The Concept of Cost Centre Accounting Explained Broken Down

by | 27 Jun 2022 | Accounting

Every business has multiple that control and optimise the business process in various ways and improves profitability. While the ultimate purpose of your business is to analyse the profitability, cost centres can help herein by centralising the function and performance monitoring of different areas/departments/outlets within your organisation.

Cost centres are not just a department. In fact, a department might have multiple cost centres.

Cost centres are solely designed to collect expenses department-wise and report them to the management. They can be either created based on different functions and departments. You can utilise cost centres to enormous potential by integrating them with your accounting software. Wondering what are the different functions of cost centres other than measuring expenses? Let’s look at the major functions and significant benefits of cost centres.

What are cost centres across businesses?

Cost centres are account tracking heads that track different projects/outlets/branches of your company’s business, to monitor each centre’s performance separately, and compare the performance of different centres to find out what is working and what is not.

By understanding how resources are used in the organisation and providing other insights, cost centres will assist your management to make informed decisions about resource allocation.

Despite the fact that cost centres most often contribute indirectly, the value generated by them cannot be overlooked. Negligence or failure in tracking the costs around departments might lead to mismanaged internal operations and slashed revenue.

There are six types of cost centres that might vary depending on the nature of the business.

Personal

This type of cost centre is primarily designed to deal with a person and an individual department.

Impersonal

This type of cost centre deals with different locations, equipment or sometimes both.

Production

These are usually set up at manufacturing units. For example, production centres such as packing centres, machine shops, assembly plants, etc.

Service

Costs related to the provision of services where products are manufactured or processed are accumulated here. The purest example of this is a retail store or an assembly area.

Operation

This cost centre deals with day-to-day operations within an organisation. HR and IT departments are the best examples in this context.

Process

This type of cost centre is relevant when a cost pool deals with a particular process, be it in manufacturing or operations.

Let’s see how cost centres help businesses to track their profitability

The primary goal of setting up a cost centre is to develop an accounting and monitoring process for separate department units in an organisation. To enable this, you will need to put in place Points of Contact, such as project/store/dept./site managers, who will be responsible for monitoring and tracking costs associated with the respective extension of your business, in adherence with your organisation’s budget.

A cost or expense centre can indirectly support a business’s profitability by eliminating flaws in accounting and improving its operational efficiency. Besides this, a cost centre can assist senior management in understanding resource utilisation and wastage within the company. These insights can help them utilise the company’s resources optimally by implementing smarter and more efficient strategies. Additionally, detailed accounting of resources will allow your business to forecast and calculate the budget more accurately.

Here are some ways in which a cost centre can increase the profitability of your company.

Improved monitoring and control

By setting up a cost centre, you can easily monitor and manage expenses. The cost centre ensures all expenses are recorded and available in a centralised location for easy access to CEOs and other responsible people. It helps get a better view of the cost of a particular unit and how resources are being utilised therein.

Better control over accounts: Budget Vs. Actuals

By having all costs accumulated in the cost centre and having a budget per cost, your managers can get a better idea of the unit’s performance by comparing expenditures against actual budgets.

  • A well-maintained cost centre can help your business make informed decisions related to a particular department. It gives better insights into actual budgets and expenses, enabling your managers to cut down additional costs. Identifying loopholes in a process or system becomes a lot easier with cost centres.
  • Cost centres don’t just help your managers but also assist the finance & accounting team in getting insights that further help in streamlining account receivables and payables. Based on the evaluations enabled by cost centre accounting, your account department can estimate and approve budgets and construct more efficient cost centres for departments within your organisation. It is undoubtedly an excellent way to ensure that each department or silo of the business gets the appropriate financial assistance and remains efficient. It also aids in allocating resources smoothly and cost-effectively.
  • When you know how and where your funds are being used, you can easily save costs and invest in upgrading your business with the latest technologies that will enable your workforce to perform even better.

The benefits of having cost centres in your business are manyfold, but do you know what the best way to set it up is?

How to set up a cost centre in your accounting software [in 10 minutes or less]

When you first think about setting up a cost centre, you’ll have to ensure that each cost entry is assigned to a cost type and a cost centre code, which will simplify the tracking and monitoring. This will ensure that every entry appears either in the cost centre or cost object, but not at both places, which will create discrepancies.

So, here’s how you can set up a cost centre for your business.

An expense or cost centre is very similar to account charts in a general ledger. If you handle your business accounting on your own, you can relate to this. Here is how you can set up the chart as per cost type in Excel.

  • Start by structuring the chart of cost types just like you do in income statement accounts in the general ledger chart. Then you can simply copy the general ledger chart of accounts to the chart of cost types. Once you execute this transfer, you can make any necessary changes to it.
  • Then add a column to add a new cost type.

Create new cost centres in the chart on the cost centre page

Excel is an excellent tool for qualitative analysis and allows you to easily set up and maintain cost centres on both the cost centre cards or on the chart of the cost centre page. Here’s how to do this in a few easy steps.

  • Open the chart of cost centre pages in edit mode.
  • In the code column, fill in the cost centre code that you created earlier.
  • In the name column, fill in the cost centre name.
  • Choose the drop-down arrow in the line type to differentiate the purpose of a cost centre.
    • For the total type of cost centre, you need to make an entry in the totalling field.
    • The total end line will be automatically filled due to the intending function.
  • Now fill in the sorting order and also add cost subtypes.
  • Go to the next empty lines and create a new cost centre.
  • Once you are done with choosing all the cost centres, you just need to click on the yes button to get it into action.

There are numerous applications that allow you to track income and expenses obtained in the cost centre of your organisation. Also, you can build different cost categories for simultaneous allocation of cost centres. Using cost centre reporting functionality in the product to monitor all incomes and expenses incurred in a specific cost centre. 

Whatever your accounting needs are, Savage and Palmer can help you with them! We’re a full service accounting firm that can help you put cost centres in place, as well as so much more. Drop us a text on WhatsApp or call us today!

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