In cost accounting, costs are understood in terms of cost centers and cost units. With this in mind, it is essential to know what these terms mean.
What Is a Cost Center?
The Institute of Cost and Management Accountants (ICMA), which is based in London, defined a cost center a location, person, or item of equipment (or a group of these) for which costs may be ascertained and used for the purposes of cost control.
That’s to say, a cost center refers to any place, person, machine, section, part, activity, or function within an organization or undertaking by which costs are collected or accumulated, and to which costs are allocated.
Given the above, a cost center is, therefore, a natural division of an undertaking that helps to measure and understand operational costs and apply costs to products.
A cost center in a company is formed by considering the convenience of cost accumulation, comparability, and cost control. If costs are accumulated for a person, machine, or department, then this entity will be treated as a cost center.
In an undertaking, cost centers may be divided into two parts:
- Production cost centers
- Service cost centers
A production cost center refers to a cost center that is engaged in regular production (e.g., converting raw materials into finished products).
A service cost center is a center that is not engaged in regular production, but which assists the production cost centers in implementing their activities (e.g., store department, personnel department, or maintenance department).
Cost centers can also be divided into operation cost centers and process cost centers, as well as personal cost centers and impersonal cost centers.
Operation cost centers are cost centers that consist of machines and/or persons carrying out similar operations, while a process cost center is one that consists of a specific process or a continuous sequence of operations.
A personal cost center is a cost center that consists of a person or group of persons (e.g., departmental foreman, salesman, supervisor, and factory manager).
An impersonal cost center refers to a cost center that consists of a location, item of equipment, or a group of these (e.g., machines, departments, and vehicles).
Factors for Selecting a Suitable and Effective Cost Center
The selection of a suitable cost center depends on several factors, including:
- Layout and organization of a factory
- Availability of cost data and information
- Management policy regarding the selection of cost centers
Classification of Cost Centers
Cost centers can be classified under the following three broad areas:
Productive, Unproductive, and Mixed Cost Centers
Factories might choose productive cost centers whereas an administrative wing might choose an unproductive cost center. Similarly, a tool department may choose a mixed cost center.
Personal and Impersonal Cost Centers
When a plant or machine is taken as a unit, it is an impersonal cost center; when a person or group of persons are taken as a unit, the personal cost center is implied.
According to the Institute of Cost and Management Accountants, “Impersonal cost center consists of a location of item of equipment whereas personal cost center consists of a person or a group of persons.”
Operation and Process Cost Centers
According to the Institute of Cost and Management Accountants, the “operation cost center is a center which consists of those machines and/or persons which carry out the same operations.”
By contrast, the “process cost center is a cost center which consists of a continuous sequence of operations.”
What Is a Cost Unit?
After costs have been ascertained, accumulated, classified, and recorded, they must be related to a convenient measure of the quantity of the product or service. This measure of the quantity of a product or service is known as the cost unit.
A cost unit is defined as “a unit of quantity of product, service, or time (or a combination of these) in relation to which costs may be ascertained or expressed.” In other words, a cost unit is a standard or unit of measurement of the goods manufactured or services rendered.
A cost unit may be expressed in terms of number, length, area, weight, volume, time, or value.
Characteristics of a Cost Unit
A unit of cost must possess the following characteristics:
- It must be one that expenditure can be conveniently associated with.
- It must be appropriate or natural to business operations and the product.
- It must be certain or definite and not change over time.
- It must be simple to understand and to quote.
- It must be universally accepted.
Types of Cost Units
Cost units can be categorized as follows:
Simple Unit: These use a single standard or unit of measurement of the goods manufactured (e.g., per piece, per kilogram, per quintal, per ton, per gallon, or per meter).
Composite Unit or Complex Unit: These combine two simple units (e.g., per passenger-kilometer, per ton-kilometer, or per kilowatt-hour).
The terms of measurement used in cost units are:
Cost units are always selected carefully based on the nature of business operations.
For instance, the cost unit of steel is naturally ascertained in terms of per ton. Similarly, the cost unit of carrying a passenger by a transporter is naturally ascertained in terms of the distance traveled in kilometers.
The following are examples of cost units applied in different industries:
|Brick Industries||Cost unit per 1000 bricks|
|Coal Mines||Cost unit per quintal|
|Cotton Mills||Cost unit per meter|
|Electric Company||Cost unit per unit|
|Transport Companies||Cost unit per kilometer|
|Steel Companies||Cost unit per ton|
|Water Supply||Cost unit per 1,000 liters|
|Furniture Industries||Cost unit per number|
|Oil Companies||Cost unit per liter|
|Soap Factory||Cost unit per dozen, per kilogram, or per tablet|
Differences Between Cost Center and Cost Unit
The main points of difference between cost centers and cost units are summarized as follows:
- Costs are accumulated by cost centers, whereas these are measured and expressed in terms of cost units.
- Costs centers may be used as the basis for cost classification, but this is not the case for cost units.
- Different cost centers may be involved in the production of a product, whereas a product will have only one cost unit in which its costs are expressed.
- The formulation of cost centers depends on production processes and techniques, as well as organizational size and structure. By contrast, determining cost units depends on the final product or final output, as well as current trade practices.
- Cost centers are created to help management in the functions of budgeting and controlling, but this is not the case with cost units.
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