Difference Between Cost Centre and Profit Centre - Key ...

Cost Centre is the smallest unit of the organization for which cost is accumulated separately to determine cost incurred. But, Profit Centres ... AcentreforwhichcostisascertainedandusedtocontrolcostisCostCenter.WhereasacentrewhoseperformancewecanmeasurethroughitsincomeearningcapacityisProfitCenter. Wedividetheorganizationintovarioussub-unitsforthepurposeofcosting.Thatisthecollectionandutilizationofcostdatainanoptimummanner.Thesesub-unitsarethesmallestareaofresponsibilityorsegmentofactivity.Suchsub-unitsarenothingbutcostcentres. Inthesimplestsense,thosesectionsoftheorganizationwherecostsareincurredandrecorded,eitherbyitem,byproductorbythedepartment,arecostcentres.Ontheotherhand,profitcentreisthatsectionoftheorganization,inwhichtheincurrenceandrecordingofbothcostsandrevenueareeitherbyproductorproductline. Bothoftheseplayaprominentroleintheorganization.Thesesupplyinformationthatassiststhemanagersindecisionmaking.Also,itimprovesaccountability,helpsidentifyingissuesandbenchmarking. WhatisResponsibilityCentre? Aresponsibilitycentreistheunitofabusinessorganization,apersonordepartmentresponsibleforaspecifictaskoractivity.Anothertermforresponsibilitycentreisactivitycentre.Wemeasuretheperformanceofthesecentresintermsof: Expenditure Revenue Returnoninvestment Profitability. Hence,therearefourmajortypesofresponsibilitycentres: Inthispost,youwillcometoknowthefundamentaldifferencesbetweencostcentreandprofitcentre. Content:CostCentreVsProfitCentre ComparisonChart WhatisCostCentre? Example Need Division Types WhatisProfitCentre? Example Advantages Disadvantages Importance KeyDifferences TransferPrice Conclusion ComparisonChart BasisforComparisonCostCentreProfitCentre MeaningAcostcentreisaseparatepartofbusinesswhereindirectandindirectcostsareincurredandrecorded.Theprofitcentreistheresponsibilitycentrethatmeasuresinputsasexpensesincurredandoutputismeasuredasrevenuereaped. Whatisit?Smallestorganizationalunitforwhichcostiscollectedseparately.Anysub-unittowhichbothcostandrevenueareassigned. ObjectiveToidentifyandcontrolcost.Todelegateauthorityandfixresponsibilitytoindividualsordepartmentstoevaluateperformance. AutonomousNoYes ResponsibleforCostonlyBothcostandrevenue AreaofOperationNarrowWide PerformanceMeasuredagainstpre-determinedstandardsorbudgets.Profitability DivisionisaresultofAccountingconvenienceDecentralizationofoperations WhatisCostCentre? Acostcentrecanbealocation,person,anitemofequipmentforwhichwedeterminecost.Thereafter,thiscostischargedtotheproduct.Foreffectivecontrolofcosts,wedividethefactoryintovariousdepartments.Further,onthebasisoftheactivitiesperformed,thesedepartmentsaresub-dividedintocostcentres.Inacostcentre,itispertinenttoclassifycostintofixedcostandvariablecost. Tomakeaperiodicalcomparisonandcontrolcost,determinationofanappropriatecostcentreandanalysisofcostunderthecostcentreisimportant.Toselectanappropriatecostcentrethefirmtakesthefollowingfactorsintoconsideration: Organizationoffactory Informationavailability Conditionofincidenceofcost Requirementofcost Managementpolicyasregardsselectionmethod Note:Alargenumberofcostcentreswillbeexpensivewhereasafewcostcentreswon’tservethepurpose.Hence,thesizeofthecostcentreisrelyonthreefactors: Operation Activity Feasibility ExampleofCostCentre Clothmakinginvolves: Spinning, Weaving Dyeing,printingandfinishing Garmentmanufacturing