In business a cost centre is a division that adds to the cost of an organisation, but only indirectly adds to its profit. Typical examples include research and development, marketing and customer service.
Companies may choose to classify business units as cost centres,profit centres or investment centres. There are some significant advantages to classifying simple, straightforward divisions as cost centres, since cost is easy to measure. However, cost centres create incentives for managers to underfund their units in order to benefit themselves, and this underfunding may result in adverse consequences for the company as a whole (for example, reduced sales because of bad customer service experiences).
Because the cost centre has a negative impact on profit (at least on the surface) it is a likely target for rollbacks and layoffs when budgets are cut. Operational decisions in a contact centre, for example, are typically driven by cost considerations. Investments in new equipment, technology and staff are often difficult to justify to management because indirect profitability is hard to translate to bottom-line figures.
Business metrics are sometimes employed to quantify the benefits of a cost centre and relate costs and benefits to those of the organization as a whole. In a contact centre, for example, metrics such as average handle time, service level and cost per call are used in conjunction with other calculations to justify current or improved funding.
Specific Cost Center Information:
- Cost Center Accounting is used to identify the costs incurred by an organization
- Costs are tracked by individual areas of the organization called cost centers. Cost centers have responsibility for controlling costs
- Cost centers can plan future costs to have a basis for comparison with actual costs. This provides a means of measuring the cost center's performance in controlling costs
- All cost centers must appear somewhere in the controlling area's "standard hierarchy"
- If business areas are active in FI, each cost center must be assigned a business area
- All work centers in PP must be tied to a cost center, for this is where activities and prices are planned
- Statistical key figures can be posted to cost centers; these are used in reporting and allocations
- Cost centers can be planned and/or budgeted (plan is pie-in-the-sky; budget is based on control)
Cost Center Hierarchy: