Introduction
Even though cost centre and cost unit are two independent terms, they are intertwined and necessary for cost control in a company. A cost unit is the measurement medium whereas a cost centre refers to a subdivision, location, department, or other institution.
The marketing department, Research & Development department, and other cost centres are examples of cost centres. Metre, kilometre, gallon, and other cost units are examples of cost units.
The first phase in the cost analysis process is to identify the cost centres, and the second is to assess the costs of those departments using the cost units determined by top management. Cost centres produce profit through operational efficiency, but they do not directly contribute. The cost unit aids in the quantification of these departments' costs.
Cost centres are primarily developed to assist management in operations like budgeting, strategic planning, decision-making, and control. Cost unit, on the other hand, serves no such purpose because it is simply a way of expressing cost.
In cost techniques, two types of important activities are involved. This is the classification and collection of expenditure based on cost elements. Another is the allocation and apportionment of the expenditure for both the cost centre and cost unit. An accountant needs to assert the cost of different objects in the system of cost accounting. The cost centre meaning is one portion of the whole organisation, to which the cost is charged. On the contrary, cost unit or unit cost refers to a unit in which cost is measured or expressed. The selection of the suitable cost centre or cost unit is evaluated based on several factors like the organisation of the factory, availability of information, size and structure of the firm, the provision of costing, condition of incidence, and others.
Define Cost Centre
In simple terms, you can define the cost centre as the one or more units of the firm that don’t contribute directly to the process of revenue generation in an organisation but incur expenses. This is a type of responsibility centre that is accountable for incurring expenses that are under their control. It indicates any section of the organisation’s product or service for which specific cost collection is looked for.
A cost centre, according to the Institute of Cost and Management Accountants (ICMA), is a location, person, or item of equipment (or a combination of these) for which costs can be determined and utilised for cost control.
A cost centre, in other words, is any location, person, machine, section, part, activity, or function inside an organisation or enterprise where expenses are gathered or aggregated and assigned.
Given the foregoing, a cost centre is a natural division of an organisation that aids in the measurement and understanding of operating costs as well as the application of costs to goods.
The simplicity of cost accumulation, comparability, and cost control are all factors that go into forming a cost centre in a corporation. A person, machine, or department will be classified as a cost centre if costs accumulate for that entity.
Cost centres can be separated into two categories in a project:
Production cost centres
Service cost centres
Cost Centre Example-
The research and development wing (R&D) is responsible for developing new techniques and products for the organisation. This department incurs a lot of expenses while comping up with new ideas, technologies, and products. There is no revenue generated for the department because the credits are transferred to the sales department for selling the products.
The cost centre meaning is important so that it doesn’t take over the profits of the company. The top management of the company always laid down precise guidelines for such departments to prevent the cost from crossing the specific amount.
Define Cost Unit
The cost unit is defined as the unit of product, service, time, activity, or combination in relation to which cost is estimated. At the time of preparing the cost statements and accounts, a particular unit is required to be selected. It helps to identify the cost accurately and allocate the various expenses. It assists the cost measurement process of the company and promotes comparison.
Cost Unit Example-
The cost unit of the hotel industry is a room and the cost unit of the steel industry would be a ton. This is preceded by the cost centre.
There are both simple units and complex units in cost units. A simple unit represents a single standard measurement like per kilogram, per piece, per metre, etc. a complex unit uses a combination of two simple units like per kilowatt-hour, per tonne-kilometre, etc.
Difference Between Cost Centre and Cost Unit: Tabular Format
The main difference between cost centre and cost unit is that the cost centre costs the incurring section of the firm. While the cost unit is the way cost is expressed or measured in terms of a specific commodity or service. The difference is shown further below in the table:
Did You Know?
The most important function of the cost centre is the tracking of expenses associated with a specific function. For instance, when a company treats its customer support centre as a separate unit, it can measure how much it is spending after its support service. In the absence of a cost centre, it will take immense effort to measure the cost of supplying this service. This will require splitting the company’s total phone bills by department. A cost centre smoothens the process, allowing management to measure, budget, and control costs for specific functions the business performs. Cost centre in cost accounting plays a vital role in assisting the management in computing financial accomplishment.
FAQs on Cost Centres and Cost Units: Explained
1. What is a cost centre in cost accounting?
A cost centre is defined as a specific location, department, person, or item of equipment within an organisation for which costs can be tracked and controlled. It is a part of the company that incurs expenses but does not directly generate revenue. For example, the Human Resources or a Research & Development department are considered cost centres as they are essential for operations but their primary role is not sales.
2. What is a cost unit and what are its key characteristics?
A cost unit is a standard unit of measurement for a product or service to which costs are allocated. It is the medium used to express the cost of an item. Key characteristics of a suitable cost unit include:
- It must be directly relevant to the business operations.
- It should be definite, clear, and easy to understand.
- It must be consistently applied over time for accurate comparison.
- It should be accepted as a standard practice within that industry.
3. Can you give some examples of cost centres and cost units in different industries?
Yes, here are some common examples:
- Transport Industry: A cost centre could be a specific vehicle or a maintenance depot. The cost unit would be per tonne-kilometre or per passenger-kilometre.
- Hotel Industry: A cost centre might be the housekeeping department or the kitchen. The cost unit is typically per room-night.
- Steel Industry: A blast furnace could be a cost centre. The cost unit would be per ton of steel produced.
- IT Services: The customer support department is a cost centre. The cost unit could be per support ticket or per hour of service.
4. How does a cost centre fundamentally differ from a cost unit?
The fundamental difference lies in their purpose and function. A cost centre is a segment of an organisation where costs are accumulated, whereas a cost unit is the measure used to express those costs. In simple terms, a cost centre is like a container for costs (e.g., the marketing department), while a cost unit is the ruler used to measure the contents (e.g., cost per advertisement).
5. What are the main types of cost centres?
Cost centres are broadly classified into two main types:
- Production Cost Centres: These are directly involved in the manufacturing process, such as assembly lines or machine shops, where raw materials are converted into finished goods.
- Service Cost Centres: These provide support services to the production cost centres and are not directly involved in production. Examples include the stores department, maintenance department, or accounts department.
6. What is the difference between a cost centre and a profit centre?
The key difference is accountability. A cost centre manager is only responsible for the costs under their control and keeping them within budget. A profit centre manager, however, is responsible for both revenues and costs. Therefore, a profit centre's performance is measured by the profit it generates, while a cost centre's performance is measured by its efficiency and cost control.
7. Why is it important for a company to establish cost centres?
Establishing cost centres is crucial for effective management and control. Their primary importance lies in:
- Cost Control: They allow management to track and manage expenses for specific functions, helping to keep costs within budget.
- Decision Making: By understanding how resources are used in different departments, management can make informed decisions about resource allocation and strategic planning.
- Performance Measurement: They provide a basis for evaluating the operational efficiency of a department or manager.
8. What is a composite cost unit and when is it used?
A composite cost unit, also known as a complex cost unit, is a unit of measurement that combines two or more simple units. It is used in industries where a single unit cannot accurately capture the service rendered. For example, in the transport industry, both weight and distance are important factors, so a composite unit like per tonne-kilometre is used. Similarly, in a hospital, the cost is often measured as per patient-day, combining the number of patients and the duration of their stay.
