# Finance Assignment

Revenue Center

Revenue center can be defined as a business unit, division or operation that generates revenue through sales of products or services. It is a part of an organization that specifically charges for their services in order to generate revenue. For example, in case of hotel industry, room division is the main revenue center for full-service hotels. It is because room division is the main cost driver for a hotel to generate sales revenue (Finkler, Kovner & Jones, 2007).

Cost Center

A cost center is the unit within an organization that has direct control over costs, but not over revenue. This center is only responsible for costs that occur in the business. It doesn’t generate profit directly from its activities because it has negative impact on profits. Manufacturing plant of an automobile company is a good example of cost center. It is because it can control manufacturing costs of the company, but not revenue (Siegel & Shim, 2006).

Profit Center

It can be defined as a business segment that is responsible for both revenue and expenses. A profit center includes cost as inputs as well as revenue as outputs to determine profit in the business. For example, iTunes Music Center is a profit center for Apple Computer (Tracy, 2011).

Investment Center

It is a business unit that is responsible for profit as well as investments in assets like property, plant and machinery. The manager of an investment center is responsible for costs, revenue and return on investments in assets. An auto product line is an example of investment center because it includes costs due to manufacturing, revenue from sales and investments in plant and equipments (Kimmel, Weygandt & Kieso, 2009).

Harrison Handbags thinks to increase its advertising budget by \$24,000 that is currently \$150,000 in order to raise its profit. The potential impact of this proposal on profit is determined below-

Proposed increase in advertising budget = \$24,000

Increase in sales = 32,000 purses

Additional profit = \$1.00 per purse

Total additional profit (from additional sales of purses) = 32,000 × \$1.00

= \$32,000

Total profit = Incremental revenue – incremental cost

= \$32,000 – \$24,000

= \$8,000

The calculation shows that if \management of Harrison Handbags accepts the proposed increase in advertising budget then it will provide additional profit of \$8,000 to the company.

Memorandum

To: Brent Bybee, Manager, Packaging Department

From: Plant Manager

Date: 3rd June, 2013

Subject: Reporting for Variances

A variance analysis is performed to determine variances for each cost that is associated with packaging department of the company. The result of variance analysis is as follows:

 Cost Item Budgeted Cost Actual Cost Variance Labor \$               12,000 \$               12,200 \$                     200 Unfavorable Materials 7500 10200 2700 Unfavorable Supplies 1700 1650 -50 Favorable Maintenance 3500 3500 0 No Impact Utilities 5000 5000 0 No Impact

The above table shows that direct labor and materials variances are unfavorable for the company. It is because actual labor as well as material costs is higher than budgeted costs. The actual labor cost is \$12,200, while budgeted amount is \$12,000 that means actual cost is higher by \$200. Similarly, the actual materials cost is higher from its budgeted figure by \$2,700. Both these situations are adverse for the company due to additional expanses on labor and materials in the packaging department.

But, supplies variance is favorable for the company because actual cost is lower than budgeted amount. Along with this, maintenance and utilities cost variances are zero due to no difference between actual and standard amounts. From variance analysis, it is found that overall variable cost variances are unfavorable for the company, so there is a need to eliminate difference between budgeted and actual costs in case of labor and materials costs.

In this way, the searching of new suppliers, who supply raw materials of packaging at lower price in the comparison of current suppliers, can be helpful to reduce actual material cost. Additionally, by avoiding the wastes of materials, the cost of packaging items can be maintained as per or below the allocated budget amount (Shim, Siegel & Shim, 2011). On the other hand, reduction in labor hours and increase in productivity of workers through training can be also helpful to restrict labor expenses within budgeted amount. Along with this, by preparing flexible budgets, unfavorable labor and material cost variances can be removed in the future (Needles, Powers & Crosson, 2010). All these ways can be useful to eliminate direct labor and material cost variances.

Decision on Investment Opportunity

Holman’s and Sons is a manufacturing company that acquired Leavitt’s Lumber in 2007. In 2010, Leavitt’s Lumber had an investment opportunity that had potential to provide 16% return on investment (ROI) and residual income of \$150000. The decision of accept the investment opportunity on the basis of ROI and residual income is discussed below-

Decision with ROI:

If ROI is used as the performance measure then there is need to compare estimated ROI of investment opportunity with desired return on capital of the company and its parent organization Holman’s and Sons. The investment opportunity had an expected ROI of 16% that is lesser by 1% from actual ROI of the company in 2010. But at the same time, it is higher by 1% from minimum rate of return of 15% (16% > 15%), which desired by Holman’s and Sons. It indicates that investment center (corporate headquarter) performed well due to potential increase in sales and decline in costs (Needles, Powers & Crosson, 2010). On the basis of this, it can be concluded that investment opportunity would be accepted.

Decision with Residual Income:

Residual income is a divisional profit that determines after deducting the cost of capital charge on investment. It is a type of income that remains after paying all expenses related to interest. In the given case, Leavitt’s Lumber had a residual income of \$150,000 in 2010 when company had an investment opportunity. The residual income of the company was positive in 2010 after paying all its debt expenses, which exhibit that it earned good returns on investments in assets during that period. From this, it is observed that managerial performance of investment center is good and enough to encourage greater profitability on investment (Drury, 2006). On the basis of positive residual income, investment opportunity would be accepted due to potential of higher returns.