Cost centre in Accounting

Definition: A cost center is a business unit that is only responsible for the costs that it incurs. The manager of a cost center is not responsible for revenue generation or asset usage. 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. A cost center is a unit or a division in an organization that does not take in any income, but must spend money to fulfill an important function. In other words, a cost center only adds to costs. 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. The management focus in a cost center is usually on keeping expenditures down to a minimum level, possibly by using outsourcing, automation, or capping pay levels. The main exception is when a cost center indirectly contributes to profitability (such as R&D), in which case a certain minimum expenditure level will be needed to support sales.

Type of Cost Centres

There are two main types of cost centres,: Production cost centres: This is where the products are manufactured or processed. Example of this is an assembly area. Service cost centres: This is where a service is provided to other cost centres. Example of this is the personnel department or the canteen.

Examples of cost centers

1. Accounting department 2. Human resources department 3. IT department 4. Maintenance department 5. Research & development 6. Marketing Department 7. Human resources 8. Research and Development 9. Work office 10.Quality Assurance Department

Function-Specific Cost

The main function of a cost centre is the tracing of all expenses linked with a certain function. For example, by considering a call center as an independent unit, the firm can calculate how much it is spending each year for its 1-800 support service. If a cost centre is not considered independent then it would take a lot of effort in measuring the cost of providing this service because it will include dividing up the company's entire personnel and phone bills by department each month.

Benefits of Cost Centre

There are numerous benefits of a cost centre which include: Monitoring efficiency- Cost centres are beneficial as they allow the effectiveness of all aspects within a company to be monitored closely. Boosts employees confidence- The delegation of authority that takes place when making employees accountable for cost centre is a good way to improve confidence. Prevents loss- 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. Increases profit- If even one of the cost centre 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 can't be performed which will affect the firm's profit negatively. Makes the manager more efficient- 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 is held accountable for costs incurring in the cost centre under his control, in which case, collecting and comparing costs may motivate the manager to be more productive.

Financial vs. Managerial Accounting

Note that keeping track of cost centers is the responsibility of the managerial accounting, as opposed to the financial accounting, department. Managerial accountants track and file data that help management make critical decisions. Financial accountants track data that are mandatory to report to the tax authority, as well as other bodies such as the Securities and Exchange Commission. Governmental bodies are primarily concerned with the profitability and resulting tax bill of the business. How much of the phone bill belongs to the marketing department vs. the call center is not the concern of a financial accountant, but matters to a managerial accountant.

Cost Center Budget

A cost center budget separates the company into different cost centers. Each cost center represents a unit within the company, such as an individual department or a separate facility. The manager of that cost center maintains responsibility for developing the budget for her area. Companies can classify cost centers in several ways. These include geographic location, individual product line or function.

Functional Budget

A functional budget considers the activities occurring throughout the company. The owner separates the budget into different segments based on the functions occurring in the organization. These functions include accounting, sales and production. The owner separates the company into functional areas and assigns responsibility for the budget to a manager in that area.