Profit Center

Dr. Aayat Fatima

 Profit Center
• When a responsibility center’s financial performance is measured in terms of profit, the center is
called as profit center.
• Area responsible for controlling costs and generating revenues
• Relationship between the inputs and output can be easily established.
• Performance evaluation and the control becomes comparatively easier exercise.
• Profit focuses the responsibility center’s efforts towards the ultimate goal, it motivates the
responsibility centers to employ its assets / resources in most efficient manner.
• In case of expenses center-cost needs to be controlled, but in case of profit center- achieving better
trade off between the cost incurred and profit earned.
 Conditions for delegating
profit responsibility
• Proposal to increase expenses with expectation of even greater increase in
sales revenue. Includes expense / revenue trade – off E.g. advertising
expenses , quality control expenses. Two conditions for safely delegating
the trade-off :
1. The manager should have access to the relevant information to make tradeoff
2. There should be some way to measure how effectively the manager is making these
trade offs.

• Management must decide whether the advantages of giving profit

responsibility offset the disadvantages.
 Advantages of Profit Centers
• Improved quality of decisions as decisions taken by mangers closest to the point of decision
• Increased speed
• Headquarters management can concentrate on broader issues
• Managers are freer to use their imagination and initiative
• Provide a training ground.
• Enhancement in profit consciousness
• Management of performance is broadened.
• Provides top management with information on profitability of the company’s individual components
• Always try to improve their competitive performance
 Difficulties with Profit Centers
• Loss of control
• If profit center manger is less capable, quality of decisions at unit level may be reduced
• Increase in friction due to arguments over allocation of common costs, credit of revenues etc
• Competition between profit centers
• Increase in overall management costs due to divisionalization.
• There may be more focus on short run profitability at the expense of long run profitability
• Not necessary that if the profits of each individual profit centers are optimized, it ensures the
optimization of the profits of the company as a whole.
 Measuring Profitability

• Measure of management performance

• Measure of economic performance
Types of Profitability Measures
1. Contribution Margin
2. Direct Profit
3. Controllable Profit
4. Income before taxes
5. Net Income
 illustration: Profit Center Evaluation
ABC Ltd. employs a budgetary control system which measures performance based on its product divisions A and
B. The budgeted and actual sales for a particular month are as follows:
Sales Quantity Sales Revenue

Division Budget Actual Budget Actual

A 40000 48000 400000 480000
B 80000 80000 400000 480000

The standard unit controllable variable costs are Rs. 4 and Rs. 2 for A and B respectively.
The budgeted controllable fixed costs for the month are Rs. 40,000 each for products A and B.
The attributable segment costs budgeted are Rs. 80,000 and Rs. 120,000 for products A and B.
Assume there is no opening and closing inventories, actual variable costs for the month were
Rs.168,000 and Rs.192,000 for division A and B respectively.
Actual controllable fixed costs amounted to Rs.44,000 for division A and Rs.52,000 for division
B.
Actual attributable segment costs are Rs.88,000 for A and Rs.1,28,000 for B.
The common firm wide costs are assumed to be Rs.96,000 to be apportioned on the basis of
segment sales revenue.

Prepare performance evaluation report if ABC Ltd. Employs profit center basis of divisional
performance.