3rd Semester MBA Finance Electives

Strategic Cost Management Course Code 22MBAFM303

Module-6 Responsibility Centres: Revenue and Expense Centers Responsibility Centers,
Revenue Centers. Transfer Pricing – Meaning, Principles of Transfer Pricing, Methods of
Transfer of Pricing expense Centers, Administrative Centers. Cost Management for Specific
Sectors – Gold, Agriculture, IT sector, Phrama and others (theory only).
Dr. UMA K
Assistant Professor
Module-6
6.1. Responsibility Centers,
1. Meaning of Responsibility Centers
📌 A Responsibility Center is a unit or department within an organization where a manager is
held accountable for financial performance.
📌 It helps in tracking costs, revenues, and profitability to improve operational efficiency.
2. Types of Responsibility Centers
✔ 1. Cost Center (Expense Center)
✅ Focuses only on controlling costs.
✅ Does not generate revenue.
✅ Performance is measured based on budget compliance and cost efficiency.
✅ Examples: HR, R&D, IT, Administration.
✔ 2. Revenue Center
✅ Responsible for generating revenue but does not control costs.
✅ Performance is measured by sales volume, market share, and revenue growth.
✅ Examples: Sales department, marketing teams, regional sales offices.
✔ 3. Profit Center
✅ Responsible for both revenue generation and cost control.
✅ Performance is measured based on profit earned.
✅ Examples: Business units, product divisions, franchise stores.
✔ 4. Investment Center
✅ Controls revenue, expenses, and investment decisions.
✅ Performance is measured by Return on Investment (ROI), Return on Assets (ROA),
and Economic Value Added (EVA).
✅ Examples: Company headquarters, major subsidiaries, independent business units.
3. Importance of Responsibility Centers
✔ 1. Enhances Accountability – Managers are responsible for financial performance.
✔ 2. Improves Decision-Making – Helps in making cost-effective and profit-driven
decisions.
✔ 3. Facilitates Performance Evaluation – Measures efficiency based on specific criteria.
✔ 4. Supports Budgetary Control – Helps in monitoring expenses and revenues.
✔ 5. Encourages Profitability – Ensures departments contribute to the company’s financial
health.

4. Comparison of Responsibility Centers

Control Over Control Over
Type Focus Performance Measure
Costs? Revenue?
Cost efficiency, budget
Cost Center Managing expenses ✅ Yes ❌ No
compliance
Revenue Sales growth, market
Generating revenue ❌ No ✅ Yes
Center share
Revenue &
Profit Center ✅ Yes ✅ Yes Profitability
expenses
Investment Revenue, costs &
✅ Yes ✅ Yes ROI, ROA, EVA
Center investments

✅ Conclusion:
📌 Responsibility Centers play a crucial role in financial management by assigning
accountability for revenue, costs, and investments.
📌 Different types of responsibility centers ensure cost control, revenue generation,
profitability, and strategic investment decisions for business success.
Revenue and expenses centres
1. Meaning of Revenue and Expense Centers
📌 Revenue Centers focus on generating sales and income but have no direct control over
costs.
📌 Expense Centers (also called Cost Centers) are responsible for managing costs but do not
generate revenue.
📌 Both are types of Responsibility Centers, ensuring better financial control within an
organization.
2. Revenue Centers
✔ 1. Definition – A division or department responsible for generating revenue but not
managing expenses.
✔ 2. Primary Goal – To increase sales and market share.
✔ 3. Performance Measurement – Based on sales revenue, customer acquisition, and
market expansion.
✔ 4. No Cost Control Authority – Revenue Centers do not have control over expenses or
capital investments.
✔ 5. Common Examples:
✅ Sales department
✅ Marketing teams
✅ Regional sales offices
✅ Online sales platforms
3. Expense Centers (Cost Centers)
✔ 1. Definition – A unit responsible for managing and controlling costs without directly
generating revenue.
✔ 2. Primary Goal – To optimize operational efficiency and reduce unnecessary
expenses.
✔ 3. Performance Measurement – Based on budget compliance, cost efficiency, and
quality of service.
✔ 4. No Direct Revenue Generation – Expense Centers do not contribute directly to income
but support business operations.
✔ 5. Common Examples:
✅ Human Resources (HR)
✅ Research and Development (R&D)
✅ IT and Administration
✅ Customer Support
4. Key Differences Between Revenue and Expense Centers
Aspect Revenue Center Expense Center (Cost Center)
Focus Generating revenue Managing and controlling costs
Sales growth, customer Budget efficiency, cost
Performance Measure
acquisition reduction
Control Over Costs? ❌ No ✅ Yes
Control Over Revenue? ✅ Yes ❌ No
Sales department, marketing
Examples HR, IT, R&D, administration
teams

