Difficulty: Intermediate | Prerequisites: Introduction to management accounting concepts, basic understanding of cost allocation.
This case sits at the intersection of cost allocation, responsibility accounting, and transfer pricing. It illustrates how internal service departments interact with revenue-generating units in a professional services firm, and why the structure of that interaction (profit centre, cost centre, expense centre) shapes behaviour. If you have not yet covered responsibility centres or transfer pricing, read those notes first. The case is commonly used in managerial and cost accounting courses to ground abstract concepts in a realistic consulting-firm scenario.
SF Bay Consulting is an economics-based consulting firm whose internal Computer Services (CS) department is in conflict with its revenue-earning consulting groups over pricing, service quality, and resource allocation. The new CFO, Donald Learner, must decide how to structure CS (as a profit centre, cost centre, or expense centre) to resolve the dispute and keep the firm profitable. The case is a vehicle for exploring responsibility centres, transfer pricing, and the behavioural effects of different cost-allocation methods.
Responsibility centre
An organisational unit whose manager is held accountable for specified financial results. The type of centre (cost, profit, expense, investment) determines what the manager controls and what they are measured on.
Think of it as: the label that tells a manager "you own these numbers."
Cost centre
A responsibility centre whose manager is accountable for costs incurred but not for revenue. The department's output is measured against a budget, and internal users are typically charged for the services they consume.
In simple terms, this means the department tracks what it spends and bills other units, but it is not expected to turn a profit.
Expense centre
A responsibility centre where costs are absorbed centrally and no internal billing takes place. Users consume the department's services without being charged directly, and the department's budget is set by senior management.
Think of it as: the company pays the tab, and nobody gets an internal invoice.
Profit centre
A responsibility centre whose manager is accountable for both revenues and costs, and therefore for the difference between them (profit). An internal service department run as a profit centre charges market-rate or negotiated prices to other units.
In simple terms, this means the department is expected to cover its costs and, ideally, generate a surplus.
Transfer price
The price charged for goods or services exchanged between divisions or departments within the same organisation. Setting this price too high or too low distorts each unit's reported profitability and can create conflict.
Think of it as: the internal price tag on a service one part of the firm sells to another.
Internal service department
A department (such as IT, HR, or legal) that exists to support the firm's revenue-generating units rather than to serve external clients directly.
In simple terms, this means a back-office team whose "customers" are all inside the company.
Professional partnership
A firm structure in which senior professionals (partners) share ownership, profits, and governance. SF Bay Consulting uses a hierarchical variant of this model.
Think of it as: the partners are both the owners and the senior workers.
SF Bay Consulting was founded in 1965 by Geoffrey Kramer, Alex Whalen, and Joan Kalper.
The firm is structured as a hierarchical professional partnership.
Two main consulting groups:
Litigation Support (56 researchers), split into Economic Litigation and Energy/Regulation.
Business Consulting (28 researchers), split into Transportation, Pharmaceuticals, Metals & Minerals, and Chemicals & Plastics.
Both groups rely on quantitative economic analysis as their core methodology.
The firm also operates an internal Computer Services (CS) department that supports both groups.
The CS department provides computing infrastructure (hardware, software, data-analysis tools) to all consulting groups.
Consultants treat high-powered computing as a competitive advantage, so demand for CS resources is intense.
The Litigation group is the heaviest user, consuming the majority of CS capacity and requesting the newest hardware and software.
Litigation's complaints about CS:
Poor service quality.
Excessively high internal prices ("exorbitant pricing").
CS's complaints about Litigation (and consultants generally):
Supporting every individual consultant's demands is operationally impossible.
CS believes its prices are well below external market rates.
Maintaining a controlled, reliable system conflicts with unlimited customisation requests.
The conflict is a classic internal-service-department tension: the users want more and cheaper, the provider wants stability and recognition.
Donald Learner, the newly appointed CFO, inherits this conflict.
His core challenge: meet the consultants' computing demands while keeping the firm as profitable as possible.
This is a responsibility-centre design problem. The choice of how to classify CS determines:
Whether CS charges the consulting groups (and at what price).
How CS's costs appear in the firm's management accounts.
What incentives CS managers and consultants face.
Run CS as an expense centre: Eliminate internal billing entirely. CS costs are absorbed centrally, and consultants use computing resources without charge. This removes the pricing conflict but may encourage overconsumption and makes it harder to control CS spending.
Run CS as a cost centre: CS charges consulting groups at cost (no markup). This preserves cost visibility and usage signals, but may not resolve disputes over what "cost" means or whether the allocation method is fair.
