3.9 Budget (HL)

Question 1

what is a cost centre

Answer 1

a department or unit of a business that incurs costs but is not involved in any earning profit.

These costs are clearly attributed to the activities of that division such as salaries, wages and capital expenditure

Question 2

Definition of budget

Answer 2

is a detailed financial plan for the future, usually involving the expected costs and revenues or a cash flow forecast, for a pre-determined period of time.

A budget is produced in order to help a business to achieve its organizational objectives and to plan for the finances needed to implement business strategy.

Question 3

cost centres are usually organised in three ways

Answer 3

1. Organisation by function
2. Organisation by product
3. Organisation by region

Question 4

what is a profit centre

Answer 4

A profit centre is a division of a business that has responsibility for both costs and revenues generated within the department. Hence, each profit centre is held accountable for the amount of profit made.

Question 5

why do large organisations tend to use profit centre

Answer 5

inorder to account for the different amounts of profit made by different divisions the organization.

Question 6

roles of cost and profit centres (MAMA)

Answer 6

Monitoring and control
Autonomy
Motivating
Accountability

Question 7

Limitations of cost and profit centres

Answer 7

Unhealthy competition – Cost and profit centres can cause unhealthy and negative competition between different departments of an organization. This undesirable outcome may include different managers hiding of information and being uncooperative, which essentially hinders the organization’s ability to reach its goals.

Loss of control – Senior executives may lose some degree of control as the managers of cost and profit centres are empowered to oversee the operational costs and/or revenues of their departments. The senior executives do not have as much personal knowledge of the operations at each centre.

Subjectivity – Organizations that use cost and profit centres need to allocate the firm’s fixed costs between the various centres. However, doing so is somewhat subjective, e.g., how much of the rent should the finance, marketing, human resources and operations departments pay? The ambiguity can cause arguments and conflict between the staff.

Short-termism – Creating cost and profit centres can encourage managers to take a short-term approach to their operations, at the expense of long-term profits. For example, in order to control costs and to maximise profit in the short-term, managers may neglect spending on training and development of human resources, maintenance of capital equipment, and research and development.