5. Importance of Revenue and Expense Centers

✔ 1. Improves Financial Management – Separates income generation and cost control for
better decision-making.
✔ 2. Enhances Accountability – Assigns clear responsibilities for revenue growth and cost
efficiency.
✔ 3. Helps in Budgeting and Performance Evaluation – Ensures better planning and
monitoring of expenses and income.
✔ 4. Supports Business Strategy – Revenue Centers drive sales, while Expense Centers
optimize resources.
✔ 5. Contributes to Overall Profitability – Effective management of both leads to higher
profits and sustainability.
✅ Conclusion:
📌 Revenue Centers focus on sales and income generation, while Expense Centers ensure
cost control and operational efficiency.
📌 Both are essential for a company's financial success, strategic planning, and long-term
growth.
6.3. Transfer Pricing
Transfer Pricing – Meaning & Principles
1. Meaning of Transfer Pricing:
📌 Transfer pricing refers to the pricing of goods, services, or intellectual property
transferred between different divisions, subsidiaries, or entities within the same organization.
📌 It is commonly used in multinational companies (MNCs) for transactions between
subsidiaries in different countries.
📌 Proper transfer pricing helps in tax planning, profit allocation, and performance
evaluation of different business units.
2. Objectives of Transfer Pricing
✔ 1. Ensure Fair Profit Allocation – Divides profits fairly among different divisions or
subsidiaries.
✔ 2. Optimize Tax Efficiency – Helps companies legally minimize tax liabilities by shifting
profits to low-tax jurisdictions.
✔ 3. Improve Performance Measurement – Evaluates the profitability of different business
units separately.
✔ 4. Maintain Compliance – Follows tax regulations and avoids penalties related to
transfer mispricing.
✔ 5. Encourage Decentralized Decision-Making – Allows divisions to operate as
independent profit centers.
3. Principles of Transfer Pricing
✔ 1. Arm’s Length Principle (ALP)
✅ The price for transactions between related entities should be the same as if they were
unrelated, independent parties.
✅ This principle ensures fairness and prevents profit shifting.
✔ 2. Consistency in Pricing
✅ The transfer price should be consistent with market conditions.
✅ Avoids manipulation of internal prices for tax benefits.
✔ 3. Compliance with Local and International Regulations
✅ Must follow OECD guidelines, domestic tax laws, and transfer pricing documentation
requirements.
✅ Helps prevent tax audits and disputes with authorities.
✔ 4. Profitability for All Units
✅ The transfer price should allow each business unit to earn a reasonable profit.
✅ Ensures that all divisions contribute to the company’s overall profitability.
✔ 5. Use of Market-Based Pricing
✅ Transfer prices should be based on comparable market prices whenever possible.
✅ Ensures fairness and transparency in intra-company transactions.
✔ 6. Consideration of Cost Structures
✅ The pricing should reflect actual production, operational, and administrative costs.
✅ Helps in fair cost recovery and profit allocation.
✔ 7. Flexibility for Business Needs
✅ Transfer pricing policies should be adaptable to changing business environments.
✅ Companies should review pricing strategies periodically for tax efficiency and profitability.
4. Common Methods of Transfer Pricing
✔ 1. Comparable Uncontrolled Price (CUP) Method – Uses market prices for similar
transactions between unrelated companies.
✔ 2. Cost-Plus Pricing – Adds a profit margin to the cost of production.
✔ 3. Resale Price Method – Determines the price based on resale value in the open market
✔ 4. Profit Split Method – Allocates profits between related entities based on value
contribution.
✔ 5. Transactional Net Margin Method (TNMM) – Compares net profit margins of
similar companies.
5. Importance of Transfer Pricing
✔ 1. Prevents Tax Avoidance – Ensures compliance with tax laws and reduces disputes
with tax authorities.
✔ 2. Encourages Efficient Resource Allocation – Helps companies allocate resources
efficiently across different units.
✔ 3. Enhances Transparency – Provides clear pricing structures for internal transactions.
✔ 4. Supports Business Expansion – Facilitates inter-company trade in multinational
businesses.
✔ 5. Helps in Cost Control – Ensures costs are allocated fairly among different divisions.
✅ Conclusion:
📌 Transfer pricing is essential for fair profit distribution, tax planning, and financial
transparency in multinational businesses.
📌 Companies must follow the arm’s length principle and global regulations to avoid legal
risks and ensure compliance.
6.4. Methods of Transfer of Pricing expense Centers
1. Meaning of Transfer Pricing for Expense Centers
📌 Expense Centers (Cost Centers) are business units that incur costs but do not generate
revenue directly, such as HR, R&D, IT, and administration.
📌 Transfer pricing for Expense Centers is the method of charging costs for services
provided by one internal unit to another within the same organization.
📌 It helps in allocating costs fairly, improving cost control, and evaluating performance.
2. Objectives of Transfer Pricing for Expense Centers
✔ 1. Fair Cost Allocation – Distributes costs among departments that benefit from shared
services.
✔ 2. Cost Control & Efficiency – Encourages expense centers to operate efficiently and
avoid unnecessary spending.
✔ 3. Performance Evaluation – Helps measure the effectiveness of cost centers by linking
expenses to service usage.
✔ 4. Encourages Decentralization – Allows each unit to manage its own budget and
expenses.
✔ 5. Compliance with Regulations – Ensures proper accounting and compliance with tax
laws.
3. Methods of Transfer Pricing for Expense Centers
1. Cost-Based Transfer Pricing
✅ The expense center charges the actual cost or standard cost of services provided to other
departments.
✅ Helps in fair cost distribution but may not always reflect the true value of services.
🔹 Example:
 An IT department incurs ₹5,00,000 in costs annually and provides support to
different departments.
 The total cost is allocated based on employee count in each department:
o Marketing (50 employees) → ₹1,00,000
o Sales (80 employees) → ₹1,60,000
o HR (30 employees) → ₹60,000
o Finance (60 employees) → ₹1,20,000
 The departments are charged accordingly.

