In the modern commercial world, costing makes an indispensable part of every entity. Businesses need to keep a track of their costs and expenses in order to effectively manage their cash flows and promote profitability. Cost centers and cost units are two important elements of an entity’s overall costing system that they massively use to measure, track, allocate and manage their costs.
This article looks into the meanings and key differences between both the terms – cost center and cost unit.
Definitions and meanings
A cost center is that division, department, or function of an organization that doesn’t contribute to its profits directly but brings direct operational costs to the organization. Unlike profit centers that directly add to the profits of an organization through their activities and strategies, cost centers only indirectly help the profits of an organization grow.
For instance, they may promote the profitability of a company through their operational efficiency, IT support, customer service, internal reporting, or by increasing the product value of a company. While all of these activities do not directly generate profits for a company, they play a vital role in offering support to all other departments and to the organization as a whole. In many organizations, cost centers are primarily responsible for keeping a track of expenses, cost management, and resource management. It is, however, difficult to discern the actual revenue generated by cost centers.
CTV Ltd. is a listed company dealing in various household goods and ancillary services. It operates in a competitive market where customer satisfaction and digital shopping place play a crucial role in the profitability of the company. CTV Ltd., therefore, pays special attention to its customer relations and towards the quality of its products.
The customer care, quality control, and IT department of CTV Ltd. are responsible for ensuring rigorous quality control, digital compatibility, and healthy relationships with its customers. These departments also support all other divisions of the company in performing their respective functions. Total profit of CTV Ltd. for the year ending 20X0 amounts to USD 100 million. Based on an internal report, the revenue made and cost incurred by various segments during the year 20X0 is as follows.
|Divisions||Profit Allocation||Cost Allocation|
|Clothing||USD 30 million||USD 19 million|
|Grocery||USD 40 million||USD 21 million|
|Electronics||USD 20 million||USD 13 million|
|Other segments||USD 10 million||USD 7 million|
However, no revenue is directly attributable to the services performed by the IT department, customer care, or quality control department of CTV Ltd. The operational cost of these departments for the year ended 20X0 is as follows.
|Information & Technology||USD 7 million|
|Customer Care||USD 3 million|
|Quality Control||USD 10 million|
These departments qualify as cost centers of CTV Ltd. and are under no specific responsibility to generate direct revenues.
Cost unit refers to a measure of quantity that can be conveniently and logically associated with a product or service. It is defined as a unit of quantity of a product, time, or service or a combination of them all that can be used to ascertain or express the costs incurred in relation thereto.
A cost unit can be expressed as a number, area, volume, weight, time, length, or value. However, it must be appropriate to the underlying product or service. Cost units are generally categorized into two types – simple and complex cost units.
Simple cost units are expressed in terms of a single standard or unit of measurement of the services rendered or the goods manufactured; for example, per meter, per ton, per gallon, etc. Complex cost units are expressed as a combination of two or more simple cost units; for example, per passenger kilometer, per man-hour, per ton-kilometer, etc.
Cost units can be simple or complex, they can vary from product to product and service to service. Some common examples of cost units used to express costs incurred in different industries are as follows.
|Bricks||Per 1000 Bricks|
|Electricity||Per Unit of electricity|
|Spa Services||Per Hour of service|
|Water||Per 100 Liters|
|Transportation Services||Per kilometer|
Difference between cost center and cost unit
Five key points of difference between cost center and cost unit are as follows:
- A cost center refers to a department, division, or function within an organization that is neither directly responsible for revenue generation nor does it directly contribute towards the profit of an organization but brings direct costs to an organization.
- A cost unit is a standard of measurement that allows costs of a product or service to be ascertained and measured in terms of units that can be logically associated with such products or services.
- Cost centers are often used to accumulate and track costs, manage them and reduce them to an acceptable level.
- Cost units are, however, used as a medium to express costs. They enable the management of a company to track and compare costs using a standard measurement unit.
- Cost centers within an organization can be broadly divided into three types.
- Productive and Unproductive Cost centers
- Personal and Impersonal Cost centers
- Operation and Process Cost Centers
- Cost units, on the contrary, have two main types.
- Simple Cost units
- Composite/Complex Cost Units
- The formulation of a cost center depends upon the size, structure, productional processes, and needs of an organization.
- Whereas, the selection of cost units depends upon the nature of the business operations of a company and on the products or services to be measured.
- There can be several cost centers within an organization depending upon its size, structure, and operations. In some jurisdictions, it might be mandatory for an entity to establish and maintain certain cost centers such as an internal audit department or legal counsel. However, in most cases, the choice rests with the management of the entity.
- On contrary, each product or service can only have a single cost unit. For example, water can only be measured in liters. The denomination of cost unit may be changed from say, per 1000 liters to per 100 liters, but the unit for each product/service is likely to remain the same.
Although both the concepts of a cost center and cost unit are unique to each other, they both greatly help the cost management process of an organization. Businesses that have a keen eye on their expenses and have effective cost-cutting mechanisms in place pay special attention to the performance and costs of their cost centers. In the process of cost analysis, the first step is to identify the cost centers, and only then the costs of these departments can be ascertained, analyzed, and compared using appropriate cost units.