Responsibility Centre Meaning
A responsibility centre is a function of a company directed by a manager who is directly responsible for its performance. It generates information and allows them to be used directly in motivating and controlling the action of each manager in charge of the responsibility centre.
A responsibility centre of a manufacturing organisation uses inputs, viz., labour, raw materials, working capital, overheads, plant and machinery, etc., in its production process to produce outputs. These outputs are measurable. However, it is not possible to measure the results of service departments like finance and accounts, administrative office, HRD, etc.
Types of Responsibility Centre
The responsibility centres are generally classified into the following categories
An investment centre is a responsibility level of an organisation where the manager is concerned not only with cost management and revenue generation but also held responsible for the investment in assets used by the centre. Here, the manager bears responsibility for both profits and the assets they oversee. The manager of an investment centre holds greater authority and responsibility compared to the managers of either’s cost centre or a profit centre.
The performance evaluation of an investment centre takes into account the centre’s Return on Investment (ROI). The investment made in each centre and profit earned by each centre is separately ascertained, based on which the ROI of each centre is measured for the evaluation of the performance. To achieve this objective, we will calculate the Return on Investment (ROI) for each centre using the method outlined below.
Return on Investment (ROI) = Profit of the Investment Centre/Assets Used in the Investment Centre * 100
Managerial Implications of Investment Centre
The investment centre serves as a platform to evaluate not only the contribution of a division as an entity but also the performance of a divisional manager. The measure of performance in an investment centre is based on the relationship between the profit/income and the income of assets employed in generating the profits. There are two methods to relate income and assets:
1) Return on Investment (ROI)
Evaluating the effectiveness of an investment centre involves considering not just its profit but also connecting that profit to the invested amount, denoted as ROI. Organizations commonly use the term Profit Centre instead of investment centre.
The determination of the rate of return for an investment centre is possible by applying the following formula:
Return on Investment = Income of the Investment Centre / Assets of the Investment Centre
2) Residual Income (RI)
It is another measure for the performance evaluation of a department. It is the excess of income or profit over the required rate of return on investment. In essence, the aim is to achieve income or profit that surpasses the imputed cost of capital investment. Capital invested in the division (s) is subject to chargeable interest. Accordingly, the interest paid on the capital invested is classified as an expenditure. The basic philosophy behind the estimation of the required rate of return lies in the concept of opportunity cost.
Advantages of Investment Centre
The following are the advantages of an investment centre:
1) Investment centres consider both profit/income and the amount of assets employed in generating the profits.
2) ROI analysis in an investment centre provides an incentive for optimum utilisation of the assets of a firm.
3) Use of ROI analysis is also compatible with the view that investments are made to achieve the goal of a desired rate of return.
4) The investment centre can serve as a foundation for evaluating the division’s contribution as a distinct entity and also assessing the performance of divisional managers.
Disadvantages of Investment
Centre Following are the disadvantages of an investment centre:
1) Measuring the investment base becomes complex due to the challenge of assigning values to the assets of a centre.
2) There is a possibility that assets shared among different departments might undergo differing treatment strategies.
3) The ROI analysis is conceptually easy as a performance measure but suffers certain operational limitations due to different ways of computation according to the need and relevance.
Cost or Expense Centres
Cost determination involves using either cost centres or cost units of both. A cost centre is a location, person or equipment (or group of these) in or connected with an undertaking, about which is ascertained and used for cost control. Through an analysis of the definition, it becomes evident that cost centres fall into two categories, specifically.
1) A personal cost centre consisting of a person or group of persons, and
2) Impersonal cost centre consists of a location or item of equipment or a combination of these elements.
Manufacturing concerns categorize cost centres as either production cost centres or service cost centres. In production cost centres, there may be operation and process cost centres. An operation cost centre is a cost centre consisting of either machines or individuals that perform a specific operation. Process cost centre cons of a continuous sequence of operations. A cost centre may be a particular workbench of machines of one type or activity.
Location-based determination of a cost centre includes divisions, departments, sales areas, stockyards, tool rooms, and administrative offices, among others. Individuals in roles such as Works manager, Sales manager, Purchase manager, Personnel manager, Finance manager, or positions like storekeeper, salesman, section officer, etc., have costs accumulated in their regard.