Page 5 - CIMA MCS Workbook May 2019 - Day 1 Suggested Solutions

SUGGESTED SOLUTIONS

CHAPTER FOUR

1. RESPONSIBILITY CENTRES

a) Cost centres, profit centres and investment centres

A cost centre is one in which the manager of a business unit only has control over costs and is
therefore responsible for the way they manage the costs of the centre. The centre either doesn’t
generate any revenues or its manager doesn’t have control over them. The manager would not
be able to make capital investment decisions in relation to the unit. Evaluation would be on the
basis of cost control and efficiency levels. Targets would be set for such things as maximum spend
levels, maximising productivity and minimising downtime.

For divisions operating as cost centres, managers would potentially control decisions such as
salaries offered to staff, the level of training spend and the choice of suppliers for consumables
such as tools, health and safety equipment, etc.

A profit centre is one in which, in addition to the control of costs, the manager also has control
over revenues. This may mean being able to set prices or have control of a marketing budget to
influence sales volumes.

Managers of profit centres can be evaluated on the same bases as cost centre managers, but also
on anything related to revenue or profit. Therefore, they could have targets set for profit margins
or sales volume growth in addition to the cost targets.

As a profit centre manager, divisional heads would need a measure of revenue to have as a target.
This may mean introducing transfer pricing between divisions, so that divisions along the chain
are able to earn revenues and profits. Managers would then be involved in the setting of these
prices with an aim to hitting margin targets.

Investment centre managers have control over both revenues and costs and, in addition, they are
able to make capital investment decisions for their centre. This means that, in addition to the
measures used to evaluate the profit centre heads, they can be evaluated on return on capital
and residual income to evaluate the result of their use of the centres capital funds.

In addition to the types of decision made by divisional managers as profit centre managers, as
investment centres, the heads would potentially be able to make decisions on the purchase of
new capital equipment, such as computers and construction equipment.

b) Advantages and disadvantages of operating as cost centres

Each division, from pre‐build to external landscaping, will incur costs but has no obvious source of
revenue.

The nature of the business model is that each division contributes to the overall product and
whilst the divisions rely on the others to successfully complete their part of the work on time,
there is no transfer of goods or services between the divisions.

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