Fundamentals of Cost Accounting

Cost Centre and Cost Unit

The technique of costing involves two major activities. They are Collection and classification of expenditure according to cost elements and  Allocation and apportionment of the expenditure to the cost centres or cost units or both. To complete the above task a  cost accountant has to ascertain cost by cost centre or cost unit or by both.

Cost Centre and Cost Unit

Cost Centre

The Chartered Institute of Management Accountants, London, defines the cost centre. A cost centre is, “a production or service location, function, activity or item of equipment whose costs will be attributable to cost units”.

A cost centre is the smallest organizational sub-divisional-unit for which we require separate cost collection.

Thus, cost centre refers to one of the convenient units into which the whole factory organization has been appropriately divided for cost allocation purposes.

Each such unit represents a department or a sub-department or item of equipment or, machinery or a person or a group of persons.

For example, although an assembly department will be supervised by one foreman, it may also contain several assembly lines.

Sometimes we treat each assembly line as a separate cost centre with its own assistant foreman. Take another example, in a dry cleaning centre, they perform activities such as collecting, sorting, marketing and washing of clothes, etc.

Thus, we may treat each activity as a separate cost centre and find all costs relating to a particular cost centre separately.

We may classify the Cost centres as under

(i) Productive, Unproductive and Mixed Cost Centres

 Productive cost centres are those cost centre which is actually engaged in making the products. In these cost centre raw materials are handled and converted into saleable products.

In these centres both direct and indirect costs are incurred, machine shops, welding shops, and assembly shops are examples of production cost centres in an engineering factory.

Service or unproductive cost centres do not make the products but are necessary aids to the production centres. Administration, repairs and maintenance, stores and drawing office departments are examples of a service cost centre. Mixed cost centres refer to those which are engaged some on productive and other lines on service works.

(ii) Personal and Impersonal Cost Centre

Personal cost centre a cost centre which consists of a person or a group of persons. An impersonal cost centre is a  cost centre that consists of a department, plant or item of equipment (or group of these).

Learn more about Meaning of Cost, Costing and Cost Accounting here in detail

(iii) Operation and Process Cost Centre

An operation cost centre is a cost centre that consists of those machines and/or persons which carry out the same operation. A process cost centre is a cost centre that consists of a continuous sequence of operations.

Hence, the determination of an appropriate cost centre is very important for ascertainment and control of cost. The manager in charge of a cost centre will be responsible for control of the cost of his cost centre.

Cost Centre

Source: freepik.com

Cost Unit

As per The Chartered Institute of Management Accountants, London, a unit of cost as “a unit of product or service in relation to which we ascertain costs”.

A cost unit is a device for the purpose of breaking up or separating costs into smaller sub-divisions.

Thus, these smaller sub-divisions are attributable to products or services to find out product cost or service cost or cost of time for a particular job etc.

We may easily determine the cost per ton of steel, per tonne-kilometer of a transport service or cost per machine hour.

The forms of measurement used as cost units are normally the units of physical measurements like a number, weight, area, length, value, time etc. A unit should be unambiguous, simple and commonly used.

Solved Illustration for You

What steps will you follow in the determination of cost per unit?

Solution: Following are the steps to determine the cost per unit:

(i) Record all overheads on an estimation basis.

(ii) Classify all recorded overheads as variable, fixed or mixed.

(iii) Charge cost units to direct costs because they are directly attributable to cost units.

(iv) Allocate or apportion all indirect cost to production or services cost centres

(v) Reallocate cost of service cost centers between production cost centres.

(vi) Calculate an estimated budgeted level.

(vii) Determine an overhead absorption (recovery) rate by dividing the total budgeted overheads by the total budgeted activity level.

(viii) Allocate production overheads to production units by applying overhead rate.

(ix) Calculate total costs by adding indirect and direct costs of production.

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