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3.9 Budgets (HL only)

Conceptual understandings
Change in the business structure can impact a business’s financial resources.
Creativity in financial reporting can have diverse impacts in a business.
Ethical financial and accounting practices can be a form of sustainable business
behaviour.

SYLLABUS CONTENT

By the end of the chapter, you should be able to understand:

the difference between cost and profit centres (AO2)
the roles of cost and profit centres (AO2)
constructing a budget (AO2, AO4)
variances (AO2, AO4)
the importance of budgets and variances in decision-making (AO2).

The difference between cost

and profit centres (AO2)
In many ways cost centres and profits centres are similar. They both relate to aspects of a
business’s operation for which it is possible to calculate important cost and revenue figures. In A cost centre is a
spite of this, there is a distinct difference. distinct part (perhaps a
division or department) of
For a cost centre it is possible to calculate the associated costs. Thus, the finance department a business for which costs
or the department providing IT services to a business could be cost centres. For these areas it is can be calculated.
straightforward to calculate costs such as wages and salaries, heating and lighting. However, it A profit centre is
is impossible to calculate the revenues earned by areas of the business such as the finance or IT similar to a cost centre,
and is a part of a business
department as they do not charge separately for their services.
for which costs and
Profit centres can calculate both costs and revenues. As an example, Alphabet Inc is an American revenues (and thus profits)
multinational technology company which owns a number of subsidiaries including Google and can be determined.

Fitbit. These subsidiary businesses

incur costs and earn revenues. For Cost centres Profit centres

these reasons Google and Fitbit

could both be profit centres for
Divide up fixed costs,
Alphabet Inc.
There are a number of ways in
which a business can create
cost or profit centres within its
organization.
1 Some large businesses might
operate a number of factories,
offices or branches. In these
Variable costs, e.g. Divide up fixed and variable costs
as for cost centres
e.g. rent and rates
materials charge to
appropriate areas
Compare cost and revenues for
each profit centre
Product, brand or Product, brand or Product, brand or
division A division B division C
Does each centre meet it profit
Cost centres aim to control costs effectively, to compare the target? How did the performance
costs of products or to establish prices of the profit centres compare?
Figure 3.9.1 The difference between cost and profit centres

362 Business Management for the IB Diploma