A Cost center is defined as a component in an organization that adds to the cost and indirectly adds to the profit of the organization. Examples include Marketing and Customer Service.
A company can classify business unit as profit center, cost center or an investment center. The simple and straightforward division in an organization can be classified as cost center as cost is easy to measure.
To create a cost center in system, you need to define a cost center hierarchical structure. The structure of a Cost center and its characteristics depend on the accounting objective and on the system, you want to use to maintain accounting.
Following are the key uses to create cost centers and performing cost center accounting in an organization −
Cost center is used to align overhead costs with activities performed in an organization. It is possible to assign different activity type to a cost center.
You perform cost center accounting to manage cost in the organization and to check profitability of each functional area and decision-making data.
You can manage and analyze the overhead cost in an organization and verify if they are incurred in the organization activities.
When you plan costs at cost center, this allows you to check the cost efficiency at the point when costs are incurred in the organization.
You can directly assign the cost-to-cost centers for products, services, and market segments, which are involved in performing these activities.
You have to implement Cost Center Accounting with Financial Accounting, which includes General Ledger (G/L), Accounts Payable (AP) and Account Receivable (AR). To implement Cost Center Accounting with Finance Accounting, you need to create company code, Chart of Accounts COA’s in Financial Accounting.
The key features of Cost Center are −
Actual Cost Accounting − You can transfer actual cost from other components like Material Management MM, Asset Accounting AA, etc. and you can also record other actual cost in the system.
Actual Cost Allocation − There are different methods that you can use to record actual cost. Actual cost can be distinguished as per transaction-based allocation and period based allocation.
Plan cost allocation − You can also plan the actual cost allocations for the cost centers.
Activity Accounting − This is used to calculate the operating cost. For a cost center and activity, output defines the target cost of cost center.
In the following illustration, you can see cost center hierarchy. At the top, you have organization, which is further divided as per the functional areas. Each Functional area is further divided into sub-areas and can be further divided as per the activities performed.