In cost accounting, costs are ascertained by cost centers and cost units. As such, it is necessary to know the meaning of these two terms.
The Institute of Cost and Management Accountants, London has defined cost center as “a location, a person or an item of equipment (or group of these) in or connected with an undertaking in relation to which costs may be ascertained and used for the purpose of cost control.”
Cost center may be defined as any location, person or item of equipment (or a group of these) for which costs may be ascertained and used for the purposes of cost control. Cost center refers to any place, person, machine, section, part, activity or function within an organization or undertaking, by which costs are collected or accumulated, and to which costs are allocated.
Cost center is, thus, a natural division of an undertaking for purposes of measuring cost of a particular operation and for applying this cost to product. Cost center in an organization is formed keeping in view the convenience of cost accumulation, comparability and control of costs. If costs are accumulated for a person or by a department or for a machine, such person, department or machine will be treated as a cost center.
In an undertaking, cost centers may be divided into two parts:
(i) Production cost centers
(ii) Service cost centers
A production cost center refers to a cost center which is engaged on regular production i.e., in converting raw materials into finished products. A service cost center is a center which is not engaged on regular production but which assists the production cost centers in carrying on their activities e.g., stores department, personnel department, maintenance department etc.
Cost centers may also be divided into operation cost centers and process cost centers; personal cost centers and impersonal cost centers. Operation cost center refers to a cost center which consists of those machines and/or persons carrying out similar operations while a process cost center is one which consists of a specific process or a continuous sequence of operations.
A personal cost center is a cost center which consists of a person or group of persons e.g., departmental foreman, salesman, supervisor, factory manager etc. An impersonal cost center refers to a cost center which consists of a location or item of equipment or a group of these e.g., machines, departments, vehicles etc.
Factors to Select a Suitable and Effective Cost Center
The selection of a suitable cost center depends on the following factors :
(a) Layout and organization of a factory:
(b) Availability of various cost data and information.
(c) The policy of the management in respect of selection of cost centers.
Classifications of Cost Center
Cost centers can easily be classified under the following three broad heads:
1. Productive, Unproductive and Mixed Cost Centres.
Factories may opt for productive cost center while administrative wing go for unproductive cost center and tool department may have a mixed cost center.
2. Personal and Impersonal Cost Center.
When the plant or a machine is taken as a unit it is the impersonal cost center and when the person or a group of persons are a unit the personal cost center is implied. “Impersonal cost centre consists of a location of item of equipment whereas personal cost center consists of a person or a group of persons,” asserts I.C.M.A., London.
3. Operation and Process Cost Center.
According to I.C.M.A., London the “operation cost center is a center which consists of those machines and/or persons which carry out the same operations,” and “process cost center is a cost center which consists of a continuous sequence of operations.
After costs have been ascertained, accumulated, classified and recorded, these have to be related to a convenient measure of the quantity of the product or service. This measure of the quantity of product or service is known as ‘cost unit‘.
A cost unit is defined as “a unit of quantity of product, service or time (or a combination of these) in relation to which costs may be ascertained or expressed”. In other words, a cost unit is a standard or unit of measurement of the goods manufactured or service rendered. Cost unit may be in terms of number, length, area, weight, volume, time and value.
Characteristics of a Cost Unit
A unit of cost must possess the following characteristics:
- It must be one with which expenditure can be conveniently associated.
- It must be appropriate or natural to business operations and the product.
- It must be certain or definite and not changing from time to time.
- It must be simple to understand and to quote.
- It must have universal acceptability.
Types of Cost Units
Cost units may be divided into two parts:
(a) Simple Unit: It involves the use of a single standard or unit of measurement of the goods manufactured e.g., per piece, per kilogram, per quintal, per tonne, per gallon, per meter etc.
(b) Composite Unit or Complex Unit: It is a combination of two simple units e.g., per passenger-kilometer, per tonne-kilometer, per kilowatt-hour etc.
The terms of measurement used in cost unit are:
Cost unit is always selected very carefully which depends on the nature of business operations. The cost unit of steal is naturally ascertained in terms of per tonne. Cost of carrying a passenger by a transporter shall naturally be ascertained in cost unit of kilometer.
The following are examples in certain cases:
|Brick Industries||Cost Unit per 1000 bricks.|
|Coal Mines||Cost Unit per quintal.|
|Cotton Mills||Cost Unit per meter.|
|Electric Company||Cost Unit per unit.|
|Transport Companies||Cost Unit per kilometre.|
|Steel Companies||Cost Unit per tonne.|
|Water Supply||Cost Unit per 1000 litres|
|Furniture Industries||Cost Unit per number|
|Oil Companies||Cost Unit per litre.|
|Soap Factory||Cost Unit per dozen, per, kilogram or per tablet.|
Difference between Cost Center and Cost Unit:
The main points of difference between cost center and cost unit may be given as follows:
(i) Costs are accumulated by cost centers, whereas these are measured and expressed in terms of cost units.
(ii) Costs centers may be used as basis of classifying costs. But cost units do not serve as basis of classification of costs.
(iii) Different cost centers may be involved in the production of a product, whereas a product will have only one cost unit in which its costs are expressed.
(iv) Formulation of cost centers depends upon the nature and techniques of production processes, size of the organization and the nature of the organizational structure. Determination of cost units depends upon the nature of the final product or final output and the prevailing practices of trade.
(v) Cost centers are created for assisting the management in the functions of budgeting and controlling. But it is not so with cost units.