Answer to Question #125627 in Accounting for Relebogile

Question

A large organization with a well developed cost center system is considering the introduction of profit center and/or investment center throughout the organization when appropriate. As management accounted you will be providing technical advice and assistance for the proposed scheme. You are required to a) describe the main characteristics and objectives of profit centers and investment center. b) explain what conditions are necessary for the successful introduction of such center. C) to describe the main characteristics and objectives of profit centers and investments centers. D) to compare two performance appraisal measures that might be used if investment centers are introduced.

Answer 1

(a) A profit center is the location of a person,an item or an equipment for which both costs and revenues are identified, while an investment center is where both costs and revenues and the capital investment are identified.

The main objective of the profit and investment center is:i)To support budgetary control.Both centers are capable of calculating the profit and losses independently, hence, the corporation can easily compute the revenue and expenses for the specific department, thereby enhancing certainty.

ii) To enhance decision making within the organization, since with the financial information, the organization have the capacity to analyze and know how finances can be allocated more effectively.

On the other hand the main characteristics of the profit and investment center are:

i)it is placed under the authority of a person in charge. Both centers are mainly headed by the cost accountant, whose duty is to analyse and report the financial and non- financial information relating to costs of acquiring and using resources within the organization.

ii) Should be flexible to control and accommodate the changes in the methods of operation and in case of new products establishment.

(b)To establish a profit and investment center, the following conditions are necessary,

i)All responsibility centers should fit into the existing organization operation.Management must decide whether it is advantageous to establish such a center.

ii)The management control system design choices should have a clear distinction

c)Return on investment

The most common measure of investment center performance  is the return on investment. It better test of profitability. It measure the manager’s attention on the assets employed, thus motivates the manager to invest in assets which an adequate return can be earned on them

ii)Residual income.

companies use the Residual income approach for investment center performance appraisal such that to eliminate the use of ratios.Thus,  manager would be willing to invest in the projects earning more than the desired rate of return.

References.

Makkar, Rajesh. (2017). Cost Accounting: Theory and practice. 16^th edn. Lexis Nexis.