ACC 148: Performance Management System
Student Activity Sheet #13
Name: ________________________________________________________
Section: ____________ Schedule: ________________________________
Lesson title: Financial Responsibility Centers
Lesson Objectives: At the end of the lesson, I should be able to:
1. Enumerate and distinguish the four basic types of financial responsibility
centers; and
2. discuss transfer pricing and its purposes.
Class number: ______
Date: ____________
References:
Management Control Systems Fourth
Edition by Kenneth A. Merchant &
Wim A. Van der Stede
Productivity Tip: “Self-belief does not necessarily ensures success, but self-disbelief assuredly spawns failure.”-Albert
Bandura
A. LESSON PREVIEW/REVIEW
1) Introduction (2 mins)
Financial results control systems have three core elements: (1) financial responsibility centers; (2) planning and
budgeting systems; and (3) incentive plan contracts. This module will provide you an introduction to the first core
element of financial results control systems, the financial responsibility centers. Also, this module will discuss
how the pricing of goods and services that are transferred from one organizational entity to another entity’s
financial performance. The next module, Module #14, will discuss planning and budgeting systems, the second
core element of financial results control system. On Module # 15, the third core element, incentive plan contracts,
will be discussed. Make sure to highlight the important points you learn from this topic. Good luck!
2) Activity 1: What I Know Chart, part 1 (3 mins)
What I Know
Questions:
1 What are the four basic types of
financial responsibility center?
2. What is meant by the term “cost
center”?
3 What is transfer pricing?
What I Learned (Activity 4)
B.MAIN LESSON
1) Activity 2: Content Notes (13 mins)
Note: The term “cost center” also has a cost accounting meaning that is different from its meaning here in the
context of responsibility center management. Most firms are comprised of many cost centers set up for cost
accounting purposes to collect like-type costs and assign them to products and services, but these are not
responsibility centers because they focus on cost categorizations rather lines of authority over expenses by
managers in charge of organizational entities with accountability for a cost budget.
Financial responsibility centers are one of the core elements of financial results control systems. The definition of
financial responsibility centers are important because they provide managers signals about what financial
statement line items they are expected to pay attention to. Responsibility center management denotes the
apportioning of responsibility for a particular set of outputs and/or inputs to an employee in charge of the
There are four basic types of financial responsibility centers: investment centers, profit centers, revenue centers,
and cost centers.
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ACC 148: Performance Management System
Student Activity Sheet #13
Name: ________________________________________________________
Section: ____________ Schedule: ________________________________
Class number: ______
Date: ____________
Table 13.1 shows the types of financial responsibility centers
Selected financial statement line items
Revenue
Cost
Profit
Investment
center
center
center
center
Income Statement
Revenue
x
x
x
x
Cost of goods sold
x
x
x
Gross margin
x
x
Advertising and promotion
x
x
x
Research and development
x
x
x
Profit before tax
x
x
Profit after tax
x
x
Balance sheet
Accounts receivable
x
Inventory
x
Fixes assets
x
Accounts payable
x
Debt
x
Revenue Centers
These are responsibility centers whose managers are held accountable for generating revenues, which is a
financial measure output. Common examples are sales management and, in non-profit organizations, fundraising
managers.
Revenues, rather than profits, provide a simple and effective way to encourage sales managers to attract and retain
customers. However it will encourage them to make profitable sales if, and only if, it can be ascertained that all
sales are approximate equally profitable.
Cost Centers
Cost (or expense) centers are responsibility centers whose managers are held accountable for some elements of
cost. Costs are a financial measure of inputs to, or resources consumed by, the responsibility center.
 In standard cost centers (sometimes called engineered cost centers) , such as manufacturing departments,
the causal relationship between inputs and outputs is direct, and both inputs and outputs are easy to
quantify. Thus, control can be exercised by comparing standard cost with the costs that were
actually incurred. In your subject cost accounting and management accounting, this is called variance
analysis.

Note: standard cost is the cost of the inputs that should have been consumed in producing the output.
In discretionary cost centers (sometimes called managed cost centers), such as research and development
department and administrative departments (e.g. personnel, purchasing, accounting, estates), the output
produces are difficult to value in monetary terms. The relationship between inputs and outputs is not well
known. Thus, evaluations of discretionary cost center managers’ performances often have a large
subjective component to them. Control is usually exercised by ensuring that the discretionary cost
centers adheres to the budgeted level of expenditures while successfully accomplishing tasks
assigned to it.
Profit Centers
These are responsibility centers whose managers are held accountable for some measure of profits, which is the
difference between the revenues generated and those costs of generating those revenues.