2. Full Cost-Plus Markup Method

✅ The expense center charges the total cost of service plus a profit margin or markup
percentage.
✅ Ensures that the cost center covers its expenses and earns a margin.
🔹 Example:
 The Legal Department provides compliance services.
 The total cost is ₹2,00,000. A 10% markup is added.
 The transfer price = ₹2,00,000 + (10% of ₹2,00,000) = ₹2,20,000.

3. Negotiated Transfer Pricing

✅ The price for services is determined through negotiation between the expense center and
the receiving unit.
✅ Helps in flexibility but may lead to conflicts between departments.
🔹 Example:
 The HR department provides employee training.
 Marketing wants training at ₹30,000, but HR estimates a cost of ₹40,000.
 After negotiation, they agree on ₹35,000.

4. Market-Based Transfer Pricing

✅ The expense center charges a price based on market rates for similar services.
✅ Ensures fairness and comparability but may not always reflect internal cost structures.
🔹 Example:
 The IT department provides cloud storage services.
 External vendors charge ₹500 per GB.
 The IT department charges internal units the same rate instead of calculating actual
costs.
5. Activity-Based Costing (ABC) Method
✅ Costs are allocated based on actual usage of services rather than a general formula.
✅ More accurate and fairer but requires detailed tracking.
🔹 Example:
 The administration department incurs ₹10,00,000 in costs for office maintenance.
 Costs are divided based on square footage used by each department:
o Finance (2,000 sq. ft.) → ₹2,00,000
o HR (1,500 sq. ft.) → ₹1,50,000
o IT (3,000 sq. ft.) → ₹3,00,000
o Sales (3,500 sq. ft.) → ₹3,50,000

6. Dual Pricing Method

✅ Uses two different prices:
 The cost center records a cost-based price.
 The receiving department records a market-based price.
✅ Helps in performance evaluation but increases complexity.
🔹 Example: The R&D department incurs ₹5,00,000 in costs.
 It transfers research results to Production:
o R&D records at cost (₹5,00,000).
o Production records at a market-based rate (₹6,00,000).

