PRESENTED BY:NEETU.P.S2K13068

Profit centre is a segment of an organization in which financial performance is measured on the basis of profit.

It is a responsibility centre in which inputs are measured in terms of expenses and outputs are measured in terms of revenues.

In simple words, Profit centre is a division or sub unit of an organization in which financial performance is measured on the basis of profit, that is, revenues less costs.

For purposes of profit centre performance, revenue represents a monetary measure of the output of a profit centre in a given accounting period whether or not the firm actually realizes the revenue in that period.

The test is that a department has output (goods & services) which are amenable to monetary measurement.

It is possible to measure the effectiveness and efficiency of performance in financial terms.

It provides a powerful tool for measuring how well the profit centre or manager of the profit centre has performed.

It resembles a business in miniature.

It makes decentralized organization possible

Provides a broader & more inclusive measurement of performance than the expense centres.

Criterion for profit centres

Measurement of expenses

Transfer prices

It is a monetary amount of interdivisional exchanges/transfer of goods and services.

It is a price used to measure the value of goods and services furnished by a profit centre to other responsibility centres within a company.

It should be objectively determinable & equal to the value of the intermediate products being transferred & compactible with the policy that maximizes attainment of company goals.

Two general approaches to the determination:

Cost-based

Market-based

Based on these, there are six types:

Cost

Cost plus a normal mark-up

Incremental cost

Market price

Negotiated price

Dual[Two-way] prices

Companies using the transfer-at-cost approach recognize that sales by international affiliates contribute to corporate profitability by generating scale economies in domestic manufacturing operations. This approach assumes lower costs lead to better affiliate performance, which ultimately benefits the entire organization.

The transfer-at-cost method helps keep duties at a minimum. Companies using this approach have no profit expectation on transfer sales; rather, the expectation is that the affiliate will generate the profit by subsequent resale.

Companies that follow the cost-plus pricing method are taking the position that profit must be shown for any product or service at every stage of movement through the corporate system. While cost-plus pricing may result in a price that is completely unrelated to competitive or demand conditions in international markets, many exporters use this approach successfully.

The entire production of the selling division is transferred & there are no independent outside customers.

In this case, it includes all variable cost plus any fixed costs directly

When there are outside customers for the goods & the division is unable to produce the full demand , it would be revenue lost on sales to such customers & it will be equal to market price.

A market-based transfer price is derived from the price required to be competitive in the international market. The constraint on this price is cost. However, there is a considerable degree of variation in how costs are defined. Since costs generally decline with volume, a decision must be made regarding whether to price on the basis of current or planned volume levels. To use market-based transfer prices to enter a new market that is too small to support local manufacturing, third-country sourcing may be required. This enables a company to establish its name or franchise in the market without investing in bricks and mortar.

The interdivisional exchange pricing can also be based on a price mutually agreed upon by the buying as well as the selling departments, through negotiation.

Advantageous to both the divisions as well as the entire organization

Limitation is that, that it can be applied only when a selling division has a choice of customers & purchasing division has a choice of suppliers

According to this method of pricing for segment performance evaluation, the transferring division is credited with one price but acquiring division is charged at different price.

This method eliminates the possibility of conflict caused by a single transfer price, in which case one segment receives relatively less contribution of profit because the price setting process entitles the segment to receive relatively more.

Sales & other major revenues

Controllable variable cost

controllable contribution margin

Controllable fixed costs

Controllable segment margin

Attributable segment costs

Segment profit contribution

Common firm-wide cost

Segment net income