10.3 Define cost, revenue, profit and investment centres and explain why managers of each must be evaluated differently.

Cost centres

A cost centre manager has control over costs but not over revenue or capital investment (long-term purchasing) decisions. Managers in cost centres are only held responsible for costs under their control. Performance reports for cost centres typically focus on differences between budgeted and actual costs using variance analysis. Other performance measures used include comparison to benchmark cost per unit / service, industry benchmarks (for example R&D costs as a percentage of sales) and efficiency measures such as days to order fulfillment.  The purchasing manager of a store, the production manager for a particular type of product in manufacturing departments, the maintenance manager in a hotel, and the human resources manager of a CPA firm would likely be considered managers of cost centres. The manager of a cost centre should be evaluated on how well he or she controls costs in the respective segment. Cost centre managers are expected to minimise cost for certain level of output or maximise output for a certain level of cost.

Revenue centres

A revenue centre manager has control over the generation of revenue but not costs. Revenue centres frequently sell products from manufacturing sub-units and have no control of the costs incurred while manufacturing. Performance reports of a revenue centre often focus on sales price variances. Other performance measures used include growth in revenues and customer satisfaction. Examples of managers of revenue centres include the sales manager of a retail store, the sales department of a production facility, and the reservation department of an airline. Managers here are expected to maximise sales.

Profit centres

A profit centre manager has control over both cost and revenue but not capital investment decisions. As profit centres include both revenues and costs, performance reports typically focus on income (revenue – costs) measures, such as segment margins. Other performance measures used include revenue and cost budgets and variances, operating income or EBIT. While the purchasing manager of a retail store is a cost centre manager, the overall manager of the store will probably be a profit centre manager. Likewise, the manager of an entire product line in a factory, the manager of a particular location of a hotel chain, and the partner in charge of the tax department at a CPA firm would be considered profit centre managers. So here managers need to maximise sales but also minimise costs.

Investment centres

Lastly, an investment centre is a separate business with its own value chain, commonly referred to as strategic business units (SBUs). Investment centre managers can be evaluated similar to profit centres, but tools are adjusted for the amount of assets or investments they also control. Investments here include any assets related to the investment centre such as PPE, intangible assets, etc. Examples of investment centre managers include the core division manager of an international company or a corporate headquarters in a large decentralised organisation. Because investment centres include revenue, costs and investment, performance measures need to consider all factors such as the amount of assets invested in generating income. We will learn two of the commonly used measures: Return on investment (ROI) and Residual Income later in Section 10.5.

In the next section, we explore profit centres and how segmented income statements can be a useful management accounting tool to measure the performance of sub-units within a business.