Every SBU is a profit center but every profit center is not a SBU?

What are the conditions that should be fulfill for an organization unit to be converted into a profit center? What are the different ways to measure the performance of profit center? Discuss their relevant merits and demerits.

Conditions for an organisation to be converted into a Profit centre ‡ Management decisions involve expense/revenue trade offs ‡ Two conditions should exist: -manager should have access to relevant information -should have ways to measure effectiveness of trade offs .

measure of economic performance .measure of management performance .Ways to measure performance of Profit centre ‡ Two ways to measure performance: .

Types of Profitability Measures ‡ ‡ ‡ ‡ ‡ Contribution margin Direct profit Controllable profit Income before income taxes Net income .

‡ Profit consciousness is enhanced.MERITS ‡ Quality of decisions may improve. ‡ Provide top management with ready information. ‡ Manager has fewer corporate restraints. . ‡ Speed of operating decisions may be increased.

‡ Quality of decisions may be reduced. ‡ Friction may increase because of arguments. ‡ Competition among functional units. ‡ May impose additional costs. .DEMERITS ‡ Top management will have to rely more on management control reports.

When do you use cost based transfer prices? .What are the objectives of transfer pricing? What is ideal transfer price in the situations of: a)Limited Market b)Shortage of capacity in the industry.

‡ Should induce goal congruent decisions. ‡ Simple to understand and administer .Objectives of transfer pricing ‡ Should provide each segment with the relevant information required to determine the optimum trade off. ‡ Help measure the economic performance of the individual profit centre.

‡ The ideal transfer price is the competitive price.IDEAL TRANSFER PRICELimited market ‡ Market for buying and selling profit centre s is limited. .

IDEAL TRANSFER PRICEShortage of capacity in the industry ‡ Output of the buying profit centre is constrained and company profits may not be optimum. . ‡ Market price or competitive price is the ideal transfer price.

‡ Two aspects to be considered: -cost basis -profit markup .When do you use cost based transfer prices? ‡ If there is no way of approximating valid competitive price.

. should there be a charge for income taxes? Should corporate overheads be allocated to districts? Should profits be computed on the basis of historical costs or replacement costs? Evaluate these issues from the standpoint of their motivational impact on the district managers.While computing district profits for performance evaluation purposes.

.Should there be a charge for income tax? ‡ May be desirable to allocate income tax expenses to profit centers not only to measure their economic profitability but also to motivate managers to minimize tax liability.

Should corporate overheads be allocated to district centre? ‡ Portion of corporate overheads should be allocated. Historical costs or replacement costs? ‡ Historical costs .

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