Introduction to Financial and Management Accounting

Decentralization and the Different Types of
Business Centres

Decentralization and the Different
Types of Business Centres
Learning Outcomes
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Understand Decentralization
Identify cost, investment, and profit centres,
Classify Service Centres,
Explain Transfer Pricing, and
Understand how to measure performance in each.

Context
Many organizations today are decentralized. This means that day-to-day operational decisions are made not by a few top people, but rather by persons throughout the organization.
This approach allows lower management to participate in the decisions that affect their day-today operations. To properly evaluate these decisions, from a financial point of view, a company must be able to measure the results of the decision.

What is Decentralization?
A decentralized organization allows the decisions that affect the day-to-day operations to be made by the individuals responsible for that specific operation.
Example:
The decentralized approach removes executives from day-to-day operational decisions and allows them to focus on more long term and strategic decisions. Since decisions are made by the individuals directly responsible for the area affected by the decision, these people are much more accountable for the decision and often enjoy much more job satisfaction.
While the above points sound good, it is important to remember that each decentralized decision must be made with the long term strategic objectives of the organization in mind.
In a centralized organization, lower level management may not be aware of all of the organization's long term plans or even of decisions made by other lower level managers that may impact their own. Clearly, in a decentralized organization, communication among lower level managers as well as between top and lower level managers is key to the best decision making. Decentralized organizations normally identify their business units as cost centres, profit centres or investment centres.

Introduction to Financial and Management Accounting

Decentralization and the Different Types of
Business Centres

Cost Centres
A cost centre is a unit that has control over its costs but not over revenue or investment in the centre. Examples of organizational departments that may be thought of as cost centres include:
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Accounting
Human Resources
Legal
Manufacturing Operations

Cost centres should attempt to minimize costs while providing the level of service required.
How do you Measure the performance of a Cost Centre?
Typical evaluations of cost centres are the comparison of actual cost against budgeted or expected costs for a given level of production.

Profit Centres
An investment centre is a business unit that has control over revenue, costs and investment in operating assets that will assist in generating revenue and running the business unit.
Investment centres are normally evaluated on return on investment (ROI).
Example:
The president of Z-Tekko has overall responsibility for profits, costs, and capital investment in operating assets and her performance is measured against the company’s return on investment.

How Do You Measure the Performance of an Investment Centre?
Typical evaluations’ of investment centres are comparisons of return rates on the investments purchased by comparison to return rates on other investments.

What is a Service Centre?
Within a single organization there is what you do to make your profits and then all the other ancillary departments necessary to facilitate how that is done. Invariably around a companies core competency (as a result of this dynamic), there are a variety of other areas within a business that make everything possible. Let’s think of some typical examples:
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Accounting Department in An Auto Parts Manufacturer
Advertising Department in a Hotel
Social Media Management team in an Online Bank

In each of the above examples you can see what the business “is” and you can