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ACC 148: Performance Management System
Student Activity Sheet #13
Name: ________________________________________________________
Section: ____________ Schedule: ________________________________
Class number: ______
Date: ____________
Profit center managers are held accountable for profits but not for the investment made to generate them. That is
the distinction of a profit center from am investments center.
In deciding whether the or not a responsibility center manager truly has profit center responsibility, the critical
question to ask is whether the manager has significant influence over both revenues and costs.
 Sales-focused entities are made into profit centers by charging the entity managers the standard cost of the
products sold, thus making them accountable for gross margin.
 Cost-focused entities are assigned revenues based on a simple function costs. For example, when a
manufacturing and administrative departments supply unique products or services, the external market
prices cannot be determined but to internal customers only. Revenues for these entities might be
calculated as cost plus markup.
Investment Centers
These are responsibility centers whose managers are held accountable for both some income statement and some
balance sheet line items; that is, for both the accounting returns (profits) an the investments made to generate
those returns. A corporation is an investment center, so top-level corporate managers, such as chief executive,
often are investment center managers. The managers of many subdiaries, operating groups and divisions in large,
decentralized organizations are also considered as invesrment center managers.
Variations
Table 13.2 Four types of “profit” center
Selected financial statement line
Gross margin
items
center
Income statement
Revenue
x
Cost of goods sold
x
Gross margin
x
Advertising and promotion
Research and development
Profit before tax
Profit after tax
Incomplete
profit center
Before-tax profit
center
Complete
profit center
x
x
x
x
x
x
x
x
x
x
x
x
x
x
x
x
x
a. Gross margin center managers may be salespeople who sell products of varying margins and who are charged
with the standard cost of the goods they sell.
b. The incomplete profit center managers may be managers of product divisions but without authority for all of
the functions that affect the success of their products or product lines, such as research and development or
advertising.
c. Complete profit center managers may be business unit managers who are accountable for all aspects of the
worldwide performance of their business segment.
Choice of financial responsibility centers
Revenue and cost center manager are held accountable for only one, or sometimes a few, income statement line
items. Profit center managers are held accountable for some revenue and some expense line items. Investment
center managers are held accountable for a measure of profit that is related directly to the resources consumed by
their entity as reflected by line items on the balance sheet.
This document is the property of PHINMA EDUCATION
ACC 148: Performance Management System
Student Activity Sheet #13
Name: ________________________________________________________
Section: ____________ Schedule: ________________________________
Class number: ______
Date: ____________
One important point to keep in mind is that the lines between the financial responsibility center types are not
always easy to discern, responsibility labels are not always informative. Much more impotents that labelling are
the decisions that have to be made in designing financial responsibility structures.
The important question to ask is: Which managers should be held accountable for which specific financial
statement line items? These choices are obviously important because they affect behaviour. Managers pay
attention to the measures for which they are held accountable. Thus, from a behavioral angle, the answer to the
question is relatively straightforward: Hold managers accountable for line items you want them to pay
attention to.
In a large firm, firm’s financial responsibility center structures are coincident with the manager’s areas of
authority. Areas of authority are defined by organization structures and policies that define manager’s decision
rights.
 In a typical functional organization, none of the managers has significant decision making authority over
both the generation of revenues and incurrence of costs.
 In a typical divisionalized organization, division managers are given authorities to make decisions in all,
or at least many, of the functions that affect the success of their division.
Decisions about the organization’s structure do not necessarily precede decisions about the type of responsibility
centers to be used. The responsibility structure decision can come first. The desire to have the managers pay
attention to a particular line item does not necessarily mean that the managers need to have a direct control and
complete control over the item, although it should mean that the managers have some influence over the line item.
The transfer pricing problem
Profit centers often supply products or services to other profit centers within the same firm. When that
happens, some mechanism for determining the prices of the transfers must be established. Transfer
prices directly affect the revenues of the selling (supplying) profit center, the costs of buying (receiving) profit
center and the profit of both entities, thus essentially making transfer prices subject to “zero-sum” considerations
(that is revenue for one is more cost for the other). The impact of these transfer prices depend largely on the
number and magnitude of internal transfers relative to the size of the entity.
When the amount of transfer significant, failure to set the rights transfer prices can significantly affect a number
of important decisions which includes those regarding production quantities, sourcing, resource allocations and
evaluations of the managers of both selling and buying profit centers.
Purposes of transfer pricing
 To provide the proper economic signals so that the managers affected will make good decisions.
 The transfer prices and subsequent profit measurements should provide information that is useful for
evaluating the performance of both the profit centers and their managers.
 Transfer prices can be set to purposely move profits between firm locations.
These multiple transfer pricing purposes often conflict.
