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Q.5. a) Describe the inherent difficulties creation of profit centers may cause and
advantages possible?
Ans: When a responsibility center’s financial performance is measured in terms of
profit (i.e. the difference between the revenue and expenses), the centers is called a Profit
Center. Profit is a particularly useful performance measure since its allows senior manager to
use one comprehensive indicator rather than the several (some of which may be pointing in
different directions).
Difficulties in creation of Profit Centers:
• Decentralized decision making will force top management to rely more on
management control reports than on personal knowledge of an operation, entailing some loss
of control.
• Friction may increase because of arguments over the appropriate transfer price, the
assignment of common sales, and the credit for revenues that were formerly generated jointly
by two or more business units working together.
• Organization units that once cooperated as financial units may now be in the
competition with one another. An increase in profits for one manager may mean decrease to
another. In such situations, manager may fail to refer sales leads to another business unit
better qualified to pursue them; may hoard personnel or equipment that, from the overall
company standpoint, would be better of used in another unit; or may make production
decision that have undesirable cost consequences for other units.
• Competent general managers may not exist in a functional organization because there
may not have been sufficient opportunities for them to develop general management
competence.
• There may be too much emphasis on short run profitability at the expense of long run
profitability. In the desire to report high current profits, the profits center manager may skimp
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on R & D, training programs or maintenance. This tendency is especially prevalent when the
turnover of profit center managers is relatively high. In these circumstances, managers may
have good reason to believe that their actions may not affect profitability until they have
moved to other jobs.
• There is no completely satisfactory system for ensuring that optimizing the profits of
ach individual profit center will optimize the profits of the company as a whole.
• The speed of operating decisions may be increased since they do not have to be
referred to corporate headquarters.
• Managers, subject to fewer corporate restraints, are freer to use their imagination and
initiative.
• Profit consciousness is enhanced since managers who are responsible for profits will
constantly seek ways to increase them. (A manager responsible for marketing activities, for
example, will tend to authorize promotion expenditures that increase sales, whereas a
manager responsible for profits will be motivated to make promotion expenditures increase
profits.)
• Because their output is so readily measured, profit centers are particularly responsive
to pressures to improve their competitive performance.
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2. The marketing decision (how, where and for how much are these goods and services
to be sold)
3. The procurement or the sourcing decision (how to obtain or manufacture the goods
and services).
If a profit center manager control all three activities, there is usually no difficulty in
assigning profit responsibility and measuring performance. In general, greater degree of
integration within a company, the more difficult it becomes to assign responsibility to a
single profit center for all three activities in a given product line; that is, if the production,
procurement, and marketing decision for a single product line are split among two or more
profit centers, separating the contribution of each profit centre to the overall success of the
product line may be difficult.
The constraints imposed by the corporate management can be grouped into three
types:
1. Those resulting from the strategic considerations
Most of the companies retain certain decisions, especially financial decisions, at the
corporate level, at least for domestic activities. Consequently, one of the major constraints on
profit centers results from corporate control over new investments. Profit centers must
compete with one another for the share of the available funds. The maintenance of the proper
corporate image may require constraints in the quality of the products or in the public
relations activities.
Companies impose some constraints on profit centers because for the necessity for
uniformity. One constraint is that profit centre must confirm to the corporate accounting
management control systems. This constraint is especially troublesome for units that have
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been acquired from the another company and that have been accustomed to using different
systems.
Corporate headquarters may also impose uniform pay and other personnel policies, as
well as uniform policies on ethics, vendor selection, computers and communication
equipment, and even the design of the business unit letterhead. The major problems seem to
resolve around corporate service activities.
3. LEASED ASSETS: Many leases are financing arrangements – that is, they provide
an alternative way of getting to use assets that otherwise would be acquired by funds obtained
from the debt and equity financing. Financial leases (i.e. long term leases equivalent to the
present value of the stream of the lease charges) are similar to the debt and are so reported on
the balance sheet. Financing decisions usually are made by corporate headquarters. For these
reasons, restrictions usually are placed on the business unit manager’s freedom to lease
assets.
Q6(b)
1. CASH: Most companies control cash centrally because central control permits use of
the smaller cash balance than would be the case if each business unit held the cash balance it
needed to whether the unevenness of its cash inflows and outflows. Business unit cash
balances may well be only the “float” between daily receipts and daily disbursements.
Consequently, the actual cash balances at the business unit level tend to much smaller than
would be required
If the business unit were an independent company. Many companies then use a formula to
calculate the cash to be included in the investment base. For example, General Motors was
reported to use 4.5% of annual sales; Du Pont was reported to use two months cost of sales
minus depreciation. One reason to include cash at higher amount than the balance normally
carried by a business unit is that the higher amount is necessary to allow comparisons to
outside companies. If only the actual cash were shown, the return by internal units would
appear abnormally high and might mislead senior management. Some companies cash from
the investment base. These companies reason that the amount of cash approximates the
current liabilities. If this is so, the sum of accounts receivable and inventories will
approximate the amount of working capital.
a satisfactory return on this investment is probably enough. On the other hand, it is possible
to argue that the business unit could reinvest the money collected from accounts receivable,
and, therefore, accounts receivable should be included at selling prices. The usual practice is
to take the simpler alternative – that is, to include receivables at the book amount, which is
the selling price less an allowance of bad debts. If the business unit does not credits and
collections, receivables may be calculated on the formula basis. This formula should be
consistent with the normal payment period – for example 30 days’ sales where payment
normally made 30 days after the shipment of the goods.
exp. Item. Summarized expenses for Nov 2005. Given to concerned productions
supervisor for comments is tabulated.
