Cost Center: Definition, How It Works, and Examples

TL;DR: A cost center is a department or function that incurs costs but does not directly generate revenue. It helps businesses track expenses, improve accountability, and make informed financial decisions.

A cost center is a core concept in financial management. It helps companies monitor expenses, allocate resources, and understand how different parts of the organization consume money.

Define Cost Center

A cost center is a department or unit within a company that does not directly bring in revenue but is essential for smooth operations. Its primary role is to manage and control costs within a defined budget.

Teams like HR, finance, or IT typically function as cost centers. Their managers are responsible for ensuring expenses stay within approved limits.

Cost Center: An Overview

A cost center represents a specific area of a business that incurs expenses such as salaries, rent, utilities, and maintenance. Even though it does not directly generate profits, it supports revenue-generating activities.

Each cost center is usually assigned a unique code. Costs are tracked against this code to compare actual spending with planned budgets and identify inefficiencies.

Types of Cost Centers

Operational Cost Center

Groups people, equipment, and activities by function but does not generate revenue.

Example: IT department including staff, hardware, and software.

Personal Cost Center

Focuses only on employee-related costs, excluding equipment or systems.

Example: HR staff salaries without HR software costs.

Machinery Cost Center

Tracks costs related to machines and equipment, excluding manpower.

Example: Manufacturing plant machinery and maintenance.

Locational Cost Center

Tracks expenses for a specific geographic location.

Example: Regional operations office.

Product Cost Center

Captures costs related to developing or producing a product, excluding sales costs.

Project Cost Center

Tracks expenses for a specific project with a defined budget and timeline.

Example: Warehouse construction project.

Service Cost Center

Supports other departments through specialized services.

Example: Facility cleaning staff.

Advantages of a Cost Center

• Improves financial accountability within departments

• Enhances customer experience through focused service teams

• Enables informed decision-making by management

• Helps identify operational gaps and cost inefficiencies

Purpose of a Cost Center

The purpose of a cost center is to track and analyze expenses linked to a specific function or department. It helps management control costs, allocate resources efficiently, and improve operational performance.

Example of a Cost Center

Departments like accounting and legal do not produce goods or sales directly, but they play a vital role in compliance, reporting, and risk management. Their costs are tracked separately to understand long-term value and efficiency.

Cost Center Accounting

Cost center accounting divides an organization into units to track expenses. Budgets are set, actual costs are recorded, and variances are analyzed to control spending and improve planning.

Related Concepts

Profit Center

A unit responsible for generating revenue and controlling costs to earn profits.

Investment Center

A unit evaluated based on returns generated from invested capital.

FAQs

What is the difference between a cost center and a profit center?

A cost center manages expenses without directly generating revenue, while a profit center is responsible for both revenue and costs.

Why are cost centers important?

They help businesses track expenses, improve accountability, and identify cost-saving opportunities.

Are cost centers the same as departments?

Not always. Departments are functional units, while cost centers are financial classifications for tracking costs.

Can a cost center become a profit center?

Yes, if it starts generating measurable revenue and is evaluated on profitability.

How do manufacturers use cost centers?

Manufacturers use cost centers to track machine costs, labor expenses, and overheads separately for better cost control.