Question

1. Describe a profit center, cost center and an investment center, explaining how each is distinguished from the other. Provide an example of each type of center in your business, or if your business is not set up in this fashion, construct an example.

2. What is the relationship between contribution margin and responsibility margin? Explain how each of these measurement tools can be used by to make management decisions.

Answer 1

ANS:

1. Distinguish between a cost center, a profit center, and an investment:Center ;

Cost center has control over costs, but not over revenue or the use of investment funds.Cost center is the most limited area of responsibility fo which costs are accumulated. The manager of a cost center has control over many costs, but no control over revenues or invested capital.

Profit center has control over both costs and revenue, but not over the use of investment funds. The profit center manager is responsible for bothe renenue and expenses but not for invested capital.

Investment center has control over cost, revenue, and investment in operating assets. The investment center manger is responsible for revenue, expenses, and invested capital.

For example:

the manager of the computer department would most certainly conduct the operations of his department differently if he were responsible for managing the department as a profit center or an investment center

currently his motivation is to minimize operating costs this objective is probably accomplished by eliminating staff,providing only accptable (rather than exceptional)service and avoiding overtime work. if he is given responsibility for a profit center, he will be motivated to maximize profits, become more service oriented, search out more cost effcient methods to maintain revenue, and probably actively solicit new accounts for the service bereau aspect of his deparment.

If the department vecame and investment center, the manager would become responsible for purchasing the most economical equipment to accomplish the work of the department in order to mxmize his return on investment.

The profit center or investment center concept usually more dedicated, satisfied employee because he has control of his own business.

2. Contribution Margin - Responsibility Margin:

Contribution margin is a measurement of perfomance that takes into consideration only revenue and variable costs. Therefore, tis measuremnt is useful in evaluationg the probable outcomes of decisions that affect primarily revenue and variavle costs. These would incuude pricing decisions and other marketing stategies.

Responsibility margin is a measure of performance that takes into consideration not revenue and variable costs but also fixed costs traceavle to the responsibility center. Therefore, responsibility margin is useful in evaluting decisions that involve significant in traceable fixed costs, such as expanding or contracting plant capacity.