4. Comparison of Transfer Pricing Methods for Expense Centers

Method Basis of Pricing Best For Limitations
Actual or standard May not reflect service
Cost-Based Simple cost allocation
cost value
Full Cost Plus Total cost + profit Covering costs with
Increases service costs
Markup margin profit
Negotiated Pricing Internal negotiation Flexibility in pricing Potential conflicts
Market-Based Market price of Comparability with May not match actual
Pricing services external rates internal costs
Activity-Based Requires detailed
Based on actual usage Precise cost allocation
Costing (ABC) tracking
Different prices for
Dual Pricing Performance evaluation Complex accounting
cost & revenue
5. Importance of Transfer Pricing for Expense Centers
✔ 1. Ensures Fair Cost Distribution – Helps in charging departments accurately based on
service usage.
✔ 2. Improves Budgeting & Cost Control – Helps departments track and control expenses
efficiently.
✔ 3. Encourages Cost Efficiency – Expense centers become more accountable for their
spending.
✔ 4. Enhances Decision-Making – Helps in financial planning by allocating costs
transparently.
✔ 5. Supports Tax Compliance – Ensures fair transfer pricing for inter-company
transactions
✅ Conclusion:
📌 Expense Center transfer pricing helps allocate costs fairly among departments while
ensuring efficiency and accountability.
📌 Companies use methods like cost-based pricing, market-based pricing, and activity-
based costing depending on their needs.
📌 Proper transfer pricing ensures financial transparency, cost efficiency, and compliance
with accounting standards.

