COST CENTRE
Cost Centre is a department or function within an organization that does not directly add to profit but still costs the organization money to operate. Cost centers only contribute to a company’s profitability indirectly.
A cost center can be defined at a smaller level than a department. It could involve a particular job position, machine, or assembly line. However, this more detailed view of cost centers requires more detailed information tracking, and so is not commonly used.
ACCORDING TO E. L. KOHLER
A cost centre is “an organisational division, department or self-division, a group of machines, men or both. It includes any unit of activity into which a manufacturing plant or other operating organisation is divided for purposes of cost assignment and allocation”.
ACCORDING TO THE TERMINOLOGY OF CHARTERED INSTITUTE OF MANAGEMENT ACCOUNTANTS
“A cost centre is a location, person or item of equipment or group of these, for which cost may be ascertained and used for the purpose of cost control.”
The performance of a cost center is usually evaluated through the comparison of budgeted to actual costs. The costs incurred by a cost center may be aggregated into a cost pool and allocated to other business units, if the cost center performs services for the other business units. Examples of cost centers are as follows:
- Accounting department
- Human resources department
- IT department
- Maintenance department
- Research & development
Cost Centre is a location, person or item of equipment for which cost may be ascertained and used for the purpose of cost control. From functional point of view, a cost centre may be relatively easy to establish, because a cost centre is any unit of the organization to which costs can be separately attributed.
A cost centre is an individual activity or group of similar activities for which costs are accumulated.
FEATURES OF COST CENTRES
- A cost center is a function within an organization that does not directly add to profit but still costs money to operate, such as the Accounting, Human Resource, or Information Technology departments.
- The main use of a cost center is to track actual expenses for comparison to budget.
- A cost center indirectly contributes to a company’s profit via operational excellence, customer service, and enhanced product value.
- The manager for a cost center is only responsible for keeping costs in line with budget and does not bear any responsibility regarding revenue or investment decisions.
TYPES OF COST CENTRES
Personal Cost Centres
A cost centre which consists of a person or group of persons is called ‘personal cost centre’. Example: Sales manager, Works manager, etc.
Impersonal Cost Centres
An impersonal cost centre consists of a location or item of equipment, production department, a machine or a group of machines.
Production Cost Centres
Production cost centres are engaged in production activity by conversion of raw material into finished production. For example, maintenance department is a service department provides service to other cost centres which include both production cost centres and service cost centres.
Service Cost Centres
Service cost centres are those which are ancillary to and render service to other production and service cost centres. A power house is a service cost centre generates and supplies power not only to production cost centres but also to other service cost centres.
Process Cost Centre
A cost centre in which a specific process or a continuous sequence of operations is carried out.
Profit Centre
Chartered Institute of Management Accountants, London defines Profit Centre as “a segment of the business entity by which both revenues are received and expenses are incurred or controlled”.
A Profit Centre is any sub-unit of an organization to which both revenues and costs are assigned, so that the responsibility of a sub-unit may be measured. Profit centre is a segment of the business entity by which both revenues are received and expenditures are caused are controlled. Such revenues and expenditure being used to evaluate segmental performance.
In profit centre, both inputs and outputs are capable of measurement in financial terms and it provides more effective assessment of the managers performance since both costs and revenues are measured in monetary terms.
A division of a company which produces and markets the products may be called as ‘profit centre’. The performance of a profit centre is evaluated in terms of the fact whether the centre has achieved its budgeted profits.
Investment Centre
Where a divisional manager of a company is allowed some discretion about the amount of investment undertaken by the division, assessment of results by profit alone is clearly inadequate. The profit earned must be related to the amount of capital invested.
Such divisions are sometimes called ‘Investment centres’ for this reason performance is measured by return on capital employed (ROCE), often referred to as return on investment (ROI) and other subsidiary ratios, or by residual income (RI). For an investment centre organization, the conditions which are necessary for a profit centre organization must exist.
BENEFITS OF COST CENTRE
- Monitoring efficiency: Cost centres are beneficial as they allow the effectiveness of all aspects within a company to be monitored closely.
- Employee confidence: The delegation of authority that takes place when making employees accountable for cost centre is a way to improve confidence. Loss prevention – Cost centres try to update processes, be more effective and save money so that they can reduce the expenses. Cost centres try to cover all of their costs with offsetting revenue by reducing expenses and producing unpredicted revenue, thus preventing loss.
