Cost Centers

Learning Outcomes

  • Identify cost centers

Three corporate buildings and a courtyardA cost center, also known as an expense center, is a responsibility center incurring only expense items and producing no direct revenue from the sale of goods or services. Examples of expense centers are service centers (e.g. the maintenance department or accounting department) or intermediate production facilities that produce parts for assembly into a finished product. Managers of expense centers are held responsible only for specified expense items.

The appropriate goal of an expense center is to minimize expenses in the long run without violating other long-term goals. For instance, a production supervisor might postpone maintenance costs for a short time, but in the long run, total costs might be higher due to more frequent machine breakdowns. Or, a production manager might select lower-cost materials that ultimately hurt sales.

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, the tighter the focus of the cost center, the more information needs to be tracked, so there is a cost-benefit analysis in determining the size of the cost center. For instance, Ford Motor Company may see the paint department overall as a cost center, rather than each step in the paint process as its own cost center.

Common examples of cost centers include the accounting department, human resources department, information technology department, maintenance department, and research and development (R&D). Often, the costs of these departments are allocated to divisions, so the manager may be responsible to many internal customers, even if he or she is ultimately accountable to a single higher-level manager.

The management focus in a cost center is usually on keeping expenditures down to a minimum level, possibly by using outsourcing, automation, or managing wages and salaries. The main exception is when a cost center indirectly contributes to profitability, such as marketing, in which case a certain minimum expenditure level will be needed to support sales. Also, certain cost centers, such as R&D, might be encouraged to spend more freely in order to increase or retain competitiveness and thus increase future revenues.

Here is a brief review of cost centers:

You can view the transcript for “Cost Center” here (opens in new window).

Now, check your understanding of cost centers.

Practice Question