6.5. Administrative Centers.

1. Meaning of Administrative Centers
📌 Administrative Centers are business units that provide essential support services to other
departments but do not directly generate revenue.
📌 These centers ensure the smooth functioning of an organization by handling
management, planning, coordination, and operational support.
📌 They are typically classified as Expense Centers because they incur costs without
generating income.
2. Functions of Administrative Centres
✔ 1. Strategic Planning – Assists in long-term business planning and decision-making.
✔ 2. Policy Implementation – Develops and enforces company policies and procedures.
✔ 3. Human Resource Management – Handles recruitment, training, payroll, and employee
relations.
✔ 4. Financial Management – Manages budgeting, accounting, and compliance with
financial regulations.
✔ 5. IT and Infrastructure Support – Ensures smooth operation of IT systems, office
facilities, and security.
✔ 6. Legal and Compliance Management – Oversees regulatory compliance and risk
management.
✔ 7. Communication and Coordination – Acts as a link between different departments for
efficient workflow.
3. Characteristics of Administrative Centers
✔ 1. Non-Revenue Generating – They do not sell products or services but provide internal
support.
✔ 2. Cost-Oriented – Operates as an Expense Center, with a focus on cost control and
efficiency.
✔ 3. Essential for Business Operations – Ensures that core departments function
effectively.
✔ 4. Centralized or Decentralized – Can be managed from a central location or spread
across different branches.
✔ 5. Indirect Contribution to Profits – Supports revenue-generating units by maintaining
efficiency and reducing risks.
4. Examples of Administrative Centers
✅ 1. Human Resources (HR) – Manages employee relations, training, and payroll.
✅ 2. Finance & Accounting – Handles budgeting, financial reporting, and tax compliance.
✅ 3. IT Department – Provides technology infrastructure and cybersecurity.
✅ 4. Legal Department – Ensures regulatory compliance and contract management.
✅ 5. Facilities Management – Manages office maintenance, security, and logistics.
5. Performance Evaluation of Administrative Centers
✔ 1. Budget Adherence – Ensuring expenses stay within allocated budgets.
✔ 2. Service Quality – Measuring efficiency in providing support services.
✔ 3. Cost Efficiency – Optimizing resources while maintaining productivity.
✔ 4. Employee Satisfaction – Gauging effectiveness through employee feedback and
engagement.
✔ 5. Compliance & Risk Management – Ensuring legal and regulatory standards are met.
6. Importance of Administrative Centers
✔ 1. Supports Core Business Functions – Enables departments like sales, production, and
marketing to operate smoothly.
✔ 2. Ensures Legal and Regulatory Compliance – Reduces risks by managing legal
obligations.
✔ 3. Enhances Employee Productivity – Provides necessary resources for employees to
perform efficiently.
✔ 4. Contributes to Cost Management – Helps in budgeting, controlling unnecessary
expenses, and improving efficiency.
✔ 5. Facilitates Decision-Making – Provides data and reports that aid in business strategy
formulation.
✅ Conclusion:
📌 Administrative Centers play a crucial role in the efficient functioning of a business by
managing essential support services.
📌 Although they do not generate direct revenue, they help in cost control, compliance, and
operational efficiency, which indirectly contribute to a company’s success.
6.6. Cost Management for Specific Sectors – Gold, Agriculture, IT sector, Phrama and
others (theory only).
Cost management varies across industries based on their operational processes, resource
utilization, and market dynamics. Below is a sector-wise approach to cost management:
1. Cost Management in the Gold Sector
✔ 1. High Capital Investment – Gold mining and refining require large upfront investments
in machinery, labor, and environmental compliance.
✔ 2. Operating Costs – Costs include exploration, extraction, refining, and regulatory
compliance.
✔ 3. Price Volatility Management – Gold prices fluctuate due to economic factors;
companies use hedging and risk management strategies.
✔ 4. Inventory & Storage Costs – Secure storage and insurance add to cost management
challenges.
✔ 5. Sustainability & Compliance Costs – Environmental and ethical mining practices
impact costs.
✔ 6. Supply Chain Efficiency – Managing transportation, refining, and distribution to
reduce unnecessary expenses.
2. Cost Management in the Agriculture Sector
✔ 1. Variable Input Costs – Costs of seeds, fertilizers, pesticides, and labor fluctuate due to
market conditions.
✔ 2. Weather & Climate Risks – Unpredictable weather impacts production, leading to
increased risk management expenses.
✔ 3. Supply Chain & Logistics – Storage, transportation, and perishability add to cost
burdens.
✔ 4. Government Regulations & Subsidies – Managing compliance with agricultural
policies, subsidies, and taxes.
✔ 5. Mechanization & Technology Adoption – Investment in machinery and precision
farming to optimize costs.
✔ 6. Seasonal Labor Costs – Hiring costs fluctuate with planting and harvesting cycles.
3. Cost Management in the IT Sector
✔ 1. High Fixed Costs in R&D – Investment in software development, cybersecurity, and
data analytics.
✔ 2. Labor Costs – Skilled workforce expenses, including salaries, training, and retention
strategies.
✔ 3. Cloud & Infrastructure Costs – Managing costs of cloud computing, servers, and data
storage.
✔ 4. Licensing & Compliance – Expenses related to software licensing, data privacy laws,
and security protocols.
✔ 5. Outsourcing & Offshore Development – Cost reduction through outsourcing IT
services to low-cost regions.
✔ 6. Scalability & Maintenance – Managing IT infrastructure for growth while optimizing
operational costs.
4. Cost Management in the Pharmaceutical Sector
✔ 1. High R&D Costs – Extensive investment in drug discovery, clinical trials, and patents.
✔ 2. Regulatory Compliance – Stringent regulations increase costs related to approvals
(FDA, WHO, etc.).
✔ 3. Manufacturing & Quality Control – Costly production processes with strict quality
assurance standards.
✔ 4. Distribution & Logistics – Cold chain storage, transportation, and retail distribution
expenses.
✔ 5. Marketing & Sales Expenses – High costs associated with branding, promotional
campaigns, and medical representatives.
✔ 6. Generic vs. Branded Drugs – Managing cost differences between patented and off-
patent drugs.
5. Cost Management in Other Sectors
a) Automobile Industry
✔ 1. High Capital Investment – Costs related to manufacturing plants, R&D, and robotics.
✔ 2. Supply Chain Costs – Managing raw materials, parts, and logistics efficiently.
✔ 3. Inventory & Production Planning – Reducing waste through lean manufacturing and
JIT (Just-In-Time) production.
b) Healthcare Sector
✔ 1. Equipment & Infrastructure Costs – Expensive medical equipment and hospital
facilities.
✔ 2. Regulatory & Compliance Expenses – Ensuring compliance with healthcare laws and
accreditation standards.
✔ 3. Operational Efficiency – Reducing administrative costs and optimizing staff
utilization.
c) Education Sector
✔ 1. Faculty & Staff Salaries – Major cost component in schools, colleges, and universities.
✔ 2. Digital Transformation Costs – E-learning platforms, online courses, and IT
infrastructure.
✔ 3. Research & Development – Investment in academic research and new learning
methodologies.
✅ Conclusion:
📌 Cost management strategies differ across industries, focusing on efficiency,
sustainability, and compliance.
📌 Sectors like gold, agriculture, IT, pharma, and others require tailored approaches to
cost control and financial optimization.