Updated July 19, 2023
Definition of Cost Centre
Cost centre refers to the unit or the department of any company for which the company has to incur the cost but it does not contribute towards earning of the revenue by the company directly, rather they contribute indirectly in earning the revenues where they are operated mainly for the purpose of tracking the actual expenses incurred by the organization and comparing the same with its budget.
Cost centrecan be any department or unit if the business which is responsible only towards the costs incurred by it and it is not responsible towards generation of the revenue or the usage of the assets. They mainly focus on proper utilization of the resources of the company where performance in case of the cost centre is evaluation on the basis of the performing comparison between the budgeted costs of the company to its actual cost. The cost which these cost centres incurs are aggregated into one cost pool and then allocated to the other units of the business. In an organization, there could be multiple cost centre. Even within one department of company there could be several cost centre.
How Does it Work?
Costs centres are the different sub units within the organization which are created not with the motive of earning revenues or profits directly from them rather they are created to track the expenses in the company. The main focus of the management is to keep the expenditure of the company at the minimum possible level with the help of its cost centreand to ensure optimum utilization of its resources as they help in providing the better understanding about how the resources are being used in the organization.
Example of Cost Centre
Accounts department in any company is one of the examples of cost centreas they are responsible for maintaining the accounts of the company and tracking the expense through various means and do not directly generate any revenues or bring any profits to the company. However for running this department there involves costs such as salary to accounting staff, software and hardware cots for facilitating them in maintaining the records etc.
Other examples of Cost centre are maintenance department, customer service centre, Information technology department, Human resource department etc.
Types of Cost Centre
On the basis of nature of the business cost centrecan be categorized into six different types which are as follows:
- Personal Cost Centre: The cost centre will be considered as the personal cost centre if it refers to any person or to the group of the persons. Example of this includes works manager, sales manager etc.
- Impersonal Cost Centre: The cost centre will be considered as the impersonal cost centre if it refers to any equipment or to the group of the equipment or to any location.
- Service Cost Center: The cost center will be considered as the service cost center if it performs any service rendering activity to its production centers or other service cost centers. Example of this includes personnel service centre which provides canteen facility to the employees of the company etc.
- Production cost Centre: The cost center will be considered as the production cost center if it deals with any production activity of the company. Example of this includes assembly shop, machine shop etc.
- Operation Cost Centre: The cost center will be considered as the operation cost center if itconsist of the persons or the machines that follows similar type of activities in the company.
- Process Cost Centre: The cost center will be considered as the production cost center if it deals with any specific process or continuous sequence of the company’s operations.
Why are Cost Centers Important?
Cost centre are very important department for the businesses as it adds value to the entity and allows the entity to make profit. Hereunder the causes why it is important for the business:
- They help the company in recovering the different overhead expenses.
- The client service department is used by an entity to resolve the complaints of clients regarding final products or to give an understanding of companies policies and warranties to the clients. This will enhance the goodwill of the company in the market and it helps to attract large number of customers for the company.
- IT Department and maintenance staff ensure that all equipment of the company is running appropriately and proper hygiene is maintained in the organization. It helps organizations to keep their employees healthy and make a profit for the company.
- It helps the company in analyzing the market and the effectiveness of their business strategies.
- Cost centre help the organization in managing their office related tasks like payroll, budgeting, etc.
Benefits of Cost Centre
Benefits of Cost centre are as follows:
- Cost centre monitor the efficiency and effectiveness of all business operations within the company.
- It will help the company to reduce its cost related to a particular function. Cost centre tries to reduce their costs by updating the processes and make it more effective which results in the generation of revenue or prevention of losses.
- If any cost centre is removed from the company, it will adversely impact the profitability of the company. Suppose, If a human resource Department is removed from an organization then the recruitment and payroll functions cannot be performed in a company that will affect the profitability of the company adversely.
- To analyze the profitability of the cost centre, cost data of different period are compared with each other. It will help managers to become more productive as they are held accountable for the expenses incurred in their control
Drawbacks of Cost Centre
Drawbacks of Cost centre are as follows:
- Mangers of cost centers are only responsible for controlling the cost of their division or cost center. They have no control over the profit of the company.
- Manager of cost centers tries to reduce the expenses of their cost center for more benefits. Sometime it will adversely affect the performance of other departments
Thus,cost centre are used by an organization for tracking all expenses related to a particular function. Their main objective is to minimize the cost. These departments does not generate revenue for the company but responsible for incurring cost for the company.
This is a guide to Cost Centre. Here we also discuss the definition and how does cost centre work? along with benefits and drawbacks. You may also have a look at the following articles to learn more –