What is a Cost Center?

A cost center is a business unit that is only responsible for the costs that it incurs. The manager of a cost center is not responsible for revenue generation or asset usage. The performance of a cost center is usually evaluated through the comparison of budgeted to actual costs. The costs incurred by a cost center may be aggregated into a cost pool and allocated to other business units, if the cost center performs services for the other business units. Examples of cost centers are the accounting, human resources, IT, maintenance, and research & development departments.

A cost center can be defined at a smaller level than a department. It could involve a particular job position, machine, or assembly line. However, this more detailed view of cost centers requires more detailed information tracking, and so is not commonly used.

The management focus in a cost center is usually on keeping expenditures down to a minimum level, possibly by using outsourcing, automation, or capping pay levels. The main exception is when a cost center indirectly contributes to profitability (such as R&D), in which case a certain minimum expenditure level will be needed to support sales.

Advantages of a Cost Center

Most organizations track a variety of cost centers, because there are multiple advantages to doing so. These advantages are as follows:

Focuses on costs. The use of cost centers places a tight focus on the level of costs being incurred. The manager of a cost center is always able to access reports that compare budgeted to actual costs, making it easier for them to keep costs under tight control.
Improved accountability. Assigning costs to specific departments or teams encourages accountability. Department heads or managers become responsible for staying within budget and optimizing their resource use.
Improves decision-making. Cost centers allow management to identify high-cost areas and evaluate whether they align with strategic objectives. This helps prioritize resources and make data-driven decisions.
Enhances budgeting. Cost centers aid in developing more accurate budgets and forecasts. By understanding the cost patterns within each center, finance teams can project future expenses more reliably.
Easier to optimize costs. The transparency of costs makes it easier for managers to compare the services being provided to the costs being incurred by a cost center. This allows them to adjust service levels to optimize costs.