Answer to Question #128368 in Accounting for Precious

Question

describe the main characteristics and objectives of profit centres and investment
centres;

Answer 1

Companies are formed to meet a number of objectives. For these objectives to be met, the company has to be segregated into smaller and manageable units. These functions, also called centers or divisions, are classified according to the purpose for which they are created. Examples of these functions are costs centers, revenue centers, profit centers and investment centers.

Profit centers are units where revenue and costs are identified. For a company to increase the shareholders’ value, profits have to be maximized and costs minimized. The person in charge of profit centers will be responsible for managing both the revenues and the costs. In the context of a profit center, sales could be both internal and external. Internal sales refer to the support that one department offers to another and billing is done e.g. the accounting function charging the IT department for data entry services. External sales on the other hand is revenue paid by clients outside of the organization.

To ensure that the profit centers is performing optimally, the person managing it could be given a budget against which to operate. This acts as the key performance indicator. Examples of profit centers are teams, projects, production lines and departments.

Investment centers on the other hand are units where capital outlays, revenues and costs are identified. The main objective is to measure the return on the capital that has been employed. The rate of return of the investment center is normally bench-marked against the overall rate of return that the company has set to achieve. The investment center could be a division or subsidiary.