The performance of each centre and its manager is measured and controlled through a system of responsibility accounting which is based on the principles of locating responsibility and tracing costs/revenue/investments etc. to the individual managers who are primarily responsible. The division of the firm into separately identifiable units of responsibility allows for more accurate measurement of managerial performance because local information is more thorough. Overall, in order to obtain an accurate measurement of managerial performance, measures should be based on elements which the manager can control or significantly influence.
There are three main types of responsibility centre. A cost centre is the lowest level of responsibility, and performance is measured in terms of the costs incurred by it. Cost centres do not generate revenue and therefore have no profit objectives, which differentiates it from profit and investment centres. Managers of cost centres are accountable only for controllable costs and are not responsible for level of activity or long-term investment decisions. Managerial performance is measured by efficiency of operations in terms of the quantity of inputs used in producing a given output. The basis of this type of measurement lies in comparing actual inputs to budgeted controllable costs or some predetermined level that represents efficient utilisation. Cost control and efficiency of operations are the main elements of this type of unit. However, costs in general can be difficult to measure, trace and allocate and it can be difficult to differentiate between controllable and uncontrollable costs. This poses a major drawback for the evaluation of cost centres and their management, since cost is its main element of measurement. The focus being mainly on costs, makes this centre some-what weak in terms of evaluation and measurement of managerial performance.
Cost centres can be split into two different types; standard cost centres and discretionary cost centres. In the former, measurement is exercised by comparing standard cost with actual cost. Variances would be indicative of the efficiency of the centre and therefore its managers’ performance. Discretionary cost centres are centres where output cannot be measured in financial terms, for example advertising and publicity, R&D etc. ‘Control normally takes the form of ensuring that actual expenditure adheres to budgeted expenditure for each expense category.’2 However, a major problem with this type of responsibility centre is the measurement of the effectiveness of expenditure and the determination of the efficiency of the centre itself and its management.
A profit centre offers an additional element to the measurement process in that both inputs and outputs are measured in monetary terms. The manager of a profit centre has increased autonomy as s/he is responsible for revenue as well as costs; hence it is easier to measure the effectiveness and efficiency of managerial performance in financial terms. ‘In this situation, managers are normally free to set selling prices, choose which markets to sell in, make product-mix and output decisions and select suppliers.’3 A profit centre differs form a cost centre in that its main objective is to...