In this article we will discuss about the meaning and types of cost centres.
Meaning of Cost Centre:
CIMA defines Cost Centre as “a production or service, function, activity or item of equipment whose costs may be attributed to cost units. A cost centre is the smallest organizational sub-unit for which separate cost allocation is attempted.”
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. For example in production departments, a machine or group of machines within a department or a work group is considered as cost centre. Any part of an enterprise to which costs can be charged is called as ‘cost centre’.
A cost centre can be:
(a) Geographical i.e., an area such as production department, stores, sales area.
(b) An item of equipment e.g., a lathe, forklift, truck or delivery vehicle.
(c) A person e.g., a sales person.
A machine can be a cost centre by charging all costs relate to it. Those costs may be depreciation, maintenance, power, consumable, share of rent and establishment expenses, heating and lighting etc.
A sales person can be treated as cost centre by charging all costs relating to him like salary, commission, travel expenses, postage and telephone, samples, entertainment expenses etc. The procedure of allocation of overheads involves identification of cost centres for which an item of expenditure is a direct cost.
The establishment of cost centre will help to achieve the following:
(1) There is a clear-cut responsibility placed on a person who is held responsible for control of expenditure in his cost centre.
(2) Cost centre-wise recovery of cost is possible, since costs are collected and accumulated in a cost centre and distributed over the products for recovery of incurred cost.
Types of Cost Centres:
The cost centres are classified into the following:
i. Personal and Impersonal 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. An impersonal cost centre consists of a location or item of equipment, production department, a machine or a group of machines.
ii. Production and Service Cost Centres:
‘Production cost centres’ are engaged in production activity by conversion of raw material into finished production. ‘Service cost centres’ are those which are ancillary to and render service to other production and service cost centres.
For example, maintenance department is a service department provides service to other cost centres which include both production cost centres 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.
iii. Process Cost Centre:
A cost centre in which a specific process or a continuous sequence of operations is carried out.
iv. Profit Centre:
CIMA 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.
v. 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.
In addition, the centre must make use of assets which can be separately attributed to it and over which the centre’s manager has control, in terms of new investment decisions, asset replacement decisions, and decisions to sell-off assets surplus to requirements.
Managers of subsidiary companies will often be treated as investment centre managers, accountable for profits and capital employed. Within each subsidiary, the major divisions might be treated as profit centres, with each divisional manager having the authority to decide the prices and output volumes for the products or services of the division. Within each division, there will be departmental managers. All managers should receive regular, periodic performance reports for their own areas of responsibility.