In: Accounting
What is meant by classifying a unit as an “investment center” vs. a “cost” or “profit” center? Discuss how each of the following tools, individually and/or collectively, can and should be used to evaluate managers of such “investment center” individual divisions of a large organization: ROI, EVA, and the Balanced Scorecard. (Hint: discuss how each works, what each helps ensure, what dysfunctional behaviors can result from its use, and how multiple approaches can help ensure behavior that aligns individual incentives with overall corporate strategy.)
Solution. A unit when is responsible and transferred to investment center when it comes or encompasses revenues, cost and capital investment of an organization. Investment center takes into account all the major financial activities in order to report accurately on organization's financial or current position in the business market to build trust with shareholder's. Whereas, a cost center encompasses all the costs units incurred by the organization for the production of goods/services during an accounting period. Cost center is responsible for recognition and record of all the direct costs and total costs incurred by an organization and forecast in budget. Profit center takes into account costs incurred and revenues generated to analyse and record profit of an organization. Profit center is responsible for decision making after analyzing such records prepared by investment and cost center in order to ignore future loss by an organization.
Cost center managers are accountable to prepare and record organization's budget by taking into account the units of production, costs incurred to convert such raw units to finished goods, and other uncertain costs if any. Any deviation from budgeted costs should be taken care in order to ignore loss. Such reports help organization in planning and controlling activities. Profit center prepares taking into record above mentioned reports in order to determine organization's profit making capacity and takes decision on price and any cost cuts for its smooth operation in market.
An investor while investing in an organization studies all share related information and determines Return on Investment(ROI) and makes decision. ROI is calculated by deducting current value of investment from investment center data and cost of investment from cost center data and dividing it to cost of investment and converted to percentage form.Economic Value Added(EVA) represents organization's true economic profit generation, it deducts organization's capital cost obtained from investment center to operating profit adjusted taxes. It represents if organization's making a positive contribution to investment made or not. Balanced Scoreboard represents organization's all center activities performance to meet organization's set objectives and targets.
Therefore, we can conclude, investment center is held accountable for proper investment accumulation to meet an organization's operational and functional cost determined and reported by cost center and transferred to profit center which assesses what generates profit and makes decision over cost overruns and deficiency in revenue generation for smooth running of an organization during an accounting period.