Chapter Summary

A cost center is a responsibility center that incurs costs (or expenses) but does not directly generate revenue. A profit center is a business center that generates both revenue and costs. Some profit centers are also considered investment centers. An investment center is a profit center for which management is able to measure objectively the cost of assets used in the center's operations.

Responsibility center information presents separately the operating results of each business center within an organization. A responsibility accounting system shows the performance of the center under each manager's control.

In responsibility income statements, revenue is assigned to the profit center responsible for generating that revenue. Two concepts are used in assigning and classifying expenses. First, each center is charged only with those costs directly traceable to the center. Second, costs charged to the center are subdivided between the categories of variable costs and fixed costs. Subtracting variable costs from revenue indicates the center's contribution margin; subtracting traceable fixed costs indicates the responsibility margin.

A cost is traceable to a particular center if that center is solely responsible for the cost being incurred. Traceable costs should disappear if the center is discontinued. Common costs are not traceable to a particular center. Thus common costs will not disappear if the center is discontinued.

Fixed costs generally cannot be changed in the short run. Therefore, the effects of short-run strategies on operating income are equal to the change in contribution margin (revenue less variable costs). In the long run, however, strategies may affect changes in the fixed costs traceable to a business center. Therefore, the profitability of long-run strategies may be evaluated in terms of changes in responsibility margin (revenue less variable costs and less traceable fixed costs).

Transfer prices are the dollar amounts used by the supplying and buying divisions within a company to record the exchange of a good or service. When an external market exists for the product or service, then most companies use the market price as the transfer price. When no external market exists, then companies use either negotiated transfer prices or cost-plus transfer prices. Negotiated transfer prices are used when the buying and supplying divisions can agree on a transfer price. Where negotiation is too costly or not possible many companies add a predetermined mark-up to the supplying division's total cost to determine the transfer price.

Under full costing, fixed manufacturing costs are viewed as product costs and are included in the cost of finished goods manufactured. Under variable costing, fixed manufacturing costs are treated as period expenses. An income statement prepared on a variable costing basis is useful for cost-volume-profit analysis; however, variable costing is not acceptable for use in published financial statements or income tax returns.

In a variable costing income statement, costs are subdivided into the classifications of variable costs and fixed costs. This classification permits arranging an income statement in a manner showing subtotals for contribution margin and total fixed costs  - two key amounts in cost-volume-profit analysis.

One purpose of this chapter is to "tie together" many of the concepts introduced in the preceding management accounting chapters. Notice, for example, how such concepts as the distinction between variable costs and fixed costs, cost-volume-profit relationships, the nature of period costs and product costs, and the flow of manufacturing costs through an accounting system have played major roles in our evaluation of a responsibility center's performance. In the next chapter, we introduce the topic of budgeting. The budget provides one of the major standards with which current performance is compared.