Budgeting Basics and Beyond

22.5. Profit Center

A profit center is a responsibility unit that measures the performance of a division, product line, or geographic area. Net income and contribution margin can be computed for a center, which typically does not have significant amounts of invested capital. The profit center approach enhances decentralization and provides units for decision-making purposes.

Use it for a self-contained division—with its own manufacturing and distribution facilities—when there are a limited number of interdivision transfers. The profit reported by the division is basically independent of other divisions' operating activities. Divisional earnings should not be increased by any action reducing overall corporate profitability.

A profit center also should be used when divisional managers have decision-making authority for quantity and mix of goods or services manufactured. With a profit center, net income is determined as if the division were a separate economic entity and the manager is more cognizant of outside market considerations. Profit may be expressed as net income, contribution margin, gross profit, controllable profit, and incremental profit. Examples of profit centers are an auto repair center in a department store and an appliance department in a retail store.

In some instances, profit centers are formed when the product or service is used solely within the company. For example, the computer department may bill each of the firm's administrative and operating units for computing ...