Cost centre (business)

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A cost center is a department within a business to which costs can be allocated. The term includes departments which do not produce directly but incur costs to the business, when the manager and employees of the cost center are not accountable for the profitability and investment decisions of the business but they are responsible for some of its costs.

Video Cost centre (business)

Types

There are two main types of cost centers:

• Production cost centers: This is where the products are manufactured or processed. Example of this is an assembly area.
• Service cost centers: This is where a service is provided to other cost centers. Example of this is the personnel department or the canteen.

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Examples

• Marketing Department
• Human resources
• Research and Development
• Work office
• Quality Assurance
• Engineering
• Logistics

Cost Centers can be trimmed down to the smallest segregated tasks within Departments. It is not necessary to consider departments as outright cost centers. Some companies adopt a different approach when treating cost centers.

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Function-specific cost

The main function of a cost center 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 center 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.

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Benefits

There are numerous benefits of a cost center which include:

• Monitoring efficiency - Cost centers 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 center is a way to improve confidence.
• Loss prevention - Cost centers try to update processes, be more effective and save money so that they can reduce the expenses. Cost centers 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 centers 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 center is becoming more or less profitable. Generally a specific person (a cost center manager) is held accountable for costs incurring in the cost center under his or her control, in which case, collecting and comparing costs may motivate the manager to be more productive.

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Drawbacks

There are a few drawbacks of cost center which include:

• Negative effects on other departments - although the cost of operating a specific department is simple to calculate, cost centers are a source of encouragement for managers to underfund their elements so that it can benefit the cost center, 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 centers are.
• 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 center, the result of a decision is calculated by cost alone; the achievements of the cost center are not measured in financial terms, therefore it is hard to assess efficiency and productivity properly.

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Difference between a cost center and a profit center

A cost center adds to a firm's cost whereas a profit center adds to the firm's cost and profit. Furthermore, the main objective of a cost center is to minimise cost whereas the main objective of a profit center is to maximise profit. Profit centers provide a wider and more general measurement of performance than the cost center. In cost center, the manager is only responsible for the cost whereas in a profit center, the manager is responsible for cost and profit. In situations like this when manager is responsible for both, profit and cost, the contribution of each manager to the goal of the firm becomes easier to measure.

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References

Source of the article : Wikipedia