The cost center manager controls costs but not revenue or the use of investment funds. Service departments such as accounting, finance, general administration, legal, and personnel are usually classified as cost centers.
Also, manufacturing facilities are often considered to be cost centers. The managers of cost centers are expected to minimize costs while providing the level of products and services demanded by other parts of the organization.
For example, the manager of a manufacturing facility would be evaluated at least in part by comparing actual costs to how much costs should have been for the actual output level during the period.
Standard cost variances and flexible budget variances are often used to evaluate cost center performance.
A cost center (CC) is a unit, location, or department collecting cost data. The purpose of the cost center is to collect, analyze and ascertain costs in their immediate context.
Cost centers usually have cost units—units or equipment for which costs are determinable or attributable. Overheads and direct costs constitute the cost structure of a CC.
Since many activities in an organization involve costs, a cost center is fundamental, especially as profit and investment centers can be cost centers.
According to the ACCA Study Text (Management Accounting, c 1999), cost centers can manifest themselves as a project, a machine, a department, or overhead costs.
One should note that a specific cost center might not necessarily have other functions. CCs are not limited to production and manufacturing since they can also be attributed to service centers, like commercial bank branches.
Profit center
The profit center manager has control over both costs and revenue but not over the use of investment funds.
For example, the manager in charge of a Six Flags amusement park would be responsible for both the revenues and costs, and hence the profits, but may not have control over major investments in the park.
Profit center managers are often evaluated by comparing actual profit to targeted or budgeted profit.
The profit center addresses both costs and revenue. Therefore, the profit center manager is responsible for the purchases and sales for that unit, department, or branch.
Since both revenue and costs fall under the purview of the profit center, it is both a cost and revenue center, although a revenue center is not a profit center, and a cost center might not necessarily be a profit center.
Investment Center
Investment centers are profit centers that are accountable for cost, revenues, and net assets for capital investment. This unit is assessed by return on investment and is a cost center.
Managers in an investment center are responsible for purchasing capital or non-current assets and making investment decisions with capital.
An investment center’s manager controls cost, revenue, and investments in operating assets.
For example, the vice president of the Truck Division at General Motors would have a great deal of discretion over investments in the division.
This vice president would be responsible for initiating investment proposals, such as funding research into more fuel-efficient engines for sport-utility vehicles.
Once the proposal has been approved by General Motors’ top-level managers and board of directors, the Truck Division vice president would be responsible for ensuring that the investment pays off.
Investment center managers are usually evaluated using return on investment (ROI) or residual income measures.
The distinctions between a cost center, a profit center, and an Investment center
Let’s see the differences between Cost Centers, Profit Centers, and Investment Centers, along with a realistic example for each:
| # | Cost Center | Profit Center | Investment Center |
|---|---|---|---|
| Definition | A unit, location, or department that collects cost data. | A unit, department, or branch that is responsible for both costs and revenue. | A profit center that is accountable for cost, revenues, and net assets for capital investment. |
| Control | The cost center manager controls costs but not revenue or the use of investment funds. | The profit center manager has control over both costs and revenue but not over the use of investment funds. | The investment center’s manager controls cost, revenue, and investments in operating assets. |
| Evaluation | Managers are evaluated by comparing actual costs to how much costs should have been. | Managers are often evaluated by comparing actual profit to targeted or budgeted profit. | Managers are usually evaluated using return on investment (ROI) or residual income measures. |
| Purpose | To collect, analyze and ascertain costs in their immediate context. | The manager is responsible for the purchases and sales for that unit, department, or branch. | Responsible for purchasing capital or non-current assets and making investment decisions with capital. |
| Example | A manufacturing facility where the manager is expected to minimize costs. | A Six Flags amusement park where the manager is responsible for both the revenues and costs. | The Truck Division at General Motors, where the vice president would have a great deal of discretion over investments. |
Conclusion
Now you have a comprehensive overview of cost, profit, and investment centers, elucidating their distinct roles within an organization.
Cost centers, primarily concerned with cost control, are fundamental to an organization’s operations, with managers striving to minimize costs while maintaining product and service levels. Conversely, profit centers encompass costs and revenue, with managers accountable for the financial performance of their unit, department, or branch.
Lastly, investment centers extend beyond cost and revenue management to include responsibility for capital investments and net assets. Managers in these centers are evaluated based on return on investment or residual income measures.
The importance of these centers in achieving organizational effectiveness, each playing a unique role in the financial health and strategic direction of the company.
Understanding the nuances of these centers is crucial for managers and stakeholders alike, as it informs decision-making processes and impacts overall business performance.