Cost Center Definition
In accounting, a cost center is a type of responsibility center. A responsibility center is an organizational subunit the manager of which is responsible for certain financial and non-financial performance measures. For accounting purposes, consider a responsibility center – in this case a cost center – a distinct entity within the context of the larger organization.
Furthermore, a cost center is an organizational subunit that incurs cost but does not directly contribute to the company’s profits. In fact, a cost center may not generate any revenues at all. The manager in a cost center has the authority to incur costs related to normal business activities and operations. Furthermore, a cost center manager’s primary goal is to contain and control the subunit’s costs. As a result, the manager of a cost center is evaluated on the basis of cost containment and control.
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Cost Centers and Discretionary Cost Centers
In addition, make a distinction between cost centers and discretionary cost centers. The difference is with the relation between inputs and outputs in the production process.
When there is a well-defined relation between inputs and outputs in the production process, the organizational subunit is a cost center. For example, a manufacturing process is a regular cost center because each unit of output requires a measurable input of raw materials and a measurable amount of direct labor time. Furthermore, in this type of process, it is easy to see the relationship between the cost-incurring inputs and the revenue-generating outputs.
When there is not a well-defined relation between inputs and outputs in a business activity, the organizational subunit is a discretionary cost center. A good example of a discretionary cost center is an administrative department where the work of the administrators is not clearly linked to any tangible or measurable output. It is not easy to see the relationship between the cost-incurring inputs and any type of revenue-generating outputs.
Cost centers are typical business units that incur costs but only indirectly contribute to revenue generation. For example, consider a company’s legal department, accounting department, research and development, advertising, marketing, and customer service a cost center. The managers in charge of these departments can control and contain costs – and they are evaluated on their ability to control and contain costs. But there is not much they can do to directly impact the company’s revenues. If you want to identify your cost centers and know how they fit within your economics, then download your free guide here.
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Hilton, Ronald W., Michael W. Maher, Frank H. Selto. “Cost Management Strategies for Business Decision”, Mcgraw-Hill Irwin, New York, NY, 2008.
Barfield, Jesse T., Michael R. Kinney, Cecily A. Raiborn. “Cost Accounting Traditions and Innovations,” West Publishing Company, St. Paul, MN, 1994.