Is a segment of an organisation whose manager is responsible for both revenues and costs?

What is a Responsibility Center?

A responsibility center is a functional entity within a business that has its own goals and objectives, dedicated staff, policies and procedures, and financial reports. It is used to give managers specific responsibility for revenues generated, expenses incurred, and/or funds invested. This allows the senior managers of a company to trace all financial activities and results of a business back to specific employees. Doing so preserves accountability, and may also be used to calculate bonus payments for employees.

There may be many responsibility centers in a business, but never less than one such center. Thus, a responsibility center is usually a subset of a business. These centers are usually stated on a firm’s organization chart.

From an accounting perspective, a financial report should be issued to each responsibility center that itemizes the revenues, expenses, profits, and/or return on investment for which the manager of each center is solely responsible. This can result in quite a large number of customized reports being issued on an ongoing basis.

The use of multiple responsibility centers requires a certain amount of corporate infrastructure to develop each center, track its results, and manage expectations with the various managers.

Types of Responsibility Centers

A responsibility center may be one of four types, which are noted below.

Revenue Center

A revenue center is solely responsible for generating sales. A typical revenue center is the sales department.

Cost Center

A cost center is solely responsible for the incurrence of certain costs. A typical cost center is the janitorial department.

Profit Center

A profit center is responsible for both revenues and expenses, which result in profits and losses. A typical profit center is a product line, for which a product manager is responsible.

Investment Center

An investment center is responsible not only for profits, but also for the return on funds invested in the group's operations. A typical investment center is a subsidiary entity, for which the subsidiary's president is responsible.

A segment is a fairly autonomous unit or division of a company defined according to function or product line. Traditionally, owners have organized their companies along functional lines. The segments or departments organized along functional lines perform a specified function such as marketing, finance, purchasing, production, or shipping. Recently, large companies have tended to organize segments according to product lines such as an electrical products division, shoe department, or food division.

A responsibility center is a segment of an organization for which a particular executive is responsible. There are three types of responsibility centers—expense (or cost) centers, profit centers, and investment centers. In designing a responsibility accounting system, management must examine the characteristics of each segment and the extent of the responsible manager’s authority. Care must be taken to ensure that the basis for evaluating the performance of an expense center, profit center, or investment center matches the characteristics of the segment and the authority of the segment’s manager. The following sections of the chapter discuss the characteristics of each of these centers and the appropriate bases for evaluating the performance of each type.

An expense centeris a responsibility center incurring only expense items and producing no direct revenue from the sale of goods or services. Examples of expense centers are service centers (e.g. the maintenance department or accounting department) or intermediate production facilities that produce parts for assembly into a finished product. Managers of expense centers are held responsible only for specified expense items.

The appropriate goal of an expense center is the long-run minimization of expenses. Short-run minimization of expenses may not be appropriate. For example, a production supervisor could eliminate maintenance costs for a short time, but in the long run, total costs might be higher due to more frequent machine breakdowns.

A profit center is a responsibility center having both revenues and expenses. Because segmental earnings equal segmental revenues minus related expenses, the manager must be able to control both of these categories. The manager must have the authority to control selling price, sales volume, and all reported expense items. To properly evaluate performance, the manager must have authority over all of these measured items. Controllable profits of a segmentresult from deducting the expenses under a manager’s control from revenues under that manager’s control.

Closely related to the profit center concept is an investment center. An investment center is a responsibility center having revenues, expenses, and an appropriate investment base. When a firm evaluates an investment center, it looks at the rate of return it can earn on its investment base.

Typical investment centers are large, autonomous segments of large companies. The centers are often separated from one another by location, types of products, functions, and/or necessary management skills. Segments such as these often seem to be separate companies to an outside observer. But the investment center concept can be applied even in relatively small companies in which the segment managers have control over the revenues, expenses, and assets of their segments.