Functions Of A Cost Center In A Management

2019/02/25

There are various business functions which do not directly add to a company’s revenue but are needed to support the functioning of an organization. Let us consider a case where your organization hires an accountant to maintain your accounts.

This person is not directly involved in sales of your product but without his support, your organization will not be able to generate invoices, record accounting transactions and ensure compliance with various regulatory requirements. Salary of this accountant is a cost to your organization, but benefits here outweigh the costs even when there is no direct contribution of this employee in increasing the revenue.

Consider a pharmaceutical firm engaged in production of medicines. Here research activity takes place on a continuous basis. Till the time an invention or a break through takes place which can help improve revenue, funds allocated to support such research activities will be treated as costs. And hence it can be called as a cost center. It is a necessary business function and even when it adds to the costs of the firm, it cannot be closed.

Responsibility Areas

The responsibility of controlling costs of a particular cost center lies with center heads. A budget is allocated to each cost center and their respective managers need to ensure that all costs incurred in connection with the activities of their department remain within the limits defined. This helps in ensuring transparency and better control over costs. It becomes easier to track as to which department or division is not performing as per the expectations. Cost efficiency can be ascertained with more accuracy and appropriate measures can be taken on time to prevent costs before they get out of control.

Performance Management/Appraisal

Performance of a cost center is measured by comparing standard versus actual. Suppose a department is allocated Rs. 50,000/- per month to meet the expenses associated with its activities. At the end of every month, a performance evaluation can be done to see how allocated money was used. If at the end of the month, costs are found to be more than what was allocated, steps can be taken to identify the reasons for variance. If such a variance occurs on a continuous basis, further steps may be taken to control costs. Department head can be asked to justify the increase in costs. However a cost center manager has no further responsibilities for generating revenue or for any investment decisions.

Problems During Crisis/Recession

Cost centers sometimes become target to negative actions by management. It is a common scenario to layoff employees; reduce salaries and so on in times of recession or during low growth of the company. Take an example of a business process outsourcing unit of an American based technology company, operating in India. Objective of this unit is to handle accounting, finance and payroll function for the parent company. Even when the objective behind opening a BPO in India would have been cost savings, still these support functions would be treated as cost centers. In case of any crisis, resources working within these functions can face problems with respect to their employment, growth or no increments and there can be situations where the center is completely shut down.

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