Profit Center Accounting: Theory and Practice
Garber, Marshall, The CPA Journal
Problems do not go away over time just because they are ignored. Divisional accounting is a case in point. The central theme of this article is to consider the issues associated with divisional entities, such as profit centers, that exist in corporations and the undeveloped state of the tools available to accountants when dealing with these business structures.
A few scholars have waded in this field, but none has arrived at a conclusive approach of proven effectiveness that could establish a path toward improved execution. This article moves the existing information forward and proposes a fresh approach to divisional accounting.
The 20th century saw dramatic changes in the evolution of business structures. It was the dawn of the conglomerate and growing complexity in the day-to-day operations of everlarger corporations. It was also the era when internal accounting practices fell perilously behind in the development of methods to accommodate these new structures. There are few, if any, issues facing the profession that are as profound and in greater need of revision - i.e., modernization - than internal accounting.
In first half of the 20th century, as the conglomerate became a more common structure, so too, by necessity, did the discrete profit center - an entity within the corporation that earned revenue for its line of business. But this segmented part of the company benefited from sharing resources with other divisions that also utilized central support departments, such as legal, marketing, public affairs, and IT. These proportioned assessments became a hallmark of the advantages to the divisionalization of the company without having to mimic a fully fleshed out corporate structure. As a result, certain costs of doing business were markedly reduced.
But this also produced a new challenge unforeseen by financial executives: how to account for a profit center that shares costs with other divisions.
The history of attempts to establish accounting protocols for profit centers is filled with debate, controversy, and inconclusive outcomes. Even today, despite advances in corporate architecture, the input of impressively educated financial caretakers within a given company, as well as cadres of expert consultants, there is no universally accepted and widely deployed approach. The academic community also has weighed in, as well it should, but these thinkers have yet to produce a broadbased solution for the business world.
Problems arise from the assignment of costs to divisions that are not rooted in transactions between buyer and seller. Instead, costs are often dumped on divisions through an artificial construct - allocations - expressly developed to find a place to put these orphaned expenses. Surely, some entity must pay for them.
There were excellent efforts to better understand divisional accounting, and significant progress was made to better manage it: In the 1960s, David Solomons, among the foremost accounting scholars of his time, was able to consolidate his thinking with that of predecessor Gordon Shillinglaw's principles\ on the matter of internal accounting, and he produced a comprehensive and well- wrought book, Divisional Performance: Measurement and Control (Financial Executives Research Foundation, 1965). The extensively researched project came at the behest of some of the country's then-largest industrial corporations, working through the Financial Executives Research Foundation. In Solomons' s study, 25 leading companies agreed to lay bare their internal accounting processes so that he could produce a bridge that spanned the gap between theory and practice. The material sanded the rough edges of what had preceded it, but still fell short of resolving every procedural question.
Though well received, Solomons' s book did not gain wide acceptance in practice. By and large, corporations went about their business as before - deploying questionable tactics and transferring costs in every way imaginable, seemingly content to build a faulty case for standing pat instead of committing to any rectifying action. …