A division manager beats budget on operating margin but does it by under-investing in maintenance and refusing internal transfers that would help a sister plant. The exam asks which responsibility center she runs, whether she should be held accountable for the maintenance shortfall, and what transfer-pricing rule would have changed her decision. Three different answers across three different LOs, all in one fact pattern.
A responsibility center is an organizational unit whose manager is accountable for a defined set of financial outcomes. The principle of controllability says you evaluate the manager only on items she can influence. Allocations she cannot control belong in a separate line for segment evaluation but not for manager evaluation.
KEY: The type is defined by what the manager controls, not by the unit's size or strategic importance.
- Cost center. Manager controls inputs (costs) but not revenue. Examples: a production plant, a maintenance department, an internal IT group. Evaluated on standard cost variances and budget adherence.
- Revenue center. Manager controls sales output but not the cost of goods sold or production. Examples: a sales district, a regional sales office. Evaluated on sales variances (price and volume).
Common mistakes
- Calling a unit a profit center when the manager cannot set prices. Profit centers require control over both revenue and controllable cost. A sales office that quotes from a fixed catalog is a revenue center, not a profit center, even though it generates sales.
- Using segment net income for keep-or-drop. The correct number is segment margin (before common allocation). Common costs persist after a drop; subtracting them creates phantom losses.
- Anchoring the transfer-price floor at full cost. Floor is variable cost plus opportunity cost. Fixed cost is irrelevant short-run. At full capacity, floor usually equals external price; at idle capacity, floor collapses to VC.
Bottom line
- Four responsibility centers: cost (inputs only), revenue (sales only), profit (revenues minus controllable costs), investment (profit plus assets used); ROI, RI, and EVA apply only to investment centers.
- Contribution margin = sales minus variable costs; segment margin = contribution margin minus traceable fixed costs (the right number for keep-or-drop).
- Organizations slice performance by product, region, customer, channel, or brand; the slice follows the decision being made.
- Common cost allocation: stand-alone uses each user's standalone-cost weight; incremental ranks users, charging the first fully and adding others marginally.
Exam shortcut
When a question hands you a manager's responsibilities, scan for what she controls: revenue only (revenue center), costs only (cost center), both (profit center), or both plus the asset base (investment center). The wording almost always names the right answer once you isolate control. When a keep-or-drop question gives you both segment margin and segment net income, use segment margin.
The full lesson (about 2,733 words, 18 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- 1C2
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