A cost centre is a division of a business that has responsibility for its own operational costs. The cost centre is held accountable for its departmental expenditure. They can help managers to collect and use cost data effectively, thereby having better budgetary control. For example, they may be held accountable for their own expenditure on advertising, wages, and material costs.

Cost centres do not specifically generate any revenue but their operations contribute to the overall costs of the organization. For instance, most IB World Schools operate with cost centres, such as the Science and Mathematics departments having responsibilities for their own spending. Non-profit organizations also tend to use cost centres for improved budgetary and cost control.

Examples of cost centres in the corporate world include:

1. Organization by function - this means the cost centres of a business are based on different functional departments, such as human resources, finance and accounts, marketing and operations management (production). Each of these functions or department is a specific cost centre.

2. Organization by product - a business that produces a range of goods and/or services, such as an IB World School, can be organized by product to ensure that each product is accountable for its own costs. For example, Nike produces sportswear and equipment for various sports (like football, basketball, tennis, athletics, and golf) as well as many other products. Cost centres would enable costs to be attributed to each product, as measured by their cost of production.

3. Organization by geography - large businesses with multiple outlets in the country or overseas, such as  McDonald's or Samsung, can be organized by their geographical location. Each location can be treated as a cost centre to determine which areas have better operational control over their costs.

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. Large organizations tend to use profit centre to account for the different amounts of profit made by different divisions the organization.

For example, chain stores (with multiple outlets) hold each branch (store) accountable its own profits or losses. Profit centres are common in organizations that are decentralised. Operating profit centres enables senior management to focus on strategic issues for the organization, leaving the tactical issues to be tackled by operational managers.

In the same way as cost centres, profit centres can be organized by function, product or geography, depending on the needs of the organization. An example of profit centres for Apple is shown in the image below. Steve Jobs had previously organized the company by function in a relatively simplistic way, but Tim Cook having taken over as CEO of the company which included a much larger product portfolio has since added new functions as profit centres:

Apple's profit centres, organized by function

 Exam Practice Question - Tsingtao Brewery Company

The Tsingtao Brewery Company (Tsingtao for short) is China’s second largest brewery. Founded in 1903, the company has been export-orientated since the 1980s with sales in more than 50 countries. Tsingtao is one of the top brands of consumer products exported from China. It has been the top selling Chinese beer in the USA since the early 1970s. To further enhance its brand development, Tsingtao’s budgeting allocated funds to officially sponsor the 2008 Beijing Summer Olympic Games, which was watched by 4.7 billion viewers worldwide. In 2013, Tsingtao confirmed a sponsorship deal with the British Superbike Championship, further widening its brand awareness and capitalizing on the global sports audience. Tsingtao was also an official sponsor of the 2022 Winter Olympics Games, held in Beijing.

 Teacher only box

Answers

(a)  Define the term budgeting.  [2 marks]

Budgeting is the cyclical (on-going) process of planning, setting, controlling, monitoring, and reviewing the financial plan of expected revenues and expenditures for an organization (or a department within an organization), for a given period of time.

Award [1 mark] for a vague definition of budgeting.

Award [2 marks] if budgeting is clearly defined, similar to the example above.

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(b)  Define the term brand awareness.  [2 marks]

Brand awareness measures the extent to which potential customers or the general public recognize a particular brand. It can be expressed as a percentage of the sample surveyed.

Award [1 mark] for a vague definition of brand awareness.

Award [2 marks] if brand awareness is clearly defined, similar to example above.

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(c)  Examine the importance of budgeting to Tsingtao Brewery Company.  [6 marks]

Being China’s second largest brewery, Tsingtao will need effective budgeting in order to run its global operations efficiently. Budgeting as a management tool is important to Tsingtao for several reasons, including:

• Budgeting can be used to motivate Tsingtao managers and other budget holders, to encourage responsibility and accountability and to aid financial control.

• It helps to control business costs in order to prevent liquidity problems.

• It has a central role in strategic planning, e.g., setting aside a sufficient budget to sponsor major sporting events such as the Beijing Olympic Games or the British Superbike Championship.

• Budgeting requires Tsingtao to plan for the future as it tries to enhance its corporate brand awareness and brand development.

• It helps to ensure that Tsingtao managers plan ahead and to anticipate any financial problems before they arise. They are required to anticipate the costs and revenues of different business activities and hence to agree on competing priorities and targets.

• Ultimately, effective budgeting avoids inefficient expenditure and improves the long-term competitiveness of Tsingtao.

Award [1 – 2 marks] if the answer is generalized and/or lacks substance.

Award [3 – 4 marks] if there is some examination of the importance of budgeting although the answer might lack detail and/or application to Tsingtao Brewery Company.

Award [5 – 6 marks] if there is a thorough examination of the importance of budgeting to Tsingtao Brewery Company. Appropriate terminology has been used with sound application to the case study.