Cost Centre and Cost Unit

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:

  1. Production cost centres

  2. 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:


Comparison Parameter

Cost Centre

Cost Unit

Definition 

Cost centre definition relates to the cost incurred by subdivision or part of the firm, that doesn’t contribute directly to the organisation’s revenue.  

The cost unit is defined as the measurable unit of the products and services with which the cost is associated. 

Scope

It offers a wider scope of the study.

It offers a narrow scope of the study. 

Purpose

It helps to classify and define cost centres. 

It acts as a standard medium for comparison. 

Sequence 

It comes first in the process of cost analysis.

It comes after the cost centre. 

Number

There can be many cost centres even if one product or service is offered. 

There are different unit costs for every product and service. 

Ascertainment

It is ascertained according to the nature of production, size, and structure of the firm. 

It is ascertained according to the nature of the final output and current trade practises. 


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 Centre and Cost Unit

1. What Are a Cost Unit and its characteristics?

Costs must be matched to a suitable measure of the quantity of the product or service after they have been determined, accumulated, categorised, and documented. A cost unit is a unit of measurement for the quantity of a product or service.


A cost unit is a unit of amount of product, service, or time (or a mix of these) that can be used to calculate or represent costs. To put it another way, a cost unit is a standard or unit of measurement for the goods or services produced.


A cost unit can be defined as a number, a length, an area, a weight, a volume, a time, or a value.


Cost Unit's Characteristics

  • It has to be one that can be easily associated with spending.

  • It must be relevant or natural to the product and business operations.

  • It must be certain or definite, and it must not shift over time.

  • It must be easy to comprehend and quote.

  • It has to be accepted by everyone.

2. What are the differences Between Cost Centre and Cost Unit?

The following are the primary points of distinction between cost centres and cost units:

  • Cost centres collect costs, which are then measured and reported in terms of cost units.

  • Cost centres can be used as the foundation for cost classification, but not for cost units.

  • Different cost centres may be engaged in the manufacture of a product, but the cost of a product will be reflected in only one cost unit.

  • The creation of cost centres are influenced by manufacturing methods and techniques, as well as the size and structure of the organisation. Cost units, on the other hand, are determined by the final product or output, as well as current trade practices.

  • Cost centres are designed to aid management in budgeting and managing functions, however, this is not the case with cost units.

3. What are the different types of cost centres?

The types are-

  1. Production cost centres

  2. Service cost centres


A cost centre engaged in regular manufacturing is referred to as a production cost centre (e.g., converting raw materials into finished products).


A service cost centre is not involved in normal production but helps the production cost centres carry out their responsibilities (e.g., store department, personnel department, or maintenance department).


Operation cost centres and process cost centres, as well as personal and impersonal cost centres, are all types of cost centres.


A process cost centre is one that consists of a specific process or a continuous sequence of operations, whereas an operation cost centre consists of machines and/or people performing comparable actions.


A personal cost centre is made up of one person or a small group of people (e.g., departmental foreman, salesman, supervisor, and factory manager).


A cost centre that comprises a place, a piece of equipment, or a set of things is referred to as an impersonal cost centre (e.g., machines, departments, and vehicles).

4. What are the uses/operations of the cost centre?

A cost centre's operations will not directly result in earnings for the company. Customer service and increasing product value, on the other hand, would help the organisation gain more business. By understanding how resources are used in the organisation, cost centres will assist management in making informed decisions about resource allocation.


Even though cost centres contribute indirectly, the earnings generated by them cannot be overlooked. For internal management, the majority of connected advantages or operations that generate revenues from various wings of the organisation are often overlooked.


The main purpose of cost centres is to keep track of the expenses that have been incurred. Managers or other high-level officials are given the responsibility of keeping expenditures in line with the authorised budget, but they are not responsible for how the cash earned is spent.


The segmentation of expenses into cost centres will allow for a high level of cost control and analysis. Accounting resources at all levels will make calculation and accounting more efficient.

5. What are Variable Costs and Fixed Unit Costs?

By managing fixed and variable costs, successful organisations look for ways to reduce the overall unit cost of their products. Fixed costs are expenses that do not change depending on the number of units produced. Rent, insurance, and equipment are just a few examples. Long-term leasing agreements can help manage fixed expenditures like warehousing and the use of production equipment.


The level of output produced determines variable costs. These costs are further subdivided into categories such as direct labour costs and direct material costs. Direct labour costs are the wages paid to people who are directly involved in the production process, whereas direct material costs are the costs of items acquired and utilised in the production process. By selecting components from the cheapest supplier or outsourcing the manufacturing process to a more efficient manufacturer, variable costs can be reduced.

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