1. Distinguish among cost centers, profit centers, and investment centers.
2. Evaluate the profitability of an investment center.
3. Explain the need for responsibility center information and describe a responsibility accounting system:
4. Prepare an income statement showing contribution margin and responsibility margin.
5. Distinguish between traceable and common fixed costs.
6. Explain the usefulness of contribution margin and responsibility margin in making short-term and long-term decisions.
7. Explain the differences,between full costing and variable costing.
8 Use a variable costing in-come statement in CVP analysis
COMMENTARY SIEMENS WHY THERE’S STILL NO PAY OFF
Reflecting the problem$ plaguing Corporate Germany, Siemens is still struggling with high labor costs at home and Intense competition abroad
When (Heinrich] van Plerer took over the company, he likened his task to that of General Electric CO.’s John F. Welch. Now it’s apparent that if he ever hopes to fix Siemens, he will have to read is mentor’s play~ook more carefully. Like GE, Siemens Is a conglomerate making evei’ythlng from light bulbs to computer chips to power plants. VQn Pierer’s first stabs at reform were on target
Once the authority for decision making has been’ assigned, organizations need a way to evaluate and reward declslon outcomes.. Chief executive officer at Siemens understands that giving profit-related deCision-making authority to 250 profit center rnanacers also requires merit-based pay and performance reviews
for those managers. Performance evaluation mechanisms are necessary to make sure decision outcomes are consistent with the organization’s long-term strategic goals and objectives
Most businesses are organized into a number of different subunits that Perform different functions. For example, a manufacturing company typically has departments .specializing in purchasing, production, sales, shipping, accounting, finance, and personnel. Production departments and sales departments often are further subdivided along different product lines or geographical areas. Organizing a business in this manner enables managers and employees to specialize in specific types of business activity. This type of organization also helps to establish clear lines of management responsibility.
In most business organizations, large responsibility centers are further subdivided into smaller ones. Consider, for example, a retail store within a chitin such as Sears or Wal-Mart. Each store is a responsibility center under the control of a store manager. Each store is further divided into many separate sales departments, such as appliances, automotive products, and sporting goods. Each sales department also is a responsibility center, under the control of a department manager. These department managers report to, and are supervised by, the store manager
The Need for Information About Responsibility Center Performance
An income statement measures the overaU performance of a business entity. However, managers also need accounting information measuring the performance of each center within the business organization. This information assists managers in the following tasks
1. Planning and allocating resources. Management needs to know how well various sections of the business are performing in order to set future performance goals and to allocate resources to those responsibility centers offering the greatest profit potential.
If one product line is more profitable than another, for example, the company’s over all profitability may increase by allocating more production capacity to the more profitable product.
2. Controlling operations. One use of responsibility center data is to identify those portions of the business that are performing inefficiently or below expectations. When. revenue lags, or costs become excessive, center information helps to focus management’s
attention on those areas responsible for the poor performance. If a part of the business is unprofitable, perhaps it should be discontinued.
3. Evaluating the performance of center managers. As each center is an area of management responsibility the performance of the center provides one basis for evaluating the skills of the center manager.
Cost Centers Profit Centers and Investment Centers
Business responsibility centers are usually classified as cost centers, profit centers, or investment centers. To illustrate, assume that Health corp owns and manages a 700-bed hospital and seven clinics located throughout the greater Chicago area. Each clinic is
equipped with its own medical lab and x-ray facilities
A cost center is a business section that incurs costs (or expenses) but docs not directly generate revenue.’ Health corp views its administrative departments accounting, finance, data processing, and legal services-as cost centers. In addition, it also views laundry, maintenance, and janitorial functions as cost centers. Each cost center provides services to other Health corp centers. However, none sells goods or services directly to Health corp’s patients.
Cost centers are evaluated primarily on (I) their ability to control ‘Costs and (2) the quantity and the quality of the services that they provide. Because cost centers do not directly generate revenue, Income statements are not prepared for them: However, accounting
systems must accumulate separately the cost” incurred by each cost center.
In some cases, costs serve as an ‘active basis for evaluating the performance of a cost center. For example, Health corp’s laundry service can be evaluated primarily on the basis of its cost per patient-day. In evaluating the performance of its main tenancq department, the focus is less on costs and more on a subjective assessment of whether medical equipment is properly maintained
A profit center is a part of a ‘business that generates both revenue and costs.: This chapter’s opening story identified 250 profit centers at Siemens AG. At Health corp, the hospital and each of its seven clinics are primary profit centers. Within the hospital, the pharmacy, radiology, emergency room, and food services also are viewed as profit centers.’ Likewise, in each clinic the medical lab and x-ray department are considered profit centers. Examples of profit centers in other types of organizations might include product lines, sales territories, retail outlets, and specific sales departments within each retail outlet
A some, for example, each of the labs in Healthcorp’s seven clinics is profitable. On a square-loot basis, however, the x-ray departments are far more profitable. In this case. management might consider closing some labs and using the space for additional x-ray facilities. (If labs are closed, lab work could be provided by independent medical laboratories.)