Run CS as a profit centre: CS charges market-based or negotiated transfer prices. This creates strong accountability for CS but risks the exact complaints the Litigation group is already making.
The case source suggests that running CS as an expense centre and eliminating internal billing is the best option for this firm, on the reasoning that the pricing dispute is more damaging to the firm than the risk of overconsumption.
Students often think an expense centre means the department has no budget discipline at all. It does not. The department still operates within a centrally set budget; the difference is that individual users are not billed.
Students often conflate cost centres and expense centres. A cost centre charges users for the resources they consume (creating a usage signal); an expense centre does not bill users at all.
Students sometimes assume that a profit centre is always the "best" structure for an internal department because it creates accountability. In a professional partnership where internal conflict damages client service, a profit centre can do more harm than good.
Students often forget that the transfer price itself is a design choice. Saying "charge at cost" still leaves open the question of which costs to include, how to allocate overheads, and whether to use actual or budgeted figures.
⚠️ Be prepared to argue for or against each responsibility-centre option for CS. Exam questions frequently ask you to recommend a structure and defend it with reference to the firm's specific circumstances.
⚠️ The behavioural effects of cost allocation are a favourite exam topic. Know how different structures change the incentives of both the service department and its users.
⚠️ Transfer pricing disputes are not just about the number. The pricing method (market-based, cost-based, negotiated) shapes behaviour, and examiners want you to explain how.
⚠️ This case illustrates the tension between cost control and service quality. An exam answer that addresses only one side will lose marks.
True or False: An expense centre charges internal users for the services they consume.
Answer: False. An expense centre absorbs costs centrally; there is no internal billing.
Fill in the blank: SF Bay Consulting's two main consulting groups are ________ and ________.
Answer: Litigation Support and Business Consulting.
True or False: Running Computer Services as a profit centre would eliminate the pricing dispute between CS and the Litigation group.
Answer: False. A profit centre charges market-based or negotiated prices, which could intensify the pricing complaints.
Fill in the blank: A transfer price is the price charged for goods or services exchanged between ________ within the same organisation.
Answer: Divisions or departments.
True or False: The Litigation group employed fewer researchers than the Business Consulting group.
Answer: False. Litigation employed 56 researchers; Business Consulting employed 28.
Q: What are the main arguments for running Computer Services as an expense centre in SF Bay Consulting's case?
A: Eliminating internal billing removes the pricing dispute between CS and the consulting groups, reduces administrative overhead, and lets consultants focus on client work without worrying about internal charges. The risk of overconsumption can be managed through a centrally set budget and usage policies.
Q: What is the primary disadvantage of running CS as an expense centre?
A: Without internal charges, consultants have no price signal to moderate their use of computing resources. This can lead to overconsumption, rising CS costs, and difficulty holding individual groups accountable for the resources they use.
Q: How does the choice of responsibility centre for CS affect the behaviour of both CS staff and consultants?
A: If CS is a profit centre, CS staff are motivated to maximise revenue (potentially by overcharging), while consultants are motivated to minimise their use of CS (potentially by underinvesting in computing). If CS is an expense centre, CS staff focus on budget management while consultants face no cost constraint on their usage. A cost centre sits between these extremes: CS recovers its costs, and consultants see the cost of what they use, but neither side has a profit motive.
Q: Explain why the Litigation group was the most vocal critic of Computer Services.
A: Litigation was the heaviest user of CS resources, consuming the majority of CS capacity and demanding the newest hardware and software. Because their usage was high, they bore the largest share of internal charges, making them the most sensitive to CS pricing. Their perception of poor service quality alongside high prices created a strong sense of unfairness.
Q: If you were advising the CFO, what additional information would you want before recommending a responsibility-centre structure for CS?
A: Useful information would include: the current internal pricing method and rate schedule, a breakdown of CS costs by type (fixed vs variable), usage data by consulting group, benchmark pricing from external IT service providers, and whether the firm has considered outsourcing any CS functions. Understanding each group's willingness to use external providers would also clarify the competitive dynamics.
This case connects directly to transfer pricing theory: the methods covered in your textbook (market-based, cost-based, negotiated, dual-rate) all apply to the CS pricing question, and the case gives you a concrete setting to test each one against.
It also ties into the broader topic of decentralisation and divisional performance evaluation. The choice of responsibility centre for CS is part of the firm-wide question of how much autonomy to give each unit and how to measure whether that autonomy is working.
If your course covers service-department cost allocation (direct method, step-down method, reciprocal method), this case is useful context: once you decide CS is a cost centre, you still need to choose how to allocate its costs across the consulting groups.
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