What Is a Cost Center?
A cost center is a department or function 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, such as human resources and accounting departments are responsible for keeping their costs in line or below budget.
- A cost center is a function within an organization that does not directly add to profit but still costs money to operate, such as the accounting, HR, or IT departments.
- The main use of a cost center is to track actual expenses for comparison to budget.
- A cost center indirectly contributes to a company’s profit via operational excellence, customer service, and enhanced product value.
- The manager for a cost center is only responsible for keeping costs in line with budget and does not bear any responsibility regarding revenue or investment decisions.
How a Cost Center Works
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 they are being used. Although cost centers contribute to revenue indirectly, 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 manager of a cost center is only responsible for keeping costs in line with budget and does not bear any responsibility regarding revenue or investment decisions. Expense segmentation into cost centers allows for greater control and analysis of total costs. Accounting for resources at a finer level such as a cost center allows for more accurate budgets, forecasts, and calculations based on future changes.
Cost centers aren’t always entire departments; it can involve any function or business unit that needs to have its expenses tracked separately.
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. Therefore, external financial statements are generally prepared with line items displayed as an aggregate of all cost centers. 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 (IT) department, and maintenance staff. Manufacturing entities typically have a cost center for quality control. The customer service center of an entity only generates costs such as salaries and telephone expenses, and is therefore 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. For example, a cost center may include all expenses related to a specific quality improvement project, grant award, or job position. A downside to having this fine level of detail is the heavy requirements of information tracking that potentially outweigh the benefits of the knowledge obtained.