Accounting and Finance – Cost and Profit Centres
Types of cost centers
Cost centers may take several forms, including:
Examples of cost centers include:
Cost center managers do not decide on pricing or creating new departments, which are company-wide financial decisions. Their role involves keeping department expenses at or below budget.
What is a cost center?
A group or department within a company that performs tasks beneficial to business operations but does not directly generate revenue is known as a cost center, also known as a revenue center. A cost center establishes its costs and finds ways to lower them. Cost centers are beneficial because they help a company’s capacity for profit by:
What is a profit center?
A division or department of a business that directly generates revenue and profits is known as a profit center. It is frequently run as a separate company, in charge of cutting costs and boosting profits.
Profit centers assist the company by:
Cost center performance
Cost center performance is measured by determining cost variance. This involves contrasting the typical price and quantity of a good—a predetermined amount determined by market research and past performance—with the actual price and quantity needed to produce a good.
Cost centers use these figures to analyze their processes, including:
Cost variance includes both price variance and quantity variance.
Total cost variance = price variance + quantity variance
Consider a clothing manufacturer. The company budgets $5 to produce its most popular shirt. This means the standard cost is $5. A standard quantity of 1,000 yards of fabric per year is the desired quantity to produce the shirts. The business uses 1,100 yards of fabric annually to make shirts that sell for $4 each.
To determine total cost variance, first determine price variance.
Actual quantity times (actual price minus standard price) equals price variance.
PV = 1,100 x ($4 – $5)
PV = 1,100 x (-1)
PV = -$1,100
The favorable price variation here is $1,100 because the actual price is less than the average price. The negative number indicates that the business spent less than it had planned.
Next, determine the quantity variance:
(Actual quantity – Standard quantity) x Standard Price equals Quantity Variance.
QV = $5 x (1,100 – 1,000)
QV = $5 x (100)
QV = $500
This is an unfavorable quantity variance of $500 because the actual quantity is greater than the standard quantity. The increase from the target amount used by the company is shown by the positive figure.
Just keep in mind that TCV equals price variance plus quantity variance.
For this example, total cost variance = (-$1,100) + $500. This becomes $500 -$1,100, which is -$600.
Once more, the negative number shows that the company is operating below budget in this department. This is a 600 dollar positive total cost variance for the cost center.
Types of profit centers
The degree to which profit centers operate independently from an organization varies. The types of profit centers include:
Profit center performance
By comparing budgeted costs to actual costs, you can gauge profit center performance.
Consider, for instance, a cell phone service provider with a $30,000 operating budget for its store selling refurbished phones and accessories. The store is doing well if its actual costs are less than $30,000. If the store’s actual costs exceed $30,000, the business should assess the store’s profitability.
Examples of profit centers include:
Cost center vs. profit center
In decentralized businesses that delegate decision-making to lower-level managers rather than relying solely on the top executives to make all business decisions, cost centers and profit centers can be seen. While both types of centers have operating expenses, only profit centers are profitable.
Cost centers and profit centers work to reduce costs. While profit centers are more focused on developing strategies for generating short-term revenue, cost centers prioritize long-term success through sustainable cost-saving measures. A given profit center may contain several cost centers. For example, consider a large manufacturing company. The business may decide to establish profit centers from each line of products it produces. Each product line may rely on the following cost centers:
Cost centers typically produce the kind of detailed, specific data that benefits internal sources more than external sources. For instance, it is unnecessary for a taxing authority to be aware of the maintenance staff’s salaries. Companies use cost center data for in-house tasks, such as:
Organizations can make important financial decisions by using the data provided by profit centers, including:
What is the difference between a profit center and a cost center?
A department or function within an organization that does not directly contribute to profit but still incurs operating expenses is known as a cost center. Contrary to profit centers, which directly influence profitability through their operations, cost centers only indirectly influence a company’s profitability.
What is difference between cost center and profit center in SAP?
The difference between a Cost Center and a Profit Center is that the former contains the balances of costs and revenues, while the latter contains specific costs incurred during a specific period.
Can a profit center also be a cost center?
The primary distinction between the two is that a profit center is in charge of both revenues and costs, whereas a cost center is only accountable for its expenses. Another distinction is that profit centers are more likely to have a complex organizational structure than cost centers do.
What is the difference between cost and profit?
The amount of money left over after a company pays its costs and expenses is referred to as its profit. Costs are the expenses incurred in developing, producing, and marketing the products and services provided by the business.