A cost center is an entity in which costs are accounted for, but not managed. Cost centers typically do not have any responsibility to generate profits says, William D King. They are responsible only for the expenses they incur and this is exactly what differentiates them from profit centers.
Cost centers can be defined as entities that produce no or negligible profit by themselves. All their activities are focused on what it takes to achieve the organizational goals without any regard for profit generation.
Cost Centers vs Profit Centers:
Both cost centers and profit centers are important elements of management accounting. The difference between them lies in their roles within various business organizations. A cost center operates with a restrictive budget (which does not allow flexibility) whereas a profit center has two budgets, one restricting (to control costs) and the other permitting a lot of latitude in financial decision making.
Profit center managers are directly responsible for achieving the company’s goals. They have the authority to make business decisions that allow them to be more efficient and increase profits says, William D King.
Cost center managers operate within a set budget given by their superiors, without additional powers or discretions. They can only watch over expenses, cutting wherever they see weak points in an organization’s spending habits. A cost center manager has absolutely no say when it comes to generating revenue since this is not part of his/her job description.
Examples of Cost Centers:
An office tasked with printing documents is a typical example of a cost center in business management. No matter how many copies one prints, the cost to the company will be the same.
It follows that increasing production may cut costs in terms of materials, but it also means spending more on electricity and other necessary utilities. When you are charge per page printout, there is no incentive to save money by printing fewer copies or using cheaper paper. So, one could say that this office’s operating budget simply does not have any provisions made for profit generation. This role comes under ‘cost centers’ since these institutions do not generate profits; they only incur expenses that are then accounted for within their respective budgets explains William D King. The managers of cost centers have no authority whatsoever to produce profits or manage revenues. All they can do is make sure that expenditures match with their respective budgets, without exceeding them (since this will lead to the firing of the manager).
Building Maintenance is another example of a cost center. Although if you monitor building maintenance costs, you would find that more attention is towards HVAC costs than electrical or plumbing issues. There are several reasons for this difference. The major one being heating and cooling systems work more frequently than other parts of the building which results in greater expenditure on their part. It makes sense for managers to direct more time into making sure that these systems operate efficiently since they spend most of their time working anyway. This does not mean that electric repairs are less important; rather, it stresses how cost centers operate within budget limitations without any reference to revenue generation.
Another fine example is an office task with ‘order taking’. The managers of such an office do not spend time thinking about whether or how this business can generate revenue explains William D King. They only focus on trying to improve the service they offer to make sure that customers order more products and stay with their organization for a longer duration of time.
The answer is: A cost center in business management is an institution that operates within a restricted budget. Whose managers have no power to increase its size, nor any authority to decide where it will be spent? A cost center manager’s duty is only to maintain expenses within the budgetary limits set by his/her superiors. Profit centers are independent divisions of a company. They are solely responsible for generating revenues without being concerned about their costs.
Cost centers generate expenses; they do not incur profits. If you find that your favorite business is not making any money. It is probably due to mismanagement of funds by one of its cost center managers.
Examine the income statement of a company in trouble and look for high costs. Which cannot be justified or reasonable revenues without profits. It will most likely lead you to the cost center(s) in question. Where ill-informed management has managed to run away with all available funds. Without having anything for further investments. If you are currently working for an organization that has more than one ‘profit center’. Chances are that some departments may turn into cost centers eventually if the revenue stream they provide starts drying up.
Conclusion:
A cost center is an institution that does not generate revenue for the business, but only generates expenses says, William D King. It reports to a different manager than that of the profit centers within an organization.