A profit center is a branch or division of a company that directly adds or is expected to add to the entire organization’s bottom line. It is treated as a separate, stand-alone business, responsible for generating its revenues and earnings.

Ideally, for accountability purposes, profits of a segment or division should be based on revenues and expenses under that manager’s control. The manager should have the authority to control selling price, sales volume, and all reported expense items.

Even so, a profit center may be assigned an allocated portion of fixed, uncontrollable costs in order to come up with a realistic bottom line. Unlike a revenue center that is only judged on gross or net revenues from services or product sales, a profit center will encompass gross sales, cost of goods sold and other variable costs, and fixed costs, but not usually taxes and interest and other non-operating expenses (such as gain or loss on sale of assets and other unusual items).

For example, a hospital might have the following responsibility centers:

• Inpatient care
• Housekeeping
• Pediatrics
• Neonatal
• Home Care
• Gift Shop
• Administration

Admin and housekeeping would be cost centers, and those costs would be allocated to other departments using some kind of burden rate or system, such as activity based costing (ABC).

The manager of the pediatric unit, a profit center, would be responsible for controlling the direct costs, such as labor, supplies, outsourced services, but the indirect/overhead costs would just be allocated.

Cost allocation helps the organization determine the full cost of providing patient services and then allows the organization to determine if payments from private and public sources are adequate.

Management should keep the following three principles in mind when allocating costs to profit centers:

• The goal should be to apportion overhead to the activities that create the need for the cost on some kind of systematic, rational basis.
• The cost-allocation method should be fair and agreed upon so that the profit-center managers believe that the allocated costs reasonably reflect that cost center’s portion of the total costs.
• The allocation process should help foster a cost-reduction or at least a cost-control mindset within the organization.

Next time you are at the zoo or a museum and you visit the gift shop or concession stand, consider whether it is a cost center, a revenue center, or a profit center. Do you think management considers only the costs of the shop or just the revenues, or do you think management takes both into account?

The fourth type of cost center is the investment center, but before we take a look at that unique responsibility center, here is a brief review of profit centers:

You can view the transcript for “Profit Center” here (opens in new window).

Now, check your understanding of profit centers.