To summarize today’s lessons, we discussed the how the financial responsibilities usually congruent with the
managers’ authorities or decision rights, but there are exemptions. Sometimes managers are held accountable for
financial statement line items over which they have no direct authority because the accountability empowers them to
influence the actions of those who do have direct authority. Also, we discussed how the pricing of goods or services
that are transferred from one organizational entity to another often causes problems in the measurement of an entity’s
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ACC 148: Performance Management System
Student Activity Sheet #13
Name: ________________________________________________________
Section: ____________ Schedule: ________________________________
Class number: ______
Date: ____________
financial performance. Except in the rare situation where there is a perfectly competitive external market for the
internally traded good or service, no transfer pricing approach can guide profit center managers to make decisions that
are optimal form the corporation’s perspective and simultaneously provide good information evaluation. Incentives to
move profits between firm locations with different tax jurisdictions cause additional transfer pricing considerations.
Transfer pricing methods based on market prices or full cost, and variations thereof, are in common use, but some
companies also use negotiated transfer prices. No method is superior in all settings; each has its advantages and
disadvantages.
2) Activity 3: Skill-building Activities (18 mins)
Briefly discuss the following:
1. Contrast the four basic financial responsibility centers
2. Differentiate the control for standard costs and discretionary cost centers
3. Transfer pricing
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ACC 148: Performance Management System
Student Activity Sheet #13
Name: _________________________________
________________________________________________________
Section: ____________ Schedule: ________
________________________________
Class number: ______
Date: ____________
Exercise 2. Enumerate the purposes of transfer pricing.
3) Activity 4: What I Know Chart, part 2 (2 mins)
Now let’s check your final understanding of providing feedback.. I hope that everything about the topic is
clear to you. This time you have to fill out the What I Learned column.
4) Activity 5: Check for Understanding (5 mins)
5) Exercise. True or False. Write T on the space provided before the number if you think the statement is correct,
otherwise F.
______1. If revenue center managers are not charged for the cost of goods or services they sell but they can be
accountable for their salesmen salaries and commissions and perhaps some travel, advertising and promotional
expenses.
______2. The evaluation of discretionary costs centers are objective rather than subjective.
______3.. Standard costs are the costs of the inputs that should have been consumed in producing the output.
______4. Expense is the difference between the revenues generated and the costs of generating those revenues.
______5. Profit center managers are also he
held
ld accountable for the investment made to generate them. ______6.
CEOs are often investment cost managers.
C. LESSON WRAP-UP
1) Activity 6: Thinking about Learning (5 mins)
A. Work Tracker
You are done with this session! Let’s track your progress. Shade the session number you just completed.
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ACC 148: Performance Management System
Student Activity Sheet #13
Name: ________________________________________________________
Section: ____________ Schedule: ________________________________
Class number: ______
Date: ____________
A. Think about your Learning
1. Please read again the learning targets for the day. Were you able to achieve those learning targets?
If yes, what helped you achieve them? If no, what is the reason for not achieving them?
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_________________________________________________________________________________
_________________________________________________________________________________
2. In today’s session, which part of the lesson was least clear to you?
_________________________________________________________________________________
_________________________________________________________________________________
_________________________________________________________________________________
_________________________________________________________________________________
_________________________________________________________________________________
FAQs
1.
KEY TO CORRECTIONS
Exercise #1 (Suggested Answers)
1. Revenue Centers are responsibility centers whose managers are held accountable for generating revenues,
which is a financial measure output. Common examples are sales management and, in non-profit organizations,
fundraising managers while cost centers are are responsibility centers whose managers are held accountable for
some elements of cost. Profit centers are managers are held accountable for some measure of profits while
investment centers are responsibility centers whose managers are held accountable for both some income
statement and some balance sheet line items; that is, for both the accounting returns (profits) an the investments
made to generate those returns.
2. For standard cost, control can be exercised by comparing standard cost with the costs that were actually
incurred. On the other hand, control is usually exercised by ensuring that the discretionary cost centers adheres to
the budgeted level of expenditures while successfully accomplishing tasks assigned to it.
3. Transfer prices directly affect the revenues of the selling (supplying) profit center, the costs of buying
(receiving) profit center and the profit of both entities, thus essentially making transfer prices subject to “zerosum” considerations (that is revenue for one is more cost for the other)
Exercise #2
1.To provide the proper economic signals so that the managers affected will make good decisions.
2.The transfer prices and subsequent profit measurements should provide information that is useful for evaluating
the performance of both the profit centers and their managers.
3.Transfer prices can be set to purposely move profits between firm locations.
Activity 5.
This document is the property of PHINMA EDUCATION
ACC 148: Performance Management System
Student Activity Sheet #13
Name: ________________________________________________________
Section: ____________ Schedule: ________________________________
1. T
2. F
3. T
4. F
5. F
6. T
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Class number: ______
Date: ____________