- Increasing profit: If one of the cost centres is removed from a firm then it has a negative impact on the profit margin of that firm. For example, if an HR department was removed then basic employment functions and essential business processes cannot be performed which will affect the firm’s profit negatively.
- Management efficiency: Managers compare cost data from different time periods in order to see whether the cost centre is becoming more or less profitable. Generally a specific person (a cost centre manager) is held accountable for costs incurring in the cost centre under his or her control, in which case, collecting and comparing costs may motivate the manager to be more productive.
DRAWBACKS/ LIMITATIONS OF COST CENTRES
- Negative effects on other departments: Although the cost of operating a specific department is simple to calculate, cost centres are a source of encouragement for managers to underfund their elements so that it can benefit the cost centre, which can have a harmful effect on other departments within the firm.
- Hard to monitor efficiency: It is hard to keep a track of how efficient these centres.
- Profit can not be controlled: Divisional performance can only be evaluated in terms of cost because profit is not in control of the manager.
- Efficiency and productivity cannot be assessed properly: In a cost centre, the result of a decision is calculated by cost alone; the achievements of the cost centre are not measured in financial terms, therefore it is hard to assess efficiency and productivity properly.
COST UNIT
A cost unit is a device for the purpose of breaking up or separating costs into smaller sub-divisions.
Thus, these smaller sub-divisions are attributable to products or services to find out product cost or service cost or cost of time for a particular job etc.
ACCORDING TO THE CHARTERED INSTITUTE OF MANAGEMENT ACCOUNTANTS, LONDON
“Cost unit is a unit of product or service in relation to which we ascertain costs”.
The forms of measurement used as cost units are normally the units of physical measurements like a number, weight, area, length, value, time etc. A unit should be unambiguous, simple and commonly used.
| Sl. No | Cost Unit Basis | Types of Industries |
| 1 | Number | Automobile |
| 2 | Metre or Kilometre | Cable, Rope, Road Construction, Wire |
| 3 | Tonne | Iron and steel, Sugar, Cement, Mines and Quarries |
| 4 | Litre, Kilogram, Tonne | Chemicals |
| 5 | Cubic Metre | Gas, Casting |
| 6 | Square Metre | Metal Plating, Fabric Printing |
| 7 | Grors or Bag of Standard Weight | Nuts and Bolts |
| 8 | Kilo-watt hour | Power (Electricity) |
| 9 | Tonne-Kilometre, Passenger Kilometre | Transport |
| 10 | Thousand | Bricks |
FEATURES OF COST UNIT
A unit of cost must possess the following characteristics:
- It must be one with which expenditure can be conveniently associated.
- It must be appropriate or natural to business operations and the product.
- It must be certain or definite and not changing from time to time.
- It must be simple to understand and to quote.
- It must have universal acceptability.
TYPES OF COST UNITS
Cost units may be divided into two parts:
(a) Simple Unit: It involves the use of a single standard or unit of measurement of the goods manufactured e.g., per piece, per kilogram, per quintal, per tonne, per gallon, per meter etc.
(b) Composite Unit or Complex Unit: It is a combination of two simple units e.g., per passenger-kilometer, per tonne-kilometer, per kilowatt-hour etc.
Cost unit is always selected very carefully which depends on the nature of business operations. The cost unit of steal is naturally ascertained in terms of per tonne. Cost of carrying a passenger by a transporter shall naturally be ascertained in cost unit of kilometer.
DIFFERENCE BETWEEN COST CENTRE AND COST UNIT
| BASIS FOR COMPARISON | COST CENTRE | COST UNIT |
| Meaning | Cost centre refers to a subdivision or any part of the organization, to which costs are incurred, but does not contribute to the company’s revenues directly. | Cost unit implies any measurable unit of product or service, with respect to which costs are assessed. |
| Use | It is used as a basis for classifying costs. | It is used as a standard for making a comparison. |
| Cost | Costs are collected and absorbed by cost units. | Costs are measured and expressed in terms of cost units. |
| Ascertainment | Cost Centres are ascertained as per the nature and technique of production process, organization size and structure. | Cost units are ascertained as per the nature of the final output and the existing trade practices. |
| Sequence | First | Second |
| How many? | Several cost centres are there, even if there is just one product or service offered. | There are different cost units for different products or services. |
CONSLUSION
Basically, cost centres are established for helping the management in the activities like budgeting, strategic planning, decision making and controlling. On the flip side, cost unit has no such role to play, as it is just a measure of expressing cost.
