When a business grows, its functions, organizational structure, and other related operations also grow in terms of volume and complexity. The management often delegates responsibility to various persons or departments to have better control over the business. These persons or departments are known as responsibility centres. There are four major types of responsibility centres, i.e., cost centres, revenue centres, profit centres, and investment centres that are held accountable for performance in terms of expenditure, revenue, profitability, and return on investment respectively. In this particular blog, we throw light on the concept of cost centre and profit centre.
Breaking down Cost Centre
A Cost Centre is defined as “a location or person or place or machine or item of equipment or thing for which cost can be ascertained and used for the purpose of cost control.” In other words, for any organization, the smallest sub-unit for which separate cost collection is attempted is known as a Cost Centre. It may be a warehouse, a department, a machine in the factory, or an individual.
Also known as expense centres, cost centres are those responsibility centres that are accountable for the incurrence of costs falling under their control. The performance of these centres is measured against a benchmark, budget, or pre-determined standards of cost. Production and service departments are good examples of cost centres in a manufacturing firm.
The identification of appropriate cost centres, as well as analysis of cost within cost centres, is extremely beneficial for cost comparison and control on a regular basis. Expenses should be appropriately segregated to cost centres in order to derive the cost of a product or service. Once the expenses are assigned to cost centres, they are attributed to cost units (products or services) on a suitable basis depending upon the consumption of resources involved in a particular product or service. In addition, the manager of a cost centre is held accountable for the cost control of his cost centre. But he or she is not concerned with meeting profit or revenue targets.
Cost centres may be classified as follows:
1. A process cost centre is one that performs a certain process or a continuous sequence of operations on a regular basis.
2. A production cost centre is one where manufacturing activities are carried out and where the form and structure of raw materials are converted into a final product.
3. Service cost centres are those that provide services to other cost centres. For instance, a maintenance and repair department, a store department, and so on.
4. An impersonal cost centre is one that comprises a place (site) or piece of equipment (or group of these).
5. A personal cost centre is one that comprises a single person or a group of people.
6. An operating cost centre is one that is constituted of machines and/or people who perform comparable tasks.
Breaking down Profit Centre
Profit centres are the responsibility centres that have the responsibility of both revenue generation as well as the incurrence of expenditure. Because managers of these profit centres are accountable for both costs and revenue, the degree of profitability is the foundation for the measurement of performance in these centres. An example of profit centres is decentralized branches of a company.
In other words, a profit centre refers to a centre in charge of developing methods and avenues to earn the highest possible profit on a product or any other business activity through market research. Furthermore, it identifies locations for exposure, aids in the formulation of sales policies, and suggests ways to add more value to the product at the same or lower cost.
The primary goal of a profit centre is to earn the desired level of profit. In fact, profit centre managers are more focused on raising income by increasing output or enhancing distribution channels. The performance of the profit centre is measured in terms of whether or not the centre met its budgeted or target profit.
Moreover, in the case of a non-profit organization, the term ‘revenue centre’ may be adopted instead of ‘profit centre’ because profit is not the primary goal of such an organization.
Differences between Cost Centre and Profit Centre
By comparing the meaning and scope of their operations, a cost centre and profit centre can be differentiated based on the points outlined below:
|Basis of difference||Cost Centre||Profit Centre|
|Meaning||A cost centre refers to the smallest segment or activity or area of responsibility in respect of which costs are determined.||A profit centre is a segment, division, or department in an organization that generates profits for the business.|
|Responsibility||A cost centre is only responsible for the incurrence of costs.||A profit centre is responsible for both the generation of revenue as well as the incurrence of costs.|
|Cost determination||A cost centre assists in determining costs by location, person, department, and so on.||A profit centre compares costs and revenue to determine profits.|
|Manager||The manager of a cost centre is held accountable for cost control.||The manager of a profit centre is held accountable for meeting the target profit.|
|Example||Production department, HR, or customer service support||Sales division|
|Importance||Even though a cost centre does not directly affect sales, it plays a crucial role in the ascertainment of the cost of production and other related costs.||A profit centre is directly responsible for increasing the sales and profits of a company.|
|Complex||A cost centre has a relatively simple structure.||A profit centre is more complex in terms of its structure and functions.|
|Objective||The objective is to minimize cost.||The objective is to maximize profit.|
|Control variable of the Centre||Prices and quantities of inputs||Prices and quantities of inputs and outputs|
|Performance measurement||By budgets or pre-determined standards||By the degree of profitability|
In a cost centre, the manager is only accountable for the costs (expenses) incurred in his sub-unit. When the actual costs of his sub-unit deviate from the anticipated costs, the manager must explain the significant differences. On the other hand, in a profit centre, the manager goes above and beyond, as he or she is also accountable for profits and their improvement. For example, the manager of a furniture department in a store is responsible for making a good amount of profit on furniture sold. During the period, he is supposed to achieve the budgeted profit.
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