it can also influence). It is likely to be a profit centre, or even an investment centre.
A regional sales office is likely to be able to influence the level of revenue generated, but the main elements of cost (e.g., sales personnel salaries) are likely to be the result of decisions made by more senior (Head Office) managers. It is likely to be a revenue centre.
Responsibility centres should be evaluated according to financial performance (comparison of budgeted and actual costs, revenues and profits as appropriate). It will probably be desirable also to measure various non-financial indicators that are important for each centre achieving its goals – for example, in the case of the service and repairs department, average response time for machine breakdowns, and in the case of the research and development department, the number of new product or process innovations, and so on.