Definition: Cost centre can be understood as a site (sales area, or department), a person (salesman, or machine operator), an item of equipment (delivery vehicle, machinery) or a combination of these, for which cost is determined and used to control the costs. It implies that segment of the organization, that helps in making its appropriate division for the purpose of product costing.
It can be a single work point like a machine or a set of various work points, a processing department or an entire plant.
The ascertainment of the appropriate cost and analysis of the costs under the cost centre is important for periodical comparison. The selection of an appropriate cost centre is based on the organization of the factory, information availability, conditions of cost incidence, cost requirement and management’s policy as to the selection method.
Cost Centre is a cost object representing that section of the firm to which cost can be charged. It is a unit of the business that is responsible for the costs incurred by it, or that relate to it, for instance, if a cost centre is a machine, then the cost centre will be charged with the cost of fuel, power, depreciation, rent, etc.
Need of Cost Centre
Basically, for the purpose of controlling costs, the cost centre has to be divided into various departments. Think of the situation, when the entire factory would be treated as a single unit, then how unmanageable it would be to look after and keep a control on all the activities going on, in the factory at the same time.
Secondly, it will lose its efficiency, essence and effectiveness as well. That is why the subdivision of a factory based on the area of activity is important.
Further, cost centre wise accumulation of cost can be compared with the standards or budgets so as to control cost as well as to fix responsibility of the person, who is in charge of the cost centre, for the purpose of controlling costs of that particular centre.
Individuals and groups on the shop floors as well as in the offices are the ones who exercise cost control. Therefore, it is important to define and also delimit the functions, area of control and responsibility of these persons. The aim of the cost centre is to determine the functions and control.
Example of Cost Centre
In a laundry, different activities like collecting, sorting, washing, drying and ironing are carried out and so with the objective of accumulation of cost, each activity can be regarded as a cost centre. And each such activity is termed as a cost centre for the accumulation of cost. Additionally, all costs associated with that activity will be severally accumulated, to determine the production cost of the concerned cost centre.
Classification of Cost Centre
Cost Centres are primarily of two types:
- Personal Cost Centre: It comprises of a person or a group of persons, in connection to which cost is determined.
Example: Sales manager, production manager, factory manager, foreman, driver of a delivery van, time study engineers, etc.
- Impersonal Cost Centre: An impersonal cost centre is one that comprises any site, department, plant, or machinery, etc.
Example: Machine shop, sales area, milling machines.
Based on functionality, cost centres are divided into the following types:
- Production Cost Centre: Cost Centres wherein real production or manufacturing activities are carried out is called production cost centre. It may include specific operations such as machining, continuous process etc.
Example: Weaving and Dying department of a textile mill, Paint shop, Welding shops, Baking shop in a Bakery, Cane crushing shop of the sugar mill, etc.
- Service Cost Centre: Cost Centres which are ancillary to as well as provide services to production cost centres, are service cost centre.
Example: Stores Department, Repair and Maintenance Shop, Canteen, Toolroom, Accounts, Powerhouse, etc.
- Operation Cost Centre: Machines and Persons undertaking similar operations are brought together, then that is termed as an operations centre.
Example: Accounting Department, Human Resource Department, Research and Development Department, etc.
- Process Cost Centre: When machines and persons are classified on the basis of a specific process or a series or steps of operation, then it is called a process cost centre.
Example: Refineries, Chemical Industries, Steel Rolling, etc
A Word from Business Jargons
The type, number and size of the cost centre in an organization is based on the nature as well as the size of the business carried out by that organization, and the attitude of the company’s management with regard to cost ascertainment and cost control. Further, a large number of cost centres can be expensive for the firm and when the number of a cost centres is limited to a few only, then it may not serve its very purpose.