(a) Explain with justification which of the 2 standards 1 or 2 is more meaningful for
expense control
(b) Can the supervisor be held responsible for all overhead expenses included?
Why / why not?
Table 1
Table for total Expenses Rupee in 000
Table 2
Total Exp. Per Ton. 2133.04 2103.39
Unit Produce 56626/2133.04 50448/2103.39
Unit Produce 25 24
Table 3
If no of unit produce is same as 25000
Unit produce 25000 25000
Total expenses 53326 50448 * 25 / 24
53326 52550
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If we consider total expenditure then obviously we select standard (2) because standard at
normal volume (1) total exp. rupee 53326 and Budgeted at actual volume (2) rupees 50448
(from table 1) & if we consider individual expenses then we can say as under
,stander volume(1) expenses more than propagated actual volume(2) as shown as under.
If we consider relationship of expenses and output then we also select the standard (2)
because output is more in the standard (1) is 25000 but expenses are also more as compare to
budgeted actual volume. This can we understand from table 2 & table 3. In that total expense
of standard (1) are Rs. 53326000 & standard (2) is Rs. 52550000 with same level of output.
So supervisor play important role in manage each activity smoothly and effective
b) Pre Post
Installation Installation
Q.12 For effective strategy implementation, Soniya Ltd. (SL) has been organized on
product decentralization basis and each division is headed by GM (General Manager).
GM is responsible for manufacturing, purchasing, finance and marketing activities for
his divisional product group. Performance measurement is Return on Investment (ROI)
of division. Annual budgets are split up into four quarters and at the beginning of each
quarter, performance of previous quarter is reviewed and budget for following quarter
may be revised in consultation with GM. Data for div P is as under. Figures in Rs.
Crores
Budget Actual
Quarter 1 Quarter 2 Quarter 1
Account 8 7.5 8.5
receivable
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Cash 4 4 2.0
Inventory 18 16.5 21.50
Fixed assets 20 20 20
Factory cost 21 19 17
Marketing Cost 7 6 3
Freight 1 0.90 0.80
Administrative 3 2.60 3.20
exp.
Sales 40 36 34
(a) Review the first-quarter performance on the basis of computation of various
Parameters.
(b) Would you suggest any revisions for the second quarters? why/why not.Justify.
Solution:
a) The first-quarter performance on the basis of computation of various parameters are as
follows:
1) Turnover of investment =__ Sales ___
Total Investment
= 40
50
= 0.8 times
2) Profit Margin = Profit*100
Sales
= 08*100
40
= 20%
Particulars Amount(Rs.)
Sales 40
Less expenses:
Factory cost 21
Marketing cost 7
Freight 1
Administration expenses 3 (32)
Operating profit 8
Cash 4
Inventory 18
Fixed Assets 20
Total Investment 50
Budgeted Actual
Particulars Quarter I Quarter II Quarter I
Profit Margin 08/40 * 100 = 7.5/36*100 = 10/34*100= 29.41
20% 20.83%
Working note:
Budget Quarter I
Particulars Amount(Rs.)
Sales 40
Less expenses:
Factory cost 21
Marketing cost 7
Freight 1
Administration expenses 3 (32)
Operating profit 8
Budget Quarter II
Particulars Amount(Rs.)
Sales 36
Less expenses:
Factory cost 19.00
Marketing cost 6.00
Freight 0.90
Administration expenses 2.6 28.5
Operating profit 7.5
Actual Quarter I
Particulars Amount(Rs.)
Sales 34
Less expenses:
Factory cost
17.00
Marketing cost 3.00
Freight 0.80
Administration expenses 24
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3.20
Operating profit 10
Budgeted Actual
Quarter I Quarter II Quarter I
Particulars Amount (Rs.) Amount (Rs.) Amount (Rs.)
Account Receivable 8 7.5 8.5
Cash 4 4 2.0
Inventory 18 16.5 21.5
Fixed Assets 20 20 20
Total Investment 50 48 52
Budgeted Actual
Particulars Quarter I Quarter II Quarter I
Turnover of Fixed 40/20 =2times 36/20 =1.8times 34/20 =1.7times
Asset
There was difference in budgeted Quarter I and actual Quarter I due to:
Increase in profit margin.
Though sales have been reduced from budgeted but there is reduction in marketing cost and
freight. Quarter II sales have been increased from actual Quarter I. So there should be
decrease in cost as compared to actual. So this will lead to increase in profit margin.
Fixed asset invest is same in Quarter II but in turnover there is difference due to sales. But
inventory budgeted in Quarter I was less than actual quarter I. so instead of increasing
inventory it has reduced than actual. So there should be increase in inventory.