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Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-1
Responsibility Centers
A responsibility center is the point in an organization where the control over revenue or expense is located, e.g. division,department or a single machine.
A responsibility center may be divided into three categories cost profit investment
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada9-2
Cost
Types of Responsibility Centers
Cost Center A business segment that
incurs expenses but does not
generate revenue.
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Profit Center A part of the
business that has control over both
revenues and expenses, but no
control over investment funds.
RevenuesSalesInterestOther
ExpensesManufacturingCommissionsSalariesOther
Types of Responsibility Centers
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Investment Center
A profit center where
management also makes capital
investment decisions.
Corporate Headquarters
Types of Responsibility Centers
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Measuring Managerial Performance
Return on investment (ROI) Residual income (RI)
CostCenter
Cost controlQuantity and qualityof services
ProfitCenter
InvestmentCenter
Evaluation Measures
Profitability
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Return on investment is the ratio of income to the investment used to
generate the income.
ROI = Net Income Investment
Return on Investment
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ROI = Net IncomeInvestment
ROI = Net IncomeSales
× SalesInvestment
MarginMargin TurnoverTurnover
Return on Investment
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Cola Company reports the following:
Net Income $ 30,000
Sales $ 500,000
Investment $ 200,000
Let’s calculate ROI.
Return on Investment
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ROI = 6% × 2.5 = 15%
Return on Investment
ROI = Net IncomeSales
× SalesInvestment
ROI = $30,000$500,000
× $500,000$200,000
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Improving R0I
Three ways to improve ROI
Increase Sales
Reduce Expenses
Reduce Investment
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Cola Company’s manager was able to increase sales to $600,000 which increased net income to $42,000.
There was no change in investment.
Let’s calculate the new ROI.
Improving R0I
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Cola Company increased ROI from 15% to 21%.
ROI = 7% × 3 = 21%
ROI = Net IncomeSales
× SalesInvestment
ROI = $42,000$600,000
× $600,000$200,000
Improving R0I
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ROI - A Major Drawback As division manager at Cola Company,
your compensation package includesa salary plus bonus based on your division’sROI -- the higher your ROI, the bigger your bonus.
The company requires an ROI of 20% on all new investments -- your division has been producing an ROI of 30%.
You have an opportunity to invest in a new project that will produce an ROI of 25%.
As division manager would you invest in this project?
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ROI - A Major Drawback
As division manager,I wouldn’t invest in
that project becauseit would lower my pay!
Gee . . .I thought we were
supposed to do what was best for the
company!
