What is a 'Cost Center'
A cost center is a department within an organization that does not directly add to profit but still costs the organization money to operate. Cost centers only contribute to a company's profitability indirectly, unlike a profit center, which contributes to profitability directly through its actions. Managers of cost centers including human resources and research and development (R&D) are responsible for keeping their costs in line or below budget.
BREAKING DOWN 'Cost Center'A cost center indirectly contributes to a company’s profit through operational efficiency, customer service or increasing product value. Cost centers help management utilize resources in smarter ways by having a greater understanding of how resources are being used. Although cost centers contribute to revenues, it is impossible to discern the actual revenue generated. Any associated benefits or revenue-producing activities of these departments are disregarded for internal management purposes.
The main function of a cost center is to track expenses. The staff of a cost center is only responsible for the costs and does not bear any responsibility regarding revenue or investment decisions. Expense segmentation into cost centers allows for greater control of total costs. Accounting for resources at a finer level such as a cost center allows for more accurate forecasts and calculations based on future changes.
Internal vs. External Use
Cost centers provide metrics more relevant to internal reporting. Internal management utilizes cost center data to improve operational efficiency and maximize profit. External users of financial statements including regulators, taxation authorities, investors and creditors have little use for cost center data. For this reason, cost center accounting falls under managerial accounting as opposed to financial or tax accounting.
Examples of Cost Centers
Cost centers include a company's accounting department, the information technology department and maintenance staff. Manufacturing entities typically have cost centers for each of the production departments as well as a cost center for quality control. The customer service center of an entity only generates costs such as salaries and telephone expenses. For this reason, it is a cost center.
Cost centers do not need to be as large as departments. In fact, a department may have multiple cost centers within it. A cost center may be any defined group in which management finds benefit in segregating the cost of the group. This may include an assembly line, a particular machine or a specific job. A major downside to have this fine level of detail is the heavy requirements of information tracking that potentially outweigh the benefits of the knowledge obtained.