The following points highlight the five main types of responsibility centre. The types are: 1. Cost Centre 2. Revenue Centre 3. Profit Centre 4. Contribution Centre 5. Investment Centre.
Responsibility Centre: Type # 1. Cost Centre:
These are segments in which managers are responsible for costs incurred but have no revenue responsibilities. The performance of each cost centre is evaluated by comparing the actual amount with the budgeted/standard amount. Such centres may be made according to location or person or service or type of product.
It is essential to differentiate between controllable costs and uncontrollable costs while judging the performance of such centres. A manager responsible for a particular cost centre will be held responsible for only controllable costs.
Cost centres relate to costs only and they do not relate to revenues or assets and liabilities of the organisation. A cost centre may be a personal cost centre or impersonal cost centre such as cost centre according to location.
From functional point of view, a cost centre may be any of the following:
(a) Production Cost Centre:
It is a cost centre where production of goods is done such as in steel rolling mill hot mill, cold mill, hardening, polishing and grinding departments can be cost centres. The number of production cost centres in a factory depends upon the nature of industry, type of work performed and the size of the factory.
(b) Service Cost Centre:
It is a cost centre which renders services to production cost centres. It is not directly engaged in production though its existence is very essential for smooth and efficient running of production departments. Such cost centres as electricity or repairs and maintenance or boiler plant render a particular type of service for the benefit of other departments.
(c) Ancillary Manufacturing or Partly Producing Cost Centre:
Such type of cost centre may normally be a service department but sometimes does some productive work. A packing department producing packing materials will come under this category.
Responsibility Centre: Type # 2. Revenue Centre:
It is a centre mainly devoted to raising revenue with no responsibility for production. The main responsibility of managers of such centres is to generate sale revenue. Such managers have nothing to do with the cost of manufacturing a product or in the area of investment of assets. But he is concerned with control of marketing expenses of the product.
Responsibility Centre: Type # 3. Profit Centre:
This is a centre which has the responsibility of generating and maximising profits is called profit centre. This is a centre whose performance is measured in terms of both expenses it incurs and revenue it earns. Thus a factory may constitute a separate profit centre and sell its production to other department or the sales department.
Even within the factory, the services departments (as maintenance department) may sell their services to the production department. This is the practice in large undertakings where each divisional manager is given a profit objective and his performance is measured accordingly. The main problem in designing control system on the basis of profit centre arises in fixing transfer pricing.
Responsibility Centre: Type # 4. Contribution Centre:
It is centre whose performance is mainly measured by the contribution it earns. Contribution is the difference between sales and variable costs. It is a centre devoted to increasing contribution. The main responsibility of the manager of such a responsibility centre is to increase contribution. Higher the contribution better will be the performance of the manager of a contribution centre.
A manager has no control on fixed expenses because these expenses are constant and depend on policy decisions of the higher level of management. He can control contribution by increasing sales and by reducing variable costs. The manger of such a centre is to see that his unit operates at full capacity and contribution is maximum.
Responsibility Centre: Type # 5. Investment Centre:
A centre which is concerned with carrying an adequate return on investment is known as investment centre. It is a centre in which a manager can control not only revenues and costs but also investments. The manager of such a centre is made responsible for properly utilizing the assets used in his centre.
He is expected to earn a requisite return on the amount employed in assets in his centre. Return on investments is used as a basis of judging and evaluating performance of various people. Many large undertakings in the U.S.A. like General Motors etc. follow this system of management control.
In calculating return on investments, beginning-of-period investment, end of period investment or average investment may be taken. However, the choice seems to be between beginning-of-period investment and average investment. Divisional investment is equal to net fixed assets of the division + current assets of the division — current liabilities of the division.
As an alternative to return on investment, the performance of the responsibility centre can be measured by another method known as residual income method. Under this method a charge for the use of assets (i.e., cost of capital) is deducted from the divisional or responsibility’s centre profit and the surplus remaining after the deduction of cost of capital or imputed interest is the residual income.
Residual income method is favoured in those cases where managers of responsibility centres are autonomous and accountable for their performances and make their own investment decisions.