Toaccumulatecost,wetreateachsuchactivityasacostcentre.Andtocalculatethecostofproductionoftherespectivecostcentre,allthecostsrelatedtothatparticularactivitywouldbeaccumulatedseparately. Whydoafirmneedscostcentres? Thinkofasituationwhenthewholefactoryistreatedasasingleunitforbothbudgetingandcostcontrolpurposes.Whatamessitcouldbetocomparethestandardswiththeactualfigures.Inthissituation,thedesiredobjectivewillnotbeachieved.Hence,thesubdivisionofthefactoryintoanumberofdepartmentsbecomesessential. However,thisdivisionisstillnotappropriatebecausethedepartmentsarebig.Andduetothisreasoncomparisonbecomesdifficult.So,thesedepartmentsarefurthersubdividedintoacostcentre.Therefore,wecanmakeacomparisonofthecostthatisaccumulatedcostcentre-wise,withthestandards,estimatesandbudgets.Thishelpstocontrolcostandfixresponsibility. DivisionofCostCentre OnthebasisofDepartment:Here,eachdepartmentisaseparatecostcentre.ForexampleFinance,HumanResources,Purchase,Production,Marketing,ResearchandDevelopment. OnthebasisofProduct:Anorganizationproducingmultipleproductscouldmakeeachproductaspecificcostcentre.ForExample,LGmanufacturesrefrigerators,washingmachines,microwaves,television,smartphonesandsoon.Eachsuchproductcanbeacostcentre,asthefirmincursacostontheirproduction. Onthebasisoflocation:MNCslikePepsicoorApplearelocatedinvariouspartsoftheworld.Eachoftheseareasinwhichthebusinessarepresentisacostcentre. OnthebasisofEmployee:Therearesomeorganizationswhereinindividualstaffmembersincurscosts.So,theseindividualsarecostcentres.ForExample,Salespersonsormanagersascostcentres. TypesofCostCentre Thetypeofcostcentrereflectsthespanoftheorganizationforwhichseparatecostsaredeterminedtomakedecisions.Itcanbe: BasicClassification PersonalCostCentre Thistypeofactivitycentrecomprisespersonsorgroupsthereofinconnectiontowhichcostsareascertained.Forexample,salesmanagerworksmanager,andsoforth. ImpersonalCostCentre Suchanactivitycentrecomprisesoflocation,departmentoranitemofequipmentisanimpersonalcostcentre.Forexamplesalesregion,warehouse,machineshop,andsoon. FurtherClassification ProductionCostCentre Thecentreswherethefirmundertakesproductionorconversionactivitiesisproductioncostcentres.Heretransformationofrawmaterialintosuchproductswhicharereadyforsalestakesplace.ForexampleMachineshops,Millingshops,Bakingshopsetc. ServiceCostCentre Thesecentresactasauxiliaryunitstotheproductioncostcentre.ForexampleCanteen,Maintenanceshop,Toolroom,Accounts,PowerHouse,etc. OtherTypes OperationCostCentre Itrepresentssuchmachinesorpersonswhichundertakethesameoperations.Theaimistodeterminethecostofeachoperationregardlessofthelocationwithintheunit. ProcessCostCentre Itrepresentsthosecostcentresthatundertakeaspecificprocessoraseriesofoperations.ForExampleOilRefineries,Steelrollingetc. AlsoRead:DifferenceBetweenCostCentreandCostUnit WhatisProfitCentre? Aprofitcentreisatypeofresponsibilitycentrewhereinthemanagerofthecentreorunitisresponsibleforbothcostandrevenuefortheassetassignedtothedivision.Here,wemeasureinputsintermsofexpenses.Whereaswemeasureoutputsintermsofrevenues.Inthisway,themeasurementofboththeelements,i.e.cost(input)andrevenue(output)isintermsofmoney.Andthedifferencebetweenthesetwoelementsistheprofit. ProfitCentrereferstothatpartofthefirmforwhichcollectionofbothcostandrevenuetakesplace.Theseareresponsibleforgeneratingprofitbeitthroughcontrollingcostorincreasingrevenue.Themanagersofprofitcentresfocusonboththeproductionandmarketingoftheproduct.Itistheresponsibilityofthemanageroftheprofitcentretogeneraterevenueandincurcostsinamannertomaximizeprofit. Wemeasuretheperformanceofaprofitcentreonthebasisofwhetherthecentresucceededinachievingitsbudgetedprofitornot.Wecanalsosaythatthecompany’sdivisionthatproducesandmarketsproductsistheprofitcentre.Themanagerofthedivisiondecides: Sellingprice Marketingprogrammes Productionpolicies Withthehelpoftheprofitcentre,itiseasiertoanalysehowmucheachcentregeneratesprofit. ExampleofProfitCentre