Center on Profit Centers in Accounting Reports - dummies

Center on Profit Centers in Accounting Reports

By John A. Tracy

From a one-person sole proprietorship to a mammoth business organization like General Electric or IBM, one of the most important tasks of managerial accounting is to identify each source of profit within the business and to accumulate the sales revenue and the expenses for each of these sources of profit.

Can you imagine an auto dealership, for example, not separating revenue and expenses between its new car sales and its service department? For that matter an auto dealer may earn more profit from its financing operations (originating loans) than from selling new and used cars.

Why concentrate on accounting for managers of profit centers? Accountants don’t mean to shun cost centers, but, frankly, the type of accounting information needed by the managers of cost centers is relatively straightforward. They need a lot of detailed information, including comparisons with last period and with the budgeted targets for the current period.

And, this shouldn’t suggest that the design of cost center reports is a trivial matter. Sorting out significant cost variances and highlighting these cost problems for management attention is very important. The spotlight of this article is on profit analysis techniques using accounting information for managers with profit responsibility.

Large businesses commonly create relatively autonomous units within the organization that, in addition to having responsibility for their profit and cost centers, also have broad authority and control over investing in assets and raising capital for their assets. These organization units are called, quite logically, investment centers.

Even small businesses may have a relatively large number of different sources of profit. In contrast, even a relatively large business may have just a few mainstream sources of profit. There are no sweeping rules for classifying sales revenue and costs for the purpose of segregating sources of profit. Every business has to sort this out on its own.

The controller (chief accountant) can advise top management regarding how to organize the business into profit centers. But the main job of the controller is to identify the profit centers that have been (or should be) established by management and to make sure that the managers of these profit centers get the accounting information they need. Of course managers should know how to use the information.