In a large organisation, tasks are subdivided amongst smaller groups that focus on a particular objective. These small groups work synchronously to achieve the organisational goal.
These small subgroups are known as responsibility centre. Each have their targets and objectives which they need to achieve within a defined timeframe. These subgroups have their resources, procedures, financial reports, and responsibilities divided so that they can function independently and contribute towards the common objective.
The accountabilities given to these responsibility centres can be related to cost incurred in the process. It can also be investment-related, profit-related or revenue-related.
Let us take an example to understand the role of these subgroups in an organisation.
KLM enterprise, manufactures a range of denim wear like shirts, pants, tops, Kurti, etc. The company need capital investment from time to time to carry out large business operations. And like every other business, they produce goods and sell them in the market to generate revenue.
Now, seeking the best investment option is quite different a task than looking for a profitable market where one can sell goods to maximise profit. And in a large organisation, every job is divided into subgroups.
Here, there is a group which dedicatedly deals with investment-related decisions and another which determines the target market to sell products out of several other subgroups. These subgroups are different types of responsibility centres.
From the above example, one can conclude that each such subgroup has defined targets which they need to achieve. And large organisations specially divide their work into smaller sections and assign each responsibility centre with one task.
Further, depending upon the type of task and duty they are assigned with, these can be segregated in various kinds.
Types of Responsibility Centres
Below mentioned are the 4 types which every large organisation has.
Investment Centre
Investment centres are the subgroups in an organisation which is responsible for making any investment-related decisions. From the acquisition of funds to collection of debts, every cost and revenue related activity comes under this section.
The manager handling these subsections needs to assign tasks and make the right decision regarding investment. In business, there are times when the available working capital isn’t enough to carry the necessary business operations.
In such times, businesses have to look for sources of investment, be it external source or internal source. They need to decide if they will borrow from financial institutions and other sources or want to acquire funds by liquefying an asset. All these decisions are taken by these types of responsibility centres.
Cost Centre
An expense centre or cost centre’s responsibilities are confined to cost incurred in various business operations. They are responsible for budget planning and cost control for various services in different departments in an organisation.
To put simply, cost centres are responsible for managing costs of operation for various departments and units. They can direct the accounting department, production department, human resource department, maintenance department, etc.
Lets take an example.
A product based company may treat various individual departments as cost centre units wherein the respective managers act as cost centre managers. These managers further report to the plant manager regarding cost-related matters. Or, there can be a dedicated department which handles the cost operations of all other departments working in the organisation.
Revenue Centre
A revenue centre is responsible for generating and managing all the revenues a business makes. Though these types of responsibility centre can’t interfere in the matters of cost and expenses, they may have a say on budgeted marketing expenses.
Revenue centres can assess the estimated expenditures for marketing with the actual price and develop ways to generate more revenues for the organisation. Here, sales representatives, marketing managers, etc. can be a part of this revenue centre.
Profit Centre
A profit is the surplus amount of revenue that a company generates, after excluding the total cost of operation. A profit centre is concerned with the profit earned by a company as they manage and operate different functions of sales.
The entire team works upon the sales strategy and marketing tactics so that they can improve the earned profit percentage. So, departments handling tasks of sales and expenses are a part of the profit centre.
Now that you have learned the basic concept of responsibility centres and their importance in the organisation test your understanding by answering these questions yourself.
Test Your Knowledge
Choose the Correct Option Which Holds True for a Responsibility Centre
Controlling costs isn’t a part of its operations
It may lead to conflicts within departments
It concentrates dedicatedly towards the product, outcome, and process
None of the above
Choose the One(s) Which are Responsibility Centres
Expense centre
Profit centre
Investment centre
All of the above
The Responsibility Centre is Segregated into How Many Types
Three
Four
Two
None of the above
With such pointers, it will be easier for students to understand the concept of responsibility centre. However, for a more comprehensive understanding of the idea, students can download Vedantu’s app and start learning in-depth. Students will be able to understand the topics precisely by adhering to the study material prepared by experienced tutors.
FAQs on Responsibility Centers: Definition and Types
1. What is a responsibility center in the context of management accounting?
A responsibility center is a specific segment or subunit of an organisation, such as a department or a division, whose manager is held accountable for a particular set of activities. The primary purpose is to delegate authority and evaluate performance by measuring the subunit's results against pre-set goals, facilitating better management control and decision-making.
2. What are the four main types of responsibility centers in a business?
The four principal types of responsibility centers are defined by the financial scope a manager is accountable for. These include:
Cost Centre: A segment where the manager is only responsible for controlling costs.
Revenue Centre: A segment where the manager is primarily accountable for generating sales revenue.
Profit Centre: A segment where the manager is responsible for both revenues and costs, and therefore, profits.
Investment Centre: A segment where the manager is accountable for profits as well as the effective utilisation of the assets invested in that center.
3. Can you provide a real-world example for each type of responsibility center?
Certainly. In a large manufacturing company, the different responsibility centers could be:
Cost Centre Example: The Human Resources (HR) department or the factory's maintenance department, as they incur costs but do not directly generate revenue.
Revenue Centre Example: The company's sales or marketing department, which is tasked with generating orders and meeting sales targets.
Profit Centre Example: A specific product line (e.g., the 'Smartphone Division') which has its own sales and production costs, making its profitability measurable.
Investment Centre Example: A self-contained subsidiary or a major regional division of the company that is expected to generate a target return on its assets.
4. What is the key difference between a Profit Centre and an Investment Centre?
The key difference lies in the scope of accountability. A Profit Centre manager is evaluated based on the profit generated (Revenue - Expenses). However, an Investment Centre manager is evaluated on not just the profit, but also on how effectively they use the centre's assets to generate that profit. This is often measured using metrics like Return on Investment (ROI), making their responsibility broader.
5. How does the principle of 'controllability' apply to responsibility centers?
The principle of controllability is fundamental to responsibility accounting. It states that a manager of a responsibility center should only be held accountable for the outcomes (costs, revenues, or investments) that they have direct control or significant influence over. For instance, a production manager (cost centre) should not be penalised for an increase in raw material prices set by the purchasing department, as it is a non-controllable cost for them.
6. Why is a simple Cost Centre not evaluated based on the profits it helps generate?
A Cost Centre, like a factory's production unit, is not evaluated on profits because its manager has authority only over incurring costs, not over generating revenue. The marketing and sales departments are responsible for pricing and selling the products. Evaluating the production unit on profit would be unfair and ineffective, as the manager does not control the key drivers of revenue. Their performance is therefore measured by their efficiency in managing and minimising controllable costs.
7. How do responsibility centers contribute to the decentralisation of an organisation?
Responsibility centers are a core tool for implementing decentralisation. By creating these centers, top management delegates decision-making authority to lower-level managers. For example, a profit center manager is empowered to make decisions about both production and sales to maximise their unit's profit. This delegation frees up senior management to focus on strategic planning, while motivating center managers and enabling faster, more responsive decisions at the operational level.