Kiacanidentifythehighlyprofitablecarmodelsbymakingacomparisonoftheprofitmadebyeachmodel. Similarly,aSupermarketchainlikeBigBazaarorWalmartcanidentifytheirhighlyprofitablestoresbymakingacomparisonoftheprofitmadebyeachcentre. Important:AsperGenerallyAcceptedAccountingPrinciples(GAAP),werecognizerevenueonlywhenthecompanymakessalestooutsidecustomers.Buttomeasuretheperformanceofaprofitcentre,revenueindicatesthemonetarymeasurementoftheoutputofaprofitcentreinaparticularaccountingperiod,regardlessofthefactthatthefirmhasactuallyrealisedtherevenueforthatperiod. AdvantagesofProfitCentre Broad-basedmeasurement Relieftotopmanagementfromday-to-daydecisionmaking Improvementinthequalityofdecisions DisadvantagesofProfitCentre Sub-unitsmaycompetewitheachother,leadingtoalackofcoordination Increaseinfrictionamongvariousdivisions.Alsoargumentsovertransferpricethatoneprofitcentreisgoingtochargefromanothermaybethere. AlsoRead:DifferenceBetweenCostControlandCostReduction ImportanceofProfitCentre Becausemanagerstakealltheimportantdecisionsregardingproductmix,promotionmixandtechnologyused.Thus,theirdecisioninfluencesbothrevenuesandexpenses.So,wecanmeasuretheperformanceofthedivisionintermsofprofits. Profitmadebyaprofitcentreisaresultofrevenueminuscost.Thefirmmayfacedifficultyinmeasuringprofitduetotransferprices,jointrevenueandcommoncost.Thisisbecause,inmostmanufacturingfirms,intra-companytransactionstakeplace.Thismayincludesalesbyoneunittoanother. Transferpriceisnothingbutthevalueplacedontheexchangeofgoodsandservicesbetweentwoprofitcentres.Andthewayinwhichwedeterminethisprofit,willdecidetheprofitabilityofthesupplying(selling)andreceiving(buying)profitcentre. KeyDifferencesBetweenCostCentreandProfitCentre CostCentreisanareaofactivityinwhichwedividetheorganizationintovarioussub-unitsinapropermannerforthepurposeofproductcosting.Ontheotherhand,themonetarymeasureofoutputisrevenueandthemonetarymeasureofinputistheexpense.Andwhenwedeductexpensesfromrevenue,wegettheprofit.Thus,whenwemeasuretheperformanceofaresponsibilitycentreintermsofrevenueearnedandcostincurred,isaprofitcentre. CostCentreisthesmallestunitoftheorganizationforwhichcostisaccumulatedseparatelytodeterminecostincurred.But,ProfitCentreshelpinevaluatingbothsegmentalperformanceandmanagerialperformance. Theobjectiveofthecostcentreistoascertainandcontrolcost.Whereastheaimofaprofitcentreistodelegateauthorityandfixresponsibilitytoindividualsordepartmentstoevaluateperformance. Whilethecostcentreisnotautonomous,theprofitcentreisautonomous. Thecostcentreisresponsibleonlyforcosts.Whiletheprofitcentreisresponsibleforboththecostsandrevenue. Asthecostcentrekeepsarecordofcostsonly,itsareaofoperationisnarrowerincomparisontotheprofitcentre. Onecanmeasuretheperformanceofthecostcentrebycomparingactualdatawiththestandardofbudgetedtargets.Incontrast,theprofitabilityofthecentreactsasameasureoftheperformanceofaprofitcentre. Thecreationofacostcentreisfortheconvenienceofaccounting.Whereas,thecreationofaprofitcentreisaresultofdecentralizationanddelegationofauthority. WhatistheTransferPrice? TransferPricereferstothepriceweusetomeasurethetotalamountofgoodsandservicesthatoneprofitcentresuppliestoanotherwithintheorganization.Thisimpliesthatwhentheinternaltransferofgoodsandservicesoccursbetweendifferentprofitcentres,itsexpressionshouldbeintermsofmoney.Hence,themonetaryamountofinter-divisionaltransfersisthetransferprice. Themajorissuethatprofitcentresencounteristheascertainmentofthetransferprice.Theuseoftransferpriceisthatforthecentrewhosegoodsarebeingtransferred,itisasourceofrevenue.Butforthecentrewhichisreceivingthegoods,itisanelementofcost.Inthisway,ithasagreatimpactontherevenue,costandprofitsofthecentre.So,oneshoulddetermineitcarefully. Conclusion Allinall,wehaveunderstoodthatthetwoarequitesimilarbutthedifferenceliesinthefactthatbesideskeepingarecordofthecostsateachcentre,profitcentrealsokeepsatrackofrevenuesintheprofitcentre.However,costcentresonlyrecordcosts. 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